1. Exchanges, Clearing & Settlement and TARGET2 Securities
Richard Derksen
2nd Conference of Macedonian Financial Sector on Payments and
Securities Settlement Systems
Ohrid
30 June 2009
De Nederlandsche Bank

2. 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

3. Securities chain trading clearing settlement
Agreement to exchange securities for funds
trading
clearing
Calculation of obligations
Delivery of securities and payment of funds
settlement

4. Clearing & settlement infrastructure
Exchanges
CCP
National
Central
Bank
CSD
Issuer
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
ICSDs
International central securities depositories: international settlement services providers, CSDs for Eurobonds
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. Exchanges, CCPs and CSDs - basic model
Buyer/
Seller
EURONEXT
Trading Member
Trading
Clearing
Members
LCH.Clearnet SA
Clearing
EUROCLEAR Nederland
Securities settlement
Partijen betrokken bij de infrastructuur van de financiële markten
Euroclear group o.a. Euroclear Nederland
ENL
DNB / T2
Admitted
Depository
Cash settlmn.
Institution

8. Clearing / CCP Role: Trade confirmation Netting
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)
Door een CCP verdwijnt het tegenpartij risico niet, maar een CCP zorgt ervoor dat
Het risico wordt beheerst
Het risico verdeeld wordt wordt
Ze doet dit middels een risico framework dat bepaalt hoe een member default wordt opgevangen en door wie de verliezen worden gedragen.
Een CCP zorgt er bovendien voor dat het bilaterale risico vervangen wordt door een standaard risico tov de CCP. Het bilaterale risico verschilt steeds, want is afhankelijk van de clearing member. Kun je nog iets zeggen over de hoogte van het bilaterale risico tov het standaard risico?
Het tijdstip van novatie heeft belangrijke implicaties voor de verdeling van tegenpartij risico tussen de CCP en de clearing members. Hoe later dat tijdstip, des te…???

9. 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

10. CSD: settlement DVP Role:
EUROCLEAR Nederland
Depository
DNB / TARGET2
ENL
Settlement (ESES)
Securities account A
Securities account B
Cash account A
Cash account B
Cash account A
Cash account B
DVP
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

11. Central Securities Depository (CSD)
CSD: Depository
Aangesloten
Aangesloten
Instellingen
Aangesloten
Euroclear Nederland
Instellingen
Aangesloten
Instellingen
Central Securities Depository (CSD)
Aangesloten
Instellingen
Admitted
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

12. 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

13. 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)

14. 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
( to 2.90 €);
- Cross-border costs higher than
domestic ones (19.5 to €).
Source: Oxera, LSE, CEPS

15. 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

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

17. 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

18. 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

19. Post trading infrastructures US
Clearing
Settlement cash
Trading
NSCC
DTC
NYSE
NASDAQ
FICC
FED
FEDERAL RESERVE
Settlement securities

20. Post trading infrastructures EU
Clearing
Settlement cash
Euronext
Amsterdam + Brussels + Lisbon + Paris
Luxembourg Stock Ex
change
Oslo Bors OM Nasdaq HEX
GPW
Trading
Clearnet SA
LCH
LCH.Clearnet Group ltd
Euroclear Nederland
CIK
Euroclear France
Crest Co
BOE
BdF
NBB
DNB
London Stock Exchange
Borsa Italia na
CC&G
Monte Titoli
Banca d´
Italia
Deut
sche Borse
Eurex Clea
ring
Bundesbank
Clearstream BL
Clearstream BF
BCL
Nordic central banks
VPS
Nordic CSD
Banca d´ Espana
Iber
clear
Bolsa y Merc. Esp.
KDPW
CRBS
Bk of Poland
TARGET2
Settlement securities

21. EU initiatives for more efficient securities markets in Europe 1
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

22. EU initiatives for more efficient securities markets in Europe – 2
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

23. 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)

24. 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)

25. Complexity European market increases
Clearing
Settlement cash
Euronext
Amsterdam + Brussels + Lisbon + Paris
Luxembourg Stock Ex
change
Oslo Bors OM Nasdaq HEX
GPW
Trading
Clearnet SA
LCH
LCH.Clearnet Group ltd
Euro
clear Neder land
CIK
Euroclear France
Crest Co
Bank of Englnd
Banq. de France
NBB
DNB
London Stock Exchange
Borsa Italia na
CC&G
Monte Titoli
Banca d´
Italia
Deut
sche Borse
Eurex Clea
ring
Bundesbank
Clearstream BL
Clearstream BF
BCL
Nordic central banks
VPS
Nordic CSD
Banca d´ Espana
Iber
clear
Bolsa y Merc. Esp.
KDPW
CRBS
Bk of Poland
TARGET2
Settlement securities
EU market = Incumbent trading, clearing and settlement + …

26. Complexity European market increases
Clearing:
New and existing CCPs
Settlement cash
Equiduct
Chi-X
BATS
Trading:
MTFs
EuroCCP
LCH.Clearnet SA
Turquoise
Euroclear Nederland
CIK
Euro
clear France
Crest Co
Bank of Englnd
Banq. de France
NBB
DNB
Smartpool
Bluenext
EMCF
Monte Titoli
Banca d´
Italia
Bundesbank
Clearstream BL
Clearstream BF
BCL
Nordic central banks
VPS
Nordic CSD
Banca d´ Espana
Iber
clear
Nasdaq OMX
KDPW
Bk of Poland
TARGET2
Settlement securities
Citibank
Fortis Bank Nederland
Settlement agents
… MTFs and new CCPs

27. 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)

28. Risks in clearing and settlement of securities
credit risk:
replacement cost risk
principal risk
liquidity risk
custody risk
Risks
legal risk
operational risk
risk of settlement bank failure
systemic risk

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

30. 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

31. Delivery versus Payment (DvP)
Securities cash
NCB
Bank A
Bank B
Sell Order
Buy Order
CSD A B 1 ^ 2 ^2 3 ^3
DvP

32. 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

33. Risks Risk of loss of unrealised gains
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)

34. 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

35. 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

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

37. 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

38. 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)

39. 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

40. Why (1)? 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

41. 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)

42. Background: Essential concepts
T2S concerns only settlement in central bank money
Investor
Investor bank
Custodian bank or ICSD
CSD
central bank money
commercial bank money

43. Traditional roles in securities market
INVESTOR
CSD
SETTLEMENT
TRADING
ISSUER
CCP
CLEARING
CASH
BANK &
BROKER
LISTING
EXCHANGE
CENTRAL BANK
HOUSE

44. Securities accounts at the centre
INVESTOR
CSD
T2S
SETTLEMENT
TRADING
ISSUER
CCP
CLEARING
CASH
BANK &
BROKER
LISTING
EXCHANGE
CENTRAL BANK
HOUSE
SECURITIES ACCOUNTS

45. 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

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

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

48. Where are the benefits coming from
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)

49. 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

50. 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
(real time liquidity transfers between T2 RTGS accounts and T2S sub cash accounts will be possible automatically and on demand)

51. Legal issues Legal basis Article 22 Statute ESCB/ECB Governance
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

52. 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.

53. Timetable T2S July 2008: Decision Governing Council to launch T2S
2009: Specification- and development phase
Possibilities External (non-Euro zone) CSD settlement
: Building, Testing and Migration phase
2013: Operational phase

54. Thank you very much !
Any qu€stions?