Clearance and Settlement for Government and Settlement for Government Securities December, 11-12, 2003 ... be lent for market ... corporate debt, government securities, derivatives – E.g

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  • Clearance and Settlement for Government Securities

    December, 11-12, 2003Bali, Indonesia

    Noritaka AkamatsuFinancial Sector Operations and Policy

    The World Bank

  • Agenda

    Why efficient C&S is important for GS market.

    Criticality of Delivery versus Payments (DVP) for GS market.

    RTGS versus net settlement.

    Alternative institutional setups of C&S bodies and use of government securities as collateral.

    Functions and services to be provided by C&S systems.

    Central counter-party (CCP): Is it needed?

    Conflicts of interest in governance of C&S institutions

  • After Trade Execution .. Comparison (of terms of the trade):

    affirmation by the client to the agent confirmation by the counterparties

    Communication of settlement instructions to central depositories / custodians.

    Computation of the obligations of the counterparties resulting from the comparison gross settlement net settlement

    Settlement: Final delivery of securities and final payments.

    C&S can also involve other complex processes such as repo clearing, collateral management, securities lending, cash management, etc.

  • International StandardsCPSS-IOSCO Recommendations (19) addresses:

    Legal framework Trade confirmation / affirmation (T+0, T+1 or less) Settlement cycles (T+3 or less) Central counterparties (CCP) & guarantee mechanisms Securities lending / borrowing and repos CSD and risk control against participants failure DVP by CSD, settlement finality and same day funds Cash settlement assets (e.g., central bank money) CSD operational reliability & business continuity Custody risk mitigation Governance, open access Efficiency Communication procedures and standards

  • Why C&S is particularlyimportant for GS market

    GSs are traded frequently in large value, thus posing significant systemic risks to the financial system.

    Fixed income trading activities are very sensitive to cost and risk of transaction. Efficient C&S is crucial in reducing those. Funds and securities tied up in C&S process not only

    necessarily but sometimes also unnecessarily; Investment and operating cost of C&S systems

    Effectiveness in organizing the trading market depends heavily on the integrity of C&S Anonymity and DVP

  • Criticality of DVP

    Simultaneous transfer of money and securities.

    Lack of DVP leaves the secondary market fragmented, non-transparent and under-developed. Makes anonymous trading very difficult, and telephone OTC

    trading prevails.

    Big banks and institutions deal only among themselves worrying about counter-party risk, i.e., the secondary market remains fragmented and non-transparent, i.e.,


    The secondary market would fail to develop beyond a small group of large banks/institutions.

  • RTGS vs. Net Settlement There is tradeoff between cost and risk in C&S.

    Unnecessary cost and risk should be eliminated.

    In choosing optimal tradeoff, utility functions of Central Bank and the market participants are often different. RTGS eliminates systemic risks and often preferred by Central


    Net settlement saves funds and securities needed for settlement and often preferred by market participants (especially if Central Bank acts as CCP).

    Central Bank can require banks to adopt a desired safe solution or incentivize them to seek it through prudential rules.

  • Risk and cost tradeoff



    Inefficient solution

    High risk low cost

    Low risk high cost

    Efficient frontier

  • Costs and Risks in RTGS and Net Settlement

    Funds needed for RTGS need to be provided by Central Bank against collateral. Funds needed tend to increase proportionally to the volume

    of trading. Thus, collateral required should also increase proportionally

    to the volume.

    Risks in net settlement should be backed up by collateral. Risks in net settlement tend to increase exponentially with

    the volume of trading. Thus, collateral required should also increase exponentially.

    Collateral tied up involves opportunity costs.

  • RTGS vs. Net settlementsystemic risk and collateral requirements

    Collateral required

    Settlement volume

    Net settlement


  • RTGS and automatic Repos for liquidity provision

    RTGS requires a high level of fund liquidity.

    High opportunity cost for market participants if they had to maintain it by themselves.

    Central bank can provide intra-day overdraft by automatically collateralizing GSs of a bank seeking the liquidity.

    The same logic applies to securities. I.e., GSs can be lent for market participants (e.g., market makers) who need those for timely settlement / delivery. Central depository of GSs could provide such a service (i.e.,

    CSD lending). Who operates the CSD?

  • Central Counter-partyQ.What value would CCP add over and beyond what is

    already achieved by DVP?

    Issues: Need of post-trade anonymity; Need of safer settlement? Proper risk management is

    needed (e.g., a loss sharing arrangement among participants to avoid moral hazard);

    Convenience, i.e., no need to assess risk of individual counterparties, thus facilitating active trading;

    Need of sure settlement for fund liquidity management (e.g., repos);

    Need of net settlement in addition to RTGS (repos).

  • Settlement of primary issues of GSs (T-bills & T-bonds)

    The settlement cycle should be standardized and made reasonably short. To enable effective cash management by the government. The more capable the government becomes in cash

    management, the more it will appreciate swift settlement.

    Use of RTGS is highly desirable.

    The settlement system should be capable of handling netting in funds for exchange offers for refinancing of outstanding debt.

    Direct counterparties for Central Bank in OMO may be limited to qualified banks holding money and securities accounts at Central Bank?

  • Settlement for OMO

    OMO in GSs, repos or CB bills (though not impossible to use certain other securities).

    Settlement of OMO should be very swift. by the end of the settlement day if not intraday or real time.

    Cash balance of the government and excess reserve of the banking system as key parameters. Sophistication of government cash management can

    simplify monetary policy of the central bank.

  • C&S of repos and reverse

    A settlement system should be capable of handling: swift settlement (by end of day, intraday or real time); sell & buyback repos (e.g., the obligation of the parties to

    trade to reverse the transaction as well as ownership transfer should be noted.);

    collateralized lending (e.g., the pledgor is blocked from using the pledged GSs.).

    If notional securities are used, the system should be capable of controlling use of GSs owned by clients of the market participant in repo Otherwise, integrity of DVP and finality is compromised.

    A system should permit netting repos and reverse.

  • Settlement finality andAccount holding structure

    Multi-tier account holding (central depository/ registrar and sub-depositories/registrars or custodians)

    Recognition of transfer of ownership at multi-level with duplication of beneficiary accounts at CSD for ownership transparency and supervisory effectiveness.

    Important basics:

    Dematerialized (book-entry) GSs (or Securities Accounts)

    Electronic payment / transfer instructions (e.g., SWIFT messaging standards)

    Straight through processing (STP)

  • Securities C&S Institutionsand their integration

    Types of institutions (Trading system) Clearing House Depository Registrar

    Integration and/or consolidation: across functions / instruments (Economies of Scope) across institutions of the same type (Economies of Scale) To avoid duplication of system investments, fragmentation

    of exposures requiring additional capital, liquidity, margins.

    Natural monopoly? But risk control is necessary.

  • Business Functions

    Securities registration

    Netting and clearing

    Securities settlement / transfer


    Collateral management

    Credit lines and risk management

    Securities lending and borrowing

    Cash management

    Corporate event services

  • Integration acrossinstruments or functions

    Integration across instruments Equity, corporate debt, government securities, derivatives

    E.g., Crest (UK), VPC (Sweden), Euroclear France, etc.

    Integration across functions / institutions Trading, clearing, custody and registration

    The functions can be integrated in a variety of combinations to suit an existing institutional setting.

    C&S process should be as STP as possible regardless of the combination. Easy to say but .

  • Costs and business viabilityof settlement systems

    System investment, maintenance and upgrading. An obvious advantage if duplication can be avoided.

    Operating cost including human resources required. An advantage but a politically difficult issue to address.

    Prudential requirements (capital, collateral, liquidity) for risk management. Less obvious but a potentially very significant cost factor. Settlement systems should permit most efficient use of

    capital, collateral and liquidity to back up systemic risks. To do so, GSs should be used efficiently for cross margining,

    etc. since they can be high quality collateral.

  • Commercial Services by CSDSLB, r


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