The impact of mandatory buy-ins under CSDR

“This piece of market regulation, buried among what is primarily meant to be settlement regulation, will have a profound and dramatic impact on liquidity and pricing for the European capital markets,” says an ICMA Impact Study for CSDR Mandatory Buy-ins[1]. There are some compelling numbers to support the debate, too, with ICMA, along with ECSDA[2], proposing a delay of two years to the imposition of new settlement rules.

Mandatory buy-ins, as outlined under CSDR (the Central Security Depository Regulation) will come into effect when a buyer of a security or bond does not have them delivered by the seller within four business days for liquid securities, and within seven business days for illiquid securities.

ICMA (the International Capital Market Association) is concerned with the impact that mandatory buy-ins will have upon European capital markets and the European repo market. ECSDA (the European Central Securities Depositories Association) is concerned with the proposition of European CSDs being so closely involved to buy-ins where failed trades occur, as well as the cost of development which it estimates to be over €3.5 million on average across its 19 members.

“When people buy a corporate bond from, say, Argentina, there will be a lot of interest and a good yield – people are interested in yields,” explains Godfried De Vidts, chairman of ICMA’s European Repo Council and director of European affairs at ICAP. “It’s not a transaction you do every day so the bank will offer a price and you basically buy the yield, which is a guaranteed return. In rare instances where the seller cannot deliver the actual bonds, the buyer can ask the bank to keep trying to get them, from places like the repo market as a temporary measure until the seller can find the actual cash bond, or ultimately make a pay-out, where the investor basically just gets the yield, without ever actually having the security.

“An elephant has been made of a mouse here and there are remedies in place already. It is possible to search for the bonds through ICSDs (International CSDs), which can look through their client database and see who is holding what. They can then approach those clients and see if they are willing to lend the bonds out. So there are remedies and procedures.”

There is also a lot going on in the European settlement space at the moment, notably the ECB’s (the European Central Bank’s) T2S (Target-2 Securities) project, which is introducing a harmonised settlement platform for Europe. De Vidts is a strong advocate of postponing the implementation of mandatory buy-ins under CSDR, until the impact and benefits of T2S are known.

“At the moment, most of the fails that we see in Europe are because of the inadequate framework and piping,” he says. “We are still working on the old legacy CSD system and we don’t have a harmonised settlement platform for Europe, which is why we are moving to T2S. It’s premature to call for mandatory buy-ins by January 2016. T2S will only have been delivered in its finality (when the fourth and final wave goes live) by the middle of 2017, so we should delay the mandatory buy-in by 18 months to two years.”

This is the same argument presented by ECSDA, which also seeks a two year postponement to allow the CSDs to avoid the parallel implementation of T2S and CSDR, something it sees as adding an unnecessary layer of risk. There is also the cost of the mandatory buy-in as outlined in CSDR. ECSDA’s paper reveals a study, based upon the November 2014 statistics of 11 of its members. ECSDA applied the CSDR mandatory buy-in principles to the data and found that over 150,000 buy-ins would have been activated against transactions worth a total of €214 billion. Assuming November 2014 was an average month, across an entire year 1.8 million buy-ins would be initiated for a total value of more than €2.5 trillion.

ICMA’s report finds that for each €1 trillion of bond activity, there will be a cost of €1.3 billion to be borne out of mandatory buy-ins in the form of wider bid-ask spreads across all fixed income asset classes, including even the most liquid sovereign bonds. “And we have about €40 trillion cash trading per year,” adds De Vidts.

In addition, almost 45 per cent of the European repo market would come under the scope of mandatory buy-ins, forcing an increased reliance on short term repo transactions; those that are exempt from the buy-in rules. Whereas for the repo market the outstanding is €5.5 trillion the estimated annual cost, again as a result of wider bid-ask spreads, would be €3.1 billion

“That cost will not be borne by the banks – it will cost the asset managers, the pension funds and the insurance companies,” says De Vidts. “Who is benefitting from that? The public will lose out. You are charging the real economy billions of Euros for something that is actually working pretty well at the moment. That is why we are complaining about this and why we are asking for a delay to implementation. It would be better to have penalties in place before mandatory buy-ins.

“If the core rationale of CSDR is to make the markets better, and safer, this is the reverse. We need to change the timing of this.”

Tags: CSDRCSDICMAECSDAmandatory buy-insLiquidityBondsT2S