The assessment of Euroclear Belgium

Transcription

1 The Assessment of Euroclear Belgium against the CPSS-IOSCO Recommendations The assessment of Euroclear Belgium against the CPSS-IOSCO Recommendations In November 2001, the Committee on Payment and Settlement Systems (CPSS) of the G-10 central banks and the Technical Committee of the International Organisation of Securities Commissions (IOSCO) published a set of standards in the form of Recommendations for Securities Settlement Systems. (1) The objective of the nineteen CPSS IOSCO Recommendations is to contribute to financial stability by strengthening the securities settlement systems (SSS) that have become an increasingly important component of the global financial infrastructure. CPSS IOSCO has also developed an Assessment Methodology which aims to provide a clear and comprehensive framework for assessments made on the basis of the Recommendations. (2) This methodology gives assessors four possible assessment categories ( Observed, Broadly observed, Partly observed and Non-observed ) defining to what extent the system complies with each Recommendation. The Euroclear group encompasses four domestic Central Securities Depositories (CSD) and one International Central Securities Depository (ICSD). The CSDs of the group are Euroclear UK & Ireland, Euroclear France, Euroclear Nederland and Euroclear Belgium, and the ICSD is Euroclear Bank, a Belgian credit institution, which operates the securities settlement system known as the Euroclear System. These five entities are owned by Euroclear SA, which acts as service provider to the group (I)CSDs. (1) Recommendations for Securities Settlement Systems, CPSS-IOSCO, November 2001, (available on the website of the Bank for International Settlements : (2) Assessment Methodology for the Recommendations for SSSs ; CPSS-IOSCO, November 2002, (available on the website of the Bank for International Settlements : The NBB is responsible for the oversight of the securities settlement systems run by the Belgian members of the group, namely Euroclear Bank and Euroclear Belgium. In the framework of these responsibilities, the NBB updated in September 2007 its CPSS IOSCO assessment of Euroclear Belgium, the outcome of which is revealed below. Such disclosure is promoted by the CPSS IOSCO methodology and should make the NBB s regulatory role clearer for users of the systems. By disclosing this assessment, the NBB also intends to promote its accountability as overseer of payment and securities settlement systems. The CIK (Caisse Interprofessionnelle de Dépôts et de Virements de Titres / Interprofessionele Effectendepositoen Girokas), is a Belgian limited liability company. At the beginning of 2006, CIK became part of the Euroclear group and is now a wholly-owned subsidiary of the Euroclear holding company, the Belgium-based Euroclear SA/NV. The new commercial name of CIK is Euroclear Belgium. Euroclear Belgium is the Belgian central securities depository for mainly Belgian-issued equities. Securities held with Euroclear Belgium include Belgian and foreign shares, warrants, corporate bonds, rights and investment funds. Euroclear Belgium provides related securities safekeeping and corporate action services. It operates settlement systems for processing Euronext Brussels cash market transactions and over-the-counter (OTC) transactions. 93

2 Box 1 The CPSS-IOSCO Recommendations for SSSs I. Legal risk The legal framework applicable to an SSS s operation is highly important for its reliability and predictability. Legal risks may cause one party to a trade to suffer losses because laws or regulations do not support the rules of the securities settlement system or the property rights and other interests held through the settlement system. 1. Legal framework Securities settlement systems should have a well founded, clear and transparent legal basis in the relevant jurisdictions. II. Pre-settlement risk Pre-settlement risk refers to the risk that an outstanding transaction for completion at a future date will not settle because one of the counterparties fails to perform on the contract or agreement during the life cycle of the transaction before settlement. The resulting exposure is the cost of replacing the original transaction at current market prices. This risk can be mitigated by trade confirmation mechanisms, shorter settlement cycles, the use of a central counterparty or the possibility to lend securities. 2. Trade confirmation Confirmation of trades between direct market participants should occur as soon as possible after trade execution, but no later than trade date (T + 0). Where confirmation of trades by indirect market participants (such as institutional investors) is required, it should occur as soon as possible after trade execution, preferably on T + 0, but no later than T Settlement cycles Rolling settlement should be adopted in all securities markets. Final settlement should occur no later than T + 3. The benefits and costs of a settlement cycle shorter than T + 3 should be evaluated. 4. Central counterparties (CCPs) The benefits and costs of a CCP should be evaluated. Where such a mechanism is introduced, the CCP should rigorously control the risks it assumes. 5. Securities lending Securities lending and borrowing (or repurchase agreements and other economically equivalent transactions) should be encouraged as a method for expediting the settlement of securities transactions. Barriers that inhibit the practice of lending securities for this purpose should be removed. III. Settlement risk Settlement risk is a general term used to designate the risk that settlement in a SSS will not take place as expected, e.g. because a party will default on one or more settlement obligations to its counterparties or to a settlement agent. 4 94

3 The Assessment of Euroclear Belgium against the CPSS-IOSCO Recommendations 6. Central securities depositories (CSDs) Securities should be immobilised or dematerialised and transferred by book entry in CSDs to the greatest extent possible. 7. Delivery versus payment (DVP) CSDs should eliminate principal risk by linking securities transfers to funds transfers in a way that achieves delivery versus payment. 8. Timing of settlement finality Final settlement should occur no later than the end of the settlement day. Intraday or real-time finality should be provided where necessary to reduce risks. 9. CSD risk controls to address participants failures to settle CSDs that extend intraday credit to participants, including CSDs that operate net settlement systems, should institute risk controls that, at a minimum, ensure timely settlement in the event that the participant with the largest payment obligation is unable to settle. The most reliable set of controls is a combination of collateral requirements and limits. 10. Cash settlement assets Assets used to settle the ultimate payment obligations arising from securities transactions should carry little or no credit or liquidity risk. If central bank money is not used, steps must be taken to protect CSD members from potential losses and liquidity pressures arising from the failure of the cash settlement agent whose assets are used for that purpose. IV. Operational risk Operational risk is the risk of a human error, or of a breakdown or deficiency of the hardware, software or communications systems that are crucial to the settlement process. It covers both operational reliability and business continuity issues. 11. Operational reliability Sources of operational risk arising in the clearing and settlement process should be identified and minimised through the development of appropriate systems, controls and procedures. Systems should be reliable and secure, and have adequate, scalable capacity. Contingency plans and backup facilities should be established to allow for timely recovery of operations and completion of the settlement process. V. Custody risk Custody risk is the risk of loss of securities held in custody occasioned by the insolvency, negligence or fraudulent action of the custodian or of a subcustodian. 12. Protection of customers securities Entities holding securities in custody should employ accounting practices and safekeeping procedures that fully protect customers securities. It is essential that customers securities be protected against the claims of a custodian s creditors. 4 95

4 VI. Other issues 13. Governance Governance arrangements for CSDs and CCPs should be designed to fulfil public interest requirements and to promote the objectives of owners and users. 14. Access CSDs and CCPs should have objective and publicly disclosed criteria for participation that permit fair and open access. 15. Efficiency While maintaining safe and secure operations, securities settlement systems should be cost-effective in meeting the requirements of users. 16. Communication procedures and standards Securities settlement systems should use or accommodate the relevant international communication procedures and standards in order to facilitate efficient settlement of cross-border transactions. 17. Transparency CSDs and CCPs should provide market participants with sufficient information for them to identify and evaluate accurately the risks and costs associated with using the CSD or CCP services. 18. Regulation and oversight Securities settlement systems should be subject to transparent and effective regulation and oversight. Central banks and securities regulators should cooperate with each other and with other relevant authorities. 19. Risks in cross-border links CSDs that establish links to settle cross-border trades should design and operate such links to reduce effectively the risks associated with cross-border settlements. The results of this assessment of Euroclear Belgium are summarised in Table 2. This assessment takes into account a series of mitigating actions that were taken by Euroclear Belgium after the preliminary assessment made by the NBB. As a result, Euroclear Belgium is now fully compliant with fifteen recommendations, whereas three recommendations (7, 12 and 19) are broadly observed. One recommendation (3) is considered irrelevant for Euroclear Belgium since it deals with aspects of the settlement cycle for which Euroclear Belgium cannot be held accountable. The legal framework supports the enforceability of transactions and the protection of participants assets. It also provides an adequate legal basis for the holding of securities (immobilisation and dematerialisation), the transfer of securities by book entry, securities lending and delivery versus payment with finality. The system s rules and contracts are considered enforceable between participants, notwithstanding the insolvency of a participant. Recommendation 1 (legal framework) is observed. Legal risk The settlement activities of the Euroclear Belgium systems are governed by consistent, clear and solid laws, rules, procedures and contractual provisions that are public and accessible to system participants. Pre-settlement risk Euroclear Belgium s systems settle Euronext Brussels stock exchange transactions and over-the-counter trades. Rules and practices regarding trade confirmation and settlement cycles are set by the market itself. In practice, Euroclear Belgium cannot interfere with these rules and practices. Settlement instructions are matched prior to 96

5 The Assessment of Euroclear Belgium against the CPSS-IOSCO Recommendations SUMMARY OF THE RESULTS OF THE ASSESSMENT OF EUROCLEAR BELGIUM AGAINST CPSS-IOSCO RECOMMENDATIONS Recommendation Assessment category I. Legal risk Recommendation 1 Legal framework Observed II. Pre-settlement risk Recommendation 2 Trade confirmation Observed Recommendation 3 Settlement cycles Not relevant Recommendation 4 Central counterparties (CCPs) Observed Recommendation 5 Securities lending Observed III. Settlement risk Recommendation 6 Central securities depositories (CSDs) Observed Recommendation 7 Delivery versus payment (DVP) Broadly observed Recommendation 8 Timing of settlement finality Observed Recommendation 9 CSD risk controls to address participants failures to settle Observed Recommendation 10 Cash settlement assets Observed IV. Operational risk Recommendation 11 Operational reliability Observed V. Custody risk Recommendation 12 Protection of customers securities Broadly observed VI. Other issues Recommendation 13 Governance Observed Recommendation 14 Access Observed Recommendation 15 Efficiency Observed Recommendation 16 Communication procedures and standards Observed Recommendation 17 Transparency Observed Recommendation 18 Regulation and oversight Observed Recommendation 19 Risks in cross-border links Broadly observed settlement. Recommendation 2 (trade confirmation) is observed. Recommendation 3 (settlement cycles) stipulates that settlement fails should not be a significant source of added risk but, if so, risks from fails should be effectively mitigated. For over-the-counter trades, the fails rate exceeds 5 p.c. of settlements and can thus be considered as a source of risk. No information is available regarding risk mitigation measures as these take place bilaterally between the transaction participants. The NBB acknowledges that the risk mitigation techniques for coping with fails are bilaterally agreed between the counterparties to the over-the-counter transaction. Recommendation 3 is thus not relevant for Euroclear Belgium. Recommendation 4 (central counterparties) requires the evaluation of the costs and benefits of a central counterparty (CCP) or the introduction of a CCP mechanism. For Euronext Brussels trades, when the transaction is registered, the Paris-based clearing house LCH.Clearnet SA positions itself as a CCP between the clearing member of the buyer and the clearing member of the seller. The recommendation is being observed. Recommendation 5 on securities lending stipulates that there should be no impediments to the development and functioning of securities lending. Securities lending helps to expedite settlement. Securities lending in Belgian stocks has recently become more efficient with a widening of the lending base. In July 2004, a law was passed allowing 97

6 Belgian funds to lend stocks, pending the implementing Royal Decree. In March 2006, this Royal Decree entered into force enabling Belgian funds to lend stocks to credit institutions, investment firms and clearing and settlement institutions. Recommendation 5 is observed. Settlement risk CPSS-IOSCO Recommendation 6 (CSDs) requires the SSS to provide immobilisation or dematerialisation of securities and to process transfers by book entry. In Belgium, a dematerialisation conversion project is being implemented from 2008 onwards, discouraging investors from holding securities in paper form. Euroclear Belgium complies with this requirement. Recommendation 7 requires a DVP mechanism so as to avoid principal risk when counterparties settle a trade. In principle, Euroclear Belgium provides proven DVP arrangements. However, the Euroclear Belgium technical and contractual framework does not always ensure DVP, as under specific circumstances, e.g. in the unlikely event that the CCP LCH.Clearnet SA would default the Euroclear Belgium participant selling securities on exchange does not always benefit from such a mechanism vis-à-vis LCH.Clearnet SA. Furthermore, the available data for over-the-counter transactions indicate that around 20 p.c. of over-the-counter trades might not be settled DVP. Therefore, Recommendation 7 is assessed as being broadly observed. The NBB recommends that within the relevant Euroclear Belgium settlement system, the CCP LCH.Clearnet SA is regarded as the same as any other participant in the sense that a DVP mechanism is always applied for trades settled between the CCP and all relevant Euroclear Belgium participants. The NBB acknowledges that the planned new settlement system (ESES), due to be implemented by Euroclear in Belgium in November 2008, will remedy this problem. Pending this solution, the NBB recommends that Euroclear Belgium amend its legal documentation so as to increase transparency on the potential risk a net seller incurs vis-à-vis the CCP in the event of a CCP default. It is furthermore recommended that the reasons for the assumed relatively high number of over-the-counter trades that are not settled DVP are determined and where appropriate the cause removed, except where it is the own free will of the parties to settle Free of Payment (FoP). Regarding Recommendation 8 (timing of settlement finality), the moment of finality is stipulated in the Euroclear Belgium legal documentation. The system complies with this recommendation. Euroclear Belgium does not offer cash accounts to its participants. The cash accounts of the systems operated by Euroclear Belgium are held at the NBB, which acts as the settlement agent for the Euroclear Belgium system participants. The cash leg of the transactions processed by Euroclear Belgium is thus settled in central bank money. Cash settlement is exclusively in euro. Overdrafts or debit balances in securities are not permitted in the system. Recommendation 9 (CSD risk controls to address participants failures to settle) and Recommendation 10 (cash settlement assets) are therefore assessed as being observed. Operational risk Euroclear Belgium has outsourced its IT operations to an external service provider, Atos Euronext Market Solutions (AEMS), under a framework agreement concluded via Euroclear SA/NV. In accordance with the Euroclear group outsourcing policy, Euroclear Belgium remains responsible as the operator of the custody and settlement system and exerts adequate control over the IT service provider. Recommendation 11 on operational reliability specifically requires all key systems to have appropriate contingency plans and backup facilities, and to be reviewed regularly. A Disaster Recovery Plan (DRP) covering IT infrastructure for key systems has been put in place and will run at another location sufficiently far away from the main site whenever needed. A business contingency plan has been drawn up. Recommendation 11 further requires a system operator, such as Euroclear Belgium, that outsources operations to a third party to make sure that those operations meet the same standards as if they were provided directly. The system operator and AEMS have identified the sources of operational risk and established related policies, so as to ensure that there are official and adequate management controls up to the level of the final provider of the outsourced service. Therefore, Recommendation 11 is being observed too. Custody risk Recommendation 12 (protection of customers securities) requires the use of adequate accounting practices and safekeeping procedures. The vast majority of the securities deposited and immobilised with Euroclear Belgium are physical securities that are kept in the vaults of Euroclear Belgium. Within Euroclear Belgium, risk controls are in place and procedures are subject to internal audit checks. Euroclear Belgium enables participants to distinguish between their own and their clients securities, which protects customers securities from a participant s insol- 98

7 The Assessment of Euroclear Belgium against the CPSS-IOSCO Recommendations vency. Euroclear Belgium has never experienced any case of insufficient securities to meet any customer claim. Also, participants including foreign CSDs receive account statements each time a securities transfer takes place, stating the transfer and the position of the securities involved. However, an account statement listing all the participant s securities positions is only sent once a year. Moreover, Euroclear Belgium can print on demand book-entry securities when an investor wants to hold this security in physical form, thanks to a Belgian law enabling this service which came into force in February When immobilised and held on account with CIK, these securities are represented by a specific global note form. The face value or capital share of this global note can be determined, as required by law, on the basis of the books and inventories held by Euroclear Belgium upon the instructions of its participants and the issuer. The Euroclear Belgium contractual framework has been adapted to specify all procedures involved regarding these print-on-demand securities. However, there is no reconciliation procedure for regularly confirming with the issuer the accuracy of the face value of this specific global note form. Based on the above, Recommendation 12 (custody Risk) is assessed as being broadly observed. The NBB recommends that Euroclear Belgium regularly sends its participants an account statement listing all their securities positions and asking for any discrepancies to be reported. The NBB also recommends that Euroclear Belgium puts together a reconciliation procedure with the issuer so as to regularly check that the face value of the specific printing-ondemand global note form is correct. Other issues Governance Access Recommendation 14 (access) stipulates that access criteria must be objective, clearly stated and publicly disclosed. Criteria that limit access to the CSD on grounds other than risks should be avoided. Euroclear Belgium has drawn up objective and risk-based access criteria. It has stipulated them in its contractual framework that is published on its website. The recommendation is therefore observed. Efficiency Euroclear Belgium has put in place procedures to regularly review its pricing levels against its operational costs. User meetings are frequently held in order to improve services, whenever requested. Users are systematically informed of all new planned products, the pricing structure and tariff changes. Regular and ad hoc user groups have been formed where users are involved in outlining the business cases for projects comprising a functional description and cost and price analysis. Recommendation 15 (efficiency) is observed. Communication procedures and standards Euroclear Belgium uses international communication standards and procedures. Besides its own proprietary system, the CSD offers file transfer facilities and SWIFT ISO Links with other CSDs are SWIFT-based. Users have different possibilities for connecting to the CSD and there is a wide range of possibilities as to the kind of reporting they want to receive, the frequency and the means of communication : SWIFT (ISO15022), Satelit (a proprietary system based on a specific software) or file transfer. Recommendation 16 (communication procedures and standards) is observed. In 2006, Euroclear Belgium became part of the Euroclear group and is now a wholly-owned subsidiary of the Euroclear holding company, called Euroclear SA/NV, established in Belgium. Euroclear SA/NV offers a broad range of services to Euroclear Belgium, as to the group s other SSSs. These include audit, financial and risk management, legal, human resources, product management, business model and harmonisation services. However, the group s (I)CSDs remain separate legal entities subject to their existing regulatory environment. Both the Euroclear Belgium and the Euroclear SA/NV governance arrangements are clearly specified and information about them is publicly available. Established user committees do take users interests into account. Consequently, Recommendation 13 (governance) is observed. Transparency Recommendation 17 on transparency requires market participants to be provided with a full and clear description of their rights and obligations, the cost of participating in the system, the rules, regulations and laws governing the system, its governance procedures, any risks arising either for participants or for the operator, and any steps taken to mitigate those risks. It further stipulates that the CPSS/IOSCO Disclosure Framework or the answers to the key questions of this assessment report should be completed and disclosed. Euroclear Belgium has coordinated all relevant contractual and technical documentation. It is available in French and Dutch and is published on the Euroclear Belgium website. Since October 2006, Euroclear Belgium has published on its website answers 99

8 to the ECSDA disclosure questionnaire which incorporates questions from the CPSS IOSCO disclosure framework. Recommendation 17 is observed. Regulation and oversight As a securities settlement system, Euroclear Belgium is overseen by the National Bank of Belgium. Euroclear Belgium has the status of settlement institution and, in this respect, is subject to prudential supervision by the CBFA. The roles and tasks of the CBFA and the NBB, and their cooperation, are clearly defined in the relevant laws and regulations on the supervision of the financial markets. Recommendation 18 (Regulation and oversight) is observed. Risks in cross-border links Recommendation 19 (risks in cross-border links) states that CSDs that establish links to settle cross-border trades should design and operate such links to effectively reduce the risks associated with cross-border settlements. It prescribes a risk assessment of the link. Euroclear Belgium has established a scheme for regular self-assessments of its link arrangements. However, it has not yet used this formal risk-assessment procedure for analysing the design of each link. Therefore, the recommendation is only broadly observed. The NBB recommends that Euroclear Belgium applies its risk analysis to the relevant legal, operational and financial aspects of each link. 100