Transcript
Speaker: This is HSBC Global Viewpoint, your window into the thinking, trends and issues shaping global banking and markets.
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Speaker: Welcome to our first edition of our Security Services Reg Talks podcast.
Speaker: We will be exploring the latest trends and updates in the regulatory space, shining a critical light on topics and their impact on the security services world.
Speaker: Joining me today are Paul Ellis, Global Head of Product Regulation and Tax, and Paul Babis, Senior Product Manager, Global Middle Office Product at its Security Services, HSBC, and
Speaker: We will discuss the application of the settlement discipline regime of the European Union's Central Securities Depository Regulation, in short, CSDR.
Speaker: I hand over now to Paul Ellis, who will give a quick recap on the scope of CSDR.
Speaker: Paul?
Speaker: Okay, thanks, Gabriella.
Speaker: Yeah, the scope of CSDR is broad, and it generally relates to all securities which settle in a European settlement system.
Speaker: So when we talk about settlement discipline, we really boil that down to three key things.
Speaker: There are measures within the regulation to prevent settlement failures.
Speaker: There are penalties or fines for the late settlement of those securities.
Speaker: And the ultimate sanction
Speaker: could be mandatory buy-ins for failures of those security settlements.
Speaker: First and foremost, I think it's probably an appropriate time to talk about timing because this regulation, the deadline on it, has changed.
Speaker: It was originally due to come into force in terms of settlement discipline rules in September, but some of those timings have changed.
Speaker: And I want to bring...
Speaker: Paul in on this because Paul Baybutt has been very active within the industry and engaging with regulators on timing and all the implications of settlement discipline.
Speaker: So Paul, where do you think we now stand in terms of the latest compliance deadlines advised by regulators, please?
Speaker: Hi Paul, thanks for giving me the opportunity to talk about this interesting subject.
Speaker: Where are we today?
Speaker: Officially had the deadline put back to February 2021.
Speaker: That was approved by European Parliament.
Speaker: But at the same time as that approval was going through, the European Commission requested ESMA to propose a further 12-month delay.
Speaker: And the first delay was down to the readiness of the industry to have the technology in place.
Speaker: This subsequent delay is purely down to the impact of COVID-19 and the fact that COVID-19 has forced firms to reconsider some of their priorities.
Speaker: In response to that, ESMA prepared an RTS, a Regulatory Technical Standard,
Speaker: which is proposed that there is a 12-month delay to February 2022.
Speaker: And I guess there is obviously another kind of key question around scope, because as we know, the UK will leave the European Union on the 1st of January.
Speaker: And they recently indicated that they were not going to proceed with the settlement discipline rules.
Speaker: First of all, is that correct?
Speaker: And if so, why is that, in your view?
Speaker: It is correct.
Speaker: The UK will not apply the EU settlement discipline rules.
Speaker: And strangely, one of my buddies in the industry told me that this would happen about 12 months ago, and we all said he was mad.
Speaker: It turns out that he was spot on.
Speaker: And the reason he was spot on was because the delay that had been proposed, the delay to 2021,
Speaker: has effectively pushed out the ability to the UK to adopt the EU settlement discipline regime.
Speaker: The reason that is that the EU withdrawal act, Brexit withdrawal act, that is going through Parliament, which will transfer European law into UK law, only brings in enacted legislation.
Speaker: And because settlement discipline won't get enacted in 2020,
Speaker: it was always going to be outside the scope of the EU withdrawal act.
Speaker: So the UK was never going to bring in the EU settlement discipline rules while it was being proposed for 2021.
Speaker: That doesn't mean, though, Paul, that it's completely off the table because the UK has left the door open to introduce their own settlement discipline regime and are already in conversation with various industry bodies as to what that settlement discipline
Speaker: regime needs to look like and whether we actually have a significant problem that needs to be addressed, which I think is the first question that they are trying to get answered.
Speaker: Okay, so I guess, yeah, that's sort of how I understood it is that the UK is going to essentially consult with industry, so we shouldn't sort of automatically conclude that settlement discipline won't arrive in the UK because there's still more discussion to be had on that, but the precise form or how it will play out is unclear, I guess, at this point.
Speaker: I get some related question on the UK, right, because sometimes I think, does that sort of remove UK regulated firms from settlement discipline full stop?
Speaker: But if you go back to my point at the start, the scope is actually, the scope is obviously at the security level.
Speaker: So, similarly, any UK manager or indeed any global manager who's investing in securities that are settling on the European settlement system is impacted, regardless of where they are in the world.
Speaker: Is that right?
Speaker: That is right.
Speaker: And this announcement has removed UK securities from a settlement discipline, but it hasn't removed UK firms.
Speaker: And strangely, it hasn't also removed the UK CSD.
Speaker: Now, addressing the firms first, if the firm is trading in EU equity or any security that is settling in a EU CSD, it is in scope.
Speaker: And therefore, all the parties in the settlement chain are pulled into scope.
Speaker: That's the scope for penalties, that's the scope for buy-ins, that's the scope for measures to address settlement failure.
Speaker: But also the UK CSD Crest is pulled into scope where they are operating an investor CSD model with the underlying security ultimately hold in an EU CSD.
Speaker: And they will need to replicate the penalty framework in Crest.
Speaker: So although the decision has been made to take the UK equities and UK settled securities that are settled interest out of scope, ultimately we're all as much involved as we were prior to the announcement.
Speaker: I think that's fair in terms of certainly what some of the industry are saying is that I guess some of the settlement discipline provisions solve one problem but actually create others arguably of equal significance.
Speaker: So
Speaker: You know, you've been tracking that obviously a lot within the industry and the forums you engage with.
Speaker: I mean, what would you summarize as the key concerns that, if you like, whether I call them unintended, but the sort of consequential concerns that some participants are focusing in on?
Speaker: I think the key concerns, the biggest concern that a large portion of the industry has is the impact on liquidity of the buying regime and possibly also the impact of liquidity of a penalty mechanism.
Speaker: The buying regime will force parties to ensure that they have even got the security or they factor in the cost of that, not having security into their spreads, into how they price transactions.
Speaker: And that can have a negative effect and a negative impact on the overall industry.
Speaker: Likewise, making a buy in itself is going to cause some significant operational impacts
Speaker: on the industry where they're not used to it.
Speaker: But Paul, I think the key thing is the industry is split.
Speaker: You know, because while some people are in favor of overhauling settlement discipline completely and changing what is required for buy-ins, others are in favor of it and believe that it's necessary to ensure that the overall objective of improving settlement in the EU is met.
Speaker: You know, somebody remarked to me the other day that markets like China and Hong Kong already have their own settlement discipline measures, already have
Speaker: buy-ins or transactions are not allowed to fail.
Speaker: And as such, they have much higher settlement rates and are far more efficient.
Speaker: And their argument is, why can't we have the same in Europe?
Speaker: But the flip side is this liquidity impact.
Speaker: And I think the industry has got to a position now whereby it needs to take time to explain to the European Commission really what the impacts on liquidity will be by that buy-in regime.
Speaker: Also by the fact that there is a lack of buying agents which are required to administer the buying regime and consequently have that debate with the Commission as to whether these are the right measures.
Speaker: Do you think there is a sort of a middle ground there?
Speaker: Because I have heard some folks saying, well, look, the buy-ins for all those reasons you've described, liquidity, spreads, etc.,
Speaker: Maybe another option is what about just focusing more on the penalties and the fines and making it, if that was sort of the key stick to drive better settlement discipline, maybe make the fines regime more onerous.
Speaker: particularly for, if you like, what I call them, repeat offenders, for those who have a track record of failing trades.
Speaker: I mean, is it possible to contemplate, if you like, a fines-only system without buy-ins?
Speaker: Do you think that's a possibility?
Speaker: Is it a possibility to consider that, Paul, there's firms out there arguing at the moment that the fines are potentially more damaging than the buy-ins.
Speaker: Well, I have yet to debate this in detail with those organizations, but
Speaker: One of the biggest concerns is that the main liquidity issue around the buy-ins is in the fixed income markets, particularly in the illiquid fixed income markets, where the brokers will have to factor in the likelihood of the buy-in into the spread.
Speaker: Penalties, however, will be across the entire market, and if the value of the penalty was to be increased,
Speaker: Even one day's failed trade will result in potentially the spreads being widened to address those short periods of settlement that up to now have been accepted as okay.
Speaker: So the impact of shifting the onus onto penalties could actually make the problem wider for all of the industry, as opposed to the buying process, which is potentially limited to the fixed income markets.
Speaker: That's not to say, Paul, that the...
Speaker: Equity markets will not also be impacted by buy-ins, but the main issue and the main impact is in that liquid fixed income space.
Speaker: Yeah, but I guess one way or another, if you're going to have a sort of a sanctions regime for failing trades, there's going to be a greater risk.
Speaker: So I guess the spreads argument was probably something always considered by regulators anyway.
Speaker: But maybe let's switch on to then...
Speaker: the mandatory nature of the buy-in, or to put it another way, what about giving the receiving party the option to seek a buy-in rather than making it mandatory in all circumstances?
Speaker: I think, you know, some participants are suggesting that might be a more pragmatic way to deal with some of the issues you highlighted.
Speaker: Any views on that?
Speaker: Well, I think, Paul, you know, if you were given the option of doing something that you don't do now and, you know,
Speaker: You could potentially do it in the future.
Speaker: Are you likely to do it?
Speaker: I personally think that there is less likelihood of a voluntary buying process being operated because firms will be pushed to make that decision to do so or will be challenged to make that decision.
Speaker: You know, some firms will decide not to do it because there's too much effort involved in doing it.
Speaker: And others will fear to do it for all, you know, because they don't want to upset their counterparty.
Speaker: So making it voluntary doesn't, in my mind, improve that settlement efficiency.
Speaker: Whether the existing framework, though, has the right periods for when a buy-in has to be implemented, I think is something that is possibly worth giving some consideration to.
Speaker: Because ultimately, what we are discussing here and discussing
Speaker: what we are debating is a trade-off between guaranteed delivery and price.
Speaker: And if that guaranteed delivery is over a wider period, then potentially there is flexibility in that to have the widening of spreads to be maybe narrowed a bit.
Speaker: maybe different considerations and different approaches to whether that buying is likely to happen, which would actually improve the liquidity issues that are being cited as a problem.
Speaker: But do you think there's, is there a, maybe a sort of third and final sort of headline option, which is to, to that point, to differentiate between liquid assets and less liquid assets, right?
Speaker: I mean, I guess that's,
Speaker: That's difficult, right, because an asset that's liquid today may not be liquid tomorrow, right?
Speaker: So I'm not sure how you make a rules-based set of arrangement around that, but in principle, the liquid assets would seem more compatible with sort of the full settlement discipline regime than less liquid based on what you sort of talked about.
Speaker: Yeah, and...
Speaker: And, Paul, that's really what the regulator has done so far.
Speaker: When you consider that an equity transaction would be bought in after four days, a fixed income transaction after seven days, and an SME growth market up to 15 days,
Speaker: That decision to split it by assets is already there.
Speaker: But I think the question is, are those dates realistic?
Speaker: Does the market agree that the dates are realistic?
Speaker: And again, it comes back to that point I made to your last question.
Speaker: It's a trade-off.
Speaker: It's a trade-off between settlement and price.
Speaker: And how much should an investor pay for guaranteed delivery?
Speaker: I think the issue at the moment is that the regulator obviously would consider four days clearly sufficient, but does the market agree with that?
Speaker: Paul, you mentioned that so far there's only one buy-in agent.
Speaker: It sort of leads to the obvious question.
Speaker: If in 12 months from now there's still only one buy-in agent in the market,
Speaker: How could the secure settlement discipline regime go live in practice?
Speaker: I think that's the main question, Paul, or one of the main questions.
Speaker: The way the text is written at the moment is you have to appoint a buying agent to affect the buying.
Speaker: The buying agent has to have no conflict of interest with you, and the buying agent is completely independent.
Speaker: And I think that's one of the reasons why that the industry is struggling to find organizations that want to be buy-in agents.
Speaker: I think the uncertainty around where the regulation is going to fall and this review presenting that uncertainty is who's going to develop a buy-in operating model while there is a possibility that mandatory buy-ins may not take place.
Speaker: So we need that review.
Speaker: We need the decision around whether buy-ins will be mandatory or not.
Speaker: And hopefully that once that's been made clear, then there can be progression towards other firms becoming, you know, buying agents.
Speaker: But I cannot see how the regulation could go live with just one firm offering the service.
Speaker: I think they will struggle, you know, in the timeframe as it stands at the moment to onboard
Speaker: everybody onto that surface should be the only provider of it, which effectively makes the whole mandatory buy-in regime obsolete.
Speaker: Okay.
Speaker: Well, I guess there's clearly an awful lot to think about here, and equally unconscious, we're sort of talking about sort of real-world, day-to-day settlement.
Speaker: So the industry's going to need certainty and plenty of lead time to put in place the final rules.
Speaker: So
Speaker: Maybe my last sort of question is, how do you think as an industry we're going to arrive at that certainty?
Speaker: It certainly seems that it's likely that the pandemic will be with us for a considerable period of time yet.
Speaker: So I assume at some stage that the settlement discipline in whatever form will go live.
Speaker: So what do you think the industry should do to bring that clarity, if you like, to the surface?
Speaker: We're certainly living in times of uncertainty.
Speaker: Should the outcome of the review that we talked about earlier prompt changes to the regulation, that's likely to require the level one to be rewritten, CSDR itself to be rewritten.
Speaker: And if CSDR gets rewritten, then there is a good chance that the RTS will need to be rewritten and then we'll go through the process of getting that all approved again.
Speaker: So I think that we will...
Speaker: live in a world of uncertainty until suddenly the outcome of the review is concluded.
Speaker: I think the review also involves a public consultation.
Speaker: And once that review has been concluded, we will at least have certainty about a pathway to when CSDR begins.
Speaker: or settlement discipline will go live.
Speaker: What I do know is whatever the outcome, we've been great so far at HSBC in bringing the news to our clients and I'm sure we will continue to do so.
Speaker: Indeed, I think you said that perfectly in terms of as a sort of a closing remark, I think there's clearly going to be more development on CSDR and we will certainly aim to continue to appraise our clients of the latest updates on developments for this kind of
Speaker: this key issue in future podcasts.
Speaker: But I think that probably closes nicely.
Speaker: Thanks, Paul, for sharing your views and insights.
Speaker: As I said, we will come back to this, but Gabrielle, maybe back to you, please, to sort of close out the podcast, please.
Speaker: So thank you, Paul.
Speaker: And again, for myself as well, it's been quite interesting hearing some divergent views on CSDR and what the future holds.
Speaker: I think in this particular atmosphere, there's a lot of things that can change and can change for the future.
Speaker: So again, thank you both of you.
Speaker: And I'd like all of the audience to join us for our next Reg Talks, where we will be focusing on ESMA's recent AIF&D letter.
Speaker: So feel free to join us for the next time.
Speaker: And thank you to all.
Speaker: Thank you for listening today.
Speaker: This has been HSBC Global Viewpoint Banking and Markets.
Speaker: For more information about anything you heard in this podcast or to learn about HSBC's global services and offerings, please visit gbm.hsbc.com.
