FEDERATION OF EURO-ASIAN STOCK EXCHANGES > YEARBOOK 2002/2003 > PAGE 10
HP CAPITAL MARKETS FRAMEWORK
CLEARING AND SETTLEMENT
CONSIDERATIONS
Major markets settlement providers and market
participants have been driven by a number of
strategic trends in recent years, the ripple effects
of which affect smaller market environments in
a material way.
By “settlement provider” we mean central
clearing and settlement institution. This covers
clearing houses (clearing and settlement services
and links to the money transfer system), Central
Securities Depositories (CSDs maintain accounts
for market participants and offer delivery versus
payment facilities) and Central Counter Parties
(CCPs offer centralized settlement guarantees).
The trends include:
Rapid increases in settlement volumes (in spite
of setback caused by the past year’s economic
slump);
The need to reduce risk;
Mergers and rationalization of exchanges and
clearing organizations;
Voluntary changes in governance and profit
objectives;
Cross-border settlement;
Business and technology standards
development.
These trends, on the one hand, force and, on
the other hand, facilitate the expansion of the
business areas of the major exchange and
clearing environments: for instance, an increasing
number of de-mutualised for-profit institutions
need to expand their traditional area of coverage
(instrument-wise, as well as geographical) to
leverage the investment in large systems, while
at the same time, the increasing experience with
cross border trading and settlement makes it
easier to expand across new borders.
We’ll briefly review some of these trends to
underscore the investment required (and thus
the need to leverage!) and than we’ll make some
suggestions as to what the smaller exchange
environments can do to ward of the threat of
oblivion and establish a solid regional niche.
Volume increases
The volume of shares traded from 1999 to 2000
increased in most major markets in the world,
placing ever-increasing stress on the settlement
providers: Hong Kong 69%, Amex 62%,
Deutsche Boerse 48%, LSE 42%, Euronext (Paris)
40%, NYSE 29%, Sao Paolo and Buenos Aires
both 28%, Tokyo 12%. Although the recent
adverse economic conditions have affected
volumes quite negatively, these conditions are
not expected to last and volume growth will
return.
Major markets are adopting clearing and
settlement structures to alleviate the stress
brought on by these growth rates.
The need to reduce risk
Central counterparties
An increasing number of exchanges are adopting
Central Counter Party (CCP) structures.
A properly constituted CCP defines the assets
and liabilities of counterparties to a transaction,
offers a guarantee system that protects
participants against settlement risk, manages and
administers collateral assets and exists as a
separate legal entity from the trading organizer
and settlement provider.
A CCP concentrates settlement risk in one
organization built on a strong legal and regulatory
foundation.
Shorter settlement cycles
Although in the US the SIA has dropped it’s
ambitious T+1 schedule (2005), the trend
towards shorter settlement cycles will continue
to place great pressures on clearing and
settlement providers to upgrade their
infrastructures.
T+1 is an initiative that is ahead of the globally
recommended standard of a T+3 settlement
cycle. Automated clearinghouses and CSDs have
achieved a relatively high degree of straight-
thru-processing (STP). Market participants, on
the other hand, still need to overcome a
formidable range of current weaknesses, due to
mainly manual, non-integrated processes and
lacking data integrity.
Continuous net settlement (CNS)
CNS systems allow settlement of net securities
positions at settlement date. Combined with
multilateral settlement of money positions, this
allows clearing participants to minimize the
movements of both securities and money, greatly
increasing the efficiency of use of their asset
positions. The National Securities Clearing
Corporation (NSCC) in the U.S. market has
successfully implemented CNS.
Real time settlement and RTGS
Real-time settlement systems are the ultimate
aim for most settlement providers, subject to
business and technological constraints of market
participants. In such an environment settlement
risk, unsettled exposures, and uncertainty of
settlement finality are virtually eliminated.
An RTGS system is the most common type of
large-value payment system. The aim of RTGS
is to allow payments to be settled on a continuous
basis throughout the day. Such systems require
interconnected applications at the Central Bank
(the infrastructure provider), the commercial
banks (payments processing), the CSD (if it has
a limited banking license) and, in some cases,
banking clients.
Settlement providers often use an RTGS system
to ensure that the money transfers that are
associated with end-of-day delivery versus
payment processing take place in an efficient
manner. Few markets currently use RTGS on a
continuous basis throughout the day to settle
matched trades in real time, but such usage is
likely to increase over the next three to five years.
Some settlement providers use RTGS facilities
to settle off-market or block trades on a gross
basis throughout the day, using either RTGS or
SWIFT terminals to complete the money transfer
leg.
Operational reliability
The increasing reliance on single central
institutions to clear, settle, and possibly register
high volumes of transactions for national or trans-
national markets makes their operational
reliability of great concern. In some major
markets, settlement volumes have increased
tenfold in five years.
Working papers issued by the BIS (Basel II)
outline the recommendations on operational risk
for banking institutions. National CSDs will have
no alternative but to follow these guidelines and
implement appropriate systems and controls.
Mergers and rationalization of exchanges
and clearing organisations
Integration of settlement with securities
depository
In large markets three different models are being
deployed to integrate settlement and depository:
Fully integrated clearinghouse and CSD systems
(most non-US equities markets)
Merged clearinghouse and CSD, but separate
systems (all in the US)
Separate clearinghouse and CSDs (some equities
markets, derivatives)
The trend toward a fully integrated clearinghouse
and CSD is expected to continue; a recent
example is the creation of the Brazilian Clearing
and Depository Corporation from numerous
separate entities. System integration would
normally follow organizational merging.
Integration of CSD with central registry
The majority of emerging markets that adopted a
mass privatization approach have settlement
systems that incorporate central registry
functionality alongside CSD features. This approach
is less common in developed markets owing to
different legal structures and business practices.
In Europe, CREST is encouraging the creation of a
single central registry that will have real-time links
with the settlement provider—this exists in all but
name for institutionally traded balances.
The majority of markets in Scandinavia and
Eastern Europe already have a central registry,
where a beneficial owner’s name is held on a
central record usually within the integrated
clearinghouse or depository.
Coupling of clearing and settlement with
trading
Many securities markets operate with an end-
of-day, uncoupled processing environment.
Coupling an order-driven trading system with a
clearing and settlement system is designed to
increase operational efficiency and reduce
settlement risk, and works at two levels. Many
of the larger markets have achieved loose
coupling, but tight coupling is more frequent in
emerging markets, usually where the exchange
and clearinghouse systems are supplied by the
same ISV.
Loose coupling
Matched trades are sent real-time or multi-batch
to the clearing and settlement system. Available
securities balances may be frozen for future
settlement. Net pay amounts for each