Insight
CSDR Client Concerns Part 3: Collateral
CJ Emson
April 2022
In part 3 of our CSDR Client Concerns series, we’re exploring the CSDR impact on collateral and the staggering impact on returns within the securities lending trade lifecycle.
The European Settlement Regime & Collateral
CSDR brought in a wave of change for European trading. The settlement regime seeks to increase efficiencies and generate greater transparency across the trading landscape, and even though it has been a decade in the planning, the industry has responded slowly. In part, the cost of upgrading legacy systems to be fit for purpose under the regime has been prohibitive for some firms, and in others the frantic pace of daily trading took priority over once-distant regulation.
Ahead of CSDR, market participants were largely unaware of the true cost of fails. Settlement ladders were eagerly monitored with predictive modelling tools built to help prioritize workflows and allow firms to resolve potential failing trades before they crystalized into a fail on settlement date resulting in a hefty fine under the new regime.
With CSDR in force now, the challenges are as expected with firms seeking to discover how best to leverage their securities lending flow for the most cost-efficient method of fails coverage.
Same-Day Settlement Hesitancy and Collateral Latency
CSDR aimed to solve for settlement latency and therefore normalize same-day settlement, but when reality kicked in the modelling tool’s outputs were unreliable and didn’t tell the true picture. As a result, either heavy fines have been incurred or excessive borrowing has taken place to cover the fail. This hesitancy to adopt same-day settlement originates largely from dual centers of concern: the complex nature of collateral and conflicting settlement schedules.
Unique to stock borrow, participants exchange an aggregated collateral payment made up of a complex combination of pending and open positions, including trades executed that day. Any dispute with the valuation can lead to missing the settlement cut off. One area in particular that causes concern is with the collateral pre-pay and the impact this has on timely settlement.
In addition to the complexity of collateral exchange, Free of Payment (FOP) trades, traditional to securities lending versus Delivery v Payment (DVP) trades settle on different schedules. Often there are hours difference between these settlement schedules. Often, this lack of schedule alignment is the primary reason for the failure of a securities lending transaction as the latency to instruct and settle the transaction is too long to satisfy the different schedules.
Same-day settlement was not usual before CSDR, but with new nervousness that daily FOP payments will be posted late, and CSDR fines incurred, there remains a natural hesitancy to embrace same-day settlement. This serves to slow the progress of positive change for the entire system.
Over-borrowing and Returns
The reality of CSDR with these issues in mind has been to create an incredible volume of returns – a process often not automated – as market participants over-borrow to create collateral cover based on the algorithmic assumption that there is any chance of fail.
It is cheaper to over-borrow and return than to incur a settlement fine. We’ve seen a significant additional strain on return processing as a result of CSDR; returns have increased by 29% since Jan 2022, as market participants look to get their excess borrows off their books as soon as possible, resulting in multiple cancel/amend instructions.
Trading Automation Tools
With greater automation in post trade, and inter-connectivity to the trading system, market participants would more easily be able to adapt to same-day settlement. EquiLend’s interoperable network of products service the complete trade lifecycle; including pre-matching post settlement comparison, automated returns and real-time exposure management.
EquiLend NGT volumes increased by nearly a third in Q1 2022. Automation at the point of trade, as offered by NGT, has shown to nearly eliminate the approximately 30% of trades that incur booking errors due to manual keying for those trades done off-platform, smoothing the way for the trade downstream.
Our interoperable network of products and services includes EquiLend Exposure, which facilitates faster collateral cover by identifying causes of disputes, recommending remediation and facilitating RQV messaging instantly to multiple tri-party agents in one workflow tool. The seamless connectivity between trading platform and RQV messaging ensures that collateral pre-pays can be agreed and received.
In addition, EquiLend’s Settlement Monitor ingests data from Unified Comparison, the nucleus of our post-trade lifecycle management suite, as well as EquiLend Exposure and Returns and Recalls to deliver a centralized, global fails management platform dedicated to tracking, reconciling and resolving pending and failed securities finance transactions.
According to our estimates, moving the borrowing process to same day could reduce excess borrowing by over 80%. Automated tools such as EquiLend Exposure and Settlement Monitor both serve to identify and support the resolution of any number of variables which could threaten settlement of a trade, furthering seamless adoption of same day settlement.
Automation and Collateral Resolution
With millions of dollars across the trading landscape tied up as collateral, reducing latency in collateral cover is a central priority for borrowers and is key to reducing drag in the current system and building confidence in lenders to adopt same–day settlement. The returns landscape is under incredible pressure under CSDR; the slow adoption of the end goal of CSDR will continue to cause problems while same–day settlement is not adopted wholesale.
Who We Are
EquiLend is a global financial technology, data and analytics firm offering Trading, Post-Trade, Data & Analytics, RegTech and Securities Finance Platform Solutions for the securities finance industry. EquiLend has offices in New York, New Jersey, Boston, Toronto, London, Dublin, India, Hong Kong and Tokyo and is regulated in jurisdictions around the globe.
