CSDR Client Concerns Part 4: Liquidity

CJ Emson

July 2022

In our CSDR Client Concerns series we’ve considered each of the points causing clients the greatest concerns ahead of CSDR and examined each in practice since CSDR go-live in Feb 2022. One issue which has only been lightly considered is that of liquidity. Has market liquidity been negatively impacted by increased regulation?

Key CSDR Concerns

Ahead of CSDR implementation, liquidity didn’t rank as a solo or standout issue. In a survey conducted among our clients, we found the key concerns relating to CSDR centred around the industry’s operational readiness to CSDR especially around the workflows associated with pre-matching, returns, standard settlement instructions (SSI) and the impact on collateral; issues relating to these certainly proved out with the introduction of CSDR.

CSDR in Practice

In practice, the implementation of CSDR has been bumpy to say the least. The industry has grappled with some CSDs and market participants not being ready which has led to confusion and a lack of transparency associated with fines. Additionally, we witnessed an increase in monthly fines leading to an understanding that settlement fails are increasing rather than decreasing as hoped: EquiLend data shows a YTD 33% and 29% increase in new loans and returns respectively as firms adopt a defensive ‘stack them high’ strategy to reduce fails.

The increase we have seen in overborrows and subsequent returns leaves firms increasingly more reactive than proactive and creates further operational inefficiencies. Firms should look towards a ‘just in time’ strategy and look to expand same day borrowing. This would allow for greater inventory management and greater operational efficiencies however, this relies on trust in the infrastructure to first enable this to happen. 

Multiple pain points have led to returns activity being some of the most problematic to settle. A key driver in this is lack of automation in the returns process, contributing to mismatches, incorrect SSIs and further compounded by lack of inventory and late-booked trades. Our statistics have shown that 30% of trades experience keying errors at the point of trade, which could impact settlement. However, if the same trade is processed on NGT this number is reduced to 0%.

Embracing automation will help to reduce the latency between executing a trade to its settlement. This is achieved is by removing the bottle necks and barriers with technology solutions such as those offered by Vendors such as EquiLend.

Vendors have invested a lot of time to remove the bottle necks and barriers to automation to make the infrastructure ready and robust to deal with these demands. Within our solutions for example there is the ability to execute the trade on the biggest stock loan trading platform; NGT, which is designed to minimise issues at the earliest point of the trade; Collateral in the form of RQV can be automatically processed to tri-party agents through EquiLend Exposure. This can help alleviate the current problem which sees participants exchange an aggregated collateral payment made up of a complex combination of pending and open positions, including trades executed that day. Loans can be released, and trades can be prematched including SSI management through EquiLend Settlement Monitor. All this can be done in a short period of time allowing for firms to confidently and comfortably complete same day borrowing, while meeting CSDR requirements.

Has CSDR Impacted Liquidity

In reality CSDR should increase liquidity, especially as securities lending’s core function is to enable a more efficient capital market by supplying fail coverage. However due to the opaqueness around fines, additional funding costs to failing trades and the lack of passing credits down to the rightful owner, some firms may simply close up shop.

The full value chain must have visibility of the process flow and the ability to manage their risk with the counterparts, clients or specific markets much of which can be managed with EquiLend Settlement Monitor. This may begin to see firms reward this positive behaviour of reducing manual processing by giving these counterparts/clients more business.

Before Mandatory Buy Ins (MBI) and same day settlement were uncoupled, market participants faced a potential blunt tool for enforcement with MBIs. For now, with MBIs not yet in place, market participants are not at risk of a blunt instrument forcing the reduction in failing trades, but without change the impact of MBI enforcement will be strong and that certainly will have negative impacts on liquidity.

CSDR and Beyond

With Mandatory Buy Ins delayed for some 2-3 years, the simplified CSDR currently in place should enable market participants to address their processes and move ever forward towards comfort with same day settlement.

Solutions such as those offered by EquiLend’s interoperable suite of front-to-back trade lifecycle solutions, minimise complications throughout the trade lifecycle and offer clients the reassurance to adapt to the change in settlement schedule whilst seeing in real time the ease of addressing any number of issues they are currently experiencing.

Agreeing as may issues as close to the point of the trade itself through automation is key to reducing complexity and subsequent delays further downstream and continuing to minimise the impact on market and corporate liquidity.

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.