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Wp2851 settlement best pratices guidance Wp2851 settlement best pratices guidance Document Transcript

  • Public Disclosure Authorized s TasI POLICY RESEARCH WORKING PAPER 2581Public Disclosure Authorized Securities Clearance and How to assesssecurities clearanceand settlement Settlement Systems systems,based on international standardsand bestpractices. A Guide to Best PracticesPublic Disclosure Authorized Mario Guadamillas Robert KepplerPublic Disclosure Authorized The World Bank Latin America and the Caribbean Region Finance Cluster and Financial Sector Development Department Financial Sector Infrastructure April 2001
  • | POLICYRESEARCH WORKINGPAPER2581 Summary findings As an essential part of a nations financial sector elements that influence the systems quality, and show infrastructure, securities clearance and settlement systems how their assessment methodology works. They focus on must be closely integrated with national payment systems the development of core principles and minimum so that safety, soundness, certainty, and efficiency can be standards for integrated systems of payments and achieved at a cost acceptable to all participants. Central securities clearance and settlement. banks have paid considerable attention to payment Their paper fills a gap by providing an evaluation tool systems, but securities clearance and settlement systems for assessors of such systems, especially those who must have only recently been subjected to rigorous assessment. assess evolving systems in developing and transition The Western Hemisphere Payments and Securities economies. Essentially, an assessment involves a Clearance and Settlement Initiative (WHI), led by the structured analysis to answer four related questions: World Bank and in cooperation with the Centro de * What are the objective and scope of a securities Estudios Monetarios Latinoamericanos (CEMLA), gave clearance and settlement system? Guadamillas and Keppler a unique opportunity to * Who are the participants, what roles do they play, observe how various countries in Latin America and the and what expectations do they have? Caribbean undertake securities clearance and settlement. * What procedures are required to satisfy the To do so, Guadamillas and Keppler developed a practical participants needs? and implementable assessment methodology covering * What inherent risks are involved, and how can they key issues that affect the quality of such systems. be mitigated at an acceptable cost? In this paper they discuss the objectives, scope, and content of a typical securities system, identify the This paper-a product of the Finance Cluster, Latin America and the Caribbean Region, and Financial Sector Infrastructure, Financial Sector Development Department-is part of a larger effort in the Bank to assess payment systems and securities clearance and settlement systems in Latin America and the Caribbean. Copies of the paper are available free from the World Bank, 1818 H Street, NW, Washington, DC 20433. Please contact Helena Issa, room 15-110, telephone 202-473-0154, fax 202-522-2106, email address hissa@worldbank.org. Policy Research Working Papers are also posted on the Web at http://econ.worldbank.org. The authors may be contacted at mguadamillas@worldbank.org or rkeppler@worldbank.org. April 2001. (34 pages) The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. objective theseries to getthe findings quickly,evenif the presentations lessthanfully polished.The An of is out are paperscariy the namesof the authorsandshouldbe cited accordingly. findings,interpretations, conclusions The and expressed this in represent view of the WorldBank,its ExecutiveDirectors, the paperareentirelythoseof the authors.They do not necessarily the or countriestheyrepresent. Produced by the Policy Research Dissemination Center
  • SECURITIES CLEARANCE AND SETTLEMENT SYSTEMS SECURITIES CLEARANCE ANDSETTLEMENT SYSTEMS A guide to Best PracticesMario Guadamillas Robert KepplerFinancial Economist Senior AdviserFinance cluster, LCSFP FinancialSector InfrastructureLatin America and the CaribbeanRegion Financial Sector Development DepartmentThe World Bank The World Bank View slide
  • SECURITIES CLEARANCE SETTLEMENT AND SYSTEMS ACKNOWLEDGEMENTThe ideas presented in this paper are a by-product of our involvement in the WHI,although they are ours and therefore do not represent the WHI position or the position ofany institution participating in the WHI. However, we are grateful for the contribution ofour colleagues in the core team of the Initiative, the International Advisory Council (IAC)members, country authorities (central banks and securities regulators) representativesfrom the Latin American and Caribbean Region and staff of private institutions visited inthe context of the Initiative. We want to thank our colleagues in the World Bank,Massimo Cirasino, Fernando Montes-Negret and Augusto de la Torre for their valuablecomments. We are also gratefil for the contribution of our colleagues in the field, Iniigode la Lastra (Comisi6n Nacional del Mercado de Valores, Spain), Ester Saverson (USSecurities Commission),Eija Holtinnen (Finland Securities Regulator), and Andrea Salas(Comisi6n Nacional de Valores, Argentina) that contributed to the development of themethodology and provided specific comments on several aspects covered in the paper. ii View slide
  • SECURITIES CLEARANCE AND SEITLEMENT SYSTEMS GLOSSARY ACRONYMS OF BIS Bank for International Settlements CEMLA Centro de Estudios Monetarios Latinoamericanos CNMV Comisi6nNacional del Mercado de Valores, Spain CNV Comision Nacional de Valores, Argentina COSRA Council of Securities Regulators of the Americas CPSS Committee on Payment and Settlement Systems CSD Central SecuritiesDepository DvP Delivery versus Payment ESCB European System of Central Banks FDvP Final Delivery versus Payment FIBV International Federation of Stock Exchanges FRBNY Federal Reserve Bank of New York IAC InternationalAdvisory Council IADB Inter-American DevelopmentBank ICSD International Central SecuritiesDepository iOSCO International Organizationof Securities Commissions ISIN International Securities IdentificationNumber ISSA International Services Securities Association OECD Organization for Economic Cooperation and Development OTC Over the Counter RTGS Real Time Gross Settlement System SADC Southern African Development Community WB World Bank WHI Western Hemisphere Payments and Securities Clearance and Settlement Initiative iii
  • SECURITIES CLEARANCE AND SETTLEMENT SYSTEMS SECURITIES CLEARANCEANDSETTLEMENTSYSTEMS A Guide to Best Practices TABLE OF CONTENTS INTRODUCTION ................................................................................. I OBJECTIVE, SCOPE, AND ELEMENTS .................................................................................. 1 PARTICIPANTS IN SECURITIES CLEARANCE AND SETTLEMENT SYSTEMS ........... ......................... 3 SECURITIES CLEARANCE AND SETTLEMENT PROCEDURES ........................................................... 5 EXPOSURE TO RISK WITHIN THE SYSTEM ................................................................................. 14 A METHODOLOGY TO ASSESS COUNTRY SYSTEMS BASED ON INTERNATIONAL STANDARDS ... 18 1. Clearing and Settlement Process ...................... ............................................... 19 2. Settlement Risks..................................................................... 20 3. Legal issues..................................................................... 22 4. Regulatory Oversight Issues..................................................................... 22 5. Clearing and settlement institutions and their participants................................................. 23 6. Safeguard Policies...................................................................... 24 7. System capacity..................................................................... 24 GOVERNMENT SECURITIES CLEARANCE AND SETTLEMENT ....................................................... 24 COOPERATION IN THE PAYMENTS SYSTEM ................................................................................. 25 CROSS-BORDER SECURITIES CLEARANCE AND SETTLEMENT ................. ................................... 25 CONCLUDING REMARKS ................................................................................. 27 REFERENCES ................................................................................. 28 ANNEX I. SECURITIES CLEARANCE AND SETTLEMENT MATRIX ................................................ 30 ANNEX II: LIST OF STANDARDS AND BEST PRACTICES ........................ ...................................... 33 Boxes: 1. Securities Clearance and Settlement Procedures ................................................................ 6 2. Trade Confirmation/Comparison/Affirmation ................................. .................................. 9 3. Example of Gross versus Net Settlement Systems ............................................................ 13 4. TheWHI ................................................................................. 18 Figure 1. Number of CSD Organizations ................................................................................. 10 Tables: 1. Number of Settlement Operations and Liquidity Needs by Settlement Type ................ 12 2. Number and Value of Transactions Affected by a Settlement Fail ................................ 13 3. Risk Management Tools for Securities Clearance and Settlement Systems ........ ..........15 iv
  • SECURITIES CLEARANCE SE7 LEMENTSYSTEMS AND INTRODUCTIONThis paper presents a methodology to assess securities clearance and settlement systems based oninternationalstandards and best practices. The first part of the paper discussesthe major componentsof atypical system and identifies those issues that determine the extent to which the system satisfies thecritical needs of all stakeholdersfor safety, soundness,certainty and efficiency at an acceptablelevel ofcost. The issues identified during this discussionprovide the foundation upon which the assessmentmethodology is constructed. Although clearance and settlementsystemsin all countrieshave a range ofcommon featuresand functions,it is also clear that local realitiesstemming from historical developmentsas well as legal and cultural precedents can have a significant influenceon the specifics of a particularnational system. With this in mind, the assessment methodology described in this paper should beapplied in a way that takes account of both internationalstandardsand local realitiesas it is evident thatno specific common system can satisfythe total needsof all countries.The primary policy, organizational,and operationalfacets of securities clearanceand settlement systemscan be identified through a structured analysis of the answers to four distinct but interconnectedquestions: * What is the objectiveand scope of a securitiesclearance and settlementsystem; * Who are the participants,what roles do they play, and what expectationsdo they have; * Whatprocedures are required to satisfyparticipantneeds; and * What inherentrisks are involvedand how can they be mitigated at an acceptablecost. OBJECTIVE, SCOPE, AND ELEMENTSA payment system can be defined as the collection of institutions, instruments, rules, procedures,standards, and technical means used to exchange financial value between two parties discharging an 2obligation. A securities clearance and settlement system can be considered as part of the overallpayment mechanismsof a country in that it satisfies the main featuresof this overall definition. In thiscase the exchange of financial valueconsists both of the exchangeof securities (equity,fixed income, orderivatives)and the exchange of liquidfunds (usually cash or sight deposits).Regulationand oversightof paymentserviceshave traditionallybeen viewed as one of the three pillars of 3central banking. The other two are the conduct of monetary policy and active prudential supervision ofdeposit taking institutions. In terms of securities,governmentsecuritieshave traditionallyreceived closeattention from the central banks due to the role that they play as the governments bank as well as theagent of the government in regard to public debt management. Many central banks have enlarged theirrole in the payments systemsfield beyond the regulatoryand supervisoryaspectsand provide operationalservices that supplementor complementservicesprovided by the private sector. The specificrole filledI This section benefits from the presentation of Keppler, R.H., 1999, Transforming PaymentSystems:The BuildingBlocks and the WorldBanks Role, World Bank/Federal Reserve Bank of New York (FRBNY) Seminar held at FRBNY, April 13-16, 1999.2 Vid. Listfield, R. and F. Montes-Negret, Modernizing PaymentSystemsin EmergingEconomies, August 1994, Policy Research Working Paper #1936, The World, Bank, Financial Sector Development Department.3 Vid. Padoa-Schiopa, 1992, La Monetae it Sistemade Pagamenti. 1
  • SECURITIES CLEARANCE AND SETTLEMENT SYSTEMSby central banks differ from country to country and can include the provision of special purpose largevalue, time-critical, funds transfer systems, bulk low value electronic systems, including automatedclearinghouse services,and governmentsecuritiesclearanceand settlementservices.The private sector, on the other hand, has traditionallyprovided most of the services for clearance andsettlement of non-governmentsecurities. Moreover, in some countries, especially those in the earlystages of capital markets development, comprehensive and rigorous attention to regulatory issues issometimes lacking as initial major emphasis is placed, quite naturally,on matters relating to operationalefficiency and cost. Today, securities clearance and settlement systems are recognized as having thesame inherent risks as those associated with systemically important payment mechanisms. Both the 4efficiencyand the safety and soundnessaspects of these systemsare now receivingcloser attention fromdomesticsecuritiesregulatorsas well as internationalorganizations. In essence,the initialprominent roleplayed by the private sector in the implementationand operation of securities systems is now beingreplaced by a combinationof roles shared between the private and public sectors with specific and welldefined roles being assignedto the securitiesregulator.The key attributes of a securities clearance and settlement system can best be illustrated by examiningeach of the elements containedin the definitionof a paymentssystem presented above, i.e., institutions,instruments,rules, procedures,standards,and technicalmeans.Institutions provide the infrastructure clear and settle securitiestransactions. Two types of institutions toare involved and include "participants" that participate directly or indirectly in the clearance andsettlementprocess(clearinghouses,settlementagents, serviceproviders)or regulatorybodiesthat providethe regulatory framework to clear and settle securities in an orderly and safe way as well as providingoverall oversightfor the entire system.Instruments are the vehicles used for transferringvalue. Two types of instrumentsare used. On the onehand, there are the securities which, in a broad sense, includeequity, fixed income and derivatives. Onthe other hand, there is the payments instrumentwhich is used to transfer funds from the buyer of thesecuritiesto the seller. rhe specific instrumentused to dischargethe paymentleg of the obligation variesand it is dependent on the participantsto the transactionand the value of the associated payment. Thisrelationship underscores the importance of an efficient and safe payments clearance and settlementsystem and its interconnectivitywith the efficiencyand safety of the securitiesclearance and settlementsystem. This interdependence be discussedagain in several sectionsof this paper. willRules refer to the required legal and administrativeframework including statutory, regulatory, andcontractual rules that govern the rights and obligations of parties to a transaction. A fumdamentalingredient of any efficient clearance and settlement system is a clear, comprehensible, sensible andenforceable (at low cost) legal regime. Technologicalinnovationis having a major impact on the legal,regulatory and administrativearrangements;for example, on the need to ensure that the judicial system4 Theseconceptsinclude:speedof settlement, certaintyof settlement (correctamount,correctparty, correct date, clear understanding whenfinality occurs),reliability(availability, accordance in with rules and regulations),safety and soundness ensureagainstfraud,creditandsystemicrisk,privacy),convenience (to (easy access, consistent with technologicalcapabilities),cost (realistic, consistentwith the service provided),universality(equitablebasisby allfinancialinstitutions, interfacewithothersystems).5 This paper is not focused on the specific details of derivatives clearance and settlement. For a detailed analysis of these issues vid BIS, September 1998, OTC Derivatives: Settlement Procedures and Counterparty Risk Management, and March 1997, Clearing Arrangements for Exchange-Traded Derivatives. 2
  • SECURITIES CLEARANCE AND SETTLEMENT SYSTEMSaccept electronicrecords as evidentiarymaterialand that digital signatureshave the same attached rightsand obligationsas physical written signatures.The securities clearance and settlementprocedures vary significantlyfrom one country to another. Insome cases, the domesticprocedureswill differ dependingon the specific nature of the securitiesthat arebeing traded. Typically, procedures have evolved over time and reflect market practices, conditions,tradition and culture. Today, there is a clear trend towardsthe use of electronicclearance and settlementmechanisms. A cornerstoneof such systems is the role played by central securitiesdepositories(CSDs).Establishing a CSD results in increases both in efficiency and safety through the immobilization ofsecuritiesand their safe storagein the CSD as contrastedwith the old arrangementsin which the "scrip"was actually held by the investor. Another benefit usually relates to the issue of securities in adematerialized or book-entry form. Despite this common evolutionary path, there are still manyvariationsin the way in which CSDsoperate at the detailedlevel.The most recent factor that has been introducedinto the world of clearance and settlementconcerns therole of standards. Standards are requiredto facilitate the efficient exchange of data between computersystems and also underpin the drive towards straight-through-processing which the entire end-to-end inor customer-to-customer transactionflow can be computerized. The use of a common set of standards isalso essential in facilitating the integration of national systems into efficient and closely integratedinternationalsystems. Today, a wide variety of internationalinstitutionsand organizations6are involvedwith the development of standards. In some cases, these standards have been established to realizespecific purposes and relate primarily to a specific system or group of systems and thus may not beapplicableto all systems. In addition,it shouldbe noted that not every system, especiallyduringthe earlyevolution of securities markets in a country, can or must satisfy all of the standards that have beenpromulgated. From a practical perspective,the primary need is the availability of a set of standards andimplementationguidelinesthat have applicabilityto securitiesmarketsat different stagesof developmentin mature, transitional, and developing economies. To achieve this end, substantial work is nowunderway at the internationallevel regarding standards development. It is worth noting that this work,quite appropriately, reflects the close interrelationshipbetween securities transfer systems and funds 7transfer systems.Finally, the technical means provide the tools, and operational infrastructurefor transmitting financialvalue between participants and intermediariesthroughout the processing cycle. As mentioned abovetechnologicalinnovation is providing significantopportunitiesto reduce operational costs and improvethe speed and the securitywith which informationcan be processed. However,technologicalinnovationis also introducingnew challenges,especiallyin regardto the needfor appropriatelegislativechanges. PARTICIPANTS SECURITIES IN CLEARANCE AND SETTLEMENT SYSTEMSA broad range of institutionsand entities are involved in securities clearance and settlement systems.Regulatory authorities (mainly central banks, superintendenciesof banks and securities regulators)create the legal and oversightenvironmentwithin which the proceduresare carried out. Sometimestheyalso provide clearance and settlementservices,mainly in the case of governmentsecurities. Participantsare those institutionsthat send/receiveorders directly to/fromthe system or which are directly bound by6 Box 4 present a list of some of the standardsand bestpracticesissued by international institutionsand organizations.7 The CPSS (BIS) and IOSCO have initiated a joint effort to develop a comprehensive list of standards with applicability to all critical aspects of securities clearance and settlement systems. 3
  • SECURITIES CLEARANCE AND SETTLEMENT SYSTEMSthe rules governing securitiestransfer systems. Directparticipantsdirectly exchange transfer orders withother participants in the system on behalf of themselves, their customers or on behalf of indirectparticipants. Indirectparticipants are distinguishedfrom direct participantsby their inabilityto performcertain activitiessuch as input of transfer orders or acting as a settlementagent. The typical participantsare described below along with a note of the functionsthat they perform and the services they provide.However, as will be noted, the roles of participantsare not unique and do vary from country to countryand from system to system. For example, some of the services/functionsundertaken by a specificparticipant could be provided/performed by separate entities, or some of the services/functionsprovided/performed severalparticipantscould be provided/performed a single participant. by byFinal investors are the individual economic agents in an economy (households and firms) that investsurplus funds or savings with the objective of earning an attractive return on their investment. Theynormallytrade in securitiesmarketsthrough an intermediary,broker/dealeror an institutionalinvestor.Institutional investors (mainly, banks, mutual funds, pension funds, and insurance companies) areplaying an increasinglyimportantrole in securities markets. The high volume and value of transactionscarried out by these institutionsplace them in a pivotal role in the clearing and settlement processes.Internationalstandards recognizethe importanceof their role and recommendthat although they usuallyare not direct participants in the trading mechanisms, they should have direct participation in theconfirmation/comparison/affirmation processes.Both, final and institutional investors are customers of the securities clearance and settlement system.They are buyers, sellers or holders of securities and funds. However, they do not participate directly inthe clearance and settlementarrangements.Issuers are institutionsthat seek financing via the securitiesmarkets; thus, are obliged to pay interest ordividendsand redeem the principalon securities issued by them. They are normally classified as publicor private issuers. This distinction is importantas countriesoften have different systems for processingtrades in the public and private securities markets. In addition,the public securities market is normallyregulated by the central bank whereas private securities markets are regulated by a separate securitiesregulatoryauthority. However, in some countries,where securitiesregulatorsdo not exist, central bankstypically assume the overall regulatoryresponsibility.Broker-Dealersundertake the primary intermediationrole in securities market trading. For this reasonthey also have a primaryrole in the clearance and settlementprocedures. It is worth mentioning that theevolution and automation of the securities clearance and settlement systems is deeply affecting thissegment of the industry. In particular,the design of the system, especially its impact on the liquidityneeds that must be funded by these institutions,constitutesometimesa significantoperational constraint.This can present particulardifficultiesfor broker-dealers focus on the retail sector. thatCustodians are entities that undertakethe safekeeping of securities and other financial instruments onbehalf of others. They may provide other services such as clearance and settlement, securities lending,etc. A Global Custodianprovidesthose servicesin respect of securitiestraded and settlednot only in thecountry where the custodianis locatedbut also in other countriesthroughoutthe world.Central Securities Depositories(CSDs)provide-facilitiesfor holding securities in either immobilizedorbook-entry form. In addition to providingthis safekeeping role, a CSD may provide trade comparisonservices, and clearing and settlementservices.International Central Securities Depositories(ICSDs) are institutionsthat settle trades in internationalsecurities and in various domesticsecurities. They usuallysettle the trades in their own books or through 4
  • SECURITIES CLEARANCE AND SErTLEMENTSYSTEMSdirect or indirect links (throughlocal agents)to domesticCSDs.Exchanges and Over the Counter (OTC) markets are the mechanismsfor trading activitycarried out bybroker-dealers. Prices are determinedby auction bidding on the floor of an exchange or by negotiation(throughtelephonecommunications,computer-controlled networks of quotation terminals,etc.) betweenbuying and selling broker-dealers in the case of OTC markets. The key factor from a clearing andsettlement perspectiveis the way in which trading informationis transmitted rather than on the way inwhich trading takes place.The clearing agent is the entity that carries out the proceduresof trade capture, matching,confirmationand calculation of obligations relating to securities transfer instructions prior to settlement. Thesefunctionsare normallyprovidedby CSDstogetherwith the depositoryfunction or by the exchange wherethe trading takes place. Sometimesthe clearing agent assumes counterpartyrisk by netting the aggregatepositions of the participants in a process referredto as "novation". In this case, the clearing agent alsoperformsthe settlementfunction.A settlementagent manages the settlementprocess,determinesthe settlementpositionsand monitorstheexchange of securitiesand payments. Again, this function is sometimesprovidedby CSDsor exchanges.The payment of funds is usually done through a settlementbank (privatebank or centralbank), althoughin some situations is directly done by the broker/dealeror its paying agent through a means of paymentsuch as a check or a certified check.A correspondent bank provides payments and other services to another bank. Such services areprimarily provided across intemationalboundaries. It is included in this list because of its relevance tocross-bordersecuritiestransactionsand especiallyin regard to the role it plays in the paymentsleg of thetransaction. SECURITIES CLEARANCEANDSETTLEMENT PROCEDURESAfter a trade is executed in an exchange or an OTC market there are still a number of stages to befollowed in order to achieve an effective transfer of value (securities vs. payment) between thecounterparties. These procedurescan be quite differentfrom one country to anotherand even in the waythat differentsecuritiesare traded withina country. This sectiondescribesthe key aspectsof this process.An exhaustivetreatment of the many variations and local conditionsembedded in such systems aroundthe world is not attempted. The primary purpose is to illustrate the key issues that authorities shouldconsider when strivingto achieve an appropriatebalance betweensafety and efficiency. To cover the fullrange of unique characteristicsencounteredin specific countriesis beyond the scope of this paper. Thistask is being performed by intemational organizationsthat have published or are in the process ofpublishing reports describingthe specific operationaland regulatory mechanisms embedded in specificnational systems.88 The Committee on Payment and Settlement Systems (CPSS) of the central banks of the Group of Ten countriesperiodically publishes - under the aegis of the Bank for International Settlements (www.bis.org)- reference works on payment systems in various countries, the so-called Red Books. Volumes that are similar to the Red Book format have also been issued by the European Monetary Institute (for the European Union countries) and by the Executives Meeting of East Asia and Pacific Central Banks and MonetaryAuthorities (for the EMEAP member countries). "The Green Book", covering the countries of the Southern African Development Community (SADC) has been produced by the SADC Payment System Project Team under the auspices of the SADC Committee of Central Bank Governors. The WHI S
  • SECUPJ TIESCLEARANCE SETTLEMENT AND SYSTEMSBox 1 presents the typical proceduresthat are undertakenin a securitiesclearance and settlementsystem.The lifecycleof a securities transactioninvolvesthree phases: trade execution,trade clearance, and trade 9settlement. These procedures should be designed and developed to work within a specific legal andoperating environment and thus take account of local regulatory and oversight arrangements. Anunderstandingof these latter factors is essential as they influencethe way in which the procedures areused and thus contribute to any inherent risks embedded in the system. The nature of the operationalenvironment is assuming increasing importance in most countries as technological innovation ischangingthe way that informationis processed and managedand thus has an impacton all other factors.The way the authorities adapt to the new operational conditionsis critical to maintaining efficient andsafe systems. It is thus clear, that both the legal and regulatoryoversightarrangementsneed to evolve inline with technologydriven changesin operationalprocedures. inttBuying t i Buying tEx Chon A Selling ini Selling r Books", Cusering both payments and securities clerance and s eBroker Ln Customer f a Emerging Market Economies World Bank Discussion Pap, N. 3 Pay;07 ing00 A gent6 9 Vid.Apri 1996,Clearace , tehm, andSettlement SsesfrScrte:Ciia einCocsi 2.iei te clients<:t.* ffW tae dtail of trnation ex aeted. f fww.iphe-whpf.org) C d Agetrad BrnkanCEML,wtrstiiaino seords nato by hearn bodrneo Advisrety between theC isnerlabratieng asaitiaeorts, intitten thradoeeugitIneationcubonal b Yelleen and s Bok" coveringse payentscupoc seuiiscommranicatnd bothrog se5ttement foais tatd comerocn Caribbean Region.9 CriticalDesign Choicesin Vid.Stehm, J., April 1996,Clearanceand SettlementSystemsfor Securities: EmergingMarketEconomies, WorldBank Discussion Papers, No. 321. 6
  • SECURITIES CLEARANCE SETTLEMENTSYSTEMS AND TRADECLEARANCE, TradeCaptureM:atchimg/ConfirmatbofComparisou andAffirmation 4. Brkers,bothbuying selling. to theClearing and semd Ae-t a details Broke deliver a c5 The to theircusters co ghe detail O custome?s citedorders. ex S. TheClring Agent com eachside ofthe tradeand trep vaq brq., 6. Forlare itutd iesrthe confirnation nrall diretedtDan it is ry as a such custodian acing as agent "forhe investor in the cleaing proces Duringtht phae the inftmadonflow continues there arenw untii msae Jntradedeta. In somecases those procses m y occuroutsid of the lewing- ee Irad executonprocess Whenthe trd are *4.nsmited oked-lW itwactliw y$e as r sstems;qfthe echnge or r market, thed f e es hw t*ed Id&,-all cemp"in of trades bedween key matiitw. *mW br Calculatiloofsettlemetoblgatio 7. TheClearing Aget sends thebrokes,custo4ianad sede to a FiJd s (gross,bilatal netor multiea net)andthefnd b :i l1lm t at(gross, or net). Incaseofmiakes, t inormationfO continues thebesare nil coe Thesellingbrokermustprovideaiaility of securities befoe the ttime,tad he buying broke mustprovideavailabiliy funds of befor the -im ---. Avaiaility of securities * &ecurities in book-entfM: .mmobilzed and demaeriaized serities are availe throuh the brokers accontsin the 4iotory Normally,Ie :w- se*it -trf trade are bloced unil the rade is setd4e andcann be usedfor othertrads hse days. 2§e T2WJhm:Yhe brokersholdmakethemavaiable : the ett..:e . da. . Availabiy offUnds * Pamen hgh asetm agent In this care brokr or it -yn genaha. an account the settlement gnt *ualy a b aand t at learing balances the settlementagewnt fore setalme day. &Oker%, to pyta t b.azks custodians or sendthefinus bore eementt- - . * Diec PaMe by t &k. In this case buying brker 4irectypovidethends at settlement time by a n&ns of payment(e.g., acheck, ceitifled a direc paymen through its paying agent to the selling broker. In someoccions thedearing agn guarantees tradenetng he d wiyad recet of the settleet obligations. Thisis referred as "novadon"w t to or oe parfor ano (the clearng agenbecomethe rto ev sreler ndtheselerto - eer b-w)y4hT most markets clkaae &pksHyrangesfrm to T+S. trade T+l TRADE SETTLEMENr 8. Securities deliveredin exchange finds. are of Deliveryof securities * Througha Depository(securities previously ar immobZized the depository issu in a in or dematerialized form) * Diectly between brokens the (physicai formof securities) 7
  • CLEARANCESECURITIES ANDSETTLEMENT SYSTEMS of scurthefrog a certainmeunt Agefntso atclrstlmn ae h rnato eal ol be agreddirectly between thebrokersntbypartiesTanso ( iont ete.g,c bertiferdcek)saeomal aym enk 9.rThed olutin ar exhanagl oregiTemrkedntheenra Boxk aicountrtes seofd trasaciona urolessethog the wil aexhneinte seteds1 and 3iaFrscleaion ceadstlmn.upsstefc by htataei xctdi Snexcuratie are OTCarkferred nthroighnihclarignttwt.itscldlvr o hog ok Taecearntcssem. the case, durtes reer laht depositoryis o determninstttin obliations ogen the dinsructmre paticpet dboepsorydeales,d t. thmovdemienroh securities takeunspolachouigh thaedxepository I inccunts smttlcheng,cnt ain, o mpadreityon trd Fcpure, ulcb ane bffrokers/delrsoyc edurs(stpsymento6ithr box agh cacuaymeno gnf o cnrlze the obiainage nesettlement ) ta t raeeiesandcupaythe 7i o nen inexse disectly reod(athroug brkers the inormaits peaying aeto thetrpaye oandciv the monuey thecounticrpaties oha bgehalfo allof eias the anyi of casen phurnscinan fod bothfecritiese tandfud,te settilemethnt r blctseuiies, isd inexchane in sstep 3 ian orceane af n 2 settl ademe sa a ta purpoesthel t dofnntone. the CexhntraorOaTk trug accounts tdeanlsecuitis shouled-n teades,veraedm,athnd sl doneThjpocessy weinswihhh trade execution adllteephase.dThes tou parutisagreeul wtoxhange aelcertai aounthinofscrmatiefonhertiinofscriatiefor therti by ay ecanount ecange.t of foreigon participate fundsion anetr settlementddate.cTheotransbactio detmailsyactul normaillyacul inetr particulate intthemtrading;.custodiansbanksobe agreedsdirectlye inestorsenthe clenterpaties.eTransactionscestween sromer/casers, andrecas agrentsforethese bnestoreenthtwo clearouncerandtses.Tlementtprocess.wInbroker/dalers, nomarket indrecnomallytcarriiedaots(instanuexchalngestors markt.dianB)x1u aTd ilutoae the casvlue theransacationprcsse ofa pathrougheaneexlchlangen or settlemaretsnot sbigainiscant. oeo rS,2 iaea e,1 r utltrlnt1joiThe weiths andinsedits execution trade pracedures o oofth siutaneously th the delierytthe calculation of settlementthedscoue caep7 beone 1.Onc deterinbiateraltd,th net,xoutilatera neto Itra ffculeaat rfr sde to obligations proceduarkesnecessaryins gross, othieob rlgtosofddiectanmarket n thos a prticogipantst(boker/dealgers, otoheier etc. securnitiesad fundsrefolltowng maktrande bdexeuto.Tit icludtesa trdeffcapturemacing,h confirmatcfeuion,sparticipants (is ienveto and cuditsetod dueafftlrmantio off thder opertions, boxmondto tutonal cmparasnc entioe the procemsdures(tp4 inablt and hh olme to 6h participantues thencalulationlofrettlrements obligation (stepd7rinbox 1).Onebeavo tradie wisxcted dofonexct, the sepsto.records(capse) the koeytinomatio lating e tradess oasr.ht re to thra andg h oneptiareuocoThisrpaseisn.I smtimes referrede OTradket Procesming. okdi"trdsrd tora athn sdnjoitl wth tae entocursioandivdallyo anes sete bsis. ordr-yoreduesocr tnosy ihtedlieyo hinor3 to yhe partiiaese offn;cstda anyetw oprtcpns T deitxadcranedits betweegn th ak nralc secogd (nttotioal exchangesnorm cretditns)du toentir systmuae and offst theaingEahparticipants stock deinetorother and recognized the selfre oditesathies cgreatesa bn thertos participantewt dllofilthe inrms performansceio secuaritessystem.to and of the inyeltion toithe enstire pospaition single nraet aleaoran settl ftaedtis t ssthemsduetohe itabilit (atog mni Th clultinofsetemntoliatos anb dn o agos, iltea nt73ormutlaerln8
  • SECURITIES CLEARANCE SETTLEMENT AND SYSTEMSbasis for both the securities balances and the funds balances. The choice is not irrelevant. On thecontrary, it impacts very importantlythe efficiency and risk exposure of the system. In addition, thischoice is influencedby market characteristics, especiallythose relatingto the availabilityof liquidity. Asit will be made clear later in this section, the principle strengths and weaknesses of the two methodsrequire careful study and always result in tradeoffs between liquidity requirementsand risk mitigation,especiallythose risks relating to settlementfailure. Gross settlementsystems eliminaterisk, but requiremore liquiditythan net settlement systems. However,net settlementsystemshave increased risk due tothe deferrednature of the settlementprocess. Box 2. Trade confirmation/comparison/affirmation | Tradecomparison type i Description Locked-in .The Exchange OTCmarketdeliver or tradesof its participants a locked-in on basis,ta is,the tradesare alreadymatched. b Theinformation securities on tradedby its participants submitted the is to clearing agentby the exchargeor OTCmarket, whichcompares matches and Matched I the buy andsellsidesof Xt trades.Comparison members subriitthe trade dat and the clearing agentsendconfinnation reportsto comparison members that validat the compason of the tradedata.Finally, settlementinvolves the dischargeof settlementobligationsthrough the final transfer of securitiesfrom the sellerto the buyer, and the final transfer of funds from the buyerto the seller. Again, this couldbe done by a variety of proceduresbut two elementsrepresentedby the concept of Final Delivery versus 5Payment (FDvP) are critical. This means that securities should be delivered if, and only if, there ispayment and vice versa, i.e., on a Delivery versus Payment (DvP) basis. But as important as thepreviousconcept is that transactionsare final, i.e., that the securitiesand funds legs cannot be reversed,itshould also be noted that finality is affected by the particularitiesof legal and judicial systems. Thus,legal issues such as the concept of nominee or the provisionsembedded in bankruptcy laws should beseriously considered by the authorities to ensure consistency with securities laws, regulations andoperationalprocedures.Clearly, securities clearance and settlement systems are characterized by many features and functions.Experience indicatesthat three featuresare especially significantwhen designing a country assessmentmethodology as they represent core system design issues with varying solutionseach having associatedstrengthsand weaknesses. They are: (a) the instrumentsthemselveswhich can be either paper-basedorheld solely as computer records, (b) the role of CSDs, and (c) the use of gross versus net settlementschemes.Systems typically evolve from an initial use of paper-based instruments with physical delivery ofcertificates between counterparties to computer-based transfer mechanisms in which records ofownershipare held in so-calledbook-entryform. Evolutionusuallytakes place in two steps. The initialstep comprises immobilization which the paper instrumentsare stored in a secure location or locations inrather than being held by the individualinvestors. The second step is concernedwith dematerializationinwhich paper instruments are replaced by computer records. Clearly the pace of evolution is heavilydependent on the availability of appropriate technology, and the size of the market in terms of bothvolume of securities issued and traded and the number of active investors. Technologicalinnovationhas 5 This concept is referred sometimes as true DvP or real DvP. 9
  • SECURITIES CLEARANCE AND SETTLEMENT SYSTEMSreduced equipment and telecommunicationscosts and has facilitatedthe trend to move away from thephysical delivery of instruments. This is not only a more efficient mechanismbut also a safer one as iteliminates the movement of paper and thus reduces associatedrisks such as those relating to lost, stolen,or altered documents In an immobilized system, physical certificates are held in secure vaults andprovide the essential supportfor book-entrymaintainedownershippositionsof market participants. In adematerializedsystem, physical securities do not exist as they are replaced by book-entry records. Insuch systemsthe individual investorhas an interest right in a pool of fungible securities.Key issues to be addressed when contemplatingthe eliminationof physical delivery relate to the legalframework and the attitudes of investors. A legal framework which is appropriate for paper-basedsystems does not readily accommodateimmobilizationor dematerialization. Normally, amendmentstolaws are required, and dependingon the legal system of the country,this can take a long time and shouldbe taken into account. In many situations,individual investorshave more confidence in a system whichallows them to hold physical securities despite the associated risks. In moving to book-entry basedsystems, it is frequently necessary to wean investors away from this practice by providing an initialoption to hold securities in either format as well as the optionto change from one fornat to the other. Amarket strategybased on incentive pricing coupledwith the dematerializationof all new issues can thenbe used to progressivelymove toward full dematerialization. Figure 1. Number of CSD Organizations 140 120~~~~~~~~~~~~2 100 x - : 80 60 .. .. 40 0 ,2 _ __ _ __ 20 1950 1960 1970 1980 1990 1999 2000* * Includes operational 20 and/orplannedCSDs. Source: Thomas Murray,"Evaluating LocalMarket Custody Arrangements"A second importantimprovementinitiative,closely related to that described above, is the establishmentof central securities depositories/registries(CSDs) (see Figure 1). These institutions are created tofacilitatethe smooth and efficientoperation of book-entrysystems. CSDs provide key services includingsecurities ownership recordkeeping and custody of physical certificates in irnmobilizationregimes.However, in some systems there are still requirements for post-settlement processing such as theupdating of share registers and the issue of replacementcertificates. CSDs usually perform the clearingagent function and sometimes they also provide dividend and interest payments services. Theseinstitutionsare normallyprivate firms with a non-profit objective and are constitutedas Self RegulatoryOrganizations (SROs) under the oversight of the securities market regulator. The use of the word"central" can be misleading,as there can be severaldepositoriesin a country rather than only one. Thenumber of depositoriesdependon the complexity and size of the market. Nevertheless,today there is atrend towards centralizing all the securities clearance and settlementactivity of a country in one singleCSD with possiblya number of linked sub-depositories.A gross settlementsystem requires a critical mass of marketablesecurities and system-wideliquidity forits efficient operation. Systemicrisk in gross settlementsystems is low as transactionsare not executedunless there are securities and funds in the accounts of the counterparties. The relatively recent and 10
  • SECURITIES CLEARANCE AND SE7TLEMENTSYSTEMS 6rapidly growing use of real time gross settlement systems reduces credit and liquidity risk incomparison with batch processing systems.1 7 However,the associated liquidity needs may represent asignificant constraint to the adoption of these systems in securities markets, as participants are mainlybroker/dealers that typically lack the amount of liquidity required for the smooth operation of suchsystems,unless they are owned by or have a close relationshipto a commercialbank. For this reason,thechoice of settlement mechanism is not straightforward. It could affect the evolution of the market interms of the dominant institutions(banks vs. non bank dependentbroker/dealers)and the pattern of themarket towardsa retail or wholesaledominance.8 As a consequence,gross settlementsystems are morefrequently used to remove the risks embedded in large-valuefunds transfers systems in which the mainparticipantsare banks that have access to intraday liquidityprovidedby the central bank within carefullycontrolled arrangements. Well designed gross settlementsystems typically include queue managementprocedures and other mechanisms such as bilateral and multilateral offset arrangements to mitigateagainst the impactof so called gridlock 9 in the system.Net systems, because of the deferred nature of settlement,avoid the need for large amounts of intradayliquidity,howeverthe specificvolume and value of transactionsflows should be studiedto determinethepotential for risk. By reducing the overall value of the final funds transfersthat have to be made betweenparticipating financial institutions,netting can enhancethe efficiencyof national payments systems. Butnetting can also contributeto an increase in systemic risk. This may be the case if, instead of achievingreductions in participants true exposures, it merely obscures the level of these exposures. The trueposition becomes apparent only when the net positionsare identifiedat the end of the clearing cycle. Atthis point, shortages of either securities or funds are identified. Should appropriate cover not beavailable, then in the simple case, transactionshave to be unwoundwith the obvious negative impact onsystem participants and market confidence. Well designed netting systems can mitigate against theseimplications by invoking previously agreed settlement assuranceprocedures. Such procedures can bequite costly and are sometimesquite difficultto put in place. In some system arrangements,the clearingagent guarantees settlement and in effect becomes the counterpartyto each trade. This mechanism isreferredto as novation and requiresthat a supporting legal environmentis in place.Operationalsystems, especiallythose in transition,often exhibit a combinationof gross and net schemes.For example, it is not uncommon to see systemsthat combinesecurities gross settlementwith funds netsettlement. The BIS made an effort to categorizethe range of existing systems0 using different flavors 2of the concept of DvP, already mentioned. It should also be noted that the boundariesbetween real timegross settlementsystems and net settlementsystemsare becomingblurred. An increasingnumber of netsettlement systems now settle periodically duringthe day rather than solely at the end of the day. Thisreduces the potential for settlement failure by reducing the progressive build-up of credit exposuresbetween participants. Also, as noted earlier, gridlock busting routines in gross settlementarrangementsmake use of embeddednet settlementoff-setconcepts. This trend is continuingand it is likely that someform of final convergencebetweenthese mechanismswill take place.16 A gross settlement system in which processing and settlement take place in real time (continuously).17 Processing of a group of securities transfer instructions and/or payment orders at a set of discrete intervals of time.18 The debate about this issue is broader and covers other areas such as equal regulatory treatment.19 Situation in which thefailure of some transfer instructionsto be executedprevents a substantial number of instructionsfrom other participantsfrom being executed20 BIS (CPSS), September 1992, Delivery versuspaymentin securities settlement systems. 11
  • SECURITIES CLEARANCE AND SE7TLEMENT SYSTEMSIn order to clarify and quantify the points previously developed, lets assume a market with kbroker/dealers and only one traded security. Matrix T represents the transactions carried over bybroker/dealers in this market. An item in the matrix, tj, represents the value of securities bought bybroker/dealer i from broker/dealer 21 In a gross seftlementsystem, matrix T represents the number and j.value of transactionsas well as the number and value of settlementoperations. If transactions are settledon a bilateral basis, the number and net value of settlementoperations are representedby Matrix N. Inthis case, nj, representsthe net positionof broker/dealeri againstbroker/dealerj. If the net system uses a 1multilateralbasis, the number and value of settlement operationsis representedby matrix M, in whicheach element of the matrix, mi, representsthe multilateralnet position of each broker/dealer. Matrix T MatrixN MatrixM O tf2 t13 .. tlk 0 nI2 n,3 nik m t21 0 t23 ... t2k 0 0 n2 3 n2k ?2 t31 t3 2 0 ... t3k ° 0 0 ... . 3k m3 tkl tk2 tk3 ... 0 0 0 0 ... 0 O ni = |tij-tiil mij = t ti-E tij }=1 11Table I shows the type of settlementin combinationwith the number and value of settlementoperations. 22In a gross settlement system the number and value of settled operationsis higher than in net systems,i.e., the liquidityneeds of the system is potentiallyhigher. The analysis could be made more exhaustiveby assuming a combinationof differenttypes of settlementfor the securities leg and the payments leg,but it would complicatethe expositionwithout affectingthe conclusions. However,as mentioned earlier,it is not uncommonto see systemsthat combine securitiesgross settlement with funds net settlement orother type of combinations. Table 1. Number of SettlementOperationsand LiquidityNeeds by SettlementType Settlement Type Number of Settlement Value of Settlement Settlement Type ~Operations Operations k k Gross k (k-I) E iti i=l j=1 k k Bilateral Net k (k-1)/2 E E n i=l j=l Multilateral Net k mi i=l21 For simplicity purposes, it is assumed that each item in the matrix, ty, represents a single operation, thus, matrix T provides the information about the number of operations (one per item) and the value. It is assumed, also for simplicity purposes, that there are no transactions within a broker.22 Note that in this case, the number and value of transactions is the same as the number and value of settlement operations, unlike the case of net systems. 12
  • SECURITIES CLEARANCE SETTLEMENT AND SYSTEMSIn order to analyze what happens if there is a fail in the system, lets suppose that broker/dealer I isunable to deliver funds on settlement date for the transactionexecuted with broker/dealer 2. That is,transactiont 12 cannot be executed. Table 2 shows the number and value of transactionsaffected. In thiscase, a gross settlementsystem would be less affected both in terms of number and value of transactions.The multilateralnet system will be the most affected due to the need for recalculationof multilateralnetpositions. Table 2. Number and Value of TransactionsAffected by a SettlementFail Settlement Type Number of Transactions Value of TransactionsAffected ype ~~~Aiffected Gross Itij Bilateral Net 2 tj + tj, k k Multilateral Net 2k-3 Ztij + ,ti2 J=l 1=1 Box 3 Exampe of GrOssversusNe Settement Systems Lets assume 4 broker dealers operatingin a market with a single security. Matrix A representsthe transactions the market. The rows showthe valueof purchases brokersadealers in by whilethe columns represent valueof sales by brokers/dealers. resultof tables I and 2 of the text are presentedbelow the The for this specific example clarifying the conclusions already presented in the text. Matrix A 0 10 15 20 20 0 30 15 35 20 0 10 5 15 40 O Numberof SetlementOperatonsand Number Valueof Transactions and Affectedby Liquidity Needsby Settment Type a Setement Fail ANumberof Value of Number of Yalueaf settlement settlement trawactions transactions typ Settlement operations oSerations- Settlement type affected affcted Gross 12 215 Gross I 10 Bilateral net 6 85 _ __Biiateral net-ert 2 _ 30 Multilateral net 4 60 Multilateral net S 13
  • SECURITIES CLEARANCE SETTLEMENT AND SYSTEMS ExPOSURE TO RISK WITHN THE SYSTEMClearing and settlement procedures expose participantsto a number of risks. Maintaining acceptablelevels of safety and soundness is a primary regulatory objective. More recently the regulatory role hasbeen expanded to include system efficiency as an equally important objective. Risks3 stem from 2weaknesses in system design and can have their origin in any of the following: (a) rules and procedures,(b) institutional arrangements,(c) participants,(d) technical mechanisms, and (e) the need for implicitand/or explicitextension of credit. The specificmajor risks are discussedin the followingparagraphs.Credit risk is the risk that a counterpartywill not settle an obligationfor full value, either when due or atany time thereafter. It involves both the replacementcost risk andprincipal risk. Replacement cost riskis the loss of unrealized gains on unsettledcontractsdue to changes in securities market prices betweenthe time a trade is executed and the time that it is settled. The exposure depends on the market pricevolatilityand the time gap between trade date and settlementdate. Principal risk is the risk that the fullvalue of securities or funds will be lost by either the seller or buyer, when the respective counterparty 24fails to settle. This risk can be eliminated by introducingan acceptable form of DvP. Third partycredit risk arises when settlementparticipantsare permnitted required to use banks or intermediariesto orguarantee or provide settlementfunds and fail to perform,whether or not the settlementparticipant hasperforned its obligations.Liquidity risk is defined as the risk that a counterpartywill not settle an obligation for full value whendue, but on some unspecific date thereafter. If a counterpartyfails to settle, it does not always mean thatit is insolvent. The reason could be a failure in the technology being used (a computer failure), atransitory liquidity problem or a "cascading" effect from other failed transactions. However, it is verydifficult to determineex-ante if the counterpartyis having a liquidityor solvencyproblem. Moreover, insome situations,an unresolvedliquidityproblem could result in subsequentinsolvency. In any case, theimplicationfor the non-defaultingcounterpartymight well be the need to liquidate assets, borrow fundsor borrow securities.Operational risk stems from breakdownsin internal controls, failureto follow procedures or inabilitytofollow procedures. Operationalweaknessesor failures can result in specific problemssuch as credit orliquidity problems and indeed can create the potential for fraud. Sufficientattention should be given tothe need for appropriate logical and physical security arrangements,especially those relating to dataintegrity includingthe use of rigorousencryptionand message authentication/non-repudiation proceduresas well as strong system access controls.Legal risk stems from ambiguity or uncertainty in the rules governing the clearance and settlementprocess. In an environment with widespread legal uncertainty,participants may view the systems asbeing unreliable, and unfair. Legal risks can also impede the ability of paymnent system operators tomanage credit and liquidity risks (unenforceabilityof netting arrangements,bankruptcy laws may forcepayments to be revoked, no validity of interests in pledged collateral). In general, legal risks can arisefrom three different sources. First, rules may not clearly allocate responsibilities (liabilities or losses)23 See Payne, Myriam, May 1999, Risks in Payments Systems, presented in the Thomas Murray Global Custody Conference on Minimizing Risk in Clearing, Payment and Settlement Systems held at New York May 24-25 1999.24 Note that this risk is non existent when there is simultaneity in the transfer of securities and funds. However, it could be that even in the absence of this simultaneity, DvP is accomplished,provided that there is delivery if and only if there is payment and vice versa. 14
  • SECURITIES CLEARANCE SETTLEMENT AND SYSTEMSamong the parties to a payment. Second,rules may fail to addresspaymentauthenticityand security(i.e.,gaps in the legislation). Finally,they may provide a favoredposition to either payment service providersor users. Ambiguous or conflicting statutes, poorly written regulations and ill-conceived privatecontracts governing securities transactions can also exacerbate these problems. A particular weaknesscan arise in situations when there may very well be appropriate laws in place but the willingness toenforcethe laws is weak or non existent.Custody risk is the risk of loss of securitiesheld in custodyoccasionedby the insolvency, negligenceorfraudulent action of the custodian or a sub-custodian. If the security is maintaineddirectly by its ownerby means of a physical certificatethis risk stems from the possibilityof stolen or lost securities (owncustody risk). Custodyrisk can also be influencedby weaknessesconnected with operational and legalrisks.Cross-bordersettlement risk 5 is the risk that one party to a cross-bordertransaction" will deliver the 2security it sold but not receive the related funds or pay for the securityit bought but not receive deliveryof the security. In cross-bordertransactionsthe enforcementrisk is of critical importanceand care mustbe taken to ensure enforceabilityin all relevantjurisdictions.Finally, from a risk perspective,a situationcan arise in which a problem createdby one counterpartycanaffect the capacity of others to settle and thus trigger a domino effect. Systemc risk is defined as the riskthat the inability of one participantto meet its required obligationswill cause other participants to beunable to meet their obligationswhendue. 27Management initiatives,procedures,and tools have been developedto mitigate the impact of the risksdescribedabove. Table 3 presentsa range of risk managementtools and the associatedtargeted risk: Table3. Risk ManagementToolsfor SecuritiesClearanceand SettlementSystems Risk Risk ManagementToolsCredit Risk Admission Standards: Clearing agents often maintain membership requirementsto ensure financialstabilityof its participantsassuringthat every memberis creditworthyupon admission. They normallyinclude requirements such as minimum capital levels, liquidity requirements, operational capabilities and, in some cases, approval from the appropriate regulatory bodies. It is very difficultto evaluate a participants overall financialhealth when it is involvedin activities acrossmultiple markets. In addition,there is an importanttrade-offbetweena safe systemand a broad and fair participation in the market.25 In the context offoreign exchange risk it is sometimes referred as Herstatt risk26 A transaction between counterpartieslocated in different countries.27 In this regard, the BIS (CPSS) has recently introduced the concept of systemically important payments systems, that is, systems which could trigger or transmit systemic disruptions in the financial area because of the size or nature of individual payments which they handle or because of the aggregate value of the payments processed Vid BIS (CPSS), December 1999, Core Principles for Systemically Important Payment Systems. 15
  • SECURITIES CLEARANCE AND SETTLEMENTSYSTEMS Risk Risk Management ToolsCredit Risk Monitoringmembers creditworthiness:In additionto admission standards participantshave to submit copies of their financialstatementsand are subject to periodicreviews. Novation: Satisfactionand discharge of existing contractual obligations by means of their replacementby new obligations. In the context of the securities clearanceand settlementsystemthe clearing agent sometimesguarantees the deliveryand receipt of settlementobligations,becoming the counterparty to each trade. However, novation moves the credit risk to the clearing agent obliging this institution to implement risk management tools to face this exposure. ClearingFund: Contributions from participantsto cover losses which might take place duringbusinessoperation. Buy ins and Sell outs: These are settlement assurance procedures that, in case of a settlement failure, allow the buy of securities in the market at the seller (who failed) cost (buys-in)or the sale of securitiesin the market at the buyer (who failed) cost (sell-outs). Net debit caps: A net debit cap is the maximum amountthat a participant is permitted to incur in its net debit position to all other participants. It establishesan upper limit to the exposurethat any participant can pose to the system. It is normally linkedto the liquid resourcesavailable for the clearing agent. In order to be effective, transactionsthat exceed a participants net debit cap shouldbe rejected. Bilateralcreditlimits: Sometimesclearing agents require each participantto establisha bilateralcredit limitwith each of the other participants Collateral: Clearing organizations require collateral to cover certain exposures. The type of collateral acceptedranges from liquid assets such as cash or governmentsecurities to the securities cleared by the arrangement. The concentration of collateral,the legal perfection of the security interests and adequatevaluation are issuesthat have to be carefully considered in order to determinethe effectivenessof the collateral. Bankruptcy laws may affect the clearing organizations and its participants collateral interests due to different priorities among creditors and the so called "zero hour" rule or simplydifferentinstitutionsmay have differentbankruptcyprocedures. In the futures/commodity markets margins act sometimes as collateral. Margin is a good faith deposit (of money, securities or other financial instruments)assuringthat a future contractwill be fulfilled.8 228 In the equity markets, margin has another meaning. It is the money deposited with the broker that serves as partial payment when purchasing securities. The money deposited with the broker is the difference between the purchase value of the shares and the collateral value (haircut). 16
  • SECURITIES CLEARANCE AND SEMTLEMENTSYSTEMS Risk Risk Management ToolsCredit Risk Loss Sharing procedures (backed-up by collateral): Loss sharing proceduresensure that settlementoccursin the event that a participantfails. It could be a systemthat incentivesparticipantsto monitor and limit their credit exposures with other participants. Loss-sharing arrangements are usually supportedby pledge collateral. Same-day settlement/Liquidity facilities: Same-day settlement eliminates overnight exposures to failures and accelerates the availability of funds. Liquidity facilitiesprovide same-day funds by means of clearing funds, repos on governmentsecurities,letters of credit payable on demand, lines of credit, arrangementswith participants to supply funds on demand, etc. Liquidity facilities should have short notice availability,be diversified and not include clauses or similar provisions that allow the lender to back out of providing timely liquidity. ReplacementCost Risk Mark to market: Clearing agents sometimesrequire all unsettled securities or fail positionsto be markedto market prices to reflect fluctuationin market pricesin order to keep obligationsas close to marketprices as possible.OperationalRisk Back-up facilities: If an operationaldisaster should occur to the primary computer system, back-up systems provide infrastructure to resume processingwithin a brief period of time (60 to 90 minutes) at a secondarysite. Automated Recovery: Duplication of databases for instantaneous availabilityin the event of a databasedevice failure. Fraud Risk Encryption/decryption:Encryption is the process of disguising a message (using mathematicalformulas called algorithms)in such a way as to hide its substance. Decryptionis the restorationof encrypted data to its originaltext. Encryption systems prevent electronic intruders from obtaining information that could be used to make unauthorizedtransfer of funds. AuthenticationProcedures: Authenticationis the process of verifyuing the identificationof the true sender of a message and also that the text of the message itselfhas not been altered. Accesscontrols: Such as uniqueuser identificationcodesand passwordsCross-BorderSettlementRisk PrincipalRisk Credit assessment and control: A careful analysis of potential trading counterparties and the establishment of limits on exposure to each counterparty constitutes a major defense against default risk in foreign exchangetrading. Netting (multilateral or bilateral): Netting is an agreed offsetting of obligations by trading partners. It reduces a large number of individual obligationsto a smaller number. It constitutesa way to reduce the magnitude of risk in foreignexchange. ExtendedExposures Operations Improvements: Operations procedures should allow to halt outgoingpaymentsor securitiesup to settlementday. Arrangementswith correspondentbanks: To withholdpayments. /7
  • CLEARANCE SETrLEMENTSYSTEMSSECURITIES ANDA METHODOLOGY TO ASSESSCOUNTRYSYSTEMSBASED ON INTERNATIONAL STANDARDSA number of international standards and best practiceshave been produced and are useful in assessingthe quality of a securities clearance and settlementsystem. Annex 2 contains references to the majorsources of standards. These were used as the starting point in developingthe assessment methodologythat is being used as an integral component of the WHI. The methodology is being used as a tool forundertaking structured assessments of securities clearance and settlement systems in countries visitedduring the Initiative and has provided a sound basis for identifying improvement opportunities. A 29summary of the methodology,expressedin matrix format, is includedin Annex 1 of this paper.A review of existing standards suggested that they had been designed to address specific problemsituations and in certain cases may not be immediately relevant to the conditions found in emergingmarkets. For this reason, the methodologyused during the WH does not focus on the application ofindividual standards. Rather, it takes a broader view based on an assessment of the way in which the29 The first version of the matrixwas preparedin the contextof the Initiativeby the securitiesteam that visited in December1999and included.De La Lastra,Inigo (Comision Chile Nacionaldel Mercadode Valores,CNMt Spain); Guad9millas, MarioeWorld Bank) and Hosttinen, tFinancial Supervision Eita Authority, FSA Finland). The document was modified by the securities team that visited Trinidad and Tobago in February2000 and included:Guadamillas, Mario eWorld Salas, Andrea (Comisi6n Bank); Nacionalde Valores,CNV Argentina)and Saverson,Ester (US SecuritiesExchangeCommission,US SEC). The matrix has benefutedfromcommentsof the rest of the international teams that visited the countries, local authorities, core teamof theprojectand IACmembers. the 18
  • SECURJTIES CLEARANCE AND SETTLEMENT SYSTEMSmain issues discussed earlier in this paper are addressed in the individual systems being assessed. Theassessmentmethodologyfocuses on seven significantissues: clearing and settlementprocess, settlementrisks, legal issues, regulatoryoversight issues, clearingand settlementinstitutionsand their participants,safeguardingissues and system capacity. They are discussed separately,for analytic purposes, althoughit is clearlyrecognizedthat strong inter-relationships exist between each issue. In addition,three specificsections are included to deal with the particularitiesof government securities clearance and settlement,cooperation with the payments systems" and internationallinkages. A primary objective is stated ineach case along with a note of the characteristicsthat are believedto best influencethe realization of theobjective.1. Clearing and Settlement Process Objective: To have prompt and reliable systemsfor processing trades, that are cost- effective and convenient to use.The clearance and settlement process includes capturing trade information,trade matching,confirmingand affirming institutionalinvestors trades, clearing,and settlement. Various intemationalorganizationshave attemptedto set standardsfor the prompt, efficientand effectivetrade processing,includingits cost-effectiveness(both, in terms of system operationand fees paid by participants),and ease and convenienceof use. Traditionally,many systemshave been designed with settlement occurring on T+5. One of themost widely recognizedconcepts is that the longerit takes to settle a securities tradethe greater is the riskthat settlementmay not take place. In this regard, the G30 recommendedthat trade settlement shouldoccur by T+3 or less. Clearlythe shortestpossibleelapsedtime between trade date and settlementdate isa desirable goal in system design. However, the practical impact of shortening this time must be 31assessed,especially if it has an impact on the number of trades that fail to settle. Same day settlementcould be considered as the final goal, although it is generallyrecognizedthat this may not be achievablein the shortlmediumterm, particularly for cross-bordertransactions. The magnitude of the changesrequired to achieve a particular standard must also be carefully considered. For example, whereas itmight be relatively easy to move from T+5 to T+3 by simply imposing more discipline on all systemparticipants;more fundamentalchanges (process re-engineering)in all aspects of the system are likely tobe necessaryto move to T+2 or T+1.The profile of market investors (retail vs. wholesale, amount of foreign investment) as well as theirintermediariesshould be taken into accountas this can influencethe practicality of the targeted clearingand settlementcycle. Appropriatetrade-offsbetween risk, cost, and conveniencemust be made, else thesystem will not satisfy user requirementsat an affordable and acceptable cost and thus might constrainmarket development.Another widely recognized concept is that trade matching should occur as soon after the trade aspossible. G30 recommended that trade comparison should be accomplished by T+l. In addition,G30 recommended that indirect market participants -- institutional investors and custodians -- should30 The content of the government securities and cooperation within the payments systems sections are based on the work that the payments team developed in the assessment of Trinidad & Tobago systems in the context of the WHI. The team was coordinated by Massimo Cirasino (WB) and included Paolo di Blasi (Payments System Consultant),Paola Giucca (Bank of Italy) and Derrelle Janey (FederalReserve Bank of New York).31 Currently, there is a debate about the adequacy of moving the settlement cycle to T+2. However, given the globalizationprocess infinancial markets, there is an increasing necessity to standardize this process at an internationallevel, even if this could imply that some countries should increase their settlement cycle. 19
  • SECURITIES CLEARANCE SETTLEMENVTSYSTEMS ANDbe members of a trade comparison system that achieves positive affirmation of trade details.Moreover, there should also be an integration system for trade matching, comparison and book-entrysettlement of securities and funds. An automated link between the Exchange/OTC and the CSD isgenerally considered to be desirable and is a prerequisite for broker/dealer straight through processingfrom execution to settlement. Likewise, when clearing and depository services are provided bydifferent entities, it is recommended that these two functions are closely tied together, otherwisefinality of settlement is difficult to achieve. Fortunately, the cost of implementing automated systemsis reducing, however, care should be taken to ensure that sufficient transaction volume exists and thatusers are willing to pay for the automated services based on tangible benefits in terms of efficiency orrisk reduction.Intra-day processing cycles are a good indicator of the processingefficiencyof a settlement system. Inessence, periodic settlement is better than a single end of day settlement mechanism. The greater thenumber of intra-dayclearing cycles, the greater the flexibility it gives to the user. In addition, multipleprocessingcycles facilitatethe effectivelinkingof settlementsystems,particularlyacross time-zones.Because of increased automation and globalization of securities markets, it is beneficial from aninterconnectivity perspective for domestic systems to use internationally recognized securitiesidentification numbering standards. With this in mind, the G30 recommended that all markets shouldadopt a numberingsystem that meets the InternationalSecuritiesIdentificationNumber (ISIN) standards.To facilitate comprehensivecoverage,especiallyfrom a market price perspective,it is also desirablethatregulatorsencouragethe developmentof a settlementprocedurefor off-markettrades. These proceduresshould be similar if not the same as for the regulatedmarket executedtrade.Finally, specific attention should be given to the need to achieve one of the acceptable forms of DvPthrough appropriatelinkageswith the nationalpayment systems.2. Settlement Risks Objective: To achievefinal and irrevocableDvP and achieve efficiencyand safety in the overall settlementprocess.The important issues of efficiency and flexibility have been touched on previously. The safety of thesystem is paramount from a participant and a regulatory perspective and should be given specificattention. The settlement process exposes market participantsand clearance and settlement systems todifferentrisks (see topic 4). The system shouldbe designedto minimizethese risks.The major settlementrisk is counterpartyrisk. DvP is one of the primary means by which a market canreduce the risk inherent in securitiestransactions. The DvP concept seeks to eliminateprincipal risk fromsecurities transactions by ensuring that sellers give up their securities if, and only if, they receive fullpayment and vice versa. There are three essential elements in a DvP transaction: (a) good andirrevocable delivery of securities,(b) final and irrevocablefunds, and (c) simultaneousexchange. TheCPSS of the BIS has identified three different models of DvP.2 Although these models vary in their 3approachto achievingDvP, all three modelsmeet the conceptof real DvP.An importantrelated concept is settlementassurance. This can be definedas the arrangementby which asystem seeks to remove counterparty risk (principal, replacement cost, and liquidity risk) from its32 Vid. DeliveryversusPayment Securities in Settlement Systems, 1992, CPSS, BIS. 20
  • SECURITIES CLEARANCE AND SE7TLEMENT SYSTEMS 33participants. Settlementassurancecan be achieved in differentways includingnovation, legislationorgovernment rules and rules and regulations issued by CSDs and exchanges. It is important that thesystem provides informationthat facilitatesthe monitoring and management of exposures at all times.Well designed informationsystemsare essentialingredientsand must be embeddedin even the simplestof systems.There are a variety of risk management procedures to reduce market risk and strengthen a DvPmechanism (see table 3). Those procedures include admission standards, members creditworthinessmonitoring, novation, participation funds, collateral, margins, buy-ins and sell-outs, net debit caps,bilateral credit limits and loss sharing arrangements. Most settlement systems use more than oneprocedureto minimize market risk. In addition,there are a number of mechanismsdesignedto improvethe settlementprocess. Amongthem are: centrallendingfacilities;pledge recording facilitiesand promptre-registration procedures. Properly regulated securities lending and borrowing can bring significantbenefits to a market and its users leading to more liquid markets. Short selling could be a usefulmechanism to add liquidity. However, when short selling is permitted, regulation must guard againstmanipulativepractices,includingthose associatedwith a significantshort position.Systems that are consideringimplementingRTGS or netting should carefully study market volume andparticipation to determine if these mechanismsare appropriate (see topic 3). Historically,netting wasintroducedas an efficient measure to reduce the amount of physical documents passing between marketmembers. Later, with the introductionof early computer systems, it was used to reduce the number ofelectronic settlements. Today, with high speed and powerfulcomputersand the introductionof RTGSsystems, the efficiency advantages are less important. Thus, the debate is focused on the trade-offbetween liquidityrequirementsand risk mitigationas discussedpreviously in this paper.Settling in same day funds 4 is essential when operating in an RTGS environment and is useful in 3achieving real intra-day DvP. In order to achieve timely and risk-free settlement in same day funds,efficient banking arrangementswill need to be developedthat will enablefunds to be moved quickly andrelatively inexpensively. As payments systemsare normallyunder the jurisdiction of the national centralbank, cooperation in the area of payments system and securities system integration by regulatoryauthorities is very important to ensure that the banking system can support the securities clearance andsettlement system. An important issue that inevitably arises relates to payment system access, andespeciallythe way in which a CSD has access (direct or indirect)to the payments system. This is not asimple issue to resolve. Central banks typically are not in favor of allowing a non-bank to have directaccess to a large value transfer system and the associated central bank provided liquidity arrangements.Some form of compromisecan howeverbe reached providingthat decisionsare taken that are in the bestinterest of the whole financial sector. For example, a CSD might be allowed to have a settlementaccountat the centralbank but not have accessto centralbank credit.Finality of both payments and securities ownershiptransfer is a crucial factor in the developmentof asecurities market. Otherwise,only local investorswill operate in the market based on well establishedclient relationshipsand the confidencethat this provides. In emerging markets, this factor is of criticalimportance if there is a desire to attract foreign investment. Foreign investors will be reluctant to3 Thereare two typesof arrangements are typicallyreferredto as settlement that assuranceschemes. One is usedto guaranteethepaymentof netpaymentsobligations arisingout of a settlement system. The other is used to guaranteethe settlementof transactions that have not yet reachedtheir settlementdate (future settlements).34 Payment is made in "same day" funds when payment of such funds is made on an irrevocable basis to the counterparty on the day of settlement such that they are availablefor use on the day of settlement. 21
  • SECURITIES CLEARANCE SETTLEMENT AND SYSTEMSparticipate in a market that is not considered to be safe and sound. Securities finality is difficult toachieve, even with securities immobilizationand dematerialization. For example, bearer or registeredsecurities could be forged and the problem not identified until the bearer security is redeemed or theregistered security lodged with the registry. Payments finality is equally important. The separation ofoversight functionsbetween the securitiesmarket regulatorand the payments system regulatorshould notpresent insurmountableproblems. An acceptable solution can always be achieved through discussionand resolutionof conflictseven if this implies compromise.3. Legal issues Objective: To establish sound legal basis that is also able to accommodate technological advances in the operationof the system.A variety of laws and legal concepts can effect the performance of clearing and settlement systems.Contract laws, company laws, bankruptcy and insolvency laws, custody laws and property laws mayimpede the performance of a clearing system. Some of the legal aspects have been mentioned in relationto other main issues. The general need is to have an adequate legal basis that is able to accommodatetechnological advances and, in this way, does not constitute a constraint for the operation or futuredevelopmentof the system. Also, the lack of legal recognitionof certain concepts such as nominee35or 36fungibility may limit a systems ability to protect itself from certain settlement risks. If a system isusing a netting scheme to clear and settletransactions,a sound legal basis for netting including the legalrecognitionof novation shouldbe in place.Another important emerging issue is the legal status of digital signatures. If digital signatures are tosubstitutefor handwritten signatures,they must have the same legal status as handwrittensignatures, i.e.,they must be legally binding. Finally, procedures for creating and enforcing a pledge of interests insecurities should be simplified in order to encourage the collateralizationof credit exposure in animmobilizedor dematerializedsystem.As mentioned earlier in this paper, a critical need is to ensure that laws are both enforced and areenforceable in all relevant jurisdictions. In addition, disputes should become the subject of courtproceedings only as a last resort. This can be achieved through the specification and acceptance ofcomprehensiveand fair arbitrationprocessesthat are clear and non-ambiguous.4. Regulatory Oversight Issues Objective: The systemfor clearanceand settlement of securities transactionsshould be subject to regulatory oversight,and designed to ensure that it is fair, effective and efficient and that it reduces systemic riskRegarding regulatory oversight by the authorities, a specific allocation of responsibility for securitiesclearance and settlementsupervisionwould be ideal. However, in most cases, this function is performedtogether with the general supervisionof the participantentitieswithout any special attentionbeing given35 A nominee is a person or entity named by another to act on his behalf. A nominee is commonly used in a securities transaction to obtain registration and legal ownership of a security. Legal ownership is the recognition in the law as the owner of a security while beneficial ownership/interest is the entitlement to receive some or all of the benefits of a security (e.g., income, voting rights,power to transfer).36 Fungibility is the method of holding securities by a CSD in which the owner of a security has the right to a certain amount of this security in a fungible pool and not to any particular physical or dematerialized security. 22
  • SECURITIES CLEARANCE AND SETTLEMENT SYSTEMSto clearance and settlement issues. There is a trend towards regulatory oversight policy beingimplemented at two levels that is substituting for traditionaldirect supervisory activity. The regulatorconducts the oversightof the Self-Regulatory Organizations(SROs) (CSDs, exchanges)activities, while 37these institutionsperform the same functionwith regardto its participants.A securities regulator should have the authority to license central clearinghouses and CSDs (SystemOperators)as SROs and review and approve their rules. As an SRO, a system operator should have theauthorityto make and enforce rules on its participants. The securitiesregulatorshould have the power toissue the guidelines that system operators should follow. In addition, the securities regulator shouldassure that the rules and proceduresissued by SROspermita sound and effective operation of the systemand provide fair access to all market participants. The securitiesregulatorshould also have the authorityto conductperiodic inspections,requirethe production of periodicreports and enforce the securities lawsand regulations.However, if the regulatory authorityis a serviceprovider,the potential conflict between this operationalactivity and its oversight role should be considered. This conflict is more important in paymentsclearance and settlement systems where the central bank operates systems that might be viewed ascompeting with the private sector. In the securities context, government securities clearance andsettlement services are sometimes operated by central banks but normally without competing with theprivate sector. 8 35. Clearing and settlement institutions and their participants Objective:To take advantageof economiesof scale.It is widely accepted that a securitiesmarket should be supported by the CSD with the broadest possibleindustry participation. Admissionshould be open to all qualifiedmarket participants needing access tothe CSD. 9 Membership standards for system operators should be established in order to minimize risk. Certainminimum standards of financial responsibility, operational capacity (including system security andintegrity),experience and competence should be prescribedfor participation in the systems. Mandatorycapital requirementsfor participants are the first safety net to mitigate against a participant failure and,thus, an important risk management tool. However, these requirements are frequently established forreasons other than clearance and settlementand a system operator should have the authority to imposehigher financial standards on its members/participantsif the general requirements do not coveradequatelythe perceivedrisks.The rules for clearing and depository organizationsshould avoid unfair discriminationin regard to theadmission of participantsor among participantsin the use of the system. The rules should provide fairproceduresfor review of decisions concerningdenials of access. In addition,the system should provideparticipants with a meaningful opportunity to participate in the administration of the organizationsaffairs.37 For a complete analysis of regulatory oversight in payments systems vid Banca dItalia, November 1999, White Paper on Payment System Oversight.38 For a detailed analysis of oversight issues vid. Banca dItalia, November 1999, White Paper on Payment System Oversight: Objectives, Methods, Areas of Interest.39 The cost is an important element to consider in order to avoid an unfair situationfor the minority investor. In any case, transactions cost per unit should be clearly identified. 23
  • SECURITIES CLEARANCE AND SETTLEMENT SYSTEMS6. Safeguard Policies Objective: To safeguardsecurities,funds and all associatedrecords.Securities clearance and settlement operators must have a demonstrable capability to safeguardsecurities and funds in their custody or control or for which it is responsible, and for protectingagainst reasonably anticipated internal or external threats to the integrity of its operations. In manymarkets, settlement is carried out and controlled through automatic data processing systems. In thesecases, the system should have appropriate procedures to back-up data and a contingency plan tominimize disruptions.Electronic technologies now in place or under development, such as the use of internet for initiatingfinancial transactions increaseconsumer choicebut at the same time provide additionalmeans for abuseand illegal activity. Safeguards should anticipate, and be designed to provide protection against thepossibilityof theft, accidentalor maliciousdestructionor loss of securities or funds and the possibilityofaccidental or intentional,but unauthorized,modification,disclosureor destructionof data.In connection with these objectives, the organizationshould have an adequately staffed internal auditdepartmentwhich has the authorityto review,monitor,and evaluatethe organizations system of internalcontrols and the integrityof the operationalprocedures.In summary,particular attentionis required to reduce fraud. Some of the issues to be addressed are: (a)the operational security of systems including identification systems, message authentication andprotection measures in safeguardingaccess to the system; (b) to ensure protection against insider fraud;(c) to have a regular independentaudit of the systems to ensure continued system integrity;and (d) thedeterminationof liabilityfor loss or technicalfailure.7. System capacity Objective: To provide the system with an adequateoperationalcapacity.The central clearance and settlementsystem should maintain an adequate capacity to process current andanticipatedfuture transactionvolume,includingprojectedpeak day and peak hour volume demands . Toachieve this, the operator must: (a) establish formal current and future capacity estimates for theirautomatedtrade comparison systems;(b) conductperiodiccapacity stress tests to determnine behavior theof systems under a variety of simulatedconditions;and (c) conduct independentannual reviews to asseswhether these systems can performadequatelyat their current and estimatedfuture capacity levels.Operational capacity must also be demonstrated to exist at the mandatory disaster-recovery site.Operators must also have in place a well designed and adequately tested mechanism for transferringsystem control to the back-up site in an acceptable time-frame without loss of data or unacceptablereduction in service levels. GOVERNMENTSECURITIESCLEARANCEAND SETTLEMENTGovernmentsecurities marketsare of significantimportancein a countrys financial sector. Governmentsecurities are used extensively to carry out monetary policy through open market operations.Furthermore, in many countries governmentsecurities pricing providesbenchmarks for wider financialmarkets. Frequently,an importantobjective of macro-financialpolicy is the developmentof a deep andefficient secondary market for governmentsecurities. In conjunctionwith appropriate primary marketarrangements,such a market is able also to reduce the cost of financing for the government. Sound andefficient proceduresfor the tradingof governmentsecuritiesare an essentialelement for the development 24
  • SECURITIES CLEARANCE SETTLEMENT AND SYSTEMSof this market. In many countries,a successfulimplementationof well designedclearance and settlementmechanisms has represented a key milestone in the development of the overall market. Due to thepeculiar characteristicsof the governmentsecuritiesmarket, in many countriescentral banks are involvedor manage directly the clearance and settlement mechanisms as well as the book entry systems thatrecord securities ownership. As mentioned previously, central banks frequently own and operate anations large value funds transfer system. Ownership of the book entry system as well as the fundstransfer system facilitatesimplementationof intradayDvP arrangements.The relativepolicy and operationalrole of the centralbank, andthe operationalrole of stock exchangesinregard to the government securities markets must be taken into account during any assessment of theoverall securities market arrangements. This is of particular importanceto fnancial system stability astrades in govermnentsecuritiestend to be of higher value as comparedwith equitiestrades. COOPERATION IN THE PAYMENTS SYSTEMEffective cooperation among market participants and regulators is essential for the developmentof asound and efficient set of national payment system mechanisms. The specific needs of the securitiesmarkets should be satisfied along with the needs of all other users.A number of specific problems should be anticipated and resolved during the preparation of a nationalpayments system vision designed to satisfy the needs of all users and not only the needs of the banks.Active involvementof all users in the decision making process will remove the potential for problemsand will result in an agreed strategy,organizationalarrangements,and operationalprocedures. Territorialdifferencesbetween regulators should not get in the way of sound decision making and willingness tocooperateas this can lead to "sub-optimal"solutionsthat impactthe systems reliabilityand efficiency. CROSS-BORDER SECURITIES CLEARANCE AND SETTLEMENTA truly global securities market requires the establishment of efficient and automated internationalsecurities clearance and settlement systems to facilitate cross-border settlement. Furthermore, theinability to settle cross-bordertransactions could also have a domesticeffect, and problems in domesticsystems could have an impacton linked markets. The growing importanceof cross-bordersettlementhassignificant implicationsfor systemicrisk. Most local domesticsystems have been designedto meet localmarket needs. For this reason, an assessment of a country system should include an analysis of how 40cross-bordertransactionsare settledif this type of trading is significant.In a cross-bordertrade, counterpartiesare located in differentcountries. A cross-bordersettlementtakesplace when the securities are settled in one country in a way that is different from the country in whichone or both of the counterpartiesare located. Risks faced by cross-border participants present someparticularitiescomparedto domesticsettlementsand dependon the way that the transactionis processed.There are severalways to effect a cross-bordertransaction: Through direct access to (membership in) the CSD in the country of issue, although CSDs normally prohibit foreign residents from becoming participants. Furthermore, even if direct40 For a detailedanalysisof issuesand specificrisks associated with cross-border securitiessettlement vid BIS, March 1995, Cross-BorderSecurities Settlements. 25
  • SECURITIES CLEARANCE SETTLEMENT AND SYSTEMS access were allowed, it is unlikely that foreign residents would opt for this solution as the establishment of local banking arrangements would also be necessary. * Through a local agent, perhaps still the most common method, that holds securities and settles trades for non-residents through an account it maintains for its customers at the local CSD. a Many institutional investors use global custodians rather than local agents to settle their cross-border trades. A global custodian settles the non residents trades in the local market through a local agent acting as its sub-custodian. * The International Central Securities Depository (ICSD) settles the majority of their participants trades on their own books under their own rules and operating procedures. ICSD also supports trades and financial transactions with other ICSDs and counterparties that settle their trades in the local markets. * CSD-to-CSD links permit the interconnection of securities clearance and settlement systems in different countries without compromising the essential soundness and integrity of each national system. Different varieties of settlement and custody services for the linked entities exist. The FIBV 1 identified three types of models: 4 a) Cross-border links between two CSDs for delivery and receipt of securities without payment facilities. b) Cross-border links as above with payment facilities. c) Cross-border settlement links between two clearing organizations providing for trade accounting, securities settlement, custody and settlement facilities with each clearing organization linked to its national CSD.Some of the specific problemsthat could arise in cross-bordersettlementare listed below: * The involvement of multiplejurisdictions raise the issue of choice of law and conflict of laws that complicates the analysis of the legal environment and could introduce new sources of risk. This is especially important when collateralized intraday loans are provided as the choice of law and conflicts of law can introduce ambiguities about the effectiveness of the liens involved. * There is a potential for foreign exchange settlement risk. * A non-resident may need to maintain larger balances of cash and securities than a direct participant would in order to settle the same type of transactions. * The use of local agents, global custodians or ICSDs may exacerbate custody risk due to further tiering of securities holdings.4 Vid FIBV June 1989,Improving International Settlement 26
  • SECURITIES CLEARANCE SETTLEMENT AND SYSTEMS * The settlement of back-to-back trades 2 by dealers that are not direct participants in the local 4 CSDs creates difficulties in some settlement systems, and dealers are often forced to borrow securities or pre-position securities to meet delivery obligations. * Direct and indirect links among CSDs and ICSDs could involve significant operational inefficiencies in the exchange of informationbetween systems. * Differences between the operating hours of the ICSDs and the operating hours and settlement practices (especially finality rules) of national payments systems and local CSDs require the ICSDs to make credit extensions to their participants that are of unusually large size and long duration. * Authorities in a home country may not become promptly aware of a disturbance to a cross- border settlement arrangement. Furthermore, once a problem becomes apparent, a high degree of coordination among several authorities in the home country and in other jurisdictions is required. The important role of international intermediaries in a cross-border settlement also complicates oversight of the domestic system.The above factors should be taken into account when designing arrangements for cross-bordersettlement. In the case of direct and indirect links, linked entities should share a set of minimumstandards in order to improve efficiencyand reduce settlementrisks. 3 In particular,they must carefully 4consider how differencesin the rules and proceduresof the linked systemsaffect settlementrisks. CONCLUDINGREMARKSThis paper has been written to evoke discussionand, therefore, should be viewed as a work-in-progressdesignedto provide input into the on-goingwork that is focusingon the developmentof core principlesand minimumstandards relating to integratedpayments and securities clearance and settlementsystems.It is an attempt to fill a current gap in the set of evaluationtools that are available to assessors of suchsystems, especially those that are required to assess evolving systems in developing and transitionaleconomies. In particular,the authors will welcomecommentsrelating to ways in which the AssessmentMatrix illustratedin Annex I mightbe improved.42 A back-to-backtrade is a pair of transactions requiresa counterparty receiveand redeliverthe that to samesecuritieson the same day.4 For a detailanalysisof theseminimumstandards IOSCO,July 1990,Clearing Settlement, vid. and Report of the Technical Committee. 27
  • SECURITIES CLEARANCE AND SETTLEMENT SYSTEMS REFERENCESBanca dItalia,November1999, WhitePaper on PaymentSystem Oversight:Objectives, Methods,Areas ofInterest.BIS (CPSS) - 1990,Minimum standards cross-border for netting and settlement schemes and multi-currency (Lamfalussy minimum standards). - September 1992,Delivery versuspaymentin securities settlement systems. - March1995,Cross-Border Securities Settlements. - March1997,Clearing Arrangements Exchange-Traded for Derivatives. - March1997,Real-time grosssettlement systems. - September 1998,OTCDerivatives: Settlement Procedures Counterparty Management. and Risk - July 1999,Securities LendingTransactions: MarketDevelopment Implications. and - December 1999,CorePrinciples Systemically for Important Payment Systems.COSRA, 1996,COSRAprinciplesof clearance settlement. andEuropean System of Central Banks (ESCB), 1998, Standardsfor the use of EU securities settlement systemsin ESCBcreditoperations.Group of Thirty (G30) - March1989,Clearance Settlement and Systemsin the WorldsSecurities Markets. - 1989,Groupof thirtyrecommendations regarding securitiesclearance settlement and (G30).Humphrey, D.B., February 1995, Payments Systems: Principles, Practice, and Improvements, World BankTechnical Paper # 260.International Federation of Stock Exchanges (FIBV) - June 1989,Improving International Settlement. - September 1999,ClearingandSettlement Practices. BestInternational Organization of Securities Commissions (IOSCO) - July 1990,Clearing Settlement, and Reportof the Technical Committee. - October 1992, Clearing and Settlement in Emerging Markets: A Blueprint, Report of the Development Committee (now calledthe Emerging Markets Committee). 28
  • SECURITIES CLEARANCE AND SE7TLEMENT SYSTEMS - May 1997, Short Selling and Securities Lending: Issues for Consideration,A report by the Emerging Markets Committee. - November 1997, Towards a Legal Framework for Clearing and Settlement in Emerging Markets, Report of the Emerging Markets Committee. - September 1998, Objectives and Principles of SecuritiesRegulation, Report of IOSCO.International Services Securities Association(ISSA) - April 1992a, Report on Cross-BorderTrade Comparison,Zurich. - April 1992b, Report on Cross-BorderSettlement and Custody, Zurich. - April 1992 c, Report on Cross-BorderProxy Voting and Corporate Actions, Zurich. - April 1992 d, Report on Global Custody, Zurich. - November 1997, G30/ISSA Recommendations: 1997 Status Review.Keppler, R.H., 1999, Transforming Payment Systems: The Building Blocks and the World Banks Role, WorldBank/Federal Reserve of New York (FRBNY) Seminarheld at FRBNY April 13-16, 1999.Listfield, R. and Montes-Negret, F., Modernizing Payment Systems in Emerging Economies, August 1994,Policy Research Working Paper #1936, The World Bank, Financial Sector DevelopmentDepartment.Montes-Negret, F. and Keppler, R., Project Design for Payment Systems, March 1995, Public Project for thePrivate Sector, FPD Note No. 37, The World Bank.Organization for Economic Cooperation and Development (OECD), Systemic Risks in Securities Markets,OECD Publication Service, Paris, 1991.Padoa-Schiopa, T., 1992, La Moneta e il Sistema de Pagamenti.Parkinson, P.; Stehm, J.; et al., Clearance and Settlement in U.S. Securities Markets, March 1992, Staff Study 1163, Board of Governors of the Federal Reserve System.Payne, M., May 1999, Risks in Payments Systems, presented in the Thomas Murray Global CustodyConference on Minimizing Risk in Clearing, Payment and Settlement Systems held at New York May 24-251999.Stehm, J., April 1996, Clearance and Settlement Systems for Securities: Critical Design Choices in EmergingMarket Economies, World Bank Discussion Papers, #321.US General Accounting Office, June 1997, Payments, Clearance and Settlement: A Guide to the Systems,Risks, and Issues. Report to the Chairman Committee on Banking and Financial Services House ofRepresentatives.Whitehill, R., May 1999, Evaluating Local Market Custody Arrangements, presented in the Thomas MurrayGlobal Custody Conference on Minimizing Risk in Clearing, Payment and Settlement Systems held at NewYork May 24-25 1999. 29
  • AND ISETLFMFNTSYSFTMSSECu!TJECSCLEARANCE ANNEX I. SECURITIES CLEARANCEANDSETTLEMENT MATRIX Relevantfactors Components Standards Statusin the Country Recomnmendallons1 - Clearing and Settlement 1.1 Settlement cycle - A market should achieve settlement by three days after trade date. (T+3), (G30-7) processes: 1.2 Tradematching - Tradematchingshouldoccuras soon afterthe tradeas possible. All comparisons trades of Objective:to haveprompt betweenmarketparticipants shouldbe done by T+l. (G30-1,IOSCO13.10) and reliablesystemsin - If possible,automatedlinksshouldbe establishedbetween trading systemand the the processing trades, a cost- settlement system. (IOSCO13.10) effectiveand a convenient systemfor its participants 1.3 Traceconfirmation/ - Institutionalinvestorsand custodians shouldbe members a trade comparison of systemthat affirmation achieves positiveaffirmation trade details. (G30-2,FIBV2) of 1.4 Systemintegration - Thereshouldbe an integrated centralsystemfor tradematching,bookentrysettlementof securitiesandbook entrysettlement payments.(FIBV8. of 15) 1.5 Commonmessage - All traded securitiesissuesshouldhavehad a security identificationnumberthat meetsthe standard Intemational SecuritiesIndustry Numbering (ISIN)standards. (G30-9)2 - Settlement Risk 2.1 Final and irrevocable - DvPshouldbe employedas the methodfor settlingall securities transactions.(G30-5) Objective:Achievefinal and deliveryversus irrevocable and improve DP payment(DvP) the overallefficiency the of 2.2 Sameday funds - Payments associated with securitiestransactionsshouldbe madein same-dayfunds. (G30- settlementprocess 6) - The systemshouldprovidepromptfinal settlement the day of value, preferably on during the day and at a minimum the end of the day. (CPIV) at 2.3 Nettingand real time - NettingandRTGSare effectivesettlement mechanisms.Theregulatorand market grosssettlement participantsshouldstudy marketvolumesandparticipation determine to whichmechanism (RTGS) settlement as is appropriate their marketplaceand havea clearunderstanding the financialrisks for of methodsto reduce affected the nettingprocess. (IOSCO by 13.11.2, CPII) Lll, risk - Multilateralnettingschemesshouldhaveclearlydefinedprocedures,ensuresettlement in the caseof inabilityto settleby the participantwiththe largestsinglenet-debitpositionand havepubliclydisclosedcriteriafor admissionwhichpermitfair and open access. (Llll, LIV, LV,CPIII, CPV,CPLX) 2.4 Assetsegregation - Thepool of securities interestsheld in a depository or shouldbe protectedagainstthe claimsof the depositorysandbrokers generalcreditors.(IOSC02) 2.5 Settlement assurance - Marginrequirements be used in combination may with othermechanisms managerisk to to procedures marketparticipants, clearinghouses exchanges.(IOSCO13.1 EU6) and 1, 2.6 Liquidityrisk - Centralclearingorganizations CSDs(SystemOperators)shouldmaintainadequate and sourcesof liquidityto meet theirfinancialobligations a timelybasis. Relianceon one on source maypose significant risksin the eventof a financialcrisis,andconsiderationshould be givento diversifying liquiditysourcesto reducesuchrisks. Thelevel of necessary liquiditysourcesshouldbe basedon an assessment the risks to whichthe organization of is subject and should be subject to regulatory review. (TCI.2, G30-8, IOSCO 13.11.3) 30
  • CLFARANCESECURITIES SYSTEMS ANDSETTLFMFNT Relevantfactors Components Standards Status in the Recommendations Country 2.7 Shortselling - Short sellingis regardedas a usefulmechanism somejurisdictionsas an aid to liquidity. in Whereshortsettingis permitted,regulationmust guard againstmanipulative practices, includingthoseassociated witha significant shortposition. In somejurisdictionsthis involvesa combination shortsales and securities of lendingandrestrictingshortsales to liquid stocks.Disclosureof shortsales andsecuritieslendingpositions(or,at least,their reportingto the regulator)is a toolfor thefurtherreductionof risk. (IOSCO13.11.3) borrowing 2.8 Securities - Securitieslendingandborrowingshouldbe encouraged a methodof expediting as the settlement securities of transactions.Thereis a legitimate importantrole for securities and lendingin thosemarketsthat permitshort selling. (TC2.3.8)3 - Legalissues 3.1 Netting(legalbasis) - Thereshouldbe soundlegal basisfor nettingincludingthe legalrecognitionof novation. Objective: Sound legal basis (LI, CPI, EUI, FIBV5) that is also ableto 3.2 Cleardefinition of - Thereshouldbe a clearlegal definitionof securitiespropertyrights. (EUla, IOSCOI,CPI) accommodate technological propertyrights advances the operation in of 3.3 Bankruptcy and held in a depository - The poolof securities interests of shouldbe protectedagainstthe the system insolvency laws claimsofthe depositorysandbrokers generalcreditors. (IOSCO2,CPI) documents 3.4 Electronic - The law shouldrecognize electronicdocuments signaturesto facilitatesecurities and andsignatures tradingclearing settlement.(CPI) and 3.5 Conflicts laws of - Thereshouldbe clear mechanisms resolvelegal uncertainties conflicts. (IOSCO4, to and CPI) 3.6 Pledging - Procedures creating enforcinga pledgeof interestsin securitiesshouldbe simplified for and in orderto encourage collateralization credit exposurein an immobilizedor the of dematerialized system. (IOSC05)4 - Regulatory oversightissues 4.1 Regulation central of - The systemfor clearance settlement securitiestransactions and of shouldbe subjectto Objective:Thesystemfor and clearinghouses regulatoryoversightand designed ensurethat it is fair, effectiveand efficientand that it to clearance settlementof and CSDsas SROs reducessystemicrisk. (IOSCO13.9) securitiestransactions should - The securitiesregulatorshouldhave the authorityto licenseSystemOperatorsas SROsand be subjectto regulatory reviewand approvaltheir rules. (COSRA4) oversight,anddesignedto - The participantsshouldbe subjectto supervision a governmental by authorityor self- ensurethat it is fair,effective regulatoryauthoritysubjectto governmental oversight. (COSRAI) and efficient that it and - As a SRO,a centralclearinghouse CSDshouldhavesufficientorganizational or structure reducessystemicrisk andcapacity enforceits rulesand the securitieslawsand regulations. (TCI.3) to 4.2 Theauthorityto issue - The securitiesregulatorshouldhavethe power to issuedirections(ordersand regulations) directions(ordersand regardingthe clearance settlement securities and of transactions clearingandsettlement and directives) participants.(IOSCO13.9) 4.3 The authorityto - The securitiesregulatoryauthorityshouldhavethe authorityto conductperiodicinspections inspectregulated and requirereportsand enforcesecuritieslaws and regulations.(COSRA3,IOSCO13.9) entitiesand enforce securitieslaws and regulations 31
  • SFCURITIFSCIFARANCEAND SETTLEMENTSYSTEMS Relevantfactors Components Standards Status in the Recomnendations Country 4.4 Govemance of - A System Operator should provide its participants with a meaningful opportunity to clearinghouse and participate in the administration of its affairs. Participants should a fair voice in the manner CSDs in which decisions are made. Participants should be kept adequately informed of proposed rule changes and should be furnished with annual audited financial statements, an audited annual report on internal controls and other relevant reports on a regular basis. (TC 1.5, CPX) 4.5 Adequacy of - The securities regulator should have sufficient staff capability with appropriate knowledge Resources to perform and skills to perform its oversight responsibilities. (IOSCO 13.8-13.9) oversight responsibilities ___5. Clearing and Settlement 5.1 Central Securities - A CSD should be in place, and the broadest possible industry participation should beInstitutions and their Depository (CSD) encouraged. A CSDs principal function is to immobilize or dematerialize securities,participants thereby assuring that the bulk of securities transactions are processed in book-entry form. Objective: Take advantage The depository system provides the basis for achieving efficient and low risk transaction of economies of scale of settlements. The most important feature of the book-entry method is that a transfer of a settlement procedures given quantity of an issuer from one account to another can be affected by a simple debit or credit on the books of the CSD. Other important features include trade clearance, safe custody, and settlement/post settlement processing of securities and information, such as corporate actions and dividend/interest processing. (G30-3) 5.2 Membership Standards - There should be an appropriate balance between the need for system security and broad participation in the clearing and settlement system. (COSRAI, LV, CPIX, EU5)6. Safeguarding Issues 6.1 Integrity of records - A System Operator should be capable of protecting against reasonably anticipated internal Objective: Safeguarding of or external threats to the integrity of its operations. (COSRA5) securities and funds under its - A System Operator should have appropriate procedures to back-up data. (TC 1.1) control and associated - A System Operator should develop contingency plan to minimize disruptions. (TC 1.I ) 6.2 Safeguarding of - A System Operator should have sufficient safeguards to ensure the safety of funds and securities and funds securities under its control. (COSRA2, EU3)7. System Capacity 7.1 Operative capacity - A System Operator should maintain adequate capacity to process reasonably anticipated Objective: Provide the volume, including projected peak volume demands. A Systems Operator should establish system with an adequate formal current and future capacity estimates, conduct periodic capacity stress tests, and operational capacity conduct independent annual reviews to assess whether these systems can perform adequately. (COSRA5) - A System Operator should have back up systems and contingency plans on how it will operate in the event of computer failure or if the computers are unavailable because of a disaster. A System Operator should periodically test these back up systems and plans. (TC 1.1, CPVII) 32
  • SECURITIES CLEARANCE AND SE7TTEAMENTSYSTEMS ANNEXII: LIST OF STANDARDS ANDBEST PRACTICESThis list is not intended to be a comprehensive listing of all the existing standards and bestpractices related to securities clearance and settlement systems. The references are presentedbelow by institution in alphabetical order, indicating the web site where the document isdirectly available or there is information on how to access it. The list also includes somedocuments that were used to design the structure of the matrix even if there is not a directreference to them in the matrix.Bank of International Settlements,BIS (www.bis.org)* Minimum standardsfor cross-borderand multi-currencynetting and settlement schemes (Lamfalussyminimum standards)-1990 Reference in the matrix: L I-VI* Delivery versus payment in securities settlement systems, September 1992.* Real-timegross settlement systems, March 1997.* Core Principlesfor Systemically Important Payment Systems, December 1999. Reference in the matrix: CP I-XCouncil of Securities Regulators of the Americas, COSRA COSRAprinciples of clearance and settlement -1996 Reference in the matrix: COSRA 1-5European System of Central Banks (ESCB) (www.ecb.int) Standardsfor the use of EU securities settlement systems in ESCB credit operations -1998 Reference in the matrix: EU 1-6Group of Thirty, G30 (www.group3O.org) Group of thirty recommendationsregarding securities clearance and settlement (G30)-1989. Reference in the matrix: G30 1-9International Federation of Stock Exchanges,FIBV (www.fivb.com)* Clearing and Settlement Best Practices -September 1999 Reference in the matrix: FIBVInternational Services SecuritiesAssociation, ISSA (www.issanet.org)* G30/ISSA Recommendations: 1997Status Review, November 1997 33
  • SECURITIES CLEARANCE AND SETTLEMENTSYSTEMSInternational Organization of Securities Commissions,IOSCO (www.iosco.org)* Clearing and Settlement, Report of the Technical Committee, July, 1990. Reference in the Matrix: TC* Clearing and Settlement in Emerging Markets -A Blueprint, Report of the Development Committee (now called the Emerging Markets Committee), October 1992.* Short Selling and Securities Lending. Issuesfor Consideration,A report by the Emerging Markets Committee, May 1997* Towards a Legal Frameworkfor Clearingand Settlement in Emerging Markets, Report of the Emerging Markets Committee,November 1997. Reference in the Matrix: IOSCO1-5* Objectives and Principles of Securities Regulation, Report of IOSCO, September 1998. Reference in the Matrix:IOSC013.8-13.11Organization for Economic Cooperation and Development (OECD) (www.ocde.org)* Systemic Risks in Securities Markets, OECD Publication Service, Paris, 1991. 34
  • Policy Research Working Paper Series Contact Title Author Date for paperWPS2566 Convexity and Sheepskin Effects Norbert R. Schady March 2001 T. Gomez in the Human Capital Earnings 32127 Function: Recent Evidence for Filipino MenWPS2567 Policy Reform, Economic Growth, Susmita Dasgupta March 2001 Y. dSouza and the Digital Divide: An Somik Lall 31449 Econometric Analysis David WheelerWPS2568 Ownership Structure and the Robert Cull March 2001 Z. Kranzer Temptation to Loot: Evidence from Jana Matesova 38526 Privatized Firms in the Czech Mary Shirley RepublicWPS2569 From Users to Custodians: Changing Liz Alden Wily March 2001 M. Yue Relations between People and the Peter A. Dewees 34102 State in Forest Management in TanzaniaWPS2570 Asymmetries in Union Relative Wage Niels-Hugo Blunch March 2001 M. Clarke Effects in Ghanaian Manufacturing: Dorte Verner 31752 An Analysis Applying Quantile RegressionsWPS2571 Stock Market Responses to Bank Daniela Klingebiel March 2001 R. Vo Restructuring Policies during the Randy Kroszner 33722 East Asian Crisis Luc Laeven Pieter van OijenWPS2572 Nonfarm Income, Inequality, and Richard H. Adams, Jr. March 2001 N. Obias Poverty in Rural Egypt and Jordan 31986WPS2573 The Gender Implications of Public Martin Rama March 2001 H. Sladovich Sector Downsizing: The Reform 37698 Program of VietnamWPS2574 How Adverse Selection Affects the Paolo Belli March 2001 H. Sladovich Health Insurance Market 37698WPS2575 The Quality of Bureaucracy and Chong-En Bai March 2001 H. Sladovich Capital Account Policies Shang-Jin Wei 37698WPS2576 Trade Policy, Standards, and Gary Clyde Hufbauer March 2001 L. Tabada Development in Central America Barbara Kotschwar 36896 John S. Wilson
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