1. De Nederlandsche Bank Eurosysteem Clearing & Settlement and TARGET2- Securities Nynke Doornbos & Michael van Doeveren 3rd Macedonian Financial Sector Conference on Payments and Securities Settlement Systems 29 June 2010 De Nederlandsche Bank

2. 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 (selfregulation)  Markets in Financial Instruments Directive (MiFID)  European Market Infrastructure Regulation (EMIR)  Securities Law Directive (SLD) Consequences for central banks TARGET2-Securities

3. 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

4. De Nederlandsche Bank Eurosysteem custodian CSD Issuer custodian Agent bank National Central Bank Agent bank Agent bank Agent bank Agent bank Agent bank Investor Clearing & settlement infrastructure CCP Exchanges

5. De Nederlandsche Bank Eurosysteem Entities in securities Issuer/Investor ICSDs Custodians Issue/hold securities CSDs 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 CCPs Central 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

6. 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)

7. De Nederlandsche Bank Eurosysteem Exchanges, CCPs and CSDs - basic model EURONEXT Trading Buyer/ Seller ENL LCH.Clearnet SA EUROCLEAR Nederland Trading Member Depository Admitted Institution Clearing Members Clearing Securities settlement DNB / T2 Cash settlmn.

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

9. 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

10. De Nederlandsche Bank Eurosysteem CSD: settlement ENL EUROCLEAR Nederland Depository Settlement DNB / TARGET2 Securities account A Securities 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. De Nederlandsche Bank Eurosysteem 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 CSD: Depository Euroclear Nederland Central Securities Depository (CSD) Aangesloten Instellingen Aangesloten Instellingen Aangesloten Instellingen Aangesloten Instellingen Aangesloten Instellingen Admitted Institution

12. De Nederlandsche Bank Eurosysteem Role of central banks Services in central bank money Cash settlement in TARGET2: DVP Collateral management for CCPs TARGET2-Securities (Pan- European platform for settlement of trades, September 2014) Oversight Financial stability – limit systemic risk Limit losses of participants Limit contagion to other markets Enhance confidence in payment systems

13. 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 and operational barriers, market based(10)  Legal and fiscal barriers (5)

14. 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 €). Source: Oxera, LSE, CEPS

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

17. De Nederlandsche Bank Eurosysteem Dynamics in the securities market Market integration, level playing field and harmonisation, regulatory (lessons learned from financial crisis) Consolidation of exchanges and SSSs in the market goes full speed on Code of Conduct for Clearing and Settlement Markets in Financial Instruments Directive European Market Infrastructure Regulation Securities Law Directive CESAME Group ? to lift technical, market practices Giovannini barriers Internalisation: huge banks settle transactions internally

18. 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 Regulatory measures to be implemented

19. De Nederlandsche Bank Eurosysteem Post trading infrastructures US Clearing Settlement cash Trading NSCC DTC NYSENASD AQ FICC FED FEDERAL RESERVE Settlement securities

20. De Nederlandsche Bank Eurosysteem Post trading infrastructures EU Clearing Settlement cash Euronext Amsterdam + Brussels + Lisbon + Paris Luxem bourg Stock Ex change Oslo Bors OM Nasdaq HEX GPW Trading Clearnet SALCH LCH.Clearnet Group ltd Euronext Amsterdam + Brussels + Lisbon + Paris Eurocle ar Nederla nd CIKEurocle ar France Crest Co BOEBdFNBBDNB London Stock Exchan ge Borsa Italia na CC&G Monte Titoli Banca d´ Italia Deut sche Borse Eurex Clea ring Bunde sbank Clears tream BL Clears tream BF BCLNordic central banks VPSVPS Nordic CSD Banca d´ Espan a Iber clear Bolsa y Merc. Esp. KDPWKDPW CRBSCRBS Bk of Poland TARGET2 Settlement securities

21. 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

22. 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

23. De Nederlandsche Bank Eurosysteem Results until now… Code of Conduct – around 2 years MiFID – around 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. De Nederlandsche Bank Eurosysteem Results till now… Negative: - Fragmentation and complexity remains - 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. 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)

26. De Nederlandsche Bank Eurosysteem 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 risk legal risk operational risk

27. De Nederlandsche Bank Eurosysteem Delivery versus Payment (DvP) Securities cash NCB Bank ABank B Sell OrderBuy Order CSD ABAB ABAB 1 ^1^1 2^2^2 3 ^3^3 DvP

28. 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

29. 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 in Central Bank Money, 2014) Oversight Financial stability – limit systemic risk Limit losses of participants Limit contagion to other markets Enhance confidence in payment systems

30. De Nederlandsche Bank Eurosysteem 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 is an option

31. De Nederlandsche Bank Eurosysteem OeKB Clearstream FFM Euroclear FR Iberclear Monte Titoli The current initiatives: Clearstream Lux Euroclear BE Euroclear NL NTMA SCL Bilbao CSD SA BOGS APK SCL Valencia SCL Barcelona Interbolsa Siteme NBB Clearing Why (1)? Deutsch Börse Gruppe Euroclear Group T2S: a workable solution for DVP cross-border settlement of securities within central bank money

32. De Nederlandsche Bank Eurosysteem Why T2S (2)? The model offers advantages in terms of efficiency and cost-cutting assuming that a critical mass of CSD’s actually joins and the system can be developed at reasonable costs (volume dependent) Commitment CSDs: MoU 2009, 27 CSD’s signed, Framework Agreement to be signed. Cost estimations to be further investigated Financial stability

33. De Nederlandsche Bank Eurosysteem 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

34. De Nederlandsche Bank Eurosysteem INVESTOR CSD INVESTOR CSD SETTLEMENT TRADING ISSUER CSD ISSUER CSD ISSUER INVESTOR CCP CLEARING CCP CLEARING CASH CLEARING CASH CLEARING BANK & BROKER BANK & BROKER LISTING EXCHANGE CSD CENTRAL BANK CLEARING HOUSE Traditional roles in securities market

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

36. 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 At the end of the day the securities return to the CSDs and the money goes back into the TARGET2 payment system functions such as custody and notary functions remain at the CSD’s (added value services)

37. De Nederlandsche Bank Eurosysteem TARGET2 Securities (during the operating hours) Euroclear (BE, FR, NL)SitemeBOGSOeKB 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 dedicated- cash accounts Securities accounts TARGET2 Cash accounts

38. De Nederlandsche Bank Eurosysteem Uncertainties Success of T2S depends on the decision of the CSDs to actually participate (signing Framework Agreement) Concentration of risk because of centralisation (impact) Prerequisite of the project: harmonisation of legal structures Removal Giovannini barriers, especially Barriers 4, 6 and 7: T2S may ensure common operating hours and finality rules for domestic and cross border transactions

39. De Nederlandsche Bank Eurosysteem The T2S User Requirements (Four central banks develop the platform: Deutsche Bundesbank, Banco de Espana, Banque de France, Banca d’Italia) 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

40. De Nederlandsche Bank Eurosysteem 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

41. 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.

42. De Nederlandsche Bank Eurosysteem Timetable T2S July 2008: Decision Governing Council to launch T2S 2009-2010: Specification- and development phase 2010-2013: Building, Testing and Migration phase September 2014: Operational phase (start of implementation in three waves)