European capital markets are ill-prepared for what some executives warn could be a quiet revolution that may produce few tangible benefits but cost the industry up to €35bn a year. Next September new EU rules are due to come into effect that will impose tougher standards on banks and asset managers whose trades fail to settle, either because the buyer does not deliver the funds to pay for the deal, or because the seller does not supply the securities.
These rules will be mandatory and represent a radical change: in the past failures were as likely to be down to IT issues or problems with paperwork as one side defaulting, and were resolved with a few phone calls. The effect may be the opposite of regulators’ intentions. As they surveyed the wreckage of the financial crisis, policymakers focused on reducing stresses in the market, such as investors’ uncertainty that they would receive the goods they had paid for.
Brussels has gone one stage further than other jurisdictions. It has stipulated that failed trades will face a mandatory “buy-in”, in which a counterparty, clearinghouse or central securities depository, would buy back the asset at the prevailing market price after a defined period, and then deliver it to the non-defaulting party. The party that created the failed trade will have to pay the costs for the buy-in, as well as any price differential between the buy-in execution price and the original transaction price.
In a fluid market, those costs may be substantial. However, the extra capital or wider trading spreads that investors and banks may need to set aside in compensation could add up to an additional €35bn in annual costs to trading and make the market less liquid and efficient, according to the International Capital Markets Association.
Small listed companies, corporate bonds and illiquid high-yield or investment-grade credit may bear the brunt of it. The trade association has also warned that only 10 per cent of the industry had “broad awareness” that the change was happening. The introduction of the rules may yet be delayed until November but there is no doubt the change is coming, with the increased cost of doing business a major concern at a time when revenues are reducing.
This event, hosted by the Financial Times, will discuss the implications of this revolution. What will be the impact on investors’ portfolios? What are the operational challenges that banks and asset managers will have to face? What will be the impact of pricing and liquidity on markets? Which markets will it affect most? Will investors be able to buy the securities they want? Will the new rules improve protections for investors?