Jacqueline Powell: In 2014, the European Commission began a journey to overcome some of the biggest bugbears for security market participants. They embarked on an action plan for developing and tightening the capital markets union. So what does this actually mean?
Well, in short, it means that the European Commission is looking to apply new directives and regulations in order to fully automate and harmonise how the trading of shares moves through all involved parties with each party taking full responsibility of their part in the transaction until the point at which the trade is settled.
Broadly speaking, this objective is good and it's widely supported. By implementing a regulated securities framework, it will achieve more control and better visibility. It will also reduce risk and protect customers, but with that comes significant challenges for all parties in the process, as they scramble to figure out how best to adhere to the new regulations and directives set out by the European Commission, how to implement the technology to support such and, of course, how to do so within the timelines provided.
Hello, I'm Jacqueline Powell, Head of Communications at Bottomline and your host of today's Payments Podcast. Today, I'm joined by Fred Viard from our Swiss office. Fred is responsible for market development at Bottomline, helping organisations connect to various financial ecosystems and networks, globally.
I've asked Fred to help us unpack some of the challenges that securities participants face and give us some insight into how they can overcome them.
Hi, Fred, thanks for joining us today.
Fred Viard: Hi Jacqui, and good morning. Good afternoon to everybody listening to this podcast.
So, prior to joining the security space, let's take a step back and consider the European marketplace, in general. This is a single currency area, but it has multiple jurisdictions. Each of them has its own specifics. It was, and it will be, a big challenge to harmonise such a big and fragmented financial place.
It started with the payments landscape with, for example, SEPA several years ago. We have now PSD2, the Payment Services Directive, number two. We also have the entire domestic evolution of the RTGS and ACH. Along with that, we have the same type of harmonisation that occurs in the security space. So, this is really a wish from the European Union: to harmonise the marketplace, in payments and in securities.
Broadly speaking, the securities framework, in general, has been subject to several regulations in the past few years, always in order to harmonise the European landscape across the various countries and the various jurisdictions. The next in line is the CSDR, the Central Securities Depositories Regulation, and one big part of it, which will come live in February, 2022, is the Settlement Discipline Regime, SDR.
All these parts of CSDR, including SDR, which goes along with other regulations such as ME on MiFID, are in order to provide a common framework, a common and harmonised area across the union in order to have an organised landscape for trading around the Central Securities Depositories, and to have a common set of rules across the European level.
So CSDR is part of this journey and it started in 2017 with some requirements, focused on the Central Securities Depositories, and consequently impacting only these players. It was followed by internalised settlement reporting in 2019. And now this is the Settlement Discipline Regime, the SDR, which is becoming live in February ‘22.
This last part is really the focus on the marketplace today, as it has a deep impact on the full marketplace because it introduces penalties on automated buying if you are not complying with the rules. It is really a pressure on the marketplace to harmonise the landscape in the settlement space of securities.
So, the banking and financial industry is, today, in front of a lot of regulation. They have just completed the Shareholders Rights Directive Two (SRDII) which had raised the rights of the shareholders in September 2020, and now they have to implement another regulation, which is this last part of CSDR, the Settlement Discipline Regime (SDR).
Jacqueline Powell: Thanks for that outline, Fred. You say that CSDR which aims to make the settlements of shares more efficient is that next deadline to be met and it's coming up quite rapidly. But before we dive into some of the challenges that the chain will face, can you explain to me exactly what is expected of them?
Fred Viard: Yeah, sure. So first we have to understand that this is a European regulation, but it applies to anyone who is involved in a trade which is settled in Europe. So wherever you are located, whatever the type of shares you are trading, as soon as the trade is settled in Europe, then you have to comply with the regulation.
In essence, the requirements around CSDR in general are around a shorter settlement period. So, it is set up at maximum T+2 (trade date plus two days). This is the common ground, everyone has to settle in T+2. It also implements new measures in terms of settlement. It asks for more dematerialisation of shares, so the digitisation of all these processes.
It establishes some strict rules on access rights towards the Central Depositories. And it's also about governance with increased potential and supervisory requirement. But if we look more closely at the SDR requirements in itself, the ones that will enter in 2022, we can highlight the following:
· It is about trade on allocation, confirmation, same day. As soon as you start initiating a trade, you have to ensure that it will be settled properly. So, you have to confirm allocation and confirmation within the same day.
· It is about preventing, or trying to prevent, as much as we can, the failure of settlement. This is the ultimate goal. So, the goal of this Settlement Discipline Regime is really about trying to have a European marketplace with no failed trade.
· It also calls for monitoring on reporting on fails, and then as mentioned, it will introduce cash penalties and buying regime. So, ‘buying regime’, meaning that if you cannot deliver the share, you will have to find a way to deliver the shares anyway. Penalties and automated buying, is creating a risk, an additional risk on top of the banks in this space. So, this is something that will have the focus of banks in the coming weeks and months, because there is some risk behind that.
Jacqueline Powell: For sure. So it sounds like there's quite a bit to be done and in a fairly short space of time. One thing that springs to mind is that many of these parties still have loads of legacy technology in place.
Tell me, Fred, aside from implementing the new rules laid out in the framework, are all the players in the chain actually already? Have they adopted this relatively new messaging platform? And do you think that they have the capability and the capacity to support the change in order to deliver on the requirements of CSDR?
Fred Viard: You are right. Many banks have a lot of legacy systems they have implemented through the years that they work with in this business, but I would say it's important to consider as well that CSDR is a regulation, so it's not a directive. So regulation has to be implemented, one fit for all, across the union, compared to a directive that can have its own flavour, per country.
So it is something which is quite strict in terms of how to implement the requirements. The focus of these requirements are really around the elapsed time that you need which is available, I would say, to settle the trade. So really the focus will be how fast you can settle the trades and how fast you can react to a possible failure.
The focus is really around changing from settlement monitoring, which is on a daily basis, or even sometimes on a weekly basis, to something which is really real-time. So we were used monitoring the holding / the positions of the shares. Now it will be around controlling the transactions end-to-end to be sure that you will identify a possible risk and that could drive to failure and then to penalties.
The first step of the exercise of CSDR, will be to test the new communication messages because the messages used most of the time are via SWIFT, and they will contain new fields such as a penalty field that will have to be managed by the bank.
In order to start being compliant with this Settlement Discipline Regime, it will be around being able to communicate and use the various messages to understand what is being requested from your counterpart. So there is a messaging part that has to be addressed in order to comply with the rules.
Then, it will be around trying to avoid these kinds of situations.
· So, the first step is really to understand the communication, to be able to interpret, read and use the messages that will be exchanged in the context of the SDR.
· The second step is to set up the functionalities in the back-office in order to monitor and control the situation of the trades in real time, in order to avoid a situation where you will be late, or you are not able to deliver the trade and then you can be subject to penalties or to automated buying.
So, two steps for me; one is really to establish the communication, understand the messaging, control the plausibility of a possible penalty. And then the second step is really to anticipate that, and to forecast what could happen, in order to avoid being in this situation.
What we've seen in the market is that most of the big CSDs in Europe are starting some test phases this autumn, by sending the messages with this new field around penalties to help the community to use these messages and to integrate these messages in their workflows. So it's really about, first, testing what it means when you will receive new messages containing penalties, how to address them, how to handle them and the second step is really about how to set up the functionalities to have a control in real-time, to monitor on the settlement more closely, to avoid being in a situation where you can be under penalties on buying.
Jacqueline Powell: Given the first and second stages that you've just mentioned, it sounds like there's a lot to do, but it also sounds like there'll be winners and losers based on who can settle most efficiently. In order to be a winner though, and given some of the challenges you've mentioned, what can the various financial institutions do to overcome these challenges?
Fred Viard: You are right. I think there will be no winners or losers, but I think there will be institutions more prepared to meet the requirements in terms of elapsed time for settling a trade and to be sure that they will not drive to a failed trade. But what will happen is that if you are a bad guy in the chain [ie a late or failed trader], then you could be avoided by the marketplace because you are not a safe player.
So I think it's really about showing a good face and being able to execute and settle the trade in an appropriate way. It will be around being able to control: to understand the communication and to control the settlement in real-time by using, most probably, a reconciliation tool, a matching and exception management tool to focus on the real-time management of all these settlements.
So we are moving from something which was a bit ‘end of day’ to something which is much more real-time around the reconciliation of transactions. Being informed by the advice that you will receive via several messages that you will receive. It's all about being able to consume this information, consume these messages and to highlight risky trade and risky transactions in order to react quickly.
There will be a real move from something which is end of day to something which is much more real-time, and it will be, most of the time, about looking and focusing on the reconciliation and matching of the various settlement with the capability to understand the information which is exchanged with the different players.
The CSDR, with these penalties and buying, will also introduce new challenges in some other regions, for instance, in Asia. Most of the time, the ‘buying’ means the possibility for a third party to automatically buy shares on behalf of the buyer in order to make the trading settle properly. This is something which is managed by the trading venue or the depository.
But the banks are not used to initiating the buying, usually, in Asia. It would be new for them because the documentation- directive asks for this automated buying. So this is something that will be new in some marketplaces, where this type of automated buying is performed by different players.
Jacqueline Powell: Thank you, Fred. That's very insightful. Before we close off, are there any examples where your team has already done this for customers or are you busy working this through at the moment?
Fred Viard: Yes. Sure. The banks have many regulations to implement, and they are also challenged by the newcomers.
So neo banks and these types of players: The banking space is really under pressure on that challenge. They are trying to catch up with the amount of things that they have to do with new regulations arriving overnight. So, they have considered the Settlement Discipline Regime some time ago and are really now at the level where they are implementing the requirements around the Settlement Discipline Regime.
It's something which is in scope, under deployment. So we don't have real, I would say, experience in that because it has not started yet. We will have the first feedback when this CSD will start to send test messages with penalties and then, the banking side will have to react to that, to control the plausibility of these penalties to highlight, to have a better view on their short position.
They will start to really focus on the requirements because they will begin receiving some test messages and will start to be part of the bigger game around this Settlement Discipline Regime.
So we know that we'll have to help our customers, mainly in the area of the reconciliation and real-time reconciliation, but also with the possibility to interpret and collect this new information, such as the penalties, and highlight the short positions, to monitor all these aspects, and to manage the workflow around the buying.
The buying principle is not 100% clear in the marketplace. But the penalties are well-defined. Although buying is a bit less blurry for some of the players, we'll need some time for adaptation around this buying because it might drive to quite complex workflow, depending if you use a central counterpart, a CCP, who will act on your behalf which might be quite simple, but on the other hand, if it's a bilateral agreement or discussion around the buy-in, it might be based on quite complex workflows.
All of this will come into force in February. We'll start with some tests to establish the communication in September, and then it will start real life. And then I expect to have some, I would say, ‘ins and outs’ regarding the buying, because it's not such an easy process depending on where you are located in the chain.
Jacqueline Powell: That's helpful for our listeners to know. Thank you, Fred. Given all this new regulation, it's good to hear how those in the settlement chain can take advantage of the knowledge and skills that external parties can provide.
I'd like to think that all parties will do whatever they can to create a far more interoperable, compliant, and secure process for the settlements of trades.
It's been great chatting to you and thank you for your time today, Fred.
Fred Viard: Thank you, Jacqui. And thank you everybody. I’m more than happy to take any questions from the market. Thank you.
Jacqueline Powell: For any listeners wanting to know more about payments and securities, please visit our website or get in touch with our financial messaging teams based in Switzerland, Germany, or London, who'll be happy to answer any questions you might have.
Unfortunately, that's all we have time for today, but in the meantime, you can listen to more episodes on our podcast channel, and if inclined, feel free to rate the episodes. See you next time.
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