While CSDR may not have been front and center for many firms over the last year, right now, as we move closer to the introduction of the cash penalty regime, firms are actively prioritizing their readiness.

From initiation, CSDR has consistently been the subject of scrutiny from multiple players in the industry, who have put forward opinions and suggestions on how best to implement the regulation. Contrary to the buy-in regime aspect of CSDR, which has been a point of contention with several industry bodies, the cash penalty regime has been broadly accepted by the industry, with most participants agreeing that it represents a positive move forwards in enhancing settlement discipline within the European securities markets. The Association for Financial Markets in Europe (AFME) had stated that the rules requiring CSDs to facilitate partial settlement and 'hold and release', along with new requirements for trade confirmation, allocation, and the penalty mechanism, will positively contribute towards improving settlement efficiency.

For the cash penalty regime, fines will be calculated and levied by a CSD for late matching, as well as late settlement. CSDs will calculate daily penalties for each trade instruction that failed to settle on its intended settlement date (SEFP) and/or is matched after its intended settlement date cut-off time (LMFP). This will result in the offending party being charged a cash penalty and the non-offending party will receive the credit. The resulting Fees will be calculated by the CSD and communicated to participants via a Swift MT 537 or MT 548 which will contain the specific 'Message Function' of 'PENA' (i.e., Penalty) to differentiate the message from the current message function Cancellation Request, or Transaction Status.

As the application of the penalty regime is more straightforward, participants have been able to make progress on their agenda to support this part of the regime. The new penalty processing functionality, within the existing interbank messaging framework, will require changes to message management and user interface. The posting of debits or credits to client accounts must be automated, with the ability to accrue, waive and pass fees on an ad-hoc basis when required. Foreign exchange transactions will also require automation to ensure risk and inefficiencies associated with manual processing are avoided. While reconciliation of fees and penalty dispute handling appear challenging, they will be necessary for institutions to correctly and transparently attribute the correct monies to their underlying clients.

"While CSDR aims to balance the responsibility between buyer and seller, ensuring both parties have equal motivation to fulfil their obligations is core," said Richard Wilson, Director, Corporate Actions & Securities Processing, IHS Markit. "Net fees derived from a combination of matching and failing penalties on the same transaction may result in unexpected outcomes, for example, a buyer being charged a larger penalty than the seller because the buyer failed to match a trade for a greater number of days than the seller, who was short to deliver beyond the intended settlement date."

"Different calculation methods across asset classes will also require sophisticated software enhancements, as well as new data models in order to source, and generate, the correct rates for calculation. Solutions for managing CSDR must provide real value with a high level of automation," Wilson added.

In response to the challenges the CSDR implementation poses for firms, IHS Markit has enhanced its Securities Processing solution to provide the foundation to support the cash penalty regime, delivering multi-asset class solutions across the post-trade landscape, with integrated regulatory components enabling clients to better manage headwinds faced in an ever evolving and uncertain environment. Working in collaboration with clients, the IHS Markit team has developed a solution that ensures firms are equipped with an integrated solution, offering automated features that maintain efficiency and transparency.

Within our post-trade solution, fines will be held against each transaction and then posted on a net basis per underlying client once per month within the post-trade solution, with each posting processed to reflect the net cash movement from the CSD and then further netted per individual custody account. Supplementary information will be added to transactions regarding the daily fees calculated and will be presented to end clients via the client decision making portal.

IHS Markit's Securities Processing solution supports the equivalent inbound ISO 20022 messaging from CSDs, as well as outbound to end clients with the functionality to support the waiving of a given fee towards an end client where the bank is at fault but the charge was still made by the CSD. Additionally, where client cash posting rules dictate a different currency cash account should be used for fees, an FX request will be generated when the appropriate Fee Posting is applied.

The development of these new features will seamlessly integrate the processing aspects of the cash penalty regime into our solution, with the goal of making it as continuous and automated as possible.

If you are still looking for a solution for CSDR, or more broadly an end-to-end securities processing solution, please do reach out to us for an overview or detailed demonstration.

S&P Global provides industry-leading data, software and technology platforms and managed services to tackle some of the most difficult challenges in financial markets. We help our customers better understand complicated markets, reduce risk, operate more efficiently and comply with financial regulation.

This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.