The Efficiency of Cross Border The Efficiency of Cross Border Settlement SystemsSettlement Systems

May 29-June 2, 2006May 29-June 2, 2006

Shanghai, ChinaShanghai, China

Noritaka AkamatsuNoritaka Akamatsu

The World BankThe World Bank

ContentsContents BackgroundBackground Alternative channels of cross border settlementAlternative channels of cross border settlement Existing networks of global custodians in the region,Existing networks of global custodians in the region, Institutional networks and system linkages among Institutional networks and system linkages among

existing clearing houses and CSDs in the region,existing clearing houses and CSDs in the region, Risk management issues,Risk management issues, Legal and regulatory infrastructure for ownership Legal and regulatory infrastructure for ownership

security and settlement finality,security and settlement finality, Multi-currency fund settlement arrangements,Multi-currency fund settlement arrangements, Business, political and technical feasibility of a Business, political and technical feasibility of a

regional clearing house.regional clearing house. Capital account liberalization requirements,Capital account liberalization requirements, StrategyStrategy

BackgroundBackground

Efficient and secure settlement is critical to Efficient and secure settlement is critical to promoting cross border trading of bonds in the promoting cross border trading of bonds in the region.region.– Unless the settlement is possible, secure and efficient, Unless the settlement is possible, secure and efficient,

investors will not trade across national borders.investors will not trade across national borders.– How can a trade between, e.g., a Korean investor and a How can a trade between, e.g., a Korean investor and a

Thai counterpart in Malaysian bonds kept in custody in Thai counterpart in Malaysian bonds kept in custody in Hong Kong be settled?Hong Kong be settled?

National CSDs are now being linked up. But their National CSDs are now being linked up. But their settlement modes differ because each of them is settlement modes differ because each of them is designed to serve for domestic needs.designed to serve for domestic needs.– Banking services are weak and different DVP modes Banking services are weak and different DVP modes

prevail in different national markets.prevail in different national markets.– Bilateral links have not been a popular channel of cross-Bilateral links have not been a popular channel of cross-

border settlement except when it involves an ICSD.border settlement except when it involves an ICSD.

Background Background –– continuedcontinued

International investors without direct access to International investors without direct access to national CSDs rely on global custodians and national CSDs rely on global custodians and their local agents.their local agents.– Liquidity pressure on local agents as repos (a popular Liquidity pressure on local agents as repos (a popular

instruments in cross border trading) and/or back-to-instruments in cross border trading) and/or back-to-back transactions grow.back transactions grow.

Any room for use of an ICSD or creation of a Any room for use of an ICSD or creation of a regional CSD?regional CSD?

Trading needs and Trading needs and patternspatterns

Investors have a need and interest to manage Investors have a need and interest to manage exposures to regional risks and currencies.exposures to regional risks and currencies.– Often seek liquid government securities market Often seek liquid government securities market

where risk-adjusted interest rate is attractive and exit where risk-adjusted interest rate is attractive and exit is easy to manage exchange rate risk.is easy to manage exchange rate risk.

OECD experienceOECD experience– Government securities repos and back-to-back trades Government securities repos and back-to-back trades

by dealers and market makers have grown rapidly.by dealers and market makers have grown rapidly.

– Those created a pressure on intermediaries in the Those created a pressure on intermediaries in the settlement chain (e.g., local agent sub-custodians).settlement chain (e.g., local agent sub-custodians).

Alternative channelsAlternative channels

NationalCSD

Localagent

Localagent

Localagent

Globalcustodian ICSD National

CSD

Non-residentcounterparty

Non-residentcounterparty

Non-residentcounterparty

Non-residentcounterparty

Non-residentcounterparty

Direct access

Local agent

Global custodian

ICSD CSD-to-CSD

Source: Cross-Border Securities Settlement, March 1995, CPSS, BIS

Countryof issue

Othercountries

Alternative channels ofAlternative channels ofcross border settlement – cross border settlement – 11

Direct access to local CSD.Direct access to local CSD.– Non-resident often not permitted.Non-resident often not permitted.– Local money settlement arrangement necessary.Local money settlement arrangement necessary.

Use of a local agent (custodian).Use of a local agent (custodian).– Often provides pre-matching services and even settlement on Often provides pre-matching services and even settlement on

its own book. But custody risks are involved.its own book. But custody risks are involved.

Use of bilateral links among national CSDs.Use of bilateral links among national CSDs.– A national CSD is often exclusively linked to a national stock A national CSD is often exclusively linked to a national stock

exchange, which limits non-resident investors’ access to non-exchange, which limits non-resident investors’ access to non-listed securities.listed securities.

– Links are created primarily to allow domestic parties to trade Links are created primarily to allow domestic parties to trade in foreign securities rather than to trade across the border.in foreign securities rather than to trade across the border.

– Banking and cash management services are weak, and Banking and cash management services are weak, and different DVP models prevail.different DVP models prevail.

Bilateral network of national CSD

CSD

CSD Local Central

Depository

Local Central

Depository

CSD

CentralSecurities

Depository

CSD

CSD

Alternative Channels – 2Alternative Channels – 2Use of global custodianUse of global custodian

Offer a single entry point for investors in Offer a single entry point for investors in multiple markets.multiple markets.

Have a network of local agent sub-custodians Have a network of local agent sub-custodians (some of which may be their own branches or (some of which may be their own branches or subsidiaries).subsidiaries).

Inexpensive service compared to separately Inexpensive service compared to separately accessing local custodians and other service accessing local custodians and other service providers thanks to economies of scale and providers thanks to economies of scale and scope despite IT investment required.scope despite IT investment required.

Provide multi-currency banking services and Provide multi-currency banking services and management of cash and securities positions.management of cash and securities positions.

Internal settlement over its own book.Internal settlement over its own book.– Can handle settlement of back-to-back trades.Can handle settlement of back-to-back trades.

Alternative Channels – 3Alternative Channels – 3Use of ICSDUse of ICSD

Provide a single entry gateway to multiple Provide a single entry gateway to multiple markets as does a global custodian.markets as does a global custodian.

Able to settle internally over its own book with Able to settle internally over its own book with direct links to national CSDs.direct links to national CSDs.– I.e., can handle settlement of back-to-back trades.I.e., can handle settlement of back-to-back trades.– In Europe, those links were exploited to settle European In Europe, those links were exploited to settle European

government securities over ICSDs.government securities over ICSDs.

Inexpensive service for core clearing and Inexpensive service for core clearing and management of cash and securities positions.management of cash and securities positions.

Use existing ICSDs or create a new regional ICSD Use existing ICSDs or create a new regional ICSD in Asia??in Asia??

Regional Custody Architecture - 1

LCD

LCD Local Central

Depository

Local Central

Depository

LCD

Local Central

Depository

LCD

LCD

Regional Hub

Alternative architectures Alternative architectures in Europein Europe

Networking CSD model.Networking CSD model.– Bilateral links among national CSDs, making each Bilateral links among national CSDs, making each

other a sub-depository (e.g., European Financial other a sub-depository (e.g., European Financial Superhighway by ECSDA)Superhighway by ECSDA)

Hub and spoke model (ICSD)Hub and spoke model (ICSD)– EuroclearEuroclear

Single CSD model (ICSD)Single CSD model (ICSD)– Creation of Clearstream by merger between Creation of Clearstream by merger between

Deutsche Borse clearing house and Cedel.Deutsche Borse clearing house and Cedel.– Controlling ownership of Clearstream by Deutsche Controlling ownership of Clearstream by Deutsche

Borse may be an impediment.Borse may be an impediment.

Regional networks of Regional networks of global custodiansglobal custodians

Global custodians active in emerging Global custodians active in emerging markets cross-border transactionsmarkets cross-border transactions– Bank of New YorkBank of New York– JP MorganJP Morgan (including (including Jardine FlemingJardine Fleming))– State StreetState Street– CitibankCitibank– Deutsche BankDeutsche Bank– PNB Paribas PNB Paribas Those in bold Italic Those in bold Italic

havehave– Northern TrustNorthern Trust strong local strong local

presence andpresence and– ABN-AMRO MellonABN-AMRO Mellon client base in Asiaclient base in Asia..– HSBCHSBC– Morgan Stanley Global CustodyMorgan Stanley Global Custody– MeesPiersonMeesPierson

Regional networks of Regional networks of global custodians global custodians – – continuedcontinued

But there are differences among them. E.g.,But there are differences among them. E.g.,– State Street:State Street: presence in regional hubs only but presence in regional hubs only but

not in each individual country nor does it directly not in each individual country nor does it directly participate in local CSDs.participate in local CSDs.

– Citibank:Citibank: presence in each individual country (i.e., presence in each individual country (i.e., local as well as global custodian) and directly local as well as global custodian) and directly participate in local CSDs.participate in local CSDs.

Their business strategies differ.Their business strategies differ.– State Street:State Street: serving for global investors and serving for global investors and

interested in serving as a regional hub for interested in serving as a regional hub for international and intra-regional settlement. international and intra-regional settlement.

– Citibank:Citibank: not interested in being a regional hub not interested in being a regional hub because it directly participate in local CSDs and can because it directly participate in local CSDs and can directly serve local clients (i.e., able to internalize directly serve local clients (i.e., able to internalize regional settlement).regional settlement).

Agent sub-custodiansAgent sub-custodiansin East Asiain East Asia

19991999 20002000 20012001 China (mainland)China (mainland) 5 5 4 4 5 5

(Hong Kong)(Hong Kong) 6 6 7 7 7 7 IndonesiaIndonesia 4 4 4 4 5 5 JapanJapan 6 6 5 5 9 9 KoreaKorea 12 12 4 4 10 10 MalaysiaMalaysia 10 10 5 5 9 9 PhilippinesPhilippines 5 5 4 4 5 5 SingaporeSingapore 6 6 5 5 8 8 ThailandThailand 9 9 5 5 9 . 9 .

Q.How many of them are branches or subsidiaries Q.How many of them are branches or subsidiaries of global custodians?of global custodians?

Networks & linkages Networks & linkages among clearing houses among clearing houses and CSDsand CSDsClearing houses and CSDs in the region.Clearing houses and CSDs in the region.

ChinaChina CGSDTC and CSDCCCGSDTC and CSDCC IndonesiaIndonesia BI-SSSS, KSEI and KPEIBI-SSSS, KSEI and KPEI JapanJapan BOJ-Net and JASDECBOJ-Net and JASDEC KoreaKorea KSDKSD MalaysiaMalaysia MCD, SCANSMCD, SCANS PhilippinesPhilippines ROSS, SCCP and PCDROSS, SCCP and PCD SingaporeSingapore Central Depository Ltd.Central Depository Ltd. ThailandThailand Bhatnet 2 and TSDBhatnet 2 and TSD

Risk managementRisk management

Issues: How to ensure cross border DVP?Issues: How to ensure cross border DVP?

Systemic risks in links among settlement systems.Systemic risks in links among settlement systems.– Local sub-custodians under pressure to receive and Local sub-custodians under pressure to receive and

redeliver securities on the same day.redeliver securities on the same day.– How to settle back-to-back trades?How to settle back-to-back trades?

Links have been being built among CSDs and Links have been being built among CSDs and between CSDs and ICSDs. But …between CSDs and ICSDs. But …– Local CSDs built to meet local needs only.Local CSDs built to meet local needs only.– Different modes of DVP even when they are said to be Different modes of DVP even when they are said to be

achieved over electronic books.achieved over electronic books.

Multi-currency cross-Multi-currency cross-border fund settlementborder fund settlement

Are continuous linked settlement and CLS Bank Are continuous linked settlement and CLS Bank needed to support the settlement in regional needed to support the settlement in regional currencies?currencies?– CLS bank has an account with each central bank in the region.CLS bank has an account with each central bank in the region.– Participating banks have an account with sub-accounts for Participating banks have an account with sub-accounts for

different currencies at CLS bank (as well as accounts at the different currencies at CLS bank (as well as accounts at the central bank).central bank).

– Participating bank pays to CLS bank account at the central Participating bank pays to CLS bank account at the central bank by use of RTGS system, or instructs its nostro agent to bank by use of RTGS system, or instructs its nostro agent to pay to CLS bank account at the central bank of the agent’s pay to CLS bank account at the central bank of the agent’s economy.economy.

Is use of CLS Bank possible?Is use of CLS Bank possible?– CLS Bank does not provide settlement in Asian currencies CLS Bank does not provide settlement in Asian currencies

other than Japanese yen.other than Japanese yen.– Create a regional CLS bank?? Does it make business Create a regional CLS bank?? Does it make business

sense??sense??

Multi-currency cross-Multi-currency cross-border fund settlement border fund settlement – – continuedcontinuedIf a regional CLS bank should be created,If a regional CLS bank should be created,

Who should own / govern / participate in it (I.e., Who should own / govern / participate in it (I.e., governance)? Should it be another subsidiary of governance)? Should it be another subsidiary of CLSS?CLSS?– Global custodians serving for the settlement in regional Global custodians serving for the settlement in regional

currencies.currencies.– Local custodiansLocal custodians– Central banks as well?Central banks as well?

Where should it be located?Where should it be located?– Center of the regional time zone?Center of the regional time zone?– In a jurisdiction whose legal framework is acceptable to as In a jurisdiction whose legal framework is acceptable to as

many participants as possible?many participants as possible?

Multi-currency cross-Multi-currency cross-border fund settlement border fund settlement – – continuedcontinued

Cross-border DVP is essential.Cross-border DVP is essential.– National CSD must achieve DVP domestically in order to National CSD must achieve DVP domestically in order to

enable cross-border DVP.enable cross-border DVP.– DVP settlement instructions must be sent to the central bank DVP settlement instructions must be sent to the central bank

and custodian.and custodian.

How to ensure settlement finality?How to ensure settlement finality?– Between banks and between a bank and CLS bank at each Between banks and between a bank and CLS bank at each

central bank.central bank.– Under what law? Law of the jurisdiction in which CLS bank is Under what law? Law of the jurisdiction in which CLS bank is

located? Laws of the jurisdictions of the central banks located? Laws of the jurisdictions of the central banks involved in each transaction? English law?involved in each transaction? English law?

Legal & Regulatory Legal & Regulatory InfrastructureInfrastructure

Conflict of laws and legal risks in defining settlement Conflict of laws and legal risks in defining settlement finality and managing cross border collateral.finality and managing cross border collateral.– Most government securities in the region are demeterialized Most government securities in the region are demeterialized

and recorded as electronic entries.and recorded as electronic entries.

– They are registered in domestic registries (central bank They are registered in domestic registries (central bank registries or CSDs), but where are they kept in custody?registries or CSDs), but where are they kept in custody?

– How can legal finality of settlement of offshore transactions in How can legal finality of settlement of offshore transactions in such securities be achieved and ensured?such securities be achieved and ensured?

– Need a common legal basis to which all the jurisdictions and Need a common legal basis to which all the jurisdictions and market participants in them can agree?market participants in them can agree?

Article 9(2) of EU Settlement Finality DirectiveArticle 9(2) of EU Settlement Finality Directive

Legal & Regulatory Legal & Regulatory InfrastructureInfrastructure Definition of settlement intermediaries.Definition of settlement intermediaries.

Legal status of “securities” differ across countries.Legal status of “securities” differ across countries.

Finality of delivery and paymentFinality of delivery and payment

Concept of “bankruptcy”Concept of “bankruptcy”

Capital account Capital account liberalizationliberalization

Exchange control on capital account transactionsExchange control on capital account transactions

Role of central banks in implementing the exchange Role of central banks in implementing the exchange control and its implications for cross border securities control and its implications for cross border securities trading.trading.

Taxation of cross-border securities transactions.Taxation of cross-border securities transactions.

Business, political and Business, political and technical feasibilitytechnical feasibility

Is it politically feasible to establish a new regional ICSD? Is it politically feasible to establish a new regional ICSD? Does it make business sense?Does it make business sense?

Information technology (IT) enablesInformation technology (IT) enables– Building bilateral links among national CSDsBuilding bilateral links among national CSDs– Building bilateral links between ICSDs and national CSDs.Building bilateral links between ICSDs and national CSDs.– Global custodians to provide sophisticated customer services for Global custodians to provide sophisticated customer services for

institutional investors, alluring them to outsource not only institutional investors, alluring them to outsource not only backoffice but also some midoffice functions while global backoffice but also some midoffice functions while global custodians themselves outsource “core clearing” to ICSDs.custodians themselves outsource “core clearing” to ICSDs.

Substantial IT investment is required, and communication Substantial IT investment is required, and communication protocol and messaging standards need to be established.protocol and messaging standards need to be established.

Requires training of staff.Requires training of staff.

StrategyStrategy

Leave various channels of competition open.Leave various channels of competition open. Policy support to encourage competition among Policy support to encourage competition among

national CSDs to become a regional ICSD.national CSDs to become a regional ICSD.– Ensure system connectivity.Ensure system connectivity.– A CSD owned by and serving for a national stock exchange A CSD owned by and serving for a national stock exchange

will be out and can only be a spoke.will be out and can only be a spoke.– A CSD serving for government securities has competitive A CSD serving for government securities has competitive

advantage from economies of scale and scope.advantage from economies of scale and scope.– A CSD operated by the central bank cannot compete for A CSD operated by the central bank cannot compete for

profit and beyond the national border.profit and beyond the national border.– A CSD supported strong clearing banks and the Central A CSD supported strong clearing banks and the Central

Bank.Bank. A CSD open to direct participation by global A CSD open to direct participation by global

custodians will have a greater chance to become a custodians will have a greater chance to become a regional ICSD.regional ICSD.

A country that is to house a regional ICSD must A country that is to house a regional ICSD must have a liberal capital account.have a liberal capital account.

Links with other Links with other initiativesinitiatives

Mutual acceptance of regional sovereign bonds as Mutual acceptance of regional sovereign bonds as collateral for central bank intra-day credit.collateral for central bank intra-day credit.

Use of ABC bonds as such collateral?Use of ABC bonds as such collateral?

Thank youThank you