The International Capital Market Association (ICMA) has published a briefing note on the European Securities and Markets Authority (ESMA) proposals for penalties under the Central Securities Depositories Regulation (CSDR).
The briefing note is in response to ESMA proposals to increase the penalty rates for settlement fails, as applied under the EU CSDR, from current levels by a factor of many multiples. ESMA also floats the concept of “progressive penalties” that increase each subsequent day of the fail.
ICMA analyses the proposals in the context of the causes of settlement fails, the “natural cost” of failing, and behavioral incentives for timely settlement. ICMA concludes that the proposals put forward by ESMA are not only disproportionate, but are unjustified, pointing to the significant improvement in settlement efficiency observed in the EU, particularly in response to a higher interest rate environment.
ICMA argues that, if implemented, the proposed penalty recalibrations would undermine the competitiveness and credibility of the EU as a global financial marketplace. Furthermore, the extreme distortions that they would bring about may incentivize adverse market behavior, as being failed would become economically more appealing than facilitating settlement. Meanwhile, these would feed into bid-ask spreads across all bond classes, as well as adversely impairing liquidity.
ICMA points to the US Treasury Markets Practices Group penalty framework as an example of a penalty mechanism that is appropriately designed and proportionately calibrated to achieve its intended purpose – that of disincentivizing poor settlement behavior in low interest rate environments.
The briefing note follows ICMA’s formal response to the ESMA consultation on its proposals.