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					                                                                                                                            NEWS &VIEWS

                  By Ed Corral
                  Clearance & Settlement Business Executive,
                  JP Morgan Worldwide Securities Services

                   What are the appropriate      underpinning the security of the financial      SETTLEMENT
roles of risk takers and risk mitigators in      markets and the highly regulated financing      In the settlement arena, depository and
the clearing and settlement process?             and credit risk that banks take when repre-     settlement systems also need robust
                                                 senting their clients for settlement. An        systems and operations. Depository and
Securities settlement across the globe
                                                 infrastructure, for example, would look to      settlement systems must move as close as
continues to evolve from stock moving free
                                                 settle as close to central bank money as        possible to settlement in central bank
of payment to movements being made
                                                 possible, whereas a highly leveraged            money to fulfill their role as guarantor to
against payment. The registration of bene-
                                                 hedge fund will typically not want central      the marketplace and avoid having to
ficial ownership has also evolved from
                                                 bank money owing to access limitations          unwind market-wide settlement processes
bilateral contracts between individuals
                                                 resulting from the nature of their activity,    if one participant does not pay its dues.
through registrars and centralized registry
                                                 capital base or appetite to pre-fund activity   Although rare today, this did occur with
systems to book-entry systems run by
                                                 and tie up collateral against settlements.      some frequency in Europe during the
central securities depositories (CSDs).
                                                 They must buy that facility from a bank or      1990s.
These depositories provide further assur-
                                                 financial institution.
ance that the paper or ‘right to stock’                                                          The number of entities in any given market
received is valid and that ownership trans-      Who the providers of clearing and settle-       with access to central bank money is,
fer is correctly effected.                       ment should be therefore depends on their       however, restricted. Technology, the cost
                                                 role in the clearing and settlement process.    of collateral and the rigidity of pre-funding
On the clearing side – defined as the func-
                                                 They may act as risk mitigator, or as risk      requirements all play a role here as do cen-
tion of novation and guarantee, typically,
                                                 taker or transformer, in either the clearing    tral bank rules themselves. Entities that
performed by central counterparties
                                                 or the settlement arena.                        cannot or do not wish to access central
(CCPs) – the introduction of CCPs has
allowed market players significantly to miti-                                                    bank money find themselves buying settle-
                                                 CLEARING                                        ment and the associated financing services
gate the risk of price variations between
trade and settlement date through margin-        Central counterparties need robust sys-         from banks that have access and are will-
ing, as well as to virtually eliminate coun-     tems and operations and precise risk man-       ing to extend intraday or overnight finance
terparty risk.                                   agement algorithms to offset the very high      on a partially or wholly uncollateralised
                                                 levels of price and counterparty risk that      basis. These banks are risk takers in the
Both of these functions are essential to the     they take in their role as the counterpart to   settlement space.
correct and secure operation of the capital      an entire market or number of markets.
markets. There are a number of past              They are risk mitigators for the market-
examples where inefficiencies in the clear-      place. CCP clearing risk is allayed by mar-     In both clearing and settlement, therefore,
ing and settlement infrastructure have led       gining, default funds and any number of         risk mitigators and risk takers have histori-
to real losses – every transaction and           different financial constructs.                 cally played very different roles - with infra-
bankruptcy tests the robustness of a clear-                                                      structures acting as risk mitigators, while
ing and settlement infrastructure. One of        However, a CCP takes intraday and               agent banks are risk takers. It is difficult to
the reasons that capital markets have con-       overnight financing risk through margin         see how the two can truly overlap without
tinued to grow over the past few years is        payment exposure against its clearing           introducing inefficiencies in the market-
exactly because of their robustness and          members, making it – to a lesser degree –       place. As infrastructures expand their
resilience.                                      also a risk taker. This financing risk needs    services, their risk-taking activities should
                                                 to be reduced as far as possible so as not      be at the forefront of scrutiny by regula-
WHERE THE RISKS LIE                              to put the market at risk. Consequently,        tors, users and shareholders. The systemic
                                                 membership of central counterparties is         risk that would be introduced by a blurring
The established cash capital markets in
                                                 restricted, typically with balance sheet size   of borders between the two functions
Europe and the US are generally well
                                                 providing a proxy for financial strength.       needs to be carefully examined by all
structured with clear ownership of “out-
standings” in bankruptcy situations. In          Those trading entities that are not eligible    stakeholders.
these markets, the risk premium becomes          for CCP membership then need to ‘buy’
quantifiable and close to zero. However,         access to the clearing system from a CCP        REGULATION
one key area is often unexplored: the steps      member, often a bank. The bank effective-       In both the risk taker and the risk mitigator
that need to be taken to translate the risk      ly provides margin payment guarantees           arenas, regulation should correspond to
that a broker or hedge fund represents           and thus assumes the risk between the           the level and type of risk taken by each
when trading into a settlement guarantee.        trading member and the CCP, transforming        player. We welcome the EU Commission's
                                                 risk and becoming a risk taker. The two         decision to propose a Code of Conduct
There is a clear delta today between the                                                         asopposed to a new Directive in the post-
                                                 functions, CCP as risk mitigator and CCP
risk that an infrastructure is willing to take                                                   trading area. We believe that banks are
                                                 members as risk takers, have little overlap.
– or indeed should take – as a guarantor
                                                                                                                       Continued on page 10

Fall 2007                                                                                                                                     3

                 By Bill Kapogiannis
                 Executive Connections
                   To improve efficiencies
                   and provide increased      Ron Marino
customer satisfaction in asset transfers
                                              President, UBS Financial Services
via the ACATS system, the SIFMA
Customer Account Transfer (CAT)               and President, SIFMA CAT Division
Division and DTCC are working together
to shorten the cycle time for full and par-   What is the benefit of shortening the            What is the CAT division doing to help
tial transfers. In this section two of the    ACAT cycle?                                      meet this goal?
industries leaders on this issue check in     The primary benefit is that Clients will be      We have hosted seminars, workshops,
with their perspective on the project.        able to transfer their accounts two days         educational dinners, and multiple street-
DTCC plans on shortening the ACATS            quicker. But another benefit is that Firms       wide on-site and conference call meetings
transfer cycle on October 22, 2007.           have the opportunity to build in other sys-      to get the word out and flush out all
DTCC will condense the transfer process       tem efficiencies while working on this.          issues. We worked with the NYSE, NASD,
by removing two (2) days for full account                                                      DTCC, FINRA, and the SEC to get the
transfers and one (1) day for partial                                                          rules changed accordingly.
                                              What are the key changes that must be
account transfers. This will improve cus-
tomer service and satisfy clients’ desire                                                      What steps should brokers and banks
to complete transfer requests in a more       There are several key changes. System            take to be ready?
expeditious manner.                           changes to allow firms to verify accounts
                                              and gather assets in one day vs. the cur-        Firms have already made their system
The reduction in the request stage will                                                        changes and are finishing up their testing.
                                              rent three days. The required enhance-
require member firms to react earlier in                                                       DTCC's relationship managers have
                                              ments have been made at DTCC to
the transfer process. Member firms must                                                        reached out to their participant firms to
                                              accommodate this. Credit and debit card
respond to transfer requests within the                                                        gauge their readiness for implementation
                                              charges, managed account fees, other
one (1) day request period to remain                                                           and initial results are positive. Firms have
                                              fees must all be figured and posted earlier.
compliant with NYSE Rule 412 and NASD                                                          indicated they are ready.
Rule 11870. To accomplish this, member
firms must begin the account closing          Has an implementation target date
process and notification to the client        been established?                                We've heard that there are special focus
intra-day. Things like check writing privi-                                                    groups set up to address settlement
leges and debit cards need to be termi-       October 22, 2007 - but many firms are            and street side issues. How can a
nated or shut down immediately.               able to start earlier                            broker or a bank get involved?
Participant testing began on July 13,                                                          Yes there are opportunities to contribute
2007. DTCC has been working with                                                               to the effort. Any interested parties can
member firms to assure a seamless                                                              contact me at 201-352-5560 or
implementation. A majority of firms have                                             
completed testing and have indicated the
results were very positive and are expect-
ing a smooth transition.
All rule filings (NSCC and FINRA) have
been submitted to the Securities and
Exchange Commission (SEC) and were
published in the federal register in early    COST AND RISK Continued from page 3
September. A comment period was
established by the SEC, which concludes       already heavily regulated in their role as risk takers. Additional regulation should only be
on October 4, 2007.                           proposed when there are clear risks demonstrated that are not already covered by exist-
If you have any questions or comments         ing regulations.
on the cycle rewrite changes, please          In the absence of an industry-wide Code of Conduct, however, self-regulation may not be
contact Bill Kapogiannis at                   enough for market infrastructures, especially those that are privately-owned and answer or                      to shareholders' demands. Users' interests and views must be protected; hence, some
212-855-5667.                                 form of light and considered legislation may be more appropriate than self-regulation
                                              for infrastructures in their role as risk mitigators.
                                              In conclusion, this distinction between risk mitigators and risk takers is and should remain
                                              an important distinction between infrastructures and banks.

10                                                                                              Securitiies Operations Division   I   News & Views