SDR Regulation – Settlement Discipline in the EU


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In our white paper last year, we explained the history of custodian banks, the differences between the Custody and Global Securities Services businesses, the evolution of securities markets, how they have been shaped by client requirements, local market and then international and EU regulations, and how IT and Fintech firms fit into this bloodstream.
We are currently on the threshold of such new regulation, which is in reality a set of directives and regulations that have been postponed several times and will not enter into force until 1 February 2022, due to the pandemic and market lobbies.
This regulation is the SDR, the Settlement Discipline Regime, which seeks to improve settlement discipline through the use of sanctions.

Basically, we consider three pieces of legislation as SDRs:

I. Regulation (EU) No 909/2014 of the European Parliament and of the Council on improving securities settlement in the European Union and on central securities depositories and amending Directives 98/26/EC and 2014/65/EU and Regulation (EU) No 236/2012.

II. Commission Delegated Regulation (EU) 2018/1229 of 25 May 2018 supplementing Regulation (EU) No 909/2014 of the European Parliament and of the Council with regard to regulatory technical standards on settlement discipline.

III. The detailed rules for the Central Securities Depositories Regulation (CSDR) in relation to fines are laid down in Regulation 2017/389/EU.


One of the objectives of the CSDR is to improve the safety and efficiency of securities settlement, in particular for cross-border transactions, by ensuring that buyers and sellers receive their securities and money in a real-time and risk-free manner. In order to achieve this objective, the SDR provides for a set of measures to prevent and manage “defaults” in the settlement of securities transactions. This package includes fines, mandatory buy ins, and in this context, imposes obligations on clearing houses to monitor the processes, take measures and fulfil their reporting obligations.

According to the CSDR and ESMA’s final regulatory technical standard, the following principles should be applied by all EU CSDs:

1. CSDs should impose a fines procedure on market participants who have caused settlement failures. Fines must be calculated on a daily basis for each business day on which an agreed instruction fails to settle on or after the Intended Settlement Date (ISD),
including those instructions that are in a so-called “on hold” state, e.g. due to lack of funds. These instructions may be free of payment, with payment, or against payment. Fines also apply to instructions that are “late instructions” which matched in the securities settlement system after the original settlement date (as recorded in the transaction).

2. Clearing houses are responsible for calculating the fines. The fines are calculated from the intended settlement date (ISD) specified in the instruction until the actual settlement or bilateral cancellation of the instruction, taking into account the reason for the failure. The Settlement Fail Penalty (SEFP) shall be imposed after the pairing of the instruction. The penalties must be applied from the ISD or the appropriate date – when the pairing occurred after the original settlement date and settlement did not occur on the pairing date – to the date of actual settlement or cancellation of the instruction at the earliest. The Late Matching Fail Penalty (LMFP) is applied retroactively from the ISD to the actual matching date.

3. In the case of so-called settlement error (inter-CSD settlements) involving multiple CSDs, SDR penalties are calculated by only one CSD, where applicable. The ‘calculating CSD’ is the Clearing House where the settlement actually takes place i.e., which is the actual place of settlement.
This also means that an investor CSD that is a client of another CSD is obliged to comply with the terms of the latter CSD. Daily reports must be sent to the CSD’s client (market participant) in order to allow them to reconcile and calculate the penalty for their clients, if applicable.
The total amount of the penalty collected shall be recalculated and distributed at least monthly to the customers (account holders) who have failed.

4. The CSD should: calculate and report penalties for counterparties that are Central Counterparties (CCPs) but do not actually collect/ and apply penalties. In addition, clearing houses must ensure that CCPs collect and redistribute failed penalty items from the clearing members concerned and must also submit a monthly report to the clearing house.
In this very complex process of pairing and settlement, the clearing houses have a huge role to play and the monitoring of defaults imposes a huge role on all market participants. You would think it is a simple process, but without adequate automation, tracking defaulted transactions, recalculating the associated penalties, informing customers, paying penalties, daily and monthly reporting is not a simple task even with the right IT background.

Not only the pandemic, but the complexity of the settlement process (and the subsequent penalty process) has given market participants, investment service providers, custodian banks and clearing houses a breathing space to rethink and improve their existing processes.

Be sure to check back for the next instalment where we will show how market players can deal with the burdens of the regulation.

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