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

De Nederlandsche Bank Eurosysteem

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

De Nederlandsche Bank


Agenda

The world of securities and exchanges

Risks in clearing and settlement of securities

TARGET2 Securities and CCBM2


Securities chain

trading

clearing

settlement

Agreement to exchange securities for funds

Calculation of obligations

Delivery of securities and payment of funds


custodian

CSD Issuer

custodian

Agentbank

National Central

Bank

Agentbank

Agentbank

Agentbank

Agentbank

Agentbank

Investor InvestorInvestorInvestorInvestor Investor Investor

Clearing & settlement infrastructure

CCP

Exchanges


Entities in securities

Issuer/Investor

ICSDs

Custodians

Issue/hold securities

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

International central securities depositories: international settlement services providers, CSDs for EurobondsNational and international settlement services providers, typically banks

CCPsCentral counterparties: central providers for clearing services

Exchanges platform for trade in securities

Agent Bank Executes transactions for customers

NCB National Central Bank; provides settlement services, oversight


Life cycle of securities transactions

Transactions (by a telephone call or system)Entry in a system (buy or sell)ValidationAuthentication & authorisationMatching & confirmation ClearingMoney settlement (usually t+3)Securities settlement (usually t+3)Custody (corporate actions)


Risks in clearing and settlement of securities

Risks

risk of settlement bank failure

liquidity risk

systemic risk

credit risk:• replacement cost risk• principal risk

custody risklegal risk

operational risk


Risks

Credit risk:The risk of loss from default by a participant,

as a consequence of its insolvency

Replacement cost risk Principal risk


Risks

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

Principal risk


Delivery versus Payment (DvP)

Securities cash

NCB

Bank A Bank B

Sell Order Buy Order

CSD

A

B

A

B

1 ^1

2 ^2

3^3

DvP


DvP in practice

Sell/buy transactionThe 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


Risks

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

Risk of failure of a

settlement bank


Risks

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

Systemic risk


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)


Inefficiencies European market

0

5

10

15

20

25

30

35

Co

st p

er t

ran

sact

ion

[E

UR

]

UnitedStates

EU domestic EU cross-border

Min Max Avg.

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


Securities landscape

Brokertecao,

Amsterdam

Paris Brussels

Lisbon LIFFE

SWXLSE Virt-xDeutsche

BorseEurex Stockholm

Copen-hagen

Oslo

Spanish Exchanges MTS

Borsa Italian

a

CLEARNET LCH X-Clear EUREX Clearing AG Non-CCP market Iberclear CCG

EuroclearBank

EuroclearNederland

EuroclearFrance

CIK

Interbolsa

CREST SISClearstream

Banking FFt AG VPC VP A/S

VPS

SCLVMonte Titoli

CommercialBank Money

BundesbankBanco

d’EspanaBanca D’Italia

OTC-trades e.g. Repos, Swaps

CeBMCeBM via DNB,BdF,BNB,Banco de Port,Bank of Engl.

CSD’s

ICSD

Iceland

Iceland CSD

Exchanges

Clearing

Custody/Settlem.

Money


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

CBISSO (IE)

Euroclear

Euroclear (ICSD) CIK (BE)

Sicovam (FR) Euroclear (NL)

Crest (UK)

Horizontal integration

Clearstream

Eurex Clearing

DeutscheBörse

Vertical integration


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 SettlementCESAME Group to lift technical, market

practices Giovannini barriersInternalisation: huge banks settle transactions

internally


Risks

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)

Replacement cost risk


Risks

Risk that counterparty will not settle an obligation when due

Costs depend on degree of liquidity

Potential to create systemic problems

Liquidity risk


Risks

Risks that securities are not adequately protected by the custodians

Either full loss or temporary inability to transfer securities

Segregation of accounts

Custody risk


Risks

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

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

Operational risk

Legal risk


TARGET2 Securities

An integrated platform of the Eurosystem for the DVP settlement of securities transactions in central bank money within the euro area


OeKB

Clearstream FFM

Euroclear FR

Iberclear

Monte Titoli

The current initiatives:

Clearstream Lux

Euroclear BE

Euroclear NLNTMA

SCL Bilbao

CSD SA

BOGS

APK

SCL Valencia

SCL BarcelonaInterbols

aSiteme

NBB Clearing

Why?Deutsch Börse Gruppe

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


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


T2S concerns only settlement in central bank money

Background: Essential concepts

Investor

Investor bank

Custodian bank or ICSD

CSD

central bank money

commercial bank money


INVESTORCSD

INVESTORCSD

SETTLEMENTSETTLEMENT

TRADINGTRADING

ISSUERCSD

ISSUERCSD

ISSUERISSUER INVESTORINVESTOR

CCPCLEARING

CCPCLEARING

CASHCLEARING

CASHCLEARING

BANK &BROKER

BANK &BROKER

LISTINGLISTING

EXCHANGE

CSD CENTRAL BANK

CLEARINGHOUSE

Traditional roles in securities market


Securities accounts at the centre

INVESTORCSD

INVESTORCSD

T2SSETTLEMENT

T2SSETTLEMENT

TRADINGTRADING

ISSUERCSD

ISSUERCSD

ISSUERISSUER

INVESTORINVESTOR

CCPCLEARING

CCPCLEARING

CASHSETTLEMENT

CASHSETTLEMENT

BANK &BROKER

BANK &BROKER

LISTINGLISTING

EXCHANGE

CSD

CENTRAL BANK

CLEARINGHOUSE

SECURITIES ACCOUNTS


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


TARGET2 Securities (during the operating hours)

Euroclear (BE, FR, NL) Siteme BOGS OeKB

NBB Clearing

TARGET2 - Securities

Clearstream

Monte Titoli

Iberclear

APK

NTMA

Other CSD’s

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

Sub-cash accounts

Securities accounts

TARGET2

Cash accounts


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


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


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

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

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