Settlement
All settlement instructions in the CREST system involving Lehman participants were frozen on 15 September, shortly after the court order appointing joint administrators to LBIE. This was essential to ensure that, amongst other things, any trades which had been closed out (following declarations of default by exchanges or clearing houses) did not settle in the CREST system. If settlement had not been frozen, settlement of transactions which had been closed out would have been contrary to the terms of the contracts and applicable default rules and would have caused a serious market impact with very large numbers of ‘incorrect’ settlements where the underlying contract had been replaced by a net cash obligation. These would all have to have been subsequently unwound.
It is important to recognise that the status of the settlement instructions in the CREST system have no effect on the terms or status of the underlying trade contract. The underlying contract would need to be dealt with in accordance with the default rules of any relevant exchange or central counterparty, or indeed under default or close-out provisions contained in the contract itself (for example in relation to ‘over the counter’ transactions not subject to specific exchange default rules).
When a settlement instruction becomes irrevocable in the CREST system (for example, when the two counterparty inputs in relation to a ‘DEL’ delivery instruction are matched), this means the settlement instruction is not capable of unilateral revocation by one counterparty. Such settlement instructions may then proceed to settle, with the protection that one counterparty (or an administrator or liquidator of one party) can’t subsequent seek to challenge or unwind the settlement.
However, there is no ‘guarantee’ that such irrevocable instructions will proceed to settlement. There are various factors which may prevent this or otherwise make it inappropriate, such as availability of stock and cash in the transferor’s/payer’s account, and the fact that the transaction may have been closed out. There is no ‘ring-fencing’ or other appropriation of a transferor’s assets in the CREST system by reason of the irrevocability of a settlement instruction which can guarantee settlement of particular instructions in relation to particular securities. In addition, participants and their CREST settlement banks are not irrevocably committed to making payment until the point of settlement.
Euroclear UK & Ireland (“EUI”) announced on 18 September that:
- all settlement instructions in the CREST system involving Lehmans were not being included in CREST settlement;
- counterparties to trades which had been closed out under exchange or central counterparty default rules should match delete the related settlement instructions in the CREST system. EUI confirmed that such settlement instructions would not settle in CREST. Parties were able to input match delete instructions at this point;
- for 'over the counter' trades (ie those not subject to exchange or central counterparty default rules), the counterparties should contact and reach agreement with the joint administrators.
EUI proceeded to issue bulletins when appropriate, and when able to do so, to keep the market informed as to steps it was taking.
It subsequently became apparent that a market solution, as to how OTC trades and their related settlement instructions in CREST should be handled, was not going to be reached. In addition, the large number of unsettled instructions in the CREST system were causing risks for the CREST system and its participants, impacting operational efficiency and causing uncertainty for CREST participants.
As a consequence, EUI took action to resolve the situation in relation to the CREST system. With the agreement of the FSA, EUI directed on 8 October that Lehmans and all counterparties should input match delete instructions into CREST to remove all settlement instructions from the system. Counterparties proceeded to do so over the next 14 days.
EUI also made clear that the status of the underlying contracts would be unaffected by the deletions of the settlement instructions and that counterparties would need to continue to work with the administrators in relation to such contracts.
