Bahrain Credit Risk Report - PowerPoint

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					THE WORLD BANK IN COLLABORATION WITH THE ARAB
MONETARY FUND AND THE BAHRAIN MONETARY AGENCY
REFORMING PAYMENT AND SECURITIES SETTLEMENT
SYSTEMS
Manama, Bahrein, March 15-17, 2005




REFORMING SECURITIES SETTLEMENT
            SYSTEMS




           Mario Guadamillas, World Bank




                                                1
Content
A. Importance of market infrastructure
B. International standards as a guide for the
   reform
  B.1 Evolution of international (regional)
     standards
  B.2 Main factors identified
C. Main challenges for SSSs
  C.1 Special consideration of CCPs
D. Interrelations between payments and
   securities settlement systems
E. Conclusions
                                                2
A. IMPORTANCE OF MARKET INFRAESTRUCTURE


  Transaction value chain:
Investment     Execution       Confimation    Clearing and   Banking           Asset         Value-added
Decision                                      Settlement     and               Servicing     Services
                                                             Finance
Transparency   Indication of   Allocation     Clearance      Credit and Cash   Income        Pricing
               Interest                                      Management
Research       Execution       Affirmation    Delivery       Securities        Collectio
                                                                               Corporate     Accounting
               and                                           Lending           n
                                                                               Actions       d
Buy-Sell       Notification    Instructions   Payment        Margin            Tax Reclaim   Performace
Decision                                                     Finance                         Reporting

  Clearing and Settlement key element to determine
   the infraestructure quality of capital markets
       •  Trading systems, intermediaries, custodians and asset
       managers can be easily changed if the inverstor perceives
       an inadequate level of servce or risk
       • Not the case of Clearing and Settlement
                                                                                                           3
A. IMPORTANCE OF MARKET INFRAESTRUCTURE


 Important changes in the supply and demand for
  capital,
   • Demographics: evolution in the population ratio between
   prime savers (40-59) and dissavers, (60+) could imply a
   surplus/deficit in capital supply
   • Economics: GDP per capita growth in emerging markets
   will increase capital demand
 will drive to changes in investors’ behavior
   • Asset reallocation: the investors and their intermediaries
   will reallocate assets in the search of increased
   predictability of returns
   • Higher specialization: need to respond to a more
   differentiated demand

                                                                  4
A. IMPORTANCE OF MARKET INFRAESTRUCTURE

                                              European Union                                                                    United States

                      70                                                                                 70
% Population by age




                                                                                   % Population by age
                      60                                       Prime Savers (40-                         60                                       Prime Savers (40-
                      50                                       59)                                       50                                       59)
                      40                                       Dissavers (60+)                           40                                       Dissavers (60+)
                      30                                                                                 30
                      20                                       Others (0-39)                             20                                       Others (0-39)
                      10                                                                                 10
                       0                                                                                  0
                        1985   2005           2025      2045                                               1985   2005          2025       2045
                                      Ye ar                                                                              Year




             In the cases of Italy and Japan the trend is even more severe
             with a ratio “prime savers” vs. “dissavers” of 2:1



             In the cases of India and China the trend is an increase of “prime
             savers” as a percentage of the population



                                                                                                                                                            5
A. IMPORTANCE OF MARKET INFRAESTRUCTURE


 Changes in the investment strategy
   • More attention to best execution and low fees
   • Outperformance in emerging markets
 Differentiated needs from investors
   • Increased speed and expandable capacity
   • “Functional flexibility” in the securitized and structured
   products area
   • Despite the specialized need, there is still a very large
   investor segment interested in “one size fits all” solution
   • Market segments interested in enhanced market
   transparency and investor protection


                                                                 6
A. IMPORTANCE OF MARKET INFRAESTRUCTURE


 How to provide more efficient and secure Clearing
  and Settlement services?
   • Lower cost
   • Reduced operational risk
   • Straight through Processing (STP)
   • Fully interoperable markets
   • Harmonized regulations
   • Fair market access
   • Adequate oversight of the systems
   • Uniform, consistent supervision of market participants
   • Etc.

                                                              7
B.1 EVOLUTION OF INTERNATIONAL STANDARDS


The international standards provide a very
 helpful framework to systematize and address
 the main factors to be considered for a reform
Despite the process of consolidation and
 generalization of accepted standards
 worldwide, some focus on minimum standards
 while others seek best practices
There is closer attention by international
 standards to the interaction between payments
 and securities settlement systems


                                                  8
B.1 EVOLUTION OF INTERNATIONAL STANDARDS

Group of Thirty Recommendations Regarding
 Securities Clearance and Settlement, 1990
  Objective: “reducing risk, improving efficiency and
  promoting greater standardization in international
  settlement”
  - Trade comparison,Trade confirmation/affirmation,
  CSDs, Netting Schemes, DvP, Same day funds, Rolling
  settlement cycle, Securities lending, Common message
  standard
Lamfalussy Minimum Standards, 1990
      Objective: “cross-border and multi-currency netting
  and settlement schemes”
  - Legal basis, Financial risks, Management of credit
  and liquidity risks, Admission criteria, Operational
  reliability of netting schemes                          9
B.1 EVOLUTION OF INTERNATIONAL STANDARDS


Technical Committee of IOSCO, 1990
  Objective: “contribute to the process of creating an
  efficient central securities depository from a national
  regulatory point of view and, at the international level,
  offering views on how to create links in accordance to
  the recommendations issued on the subject”
  - Regulatory aspects (including SRO role)
  - Liquidity risk
  - Industry organizational arrangements
  - Operational reliability
  - Endorses G30 recommendations


                                                              10
B.1 EVOLUTION OF INTERNATIONAL STANDARDS


 ISSA, 1995
   Objective: “amendment of G30 recommendations”
   - Trade comparison in T+0 instead of T+1
   - Positive affirmation of trade details by indirect
     market participants by T+1
   - Explicit reference to immobilization/dematerialization
   - Rules when several CSDs operate in a country in
     order to allow for use of funds and cross-collateral
   - Choice between a RTGS or “Lamfalussy
     Recommendations” compliant netting system for
     funds settlement

                                                        11
B.1 EVOLUTION OF INTERNATIONAL STANDARDS


Emerging Markets Committe of IOSCO, 1997
  Objective: “study on the legal and regulatory framework
  for clearing and settlement in emerging markets”
  - Legal and custody issues
IOSCO, Objectives and Principles of Securities
 Regulation, 1998
  Objectives: “The principles are based upon three main
  objectives of securities regulation: protection of
  investors; ensure that markets are fair, efficient and
  transparent; reduction of systemic risk”
  - SSSs should be subject to regulatory oversight and
  designed to ensure that they are fair, effective and
  efficient and that thay reduce systemic risk
                                                       12
B.1 EVOLUTION OF INTERNATIONAL STANDARDS



FIVB, Clearing and Settlement Best Practices
 Report, 1999
  Objective: “to enable FIBV members and their
  respective clearing and settlement organizations to
  score their performance against benchmarks and best
  practices, and to identify areas in their processes
  where improvements should be considered”
  - Trade confirmation, Settlement cycles, Securities
  lending, CSDs and risk controls, DvP, Operational
  reliability, Efficiency, Netting schemes, Systems
  integration


                                                        13
B.1 EVOLUTION OF INTERNATIONAL STANDARDS

ISSA, New Recommendations, 2000
  Objective: “to tackle key risks in today’s world of
  settlement and clearance”
  - Governance of infrastructure
  - Technology: core processing
  - Technology: messaging and standards
  - Uniform market practice
  - Reduction of settlement risk
  - Market linkages
  - Investor protection
  - Securities lending
  - Legal infrastructure                                14
B.1 EVOLUTION OF INTERNATIONAL STANDARDS
CPSS, Core Principles for Systemically
 Important Payment Systems, 2001
  Public Policy Objectives: “safety and efficiency”
  Introduction of the SIPS concept
  - Ten principles: legal foundation (CPI), understanding
    and management of risks (CP II and III), settlement
    (CPs IV-VI), security, operational reliability and
    contingency arrangements (CP VII), efficiency and
    practicality (CP VIII), criteria for participation (CP IX)
    and governance (CP X)
  - Four central bank’s responsibilities: objectives and
    policy (A), observance of CPs (B and C),
    cooperation (D)
  - Not specific for SSSs but relevant
                                                            15
B.1 EVOLUTION OF INTERNATIONAL STANDARDS
CPSS-IOSCO, Recommendations for SSSs,
 2001
  Objective: “to promote implementation by SSSs of measures that
  can enhance international financial stability, reduce risks, increase
  efficiency and provide safeguards for investors by developing
  recommendations for the design, operation and oversight of such
  systems”
                        19 Recommendations
  -   Legal risk
  -   Pre-settlement risk (including CCPs)
  -   Settlement risk
  -   Operational risk
  -   Custody risk
  -   Other issues (governance, access, efficiency, communication
      procedures and standards, transparecy, regulation and oversight,
      risks in cross-border links)
                                                                         16
B.1 EVOLUTION OF INTERNATIONAL STANDARDS

G30, New Recommendations, 2003
  Objective: “to establish a set of new recommendations
  focused on the cross-border and international context
  that go beyond minimum standards and try to identify
  best practices”
  - Building a strengthened interoperable global
    network
  - Strengthening network safety and stability
  - Improving governance
CPSS-IOSCO Task Force, Risk Management
 Standards for Central Counterparties,
 November 2004
                                                      17
B.1 EVOLUTION OF REGIONAL STANDARDS
EMI, Standards for the use of EU Securities
 Settlement Systems in ESCB Credit
 Operations”, 1998
  Objective: “assessing the soundness of SSSs seeking to qualify for
  involvement in monetary policy and intraday credit operations”
  -   Legal soundness
  -   Settlement in central bank money
  -   No undue custody risks
  -   Regulation and/or control by competent authorities
  -   Transparency of risks and conditions for participation in a
      system
  -   Risk management procedures
  -   Intraday finality of settlement
  -   Operating hours and days
  -   Operational reliability of technical systems and availability of
      adequate back-up facilities                                        18
B.1 EVOLUTION OF REGIONAL STANDARDS

Giovannini Group 1st Report, 15 Barriers to
 the EU C&S Integration, 2002
Giovannini Group 2nd Report, Action
 proposals for removing barriers, 2003
  Objective: “conduct a comprehensive analysis of clearing and
  settlement arrangements for equities, fixed-income securities and
  derivatives”

  15 Barriers to efficient cross-border
  settlement:
  - Technical requirements/market practice
  - Differences in tax procedures
  - Issues related to legal certainty                             19
B.1 EVOLUTION OF REGIONAL STANDARDS

ESCB-CESR Standards for Securities
 Clearing and Settlement Systems in the
 European Union (consultative report), 2003
  Objective: “to increase the safety, soundness and efficiency of
  securities clearing and settlement systems in the European
  Union”

  - Based on CPSS-IOSCO recommendations
  - Beyond recommendations (standards) to be
    used as a regulatory tool
  - Identifying “systemically important
    institutions”
  - Standards to major custodian banks
                                                                    20
    B.1 EVOLUTION OF INTERNATIONAL STANDARDS (SUMMARY)

Standards/Best Practices                                                                   GLOBAL                                   REGIONAL
                                                                                                           CPSS-
                              G30/1989 IOSCO/1990 G30/ISSA1995 IOSCO/1997 IOSCO/1998 FIBV/1999 ISSA/2000 IOSCO/2001 NEWG30/2002 COSRA1996 ESCB1998
Legal Framework
                                                                      Sec. 2, 4, 6   Sec. 13.8                  Rec. 8   Rec. 1    Rec. 14; 15; 16                Stand. 1
                                          Sec. 2.3.1;
Trade Confirmation
                              Rec. 1, 2   2.3.2           Rec. 1, 2                  Sec. 13.10   Rec. 2        Rec. 5   Rec. 2    Rec. 1; 5
Settlement Cycles             Rec. 7      Sec. 2.3.7      Rec. 7                                  Rec. 3        Rec. 5   Rec. 3
                                                                                                                                   Rec. 6; 9; 15;
Central Counterparties
                                                                                                                         Rec. 4    16
Securities Lending
                              Rec. 8      Sec. 2.3.8      Rec. 8      Sec. 5         Sec. 13.11.3 Sec. 8.3.5    Rec. 5   Rec. 5    Rec. 7
Central Securities
Depositories                  Rec. 3      Sec. 2; 2.3.3 Rec. 3        Sec. 1                      Sec. 8.3.6             Rec. 6    Rec. 1
Delivery versus Payment       Rec. 5      Sec. 2.3.5    Rec. 5        Sec. 5                      Sec. 8.2.1    Rec. 5   Rec. 7    Rec. 13
Timing of Settlement
Finality                      Rec. 6      Sec. 2.3.6      Rec. 6      Sec. 5                                             Rec. 8    Rec. 8                         Stand. 7
CSD risk controls to
address participant's                                                                             Sec. 8.2.2;
failures to settle                                                                                8.2.3                  Rec. 9    Rec. 9                         Stand. 6
Cash Settlement Assets                                                                                                   Rec. 10                                  Stand. 2

Operational Reliability                   Sec. 2.2.4 to
                                          2.2.9                                                   Rec. 1        Rec. 2   Rec .11   Rec. 11; 12       Prin. 2; 5   Stand. 9
Protection of customers'
securities                                Sec. 1.1                    Sec. 2, 3, 4                                       Rec. 12                                  Stand. 3
Governance
                                          Sec. 1.5                                                              Rec. 4   Rec. 13   Rec. 13; 17; 18
                                          Sec. 1.4;
Access
                                          2.2.3                                                                          Rec. 14   Rec. 10; 19       Prin. 1; 4
Efficiency                                                                                        Rec. 1; 4     Rec. 1   Rec. 15   Rec. 1
Communication
Procedures and Standards
                              Rec. 9      Sec. 2.3.9      Rec. 9                                                Rec. 3   Rec. 16   Rec. 2; 3
Transparency                              Sec. 2.2.10                                                                    Rec. 17   Rec. 19                        Stand. 5
                                          Sec. 2.2.1;                                Sec. 13.8;
Regulation and oversight
                                          2.2.11                                     13.9                       Rec. 7   Rec. 18   Rec. 18           Prin. 3      Stand. 4
Risks in cross-border links                                                                                     Rec. 6   Rec. 19   Rec. 4
Netting Schemes               Rec. 4      Sec. 2.3.4                                 Sec. 13.11.2 Rec. 5        Rec. 5
Systems integration                                                                               Sec. 8.1.5
Liquidity Risk                            Sec. 1.2                                                                                                   Prin. 2
SRO Role                                  Sec. 1.3                                                                                                   Prin. 3
Code of Good Practice                                                                             Rec. 6
Operating Hours and Days                                                                                                                                          Stand. 8

                                                                                                                                                                  21
B.2 MAIN FACTORS IDENTIFIED

 Legal & custody
 C&S processes: trade confirmation, settlement cycles,
  systems integration, securities lending, communication
  procedures standards and securities identification
 Settlement risk: CSDs, DvP, timing of settlement
  finality, risk management mechanisms, cash settlement
  assets,netting versus gross schemes, liquidity risk
    CCPs
 Operational reliability
 Regulatory&Oversight (including SRO role)
 Organizational arrangements: participation
  requirements, governance, transparency
 Cross-border
 Cost-efficiency

                                                      22
B.2 MAIN FACTORS IDENTIFIED

LEGAL&CUSTODY


C&S PROCESSES


SETTLEMENT RISK


 CCP


OPERATIONAL


REG.&OVERSIGHT


ORG.
ARRANGEMENTS


CROSS-BORDER


COST-EFFICIENCY

                  G30    IOSCO   G30/ISSA   IOSCO   IOSCO   FIBV   ISSA   CPSS    NEWG30
                  1989    1990     1995      1997    1998   1999   2000   IOSCO    2002
                                                                           2001
                                                                                           23
C. MAIN CHALLENGES FOR SSSs

 Legal Framework and Custody Risk
  - Trading takes place global while underlying legal
      systems continue to be domestic
      * Absence of a unique framework for the treatment
      of security interests
      * Problems with legal certainty in collateralized
      transactions
      * Uneven application of national conflict of law rules
  -   Finality: importance to adapt financial institutions
      bankruptcy legislation to protect SSSs
  -   Enforceability of security interests provided under
      collateral arrangements, legal basis for netting,
      electronic documents and signatures (for developing
      systems)
                                                             24
C. MAIN CHALLENGES FOR SSSs

 Legal Framework and Custody Risk
  - The Hague Securities Convention. Unique legal
  framework for:
     * Transfer of the collateral to the pledgee
     * Power of disposal over collateral
     * The order in which creditors have rights to the collateral
     * The duties of the intermadiary actually holding the pledged
     securities in custody
     * The correct procedure for realizing the collateral
     * Rules regarding claims to dividends and the rights
     associated to securities while they are pledged.

  - Not yet applicable. Incorporation to national legal
  frameworks expected by the end of 2006

                                                               25
C. MAIN CHALLENGES FOR SSSs

 Clearing and settlement processes
   -   Standardization of messaging standards and
       communication protocols
   -   Synchronization of timing among systems
   -   National differences in settlement cycles
   -   Tax and other impediments to securities lending and
       borrowing
   -   Mix of securities and money markets settlement
       procedures creates problems for market
       development (different settlement needs)
   -   Diversity of trading and settlement mechanims and
       procedures even for similar type of securities
   -   Eliminate paper processing (for developing systems)
                                                        26
C. MAIN CHALLENGES FOR SSSs

 Settlement risk
   -   CCPs: risk reduction but higher risk concentration

   -   Increasing need to ensure financial integrity.
       Delicate balance between access and competition

   -   Reduction of the settlement cycle not always
       accompanied by reduction of settlement risk

   -   Systemically important systems must have
       adequate risk management mechanisms

   -   Settlement assurance procedures (for developing
       systems)
                                                            27
C. MAIN CHALLENGES FOR SSSs

 Operational issues
   Interoperability of global network (more than
     technical compability of systems)
     - Global identification methodology to facilitate STP
     - National differences in IT and interfaces
     - Practical impediments to remote access

   Need to accommodate increasing volume of
     traffic and volatility in markets
   Adequate contingency procedures and back-
     up systems (for developing systems)
                                                        28
C. MAIN CHALLENGES FOR SSSs

 Regulation & oversight
   Increasing importance of settlement issues
     for securities regulators and role of SROs
     - No role in operating systems
     - More attention to regulation and oversight. Dual
     roles: public policy framework for competition and
     prudential oversight
     - Increasing need to coordinate with other
     regulators/supervisors, specially central bank, both
     domestically and internationally
     - Interaction with private sector through SROs.
     Importance of overlaps/gaps in regulation and
     supervision                                          29
C. MAIN CHALLENGES FOR SSSs

 Organizational arrangements
  Governance of infrastructure is a key issue
  for markets integration
     - Transparency: full disclosure to system users
     - Non discrimination: fair access to SSSs
     - No single group or single interest group with
     majority control
     - Effective attention to users interests

  Access to liquidity can be an important
  obstacle (interaction with funds transfer
  system)
                                                       30
C. MAIN CHALLENGES FOR SSSs

 Cross-border settlement
   -   Inconsistent legal and regulatory underpinnings
   -   Lack of globally recognized technical standards
   -   Differing business processes
   -   Differences in tax procedures
   These problems lead to higher costs due to
   -   Direct costs from higher fees of the services
       provided
   -   Indirect costs from extra back-office facilities
   -   Opportunity costs from inefficient use of collateral
       and higher incidence of failed trades
                                                              31
C. MAIN CHALLENGES FOR SSSs

 Cost-efficiency issues
   -   Level of market competition on clearing and
       settlement organizations is low (lack of direct
       competitors to use as a benchmark), thus,
       alternatively in-house unit costing techniques need
       to be developed.
   -   Composition on costs is changing rapidly with
       diminishing IT costs. Increasing use of outsourcing
   -   Small value transactions normally subsidized by
       imposing higher charges on large value
       transactions.
   -   Many systems may be under-recovering their
       operating costs

                                                        32
C.1. SPECIAL CONSIDERATION OF CCPs

 Benefits
   Attributed to multilateral netting
   -   Reduction in the number of settlements
   -   Reduction in individual contractual obligations
   -   May help reduce the margins required to
       collateralize current and potential future credit
       exposures
   -   May help to reduce the capital required to support
       participant’s trading activity
   -   Helps to sustain anonymity where trade execution
       process itself is anonymous
                                                            33
C.1. SPECIAL CONSIDERATION OF CCPs


 Benefits
   Provides risk management services
   -   Replaces exposures to multiple counterparties with
       a single exposure to a single counterparty
   -   No worry about the creditworthiness to a single
       counterparty
   -   Does not eliminate counterparty credit risk, but
       redistribute it much more efficiently than market
       participants could do in isolation



                                                           34
C.1. SPECIAL CONSIDERATION OF CCPs


 Risks
   Legal and technical risks (not specific to CCPs but
   higher potential systemic impact)
   Principal risk (reduction but concentration)
   Replacement cost risks (not specific to CCPs but
   higher potential systemic impact)

 Risk management tools
    Financial and operational requirements (to
   minimize probability of failure of a market participant)
   Margins (to minimize the loss if a participants fails)
   Limit build-up of exposures by means of periodic
   settlement of positions (normally used in derivative
   markets)
                                                         35
C.1. SPECIAL CONSIDERATION OF CCPs

 Main concerns
   Concentration of risk
   Moral hazard (too big to fail)
  Information asymmetry is reduced but only if CCP is
  perceived to be solvent
   Competition between CCPs could negatively affect
  risk management standards
  A single CCP would maximize externalities and
  economies of scale but could produce potential
  inefficiencies (lack of innovation). Need of appropriate
  governance rules
  Contagion effects (cross-process, cross-products,
  cross currencies)                                      36
C.1. SPECIAL CONSIDERATION OF CCPs

 Main issues to be considered
    Legal Framework
    Participation Requirements
    Understanding Risks
    Novation
    Settlement
    Default Procedures
    Risk Controls
     • Margins/Guarantee fund/Loss Sharing
    Governance
    Operational Risk
    Regulatory Reporting
                                             37
D. INTERRELATIONS BETWEEN PAYMENTS
AND SECURITIES SETTLEMENT SYSTEMS

 Timing of settlement finality
     – Careful analysis of design, procedures, operational
     timetables and funding cut-off times
     – SSSs settlement end-of-day, intra-day, real-time?
   Cash settlement asset and settlement agent risks
     – Is central bank money used?
     – Credit, liquidity, and operational risks
     – Management of a settlement agent’s failure
     – Concentration of settlement flows
     – Who has access to the funds transfer system
     – Participants ability to choose a settlement agent
     – Range of services provided by agent
     – Participants’ views on agent’s competitive neutrality
     – Arrangements for funding/defunding accounts           38
D. INTERRELATIONS BETWEEN PAYMENTS
AND SECURITIES SETTLEMENT SYSTEMS


 Higher potential contagion effects in the financial
  system from the use of CCPs
 Impact of SSSs on the implementation of monetary
  policy
 Impact of SSSs on the liquidity management of the
  system (increasingly important with the generalized
  use of RTGS systems)
 Impact of SSSs on the fiscal policy (especially for
  development markets)
 Need of coordination between central bank and
  securities regulator

                                                        39
E. MAIN CONCLUSIONS
 Integrated approach for SSSs
   Integration of payments and securities settlement
 SSSs recognized as incurring same inherent risks as
  those associated with SIPS
 Consolidation of SSSs functions (efficiency gains, risk
  reduction, higher concentration of risk)
 Cross-border settlement main obstacles: differences in
  legal & regulatory frameworks, lack of enough technical
  and processes standardization, differences in tax
  procedures
 Domestic settlement main challenges: legal issues
  (finality, collateral), adequate risk management
  procedures (beyond DvP), adequate coordination with
  other regulators and cooperation with the private sector
 SSSs reform an on-going process
                                                            40

				
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