The European Securities and Markets Authority (ESMA) published its Final Report on the Technical Advice for the European Commission on the Penalty Mechanism under the Central Securities Depositories Regulation (CSDR). The advice aims at incentivizing all actors in the settlement chain to improve settlement efficiency, also in view of the potential move to T+1 in the EU.
The report outlines ESMA’s advice to improve the application of the CSDR penalty mechanism on three main aspects:
- alternative parameters to calculate the penalties due to lack of cash, when the official interest rate for overnight credit charged by the central bank issuing the settlement currency is not available;
- the treatment of historical reference prices for the calculation of late matching fail penalties;
- the design and level of the penalty rates for each asset class.
Regarding the last point, ESMA proposes to maintain the design of the current penalty mechanism, for example not introducing fundamental changes to the methods for calculating penalties, and to introduce an overall moderate increase of the penalty rates, in full alignment with the current types of settlement fails and targeting most asset classes.
Dynamic penalties tied to SBL rates
The report stated that respondents “welcomed” the introduction of the cash penalty mechanism as an incentive for the industry to enhance the efficiency of their settlement efficiency practices, alongside external factors. ESMA noted that a moderate increase of cash penalties rates (using as reference the average securities lending and borrowing rates) could ultimately lead to an improvement in terms of settlement efficiency.
There was strong pushback on the proposed increase of penalty rates, and ESMA noted that a significant increase of penalty rates may divert resources from expected investments and costs of moving to T+1. As an alternative, ESMA favors a moderate increase of penalty rates, using the securities lending and borrowing rates observed in 2022 and in 2023 as reference to ensure that the costs of penalties would remain on average above the costs of borrowing securities to resolve the fail.
“At this stage, ESMA has not taken forward the proposals of a dynamic approach to penalty rates and/or the introduction of flat rates, as they may be considered a structural change to the penalty mechanism. These options are however reflected in the costs/benefits analysis in Annex V and could be explored during the next review of the penalty mechanism,” according to the report.