New legislation of the European Commission regulates securities transactions settlement discipline. One issue related to the central depositories and their participants is so called penalty mechanism.
The penalty mechanism introduces obligation for the central securities depositories to collect and distribute among their participants cash penalties for late settlement or late matching of the settlement instructions. This is one of the instruments improving discipline in timely settlement of securities transactions in the European Union. Purpose of this mechanism is to enhance settlement effectivity.
While the mechanism does not rule out existence of cash penalties on level of trading venues, e.g. stock exchanges, for the central depositories it implements new, but independent with regards to other potential sanctions, obligation to monitor, calculate, report, collect and distribute cash penalties for settlement fails. Entire monitoring, reporting, collection and distribution process of cash sanctions will be harmonised in all depositories in the European Union and for relevant participants will be fully transparent with respect to amount of sanctions.
What does it apply to?
Whereas before validity of the delegated regulation the term settlement failure could address primarily matched settlement instruction unsettled on intended settlement date, newly also late placement or late matching of settlement instructions will be sanctioned to the same extent and equally strictly. It means that if party in trade sends to the central depository a settlement instruction with past Intended Settlement Date, or with Intended Settlement Date which cannot settle on given settlement date, the party will be sanctioned for each day after the Intended Settlement Date when the matched instruction is not settled.
Also matched instructions which were put on hold will be sanctioned. Settlement failure will not relate only to lack of cash or securities, but also to purposeful hold of instruction preventing it from settlement. Eventual ex-post cancellation of matched instruction will not remove obligation to pay sanction for each day when matched instruction was not settled as cash sanctions will be calculated for events subjected to sanctions and not for failed instructions per-se.
Amount of sanctions
Sanctions will be calculated in accordance with the sanction parameters set by the regulation, market value, type and liquidity of the financial instrument, value and duration of the failure. Regarding the penalty mechanism, the central depositories as such will not increase or decrease these amounts due to fees or other modifications. The full amount will be transferred from failed party to entitled party. Thus fee related to operation of the mechanism will not be included in this process directly, but regular invoice for services provided by the central depository will be issued.
Method of payment
The central depositories will inform the participants on sanctions via daily reports in ISO20022 format, which the participants should check and forward to their clients when required. The payments will be done monthly in net form and similarly as with reporting, it is expected that the participants will pay or receive the sanctions on behalf of their clients. The monthly payments of sanctions will be strictly separated from the monthly invoice for services and the schedule of sanctions will be harmonised on the level of central depositories to which the delegated regulation applies. To ensure smooth payment process of collection and distribution of sanctions which should be done in one day, it is expected that the participants will grant the central depositories Direct Debit authorisation to their cash accounts on which resources for payment of sanctions will be held. Each participant will be delivered a payment notice on expected payment two days before intended settlement day informing on direction and amount of payment, intended settlement day and information on cash accounts.
The participants will be allowed to revise the sanctions during appellate time period. The participants can provide a feedback and eventual correction can be done during the appellate period. The appeal period will last from the day when sanction is applied until middle of next month. After closing of the appellate period it won’t be possible to change amount of sanctions, so sanctions will be definite and unchangeable.
This article is for informative purpose and does not provide binding explanation on application of sanctions. We would like to recommend all participants interested in further details on the penalty mechanism to become acquainted to the regulation and also detail description of the penalty mechanism prepared by the ECSDA (ECSDA Single Settlement Fails Penalties Framework) which should be applicable from the delegated regulation validity date.
(Author: Juraj Aksamít)