Securities Settlement Research Articles

New rules for securities settlement in Europe

In the European Union, securities transactions worth over €900 trillion are settled each year by Central Securities Depositories (CSDs). As part of its ongoing efforts to create a sounder financial system, the European Commission has recently proposed to set up a common regulatory framework for European CSDs and to harmonise certain aspects of the securities settlement in Europe. The proposal, which is currently being considered by the Council (Member States) and the European Parliament, will bring more safety and efficiency to securities settlement in Europe.

Report to the Executive Boards of the IMF and the World Bank on the New CPSS-IOSCO Principles for Financial Market Infrastructures

New and revised international standards for safe and efficient Financial Market Infrastructures (FMIs) were published in April 2012. The Committee on Payment and Settlement Systems (CPSS) and the International Organization of Securities Commissions (IOSCO) reviewed the existing sets of standards for FMIs and replaced them by one new set of Principles for Financial Market Infrastructures. Appendix I outlines the 24 new Principles for FMIs as well as the 5 responsibilities for authorities. FMIs facilitate the clearing, settlement, and recording of monetary and other financial transactions, such as payments, securities and derivatives contracts. The term FMI refers to payment systems (PSs) that are systemically important, central securities depositories (CSDs), securities settlement systems (SSSs), and central counterparties (CCPs). The revised standards also incorporate additional guidance for over-the-counter (OTC) derivatives CCPs and trade repositories (TRs).

Should the European repo market clear and settle only in central bank money?

One of the threads in the regulatory discussions that have been taking place in Europe in the wake of the Lehman crisis has been about strengthening the financial market infrastructure. Attention has turned to the issue of whether payments by so-called financial market infrastructures should be made in ‘central bank money’ (CEBM) rather than ‘commercial bank money’ (COBM). This paper looks at the roles of CEBM and COBM in the clearing and settlement of fixed-income securities in Europe. CEBM is seen as a risk-free settlement asset. The problem is that most institutions wishing to make payments do not have access to central bank accounts and many institutions that do have access do not necessarily think it economic or worthwhile to open an account. But, most importantly, few central banks offer cross-border access (a major exception being the European Central Bank within the eurozone) and none offer foreign currency payments. All developed economies therefore use CEBM and COBM in tandem, but the vast bulk of payments are made in COBM. In order to aid an understanding of the complex interaction of CEBM and COBM in the clearing and settlement of repos in Europe, the paper maps the flow of money and securities in central counterparty-cleared repo business.

Eleven features of an excellent securities settlement system in an investment bank

The settlement is a critical function in the trade lifecycle. With increased focus on reducing counterparty risk and ensuring trade fails are kept to the minimum, settlement systems have gained importance in the equities back office of investment banks. This in turn makes the choice of settlement system in securities operations very important. Awareness of best features will definitely help in making the right choice of settlement system while setting up operations. This paper looks at some of the key features of a securities settlement system.

Facilitating Investor Engagement and Stewardship

Facilitating Investor Engagement and Stewardship

Interlinkages between payment and securities settlement systems

Payments systems involve a number of interconnected systems that center around a large-value payment system through which banks send funds to each other for various purposes. Of fundamental interest to central banks are the interlinkages among these types of systems. This paper builds on Mills and Nesmith (J Monet Econ 55:542–553, 2008) to construct a relatively simple economic framework to begin to understand some of the different linkages of such systems with particular emphasis on the impact various disruptions may have. It looks at three alternative arrangements through which a funds transfer system and securities settlement system are linked. Each arrangement differs by the way the securities settlement system is designed. The main finding is that, although the different arrangements have different possible implications during a settlement shock ex ante, the equilibrium behavior of banks leads to the arrangements having similar implications ex post.

Risk management in securities settlement systems

This paper looks at how risk management in securities settlement systems seeks to ensure the continued robustness of an essential part of the financial market infrastructure. It takes the example of Euroclear and describes the role of the risk management function and how it has evolved. The paper outlines the three lines of defence model which ensure clarity of roles and responsibilities, and how the different components of risk management, including compliance with rules and regulations, can be implemented in practice. The particular importance of ensuring business continuity through high levels of operational resilience is noted and how that can be achieved is described. The risks that need to be considered by the risk function are likely to include some or all credit, market, liquidity, operational, business and strategic risks, as well as derived risks such as reputation risk. All financial market infrastructures will have to pay particular attention to operational risk and service reliability. For all financial market infrastructures, relevant stakeholders will want to be confident that the full range of risks facing those infrastructures is properly controlled. The risk function, therefore, will be subject to considerable scrutiny.

Loan and nonloan flows in the Australian interbank network

High-value transactions between banks in Australia are settled in the Reserve Bank Information and Transfer System (RITS) administered by the Reserve Bank of Australia. RITS operates on a real-time gross settlement (RTGS) basis and settles payments and transfers sourced from the SWIFT payment delivery system, the Austraclear securities settlement system, and the interbank transactions entered directly into RITS. In this paper, we analyse a dataset received from the Reserve Bank of Australia that includes all interbank transactions settled in RITS on an RTGS basis during five consecutive weekdays from 19 February 2007 inclusive, a week of relatively quiescent market conditions. The source, destination, and value of each transaction are known, which allows us to separate overnight loans from other transactions (nonloans) and reconstruct monetary flows between banks for every day in our sample. We conduct a novel analysis of the flow stability and examine the connection between loan and nonloan flows. Our aim is to understand the underlying causal mechanism connecting loan and nonloan flows. We find that the imbalances in the banks’ exchange settlement funds resulting from the daily flows of nonloan transactions are almost exactly counterbalanced by the flows of overnight loans. The correlation coefficient between loan and nonloan imbalances is about −0.9 on most days. Some flows that persist over two consecutive days can be highly variable, but overall the flows are moderately stable in value. The nonloan network is characterised by a large fraction of persistent flows, whereas only half of the flows persist over any two consecutive days in the loan network. Moreover, we observe an unusual degree of coherence between persistent loan flow values on Tuesday and Wednesday. We probe static topological properties of the Australian interbank network and find them consistent with those observed in other countries.

Modeling, simulation and analysis of a securities settlement system: The case of Central Securities Depository of Mexico

The Instituto para el Depósito de Valores (INDEVAL) is the Central Securities Depository of Mexico. It is the only Mexican institution authorized to perform, in an integrated manner, the activities of safe-keeping, custody, management, clearing, settlement and transfer of securities. In this article, we report the modeling, simulation and analysis of a new Securities Settlement System (SSS) implemented by INDEVAL, as part of a project for the implementation of a safer and more efficient operating system. The main objective of this research was to use reduced amounts of cash and securities, within reasonable periods of time, for the settlement of securities of the Mexican market. A linear programming model for the netting and clearing of operations was used. The performance of the new SSS was evaluated by performing experiments using a deterministic simulation model under different operation parameters, such as the number and monetary value of transactions, the time between clearing cycles and also under a new set of rules for pre-settlement operations. The results presented may be used by other Central Securities Depositories to make decisions related to the efficient and safer use of their resources. The implementation of the model took more than three years. Now many transactions that would remain pending if processed individually are settled together, thus reducing liquidity requirements dramatically –by 52% in cash and 26% in securities.

Sophisticating business performance management for banks: using data envelopment analysis on business process level

Crucial bank inefficiencies are rooted in the bank’s production processes. From an operations perspective, the assessment of inefficiencies, especially in highly standardised processes, should lead to better directed action for improvement and hence efficiency enhancement. This paper presents a new application of DEA for the measurement of business process efficiency. In our case study, the efficiency of the securities settlement and clearing process of a large European bank is analysed. It is a unique, large-scale dataset containing actual production data of this bank. Two different input-output models are used, representing most important objectives of operations managers in process performance analysis. The results show a high variance in process performance among different perspectives of analysis, indicating production inefficiencies in the process execution.

People�s Republic China: Detailed Assessment Report: CPSS-IOSCO Recommendations for Securities Settlement Systems and Central Counterparties

People�s Republic China: Detailed Assessment Report: CPSS-IOSCO Recommendations for Securities Settlement Systems and Central Counterparties

Indonesia: CPSS-IOSCO Recommendations for Securities Settlement Systems: The Equity and Corporate Bonds Securities Settlement Systems

"Volume 2012 (2012): Issue 186 (Jul 2012): Indonesia: CPSS-IOSCO Recommendations for Securities Settlement Systems: The Equity and Corporate Bonds Securities Settlement Systems" published on 18 Jul 2012 by International Monetary Fund.

The Reform of European Securities Settlement Systems: Towards an Integrated Financial Market

The European Central Bank (ECB) will offer to banks in 2013 an european shared platform for securities settlement, named TARGET 2 Securities (T2S), in order to open the national financial markets. The financial crisis did not change the ECB agenda. This paper develops a spatial competition model to understand the impact of this new organisation on european post-trading services. We analyse the incentives of the Central Securities Depositaries (CSD) to move to T2S when they become competitors in the market for settlement services and remain in a monopoly position for depository services. Settlement and depository services are complementary goods, because banks have to pay for these two services to buy or sell a security. We show that such a reform should induce a decrease in the settlement price and more generally in post-trading prices, but that prices depend strongly on market organisation. Under certain conditions, partial adhesion would make prices increase. This configuration appears as a Nash equilibrium. As CSDs are free to adhere to T2S, the ECB might be forced to regulate.

Addressing risk through best practice in Japan: Shortening settlement cycles and imposing fail charges

From 2002 to 2009, the Japanese securities settlement infrastructure and environment improved dramatically to realise delivery-vs-payment (DvP) settlement and dematerialisation of government bonds, commercial papers, corporate bonds, investment funds and even stocks. However, after the financial crisis, they recognised this improvement was still insufficient and that there was a significant need to improve the efficiency of the securities settlement system further and to enhance the risk control mechanism in order to reinforce the competitiveness of the financial and capital markets. Through feasibility studies and active discussion by market participants, the standard Japanese Government Bond (JGB) settlement cycle is scheduled to be shortened by one day to T+2 from 23rd April, 2012, and the fail charge system has been effective since 1st November, 2010, and has quickly penetrated the market. The study is continuing on T+1 settlement for outright trades. Both the shortened settlement cycle and the fail charge are expected to contribute to market stabilisation especially in irregular economic and/or market situations. The regulators of Japan FSA and Bank of Japan (BoJ) are positive and supportive of these initiatives.

Contributors

Contributors

United Kingdom: Observance by CREST of the CPSS-IOSCO Recommendations for Securities Settlement Systems Detailed Assessment of Observance

United Kingdom: Observance by CREST of the CPSS-IOSCO Recommendations for Securities Settlement Systems Detailed Assessment of Observance

Heart of Darkness: The Problem at the Core of the US Proxy System and its Solution

Voting rights are a shareholder’s main legal channel to exercise control internally over the company in which she invests her savings. Under the corporate law of the US states, a shareholder is someone registered on the stockholders’ list, not a person who has title to shares. When in the 1970s transferring paper certificates became impossible on high-volume markets, Congress ordered that the market’s securities be put into the vaults of a central depository and that claims against the depository’s accounts be transferred rather than the shares themselves. Once this was done, however, issuers no longer knew who owned their shares; they only knew a depository or its broker participant was registered as a shareholder. The heart of the securities market went dark. Communications with shareholders became impossible, so to facilitate the delivery of proxy materials to shareholders, the SEC formulated “shareholder communication” rules, which require financial intermediaries to pass along proxy packets to their customers for a fee. As this process is complex and the deadlines short, votes get lost and misattributed. An entire industry has sprung up to help issuers distribute proxy materials and collect votes. Issuers, who the law forced to give shareholder data to intermediaries, now pay these same intermediaries for information services. But paper certificates, the cause of this dilemma, are rarely used in contemporary securities markets. So why does the problematic system still persist? Because it generates a substantial transfer of wealth from the issuers to the financial intermediaries, and the latter understandably do not welcome its dissolution. This paper shows how the indirect holding system impedes the effective exercise of voting rights, exposes the interests that support the system’s persistence, and proposes a practical solution for the disintermediation of securities settlement, which will allow the restoration of issuer-shareholder transparency.

Regulatory Failures in the Design of Securities Settlement Infrastructure

Nearly all transactions in listed securities on the US capital markets are settled through a securities settlement infrastructure that generates extensive negative externalities for issuers and securityholders. This model is still advocated by regulators and market structure experts; it is an intermediated structure originally designed for depositing paper certificates in the accounts of a depository to allow book entry transfers of claims on the deposited certificates. The structure dates back at least to 1873. It accelerates transfer by short circuiting endorsement, delivery and cancellation of certificates, as all securities are and remain registered in the name of a single entity or a few intermediaries. The depository in effect issues uncertificated claims on the pool of assets (the underlying securities) kept in its accounts, creating an effect like “dematerializing” the securities, i.e., issuing securities in electronic rather than in paper form. This shortcut severs owners from issuers, inserts intermediaries as new owners, disrupts communication, and can lead to erroneous exercise of securityholder rights. It can also lead the creation of securities that were never issued, as account bookings multiply and exceed the number of securities existing on the primary account of the issuer’s list of securityholders. While directly damaging to issuers and securityholders, it creates significant advantages for intermediaries, as they become the owners of the economy's outstanding securities as well as of all the information about securityholders. They use this information to bind their clients to them and profit from value-added services that issuers cannot perform because they have transferred the information regarding their securityholders to the intermediaries. This structure generates high costs but there is no movement to replace it with a viable alternative based on electronic transfer displayed directly in a securities register available to issuers. The situation can be described as strong-form path dependence, given that a costly model adopted for past historical reasons has not been superseded because of a lack of good information, influential voices set against change, and the failure of regulators to grasp the problem and correct it. This article offers the analysis of the situation that regulators currently lack: it explains the genesis of the current infrastructure, presents the various changes that law and the markets have suffered in adapting to it, exposes its negative effects on issuers and securities holders, and analyzes how its owners and operators have successfully resisted change. By tying together the reasons for the system’s creation as derived from commercial law, the negative effects it has on the optimal operation of the corporate and securities laws, and the organizational and informational impediments that have and continue to hold regulators back from recommending a fundamental improvement of the securities settlement infrastructure, the article would fill the current deficit of information.

The Challenges of Establishing an Efficient Securities Settlement System in an Emerging Market

The Challenges of Establishing an Efficient Securities Settlement System in an Emerging Market

Bridging the gap between software architecture rationale formalisms and actual architecture documents: An ontology-driven approach

Documenting software architecture rationale is essential to reuse and evaluate architectures, and several modeling and documentation guidelines have been proposed in the literature. However, in practice creating and updating these documents rarely is a primary activity in most software projects, and rationale remains hidden in casual and semi-structured records, such as e-mails, meeting notes, wikis, and specialized documents. This paper describes the TREx (Toeska Rationale Extraction) approach to recover, represent and explore rationale information from text documents, combining: (1) pattern-based information extraction to recover rationale; (2) ontology-based representation of rationale and architectural concepts; and (3) facet-based interactive exploration of rationale. Initial results from TREx’s application suggest that some kinds of architecture rationale can be semi-automatically extracted from a project’s unstructured text documents, namely decisions, alternatives and requirements. The approach and some tools are illustrated with a case study of rationale recovery for a financial securities settlement system.