Transcript EBF_009576 - Industry Presentation on buy

Annex 1 of the response from the German
Banking Industry Committee (GBIC)
CSD Regulation: Potential buy in regimes and
principles for settlement discipline
Background to Industry Work
 On 5th June 2014, AFME hosted a cross industry workshop to discuss and seek agreement on models and principles for the
proposed CSDR settlement discipline regime
 Representatives from the following trade associations were present: AFME, AFTI, EACH, EBF, ECSDA, FESE
 Breakout sessions focussed on the following topics:
 Buy in regimes
 Settlement penalties
 Agreement on a number of key principles and potential solutions for settlement discipline regimes
 The group deemed it important to meet and discuss findings further with National Competent Authorities and ESMA, to
highlight areas of complexity that were covered and discussed, and describe potential models reviewing pros and cons of
each
1
Buy-in regimes: objectives and current regimes (1/2)
Buy-in: key objectives
 Buy-ins are a way to enforce the delivery of securities bought/sold under a trade agreement.
If the seller fails to deliver the securities to the buyer on time, he is bought in by the buyer, whereby a third party delivers the
securities to the buyer, and the seller is charged the corresponding costs.
 The main objective of a buy-in is to:
 Protect the buyer, by ensuring that the buyer receives what it is contractually entitled to.
 From the perspective of a buyer, a buy-in preserves the original terms of the trade, so that the buyer receives the
securities which it has purchased, and pays the original purchase price.
 The buyer may in addition receive a compensation for any additional costs (administrative etc) that the delayed delivery
may have generated, but should not make an undue profit as a result of the buy-in.
 A subsidiary objective is to reduce risk /number of ageing outstanding settlements (alternatives exist)
 Buy-ins occur between trading counterparties (buyer-seller) and in case of CCP cleared transactions between the CCP and
the failing clearing member.
 Settlement agents/CSDs provide a service for the delivery of the securities vs. cash, but do not become party to the trade
 CCPs become – through open offer/trade novation - counterparties to the trade as the seller to every buyer, and the buyer
to every seller, and also settlement counterparties/input settlement instructions
 Exchanges provide a service to execute transactions, but do not become party to the trade
2
Buy-in regimes: objectives and current regimes (2/2)
Current buy-in regimes
OTC markets (neither cleared nor traded on a regulated trading venue)
 Buy-in provisions are often already included in contracts between OTC counterparties/market conventions (e.g. ICMA)
 Currently, there are very few OTC buy-ins due to the costs and complexities involved. In many cases a buyer may see little
benefit in executing a buy-in, and prefer to wait until the seller is able to deliver the securities.
CCP cleared markets
 CCPs usually have buy-in provisions and mechanism in their rules:
 These rules are different per market/instrument/CCP; in the case of equities, the settlement discipline under the Short
Selling Regulation (SSR) only limits the harmonisation to the extension period across CCPs.
 CCPs initiate/enforce buy-ins to manage their open risk
 Given their role of aggregator, CCPs play a key part in settlement (especially for equities), and are key counterparties for
settlements and related fails
 The settlement netting process impacts the buy-in process:
 As gross trades are netted into a net settlement instruction, there is no direct correlation between the settlement price and
the original trading price. The characteristics of the netting model also play a role
 The CCP executes cash settlement where required/needed. The reference price is calculated based on the last available
closing price (as used in margin calculation) or any other price depending on specific circumstances at the discretion of
the CCP. It should allow sufficient compensation for the buyer without any loss, but should not lead to any potential gain
to any of the parties
Exchange traded transactions which are not CCP cleared
 Need for further analysis on current rules/processes
3
Buy-in regimes: Key principles /suggestions
 Buy ins should be conducted at trading level, not at the level of settlement intermediaries or CSDs.
It should be noted that trading chains are not always identical to settlement chains, and that trading sizes/prices can be
different from settlement sizes/prices (e.g. as a result of netting)
 Buy-in should be conducted by:
 For CCP cleared transactions:
by CCPs against their failing clearing members according to the CCP rules
 For OTC transactions:
by the Buyer against the seller according to contract/industry rules
 For trading venues/non CCP cleared:
Trading venues to stipulate rules for their members
Buyer against seller according to rules of the trading venue
 Any buy-in method should prevent and avoid duplicate buy-ins across chains of CCP/OTC transactions, in order to ensure
only one buy in is executed, and avoid excessive costs/impacts. See next slides for potential methods.
 Buy in rules and processes/timelines need to be harmonised/synchronised across markets and venues
 Buy in process of pre-advices & notifications must be automated, including any reporting from CSD/CCP:
 CCPs already have this process in place for cleared transactions; each CCP has individual standards/reports.
 Potential need to create an industry-wide formatted message for notifications/ executions.
 Settlement partialling, which could occur both before and after the buy-in procedure is initiated, should ideally be made
mandatory, even for OTC activity, from a certain moment (e.g. issuance of a buy-in pre-advice), to allow maximum
opportunity to settle ahead of buy-in. There should be a minimum delivery value threshold agreed per asset class. (note: This will
require market infrastructures and industry participants to provide an automated mechanism, which may not exist in all markets currently. )
 Where securities are undergoing a (voluntary) corporate action, there should be a mechanism for buyer and seller to agree
to the delivery of the corporate action proceeds. Sellers need to protect entitlements requested by the purchaser.
 Cash compensation should be applied where a buy in is not possible or appropriate . Neither buyer nor seller should gain
from the process. The cash compensation should be equivalent to the original cost or cost of buying those securities at the
prevailing market price. For CCP cleared trades the reference price for the cash compensation is based on the last available
closing price (as used in margin calculation) or any other price depending on specific circumstances at the discretion of the
CCP.
 ESMA may seek to establish guidelines to ensure uniform, reasonable
administration costs for buy-ins. They could be
4
similar to the admin fees charged by CCPs under the Short Selling Regulation (SSR).
Buy-ins in the context of transaction chains
 Market activity is interconnected at trading and settlement level. Fails to deliver by one party often cause subsequent fails
further along the chain.
 This is particularly relevant for intermediaries (e.g. market makers) who provide two-way liquidity and thus are dependent on
their counterparties.
 In the workshop, particular emphasis was placed on ways to ensure that buy-ins are minimised (in transaction chains) where
possible and costs/timings are well calibrated, while ensuring compliance with CSDR and with the key principles of a buy-in
(page 4)
 For transaction chains, several models were reviewed to determine the best way to initiate and execute buy-ins: at all points
of the chain, at the start, at the end and considering where a CCP is involved.

The output was:

Two models which could potentially work, and 3 models (included in appendix) that would not

The following scenarios have been kept simple deliberately (similar shapes/dates/sizes) to facilitate
the discussion
5
Buy-in at end of the chain with pass-on of costs
Actual
Buy-in
A
(Initial Seller)
Buy-in
notice
1000 secs
TP = -1000
AP= 0
D = -1000
Actual position
Delta
C
Not OK
(but expected)
Pass on of
fees/costs
TP = 0
AP= 0
D= 0
1000 secs
D
OK
(no position)
E
Final Buyer
buy-in
agent
Pass on of
fees/costs
TP = 0
AP= 0
D= 0
OK
(no position)
Buy-in
notice
1000 secs
1000 secs
B
Pass on of
fees/costs
Traded position
Buy-in
notice
TP = 0
AP= 0
D= 0
OK
(no position)
TP = +1000
AP= +1000
D=0
OK
(covered)
How it could work


Each party in the chain can issue a buy-in notice upon failure to receive (S+1,S+2, S+3 tbd)
While E will stipulate in his notice that he wants to execute a buy-in to receive the actual securities, parties D,C,B can (after verification):
 ‘pass on’ the buy-in notice for the quantity they expect to receive themselves
 indicate in the notice that they will pass on any buy-in costs further down the chain (implying that they will not do an actual buy-in)

The result will be that the buy-in will be executed only once (between D and E). E will receive the securities, D will receive the costs/fees
invoice, which he then will pass (after consideration of his own trade price) on to C, C to B, B to A
Pros

Avoids issues around multiple buy-ins

Avoid issues around identifying start of the chain/central utility

Works for shapes/partials etc, though receiver needs to accept partial delivery (see recommendation on mandatory partialling)
Further consideration required

Clear definition of timing of notification/execution + need for automation of the notification/execution/pass on process

Does not work where a CCP is one of the parties in the chain (see next slide)

What is the impact on related transactions with different settlement date/what with equal/opposite trades?

What is the impact on economics of the trade, especially for repo’s and liquidity drying up?
Conclusion: Potential option for OTC activity, but need for automation/clear definition on timing and exemption for SFT’s
6
Settlement chains with CCPs: CCP performs the buy-in
Buyin
notice
1000 secs
A
(Initial Seller)
TP = -1000
AP= 0
D = -1000
Traded position
Actual position
Delta
B
Pass on
of
fees/costs
Not OK
(but expected)
buy-in
agent
Buyin
notice
TP = 0
AP= 0
D= 0
OK
(no position)
1000 secs
1000 secs
CCP
Pass on
of
fees/costs TP = 0
Buyin
notice
D
1000 secs
TP = 0
AP= 0
D= 0
AP= 0
D= 0
OK
(no position)
OK
(no position)
E
Final Buyer
TP = +1000
AP= +1000
D=0
OK
(covered)
How it could work

The CCP shall be the entity that executes the buy-in procedures (no ‘pass on’ possible for the CCP) against B

The CCP will execute the buy-in and deliver the securities downstream to D (who then delivers to E)

D (who cannot buy in the CCP), should have the right to revert to E to either extend the period before buy-in or suspend the buyin until the CCP has performed the buy-in and delivered the securities to D, who then delivers to E

B will be charged the costs and fees by the CCP, which he can then be charged back to A
Pros

Avoids issues around multiple buy-ins

Avoid issues around identifying start of the chain/central utility

Works for shapes/partials etc, though receiver needs to accept partial delivery
Further consideration required

Interoperating CCPs cannot initiate buy-in against one another

Additional work is required in case the chain of CCPs is broken by a bank.

Clear definition of timing of notification/execution + need for automation of the notification/execution/pass on process

What evidence is required to allow D to revert to E to obtain an extension/suspend the buy-in, and be neutral re costs

What is the impact on related transactions with different settlement date/what with equal/opposite trades

What is the impact on economics of the trade, especially for repo’s and liquidity drying up ?
Conclusion: Potential option for CCP+OTC activity, but requires further analysis/automation
7
Timing of buy-in process
Event
Timing
Comments
Balance generating multiple notifications with benefits of early
warning
Notice of buy-in
notification/pass on
Extension date minus x days (or SD + x
days) ?
Requires automation/standardisation of process if volumes of
notifications increase as expected
Dependant on length of extension period
Incorporate a process for updated notifications following
delivery of securities by seller
Specify the method for the execution of the buy-in
Notice of start of buy-in
procedure
End of last date of extension period
Include timing of execution (start-end) and agent
Define what applicable market deadline is
Notice of execution of buy in
Day within the execution period to be
determined by the
executing/administering party taking into
account market conditions and the
interest of the receiving party.
Automate/communicate asap across the chain
Communication of buy-in result
Day following the execution date
How long is that period/optionality on choice between
cash/deferment. The CCP is not required to give the choice.
8
Principles for a Settlement Discipline Regime (1)

The fining regime must be transparent and fines should be able to be passed back to the failing party, without
disadvantaging others in the settlement chain. The model should be able to circumvent a CCP if they are an actor in the
settlement chain and to take into account scenarios where counterparties have opted out of partial deliveries

Whenever possible, settlement fines should be forwarded to the aggrieved party. The CSD should be reimbursed for the
cost of operating the regime

Counterparties should not be charged a daily penalty fee by both a CCP and a CSD for the same failing instruction

Fines should only be levied on matched transactions

Fines can be levied against either the buyer or the seller, depending on which party causes the fail.

On Hold instructions should be considered as fails after the Intended Settlement Date (ISD) and therefore subject to the
same discipline

Technical standards should not prevent a harmonised settlement regime across European CSDs to be operated centrally
(e.g. in the case of T2S CSDs) in the medium or long term.

We would support an ad valorem fee with a minimum and maximum cap , rather than a fixed fee approach. A different
rate and appreciably lower rate should be applied to fixed income / higher value transactions when compared to equities.

For an ad valorem approach, a reference price should be provided by a central body in order to address the issues due to
different cash values and cater for a equal balance between debited and receiving party.
11
Principles for a Settlement Discipline Regime (2)

The CSDs should provide on a daily basis to their participants detailed, up-to-date information on the status of their failing
instructions. Actual payments of the fines and the reference price used should be part of the CSD monthly invoice
process and provide sufficient detail to allow the costs to be passed back to the failing seller.

There should be an appeals process.

Settlement discipline should be considered for suspension, in conjunction with the relevant competent authorities, over
major market events.

The working group recognises two distinct models when applying penalties. Each market could decide which is most
suitable:

A gross model where all parties in the chain are fined by a CSD which then reimburses those parties who are
pending receipts and deliveries.

A net model where the failing participant is debited by the CSD and the fine reimbursed to the end aggrieved
party.
Potential model for Fixed Income transactions (awaiting outcome of ICMA considerations)

For US Treasury markets, there is a voluntary process for fail fines created by The Treasury Market Practices Group
(TMPG).

Fines are calculated using an interest rate driven formula which would need to be calibrated by market.

A reference interest rate would be required. We could discuss further if ESMA wishes/likes the model.
12
Comparison of Per Settlement Instruction vs. Net position
Per Settlement Instruction
1000 shares
Initial Seller
1000 shares
1000 shares
Y
Z
Final Buyer
B
C
D
E
-1000 +1000
-1000 +1000
A
CSD -1000
1000 shares
X
-1000 +1000
+1000
Net position = - failing deliveries + failing receipts + position on the participant account
(*)
(*) position to be taken into account only if the participant doesn’t put any of its instructions On Hold
1000 shares
Initial Seller
A
CSD NP = -1000
Order / trade
1000 shares
1000 shares
1000 shares
X
Y
Z
Final Buyer
B
C
D
E
NP = -1000+1000+0=0
Instruction sent to
the participant to
receive/deliver
NP = -1000+1000+0=0
NP = -1000+1000+0=0
Fines to be paid
Failing settlement
13
Indirect compensation
Indemnity/compensation to be received
Appendix
1. Criteria for an efficient/effective buy-in process
2. Info required to initiate/execute a buy-in
3. Options for buy in considered by the group but discounted
4. At what level should a buy-in be executed for OTC and for CCP cleared
Criteria for an efficient/effective buy-in process
 Buy-in processes and timeframes should be:
 Fully transparent
 As simple as possible
 Scaleable/automated
 Harmonised (to the extent possible) across CCP and OTC activity
 Harmonised (to the extent possible) across markets
 info on buy-in execution should be quasi real time to avoid additional market risk for non CCP cleared transactions.
 Costs of buy-ins should be minimised:
 Only used when other means to settle have been exhausted for non CCP cleared transactions.
 Avoid duplication and multiple buy-ins
 Be done at market prices or close thereto
 Not be construed as a penalty
 Objectives of buy-in are to:
 Ensure delivery to the end buyer, not provide arbitrage opportunities
 be neutral to settlement intermediaries, market makers and CCPs
 not discourage trading activity, but encourage good settlement behaviour
 Reduce market risk
 Not negatively impact liquidity in the instrument
15
What info is required to initiate/execute a buy-in
Information on OTC buy-in notice/pass on (dummy example)
 Buy-in notification/pass on
 Name of sender/deliverer
 Trade date:
dd/mm/yyyy
 Settlement date:
dd/mm/yyyy
 Nominal amount:
xxxx
 Security description:
name of security
 ISIN:
XYZ…
 Price:
xx.xxxx
 Net amount:
xxxx EUR/GBP/USD
 Delivery details:
delivering/receiving account
Other info which might be useful/needed
 Date of last delivery
 Date/hour of execution
 Evidence of the fail/reason code
 Buy-in agent/process
 Deadline after which buy in will be initiated/executed
16
Option discounted - Buy-in at every point throughout the
transaction chain – multiple buy-ins
Deemed unworkable by cross industry group
Buy-in
notice
A
(Initial Seller)
Buy-in
notice
B
1000 secs
buy-in
agent
Traded position
Actual position
Delta
Buy-in
notice
C
1000 secs
buy-in
agent
1000 secs
Buy-in
D
buy-in
agent
E
Final Buyer
1000 secs
buy-in
agent
TP = -1000
AP= 0
D = -1000
TP = 0
AP= +1000
D = -+1000
TP = 0
AP= +1000
D = -+1000
TP = 0
AP= +1000
D = -+1000
TP = +1000
AP= +1000
D=0
Not OK
(but expected)
Not OK
(open position)
Not OK
(open position)
Not OK
(open position)
OK
(covered)
Comments/questions/issues
The amount of buy-ins largely exceeds the amount of securities needed. This will lead to:

Duplication of processes and costs

Manual/intensive

Surplus securities being bought in (4000 vs. 1000 needed), which then need to be sold again (impact on prices)

New open positions/market risks for intermediaries/market makers

Timing issues of buy-ins

Insufficient liquidity to satisfy all buy-ins, aggravating the process

Conclusion: this is not an efficient and effective method, and will lead to multiple buy ins where they are not
required. This could significantly move markets and affect liquidity
17
Option discounted - Buy-in at start of the transaction: single buy-in +
onward deliveries - Deemed unworkable by cross industry group
Actual
Buy-in
A
(Initial Seller)
Buy-in
notice
Buy-in
notice
1000 secs
Buy-in
notice
1000 secs
1000 secs
1000 secs
B
C
D
TP = 0
AP= 0
D= 0
TP = 0
AP= 0
D= 0
TP = 0
AP= 0
D= 0
E
Final Buyer
buy-in
agent
Traded position
TP = -1000
AP= 0
D = -1000
Actual position
Delta
Not OK
(but expected)
OK
(no position)
OK
(no position)
Pros
Avoids most issues related to multiple buy-ins, i.e:

Single buy-in, (avoiding duplication of processes and costs)

Less manual/intensive provided notification process is automated

No more surplus securities being bought in

No new open positions/market risks for intermediaries/market makers

Less timing issues of buy-ins, if settlement process works efficiently
Cons/questions/issues

How to identify the start of a chain ?

Need to automate notification process

Existing settlements will still be in system, attracting penalties

Does not work well for partials/shapes

Will it work for cross-CSD settlements, and for chains where CCP’s are involved ?

Depot management/reconciliation issues
Conclusion: Theoretical option, with a number of practical issues/drawbacks
18
OK
(no position)
TP = +1000
AP= +1000
D=0
OK
(covered)
Option discounted - Centralised buy- in process/agent
Deemed unworkable by cross industry group
Central buy-in agent
copy
copy
Actual
Buy-in
A
(Initial Seller)
Traded position
Actual position
Delta
Not OK
(but expected)
Buy-in
notice
buy-in
1000 secs
TP = -1000
AP= 0
D = -1000
copy
Buy-in
notice
copy
Buy-in
notice
1000 secs
1000 secs
1000 secs
B
C
D
TP = 0
AP= 0
D= 0
TP = 0
AP= 0
D= 0
TP = 0
AP= 0
D= 0
OK
(no position)
OK
(no position)
OK
(no position)
Pros

Avoids most issues related to multiple buy-ins
Cons/questions/issues

What is the precise role of the central buy-in agent, and who is willing to act in this capacity?

The buy-in agent may be part of the transaction chain (esp. if they are a market maker/primary dealer)

Everyone needs to agree to this process: is this realistic ?

How/ on what basis will the agent identify chain transactions, and the best place to execute the buy-in

Are there constraints (privacy, other) in providing info the central agent, and vice versa

Speed/timings of creating and running this structure

What with shapes/partials/different settlement dates

Does not work where a CCP is involved (unless the CCP is willing to take on the role of the buy-in agent)
Conclusion: Theoretical option, with a number of practical issues/drawbacks + timing issues.
Even if it could work, the Central Buy In agent may become a consolidated centre of risk.
19
E
Final Buyer
TP = +1000
AP= +1000
D=0
OK
(covered)
At what level should a buy-in be executed? (OTC)
Type of activity: OTC
Buy-in
Settlement Agent
T rading / Clearing
Settlement location: Domestic & Cross-CSD (generic)
Sale Trade
A
Sale Trade
Sale Trade
Sale Trade
B
C
D
E
CITI
HSBC
JPM
DB
Settlement
impact / reporting
BNP
Settlement
impact / reporting
Settlement
Settlement
CSD
Settlement
MT
ESES
CBF
20
Settlement
VP
At what level should a buy-in be executed? (CCP)
Type of activity: CCP cleared (OEX)
Buy-in
Settlement / Agent
Trading / Clearing
Settlement location: Domestic & Cross-CSD (generic)
Sale Trade
A
Novated Trade
Novated Trade
Sale Trade
B
Exchange/CCP
D
E
CITI
CCP (on agent)
JPM
DB
Settlement
impact / reporting
BNP
Settlement
impact / reporting
CSD
Settlement
MT
Net
Settlement
Net
Settlement
ESES
CBF
21
Settlement
VP