Title: THE WORLD BANK AND THE BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM TRAINING COURSE REFORMING PAYMENT AND SECURITIES SETTLEMENT SYSTEMS Washington, D.C., November 3-7, 2003
1THE WORLD BANK AND THE BOARD OF GOVERNORS OF THE
FEDERAL RESERVE SYSTEM TRAINING COURSEREFORMING
PAYMENT AND SECURITIES SETTLEMENT SYSTEMS
Washington, D.C., November 3-7, 2003
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- IMPROVING SECURITIES SETTLEMENT SYSTEMS
- Mario Guadamillas, World Bank
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2Content
- International standards as a guide for the reform
- A.1 Evolution of international (regional)
standards - A.2 Main factors identified
- Main challenges for SSSs
- B.1 Special consideration of CCPs
- C. Interrelations between payments and
securities settlement systems - D. Conclusions
3A.1 EVOLUTION OF INTERNATIONAL STANDARDS
- The international standards provide a very
helpful framework to systematize and address the
main factors to be considered for a reform - Despite the process of consolidation and
generalization of accepted standards worldwide,
some focus on minimum standards while others seek
best practices - There is closer attention by international
standards to the interaction between payments and
securities settlement systems
4A.1 EVOLUTION OF INTERNATIONAL STANDARDS
- Group of Thirty Recommendations Regarding
Securities Clearance and Settlement, 1990 - Objective reducing risk, improving efficiency
and promoting greater standardization in
international settlement - - Trade comparison,Trade confirmation/affirmation
, CSDs, Netting Schemes, DvP, Same day funds,
Rolling settlement cycle, Securities lending,
Common message standard - Lamfalussy Minimum Standards, 1990
- Objective cross-border and multi-currency
netting and settlement schemes - - Legal basis, Financial risks, Management of
credit and liquidity risks, Admission criteria,
Operational reliability of netting schemes
5A.1 EVOLUTION OF INTERNATIONAL STANDARDS
- Technical Committee of IOSCO, 1990
- Objective contribute to the process of
creating an efficient central securities
depository from a national regulatory point of
view and, at the international level, offering
views on how to create links in accordance to the
recommendations issued on the subject - - Regulatory aspects (including SRO role)
- - Liquidity risk
- - Industry organizational arrangements
- - Operational reliability
- - Endorses G30 recommendations
6A.1 EVOLUTION OF INTERNATIONAL STANDARDS
- ISSA, 1995
- Objective amendment of G30 recommendations
- - Trade comparison in T0 instead of T1
- - Positive affirmation of trade details by
indirect market participants by T1 - - Explicit reference to immobilization/demateria
lization - - Rules when several CSDs operate in a country
in - order to allow for use of funds and
cross-collateral - - Choice between a RTGS or Lamfalussy
- Recommendations compliant netting system for
funds settlement
7A.1 EVOLUTION OF INTERNATIONAL STANDARDS
- Emerging Markets Committe of IOSCO, 1997
- Objective study on the legal and regulatory
framework for clearing and settlement in emerging
markets - - Legal and custody issues
- IOSCO, Objectives and Principles of Securities
Regulation, 1998 - Objectives The principles are based upon three
main objectives of securities regulation
protection of investors ensure that markets are
fair, efficient and transparent reduction of
systemic risk - - SSSs should be subject to regulatory
oversight and designed to ensure that they are
fair, effective and efficient and that thay
reduce systemic risk
8A.1 EVOLUTION OF INTERNATIONAL STANDARDS
- FIVB, Clearing and Settlement Best Practices
Report, 1999 - Objective to enable FIBV members and their
respective clearing and settlement organizations
to score their performance against benchmarks and
best practices, and to identify areas in their
processes where improvements should be
considered - - Trade confirmation, Settlement cycles,
Securities lending, CSDs and risk controls, DvP,
Operational reliability, Efficiency, Netting
schemes, Systems integration
9A.1 EVOLUTION OF INTERNATIONAL STANDARDS
- ISSA, New Recommendations, 2000
- Objective to tackle key risks in todays world
of settlement and clearance - - Governance of infrastructure
- - Technology core processing
- - Technology messaging and standards
- - Uniform market practice
- - Reduction of settlement risk
- - Market linkages
- - Investor protection
- - Securities lending
- - Legal infrastructure
10A.1 EVOLUTION OF INTERNATIONAL STANDARDS
- CPSS, Core Principles for Systemically Important
Payment Systems, 2001 - Public Policy Objectives safety and
efficiency - Introduction of the SIPS concept
- - Ten principles legal foundation (CPI),
understanding and management of risks (CP II and
III), settlement (CPs IV-VI), security,
operational reliability and contingency
arrangements (CP VII), efficiency and
practicality (CP VIII), criteria for
participation (CP IX) and governance (CP X) - - Four central banks responsibilities
objectives and policy (A), observance of CPs (B
and C), cooperation (D) - - Not specific for SSSs but relevant
11A.1 EVOLUTION OF INTERNATIONAL STANDARDS
- CPSS-IOSCO, Recommendations for SSSs, 2001
- Objective to promote implementation by SSSs of
measures that can enhance international financial
stability, reduce risks, increase efficiency and
provide safeguards for investors by developing
recommendations for the design, operation and
oversight of such systems - 19 Recommendations
- - Legal risk
- - Pre-settlement risk (including CCPs)
- - Settlement risk
- - Operational risk
- - Custody risk
- - Other issues (governance, access, efficiency,
communication procedures and standards,
transparecy, regulation and oversight, risks in
cross-border links)
12A.1 EVOLUTION OF INTERNATIONAL STANDARDS
- G30, New Recommendations, 2003
- Objective to establish a set of new
recommendations focused on the cross-border and
international context that go beyond minimum
standards and try to identify best practices - - Building a strengthened interoperable global
network - - Strengthening network safety and stability
- - Improving governance
- CPSS-IOSCO Task Force, Risk Management Standards
for Central Counterparties, work in progress
13A.1 EVOLUTION OF REGIONAL STANDARDS
- EMI, Standards for the use of EU Securities
Settlement Systems in ESCB Credit Operations,
1998 - Objective assessing the soundness of SSSs
seeking to qualify for involvement in monetary
policy and intraday credit operations - - Legal soundness
- - Settlement in central bank money
- - No undue custody risks
- - Regulation and/or control by competent
authorities - - Transparency of risks and conditions for
participation in a system - - Risk management procedures
- - Intraday finality of settlement
- - Operating hours and days
- - Operational reliability of technical systems
and availability of adequate back-up facilities
14A.1 EVOLUTION OF REGIONAL STANDARDS
- Giovannini Group 1st Report, 15 Barriers to the
EU CS Integration, 2002 - Giovannini Group 2nd Report, Action proposals for
removing barriers, 2003 - Objective conduct a comprehensive analysis of
clearing and settlement arrangements for
equities, fixed-income securities and
derivatives - 15 Barriers to efficient cross-border
settlement - - Technical requirements/market practice
- - Differences in tax procedures
- - Issues related to legal certainty
15A.1 EVOLUTION OF REGIONAL STANDARDS
- ESCB-CESR Standards for Securities Clearing and
Settlement Systems in the European Union
(consultative report), 2003 - Objective to increase the safety, soundness
and efficiency of securities clearing and
settlement systems in the European Union - - Based on CPSS-IOSCO recommendations
- - Beyond recommendations (standards) to be
used as a regulatory tool - - Identifying systemically important
institutions - - Standards to major custodian banks
16A.1 EVOLUTION OF INTERNATIONAL STANDARDS (SUMMARY)
17A.2 MAIN FACTORS IDENTIFIED
- Legal custody
- CS processes trade confirmation, settlement
cycles, systems integration, securities lending,
communication procedures standards and securities
identification - Settlement risk CSDs, DvP, timing of settlement
finality, risk management mechanisms, cash
settlement assets,netting versus gross schemes,
liquidity risk - CCPs
- Operational reliability
- RegulatoryOversight (including SRO role)
- Organizational arrangements participation
requirements, governance, transparency - Cross-border
- Cost-efficiency
18A.2 MAIN FACTORS IDENTIFIED
LEGALCUSTODY
CS PROCESSES
SETTLEMENT RISK
CCP
OPERATIONAL
REG.OVERSIGHT
ORG.
ARRANGEMENTS
CROSS-BORDER
COST-EFFICIENCY
G30
IOSCO
G30/ISSA
IOSCO
IOSCO
FIBV
ISSA
CPSS IOSCO
NEWG30
1989
1990
1995
1997
1998
1999
2000
2002
2001
19B. MAIN CHALLENGES FOR SSSs
- Legal Framework and Custody Risk
- - Trading takes place global while underlying
legal systems continue to be domestic - Absence of a unique framework for the treatment
of security interests - Problems with legal certainty in collateralized
transactions - Uneven application of national conflict of law
rules - - Finality importance to adapt financial
institutions bankruptcy legislation to protect
SSSs - - Enforceability of security interests provided
under collateral arrangements, legal basis for
netting, electronic documents and signatures
(for developing systems)
20B. MAIN CHALLENGES FOR SSSs
- Clearing and settlement processes
- - Standardization of messaging standards and
communication protocols - - Synchronization of timing among systems
- - National differences in settlement cycles
- - Tax and other impediments to securities lending
and borrowing - - Mix of securities and money markets settlement
procedures creates problems for market
development (different settlement needs) - - Diversity of trading and settlement mechanims
and procedures even for similar type of
securities - - Eliminate paper processing (for developing
systems)
21B. MAIN CHALLENGES FOR SSSs
- Settlement risk
- - CCPs risk reduction but higher risk
concentration - - Increasing need to ensure financial integrity.
Delicate balance between access and competition - - Reduction of the settlement cycle not always
accompanied by reduction of settlement risk - - Systemically important systems must have
adequate risk management mechanisms - - Settlement assurance procedures (for developing
systems)
22B. MAIN CHALLENGES FOR SSSs
- Operational issues
- Interoperability of global network (more than
technical compability of systems) - - Global identification methodology to facilitate
STP - - National differences in IT and interfaces
- - Practical impediments to remote access
- Need to accommodate increasing volume of traffic
and volatility in markets - Adequate contingency procedures and back- up
systems (for developing systems)
23B. MAIN CHALLENGES FOR SSSs
- Regulation oversight
- Increasing importance of settlement issues for
securities regulators and role of SROs - - No role in operating systems
- - More attention to regulation and oversight.
Dual roles public policy framework for
competition and prudential oversight - - Increasing need to coordinate with other
regulators/supervisors, specially central bank,
both domestically and internationally - - Interaction with private sector through SROs.
Importance of overlaps/gaps in regulation and
supervision
24B. MAIN CHALLENGES FOR SSSs
- Organizational arrangements
- Governance of infrastructure is a key issue for
markets integration - - Transparency full disclosure to system users
- - Non discrimination fair access to SSSs
- - No single group or single interest group with
majority control - - Effective attention to users interests
- Access to liquidity can be an important obstacle
(interaction with funds transfer system)
25B. MAIN CHALLENGES FOR SSSs
- Cross-border settlement
- - Inconsistent legal and regulatory
underpinnings - - Lack of globally recognized technical
standards - - Differing business processes
- - Differences in tax procedures
- These problems lead to higher costs due to
- - Direct costs from higher fees of the services
provided - - Indirect costs from extra back-office
facilities - - Opportunity costs from inefficient use of
collateral and higher incidence of failed trades
26B. MAIN CHALLENGES FOR SSSs
- Cost-efficiency issues
- - Level of market competition on clearing and
settlement organizations is low (lack of direct
competitors to use as a benchmark), thus,
alternatively in-house unit costing techniques
need to be developed. - - Composition on costs is changing rapidly with
diminishing IT costs. Increasing use of
outsourcing - - Considerable variation around the world in
SSSs charging arrangements (standard, ad valorem) - - Small value transactions normally subsidized by
imposing higher charges on large value
transactions. - - Many systems may be under-recovering their
operating costs
27B.1. SPECIAL CONSIDERATION OF CCPs
- Benefits
- Attributed to multilateral netting
- - Reduction in the number of settlements
- - Reduction in individual contractual obligations
- - May help reduce the margins required to
collateralize current and potential future
credit exposures - - May help to reduce the capital required to
support participants trading activity - - Helps to sustain anonymity where trade
execution process itself is anonymous
28B.1. SPECIAL CONSIDERATION OF CCPs
- Benefits
- Provides risk management services
- - Replaces exposures to multiple counterparties
with a single exposure to a single counterparty - - No worry about the creditworthiness to a single
counterparty - - Does not eliminate counterparty credit risk,
but redistribute it much more efficiently than
market participants could do in isolation -
29B.1. SPECIAL CONSIDERATION OF CCPs
- Risks
- Legal and technical risks (not specific to CCPs
but higher potential systemic impact) - Principal risk (reduction but concentration)
- Replacement cost risks (not specific to CCPs but
higher potential systemic impact) - Risk management tools
- Financial and operational requirements (to
minimize probability of failure of a market
participant) - Margins (to minimize the loss if a participants
fails) - Limit build-up of exposures by means of periodic
settlement of positions (normally used in
derivative markets)
30B.1. SPECIAL CONSIDERATION OF CCPs
- Main concerns
- Concentration of risk
- Moral hazard (too big to fail)
- Information asymmetry is reduced but only if CCP
is perceived to be solvent - Competition between CCPs could negatively affect
risk management standards - A single CCP would maximize externalities and
economies of scale but could produce potential
inefficiencies (lack of innovation). Need of
appropriate governance rules - Contagion effects (cross-process, cross-products,
cross currencies)
31B.1. SPECIAL CONSIDERATION OF CCPs
- Main issues to be considered
- Legal Framework
- Participation Requirements
- Understanding Risks
- Novation
- Settlement
- Default Procedures
- Risk Controls
- Margins/Guarantee fund/Loss Sharing
- Governance
- Operational Risk
- Regulatory Reporting
32C. INTERRELATIONS BETWEEN PAYMENTS AND SECURITIES
SETTLEMENT SYSTEMS
- Timing of settlement finality
- Careful analysis of design, procedures,
operational timetables and funding cut-off times - SSSs settlement end-of-day, intra-day,
real-time? - Cash settlement asset and settlement agent risks
- Is central bank money used?
- Credit, liquidity, and operational risks
- Management of a settlement agents failure
- Concentration of settlement flows
- Who has access to the funds transfer system
- Participants ability to choose a settlement
agent - Range of services provided by agent
- Participants views on agents competitive
neutrality - Arrangements for funding/defunding accounts
33C. INTERRELATIONS BETWEEN PAYMENTS AND SECURITIES
SETTLEMENT SYSTEMS
- Higher potential contagion effects in the
financial system from the use of CCPs - Impact of SSSs on the implementation of monetary
policy - Impact of SSSs on the liquidity management of the
system (increasingly important with the
generalized use of RTGS systems) - Impact of SSSs on the fiscal policy (especially
for development markets) - Need of coordination between central bank and
securities regulator
34D. MAIN CONCLUSIONS
- New approach for SSSs
- Integration of payments and securities settlement
- SSSs recognized as incurring same inherent risks
as those associated with SIPS - Consolidation of SSSs functions (efficiency
gains, risk reduction, higher concentration of
risk) - Cross-border settlement main obstacles
differences in legal regulatory frameworks,
lack of enough technical and processes
standardization, differences in tax procedures - Domestic settlement main challenges legal issues
(finality, collateral), adequate risk management
procedures (beyond DvP), adequate coordination
with other regulators and cooperation with the
private sector - SSSs reform an on-going process