On Tuesday 19 November, the European Securities and Markets Authority (ESMA) published technical advice to the European Commission on the penalty mechanism under the Central Securities Depositaries Regulation (CSDR). 

The EU CSDR includes measures to prevent and address failures in the settlement of securities transactions, such as cash penalties for the responsible CSD participants in case of settlement fails that rise with each passed day. The penalties regime entered into force on 1 February 2022 and was amended as part of the CSDR REFIT. As the regime only resulted in a small reduction of settlement fails, ESMA was mandated to provide Technical Advices on three overlapping issues - most notably on alternative methods for calculating penalties, including progressive penalty rates. Further to a December 2023 consultation paper on this, the issues have been combined into a single Final Report with view to advising the European Commission on amending the delegated act defining the parameters for the calculation of cash penalties. The technical advice was published a day after the publication of ESMA's report on T+1, linking the necessity of improving settlement efficiency to an EU transition to an accelerated T+1 settlement cycle. 

In summary, ESMA:

• Proposes to maintain the design of the current penalty mechanism (abstaining from introducing any fundamental changes) and limiting changes to an "overall moderate increase of the penalty rates, in full alignment with the current types of settlement fails and targeting most asset classes". The underlying rationale for the increase is to render the rates higher than related securities lending and borrowing rates, which should act as an incentive for market participants to borrow the securities and cure the settlement fails. The outlook regarding a potential suspension of the cash penalties in the context of the transition to T+1 remains unchanged - the European Commission will consider alleviating measures but, in the words of ESMA, only given "substantial evidence from market participants in the context of the governance for T+1".
• Endorses the use of other comparable interest rates of the European Central Bank and the relevant central bank to calculate a proxy for penalty calculation in cases where an overnight interest credit rate due to the monetary policy of the central bank issuing the settlement currency is not available.
• Supports usage of oldest available reference prices for the calculation of late matching fail penalties (conditional on the settlement date being beyond 40 business days in the past from the matching date) and recomends amending corresponding Level 2 provisions.

The European Commission will consider ESMA's technical advice when deciding how to amend the relevant delegated act.

If you have any questions, please contact Aniqah Rao.