Settlement Finality Directive (SFD) is the Directive 98/26/EC of the European Parliament and of the Council of 19 May 1998 on settlement finality in payment and securities settlement systems.





Settlement finality represents a crucial element of settlement systems, which their efficiency base on the confidence participants have that they receive full legal and beneficial ownership / title to the relevant asset or payment at the point of settlement.

The SFD was passed to reduce systemic and legal settlement risks in payment and securities settlement systems in the EU, in particular arising from the insolvency.


SFD constitutes an exception to the equal treatment of creditors upon the opening of insolvency proceedings as well as to the principle of universality of insolvency proceedings, however, it was deemed justified by the overriding public interest in avoiding systemic contagion risks throughout the EU.

According to the SFD, the EU Member States may designate systems as qualifying for the purposes of the SFD provided they constitute formal arrangements between three or more participants with common rules and standardised arrangements for the clearing or execution of payment or securities transfer orders between the participants.


The SFD protects a duly designated, notified and published system (SFD system) and its participants – whether domestic or foreign – from the legal uncertainty and unpredictability inherent in the opening of insolvency proceedings against one of their number.


It does so, by stipulating protections for the irrevocability and finality of transfer orders entered into an SFD system, thus, preventing them from being interfered with in such proceedings (settlement finality).


It also provides for the enforceability of the netting of transfer orders, from the effects of the insolvency of a participant.


Furthermore, the SFD ring-fences collateral security provided either in connection with participation in an SFD system or in the monetary operations of the Member States’ central banks or the European Central Bank (ECB) from the effects of the insolvency of the collateral provider.


Finality in respect of securities transfers is achieved by a combination of three provisions in the SFD:


- Article 3 ensures that transfer orders and netting remain legally enforceable against a participant provided the transfer orders are entered into the SFD designated system before the commencement of insolvency,

- Article 5 provides for transfer orders being irrevocable from the moment defined by the rules of the system.

- Article 7 abolishes the ‘zero hour rule’ applied by some Member States to determine the moment at which insolvency proceedings are deemed to take effect,


In addition, Article 9 protects the rights of a system operator or a participant to collateral security provided in connection with a designated system against the insolvency of the participant or a third party that provided the collateral.


Recital 13 of the SFD states that nothing should prevent a participant or a third party from exercising any right or claim resulting from the underlying transaction which they may have in law to recovery or restitution in respect of a transfer order.


An account holder’s remedies for fraud, negligence or other wrong-doing in relation to misappropriated securities are therefore unchanged by the SFD and will depend upon the domestic law of the relevant Member State.

Interlinkages of the SFD with the emissions market



With regard to emissions market it is necessary to be able to designate the point in time when transfers of EUAs or payments in relation to settlement of any EUA or EUA derivatives trade become final and irrevocable - to mitigate the risk of challenge in the event, for example, of the insolvency of one of the parties to a trade or one of the institutions through which the EUAs or cash was being transferred.


Securities under MiFID I were defined as MiFID financial instruments, hence a transfer of EUA derivatives constituted a securities transfer for the SFD purposes, which was not the case as regards a transfer of EUAs.


This has changed under MiFID II (i.e. as from 3 January 2018), which means that the transfers of EUAs between the accounts of different participants are better protected, to the same extent as cash and other assets that are financial instruments used as collateral.


Emission allowances auction platforms


European Commission Consultation document of 12 February 2021 “Review of the Directive on settlement finality in payment and securities settlement systems” contains the following remarks as regards finality status of emission allowances auctioned by the auction platforms.


The Auctioning Regulation requires that an auction platform should be connected to at least one clearing system or settlement system and for the auction platform including the clearing system or settlement system connected to it to implement collateral and other risk management processes necessary to ensure that auctioneers receive full payment regardless of any payment default by the bidder or a successor in title.


Collateral in this context means collateral security as defined in the SFD (“all realisable assets provided under a pledge, repurchase or similar agreement for the purpose of securing rights and obligations arising in connection with a [designated] system”) “including any allowances accepted as security by the clearing system or settlement system”.


The Auctioning Regulation provides that, where a successful bidder is in default of payment, the central counterparty shall interpose itself or the settlement agent shall apply collateral taken from the bidder to effect payment of the sum due to the auctioneer.


This effectively means that the clearing and/or settlement system to which an auction platform is connected has to be a SFD designated system, either because it is a central counterparty or because it needs to take collateral security.


ECC fulfils this requirement. EEX and the ECC require that the auctioneer is a participant and that the auctioned EUAs are held as collateral security in a German law governed escrow account by ECC Lux.


Hence, under the contractual terms of the EEX and ECC arrangements, if a successful bidder fails to make payment, the auctioneer can apply the EUAs and re-auction them.


If the provider of the collateral security were to become insolvent, the SFD would ensure that the rights of the auctioneer should not be affected by the insolvency proceedings.


However, European Commission’s advisors signal that “it is not easy to understand whether and how SFD protections apply to their arrangements relating to EUAs” and believe that “a little more clarity on this point would be helpful to the market”.

Secondary trading of EUAs and EUA derivatives


The concept of collateral security can also be used to protect a collateral taker in a secondary market which is designated as a SFD system where collateral is taken on a pledged basis.

For example, original margin can be provided to the CCP on a pledged or title transfer basis.

Where title transfer is used by a settlement system, the collateral security provisions of the SFD will not apply but the system can protect transfers of cash and securities from the failure of any of the participants in the system (such as settlement agents through whose accounts they are transferred) by designating such transfers as transfer orders and specifying the point at which they become final or irrevocable.



The status of the EU ETS Registry under SFD



The Union EU ETS Registry has not designated as a "system" under the SFD, which means that comprehensive applicability of SFD-protections to transfers of EUAs settled in the Union Registry is not possible.


However, as regards the EU ETS auctions (primary market) this shortcoming is alleviated by the fact that auction platforms have to be connected to at least one clearing or settlement system designated as CCP under EMIR and CSDs under the CSDR.


Also on the secondary market under MiFIR any transactions in derivatives that are concluded on a regulated market have to be cleared by a CCP (access to CCP is also possible for many MTFs and OTFs alike).


Nevertheless, private or OTC trades in EUAs (whether spot or derivative trades) which are not cleared through a CCP and not otherwise processed through an SFD designated “system” are not protected by the SFD (the Registry Regulation’s own provisions on settlement finality help to limit the size of this gap).


In addition, if any derivatives in EUAs are listed on ESMA’s register for mandatory clearing, any OTC trades in those derivatives will benefit from the protections offered by the CCP.


In turn, if derivatives in EUAs are considered suitable for mandatory trading, they will have to be traded on a regulated market, MTF, OTF or third country equivalent trading venue.


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