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De Nederlandsche Bank. Exchanges, Clearing & Settlement and TARGET2 Securities Richard Derksen 2nd Conference of Macedonian Financial Sector on Payments and Securities Settlement Systems Ohrid 30 June 2009. Agenda. The world of securities and exchanges

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De Nederlandsche Bank

Exchanges, Clearing & Settlement and

TARGET2 Securities

Richard Derksen

2nd Conference of Macedonian Financial Sector on Payments and

Securities Settlement Systems

Ohrid

30 June 2009


Agenda
Agenda

  • The world of securities and exchanges

  • Risks in clearing and settlement of securities

  • What´s going on in Europe?

    • Code of Conduct clearing & settlement

    • Markets in Financial Instruments Directive (MiFID)

  • Consequences for central banks

  • TARGET2 Securities


Securities chain
Securities chain

Agreement to exchange securities for funds

trading

Calculation of obligations

clearing

Delivery of securities and payment of funds

settlement


Clearing & settlement infrastructure

Exchanges

CCP

National

Central

Bank

Issuer

CSD

custodian

custodian

Agent

bank

Agent

bank

Agent

bank

Agent

bank

Agent

bank

Agent

bank

Investor

Investor

Investor

Investor

Investor

Investor

Investor


Entities in securities
Entities in securities

Issue/hold securities

Issuer/Investor

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

CSDs

International central securities depositories: international settlement services providers, CSDs for Eurobonds

ICSDs

National and international settlement services providers, typically banks

Custodians

platform for trade in securities

Exchanges

Central counterparties: central providers for clearing services

CCPs

Executes transactions for customers

Agent Bank

National Central Bank; provides settlement services, oversight

NCB


Life cycle of securities transactions
Life cycle of securities transactions

  • Transactions (by a telephone call or system)

  • Entry in a system (buy or sell)

  • Validation

  • Authentication & authorisation

  • Matching & confirmation

  • Clearing

  • Money settlement (usually t+3)

  • Securities settlement (usually t+3)

  • Custody (corporate actions)


Exchanges ccps and csds basic model
Exchanges, CCPs and CSDs - basic model

Buyer/

Seller

EURONEXT

Trading Member

Trading

Clearing

Members

LCH.Clearnet SA

Clearing

EUROCLEAR Nederland

Securities settlement

ENL

DNB / T2

Admitted

Depository

Cash settlmn.

Institution


Clearing ccp
Clearing / CCP

Clearing Member

Clearing Member

Clearing House

Role:

  • Trade confirmation

  • Netting

  • CCP = central counterparty

    Issues:

  • Counterparty credit risk concentrates at CCP. Default CCP might affect the whole financial system (so… Oversight)


Central counterparty
Central counterparty

CCP = central counterparty

  • Interposes itself between buyer and seller of a security

  • Guarantees clearing and settlement towards market participant

  • Takes over exposure counterparty credit risk

  • Novation: 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
    CSD: settlement

    EUROCLEAR Nederland

    Depository

    DNB / TARGET2

    ENL

    Settlement (ESES)

    Securities account A

    Securities account B

    Cash account A

    Cash account B

    Cash account A

    Cash account B

    DVP

    • Role:

    • 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


    Csd depository
    CSD: Depository

    Aangesloten

    Aangesloten

    Instellingen

    Aangesloten

    Euroclear Nederland

    Instellingen

    Aangesloten

    Instellingen

    Central Securities Depository (CSD)

    Aangesloten

    Instellingen

    Admitted

    Instellingen

    Institution

    • 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


    Role of central banks
    Role of central banks

    • Services in central bank money

      • Cash settlement in TARGET2: DVP model 2 (with ESES DVP model 1)

      • Collateral management for CCPs

      • And in the future… TARGET2Securities (Pan- European platform for settlement of trades, 2013)

    • Oversight

      • Financial stability – limit systemic risk

      • Limit losses of participants

      • Limit contagion to other markets

      • Enhance confidence in payment systems


    European developments
    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
    What is the status of integration…

    Too high settlement costs

    - EU domestic costs range from

    0.35 to 3.43 €;

    - … and are higher than US

    (+ 0.10 to 2.90 €);

    - Cross-bordercosts higher than

    domestic ones (19.5 to 35.0 €).

    Source: Oxera, LSE, CEPS


    Integration consolidation
    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

    Vertical integration

    Deutsche

    Börse

    Eurex Clearing

    Clearstream

    Integration models in Europe

    Horizontal integration

    Euroclear (ICSD)

    CIK (BE)

    Euroclear (FR)

    Euroclear (NL)

    Crest (UK)

    CBISSO (IE)

    Euroclear


    Dynamics in the securities market
    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 Settlement

    • CESAME Group to lift technical, market practices Giovannini barriers

    • Internalisation: huge banks settle transactions internally


    Post trade market in europe
    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

    Trading

    NYSE

    NASDAQ

    NSCC

    FICC

    Clearing

    DTC

    FED

    Settlement securities

    FEDERAL RESERVE

    Settlement cash

    Post trading infrastructures US


    Post trading infrastructures eu

    Trading

    Euronext

    Amsterdam + Brussels + Lisbon + Paris

    Euronext

    Amsterdam + Brussels + Lisbon + Paris

    London Stock Exchange

    Borsa Italia

    na

    Deut

    sche Borse

    Luxembourg Stock Ex

    change

    Oslo Bors OM Nasdaq HEX

    Bolsa y Merc. Esp.

    GPW

    LCH.Clearnet Group ltd

    Clearnet SA

    LCH

    CC&G

    Eurex Clea

    ring

    Clearing

    Euroclear Nederland

    CIK

    Euroclear France

    Crest Co

    Monte Titoli

    Clearstream BF

    ClearstreamBL

    VPS

    Nordic CSD

    Iber

    clear

    KDPW

    CRBS

    Settlement securities

    DNB

    NBB

    BdF

    BOE

    Banca d´

    Italia

    Bundesbank

    BCL

    Nordic central banks

    Banca d´ Espana

    Bk of Poland

    Settlement cash

    TARGET2

    Post trading infrastructures EU


    Eu initiatives for more efficient securities markets in europe 1 code of conduct
    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
    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 CSD

      • The right of a regulated market/MTF to choose a particular CCP/ CSD

      • No double regulation


    Results until now
    Results until now… Europe –

    Code of Conduct – around 2 years

    MiFID – nearly 1 year

    Guideline on Interoperability – 1 year

    Results:

    • New MTFs and in their slipstream…

    • New CCPs

    • Around 90 requests for interoperability (links between CCPs and CSDs)


    Results till now
    Results till now… Europe –

    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

    Trading Europe –

    Euronext

    Amsterdam + Brussels + Lisbon + Paris

    Euronext

    Amsterdam + Brussels + Lisbon + Paris

    London Stock Exchange

    Borsa Italia

    na

    Deut

    sche Borse

    Luxembourg Stock Ex

    change

    Oslo Bors OM Nasdaq HEX

    Bolsa y Merc. Esp.

    GPW

    LCH.Clearnet Group ltd

    Clearnet SA

    LCH

    CC&G

    Eurex Clea

    ring

    Clearing

    Euro

    clear Nederland

    CIK

    Euroclear France

    Crest Co

    Monte Titoli

    Clearstream BF

    Clearstream BL

    VPS

    Nordic CSD

    Iber

    clear

    KDPW

    CRBS

    Settlement securities

    DNB

    NBB

    Banq. de France

    Bank of Englnd

    Banca d´

    Italia

    Bundesbank

    BCL

    Nordic central banks

    Banca d´ Espana

    Bk ofPoland

    Settlement cash

    TARGET2

    Complexity European market increases

    EU market =

    Incumbent trading, clearing and settlement + …


    Complexity european market increases1

    Trading: Europe –

    MTFs

    Turquoise

    Smartpool

    Bluenext

    Equiduct

    Chi-X

    Nasdaq OMX

    BATS

    Clearing:

    New and existing CCPs

    EuroCCP

    LCH.Clearnet SA

    EMCF

    Settlement agents

    Citibank

    Fortis Bank Nederland

    Euroclear Nederland

    CIK

    Euro

    clear France

    Crest Co

    Monte Titoli

    Clearstream BF

    Clearstream BL

    VPS

    Nordic CSD

    Iber

    clear

    KDPW

    Settlement securities

    DNB

    NBB

    Banq. de France

    Bank of Englnd

    Banca d´

    Italia

    Bundesbank

    BCL

    Nordic central banks

    Banca d´ Espana

    Bk of Poland

    Settlement cash

    TARGET2

    Complexity European market increases

    … MTFs and new CCPs


    Consequences for central banks
    Consequences for central banks Europe –

    • Services in central bank money

      • Cash settlement also for MTFs and new CCPs – national silo´s disappear

      • Collateral management for new CCPs

    • Oversight

      • What stability risks come with

        • New CCPs and their settlement agents

        • Increased complexity

        • Interoperabiliteit

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


    Risks in clearing and settlement of securities
    Risks in clearing and settlement of securities Europe –

    liquidity risk

    • credit risk:

    • replacement cost risk

    • principal risk

    custody risk

    Risks

    legal risk

    operational risk

    risk of settlement bank failure

    systemic risk


    Risks
    Risks Europe –

    Credit risk:

    The risk of loss from default by a participant,

    as a consequence of its insolvency

    Replacement cost risk

    Principal risk


    Risks1
    Risks Europe –

    Principal risk

    • 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


    Delivery versus payment dvp

    Securities Europe – cash

    2

    ^2

    CSD

    NCB

    A

    B

    A

    B

    ^3

    3

    ^

    1

    1

    Bank A

    Bank B

    Sell Order

    Buy Order

    Delivery versus Payment (DvP)

    DvP


    Dvp in practice
    DvP Europe – in practice

    • Sell/buy transaction

    • The 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


    Risks2
    Risks Europe –

    Replacement cost risk

    • 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)


    Risks3
    Risks Europe –

    Risk of failure of a

    settlement bank

    • 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


    Risks4
    Risks Europe –

    Systemic risk

    • 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


    Risks5
    Risks Europe –

    Liquidity risk

    • Risk that counterparty will not settle an obligation when due

    • Costs depend on degree of liquidity

    • Potential to create systemic problems


    Risks6
    Risks Europe –

    Custody risk

    • Risks that securities are not adequately protected by the custodians

    • Either full loss or temporary inability to transfer securities

    • Segregation of accounts


    Risks7
    Risks Europe –

    Operational risk

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

    Legal risk

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


    What is t2s
    What is T2S? Europe –

    • 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


    Why (1)? Europe –

    The current initiatives:

    Deutsch Börse Gruppe

    T2S: a workable solution for DVP cross-border settlement of securities within central bank money

    Euroclear Group

    APK

    Euroclear NL

    NTMA

    Euroclear BE

    Clearstream FFM

    NBB Clearing

    Clearstream Lux

    OeKB

    Euroclear FR

    Monte Titoli

    SCL Bilbao

    BOGS

    SCL Barcelona

    Interbolsa

    Iberclear

    CSD SA

    Siteme

    SCL Valencia


    Why t2s 2
    Why T2S (2)? Europe –

    • 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 CSDs

      • Cost estimations to be further investigated

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


  • CSD Europe –

    Custodian bank or ICSD

    central bank money

    Investor

    Investor bank

    Background: Essential concepts

    T2S concerns only settlement in central bank money

    commercial bank money


    EXCHANGE Europe –

    LISTING

    TRADING

    CCP

    CLEARING

    CLEARING

    HOUSE

    CENTRAL BANK

    CSD

    SETTLEMENT

    CASH

    CLEARING

    INVESTOR

    ISSUER

    CSD

    INVESTOR

    CSD

    BANK &

    BROKER

    ISSUER

    Traditional roles in securities market


    EXCHANGE Europe –

    LISTING

    TRADING

    CCP

    CLEARING

    CLEARING

    HOUSE

    CENTRAL BANK

    T2S

    SETTLEMENT

    CASH

    SETTLEMENT

    SECURITIES ACCOUNTS

    INVESTOR

    BANK &

    BROKER

    CSD

    ISSUER

    CSD

    INVESTOR

    CSD

    ISSUER

    Securities accounts at the centre


    How? Europe –

    • 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


    Euroclear (BE, FR, NL) Europe –

    Euroclear (BE, FR, NL)

    Siteme

    Siteme

    Securities accounts

    Securities accounts

    Securities accounts

    Securities accounts

    TARGET2 – Securities outside of operating hours

    Euroclear (BE, FR, NL)

    Siteme

    BOGS

    Securities accounts

    Securities accounts

    Securities accounts

    OeKB

    Securities accounts

    Clearstream

    Securities accounts

    TARGET2 - Securities

    NBB Clearing

    Securities accounts

    Monte Titoli

    Securities accounts

    TARGET2

    NTMA

    Cashaccounts

    Iberclear

    Securities accounts

    Securities accounts

    Other CSD’s

    APK

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

    Securities accounts

    Securities accounts


    TARGET2 – Securities during the operating hours Europe –

    Euroclear (BE, FR, NL)

    Siteme

    BOGS

    OeKB

    Clearstream

    TARGET2 - Securities

    NBB Clearing

    Sub-cashaccounts

    Securities accounts

    Monte Titoli

    TARGET2

    NTMA

    Cashaccounts

    Iberclear

    Other CSD’s

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

    APK


    What is T2S? Europe –

    Where are the benefits coming from

    • 3 sources of cost savings

      • fee savings:

        • economics of scale

        • elimination 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
    Uncertainties Europe –

    • 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 rules

      • Removal 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
    The T2S User Requirements Europe –

    • Scope of assets

      • All types of securities which CSD’s are settling today (debt instruments, equities, investment funds, warrants)

    • Scope of services

      • Whole 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 issues Europe –

    • Legal basis Article 22 Statute ESCB/ECB

      • Enables the Eurosystem to provide facilities to deliver efficient and sound clearing and payment systems

    • Governance

      • The infrastructure will be wholly owned by the Eurosystem

      • (I)CSDs and users are involved during specification phase


    Impact t2s
    Impact T2S Europe –

    • Fosters competition among CSDs

    • Reduces intermediary costs

    • Reduces collateral needs and costs

    • Reduces back-office costs

    • Facilitates cross border business with easier and cheaper cross-CSD settlement.


    Timetable t2s
    Timetable Europe – T2S

    • July 2008: Decision Governing Council to launch T2S

    • 2009: Specification- and development phase

      • Possibilities External (non-Euro zone) CSD settlement

    • 2010-2012: Building, Testing and Migration phase

    • 2013: Operational phase


    Thank you very much ! Europe –

    Any qu€stions?


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