A lack of securities is driving settlement fails in Europe, according to a paper published by the European Central Securities Depositories Association (ECSDA). So-called ‘on-hold’ instructions, often linked to the lack of securities available, as well as late matching, are also driving fails according to the research gleaned from Central Securities Depositories (CSDs).
Settlement fails stymie efficiency by generating undue costs, creating further frictions for the connected transactions and ultimately acting as a driver of systemic risk.
ECSDA CSDs observed that, in the months leading up to February 2022, on average, settlement efficiency improved. “To our understanding, this increase was triggered by the preparation of the CSD participants for the entry into force of the CSD Regulation´s requirements on the settlement fail cash penalties,” the group said.
However, from February to July 2022, the war in Ukraine and subsequent increase in market volatility, in addition to the need to establish legally and operationally the corresponding sanctions upon the accounts of certain participants, had an impact on the efficiency rates that dropped “quite significantly” in some EU markets.
“External shocks and systemic stress – such as the ones mentioned in the previous paragraph – tend to lead to lower settlement efficiency rates,” the paper surmised.
However, allowing for a lower level of fails is preferable to aspiring to full efficiency, the group say, as this may lead to an “unreasonable” level of rigidity in financial markets and result in high costs (for pre-funding in addition to the necessary ecosystem technology upgrades). “A certain level of tolerance is instrumental to the well-functioning financial markets aspiring for high levels of liquidity and settlement velocity.”
This paper is, therefore, looking at how to reduce the number of fails, while not reducing the volume and value of transactions to be settled. To support this aim, the paper recommended that: The use of the available tools offered by the CSDs, such as H&R, partial settlement and partial release, should be expanded; Further services tools should be considered at the CSD level; CSDs should engage with market stakeholders.
Ultimately, participants should work with underlying clients to decrease the chances of late receipt of settlement instructions or to adapt instructions before sending them to the CSD, the paper suggested, and participants should also assess how the lack of securities due to pending purchases/receipts/internal realignments could be addressed, and how securities inventory management could be optimised.
© Markets Media Europe 2023
