Exchanges, Clearing & Settlement and TARGET2 Securities Richard Derksen

De Nederlandsche Bank Eurosysteem

Exchanges, Clearing & Settlement and

TARGET2 Securities

Richard Derksen

2nd Conference of Macedonian Financial Sector on Payments and

Securities Settlement Systems

Ohrid

30 June 2009

De Nederlandsche Bank


Agenda

The world of securities and exchanges

Risks in clearing and settlement of securities

What´s going on in Europe?Code of Conduct clearing & settlementMarkets in Financial Instruments Directive (MiFID)

Consequences for central banks

TARGET2 Securities


Securities chain

trading

clearing

settlement

Agreement to exchange securities for funds

Calculation of obligations

Delivery of securities and payment of funds


custodian

CSD Issuer

custodian

Agentbank

National Central

Bank

Agentbank

Agentbank

Agentbank

Agentbank

Agentbank

Investor InvestorInvestorInvestorInvestor Investor Investor

Clearing & settlement infrastructure

CCP

Exchanges


Entities in securities

Issuer/Investor

ICSDs

Custodians

Issue/hold securities

CSDsCentral securities depositories: storehouses for securities and domestic settlement services providers

International central securities depositories: international settlement services providers, CSDs for EurobondsNational and international settlement services providers, typically banks

CCPsCentral counterparties: central providers for clearing services

Exchanges platform for trade in securities

Agent Bank Executes transactions for customers

NCB National Central Bank; provides settlement services, oversight


Life cycle of securities transactions

Transactions (by a telephone call or system)Entry in a system (buy or sell)ValidationAuthentication & authorisationMatching & confirmation ClearingMoney settlement (usually t+3)Securities settlement (usually t+3)Custody (corporate actions)


Exchanges, CCPs and CSDs - basic model

EURONEXTTrading

Buyer/Seller

ENL

LCH.Clearnet SA

EUROCLEAR Nederland

Trading Member

DepositoryAdmitted

Institution

ClearingMembersClearing

Securities settlement

DNB / T2Cash settlmn.


Clearing / CCP

Role: Trade confirmation Netting CCP = central counterpartyIssues: Counterparty credit risk concentrates at CCP. Default

CCP might affect the whole financial system (so… Oversight)

Clearing HouseClearing Member Clearing Member


Central counterparty

CCP = central counterpartyInterposes itself between buyer and seller of a security Guarantees clearing and settlement towards market

participant Takes over exposure counterparty credit riskNovation: contract between buyer and seller replaced by

contract between buyer and CCP and seller and CCP

Pro: Decrease counterparty credit risk; CCP risk management for clearing member Cost reduction Trade benefits


CSD: settlement

ENL

EUROCLEAR Nederland

Settlement (ESES)

Depository

DNB / TARGET2

Securities account A

Securities account B

Cash account A

Cash account BDVPRole:• Recording of changes in legal titles resulting from securities

transactions• Exchange trades settle on T+3

Issues:• DVP: delivery versus payment to limit principal risk (Herstatt

risk)• SFD: Finality offers protection against unwinding

Cash account A

Cash account B


Role:• Maintenance of securities accounts• Facilitating reconciliation with any official register• Facilitating the exercise of securities holders’ rights and

corporate actions

Issues:• Immobilisation and demateralisation• Operational risk

CSD: Depository

Euroclear NederlandCentral Securities Depository (CSD)

Aangesloten InstellingenAangesloten

InstellingenAangesloten InstellingenAangesloten

InstellingenAangesloten InstellingenAdmitted

Institution


Role of central banks

Services in central bank moneyCash settlement in TARGET2: DVP model 2 (with ESES DVP model 1)

Collateral management for CCPsAnd in the future… TARGET2Securities (Pan- European platform for settlement of trades, 2013)

OversightFinancial stability – limit systemic riskLimit losses of participantsLimit contagion to other marketsEnhance confidence in payment systems


European developments

Lisbon agenda 2010: European economy has to become stronger to compete with the USA and Japan/China

National markets in Europe have remained isolated, cross border transactions too complex, too costly: there is no integrated European financial market

Importance of clearing and settlement of those trades for smooth functioning of the financial system: inefficiencies have serious consequences

European Union has identified 15 barriers for integration (Giovannini 2001) Technical, market practices (10) Legal and fiscal barriers (5)


What is the status of integration…

Too high settlement costs

0

5

10

15

20

25

30

35

UnitedStates

EUdomestic

EU cross-border

Min Max Avg.

- EU domestic costs range from

0.35 to 3.43 €;

- … and are higher than US

(+ 0.10 to 2.90 €);

- Cross-border costs higher than

domestic ones (19.5 to 35.0 €).

Source: Oxera, LSE, CEPS


Integration & consolidation

Financial integration for all market participants:

• Equal access

• Uniformal set of rules

• Treatment in an equal way

Consolidation means a less number of service providers


Integration models in Europe

CBISSO (IE)

Euroclear

Euroclear (ICSD) CIK (BE)

Euroclear (FR) Euroclear (NL)

Crest (UK)

Horizontal integration

Clearstream

Eurex Clearing

DeutscheBörse

Vertical integration


Dynamics in the securities market

Market integration, level playing field and harmonisation

Consolidation of exchanges and SSSs in the market goes full speed on

Markets in Financial Instruments Directive Code of Conduct for Clearing and SettlementCESAME Group to lift technical, market

practices Giovannini barriersInternalisation: huge banks settle transactions

internally


Post trade market in Europe

No central system as in the US, but still very fragmented

Different models: horizontal, vertical, user-owned, demutualised…

High cross border tariffs, (semi) monopolies, low competition

No EU Directive for clearing and settlement… so no European passport for cross-border services


Post trading infrastructures US

Clearing

Settlement cash

Trading

NSCC

DTC

NYSE NASDAQ

FICC

FED

FEDERAL RESERVE

Settlement securities


Post trading infrastructures EU

Clearing

Settlement cash

Euronext

Amsterdam + Brussels + Lisbon + Paris

Luxembourg Stock

Exchange

Oslo Bors OM

Nasdaq HEX

GPW

Trading

Clearnet SA LCH

LCH.Clearnet Group ltd

Euronext


Euroclear

Nederland

CIK Euroclear

France

Crest Co

BOEBdFNBBDNB

London Stock

Exchange

Borsa Italiana

CC&G

Monte Titoli

Banca d´

Italia

Deutsche Borse

Eurex Clearing

Bundesbank

Clearstream

BL

Clearstream

BF

BCL Nordic central banks

VPS

Nordic CSD

Banca d´

Espana

Iberclear

Bolsa y

Merc. Esp.

KDPW

CRBS

Bk of Poland

TARGET2



EU initiatives for more efficient securities markets in Europe 1. Code of Conduct

The solution from EU commissioner McCreevy (2006) Selfregulation: Code of Conduct Signed by 60 EU exchanges, CCPs and CSDs in

November 2006 Objective: stimulate competition and decrease

cross-border cost 3 parts

Price transparancy – 1 January 2007 Interoperability – 1 July 2007 (Guideline) Unbundling & account separation – 1 January 2008


EU initiatives for more efficient securities markets in Europe – 2. MiFID

´Markets in Financial Instruments Directive´, 1 November 2007

MTF: alternative trading platforms next to regulated markets

Best execution moves trading to markets that offer the best price

Art 34 and 46: the right of a market participant to access remotely a foreign

CCP and/or CSDThe right of a regulated market/MTF to choose a particular

CCP/ CSDNo double regulation


Results until now…

Code of Conduct – around 2 yearsMiFID – nearly 1 yearGuideline on Interoperability – 1 year

Results:New MTFs and in their slipstream… New CCPsAround 90 requests for interoperability (links

between CCPs and CSDs)


Results till now…

Negative:- Increased fragmentation and complexity- No European passport, so a regulatory mess- Not 1 link realised

Positive:+ Increased competition+ Breaking down monopolies+ Significant reduction in tariffs (in the

Netherlands clearing cost from 0.65 eurocent to 0.05 eurocent per trade)


Complexity European market increases

EU market =Incumbent

trading, clearing and settlement

+ …

Clearing

Settlement cash

Euronext


Luxembourg Stock

Exchange

Oslo Bors OM

Nasdaq HEX

GPW

Trading

Clearnet SA LCH

LCH.Clearnet Group ltd

Euronext


Euroclear Nederland

CIK Euroclear

France

Crest Co

Bank of Englnd

Banq. de

France

NBBDNB

London Stock

Exchange

Borsa Italiana

CC&G

Monte Titoli

Banca d´

Italia

Deutsche Borse

Eurex Clearing

Bundesbank

Clearstream

BL

Clearstream

BF


VPS

Nordic CSD

Banca d´

Espana

Iberclear

Bolsa y

Merc. Esp.

KDPW

CRBS

Bk of Poland

TARGET2



Complexity European market increases

… MTFs and

new CCPs

Clearing:

New and existing CCPs

Settlement cash

Equiduct Chi-X BATSTrading:

MTFs

EuroCCP LCH.Clearnet SA

Turquoise

Euroclear

Nederland

CIK Euroclear

France

Crest Co

Bank of Englnd

Banq. de

France

NBBDNB

Smartpool Bluenext

EMCF

Monte Titoli

Banca d´

Italia

Bundesbank

Clearstream

BL

Clearstream

BF


VPS

Nordic CSD

Banca d´

Espana

Iberclear

Nasdaq OMX

KDPW

Bk of Poland

TARGET2


Citibank Fortis Bank NederlandSettlement agents


Consequences for central banks

Services in central bank moneyCash settlement also for MTFs and new CCPs – national silo´s disappear

Collateral management for new CCPs

OversightWhat stability risks come with

New CCPs and their settlement agentsIncreased complexityInteroperabiliteit

Rely on foreign regulators, supervisors and overseers (MiFID art 34 and 46)


Risks in clearing and settlement of securities

Risks

risk of settlement bank failure

liquidity risk

systemic risk

credit risk:• replacement cost risk• principal risk

custody risklegal risk

operational risk


Risks

Credit risk:The risk of loss from default by a participant,

as a consequence of its insolvency

Replacement cost risk Principal risk


Risks

Risk that full value of securities or funds will be lost when either the seller or buyer fails to settle

Can be eliminated by Delivery versus Payment

Principal risk


Delivery versus Payment (DvP)

Securities cash

NCB

Bank A Bank B

Sell Order Buy Order

CSD

A

B

A

B

1 ^1

2 ^2

3^3

DvP


DvP in practice

Sell/buy transactionThe CSD blocks the securities in the account

of the seller, followed by sending a payment instruction to the NCB

The central bank transfers the funds from the buyer’s to the seller’s account and sends a confirmation to the CSD

The CSD move the securities from the seller’s to the buyer’s account


Risks

Risk of loss of unrealised gains

Due to price changes between trade and settlement

Exposure depends on price validility and time gap between trade settlement (i. e. t+3)

Replacement cost risk


Risks

Failure of bank providing cash accounts for payments Impact particularly severe if all CSDs use the same Approaches to control: use of the central bank money,

limited purpose bank

Risk of failure of a

settlement bank


Risks

Failure of one institution could cause other institutions to fail

Liquidity and credit problems may disrupt financial markets

Liquidity is dependent on confidence in reliability of SSS

Oversight function central bank

Systemic risk


Risks

Risk that counterparty will not settle an obligation when due

Costs depend on degree of liquidity

Potential to create systemic problems

Liquidity risk


Risks

Risks that securities are not adequately protected by the custodians

Either full loss or temporary inability to transfer securities

Segregation of accounts

Custody risk


Risks

Due to deficiencies in systems and controls, human error or management failure

Due to uncertain legal rules (unenforceability of contracts, bankruptcy laws, delay in recovering funds or securities)

Operational risk

Legal risk


What is T2S?

An integrated settlement platform of the Eurosystem for the DVP settlement of securities transactions in central bank money within the euro area : - All securities which have to be transferred- Cash needed for settlement

Supports the integration of the securities settlement market infrastructure

Making cross-border transactions domestic ones in the Eurozone

The extension to other currencies will also be possible


OeKB

Clearstream FFM

Euroclear FR

Iberclear

Monte Titoli

The current initiatives:

Clearstream Lux

Euroclear BE

Euroclear NLNTMA

SCL Bilbao

CSD SA

BOGS

APK

SCL Valencia

SCL BarcelonaInterbols

aSiteme

NBB Clearing

Why (1)?Deutsch Börse Gruppe

Euroclear GroupT2S: a workable solution for DVP cross-border settlement of securities within central bank money


Why T2S (2)?

The model can offer advantages in terms of efficiency and cost-cutting

provided that a critical mass of CSDs actually join and the system can be developed at reasonable costs

Commitment CSDsCost estimations to be further investigated

It will benefit financial stability (enabling cross border securities settlement in Central Bank Money)


T2S concerns only settlement in central bank money

Background: Essential concepts

Investor

Investor bank

Custodian bank or ICSD

CSD

central bank money

commercial bank money


INVESTORCSD

INVESTORCSD

SETTLEMENTSETTLEMENT

TRADINGTRADING

ISSUERCSD

ISSUERCSD

ISSUERISSUER INVESTORINVESTOR

CCPCLEARING

CCPCLEARING

CASHCLEARING

CASHCLEARING

BANK &BROKER

BANK &BROKER

LISTINGLISTING

EXCHANGE

CSD CENTRAL BANK

CLEARINGHOUSE

Traditional roles in securities market


Securities accounts at the centre

INVESTORCSD

INVESTORCSD

T2SSETTLEMENT

T2SSETTLEMENT

TRADINGTRADING

ISSUERCSD

ISSUERCSD

ISSUERISSUER

INVESTORINVESTOR

CCPCLEARING

CCPCLEARING

CASHSETTLEMENT

CASHSETTLEMENT

BANK &BROKER

BANK &BROKER

LISTINGLISTING

EXCHANGE

CSD

CENTRAL BANK

CLEARINGHOUSE

SECURITIES ACCOUNTS


How?

CSDs outsource the administration of securities accounts to T2S

Credit institutions transfer cash to T2S, real time DVP is now possible

During or at the end of the day the securities return to the CSDs and the money goes back into the TARGET2 payment system

CSDs retain the remaining functions such as custody and notary functions


TARGET2

TARGET2 – Securities outside of operating hours

Euroclear (BE, FR, NL)

Securities accounts

Siteme

Securities accounts

BOGS

Securities accounts OeKB

Securities accounts

NBB Clearing

Securities accounts

TARGET2 - Securities

Clearstream

Securities accounts

Monte Titoli

Securities accounts

Iberclear

Securities accounts

APK

Securities accounts

NTMA

Securities accounts

Other CSD’s OeNB, NBB, BBK, BdE, BoF, BdF,BoG, CBFSAI, BdI, BcL, DNB, BdP Securities

accounts

Cash accounts


Securities accounts

Siteme

Securities accounts


Securities accounts

Siteme

Securities accounts


Euroclear (BE, FR, NL) Siteme BOGS

OeKB

NBB ClearingTARGET2 - Securities

Clearstream

Monte Titoli

Iberclear

APK

NTMA

Other CSD’s

OeNB, NBB, BBK, BdE, BoF, BdF,BoG, CBFSAI, BdI, BcL, DNB, BdP

Sub-cash accounts

Securities accounts

TARGET2

TARGET2 – Securities during the operating hours

Cash accounts


What is T2S?

Where are the benefits coming from 3 sources of cost savings

fee savings: economics of scaleelimination of the cross-border aspect

collateral savings (single pool of collateral) back-office savings (one or few technical interfaces)

Non-quantifiable benefits driver for harmonisation enhanced competition in market infrastructure market liquidity (dynamic effect)


Uncertainties

Success of T2S depends on the decision of the CSDs to participate (voluntary)

Concentration of risk, monopolisation of settlement Prerequisite of the project: harmonisation of legal

structures and operating rulesRemoval Giovannini barriers, especially

Barriers 4, 6 and 7: T2S may ensure common operating hours and finality rules for domestic and cross border transactions


The T2S User Requirements

Scope of assetsAll types of securities which CSD’s are settling today (debt

instruments, equities, investment funds, warrants)

Scope of servicesWhole life cycle of a transaction: receiving settlement

instructions, providing matching facilities, verifying availablity of securities and CeBM etc

T2S Four central banks develops the platform: Deutsche

Bundesbank, Banco de Espana, Banque de France, Banca d’Italia


Legal issues

Legal basis Article 22 Statute ESCB/ECB Enables the Eurosystem to provide facilities to

deliver efficient and sound clearing and payment systems

GovernanceThe infrastructure will be wholly owned by the

Eurosystem(I)CSDs and users are involved during

specification phase


Impact T2S

Fosters competition among CSDs Reduces intermediary costsReduces collateral needs and costsReduces back-office costs Facilitates cross border business with easier

and cheaper cross-CSD settlement.


Timetable T2S

July 2008: Decision Governing Council to launch T2S

2009: Specification- and development phasePossibilities External (non-Euro zone) CSD settlement

2010-2012: Building, Testing and Migration phase

2013: Operational phase


Thank you very much !

Any quu€€stions?stions?

Exchanges, Clearing & Settlement and TARGET2 Securities Richard Derksen

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Transcript of Exchanges, Clearing & Settlement and TARGET2 Securities Richard Derksen