It is a recurring theme in this Commentary that market participants take a risk when they underestimate the importance of the post-trade processes. They may be complicated and less glamorous than sub-millisecond trading systems, but if they don’t work well, then the market will not function.
This is well illustrated by a fascinatingly detailed paper by Richard Comotto for the European Repo Council.
It describes the many inconsistencies in market practices, opening hours and membership criteria among the national and international securities depositories that result in settlement failures on repo transactions. In some cases these can give rise to bizarre results. In Italy, for example, it is possible that the opening leg of a repo trade fails to settle, but the closing leg does settle! (Para 8.13.1)
The paper looks in particular detail at the settlement arrangements in Greece, Italy and Spain. These markets were at the centre of the recent financial storm, but it is quite possible that the inadequacies of the settlement infrastructure contributed to whipping up a more serious storm. When markets are stressed and participants have concerns about the creditworthiness of their counterparties, they will be more concerned to avoid settlement failures that leave them exposed. Ironically, the facilities that can help to reduce settlement failure, such as securities lending, also dry up in these periods, further exacerbating the problem.
One could take issue with some of the detailed descriptions of market structures and, in particular, the omission of any discussion of the T2S settlement system as a future solution to many of the issues identified.
Nevertheless, it may not be an exaggeration to lay part of the blame for the crisis in southern European bond markets on the inadequacies of the settlement infrastructure.