By Heiko Stuber, senior product manager, financial information, SIX

What trades will we have to pay penalties on and how much will we need to pay? This is still the fundamental question financial institutions face since the Central Securities Depository Regulation (CSDR) Settlement Discipline Regime came into force back in February.

But, as so often is the case with highly complex capital markets regulations, the devil is very much in the detail. CSDR of course requires impacted European CSDs to calculate, collect and redistribute the fines to financial institutions for failing to complete transactions on the Intended Settlement Date and award these penalties to the other side of the transaction. Instead of having a formal agreement between the buyer and seller, there is now a legal obligation for one side to pay a penalty fee, while the other side receives cash if the trade is not settled on time where they are settling through an impacted CSD. Worked out on basis points, these penalties are dependent on the type of instrument transacted, with different rates applying to equities, corporate bonds and government bonds etc.

Questions such as “why is this financial instrument in scope when the main trading venue it is traded on resides outside the European Union (EU)?” are starting to crop up. Questions like this reinforce just how important it is to identify the precise nature of the transactions that fall under CSDR. Classifying financial instruments correctly is crucial, as it has a direct impact on the assignment of the right penalty rate. Herein lies the inherent complexity of the detail that underpins CSDR.

Typically, financial instruments are defined using the Classification of Financial Instruments (CFI) codes. This is a very intricate code used to describe the structure and function of the instrument. Key to ensuring that financial institutions have the right CFIs is having a so-called golden source of data (something that encompasses all the data in every system of record within a financial institution). The intricate nature of CFIs means they require proper quality control checks.

However, it is not just about the issues of providing the correct CFIs. The other challenge is around identifying the closing price on the most relevant trading venue inside the EU, in addition to identifying the trading venue with the highest turnover trades inside the block. In order to support the correct calculation of penalties where a bond fails to settle, ESMA is providing the market identifier codes of the trading venue with the highest turnover for bonds. Penalties would therefore be dished out on the closing price for bonds that fail to settle.

Ultimately, the CSDR Settlement Discipline Regime should not be about financial institutions doing everything in their power to avoid paying penalties. On a contrary, it should be seen as a flagship for broader efforts to bring greater efficiency to the overall settlement process. Unless financial institutions are connected to the right trading venues turning over CSDR related trades, and have accurate CFI codes, then it will not just be the penalties regime they will be failing to adhere to. It will be a failure in the overall approach to settlement efficiency.