What is CSDR, and how are you affected?

The Central Securities Depository Regulation, or CSDR, is now live as of February 1, 2022. Learn how the new rules function in practice so you can work to avoid financial penalties.

The settlement discipline regime (SDR) is now in force, which introduced cash penalties for late matching and settlement fails for trades that settle at a European central securities depository (CSD) or international central securities depository (ICSD, e.g., Euroclear, Clearstream). The mandatory buy-in provisions, which were originally planned for a February 1, 2022 live date, are postponed for the time. A revised effective date has not yet been announced. U.S. Bank continues to monitor the buy-in portion of the regulation closely.

CSDR was designed to achieve higher rates of efficiency and liquidity in the European securities markets. With nearly six months of the SDR regulation now in force, ensure you are up to date on how current and future rules will impact you and your teams.

CSDR: Harmonising the cycle

The goal of CSDR is to harmonise certain aspects of the settlement cycle while providing a set of common requirements for any central securities depository (or CSD) that operates securities settlement systems across the European Union. It requires all parties in the chain, including investment firms, to have measures in place that mitigate fails.

In Europe, financial penalties have now been imposed for late matching and failing transactions. The goal in introducing these penalties is to change the mindset and client behavior when it comes to settlements in the industry and, in turn, increase efficiency.

CSDs pass on financial penalties to their participants (e.g., custodians), who pass them on to their clients.

According to Sean Boyle, head of global custody operations at U.S. Bank, CSDR plays a pivotal role in the post-trade harmonisation efforts in Europe. “It enhances the legal and operational conditions for cross-border settlement while increasing the safety and efficiency of securities and CSDs in the EU,” he says.

This is accomplished by the following:

• Shorter cycle periods
• Discipline measures, such as mandatory cash penalties
• An obligation regarding dematerialisation for most securities
• Strict prudential and conduct of business rules for CSDs
• Buy-ins (delayed) 

Following the same rules

Boyle explains that all EU countries have had different standards in the past and followed their own practices for settling securities transactions, which has made executing cross-border transactions more difficult. “This is why the harmonising aspect of CSDR is so important,” he says. “With everyone following the same rules and practices, the process will be faster and more efficient.

“We’ve all done things differently in the past,” he adds, “and now we’re going to try to do them the same way.”

A common misconception about CSDR is that it applies only to companies in the EU, notes Breda Sullivan, head of Depositary Services – Europe for U.S. Bank. “The regulation ultimately impacts any securities settlement within an EU or international CSD, so geography does not apply,” she says.

This means CSDR affects all financial firms that trade in EU-issued securities, regardless of where they’re located. These include banks and broker-dealers, hedge funds, investment and asset managers, custodians, agents and CSDs. “The regulation truly has a global reach,” says Sullivan.

Boyle stresses that even though the regulation is directed at CSDs, every party in the chain will be affected by CSDR. “Everyone needs to know what their responsibilities are within the chain,” he says.

Manage your fails exposure

Boyle says that operational control and efficiency are paramount to avoid failing transactions and financial penalties associated with CSDR. “If you don’t manage your fails exposure in a timely manner, it’s going to cost you from this point forward,” he says. “So, you should make sure you’ve got strong visibility reporting and you’re partnering with custodians and brokers that can handle fails report on buy-ins and penalty risk at any given time.”

Boyle says that operational control and efficiency are paramount to avoid failing transactions and financial penalties associated with CSDR. “If you don’t manage your fails exposure in a timely manner, it’s going to cost you from this point forward,” he says. “So, you should make sure you’ve got strong visibility reporting and you’re partnering with custodians and brokers that can handle fails report on buy-ins and penalty risk at any given time.”

Boyle continues: “All parties in the chain must evaluate their current fails management processes to ensure they’re fit for the new environment by analysing behaviors, patterns and root causes,” he says.

“Check in with your custodian about their approach to CSDR,” adds Sullivan. “You need good visibility into and timely updates on the status of your trades, such as through an online portal. Is your custodian providing it? This is where they should bring added value in this changing environment. In addition, custody or depositary contracts may require updating to capture the new requirements.”

Who’s responsible for what?

Clients are responsible for the following with respect to penalties, charges and the appeals process under CSDR:

• Reviewing all charges both internally and with any subsequent underlying clients
• Ensuring an appeals process is in place and appeals are requested in line with the ECSDA rules
• Ensuring funding is in place to pay charges on a monthly basis
• Creating a partial settlement process in line with your custodian’s requirements
   

While there is a known delay in terms of the buy-in regime, a mandatory buy-in process could come into force in the near future. In this scenario, clients would be responsible for the following:

• Placing or requesting the transaction “on hold”
• Cancelling the original failing transaction once the buy-in is completed
• Appointing a buy-in agent to source shares for the buy-in
• Making payments as required to the receiving party to cover the costs of the buy-in

What impact does CSDR have on clients?

Clients may need to make changes before and after the introduction of CSDR provisions, including:

• Repapering contracts to include provisions for buy-in responsibilities
• Increasing headcount to manage financial exposure risks to fails management
• Increasing partial settlements
• Requiring improved visibility of fails and reporting
• Increasing securities lending activities to cover failing obligations
• Ensuring you understand your custodian’s billing process for collecting CSDR penalties

At U.S. Bank, we employ a partial trade settlement functionality to reduce fails exposure. We support daily processes to review and transmit charges to the responsible party and create a monthly process for payment of penalties to the CSD or sub-custodian. Our in-house trade services group’s fails/pending transaction process will aid clients and reduce the number of failing transactions, thus reducing the cost of penalties to clients.

As more CSDR provisions are implemented, be sure to ask your custodian about how they’re preparing and how they will work with you to ensure you remain compliant. Major regulatory changes like this one demand a true partnership.

At U.S. Bank, our experts serve as trusted partners to keep you updated on regulatory changes so you can focus on reaching your business goals. To learn more about our comprehensive investment services, visit usbank.com/investmentservices.