Political agreement reached on CSDR amendments: mandatory buy-ins retained but significantly reformed

On 27 June 2023, the Council of the EU announced that it had reached a provisional agreement with the European Parliament on amendments to the Central Securities Depositories Regulation (CSDR).

The amendments include substantial changes to the much-criticised mandatory buy-in (MBI) regime, which was due to apply from February 2022 but was postponed pending the CSDR review.

Mandatory buy-in regime reform: a two-step approach

MBIs will only be used as a measure of last resort, once a number of stringent conditions have been satisfied.

The Commission will have the power to implement MBIs in respect of a particular category of transaction or financial instrument type if, having consulted with the ESRB and on the basis of a cost-benefit analysis from ESMA, it considers MBIs to be a necessary, appropriate and proportionate measure. In doing so, it must base its analysis on the possible impact of MBIs on the EU market, on the number, volume and duration of settlement fails as well as on whether an instrument or category of instruments is already subject to contractual buy-in provisions (which would include, for example, international non-cleared bonds subject to the ICMA Buy-in Rules).

Even then, the Commission will only be able to adopt the relevant implementing measure if two conditions have been met:

(a) the application of the cash penalty regime has not resulted in a long-term, sustainable reduction in settlement fails in the EU; and

(b) the level of settlement fails has or is likely to have a negative effect on the financial stability of the EU.

The list of transaction types excluded from the MBI regime has also been significantly widened to include, among others, all securities financing transactions, types of transactions that render the buy-in process unnecessary, settlement fails whose underlying cause is not attributable to the parties and operations that are not considered as trading.

More detail on some of these exemptions will follow from ESMA and the Commission, but the draft regulation does provide some useful clarification; transactions that render the buy-in process unnecessary are stated to include financial collateral arrangements and transactions that include close-out netting provisions, which will be welcome news to the derivatives industry and other market participants that had been concerned that collateral transfers could be in-scope for the MBI regime.

Once MBIs have been implemented for a particular category of transaction or instrument type, the Commission must review that decision at least every four years to determine whether the conditions described above remain fulfilled. ESMA may also recommend that the Commission temporarily suspend MBIs where necessary to avoid or address a serious threat to financial stability or to the orderly functioning of financial markets in the Union. This addresses feedback received during the review that MBIs would have had a procyclical and destabilising effect on markets during the March-April 2020 COVID-19 market turmoil.

Other improvements to the MBI regime

A number of flaws in the original MBI process have been fixed in response to comments from market participants. A pass-on mechanism has been included which will allow buy-ins to be applied along a chain of transactions. The much-criticised payment asymmetry has also been removed, so that payment of the difference between the original trade price and the buy-in price could be paid in either direction (as things currently stand it is only payable by the seller where the buy-in price was higher than the original trade price, which operates as a punitive measure rather than seeking to restore the parties to their economic positions had the trade settled as intended).

Shortening the settlement cycle

Away from mandatory buy-ins, ESMA has been tasked with producing a report on the possibility of shortening the settlement cycle in the EU. This follows the move by the US and Canada to implement T+1 settlement in May next year and the formation of the Accelerated Settlement Taskforce to investigate a similar proposal in the UK. ESMA’s report is expected to be due by late 2024.

Next steps

We expect the amending regulation to be published in the Official Journal in Q4 2023. It will enter into force 20 days later.