Clearing & Settlement and TARGET2-Securities Nynke Doornbos & Michael van Doeveren

1. De Nederlandsche Bank Clearing & Settlement and TARGET2-Securities Nynke Doornbos & Michael van Doeveren 3rd Macedonian Financial Sector Conference on Payments and Securities Settlement Systems 29 June 2010

2. 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 (selfregulation) • Markets in Financial Instruments Directive (MiFID) • European Market Infrastructure Regulation (EMIR) • Securities Law Directive (SLD) • Consequences for central banks • TARGET2-Securities

3. Securities chain Agreement to exchange securities for funds trading Calculation of obligations clearing Delivery of securities and payment of funds settlement

4. 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

5. 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

6. 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)

7. 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

8. 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)

9. 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

10. 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 T+3 • Issues: • DVP: delivery versus payment to limit principal risk (Herstatt risk) • SFD: Finality offers protection against unwinding

11. 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

12. 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

13. 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)

14. 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

15. 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

16. 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

17. 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

18. 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

19. Trading NYSE NASDAQ NSCC FICC Clearing DTC FED Settlement securities FEDERAL RESERVE Settlement cash Post trading infrastructures US

20. 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

21. 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

22. 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

23. 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)

24. 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)

25. Consequences for central banks • 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)

26. 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

27. Securitiescash 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

28. 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 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

29. 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

30. 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

31. 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 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

32. Why T2S (2)? • The model offers advantages in terms of efficiency and cost-cutting • assuming that a critical mass of CSD’s actually joins and the system can be developed at reasonable costs (volume dependent) • Commitment CSDs: MoU 2009, 27 CSD’s signed, Framework Agreement to be signed. • Cost estimations to be further investigated • Financial stability

33. CSD Custodian bank or ICSD central bank money Investor Investor bank Background: Essential concepts T2S concerns only settlement in central bank money commercial bank money

34. EXCHANGE 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

35. EXCHANGE 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

36. 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 CSD’s (added value services)

37. Euroclear (BE, FR, NL) Siteme BOGS OeKB Clearstream NBB Clearing TARGET2 - Securities dedicated-cash accounts Securities accounts Monte Titoli NTMA TARGET2 Cashaccounts Iberclear Other CSD’s OeNB, NBB, BBK, BdE, BoF, BdF,BoG, CBFSAI, BdI, BcL, DNB, BdP APK TARGET2 Securities (during the operating hours)

38. 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

39. The T2S User Requirements (Four central banks develop the platform: Deutsche Bundesbank, Banco de Espana, Banque de France, Banca d’Italia) • 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

40. 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

41. 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.

42. 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)