Beginning in 2025, financial entities will have to maintain registers of information regarding their use of ICT third-party providers under the Digital Operation Resilience Act (DORA).

DORA is aimed at strengthening the IT security of financial entities and ensuring that the European financial sector can remain resilient in the event of severe operational disruption.

Specifically, the regulation is focused on the harmonisation of rules related to operational resilience for the financial sector, applying to 20 different types of financial entities and ICT third-party service providers.

This dry run exercise initiated by the European Banking Authority (EBA), European Insurance and Occupational Pensions Authority (EIOPA) and European Securities and Markets Authority (ESMA) -the ESAs – will collect information from financial entities through their competent authorities and will act as preparation for the implementation and reporting of registers of information under DORA.

The voluntary exercise will gather the relevant information specified in the ESAs’ final draft implementing standards on the registers of information and report these to respective competent authorities who will ultimately provide those to the ESAs.

The ESAs have confirmed that they will support participating financial entities in: building their register of information in the format as close as possible to the steady-state reporting from 2025; testing the reporting process; addressing data quality issues; and improving internal processes and the quality of their registers of information.

The ESAs will also provide feedback on data quality to participating financial entities and return cleaned files with their register of information, alongside organising workshops and respond to frequently asked questions.

The ad-hoc data collection is set to launch in May, with the financial entities expected to submit their registers of information to the ESAs through their competent authorities between 1 July and 30 August. 

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The European regulator published the report on the feedback received to its call for evidence on shortening the settlement cycle, where it received 81 responses from associations.

Among the responses, the issue of reduced time for post-trade processes was highlighted by respondents, with varying viewpoints on how this can be addressed.

According to ESMA, several associations and individual respondents questioned extending trading hours to accommodate any accelerations of settlement times, with one highlighting that there may be an advantage if there was an earlier official closing time for EU exchanges.

However, one association warned that reduced trading hours would result in a greatly reduced window in which European and American markets would remain open simultaneously – highlighting that EU market volumes are significantly higher during that window.

The possibility of extending market hours is something participants have expressed concern over in recent years. In 2020, buy- and sell-side traders called on the London Stock Exchange and other European venues to shorten equity market opening hours to 9 am to 4 pm GMT, highlighting that the shift could improve the culture and diversity on trading floors and boost intraday liquidity, in response to several industry consultations.

However, exchanges later rejected these bids, following extensive debate, stating that the move would not act as a silver bullet solution for the complex issues around diversity and mental health.

In its report on Thursday, ESMA also stated that a number of respondents, mainly on the buy-side, indicated that T+1 might make pre-matching impossible for them or that they will not be able to afford the extra cost on human resources to get sufficient operational coverage to accommodate T+1 settlement.

Another major takeaway from ESMA’s consultation was that respondents were “almost unanimous” regarding T+0 and have suggested ESMA focus its assessment on T+1. The watchdog said therefore it will focus its work on shortening the settlement cycle on T+1.

With the T+0 window conversation closed, for now, the focus turns to T+1 – which still remains a unique beast in terms of an entire region moving simultaneously.

While many of the concerns raised by market participants mirror those voiced with the US transition, Europe has its own additional challenges due to the sheer number of markets, CSDs, exchanges and CCPs in the region.

In addition, associations highlighted some of the significant time shifts, with one calculating that the available time for post-trade processes in a T+1 environment would be reduced by 82%, from 12 hours to two hours. Another association saw the reduction of the “common working hours” available to finalise the settlement of a transaction drastically reduced up to 92% (from 26 hours to two hours).

Despite these divergent views, many respondents agree on the need to delay the start of T2S night-time settlement (NTS) currently starting at 8pm CET. 

Andrea Gentilini, head of market infrastructures division at ESMA, noted in a social media post that there is strong demand for a “clear signal from the regulatory front at the start of the work and clear coordination between regulators and the industry”.

ESMA did note that, overall, views on whether T+1 should be pursued are “quite mixed”.

“Respondents have highlighted a number of operational impacts that go beyond simple adaptations of post-trade processes,” ESMA said. “From a cost and benefit perspective, while respondents have clearly identified the main areas of focus and have clearly highlighted the negative aspects and the costs, together with a number of benefits resulting from shorter settlement cycles, ESMA has received limited quantitative evidence due to forecasting complexities.”

In order for the regulator to produce its assessment on the appropriateness of shortening the settlement cycle and of the costs and benefits of doing so, ESMA stated that several questions remain to be “further assessed and better understood”. These include – but are not limited to – the impacts on securities lending and borrowing, market making, and the repo market; FX trading; cross-border activities; corporate actions standards; and benefits resulting from margin reductions for cleared transactions.

ESMA said it will also aim to clarify the possible implications of T+1 for retail investors and smaller market players.

The regulator will continue to engage with the industry and has been strongly encouraged to consult with investors located in the APAC region.

ESMA said it will seek to publish the report before 17 January 2025.

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MiCA will cover crypto-assets that are not regulated by existing financial services legislation and is based on the principle of passporting, requiring operators in the space to obtain a single licence to provide crypto-asset services across member states of the EU.

The regulation was developed following increased demand for crypto products and the observable lack of uniform rules around the relatively new asset class.

In the first of three consultation packages, the EU watchdog stated that it is seeking input on proposed rules for crypto-asset service providers (CASPs), related to their authorisation, identification and management of conflicts of interests, as well as how CASPs should address complaints.

ESMA is also looking to gain insight on respondents’ current and planned activities to improve its understanding on crypto-asset markets within the EU and their future development. This will include questions related to expected turnover of the respondents, the amount of whitepapers they plan to publish and the use of on-chain versus off-chain trading.

The EU regulator stated that this aspect of the consultation will remain confidential and will serve to calibrate certain proposals to be inserted in the second and third consultation package. 

“This first consultation package is an important milestone for ESMA in the implementation of the MiCA framework. It translates our ambition to set high regulatory standards in the EU for crypto-asset related activities into concrete requirements,” said Verena Ross, chair of ESMA.

“We are determined to ensure entities involved in crypto-asset related activities understand that the EU is not a place for forum-shopping. We also want to remind consumers that, even with the implementation of MiCA, there will be no such thing as a safe crypto-asset.”

Feedback from this consultation will be considered by ESMA, with the expectation to publish a final report and submit the draft technical standards to the European Commission for endorsement by 30 June 2024.

The full consultation package can be accessed here.

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ESMA will instead ensure a speedy resolution of the issue before the next publication in February next year, covering data from 1 October to 31 December 2022. However, ESMA will maintain the ongoing publication of the liquidity status of newly issued bonds.

ESMA voluntarily publishes the denominators to be used for the performance of the SI test quarterly, which includes the total number of transactions and total turnover executed in the financial instrument/class of financial instruments in the EU. Due to quality issues, ESMA will not perform the publication of the SI calculations for bonds on 1 November 2022.

As a result, investment firms will not need to perform the SI-test for bonds until ESMA publishes the results of the next SI-calculations on 1 February 2023, and the mandatory SI regime will not apply from 15 November 2022 to 14 February 2023. Investment firms will still be able to opt into the SI-regime for all financial instruments.

On 1 February 2023, SI-calculations will be resumed based on an observation period from 1 July to 31 December 2022, and investment firms will be required to perform the SI determination by 15 February 2023.

ESMA stated that it reminds reporting entities of their obligations to continue reporting transparency data also in the absence of the November publications in order to ensure that the transparency data covers trading activity necessary for the next publications.

The publication of the SI-data for equity, equity-like instruments and non-equity instruments other than bonds will not be affected, and will be published as planned on 1 November. Investment firms will be required to perform the SI test for those asset classes and comply with the related obligations by 15 November 2022 as a result.

Similarly, the publication for the purpose of the calculation of cash penalties, which includes information on the trading venue that recorded the highest volume traded for each bond instrument, will be provided by 1 November, as originally intended.

According to ESMA, given that computations are based on trading venue data only, this publication is not affected by the above mentioned quality issues detected in the reporting of the approved publication arrangement (APA).

“We are seeing in addition to deteriorating liquidity in the corporate bond market, increased price volatility, which indicates heightened market risk and makes overall trading conditions harder to execute with precision and best execution objectives,” said Vuk Magdelinic, CEO of fixed income data analytics provider, Overbond.

“In the absence of observable consolidated tape in Europe, and technical issues for ESMA in reporting post-trade data, trading desks are left to internal systems of available vendor solutions to aggregate data and discover price and liquidity in the market. This will certainly be needed for a number of years to come given the pace of regulatory reform and technical implementation difficulties.”

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ESMA stated that it recognises the human cost of Russia’s military aggression against Ukraine, as well as the major challenges that the invasion poses to business activity and the global economic and financial system.

The public statement, which aims to improve investor protection and convergence, provides fund managers with guidance on the appropriate action in situations where exposures to Russian, Belarusian and Ukrainian assets exist, given valuation and liquidity uncertainties. It also outlines how fund managers should evaluate these assets, and whether side pockets should be considered to segregate them.

ESMA wants investment funds to be managed in the best interest of investors, ensuring that fund managers have adequate liquidity management systems in place and that assets receive a fair valuation. 

The regulator stated that as a general principle, fund managers of investment funds with exposures to assets facing liquidity issues need to assess whether a fair value of these assets can still be determined and adapt the valuation without undue delay.

A consistent approach to the valuation of assets needs to be followed by fund managers in line with EU and national law and a one-size-fits-all approach should be avoided, whereby all assets facing liquidity issues are written down to zero by default.

“Where fund managers of investment funds with material exposures to assets facing liquidity issues reach the conclusion that a fair value can no longer be determined, or that the subscription or redemption of shares or units at the current market price is not in the best interest of investors, consideration should be given to suspending temporarily both subscriptions and redemptions as an immediate measure aimed at mitigating the risks of dilution or arbitrage by incoming and outgoing investors,” ESMA said.

In relation to the Russian invasion of Ukraine, managers may assess whether additional actions, rather than a prolonged temporary suspension that prevents existing investors from accessing liquidity, are more desirable from an investor protection standpoint in some situations.

This could include the total write off of the relevant assets, the liquidation of the fund or the segregation of assets that have become illiquid or non-tradable as a result of Russia’s invasion of Ukraine.

The consideration as to whether to use side pockets to segregate assets that have become illiquid or non-tradable is a central question that ESMA is keen to address.

It highlighted two benefits that side pockets could provide. Firstly, investors that require liquidity can still withdraw funds from the liquid portion of the investment fund’s portfolio at a presumably low liquidation cost.

Secondly, the strategy safeguards the interests of investors who want to stay in the investment fund because the fund manager is not forced to liquidate assets at or below market prices in the event of high redemption demand.

ESMA did, however, note that side pockets could potentially pose some risks, including potential moral hazard problems, which some national competent authorities (NCAs) are concerned about.

In addition, illiquid assets transferred to side pockets are not guaranteed to become liquid or acquire value in the future, which means that in some situations, writing off relevant assets from the start could have saved investors’ money on side pocket development.

Looking at the next steps ESMA intends to take, the securities markets regulator said it would “continue to closely monitor the situation and take or recommend any measures necessary to mitigate the impact of the Russian invasion of Ukraine on investment funds.”

The full public statement can be found here.

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The invasion of Ukraine by Russia and its economic ramifications have worsened the outlook for growth and inflation, and increased market volatility. Market resilience will be determined by markets’ and financial institutions’ ability to deal with the economic effects of Russia’s invasion of Ukraine, as well as their ability to resist changes in monetary and fiscal policy support without causing substantial disruptions.

The EU economy was on course to make a robust recovery from the Covid-19 pandemic-related crisis and the financial sector proved to be largely resilient. However, new waves and variants of the virus, concerns about inflation risk, rising commodity prices and increased geopolitical risks, along with the Russian invasion, have hampered the recovery.

Over time, the financial system has seen additional vulnerabilities and risks build up. Persistently low interest rates alongside accommodative monetary policies have driven “search for yield” behaviour that has made financial markets vulnerable to a deteriorating market sentiment, particularly if financial conditions should tighten unexpectedly due to inflationary pressures.

“Financial institutions and supervisors should prepare for a possible deterioration of asset quality in the financial sector,” stressed ESMA.

“Fund liquidity needs to be closely monitored should market liquidity deteriorate in case of wider market stress.”

The report also recommended that institutions incorporate ESG considerations into their business strategies, and warned against the possibility of increased cyber-attacks.

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The breaches relate to failures in ensuring the integrity of data and providing direct and immediate access to regulators, and were committed between 2017 and 2020. Five out of eight breaches were found to have resulted from negligence on the part of REGIS-TR.

ESMA criticised REGIS-TR for generating incorrect reports, failing to provide reports within the specified time limits and omitting data in the reports due to wrong rejections. The regulator also found that REGIS-TR failed to ensure the integrity of reported data, and incorrectly rejected data that had in fact been correctly reported by the relevant parties.

In addition, the repository committed three further breaches resulting in the provision of wrong and unreliable reports to regulators, by failing to verify the correctness and completeness of the data received.

“In calculating the fine for negligent infringements, ESMA considered both aggravating and mitigating factors under EMIR,” said ESMA.

The announcement comes just two days after the trade repository’s UK branch, REGIS-TR UK, was awarded a full EMIR reporting license by the UK’s Financial Conduct Authority (FCA), the first trade repository to receive one post-Brexit.

“We have had a successful start to UK EMIR reporting since it began in January last year, and we are delighted to be the first TR to receive our full license from the FCA,” said REGIS-TR UK CEO John Kernan at the time.

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Despite monthly fails never hitting the highs of March 2020 when percentages leapt to 14%, the one-year moving average still sat at around 8% towards the end of 2021, significantly higher than pre-pandemic levels. Three spikes in monthly fails figures also occurred between November 2020 and June 2021 where levels neared 12%.

“We’ve seen a fairly sustained high level of settlement failures within the European equities markets over the last two years, noticeably higher than the previous five years,” said Virginie O’Shea, founder of Firebrand Research.

“The volatility of the markets during the pandemic and the ongoing pressure on a smaller number of operational staff to cope with increased workload are partially to blame.”

The numbers are especially alarming given the introduction of the Settlement Discipline Regime (SDR) on 1 February, which enforces penalties for failed trades.

The levying of cash penalties is designed to improve settlement discipline by encouraging market participants to settle trades in a more timely fashion. The penalties – which range from 0.5 bps (basis points) to 1 bps depending on the nature of the financial instrument involved – will apply to securities which are either traded on an EEA exchange or cleared in an EEA central counterparty clearing house. Under the rules, central securities depositories (CSDs) are entrusted with imposing the cash penalties on the counterparty responsible for the failed trade. If the trade has failed because of an error further down the settlement chain, then the CSD participant is within their right to pass down the costs of such penalties to the at-fault entity(ies).

“These latest findings from ESMA reinforce why reducing settlement fails must be a primary goal for all market participants,” said Daniel Carpenter, head of regulation at Meritsoft (a Cognizant company).

“Huge strides have been made as banks prepared for the CSDR penalty regime introduced earlier this month, but this is only one part of the story. What’s needed is a better understanding of when, why and with which counterparties trades are failing to settle. All the relevant data from across the organisation needs to be centralised and accessible to enable any meaningful analysis of fails. Only then can banks take steps to address the operational inefficiencies and counterparty relationships that are impacting their profitability and, in so doing, reduce their overall fail rates.”

The European Securities and Markets Authority (ESMA) noted in its report on trends, risks and vulnerabilities that rising settlement fails remains a moderate risk in the markets. The regulator added that equity settlement fails remained more frequent than before the COVID-19 crisis and slightly above 2H20 levels across asset classes.

“These latest findings from ESMA show there is still room for improvement when it comes to driving settlement efficiency across the industry,” said Philip Slavin, CEO of Taskize. “However, there is evidence to suggest progress is being made with the more complex issue that require humans to come together to effect swift resolution. Our clients are currently reporting up to a 70% reduction in issue resolution time and a 90% reduction in operational emails.”

O’Shea noted that there was a lot of reticence to spend prior to the introduction of SDR due to the assumption that all of the requirements would be delayed. She added that the increase in failures across asset classes strengthens the case for investment in technology.

“We can expect settlement penalties to be the real driver over the next year or so to kick these projects into gear,” O’Shea explained.

“Financial institutions have spent years offshoring and downsizing their operations teams but there hasn’t been enough focus on modernising post-trade systems.

“No one likes to spend on the plumbing and the delays to CSDR have not helped firms to prepare for the changes that went into force this month.”

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Originally coming into force in January 2018, the introduction of MiFID II changed the way that costs and charges were presented.

As part of improving investor protection, MiFID II requires investment firms to disclose far more comprehensive information around costs and charges, with the goal of improving transparency and competition, exerting downwards pressure on charges, and helping clients to make more informed decisions about who they want to trade with.

However, the new requirements caused some initial confusion amongst investors, especially retail investors, with different firms using different methodologies, making cost comparisons confusing.

Conducted throughout 2022, the focus of ESMA’s latest CSE will therefore be on how firms provide information to retail clients, with an emphasis on making sure that disclosures are fair, clear and not misleading; provided in a timely manner; based on accurate data reflecting all explicit and implicit costs and charges; and reveal any inducements.

“ESMA believes this initiative and the related sharing of practices across NCAs, will help ensure consistent implementation and application of EU rules and enhance the protection of investors in line with ESMA’s objectives,” said the regulator.

ESMA last updated its guidance on the matter in December 2020, when it updated its Q&A on the implementation of investor protection topics under MiFID II/MiFIR with a new entry providing guidance on how firms should present ex-post costs and charges information to clients in a “fair, clear and not misleading manner”.

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Verena Ross will take on the role, replacing Steven Maijoor who served the maximum term as chair of ESMA, having held the position since April 2011.  

Ross will start her new position on 1 November 2021 and is appointed for a five-year term, renewable once.

Ross’ appointment was confirmed by the Council of the European Union at its meeting in Brussels.

“I am extremely delighted to welcome Verena’s appointment as the new Chair of ESMA. She brings with her an in-depth knowledge of European and global markets as well as of ESMA itself, which will be invaluable and I am, along with the Board of Supervisors and Management Board, looking forward to working with Verena,” said Anneli Tuominen, interim chair.

“For my own part it has been an honour to lead ESMA for the last 7 months and I want to thank ESMA staff for their commitment and praise them for their high level of expertise. My thanks also to my colleagues on the Management Board and Board of Supervisors for their support.”

Ross has been promoted to the position of chair after serving as executive director at ESMA from 2011 to 2021.

Prior to this, Ross held regulatory and supervisory roles in London, most recently acting as director of Financial Services Authority.

“I am honoured to have been entrusted with this role as ESMA enters its second decade. I am looking forward to working with the Board members, ESMA staff and our stakeholders in responding to the challenges and opportunities faced by the European Union and its capital markets,” said Ross.

“I believe that ESMA has an important role to play in ensuring that European markets support the financial needs of its companies and citizens.”

Earlier this year ESMA announced that Natasha Cazenave would replace Ross as its new executive director, joining ESMA from the Autorité des Marchés Financiers (AMF).

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