On 19 November 2024, the European Securities and Markets Authority (ESMA) published a final report containing technical advice on the Central Securities Depositories Regulation (CSDR) penalty mechanism.

Background

The CSDR contains measures intended to prevent and address failures in the settlement of securities transactions (settlement fails), commonly referred to as settlement discipline measures. They consist of reporting requirements, cash penalties for central securities depositories (CSD) participants in case of settlement fails and mandatory buy-ins where a CSD participant fails to deliver the securities within a fixed extension period.

The European Commission (Commission) is empowered to adopt delegated acts to specify the parameters for the calculation of a deterrent and proportionate level of cash penalties.

In December 2023 ESMA issued a consultation paper seeking views on the effectiveness of the current penalty mechanism in discouraging settlement fails and set out preliminary views on three topics:

  • Alternative parameters, 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  • The treatment of historical reference data for the calculation of late matching fail penalties.
  • Alternative methods for calculating cash penalties, including progressive penalty rates.

The consultation closed in February 2024.

Final report

The final report now published contains three main sections on the topics mentioned above.

It also summarises the feedback received to the earlier consultation together with ESMA’s technical advice to the Commission.

ESMA’s technical advice includes:

  • Recommending that in the absence of an overnight interest credit rate due to the monetary policy of the central bank issuing the settlement currency, other comparable interest rates of the European Central Bank (ECB) and the relevant central bank could be used to calculate a proxy which a CSD can use to calculate the cash penalties due to lack of cash.
  • Recommending that the Commission amend the relevant CSDR Level 2 provisions to allow CSDs to use the oldest available reference price for the calculation of the related cash penalties, where settlement instructions have been matched after the intended settlement date, and that intended settlement date is beyond 40 business days in the past from the matching date.
  • Recommending that the design of the current penalty mechanism be maintained, i.e. not to introduce fundamental changes to the methods for calculating penalties.
  • Discarding at this stage the introduction of progressive penalty rates (with or without convexity), as well as changes to the parameters defining the rate levels (e.g. introducing an explicit link between the penalty rates and interest rates for settlement fails due to lack of financial instruments). These policy options may be further explored in a future review of the penalty mechanism.
  • Proposing certain changes to penalty rates:
    • maintain the current penalty rates for settlement fails due to lack of liquid shares, and due to lack of instruments traded on an SME growth market;
    • increase penalty rates by 50% for settlement fails due to lack of illiquid shares, bonds other than sovereign bonds and all other financial instruments including ETFs; and by 100% for settlement fails due to lack of sovereign bonds; and
    • increase the floor from 0 to 1 for the penalty rate for settlement fails due to lack of cash.

Next steps

The Commission will consider ESMA’s technical advice when amending Commission Delegated Regulation (EU) 2017/389.

The powers of the Commission to adopt delegated acts are subject to Article 67 of the CSDR that allows the European Parliament and the Council to object to a delegated act within a period of 3 months, extendible by 3 further months at the initiative of the European Parliament or of the Council.

The delegated act will only enter into force if neither the European Parliament nor the Council have objected on expiry of that period or if both institutions have informed the Commission of their intention not to raise objections.