Exchanges, Clearing & Settlement and
TARGET2 Securities
De Nederlandsche Bank
Richard Derksen
2nd Conference of Macedonian Financial
Sector on Payments and
Securities Settlement Systems
Ohrid
30 June 2009
De Nederlandsche Bank
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
Markets in Financial Instruments Directive (MiFID)

Consequences for central banks

TARGET2 Securities
De Nederlandsche Bank
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Securities chain
trading
clearing
settlement
Agreement to
exchange securities for
funds
Calculation of obligations
Delivery of securities
and payment of funds
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Clearing & settlement infrastructure
Exchanges
CCP
National
Central
Bank
CSD
custodian
Agent
bank
Investor
Investor
Agent
bank
Investor
Agent
bank
Investor
Agent
bank
Investor
Issuer
custodian
Agent
bank
Investor
Agent
bank
Investor
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Entities in securities
Issuer/Investor
CSDs
ICSDs
Custodians
Exchanges
CCPs
Agent Bank
NCB
Issue/hold securities
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
platform for trade in securities
Central counterparties: central providers for
clearing services
Executes transactions for customers
National Central Bank; provides settlement
De Nederlandsche Bank
services, oversight
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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)

De Nederlandsche Bank
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Exchanges, CCPs and CSDs - basic model
EURONEXT
Trading
LCH.Clearnet SA
Clearing
Trading
Member
Buyer/
Seller
Clearing
Members
EUROCLEAR Nederland
Securities settlement
ENL
Depository
DNB / T2
Cash settlmn.
Admitted
Institution
De Nederlandsche Bank
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Clearing / CCP
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)
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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
De Nederlandsche Bank
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CSD: settlement
EUROCLEAR Nederland
Depository
ENL
DNB / TARGET2
Settlement (ESES)
Securities account A
Securities account B
DVP
Cash account A
Cash account A
Cash account B
Cash account B
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)
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• SFD: Finality offers protection against unwinding
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CSD: Depository
Euroclear Nederland
Central Securities Depository (CSD)
Aangesloten
Aangesloten
Instellingen
Aangesloten
Instellingen
Aangesloten
Instellingen
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
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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 (PanEuropean 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
De Nederlandsche Bank
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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)
De Nederlandsche Bank
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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 €);
35
30
25
20
15
- Cross-border costs higher than
domestic ones (19.5 to 35.0 €).
10
5
0
United
States
EU
domestic
Min
Source: Oxera, LSE, CEPS
Max
EU crossborder
Avg.
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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
De Nederlandsche Bank
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Integration models in Europe
Horizontal integration
Vertical integration
Euroclear (ICSD)
CIK (BE)
Euroclear (FR)
Euroclear (NL)
CBISSO (IE)
Crest (UK)
Euroclear
Deutsche
Börse
Eurex
Clearing
Clearstream
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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

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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
De Nederlandsche Bank
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Post trading infrastructures US
Trading
NYSE
NASDAQ
NSCC
FICC
DTC
FED
Clearing
Settlement
securities
FEDERAL RESERVE
Settlement
cash
De Nederlandsche Bank
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Post trading infrastructures EU
Trading
Euronext
Amsterdam + Brussels
+ Lisbon + Paris
London
Stock
Exchan
ge
Luxem
bourg
Stock
Ex
change
Borsa
Italia
na
Deut
sche
Borse
LCH
CC&G
Eurex
Clea
ring
Crest
Co
Monte
Titoli
Clears
tream
BF
Clears
tream
BL
Bunde
sbank
BCL
Oslo Bors
OM
Nasdaq
HEX
Bolsa
y
Merc.
Esp.
Nordic
CSD
Iber
clear
Nordic central
banks
Banca
d´
Espan
a
GPW
LCH.Clearnet Group ltd
Clearnet SA
Clearing
Settlement
securities
Eurocle
ar
Nederla
nd
CIK
Eurocle
ar
France
Settlement
cash
DNB
NBB
BdF
BOE
Banca
d´
Italia
V
P
S
K
D
P
W
C
R
B
S
Bk of
Poland
TARGET2
De Nederlandsche Bank
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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
De Nederlandsche Bank
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EU initiatives for more efficient
securities markets in Europe –
2. MiFID
´Markets in Financial Instruments Directive´, 1 November 2007
 MTF:
 Best
alternative trading platforms next to regulated markets
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
De Nederlandsche Bank
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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)
De Nederlandsche Bank
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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)
De Nederlandsche Bank
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Complexity European market
increases
Trading
Euronext
Amsterdam + Brussels
+ Lisbon + Paris
London
Stock
Exchan
ge
Borsa
Italia
na
Deut
sche
Borse
Luxem
bourg
Stock
Ex
change
Oslo Bors
OM
Nasdaq
HEX
Bolsa
y
Merc.
Esp.
GPW
EU market
=
LCH.Clearnet Group ltd
Clearnet SA
LCH
CC&G
Eurex
Clea
ring
Crest
Co
Monte
Titoli
Clears
tream
BF
Clearing
Settlement
securities
Euro
clear
Neder
land
CIK
Eurocle
ar
France
Incumbent
trading,
clearing
and
settleme
Clears
tream
BL
V
P
S
Nordic
CSD
Iber
clear
K
D
P
W
C
R
B
S
nt
+
…
Settlement
cash
DNB
NBB
Banq.
de
France
Bank of
Englnd
Banca
d´
Italia
Bunde
sbank
TARGET2
BCL
Nordic central
banks
Banca
d´
Espan
a
Bk of
Poland
De Nederlandsche Bank
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Complexity European market
increases
Trading:
Turquoise
Smartpool
Bluenext
Equiduct
Chi-X
Nasdaq
OMX
MTFs
BATS
Clearing:
New and
existing
CCPs
EuroCCP
Settlement
agents
Citibank
LCH.Clearnet SA
EMCF
Fortis Bank Nederland
Settlement
securities
Eurocle
ar
Nederla
nd
CIK
Euro
clear
France
Settlement
cash
DNB
NBB
Banq.
de
France
Crest
Co
Bank of
Englnd
Monte
Titoli
Banca
d´
Italia
Clears
tream
BF
Clears
tream
BL
Bunde
sbank
BCL
V
P
S
Nordic
CSD
Iber
clear
Nordic central
banks
Banca
d´
Espan
a
K
D
P
W
…
MTFs and
new
CCPs
Bk of
Poland
TARGET2
De Nederlandsche Bank
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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)
De Nederlandsche Bank
Eurosysteem
Risks in clearing and settlement
of securities
credit risk:
• replacement cost risk
• principal risk
legal risk
liquidity risk
custody risk
Risks
operational risk
risk of settlement bank failure
systemic risk
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Risks
Credit risk:
The risk of loss from default by a participant,
as a consequence of its insolvency
Replacement cost risk
Principal risk
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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
De Nederlandsche Bank
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Delivery versus Payment (DvP)
Securities
2
cash
A
^
2
A
DvP
CSD
B
3
1
Bank A
Sell Order
NCB
B
^
3
^
1
Bank B
Buy Order
De Nederlandsche Bank
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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

De Nederlandsche Bank
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Risks
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)
De Nederlandsche Bank
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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
De Nederlandsche Bank
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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
De Nederlandsche Bank
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Risks
Liquidity risk



Risk that counterparty will not settle
an obligation when due
Costs depend on degree of liquidity
Potential to create systemic problems
De Nederlandsche Bank
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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
De Nederlandsche Bank
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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)
De Nederlandsche Bank
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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
De Nederlandsche Bank
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Why (1)?
The current initiatives:
T2S: a workable solution for DVP
cross-border settlement of
securities within central bank
APK
money
Deutsch Börse Gruppe
Euroclear Group
Euroclear NL
NTMA
Euroclear BE
NBB Clearing
Clearstream FFM
Clearstream Lux
OeKB
Euroclear FR
SCL Bilbao
Interbolsa
Siteme
SCL Barcelona
Iberclear
SCL Valencia
Monte
Titoli
BOGS
CSD SA
De Nederlandsche Bank
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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)
De Nederlandsche Bank
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Background: Essential concepts
T2S concerns only settlement in central bank money
CSD
Custodian bank
or ICSD
central bank money
commercial bank money
Investor bank
Investor
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Traditional roles in securities market
EXCHANGE
LISTING
TRADING
CLEARING
CCP
HOUSE CLEARING
CENTRAL BANK
CSD
SETTLEMENT
ISSUER
ISSUER
CSD
INVESTOR
CSD
CASH
CLEARING
BANK &
BROKER
INVESTOR
De Nederlandsche Bank
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Securities accounts at the centre
EXCHANGE
LISTING
TRADING
CLEARING
CCP
HOUSE CLEARING
CENTRAL BANK
T2S
SETTLEMENT
CASH
SETTLEMENT
SECURITIES ACCOUNTS
BANK &
BROKER
CSD
ISSUER
ISSUER
CSD
INVESTOR
CSD
INVESTOR
De Nederlandsche Bank
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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

De Nederlandsche Bank
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TARGET2 – Securities outside of operating hours
Euroclear (BE, FR, NL)
Siteme
Securities
Securities
accounts
accounts
Securities
Securities
accounts
accounts
BOGS
Securities
accounts
Securities
accounts
Clearstream
Securities
accounts
OeKB
TARGET2 - Securities
NBB Clearing
Securities
accounts
Monte Titoli
Securities
accounts
Iberclear
Securities
accounts
APK
Securities
accounts
Cash
accounts
NTMA
Securities
accounts
TARGET2
Other CSD’s
OeNB, NBB, BBK, BdE, BoF, BdF,
BoG, CBFSAI, BdI, BcL, DNB, BdP
Securities
accounts
De Nederlandsche Bank
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TARGET2 – Securities during the operating hours
Euroclear (BE, FR, NL)
Siteme
BOGS
OeKB
Clearstream
TARGET2 - Securities
Monte Titoli
Sub-cash
accounts
NBB Clearing
Securities
accounts
NTMA
Iberclear
Cash
accounts
TARGET2
APK
OeNB, NBB, BBK, BdE, BoF, BdF,
BoG, CBFSAI, BdI, BcL, DNB, BdP
Other CSD’s
De Nederlandsche Bank
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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)
De Nederlandsche Bank
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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
De Nederlandsche Bank
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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
De Nederlandsche Bank
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Legal issues
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
De Nederlandsche Bank
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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.

De Nederlandsche Bank
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Timetable T2S
July 2008: Decision Governing Council to
launch T2S
 2009: Specification- and development phase
Possibilities External (non-Euro zone) CSD
settlement
 2010-2012: Building, Testing and Migration
phase
 2013: Operational phase

De Nederlandsche Bank
Eurosysteem
Thank you very much !
Any qu€stions?
De Nederlandsche Bank
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