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International Capital Market Infrastructure Experience and Practices

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Presentation on theme: "International Capital Market Infrastructure Experience and Practices"— Presentation transcript:

1 International Capital Market Infrastructure Experience and Practices
5th International Conference of the Association of Eurasian CSDs (AECSD) Almaty , Kazakhstan 2 October 2008

2 Agenda Introduction – Thomas Murray Best Market Practice and Standards
Market trends The Evolving Roles of CSDs Corporate Actions Lehman’s Default Response AECSD Market Comparisons

3 Introduction – Thomas Murray

4 Thomas Murray – Who are we?
Introduction Thomas Murray – Who are we? Established in 1994 Based in London, U.K, Ontario Canada. Originally created to assist investment managers and pension funds in selecting global custodians Transitioned to working with global custodians in selecting domestic custodians Produced the first international CSD Guide in 1997 Developed depository risk ratings service in 2000/2001 Developed capital market infrastructure risk ratings 2003 Launched Public CSD Ratings in 2005 Multinational staff from: Australia, Canada, China, Colombia, France, Ireland, Mauritius, New Zealand, Philippines, Poland, United Kingdom, Ukraine, Uzbekistan, Total professional staff: 40+

5 PRIMARY RESEARCH, ANALYSIS AND INFORMATION
Introduction Thomas Murray has three principal business lines: Ratings, Data Services and Advisory SECURITIES MARKET DATA MANAGEMENT SERVICES Delivery of capital market and CSD ratings and securities market data Daily Market Newsflashes Data management technology CUSTODIAN BANK, CAPITAL MARKET AND CSD RATINGS Global and domestic custody ratings CSD and capital market ratings Custodian monitoring PRIMARY RESEARCH, ANALYSIS AND INFORMATION PROPRIETARY & CONFIDENTIAL Copyright © Thomas Murray Ltd 2002 Will all corporate governance information be supplied to clients in English? What is your cut-off time prior to the meeting by which the client must instruct? VOTING INSTRUCTION REQUIRED WITHIN 1 DAY OF MARKET DEADLINE MEETING/VOTING INFORMATION NOT SUPPLIED IN ENGLISH VOTING INSTRUCTION REQUIRED WITHIN 7 DAYS OF MARKET DEADLINE ALL MEETING/ VOTING INFORMATION Representations 4.3 Core Services 5 4 10 7 6 COMMENTS Vertical Horizontal Bank of Tokyo Mitsubishi Fuji Bank Ltd HSBC Standard Chartered Bank Sumitomo Mitsui Banking Corporation The bank can provide all information in English except Notices of Agenda due to the time restraints. DD The bank’s standard deadline to receive voting instructions from the client is 4 business days prior to the meeting date. Yes, the bank will supply information in English. The bank’s cut-off time varies between 0-72 hours depending on request significance first, followed by processing time and volume.. The bank's standard reporting items in English on Corporate Governance are: Meeting date/place, meeting type, available holdings, agenda items and instruction deadline. As the bank has previously mentioned that Corporate Governance services are classed as a value added service at additional cost, it is unclear if these items are included in the standard custody fee. The bank’s cut-off time is 9:00 (JST). Yes, the bank will supply information in English within 24 hours from its receipt of the information. The bank expects voting instructions to be provided 3 business days prior to the meeting, 5 business days in the case of partial votes. The bank’s cut-off time is 8:00 3 business days prior to the meeting. BTM FB SCB SMBC No, the bank states that English is mandatory only for those stocks listed on the Nikkei 225, all other corporate governance instructions would be distributed in Japanese. The client must instruct the bank 1 week before the actual meeting. Citibank CITI ADVISORY SERVICES Investor Services: Global custody reviews Alternative investment supplier reviews Specialist support Network Management support for banks: Due diligence support Agent bank evaluation and selection Overseas advisory services for Governments and Exchanges: Capital market structural advice and workshops

6 Best Market Practice and Standards

7 Best Market Practice The International Organisation of Securities Commissions (IOSCO) BIS/IOSCO "Recommendations for Securities Settlement Systems", Report of the Committee on Payment and Settlement Systems and the Technical Committee of IOSCO November 2001 Some recommendations of particular relevance at this time; Recommendation # 1 – Legal Framework Securities settlement systems should have a well founded, clear and transparent legal basis in the relevant jurisdictions. Recommendation # 5 – Securities Lending Securities lending and borrowing should be encouraged as a method for expediting the settlement of securities transactions. Barriers that inhibit the practice of lending securities for this purpose should be removed. Recommendation # 9 – CSD Risk Controls to Address Participant Default: Deferred net settlement systems should institute risk controls that, at a minimum, ensure timely settlement in the event that the participant with the largest payment obligation is unable to settle. In any system in which a CSD extends credit or arranges securities loans to facilitate settlement, best practice is for the resulting credit exposures to be fully collateralised. Recommendation # 13 – Governance: Governance arrangements for CDSs and CCPs should be designed to fulfill public interest requirements and to promote the objectives of owners and users Recommendation # 17 – Transparency CSDs and CCPs should provide market participants with sufficient information for them to identify and evaluate accurately the risks and costs associated with use of the CSD or CCP services.

8 Best Market Practice The International Organisation of Securities Commissions (IOSCO) BIS/IOSCO "Recommendations for Securities Settlement Systems“. Other recommendations of particular relevance are; Recommendation # 4 – Central Counterparties (CCPs) The benefits and costs of a CCP should be carefully evaluated. Where such a mechanism is introduced, the CCP should rigorously control the risks it assumes. Recommendation # 10 – Cash Settlement Assets Assets used to settle the cash leg of securities transactions between CSD members should carry little or no credit or liquidity risk. If central bank money is not used, steps must be taken to protect CSD members from potential losses and liquidity pressures arising from the failure of a settlement bank. Recommendation # 11 – Operational Reliability: Sources of operational risk arising in the clearing and settlement process should be identified and minimised through the development of appropriate systems, controls and procedures. Systems should be reliable and secure and have adequate scaleable capacity, Contingency plans and backup facilities should be established to allow for timely recovery of operations and completion of the settlement process. Recommendation # 16 – Communications Procedures and Standards Securities settlement systems should use or accommodate the relevant international procedures and standards in order to facilitate efficient settlement of cross border transactions.

9 Best Market Practice Group of Thirty (G30) www.group30.org
The report promotes “best practice” for the most developed markets in the world. There is considerable overlap with the IOSCO recommendations, however the material should certainly be heeded by any market contemplating infrastructure or process changes. Association of National Numbering Agencies (ANNA) International securities identification numbering system (ISIN). Recognised as the ISO standard for securities numbering ISO 6166. The Giovannini Group ec.europa.eu/economy_finance/giovannini_en.htm The Giovannini Group is a group of financial-market participants, which advises the European Commission on financial market issues. In its 2003 report, the Group, as advisor to the European Commission, published a report identifying 15 barriers to efficient EU cross-border clearing and settlement. FIX Protocol Organisation Their goal is to improve the global trading process by defining, managing, and promoting an open protocol for real-time, electronic communication between industry participants, while complementing industry standards.

10 Best Market Practice Securities and Exchange Commission (SEC) 17f-7 Rule Rule 17f-7 sets forth the circumstances under which U.S. investment companies may hold securities through the facilities of non-U.S. securities depositories. A principal requirement of Rule 17f-7 is that an investment company must receive from its Primary Custodian an analysis of the custody risks associated with maintaining assets with each depository it uses. Association of Global Custodians AGC The AGC is not a standards setting body as such, but its members have the ability to disqualify a CSD as an eligible custody location based upon a failure of the CSD to respond to its questionnaire or a determination that the CSD presents an unacceptable level of risk. Society for Worldwide Interbank Financial Telecommunication (SWIFT) SWIFT acts as the secretariat for ISO for securities messaging. ISO/SWIFT messaging standards should be referenced prior to the adoption of and messaging standards for domestic or cross border activity.

11 Market Trends

12 Market Trends Pressure on profitability of exchanges
Exchanges downstream - vertical silos (e.g Spain, Germany, Norway) Horizontal consolidations (e.g OMX Group, Euroclear) Historical transition from exchange/broker owned, to market owned to public ownership (e.g. Australia, Hong Kong) Transfer from market utility to commercial enterprises Involvement of central banks in CSD business (e.g Costa Rica, NZ, T2S) Expanding added value services (e.g issuers service, derivatives, funds processing) Renewed focus on risk mitigation measures following Financial crisis and Lehman’s Default

13 The Evolving Role of CSDs

14 Role of CSDs Traditional Roles of CSDs
The Provision of domestic custody and support services for equity and debt issues. Offering settlement services to regulated domestic financial intermediaries. Processing income distributions in support of issues on deposit .

15 The Evolving Roles of CSD
Role of CSDs The Evolving Roles of CSD Value Added Services With increasing frequency CSDs are providing Clearing and Trade Matching services to their markets. CSDs are providing a range of Outsourcing services including back office services, corporate actions processing as well as systems management and operations. Among CSDs providing these services are HEX (Finland), CDS (Canada). TSD (Thailand) CSDs are providing an expanded range of Information Services including; corporate events, proxy services, reference data and even pricing information, e.g. VP (Denmark), CDS (Canada), DTCC (USA)

16 Role of CSDs Value Added Services
A number of CSDs around the world are providing Securities Lending services ranging from lending securities as principle, to matching up borrowers and lenders, to the provision of transaction and loan management services, e.g. KSD (Korea) A great number of CSDs provide International Links to other markets, providing services that extend from basic custody facilities to DVP settlement services. Increasingly CSDs are moving to provide expanded Corporate Actions Processing for their markets, thus allowing their participants to capitalise on economy of scale opportunities and focus on more commercially oriented activities. (Many CSDs around the world) Responsibility for Securities Numbering has increasingly come under the purview of CSDs. A significant number of the recognised national numbering agencies are now CSDs. Among the CSDs performing this function are DECEVAL (Colombia), CDS (Canada), Indeval (Mexico), NDC (Russia). CSDs are now providing Mutual Fund Services including account maintenance and transaction processing. VPS (Norway) With dematerialisation and high rates of immobilisation at CSDs the provision of Registry Services are becoming common place. VPS (Norway), VPC (Sweden), MCDR (Egypt)

17 Role of CSDs Range of services Traditional Services
Value Added Services Bermuda, Bolivia, Costa Rica, Ecuador, El Salvador, Guatemala, Jamaica, Panama, T&T, Uruguay, Venezuela Chile, Colombia, Peru, Egypt, Russia, China, Canada, UK, Japan, Singapore, Sweden, Finland, Denmark, Malaysia, South Africa France, Germany, Italy, Poland, Hong Kong, Australia, Thailand USA, Norway, Euroclear, Clearstream

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19 Role of CSDs

20 Utility vs. Commercial Motivations
Role of CSDs Utility vs. Commercial Motivations Pursuing commercial activities can have the effect of causing staff to think more innovatively about the core business. Increasingly CSDs are augmenting their core businesses and revenue sources with new “non-traditional” revenue streams. In 2006, CDS in Canada (a not for profit CSD) realised in excess of 35% of its total revenue (in excess of CAD 34 Million) from non-core/non-traditional (clearing, settlement and depository) activities.

21 Corporate Actions

22 Corporate Actions Mandatory Corporate Actions – don’t require an instruction from participant Voluntary Corporate Actions – requires participant to provide an instruction for each corporate action

23 Corporate Actions

24 Corporate Actions Asset Servicing Risk Asset Servicing Risk - The risk that a participant may incur a loss arising from missed or inaccurate information provided by the depository, or from incorrectly executed instructions, in respect of corporate actions and proxy voting. This risk arises when a participant places reliance on the information a depository provides or when the participant instructs the depository to carry out an economic transaction on its behalf. If the depository fails either to provide the information or to carry out the instruction correctly then the participant may suffer a loss for which the depository may not accept liability. The depository may provide these services on a commercial basis, without statutory immunity, or it may provide the service as part of its statutory role, possibly with some level of protection from liability. This risk is likely to become much higher when international securities are included in the service.

25 Asset Servicing Risk Criteria
Corporate Actions Asset Servicing Risk Criteria Receipt of Corporate Action information. Requires a reliable ‘official’ source Multiple information sources allow for verification/’data scrubbing’ Distribution of Corporate Action information Requires timely, accurate, efficient and comprehensive event notification Receipt of Corporate Action Instructions Requires pro-active client servicing Multiple and efficient electronic means of receiving information Straight Through Processing Processing of Corporate Action Instructions Requires timely, accurate and comprehensive event processing Proxy Voting

26 Asset Servicing Risk Criteria
Corporate Actions Asset Servicing Risk Criteria Clear statement of liability Investors need to be aware of the liability assumed by CSD and custodian in event of an error Manual processing of asset servicing operations more common Likelihood of error is higher for Asset servicing Potential losses can be high Managing corporate actions effectively is perhaps the biggest potential risk exposure

27 Asset Servicing Risk Rating Asset Service Criteria AAA AA+ AA AA- A+ A
BBB BB B CCC CC C Info Collection Info Dissemination Receipt of Instructions Execution of Instructions Proxy Voting AS1 AS2 AS4 AS3 AS4 AS3 CSD AS2 Comparative Chart Average Americas - TM Proprietary Rating Average Eastern Europe – TM Proprietary Avge West Euro – TM Proprietary Avge Asia Pac – TM Proprietary Average Africa – TM Proprietary Avge Mid East – TM Proprietary Asset ServiceRating CSD AS5 AS5 AS1 Less important Important Critical

28 Lehman’s Default Response

29 Initial response – suspension by exchanges and clearing houses
Lehman Default Initial response – suspension by exchanges and clearing houses Typically took one to two days for action Follow-up Response – settlement of outstanding obligations or default Action ranged from settlement of transactions to widespread default Guarantee Funds utilised in many markets Reporting by markets was inadequate => confusion Regulator Concern – action on short selling Action ranged from identifying short sales (Greece) to banning short selling of all securities (Australia) New disclosure requirements introduced Issues Information on situation slow, incomplete and sporadic Use of Guarantee Fund not always disclosed Position of unmatched OTC trades not disclosed Tightening in fails arrangements

30 Lehman Default Timeline of Actions Monday 15 September 5.00am GMT
Parent Company of Lehman’s filed for bankruptcy Tuesday 16 September, am GMT Markets started managing situation by suspending membership and ceasing to settle transactions related to Lehmans Use of Guarantee Funds was indicated (Japan) Mainly Asian markets providing advice Tuesday 16 September, pm GMT European markets started taking action Wednesday 17 September, am GMT Markets continue to clarify default arrangements Trading in Russia (RTS and MICEX) suspended by order of FFMS Wednesday 17 September, pm GMT Some European and Nordic markets releasing information for first time South Africa and Australia released information on default for first time

31 Thursday 18 September, am GMT
Lehman Default Timeline of Actions Thursday 18 September, am GMT Italy’s CCP (CC&G) advised of delays in settlement processing of some previous day transactions UAE advises of suspension of participation of Lehmans Thursday 18 September, pm GMT France, Germany and the UK advise of suspension of Lehman operations for first time Friday 19 September, am GMT FSA took action to stop short selling in publicly quoted finance company shares Irish regulator and US SEC also banned short selling in financial company shares Russia’s FFMS allowed trading to resume on MICEX and RTS Bank of Spain temporarily suspends Lehman activities in debt market Friday 19 September, pm GMT DTC of USA announces increase in its fails management resources from US$2.5 bn to US$3.2 bn

32 Lehman Default Timeline of Actions Monday 22 September, am GMT
China Securities Regulatory Commission reminds QFIIs of reporting responsibilities Belgium, France Netherlands ban naked short selling of financial shares for 3 months Australia bans short selling of all company shares for at least 30 days Monday 22 September, pm GMT Canadian regulator bans short selling for 2 weeks on a few financial shares Tuesday 23 September, am GMT SGX enhances disclosure of naked shorts and increases penalties on buy-ins Tuesday 23 September, pm GMT FFMS in Russia suspends naked short selling Portugal requires daily disclosure on short selling Wednesday 24 September, am GMT FSS of Korea discovers violations of naked short selling, takes action to increase collateral requirements for SLB transactions and enhances disclosure requirements, introduces ‘cooling period’ in which short sales not allowed

33 Wednesday 24 September, pm GMT Thursday 25 September
Lehman Default Timeline of Actions Wednesday 24 September, pm GMT Luxembourg regulator bans short selling of shares issued by finance companies Thursday 25 September LCH Clearnet advises that the risk exposure as a result of Lehman’s default had fallen by over 90% and that the remaining exposure would be covered by use of margins rather than access to the Guarantee Fund. Eurex (Germany) advised that exposure of Lehman trades covered by collateral and guarantee fund was not used. Issues relating to OTC trades unsettled in Crest have yet to be finalised with the administrators Friday 26 September SGX continues to provide clarity around changes to its penalties for failed trades

34 Lehman Default Issues Regulator Response CSD Response
Many markets around the world have made significant changes to rules regarding short selling in recent weeks. In particular, many regulators have moved to restrict or ban “naked” short selling ( prohibited from outset in some markets ) or to completely suspend short selling for certain stocks. CSD Response Identify the problem Deal with issue (Suspend membership, settle matched transactions, close-out defaults) Recover (Replenish guarantee funds, boost guarantee funds – i.e.DTC, enhance penalty arrangements for failed trades, examine ability to identify naked short selling) Provide Market Information (Keep the market and public informed)

35 Lehman Default Observations On-exchange trades and trades covered by CCP arrangements have generally been settled adequately Off exchange trades have been left to the market to settle – arrangements are more difficult and invariably involve the administrator - PWC Questions Remain Has the infrastructure been effective at managing a major default? How would the market have managed with a major bank default? Are the measures to manage a default adequate? Are the resources available for a default appropriate? Should more be done to manage the settlement and provide protection for OTC trades? Are the CSD communication channels appropriate in times of crisis?

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37 AECSD Market Comparisons

38 Thomas Murray Capital Markets Infrastructure Ratings
AAA AA+ AA AA- A+ A A- BBB BB Comparative Chart Average Americas Average East Europe Avge West Europe Avge Asia Pacific Avge Mid East Africa B CCC

39 AECSD Market Comparisons
Rating Overall Rating Rating ACR LR CR ASR FR OR AAA AA+ AA AA- A+ A A- BBB BB B CCC CC C AAA AA+ AA AA- A+ A A- BBB BB B CCC CC C Average Rating - Eastern Europe TM Rating of 7 CSDs in AECSD Average Rating - Highest Rated Regions Gap between top and bottom rated AECSD country Average Rating - AECSD

40 Rating Gap Analysis - MCDR
AECSD Market Comparisons Rating Gap Analysis - MCDR Overall Rating ACR LR CR ASR FR OR AAA AA+ AA AA- A+ A A- BBB BB B CCC AAA AA+ AA AA- A+ A A- BBB BB B CCC Average Rating - AECSD Highest Public Rated Depository Rating Gap between MCDR and Highest Rated CSD Average Rating - Highest Rated Region/s MCDR Public Rating

41 Rating Gap Analysis – Best Practice
AECSD Market Comparisons Rating Gap Analysis – Best Practice Overall Rating ACR LR CR ASR FR OR AAA AA+ AA AA- A+ A A- BBB BB B CCC AAA AA+ AA AA- A+ A A- BBB BB B CCC Average Rating - AECSD Highest Public Rated Depository Rating Gap between Top AECSD Rating and Highest Rated CSD Average Rating - Highest Rated Region/s Highest Rating in AECSD

42 Conclusions Range of service offerings provided by Eurasian CSDs is more closely represented by the traditional CSDs Eurasian CSDs portray wide disparities in their risk ratings generally reflecting their stage in market and infrastructure development Greater need for awareness of best practice standards amongst Eurasian CSDs


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