Hidden regulatory risk in CSDR

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An apparently back-office focused rule, the Central Securities Depositories Regulation (CSDR), could have a serious impact on bond market liquidity, when it comes into effect in 2020. The European CSDR sets out a framework intended to make settlement of trades more efficient, however its approach is raising hackles on both buy- and sell-side.

“A key topic are the regulatory initiatives which are around the corner. We have the EMIR REFIT looking at fixed income derivatives. In this context, central clearing

Christoph Hock, head of Multi-Asset Trading, Union Investment

is one of the key themes we are focussing on for interest rate swaps, CDS business and at a later stage also for FX products,” says Christoph Hock, head of Multi-Asset Trading at Union Investment. “CSDR, the buy-in regulation which will get in place in 2020, will from my point of view have significant impact on how broker firms will back their market making activities, because there is a fairly strict and harsh penalty for transactions you fail to deliver.”

The rules, which will come into effect in Q3 2020, will affect market participants and market infrastructure providers, requiring them to comply with the newly introduced mandatory buy-in regime, which will see settlement failures subject to cash penalties.

Past research by the International Capital Markets Association (ICMA) has suggested that liquidity across secondary European bond and financing markets would be hurt significantly by this provision. Bid-offer spreads will widen dramatically, even in very liquid sovereign bonds, which the research suggested would see bid-offer spreads double, while warning that ‘secondary markets in less liquid corporate bonds may effectively close.’

Liz Callaghan, director, ICMA

“CSDR’s mandatory buy-in regime could impact levels of liquidity,” says Liz Callaghan, director at ICMA. “This is going live next year and it’s big.”

Buy-side traders will need to be cognisant of the potential impact this could have upon sell-side market-making provision.

Hock explains, “In the equity space it hits small to mid-cap names, but even more so in fixed income, in credit. When one is asking broker firms for prices, how often do they give us prices for ISINs that they don’t have on their books, knowing in the worst case and they can fail to deliver for a certain period of time? From a regulatory perspective that is not acceptable anymore, and there is no discretion.”

©The DESK 2019

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