The impact of the creation of CSDs in CEECs. Implications for Armenia. Karine THEMEJIAN (ECB)...

The impact of the creation of CSDs in CEECs.

Implications for Armenia.

Karine THEMEJIAN (ECB)

Dominique CHABERT (University Lyon 2 / GATE UMR 5824 – CNRS)

The views expressed herein are solely those of the authors and do not represent the views of the European Central

Bank

General framework

Market infrastructures: critical component of operational efficiency of markets

Focus on one of the components of financial infrastructure: CSDs as « organic links » between issuers and investors

Purpose of our presentation

Present the impact of the creation of CSDs in CEECs

Examine the impact of these post-market infrastructures on the development of securities markets and the economy in general

Derive implications for the Armenian case

Outline

The role of CSDs as stabilising institutions for markets (1)

The implementation of CSDs in CEECs (2)

Implications for Armenia (3)

1. CSDs functions within a domestic area: post-market stabilisation

CSDs : a « double-sided market » with: A link to the issuer A link to investors

Issuers CSDInvestors

CSDs functions within a domestic area: post-market stabilisation

CSDs as « notaries » for securities: Keep record of the securities issued in the

country where they operate; Testify to the authenticity and the existence

of outstanding securities CSDs as a « securities carrier »:

Operate one or several SSSs and ensure the circulation of securities within the market

Ensure the traceability of securities flow in a dematerialized environment

CSDs functions within a domestic area: post-market stabilisation

Two parallel worlds: the money world and the securities world

MONEY SECURITIES

Central bank Central depositary

Bank A

Bank B

Custodian A

Custodian B

Agent X Agent Y Agent X Agent Y

CSDs functions within a domestic area: post market stabilisation

Central Banks Hold central

accounts of commercial banks

Operate the interbank systems and notably the RTGS

CSDs Hold central

accounts of custodians

Operate the SSS


A central and ultimate custodian for issuers and investors

A central hub for securities flows For issuers & for investors For market users, banks and investment firms…but…

…not a « Central Bank for securities » ! CSDs are not securities issuers CSDs do not certify the stability of securities CSDs are not « lender of last resort »


CSDs, like Stock Exchanges, can be demutualized

Status of CSDs in the world

private CSD 15%

not-for profit CSDs15%

CSD owned by the stock exchange

30%

Other20%

CSD owned by the Central

Bank20%

Source: Karyotis,2005


CSDs and SSSs: important features of a « financial territory »

Like payment systems, SSSs constitute a tool for the operational efficiency of markets i.e.create the conditions of relationships between issuers and investors with conditions of: security rapidity cost


SSSs cannot be reduced to their technical components. They represent a critical element of the issuance and circulation of property rights.

CSDs as « post-market » centralized actors are not only « back-office » actors.

International standards and recommendations for SSSs (1/3)

International initiatives Private sector level: G30, FIBV, ISSA Public sector level: CPSS and IOSCO with

notably Recommendations for SSSs (2001) risk-based approach covers all countries

But, need to take into account specificities linked to the particular context within a country


At the European level Standards for securities clearing and

settlement in the European Union Developed by the ESCB in cooperation with CESR Consists in Europeanisation of CPSS-IOSCO

recommendations

Standards for the use of EU SSSs in ESCB credit operations


For emerging/transition economies: Guadamillas & Keppler (2001): seven features for evaluation Clearing and settlement process Settlement risks Legal issues Regulatory oversight Clearing and settlement institutions Safeguard policies System capacities

2. The implementation of CSDs in CEECs

Criteria for assessment: Guadamillas and Keppler (2001) Level of consolidation of the post-trading

infrastructure, enabling to reap benefits of Economies of scale Economies of scope Network effects

Countries examined 8 CEECs new Member States of the EU (since 1 May

2004) 2 Accession countries

Country Single CSD

Name of CSD

Main functions Name of other CSD / SSS

Main functions

Bulgaria No CDAD Provides settlement services to the Bulgarian Stock Exchange and the OTC market securities depository

BNBG-SSS All kinds of government securities transactions

Czech Republic

No SCP Depository of securities SKDUnivycRM-SystemCentral Bank

Settles short term fixed income securitiesSettles securities listed on the PSESettles securities listed on the RM-System’s marketCentral depository for short-term government debt issues

Estonia Yes ECSD ClearingSettlement of stock exchange and OTC trades

Hungary Yes KELER

Clearing house, central counterparty and settlement agent for securities and derivatives traded on the BSE, BCE and can also settle OTC securities contracts

Latvia No LCD-DENOS

Settlement of private sector securities and government debtsecurities for non-banks. Safe custody; clearing

LB-VNS Settlement services for transactions in Latvian government debt securities (only for banks)

Lithuania Yes CDSL Clearing and settlement services

Poland No KDPW National depository for securitiesClearing and settlement of cash and derivatives transactions

CRBS-SKARBNET

CRBS: register for Treasury billsSKARBNET: book entry settlement system for Treasury bills

Romania No NSCSD Settlement of trades carried on the RASDAQ market BSE-SSSCentral Bank

Clearing and settlement of securities listed on the BSE

Settlement of trades in government securities

Slovakia No CDCP SR Clearing and settlement of all transactions executed on the BSSE and the OTC market

NBS-CR Settlement of trades on the short-term securities market

Slovenia No KDD Securities clearing and settlementActs as the CSD

BOSS Depository and settlement services for Bank of Slovenia tolar bills and foreign exchange bills

The implementation of CSDs in CEECs

Level of consolidation: progresses achieved at varying degrees. 3 main situations: Single CSD acting as central register, clearing

and settlement agent for private securities and public shares

Bicephalous organisation, distinguishing between a single CSD for private securities and the NCB acting as central depository for Government bonds

CSD acting as central depository only, besides other SSSs and the NCB


Criteria defined by Guadamillas and Keppler (2001) Clearing and settlement processes: general

compliance with some exceptions Legal soudness: difficulty to assess Settlement risks: Most of the countries

implement DvP schemes (majority DvP model 1)

Settlement of transfer instructions

Final transfer of securities and funds Potential risks

Model 1 Gross basis Simultaneous settlement of individual securities transfer instructions and associated funds transfer instructions

High fail rates (linked to the need to maintain important money and securities balances) with consequences on replacement cost risk and liquidity risk

Model 2 Gross basis for securities Net basis for funds

Final transfer of securities throughout the processing cycle;Settlement of funds transfer on a net basis with final transfer at the end of the processing cycle

Principal risk (if no additional safeguard)Replacement cost risk and liquidity risk, but reduced thanks to the possibility to settle funds transfer on a net basis

Model 3 Net basis Simultaneous settlement at the end of the processing cycle

Principal risk may occurReplacement cost risk and liquidity riskSettlement bank failure if accounts are not held at a central bankPotential for high liquidity pressures Unwind


Criteria defined by Guadamillas and Keppler (2001) Regulatory oversight: all SSSs are subject to

some form of regulation Clearing and settlement institutions and

their participants: no undue restriction Safeguard policies: various risk control

measures in place System capacities: progress in the

implementation of back up and disaster recovery facilities


Most of these infrastructures comply with the minimum criteria

To what extent has the compliance with international requirements enabled a significant development of markets and the economy?


Overview of market and post-market activity over the past ten years


A relatively low level of market capitalisation


Growth rates of volume of transactions on SEs and of volume of instructions handled by CSDs / SSSs

Country Growth rate of volume of transactions on Trading platforms

Growth rate of volume of instructions CSD

Global growth rate Average growth rate

Global growth rate

Average growth rate

Estonia + 32 % + 3,5 % + 125 % + 10,6 %

Hungary + 359 % + 21 % + 302 % + 19 %

Latvia + 812 % + 32 % + 229 % + 16 %

Lithuania + 679 % + 29,3 % + 1083 % + 36 %

Poland + 110 % + 9.7 % + 60.3 % + 6.1 %

Slovakia + 1472 % + 41,1 % + 1070 % + 35 %

Slovenia + 169 % +13,2 % + 163 % +12,9 %

Source: from ECB, 2006, Blue Book, addendum,

In all countries, a growing trend in market activity and settlement instructions held by CSDs


Securities issues and securities registered between 1996 and 2004 (average annual growth rate)

Value of new issues / securities issued

Number of new issues / Number of securities

issued

Value of securities registered

Number of securities registered

New member states (CEEC countries only)

Czech Republic (val: 1996-2004 / Vol: 1999-2004)

13.46 % 12.5 %

Estonia (2000-2004) 58.4 % 80 % 34.4 % 128 %

Latvia nav nav 23.1 % 4.53 %

Lithuania nav nav 13.12 % - 7.16 %

Hungary 22.8 % - 23.16 %

Slovenia 24.7 % 17.6 %

Slovakia (97-04)BSSE + CSD

51% 60 % 25.5% 19 %

Poland KDPWPoland SKARBNETPoland SEBOP

Value of securities issued and registered Number of securities issued and registered

38.78 % 19.81 %

2.24 %31.6 %

- 0.25 %- 7 %

7.11 %- 9.3 %

- 0.25 %- 32.8 %

Accession countries

Bulgaria CDAD (97 – 04)Bulgaria GSD

nav nav 8 % - 52.5 %

13.9 % - 13.9 %

RomaniaBVB GSS

Value of securities issued and registered Number of securities issued and registered

149 % 21.7 %

27.8 % 6.2 %

Source : data from ECB, Blue Book

Securities issues and securities registered between 1996 and 2004 (average annual growth rate)


In most countries under review, CSDs’ activity in volume & in value of transactions handled went along with the development of the volume of transactions on stock exchanges

A covariation sometimes blurred by the coexistence of several SSSs (for instance when the Central Bank operates a specific system for public bonds)


In most countries, a significant growth of securities issued and securities registered at the national CSD IPO’s and privatisation process Development of mutual funds and pension

funds But, still a shy development

Privatisations have created a flow (not always with the expected effects)

Investment portfolios by non-residents still low


The case of Baltic markets

The Baltic list

The links with OMX Group


In grey : arithmetic scaleIn white: semi-logarithmic scale Data: from ECB, Blue Book

Volumes of trading transactions & of settlement instructions

Estonia

0

50

100

150

200

Year

Vo

l in

Th

ou

san

ds

Vol of transactionsTrading Platforms

Vol.of instructionshandled CSD


Latvia

0,00

10,00

20,00

30,00

40,00

50,00

60,00 1996

1997

1998

1999

2000

2001

2002

2003

2004

Year

Vo

l in

th

ou

san

ds Volume of

Transactions onStock Exchange inLatvia

Volume oftransactions CSD

In grey : arithmetic scale Data: from ECB, Blue Book

In white: semi-logarithmic scale



Lithuania

0,00

20,00

40,00

60,00

80,00

100,00

120,00

1996

1998

2000

2002

2004

Year

Vo

l in

th

ou

san

ds

Volume ofTransactions onStock Exchange inLithuania

Volume ofTransactionshandled by CSD inLithuania





Estonia

05

10152025303540

1996

1997

1998

1999

2000

2001

2002

2003

2004

Year

Va

lue

in E

EK

Bill

ion

Market value oftransactions ontrading platform

Market value ofinstructions CSD

Market value of trading transactions & of settlement instructions




Latvia

1

10

100

1000

10000

100000

1996

1997

1998

1999

2000

2001

2002

2003

2004

Year

Va

lue

in L

VL

Mill

ion

Market value oftransactions ontrading platform

Market value ofinstructions CSD





Lithuania

-

1 000,0

2 000,0

3 000,0

4 000,0

5 000,0

6 000,0

7 000,0 1

99

6

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

Year

Va

lue

in L

TL

Mill

ion

Market value oftransactions ontrading plateform

Market value of DVPtransactions

Market value of FOPtransactions





Development of several arrangements with OMX Group over the past few years: Estonian’s CSD (ECSD) is part of the OMX group Riga Stock Exchange (RSE) is owned by OMX

group Project of a single settlement platform

The stake of a connection with A « mature » trading plateform to improve

liquidity CCPs and CSDs to improve post-markets

processings


Foreign equity as % of total equity (listed equity turnover) in 5 new EU members

Market Foreign equity as % of

total equity (listed

equity turnover)

Prague stock exchange

Warsaw stock exchange

Ljubljana stock exchange

Bratislava stock exchange

OMX Vilnius stock

exchange

Average in European

stock exchanges

13.4

4.2

0

0

nav

19.9

Source: Federation of European Securities Exchanges, December 2004, p. 22.


Link between Portfolio investment and market infrastructures Levelling of markets and post-market

infrastructures (DvP, RTGS…): components of the « check list » of international investors

Market infrastructure: an « operations centre » for traceability and monitoring


Market infrastructures do not « make » market but…

…are a pre-requisite for connecting with mature markets and contributing to create liquidity


The creation of CSDs has enabled to create the conditions to a shift towards a « secure securities economy ».

CSDs are also, with other market infrastructure, decisive actors: They enable to attract foreign investors who

would not invest in « CSD less » countries They enable issuers to have confidence in the

registry of securities issued They build, with Central Banks, a link

between the securities world and the cash world for repos operations

3. The financial reform in Armenia

Independence of the Republic of Armenia on 21 September 1991

Mass privatisation process started in 1995

USAID Capital markets development project In cooperation with Armenian actors In two phases (Jan. 1998 – June 2001 and May 2002

– May 2005)

The financial reform in Armenia

2 main actors in the post market infrastructure The CBA Government Securities Accounting

and Settlement System For settlement and central custody of Government

securities implemented in 2000 and enhanced in 2004 with the

addition of a secondary market module securing final settlement for transaction according to the DvP principle

Since 2005: implementation of the Armenian Stock Exchange FOREX Operations Settlement System (settlement performed by the CBA)

The financial reform in Armenia

The Central Depository of Armenia Processus of consolidation around one

depository (1996 – 2000) Non commercial, not-for profit organisation Functions

For corporate securities Central custody, central registry, clearing and

final settlement agent

Impact of the reform (1/2)

Processus of consolidation Progress towards centralisation around two

poles Further room for consolidation

Assessment against the criteria defined by Guadamillas and Keppler (2001) Clearing and settlement processes: T+0 Settlement risks: DvP model 3 Legal soundness: difficult to assess

Impact of the reform (2/2)

Assessment against the criteria defined by Guadamillas and Keppler (2001) Regulatory oversight: CBA Clearing and settlement institutions and

their participants: no undue restrictions Safeguard policies: guarantee funds System capacities: back up procedures

Recommendations for the future (1/3)

Based on information found on the Internet. More than recommendations, paths that could be

considered for the future development of Armenian infrastructures

Proper recommendations could only be derived after a mission is lead on site

Optimising the depository / registrar system Consolidation of the infastructures to offer wider

service to investors and benefit from scale and scope economies


Strengthening the financial and operational soundness of the CSD

Developing the attractiveness for international investors improve settlement efficiency Implement DvP model 1 or 2 Enhance the level of information in English Develop cooperation with other markets Create a CCP


Creating the conditions for a a structural demand of securities: Pension funds, mutual funds as « catalysts »

of a securities demand Few listed companies as « benchmarks »

On the local market On an other mature market

Thank you for your attention!

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