European regulators have ended a year of speculation around whether penalties for settlement fails would increase substantially or their calculation be altered by maintaining the current system and only recommending a moderate increase of the rates.
Both the idea of an increase in the penalty rates and a change in design of the mechanism were in play – with the latter potentially including progressive rates – under changes to the Central Securities Depositories Regulation (CSDR).
However, the European Securities and Markets Authority (ESMA) said this week that in light of market feedback it would not recommend fundamental changes to the methods for calculating penalties, in its final report on the Technical Advice for the European Commission.
ESMA said it recognised that a significant increase of penalty rates may divert resources from expected investments and costs for the industry in the context of the move to T+1.
Instead, a moderate increase has been recommended, which ESMA said was “in full alignment with the current types of settlement fails and targeting most asset classes.”
While the highest rate would remain one basis for settlement fails due to lack of liquid shares, there could now be an increase by 50% to 0.75 basis points if the reason is a lack of illiquid shares, bonds other than sovereign bonds and all other financial instruments including ETFs.
ESMA also raised the floor for settlement fail due to a lack of cash.
In addition, the EU watchdog’s technical advice included that, in the absence of an overnight interest credit rate due to the monetary policy of the central bank issuing the settlement currency, other comparable interest rates of the ECB and the relevant central bank could be used to calculate a proxy which a CSD can use to calculate the cash penalties due to lack of cash.
In order to prevent the accumulation of reference data over time and to ensure the efficient operation of securities settlement systems, ESMA has recommended to amend the relevant Level 2 provisions to allow CSDs to use the oldest available reference price for the calculation of the related cash penalties, where settlement instructions have been matched after the intended settlement date, and that intended settlement date is beyond 40 business days in the past from the matching date.