1. De Nederlandsche Bank Eurosysteem Exchanges, Clearing, Settlement and TARGET2 Securities Michael van Doeveren Richard Derksen Financial Sector of Macedonia Conference on Payments and Securities Settlement Systems Ohrid 24 June 2008 De Nederlandsche Bank

2. Eurosysteem Agenda The world of securities and exchanges Risks in clearing and settlement of securities TARGET2 Securities and CCBM2

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 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

8. De Nederlandsche Bank Eurosysteem Risks Credit risk : The risk of loss from default by a participant, as a consequence of its insolvency Replacement cost riskPrincipal risk

9. De Nederlandsche Bank Eurosysteem Risks 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 Principal risk

10. 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

11. 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

12. De Nederlandsche Bank Eurosysteem Risks 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 Risk of failure of a settlement bank

13. De Nederlandsche Bank Eurosysteem Risks 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 Systemic risk

14. De Nederlandsche Bank Eurosysteem European developments Lisbon agenda 2000: European economy has to become stronger to compete with the USA and Japan/China Shortage: there is no integrated European financial market European Union has identified 15 barriers for integration (Giovannini 2001)  Technical, market practices (10)  Legal and fiscal barriers (5)

15. De Nederlandsche Bank Eurosysteem Inefficiencies European market Huge difference in costs of securities transactions:  Domestic costs vary within the EU  In average higher than in the USA  EU cross-border costs are much higher than domestic costs in the USA

16. De Nederlandsche Bank Eurosysteem Securities landscape

17. 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

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

19. De Nederlandsche Bank Eurosysteem 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

20. De Nederlandsche Bank Eurosysteem Risks 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 (e.i. t+3) Replacement cost risk

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

22. De Nederlandsche Bank Eurosysteem Risks Risks that securities are not adequately protected by the custodians Either full loss or temporary inability to transfer securities Segregation of accounts Custody risk

23. De Nederlandsche Bank Eurosysteem Risks Due to deficiencies in systems and controls, human error or management failure Due to uncertain legal rules (unenforceability of contracts, bankruptcy laws, delay in recovering funds or securities) Operational risk Legal risk

24. De Nederlandsche Bank Eurosysteem TARGET2 Securities An integrated platform of the Eurosystem for the DVP settlement of securities transactions in central bank money within the euro area

25. 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? Deutsch Börse Gruppe Euroclear Group T2S: a workable solution for DVP cross-border settlement of securities within central bank money

26. De Nederlandsche Bank Eurosysteem Why? The model can offer advantages in terms of efficiency and cost-cutting, provided that a critical mass of CSDs actually joins and the system can be developed at reasonable cost. It would benefit financial stability

27. 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

28. 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

29. 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

30. De Nederlandsche Bank Eurosysteem How? The CSDs outsource the administration of securities accounts to the Eurosystem, which then manages the securities and associated cash accounts on the platform. At the end of the day the money goes back into the TARGET2 payment system, and the securities return to the CSDs Only securities settlement, CSDs keep the custody and notary functions Based on DVP

31. 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 Sub-cash accounts Securities accounts TARGET2 Cash accounts

32. De Nederlandsche Bank Eurosysteem Potential obstacles Dependence 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

33. De Nederlandsche Bank Eurosysteem TARGET2 Securities TARGET2 Securities is a workable solution for the long term Market consultation and user requirements is going on Governing Council of the ECB will take a decision on the implementation of T2S in March 2008

34. De Nederlandsche Bank Eurosysteem CCBM2 Currently, banks hold collateral at several locations, it is exchanged through the Correspondent Central Bank Model CCBM2 is a common platform for central banks that integrates both domestic and cross-border collateral management