4Thomas Murray – Who are we? IntroductionThomas Murray – Who are we?Established in 1994Based in London, U.K, Ontario Canada.Originally created to assist investment managers and pension funds in selecting global custodiansTransitioned to working with global custodians in selecting domestic custodiansProduced the first international CSD Guide in 1997Developed depository risk ratings service in 2000/2001Developed capital market infrastructure risk ratings 2003Launched Public CSD Ratings in 2005Multinational staff from: Australia, Canada, China, Colombia, France, Ireland, Mauritius, New Zealand, Philippines, Poland, United Kingdom, Ukraine, Uzbekistan,Total professional staff: 40+
7Best Market PracticeThe 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 2001Some 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 usersRecommendation # 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.
8Best Market PracticeThe 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.
9Best 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.htmThe 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 OrganisationTheir 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.
10Best Market PracticeSecurities and Exchange Commission (SEC) 17f-7 RuleRule 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 AGCThe 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.
12Market 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 enterprisesInvolvement 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
14Role 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 .
15The Evolving Roles of CSD Role of CSDsThe Evolving Roles of CSDValue Added ServicesWith 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)
16Role 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)
17Role of CSDs Range of services Traditional Services Value Added ServicesBermuda, Bolivia, Costa Rica, Ecuador, El Salvador, Guatemala, Jamaica, Panama, T&T, Uruguay, VenezuelaChile, Colombia, Peru, Egypt, Russia, China,Canada, UK, Japan, Singapore, Sweden, Finland, Denmark, Malaysia, South AfricaFrance, Germany, Italy, Poland, Hong Kong, Australia, ThailandUSA, Norway, Euroclear, Clearstream
20Utility vs. Commercial Motivations Role of CSDsUtility vs. Commercial MotivationsPursuing 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.
24Corporate ActionsAsset Servicing RiskAsset 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.
25Asset Servicing Risk Criteria Corporate ActionsAsset Servicing Risk CriteriaReceipt of Corporate Action information.Requires a reliable ‘official’ sourceMultiple information sources allow for verification/’data scrubbing’Distribution of Corporate Action informationRequires timely, accurate, efficient and comprehensive event notificationReceipt of Corporate Action InstructionsRequires pro-active client servicingMultiple and efficient electronic means of receiving informationStraight Through ProcessingProcessing of Corporate Action InstructionsRequires timely, accurate and comprehensive event processingProxy Voting
26Asset Servicing Risk Criteria Corporate ActionsAsset Servicing Risk CriteriaClear statement of liabilityInvestors need to be aware of the liability assumed by CSD and custodian in event of an errorManual processing of asset servicing operations more commonLikelihood of error is higher for Asset servicingPotential losses can be highManaging corporate actions effectively is perhaps the biggest potential risk exposure
27Asset Servicing Risk Rating Asset Service Criteria AAA AA+ AA AA- A+ A BBBBBBCCCCCCInfo CollectionInfo DisseminationReceipt of InstructionsExecution of InstructionsProxy VotingAS1AS2AS4AS3AS4AS3CSDAS2Comparative ChartAverage Americas - TM Proprietary RatingAverage Eastern Europe – TM ProprietaryAvge West Euro – TM ProprietaryAvge Asia Pac – TM ProprietaryAverage Africa – TM ProprietaryAvge Mid East – TM ProprietaryAsset ServiceRatingCSDAS5AS5AS1Less importantImportantCritical
29Initial response – suspension by exchanges and clearing houses Lehman DefaultInitial response – suspension by exchanges and clearing housesTypically took one to two days for actionFollow-up Response – settlement of outstanding obligations or defaultAction ranged from settlement of transactions to widespread defaultGuarantee Funds utilised in many marketsReporting by markets was inadequate => confusionRegulator Concern – action on short sellingAction ranged from identifying short sales (Greece) to banning short selling of all securities (Australia)New disclosure requirements introducedIssuesInformation on situation slow, incomplete and sporadicUse of Guarantee Fund not always disclosedPosition of unmatched OTC trades not disclosedTightening in fails arrangements
30Lehman Default Timeline of Actions Monday 15 September 5.00am GMT Parent Company of Lehman’s filed for bankruptcyTuesday 16 September, am GMTMarkets started managing situation by suspending membership and ceasing to settle transactions related to LehmansUse of Guarantee Funds was indicated (Japan)Mainly Asian markets providing adviceTuesday 16 September, pm GMTEuropean markets started taking actionWednesday 17 September, am GMTMarkets continue to clarify default arrangementsTrading in Russia (RTS and MICEX) suspended by order of FFMSWednesday 17 September, pm GMTSome European and Nordic markets releasing information for first timeSouth Africa and Australia released information on default for first time
31Thursday 18 September, am GMT Lehman DefaultTimeline of ActionsThursday 18 September, am GMTItaly’s CCP (CC&G) advised of delays in settlement processing of some previous day transactionsUAE advises of suspension of participation of LehmansThursday 18 September, pm GMTFrance, Germany and the UK advise of suspension of Lehman operations for first timeFriday 19 September, am GMTFSA took action to stop short selling in publicly quoted finance company sharesIrish regulator and US SEC also banned short selling in financial company sharesRussia’s FFMS allowed trading to resume on MICEX and RTSBank of Spain temporarily suspends Lehman activities in debt marketFriday 19 September, pm GMTDTC of USA announces increase in its fails management resources from US$2.5 bn to US$3.2 bn
32Lehman Default Timeline of Actions Monday 22 September, am GMT China Securities Regulatory Commission reminds QFIIs of reporting responsibilitiesBelgium, France Netherlands ban naked short selling of financial shares for 3 monthsAustralia bans short selling of all company shares for at least 30 daysMonday 22 September, pm GMTCanadian regulator bans short selling for 2 weeks on a few financial sharesTuesday 23 September, am GMTSGX enhances disclosure of naked shorts and increases penalties on buy-insTuesday 23 September, pm GMTFFMS in Russia suspends naked short sellingPortugal requires daily disclosure on short sellingWednesday 24 September, am GMTFSS 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
33Wednesday 24 September, pm GMT Thursday 25 September Lehman DefaultTimeline of ActionsWednesday 24 September, pm GMTLuxembourg regulator bans short selling of shares issued by finance companiesThursday 25 SeptemberLCH 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 administratorsFriday 26 SeptemberSGX continues to provide clarity around changes to its penalties for failed trades
34Lehman 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 ResponseIdentify the problemDeal 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)
35Lehman DefaultObservationsOn-exchange trades and trades covered by CCP arrangements have generally been settled adequatelyOff exchange trades have been left to the market to settle – arrangements are more difficult and invariably involve the administrator - PWCQuestions RemainHas 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?
38Thomas Murray Capital Markets Infrastructure Ratings AAAAA+AAAA-A+AA-BBBBBComparative ChartAverage AmericasAverage East EuropeAvge West EuropeAvge Asia PacificAvge Mid East AfricaBCCC
39AECSD Market Comparisons RatingOverallRatingRatingACRLRCRASRFRORAAAAA+AAAA-A+AA-BBBBBBCCCCCCAAAAA+AAAA-A+AA-BBBBBBCCCCCCAverage Rating - Eastern EuropeTM Rating of 7 CSDs in AECSDAverage Rating - Highest Rated RegionsGap between top and bottom rated AECSD countryAverage Rating - AECSD
40Rating Gap Analysis - MCDR AECSD Market ComparisonsRating Gap Analysis - MCDROverallRatingACRLRCRASRFRORAAAAA+AAAA-A+AA-BBBBBBCCCAAAAA+AAAA-A+AA-BBBBBBCCCAverage Rating - AECSDHighest Public Rated DepositoryRating Gap between MCDR and Highest Rated CSDAverage Rating - Highest Rated Region/sMCDR Public Rating
41Rating Gap Analysis – Best Practice AECSD Market ComparisonsRating Gap Analysis – Best PracticeOverallRatingACRLRCRASRFRORAAAAA+AAAA-A+AA-BBBBBBCCCAAAAA+AAAA-A+AA-BBBBBBCCCAverage Rating - AECSDHighest Public Rated DepositoryRating Gap between Top AECSD Rating and Highest Rated CSDAverage Rating - Highest Rated Region/sHighest Rating in AECSD
42ConclusionsRange of service offerings provided by Eurasian CSDs is more closely represented by the traditional CSDsEurasian CSDs portray wide disparities in their risk ratings generally reflecting their stage in market and infrastructure developmentGreater need for awareness of best practice standards amongst Eurasian CSDs