Cross-border securities settlement and risk analysis framework for ...

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Box 2 – Settlement of cash obligations in securities transactionsThe cash settlement agent, whose assets are used to settle the payment obligations arising from securities transferswithin an (I)CSD, could be either a central bank or a commercial bank. Traditionally in Europe, assets used forsettlement of securities transactions in a CSD are a claim on the local central bank, i.e. settlement is in central bankmoney. Foreign investors in a CSD may not always have direct access to intraday liquidity or credit in the settlementcurrency with the local central bank. They will therefore use a local settlement bank to settle funds transfers ontheir behalf in the books of the central bank. As a result, such investors settle in commercial bank money althoughthe ultimate cash settlement agent is the local central bank of the country where the CSD is located.ICSDs typically have banking status and settle on their own books in commercial bank money, since the vastmajority of their participants do not have access to central bank credit in the country or monetary zone where theICSDs are established. Also, ICSDs operate a multi-currency settlement system providing – like global custodians –multi-currency banking and cash management services for their participants.ICSDs have set up links with other (I)CSDs to transfer foreign securities against payment. Cross-system settlementthrough (I)CSD links requires settlement in the books of the issuer (I)CSD. In the Eurosystem, in accordance withthe current rules, operators of securities settlement systems are not entitled to obtain central bank credit unlessthey are credit institutions established in that country. To execute the settlement of cash obligations in securitiestransactions, the investor ICSD will make use of settlement banks or cash correspondents to access the local cashclearing system in the country of the settlement currency. Settlement is therefore executed in commercial bankmoney instead of on the books of the local central bank. As a rule, and for efficiency reasons, the intermediaryholding the securities positions also plays the role of cash correspondent on behalf of the investor ICSD.The investor (I)CSD may have access to the issuer (I)CSDeither directly (i.e. direct or operated link) or indirectlythrough an intermediary (i.e. indirect or relayed link).Due to the intermediation, the chaining process of crossbordersettlement through indirect and relayed links islonger. The main steps for executing a cross-border settlementremain, however, the same for all types of links.Chart 1 below assumes that the participant in an investorICSD is buying foreign securities from a local counterpartythat participates in the issuer CSD. It is further assumedthat the issuer CSD settles in the books of the local centralbank with which it has a technical link in place. The investorICSD will therefore make use of cash correspondentsto provide the connection with the local cash clearingsystem. Upon settlement in the local issuer CSD, securitiesare transferred from the seller’s securities accountto the investor (I)CSD’s omnibus account in the case ofdirect and operated links, or to an intermediary’s omnibusaccount in the case of indirect or relayed links. When theissuer CSD settles securities transactions on a deliveryversus-payment(DVP) basis, securities and cash transfersare organised so as to ensure that a delivery occurs if, andonly if, payment occurs.After settlement, the issuer CSD or the intermediary willsend a confirmation report to the investor ICSD. Uponreceipt of this report, the investor ICSD will record the settlementconfirmation by crediting the received securitieson the buyer’s securities account. The cash correspondentwill also deliver a report to confirm the execution of thepayment related to the securities transaction.It cannot be excluded that, when intermediaries involvedin cross-border settlement through indirect and relayedlinks (i.e. local agents, global custodians or (I)CSDs) havesufficient critical mass of clients buying and selling securities,settlement of foreign securities transactions is internalisedin their own books, without having to process thetransaction at the level of the issuer (I)CSD. Internalisationof settlement would be possible if the counterparty of aninvestor (I)CSD’s participant has an account in the booksof the intermediary. Although the issuer (I)CSD is notdirectly involved in such transaction, this also induces across-system transfer from the perspective of the investor(I)CSD. The possibility to internalise settlement at the levelof the intermediary might be part of the service offeredby the intermediary for the investor (I)CSD (e.g. betterinstruction deadlines or cost reductions in general).126
CROSS-BORDER SECURITIES SETTLEMENT ANDRISK ANALYSIS FRAMEWORK FOR CROSS-BORDER LINKSCHART 1CROSS-SYSTEM SETTLEMENT(Securities and cash leg)Investor ICSDINT (1)Issuer CSDCash Securitiesbuyernostrocash a/c(5)(1)nostro a/cbuyercash a/c(4)SecuritiesinvestorICSD a/c(3)sellerLink between securities andfunds transfer system(4)Cash correspondentLocal cash clearinginvestor ICSDcash a/csellercashcorrespondent(2)(3)(1) Buyer’s cash balances (cash or credit) in the books of the investor ICSD are reserved for settlement.(2) The cash correspondent uses the available funds to settle in the local cash clearing on behalf of the investor ICSD.(3) Subject to DVP, securities delivery occurs if, and only if, payment occurs.(4) Reporting of settlement to investor ICSD by issuer CSD (via intermediary, if applicable) and by cash correspondent.(5) Recording of securities settlement confirmation in investor ICSD.(1) INT is the intermediary in case of indirect or relayed links holding a securities account on behalf of the investor ICSD in the issuer CSD.1.2.2 Internal settlement at the investor (I)CSDSettlement of foreign securities can be internalised at thelevel of the investor (I)CSD if both buyer and seller havea securities account in the investor (I)CSD. The type oflink as such is not relevant to enable internal settlementat the level of the investor (I)CSD. As shown in Chart 2,securities transactions are settled internally in the booksof the investor (I)CSD, without settlement on the accountsof the issuer (I)CSD, and without settlement on the booksof an intermediary in the case of indirect links or relayedlinks. Technically, the recording of the transfer of securitiestakes place in the books of the investor (I)CSD only. As theinvestor (I)CSD holds the foreign securities positions in thesystem of the issuer (I)CSD, the link would, for this typeof transactions, function as a mere cross-border custodyarrangement between the (I)CSDs involved.settlement currencies in the books of the ICSD. As aresult, investor ICSDs can internalise cross-border settlementagainst payment in their own books in a wide rangeof currencies. The settlement asset for foreign securitiesis then commercial bank money instead of central bankmoney, as in the case of domestic securities transactionssettled in the issuer CSD (1) .A special case of a cross-border settlement through alink is the “Bridge” which has been established betweenEuroclear and Clearstream, the two major EuropeanICSDs. In this scheme, both ICSDs settle transactions inforeign securities bilaterally before updating the resultingpositions at the level of the local CSD where the securitiesare issued. This specific case of internal settlement isfurther explained in Box 3.An investor CSD would generally internalise against paymenttransactions in the home currency of the centralbank with which its system is connected. In contrast,participants of an ICSD hold cash accounts in different(1) ICSDs settle in commercial bank money but may also offer the possibility to settlein central bank money.127
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