SOLUTION OUTLINE TOPIC 4.2: BONDS STRIPPING AND RECONSTITUTION DRAFT

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1 TS PROGRAMME OFFICE / TFAX February /0/000 Item. SOLUTION OUTLINE TOPIC.: BONDS STRIPPING AND RECONSTITUTION DRAFT. Introduction Different practices exist for stripping/reconstitution of Bonds in the European market. This paper discusses some of the models with respect to the cross-csd environment and in view of TS Bond stripping with restrictions Bond stripping is usually instructed using FOP instructions or via proprietary messages or tools. In some markets, there are limitations with respect to the parties allowed to instruct the stripping or reconstitution of bonds. For instance, in Belgium and France only the participants identified as primary dealers (PD) or recognised dealers (RD) are allowed to send bond striping instructions to the CSD. As a result, CSDs in some markets perform additional validations on the bond stripping instructions (as compared to the settlement instructions) from their participants. In the context of TS, additional validations on the bond stripping instructions are analysed on two models. The models are discussed in the below sections. These models apply for the different types of bond stripping as explained in the Annex.. Indirect connectivity to TS In this case the participants are obliged to send the bond stripping instructions to the CSD. Participants cannot send the bond stripping instructions directly to TS. The CSD performs the additional validations on the bond stripping instructions and instructs TS for settlement. In case of cross-csd bond stripping instruction, the participant has to instruct its investor CSD. There will always be the need for the investor CSD to maintain external connectivity to the technical issuer CSD or issuer CSD, in order to instruct the bond stripping all the way up to the issuer CSD. The diagram below (Figure -) depicts the message flow for bond stripping instructions: ) The participant instructs the investor CSD outside TS for bond stripping. ) The investor CSD validates the instruction and instructs TS for moving the bonds, stripped bond and coupons between omnibus of participant and mirror

2 [reflecting investor CSDs omnibus at issuer CSD]. In parallel the investor CSD instructs the issuer CSD outside TS for bond stripping. ) The issuer CSD validates the instruction from the investor CSD and instructs TS for moving the bonds, stripped bond and coupons between omnibus of investor CSD and the issuer s securities. This process is similar to the existing ones where the bond stripping transactions are always within a single CSD, but with settlement inside TS. This model is applicable for both intra-csd and cross-csd bond stripping transactions. Figure : Indirect connectivity to TS Issuer CSD Settlement instruction Investor CSD Bond stripping instruction Settlement instruction Bond stripping instruction Participant. Direct connectivity to TS X 0 With direct connectivity the participants are allowed (by the CSD) to instruct bond stripping directly in TS. The CSD must be able to identify the bond stripping instructions originating from the participants. For this purpose, the task force recommends using the securities transaction type code value CONV in the bond stripping instructions.. a) Do you agree that the bond stripping should be instructed to TS as FOP instructions with securities transaction type code as CONV? b) With respect to your market, do you see any substantial barriers in implementing this? 0 In the direct connectivity model, the investor CSD and the issuer CSD should configure restriction rules in TS reflecting the validations they intend to perform on the bond stripping instructions from their participants (e.g. to allow instructions only from a PD or RD). Intra-CSD bond stripping In case of intra-csd bond stripping instructions, the issuer CSD needs to define restriction rules in TS. For instance, the issuer CSD needs to identify its participants who are acting as PD or RD. For this purpose the issuer CSD defines an (Market Specific Attribute) for the party (e.g. Party-Dealer-Type, with values Y/N, where Y indicates the party is a PD or RD) in TS. Using this, issuer CSD sets-up a negative rejection restriction rule (Rule ) to ensure that stripping instructions from PD or RD only are accepted in TS. With rule, instructions with transaction code CONV (bond stripping instructions are allowed only from the instructing party who is a PD or RD (i.e. Party-dealer-type as Y ). Page of

3 Table -: Rule Rule Parameter Party-Dealer-Type Securities transaction type Value Y CONV (to identify the bond stripping instruction) 0 0 Issuer CSD also requires to set-up an additional rule to reject all other instructions with the securities transaction type CONV (i.e. where party-dealer-type is not Y ). TS will apply these rules on the instructions received from the participants and will accept bond stripping instructions only from PD or RD. Cross-CSD bond stripping For cross-csd bond stripping instructions, if the investor CSD allows DCPs (directly connect parties) to instruct TS directly, the investor CSD as well needs to perform the same validations as performed by the issuer CSD. For this purpose the investor CSD needs to define additional s and restrictions (similar to the ones defined by issuer CSD) in TS. The participants of the investor CSDs will be able to instruct TS for bond stripping of ISINs that are issued by other CSDs as well. However, in case the participants of the investor CSD are PDs or RDs in one or more issuer CSDs, the configuration of the s and restriction rules at the investor CSD becomes complex. The investor CSD need to replicate the and restriction rules (for the purpose of validating the bond stripping instructions) as configured in each issuer CSD. For instance, in the below diagram, the investor CSD is linked to three issuer CSDs. The investor CSD need to defined three s for the party in order to identify if the party is a PD/RD in each of the issuer CSDs. Similarly, investor CSD should set-up three sets of restriction rules, each for validations required by one issuer CSD. Figure : Definition of s and restriction rules at the investor CSD in a cross-csd scenario Issuer CSD Issuer CSD Issuer CSD (party) (party) (party) Party Investor CSD For identifying the participant as a PD/ RD in one issuer CSD For allowing bond stripping instructions only from PD/ RD at CSD I Page of

4 In case the investor CSD (depicted in the above diagram), is an issuer CSD itself for a certain set of ISINs, it needs to validate the bond stripping instructions from the participants on those ISINs as well. For this purpose it needs to maintain one more set of restriction rules in TS.. a) Given the merits and demerits of the direct and indirect connectivity models for bond stripping, which model do you prefer to implement with TS? b) With respect to your market, do you see any substantial barriers with the two models?. Bond stripping without restrictions Some markets (e.g. Germany) allow bond stripping to be instructed by all participants, and do not have restrictions. This model makes the processing of cross-csd bond stripping transactions non-complex as no additional validations are required by the investor or issuer CSD.. a) Do you agree that the restrictions on bond stripping instructions should be removed for all markets? b) With respect to your market, do you see any substantial barriers in removing the restrictions on bond stripping instructions? Page of

5 0. Annex : Bond stripping/ reconstitution types Two different types of bond stripping exist in the markets. ) Stripping of all outstanding coupons: In some markets case, the stripping request from the participant will always result in one zero coupon Bond (stripped bond), and a number of all outstanding coupons. The participant need not instruct for receipt of the resulting coupons and stripped Bond. ) Stripping of certain outstanding coupons: In some markets (e.g. Greece), stripping of only a certain number of unpaid coupons from the bond is also allowed. I.e. The stripped bond could still have the remaining set of coupons attached. In such markets the participants send a stripping request to the CSD along with the details of which stripped bond and coupons it intends to receive. The participant sends a set of FOP instructions to the CSD, to effect stripping of bonds. There will be at least three FOP instructions; ) Deliver Bonds ISIN to the issuer ) Receive a certain stripped bond from the issuer ) Receive certain coupons from the issuer (as one FOP per coupon). The issuer CSD validates if the amount of bonds requested for stripping is consistent with the amount of stripped bonds and coupons, and processes the instructions. 0. Annex : Belgium In Belgium, Bond stripping/reconstitution instructions are allowed only from a party who is a PD or a RD. NBB could allow direct connectivity for its participants to instruct stripping/reconstitution. In this case, NBB can create an at the level of party to identify a PD or RD. NBB could create rejection restriction rules based on this. Bond stripping instruction could be implemented as a FOP instruction delivering into the securities. Figure : Intra-CSD scenario current BOOKINGS -0 (ISINA) Initial positions ACTIONS Debt instrument: ISINA Stripped bond: ISINB Coupon: ISINC -0 (ISINA) DCP (PD/RD) instructs TS to deliver 0 quantity to the. It specifies CONV as transaction type code. NBB identifies that the stripping is requested. NBB creates the matching receipt instruction TS matches both instructions and settles. 0(ISINB) (ISINC) 0(ISINB) (ISINC) NBB creates one already matched SI to deliver from the to the NBB instructs the already matched delivery of the stripped bond to the client from the NBB instructs already matched SI the delivery of the coupon(s) to the client from the Page of

6 Figure : Cross-CSD scenario foreseen BOOKINGS ACTIONS -0 (ISINA) Debt instrument: ISINA Mirror Omnibus Initial positions Stripped bond: ISINB Coupon: ISINC Mirror Omnibus -0 (ISINA) CSD or DCP (PD/RD) instructs TS to deliver 0 quantity to the from participant in Investor CSD. It specifies CONV as transaction type code. NBB identifies that the stripping is requested when receiving the allegement. NBB creates the matching receipt instruction TS matches both instructions, generates the necessary realignments and settle all. 0 (ISINA) NBB creates one already matched SI to deliver from the to the NBB instructs delivery instructions for ISINB and ISINC to client in Investor CSD 0(ISINB) Mirror 0(ISINB) Omnibus 0(ISINB) 0(ISINB) Counterpart (CSD/DCP) receives allegement and instructs the receipt instructions TS matches, create necessary realignments and settles. (ISINC) (ISINC) (ISINC) (ISINC). Annex : France Similar to Belgium, France distinguishes primary dealers and recognised dealers from other market participants. Only the PD/RD can instruct bond stripping instructions to the CSD. France foresees to implement the stripping/reconstitution of bonds as a service provided only via indirect connectivity. Page of