Clearing

1

• Clearing Settlement and TARGET2-Securities
• Nynke Doornbos Michael van Doeveren
• 3rd Macedonian Financial Sector Conference on
  Payments and Securities Settlement Systems
• 29 June 2010

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Agenda

• The world of securities and exchanges
• Risks in clearing and settlement of securities
• Whats going on in Europe?
• Code of Conduct Clearing Settlement
  (selfregulation)
• Markets in Financial Instruments Directive
  (MiFID)
• European Market Infrastructure Regulation (EMIR)
• Securities Law Directive (SLD)
• Consequences for central banks
• TARGET2-Securities

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Securities chain
Agreement to exchange securities for funds
trading
Calculation of obligations
clearing
Delivery of securities and payment of funds
settlement
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Clearing settlement infrastructure
Exchanges
CCP
National Central Bank
CSD
Issuer
custodian
custodian
Agent bank
Agent bank
Agent bank
Agent bank
Agent bank
Agent bank
Investor
Investor
Investor
Investor
Investor
Investor
Investor
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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
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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 t3)
• Securities settlement (usually t3)
• Custody (corporate actions)

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Exchanges, CCPs and CSDs - basic model
Buyer/ Seller
EURONEXT
Trading Member
Trading
Clearing Members
LCH.Clearnet SA
Clearing
EUROCLEAR Nederland
Securities settlement
ENL
Admitted
DNB / T2
Depository
Cash settlmn.
Institution
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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)

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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

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CSD settlement
EUROCLEAR Nederland
Settlement
Depository
ENL
DNB / TARGET2
Securities account A Securities account B
Cash account A Cash account B
DVP

• Role
• Recording of changes in legal titles resulting
  from securities transactions
• Exchange trades settle on T3
• Issues
• DVP delivery versus payment to limit principal
  risk (Herstatt risk)
• SFD Finality offers protection against unwinding

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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

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Role of central banks

• Services in central bank money
• Cash settlement in TARGET2 DVP
• Collateral management for CCPs
• TARGET2-Securities (Pan- European platform for
  settlement of trades, September 2014)
• Oversight
• Financial stability limit systemic risk
• Limit losses of participants
• Limit contagion to other markets
• Enhance confidence in payment systems

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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 and operational barriers, market
  based(10)
• Legal and fiscal barriers (5)

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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-border costs higher than
• domestic ones (19.5 to 35.0 ).

Source Oxera, LSE, CEPS
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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

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Integration models in Europe
Horizontal integration
Euroclear (ICSD)
CIK (BE)
Euroclear (FR)
Euroclear (NL)
Crest (UK)
CBISSO (IE)
Euroclear
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Dynamics in the securities market

• Market integration, level playing field and
  harmonisation, regulatory (lessons learned from
  financial crisis)
• Consolidation of exchanges and SSSs in the market
  goes full speed on
• Code of Conduct for Clearing and Settlement
• Markets in Financial Instruments Directive
• European Market Infrastructure Regulation
• Securities Law Directive
• CESAME Group ? to lift technical, market
  practices Giovannini barriers
• Internalisation huge banks settle transactions
  internally

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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
• Regulatory measures to be implemented

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Post trading infrastructures US
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Post trading infrastructures EU
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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

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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

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Results until now

• Code of Conduct around 2 years
• MiFID around 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)

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Results till now

• Negative
• Fragmentation and complexity remains
• 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)

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Consequences for central banks

• Services in central bank money
• Cash settlement also for MTFs and new CCPs
  national silos 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)

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Risks in clearing and settlement of securities
liquidity risk

• credit risk
• replacement cost risk
• principal risk

custody risk
Risks
legal risk
operational risk
risk of settlement bank failure
systemic risk
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Delivery versus Payment (DvP)
DvP
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DvP 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
  buyers to the sellers account and sends a
  confirmation to the CSD
• The CSD move the securities from the sellers to
  the buyers account

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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 in
  Central Bank Money, 2014)
• Oversight
• Financial stability limit systemic risk
• Limit losses of participants
• Limit contagion to other markets
• Enhance confidence in payment systems

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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 is an option

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Why (1)?
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
Clearstream FFM
Euroclear BE
NTMA
Clearstream Lux
NBB Clearing
OeKB
Euroclear FR
Monte Titoli
SCL Bilbao
BOGS
SCL Barcelona
Interbolsa
Iberclear
CSD SA
Siteme
SCL Valencia
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Why T2S (2)?

• The model offers advantages in terms of
  efficiency and cost-cutting
• assuming that a critical mass of CSDs actually
  joins and the system can be developed at
  reasonable costs (volume dependent)
• Commitment CSDs MoU 2009, 27 CSDs signed,
  Framework Agreement to be signed.
• Cost estimations to be further investigated
• Financial stability

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Background Essential concepts
T2S concerns only settlement in central bank money
commercial bank money
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Traditional roles in securities market
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Securities accounts at the centre
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How?

• CSDs outsource the administration of securities
  accounts to T2S
• Credit institutions transfer cash to T2S, real
  time DVP is now possible
• At the end of the day the securities return to
  the CSDs and the money goes back into the TARGET2
  payment system
• functions such as custody and notary functions
  remain at the CSDs (added value services)

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TARGET2 Securities (during the operating hours)
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Uncertainties

• Success of T2S depends on the decision of the
  CSDs to actually participate (signing Framework
  Agreement)
• Concentration of risk because of centralisation
  (impact)
• Prerequisite of the project harmonisation of
  legal structures
• Removal Giovannini barriers, especially
• Barriers 4, 6 and 7 T2S may ensure common
  operating hours and finality rules for domestic
  and cross border transactions

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The T2S User Requirements (Four central banks
develop the platform Deutsche Bundesbank, Banco
de Espana, Banque de France, Banca dItalia)

• Scope of assets
• All types of securities which CSDs 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

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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

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Impact T2S

• 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.

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Timetable T2S

• July 2008 Decision Governing Council to launch
  T2S
• 2009-2010 Specification- and development phase
• 2010-2013 Building, Testing and Migration phase
• September 2014 Operational phase (start of
  implementation in three waves)