Exchanges, Clearing & Settlement and

De Nederlandsche Bank

TARGET2 Securities

Richard Derksen 2nd Conference of Macedonian Financial Sector on Payments and Securities Settlement Systems

Ohrid 30 June 2009

De Nederlandsche Bank Eurosysteem

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  Markets in Financial Instruments Directive (MiFID)  Consequences for central banks  TARGET2 Securities De Nederlandsche Bank Eurosysteem

Securities chain

trading clearing settlement

Agreement to exchange securities for funds Calculation of obligations Delivery of securities and payment of funds De Nederlandsche Bank Eurosysteem

Clearing & settlement infrastructure

Exchanges CCP CSD National Central Bank Issuer custodian custodian Investor Investor Agent bank Agent bank Investor Agent bank Investor Agent bank Investor Investor Agent bank Agent bank Investor

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Entities in securities

Issuer/Investor CSDs ICSDs Custodians Exchanges CCPs Agent Bank NCB Issue/hold securities Central securities depositories: storehouses for securities and domestic settlement services providers International central securities depositories: international settlement services providers, CSDs for Eurobonds National and international settlement services providers, typically banks platform for trade in securities Central counterparties: central providers for clearing services Executes transactions for customers National Central Bank; provides settlement services, oversight De Nederlandsche Bank Eurosysteem

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) De Nederlandsche Bank Eurosysteem

Exchanges, CCPs and CSDs - basic model

EURONEXT

Trading

LCH.Clearnet SA

Clearing

EUROCLEAR Nederland

Securities settlement

ENL

Depository

DNB / T2

Cash settlmn.

Trading Member Clearing Members Admitted Institution Buyer/ Seller

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Clearing / CCP

Clearing Member Clearing House Clearing Member

Role:  Trade confirmation  Netting  CCP = central counterparty Issues:  Counterparty credit risk concentrates at CCP. Default CCP might affect the whole financial system (so… Oversight) De Nederlandsche Bank Eurosysteem

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 De Nederlandsche Bank Eurosysteem

CSD: settlement

EUROCLEAR Nederland

Depository

ENL Settlement (ESES)

Securities account A Cash account A

DNB / TARGET2

Cash account A Securities account B DVP Cash account B Cash account B 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 De Nederlandsche Bank Eurosysteem

CSD: Depository

Euroclear Nederland

Central Securities Depository (CSD)

Aangesloten Instellingen Instellingen Aangesloten 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 De Nederlandsche Bank Eurosysteem

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, 2013)  Oversight  Financial stability – limit systemic risk  Limit losses of participants  Limit contagion to other markets  Enhance confidence in payment systems De Nederlandsche Bank Eurosysteem

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, market practices (10)  Legal and fiscal barriers (5) De Nederlandsche Bank Eurosysteem

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 €).

15 10 5 0 35 30 25 20 United States Min EU domestic Max Avg.

EU cross border

Source: Oxera, LSE, CEPS De Nederlandsche Bank Eurosysteem

Integration & consolidation

Financial integration for all market participants

: •

Equal access

•

Uniformal set of rules

•

Treatment in an equal way

C

onsolidation means a less number of service providers

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Integration models in Europe

Horizontal integration Euroclear (ICSD) Euroclear (FR) CIK (BE) Euroclear (NL) CBISSO (IE) Crest (UK) Vertical integration Deutsche Börse Eurex Clearing Euroclear Clearstream

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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 De Nederlandsche Bank Eurosysteem

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  No EU Directive for clearing and settlement … so no European passport for cross-border services De Nederlandsche Bank Eurosysteem

Post trading infrastructures US

Trading NYSE NASDAQ Clearing NSCC FICC DTC FED Settlement securities Settlement cash FEDERAL RESERVE De Nederlandsche Bank Eurosysteem

Trading

Post trading infrastructures EU

Amsterdam + Brussels + Lisbon + Paris London Stock Exchan ge Borsa Italia na Deut sche Borse Luxem bourg Stock Ex change Oslo Bors OM Nasdaq HEX Bolsa y Merc. Esp.

GPW Clearing LCH.Clearnet Group ltd Clearnet SA LCH CC&G Eurex Clea ring Settlement securities Eurocle ar Nederla nd CIK Eurocle ar France Crest Co Monte Titoli Clears tream BF Clears tream BL V P S Nordic CSD Iber clear K D P W C R B S Settlement cash DNB NBB BdF BOE Banca d ´ Italia Bunde sbank TARGET2 BCL Nordic central banks Banca d ´ Espan a Bk of Poland De Nederlandsche Bank Eurosysteem

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 De Nederlandsche Bank Eurosysteem

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 De Nederlandsche Bank Eurosysteem

Results until now…

Code of Conduct – around 2 years MiFID – nearly 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) De Nederlandsche Bank Eurosysteem

Results till now…

Negative: Increased fragmentation and complexity 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) De Nederlandsche Bank Eurosysteem

Complexity European market increases

Trading London Stock Exchan ge Borsa Italia na Deut sche Borse Luxem bourg Stock Ex change Oslo Bors OM Nasdaq HEX Bolsa y Merc. Esp.

GPW Clearing Settlement securities LCH.Clearnet Group ltd Clearnet SA LCH Euro clear Neder land CIK Eurocle ar France Crest Co CC&G Eurex Clea ring Monte Titoli Clears tream BF Clears tream BL V P S Nordic CSD Iber clear K D P W C R B S EU market = Incumbent trading, clearing and settleme nt + … Settlement cash DNB NBB Banq. de France Bank of Englnd Banca d ´ Italia Bunde sbank TARGET2 BCL Nordic central banks Banca d ´ Espan a Bk of Poland De Nederlandsche Bank Eurosysteem

Complexity European market

Trading:

increases

Turquoise Smartpool

MTFs

Bluenext Equiduct Chi-X Nasdaq OMX BATS Clearing:

New and existing CCPs Settlement agents

EuroCCP Citibank LCH.Clearnet SA EMCF Fortis Bank Nederland Settlement securities Eurocle ar Nederla nd CIK Euro clear France Crest Co Monte Titoli Clears tream BF Clears tream BL V P S Nordic CSD Iber clear K D P W … MTFs and new CCPs Settlement cash DNB NBB Banq. de France Bank of Englnd Banca d ´ Italia Bunde sbank TARGET2 BCL Nordic central banks Banca d ´ Espan a Bk of Poland De Nederlandsche Bank Eurosysteem

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) De Nederlandsche Bank Eurosysteem

Risks in clearing and settlement of securities

• •

credit risk: replacement cost risk principal risk liquidity risk custody risk legal risk

Risks

operational risk risk of settlement bank failure systemic risk

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Risks

Credit risk :

The risk of loss from default by a participant, as a consequence of its insolvency

Replacement cost risk Principal risk

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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 De Nederlandsche Bank Eurosysteem

Delivery versus Payment (DvP)

CSD 1 2 3 Securities A DvP B cash

A B

^ 3 ^ 2 NCB ^ 1 Bank A Bank B

Sell Order Buy Order De Nederlandsche Bank Eurosysteem

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 De Nederlandsche Bank Eurosysteem

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 (i. e. t+3)

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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 De Nederlandsche Bank Eurosysteem

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

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Risks

Liquidity risk

  

Risk that counterparty will not settle an obligation when due Costs depend on degree of liquidity Potential to create systemic problems

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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

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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)

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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 will also be possible De Nederlandsche Bank Eurosysteem

Why (1)?

The current initiatives: T2S: a workable solution for DVP cross-border settlement of securities within central bank money APK Deutsch Börse Gruppe Euroclear Group NTMA Euroclear NL Euroclear BE NBB Clearing Clearstream FFM Clearstream Lux OeKB Euroclear FR SCL Bilbao Interbolsa Iberclear SCL Barcelona Siteme SCL Valencia Monte Titoli BOGS CSD SA

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Why T2S (2)?

 The model can offer advantages in terms of efficiency and cost-cutting  provided that a critical mass of CSDs actually join and the system can be developed at reasonable costs  Commitment CSDs  Cost estimations to be further investigated  It will benefit financial stability (enabling cross border securities settlement in Central Bank Money) De Nederlandsche Bank Eurosysteem

Background: Essential concepts

T2S concerns only settlement in central bank money

CSD Custodian bank or ICSD commercial bank money central bank money Investor bank Investor De Nederlandsche Bank Eurosysteem

Traditional roles in securities market

EXCHANGE LISTING TRADING ISSUER CSD CLEARING HOUSE CCP CLEARING SETTLEMENT CENTRAL BANK CASH CLEARING ISSUER CSD INVESTOR CSD BANK & BROKER INVESTOR De Nederlandsche Bank Eurosysteem

Securities accounts at the centre

EXCHANGE LISTING TRADING CLEARING HOUSE CCP CLEARING T2S SETTLEMENT CENTRAL BANK CASH SETTLEMENT ISSUER SECURITIES ACCOUNTS CSD ISSUER CSD INVESTOR CSD BANK & BROKER INVESTOR De Nederlandsche Bank Eurosysteem

How?

 CSDs outsource the administration of securities accounts to T2S  Credit institutions transfer cash to T2S, real time DVP is now possible  During or at the end of the day the securities return to the CSDs and the money goes back into the TARGET2 payment system  CSDs retain the remaining functions such as custody and notary functions De Nederlandsche Bank Eurosysteem

TARGET2 – Securities outside of operating hours BOGS Securities accounts OeKB Securities accounts Clearstream Securities accounts Monte Titoli Securities accounts Iberclear Securities accounts APK Securities accounts TARGET2 - Securities Cash accounts TARGET2 OeNB, NBB, BBK, BdE, BoF, BdF, BoG, CBFSAI, BdI, BcL, DNB, BdP NBB Clearing Securities accounts NTMA Securities accounts Other CSD’s Securities accounts

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

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What is T2S?

Where are the benefits coming from

  3 sources of cost savings  fee savings:  economics of scale  elimination of the cross-border aspect  collateral savings (single pool of collateral)  back-office savings (one or few technical interfaces) Non-quantifiable benefits  driver for harmonisation  enhanced competition in market infrastructure  market liquidity (dynamic effect) De Nederlandsche Bank Eurosysteem

Uncertainties

 Success of T2S depends 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 De Nederlandsche Bank Eurosysteem

The T2S User Requirements

 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  T2S  Four central banks develops the platform: Deutsche Bundesbank, Banco de Espana, Banque de France, Banca d’Italia De Nederlandsche Bank Eurosysteem

Legal issues



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 De Nederlandsche Bank Eurosysteem

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: Specification- and development phase  Possibilities External (non-Euro zone) CSD settlement  2010-2012: Building, Testing and Migration phase  2013: Operational phase De Nederlandsche Bank Eurosysteem

Thank you very much !

Any qu

€

stions?

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