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Exchanges, Clearing, Settlement and TARGET2 Securities Michael van Doeveren Richard Derksen

De Nederlandsche Bank. Exchanges, Clearing, Settlement and TARGET2 Securities Michael van Doeveren Richard Derksen Financial Sector of Macedonia Conference on Payments and Securities Settlement Systems Ohrid 24 June 2008. Agenda. The world of securities and exchanges

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Exchanges, Clearing, Settlement and TARGET2 Securities Michael van Doeveren Richard Derksen

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  1. De Nederlandsche Bank Exchanges, Clearing, Settlement and TARGET2 Securities Michael van Doeveren Richard Derksen Financial Sector of Macedonia Conference on Payments and Securities Settlement Systems Ohrid 24 June 2008

  2. Agenda • The world of securities and exchanges • Risks in clearing and settlement of securities • TARGET2 Securities and CCBM2

  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. 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

  8. Risks Credit risk: The risk of loss from default by a participant, as a consequence of its insolvency Replacement cost risk Principal risk

  9. Risks 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

  10. 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

  11. 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

  12. Risks 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

  13. Risks 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

  14. European developments • Lisbon agenda 2000: European economy has to become stronger to compete with the USA and Japan/China • Shortage: there is no integrated European financial market • European Union has identified 15 barriers for integration (Giovannini 2001) • Technical, market practices (10) • Legal and fiscal barriers (5)

  15. Inefficiencies European market Huge difference in costs of securities transactions: • Domestic costs vary within the EU • In average higher than in the USA • EU cross-border costs are much higher than domestic costs in the USA

  16. Brokertec ao, Amsterdam SWX Virt-x Deutsche Borse Eurex Stockholm Copen- hagen Spanish Exchanges Borsa Italiana LSE MTS Exchanges Paris Brussels Oslo Iceland OTC-trades e.g. Repos, Swaps Lisbon LIFFE CLEARNET LCH X-Clear EUREX Clearing AG Non-CCP market Iberclear CCG Clearing Euroclear Bank Euroclear Nederland SIS Clearstream Banking FFt AG VPC VP A/S SCLV Monte Titoli CREST Custody/ Settlem. CIK VPS Euroclear France Iceland CSD Interbolsa CSD’s ICSD Money Commercial Bank Money CeBM via DNB,BdF,BNB,Banco de Port,Bank of Engl. Bundesbank CeBM Banco d’Espana Banca D’Italia Securities landscape

  17. 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

  18. Vertical integration Deutsche Börse Eurex Clearing Clearstream Integration models in Europe Horizontal integration Euroclear (ICSD) CIK (BE) Sicovam (FR) Euroclear (NL) Crest (UK) CBISSO (IE) Euroclear

  19. 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

  20. Risks 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 (e.i. t+3)

  21. Risks Liquidity risk • Risk that counterparty will not settle an obligation when due • Costs depend on degree of liquidity • Potential to create systemic problems

  22. Risks Custody risk • Risks that securities are not adequately protected by the custodians • Either full loss or temporary inability to transfer securities • Segregation of accounts

  23. Risks 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)

  24. TARGET2 Securities • An integrated platform of the Eurosystem for the DVP settlement of securities transactions in central bank money within the euro area

  25. Why? 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

  26. Why? • The model can offer advantages in terms of efficiency and cost-cutting, provided that a critical mass of CSDs actually joins and the system can be developed at reasonable cost. • It would benefit financial stability

  27. 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

  28. 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

  29. 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

  30. How? • The CSDs outsource the administration of securities accounts to the Eurosystem, which then manages the securities and associated cash accounts on the platform. • At the end of the day the money goes back into the TARGET2 payment system, and the securities return to the CSDs • Only securities settlement, CSDs keep the custody and notary functions • Based on DVP

  31. Euroclear (BE, FR, NL) Siteme BOGS OeKB Clearstream NBB Clearing TARGET2 - Securities Sub-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)

  32. Potential obstacles • Dependence 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

  33. TARGET2 Securities • TARGET2 Securities is a workable solution for the long term • Market consultation and user requirements is going on • Governing Council of the ECB will take a decision on the implementation of T2S in March 2008

  34. CCBM2 • Currently, banks hold collateral at several locations, it is exchanged through the Correspondent Central Bank Model • CCBM2 is a common platform for central banks that integrates both domestic and cross-border collateral management

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