What price is worth paying to reduce failed trades? According to the European Union’s central securities depositories regulation (CSDR), quite a big one.
The regulation is scheduled to implement a new mandatory buy-in regime in September 2020, and although market participants expect this to be delayed, it is unlikely to be by more than a few months.
It matters because the proposed framework is set to hurt market-making willingness and therefore liquidity, particularly in sectors that are already less liquid.
Cleared markets tend to have their own rules around buy-ins, but for non-cleared markets, instead of the current regime of voluntary, contractual buy-ins, the regulation will impose a legal duty to issue a buy-in against the failing counterparty where a trade has failed to settle within seven days.
Market participants who have not yet taken steps to address this had better get a move on
Crucially, the new rules will create asymmetric treatment of parties. Rather than a buy-in resulting in the original counterparties being restored to the economic position they would have been in had the trade succeeded, buy-ins under CSDR only allow payments to be made from a seller to a buyer, meaning that a seller is penalized when a buyer is able to source a security cheaper through a buy-in.
This asymmetry also makes it impossible to implement a pass-on mechanism to allow a chain of failed trades to be resolved smoothly.
The International Capital Market Association (ICMA), which has its own guidelines for participants when it comes to dealing with failing or failed trades, has been leading the charge to alert the market of the impact of CSDR.
Its latest study found that 84% of respondents were expecting the new regime to worsen or significantly worsen market efficiency and liquidity, but only 10% of respondents thought there was broad market awareness of the move across the buy side and sell side. You have been warned.
Opportunities
As always, there are opportunities in the gloom. Demand for accurate and detailed monitoring of the life cycle of a trade is rocketing. The buzzwords are “trade exceptions” – those errors that pop up in many trades to prevent them from settling smoothly.
Monitoring, resolving and ultimately preventing recurrence of trade exceptions has for many years been a farcically inefficient task, involving thousands upon thousands of emails. Different parties within the process might be searching for the same information. One party might have the information required to hand but be unaware that it is needed.
Trade exceptions could be set to be big business. Trading infrastructure companies like MarketAxess and the Depository Trust & Clearing Corporation (DTCC) have established their own trade-exception management platforms for clients.
Looking to sit on top of everything is Access Fintech, a bank-backed youngish start-up that has developed a network that firms can plug into to help make the process of resolving trade exceptions more efficient.
Such offerings will become more important with the advent of CSDR, the scope of which is often not properly understood. While the regulation sits within the EU, participants far beyond the region will be affected, since it applies to all securities that settle within EU-based central securities depositories, even if the parties to the trade are based elsewhere.
Market participants who have not yet taken steps to address this had better get a move on.
You may already have worthy and exciting New Year’s resolutions for 2020, but another should involve thinking hard about trade exceptions.
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