Cross Border Settlement andRegional Bond Market Integration

November 4-6, 2005

Shanghai, China

Noritaka Akamatsu

The World Bank

Contents Background Alternative channels of cross border settlement Existing networks of global custodians in the region, Institutional networks and system linkages among

existing clearing houses and CSDs in the region, Risk management issues, Legal and regulatory infrastructure for ownership

security and settlement finality, Multi-currency fund settlement arrangements, Business, political and technical feasibility of a

regional clearing house. Capital account liberalization requirements, Strategy

Background Efficient and secure settlement is critical to

promoting cross border trading of bonds in the region. Unless the settlement is possible, secure and efficient,

investors will not trade across national borders. How can a trade between, e.g., a Korean investor and a

Thai counterpart in Malaysian bonds kept in custody in Hong Kong be settled?

National CSDs are now being linked up. But their settlement modes differ because each of them is designed to serve for domestic needs. Banking services are weak and different DVP modes

prevail in different national markets. Bilateral links have not been a popular channel of cross-

border settlement except when it involves an ICSD.

Background - continued

International investors without direct access to national CSDs rely on global custodians and their local agents. Liquidity pressure on local agents as repos (a popular

instruments in cross border trading) and/or back-to-back transactions grow.

Any room for use of an ICSD or creation of a regional CSD?

Trading needs and patterns

Investors have a need and interest to manage exposures to regional risks and currencies. Often seek liquid government securities market where

risk-adjusted interest rate is attractive and exit is easy to manage exchange rate risk.

OECD experience Government securities repos and back-to-back trades by

dealers and market makers have grown rapidly. Those created a pressure on intermediaries in the

settlement chain (e.g., local agent sub-custodians).

Alternative channels

NationalCSD

Localagent

Localagent

Localagent

Globalcustodian ICSD National

CSD

Non-residentcounterparty

Non-residentcounterparty

Non-residentcounterparty

Non-residentcounterparty

Non-residentcounterparty

Direct access

Local agent

Global custodian

ICSD CSD-to-CSD

Source: Cross-Border Securities Settlement, March 1995, CPSS, BIS

Countryof issue

Othercountries

Alternative channels ofcross border settlement – 1

Direct access to local CSD. Non-resident often not permitted. Local money settlement arrangement necessary.

Use of a local agent (custodian). Often provides pre-matching services and even settlement on

its own book. But custody risks are involved.

Use of bilateral links among national CSDs. A national CSD is often exclusively linked to a national stock

exchange, which limits non-resident investors’ access to non-listed securities.

Links are created primarily to allow domestic parties to trade in foreign securities rather than to trade across the border.

Banking and cash management services are weak, and different DVP models prevail.

Alternative Channels – 2Use of global custodian

Offer a single entry point for investors in multiple markets.

Have a network of local agent sub-custodians (some of which may be their own branches or subsidiaries).

Inexpensive service compared to separately accessing local custodians and other service providers thanks to economies of scale and scope despite IT investment required.

Provide multi-currency banking services and management of cash and securities positions.

Internal settlement over its own book. Can handle settlement of back-to-back trades.

Alternative Channels – 3Use of ICSD

Provide a single entry gateway to multiple markets as does a global custodian.

Able to settle internally over its own book with direct links to national CSDs. I.e., can handle settlement of back-to-back trades. In Europe, those links were exploited to settle European

government securities over ICSDs.

Inexpensive service for core clearing and management of cash and securities positions.

Use existing ICSDs or create a new regional ICSD in Asia??

Alternative architectures in Europe

Networking CSD model. Bilateral links among national CSDs, making each other a

sub-depository (e.g., European Financial Superhighway by ECSDA)

Hub and spoke model (ICSD) Euroclear

Single CSD model (ICSD) Creation of Clearstream by merger between Deutsche

Borse clearing house and Cedel. Controlling ownership of Clearstream by Deutsche Borse

may be an impediment.

Regional networks of global custodians

Global custodians active in emerging markets cross-border transactions Bank of New York JP Morgan (including Jardine Fleming) State Street Citibank Deutsche Bank PNB Paribas Those in bold Italic

have Northern Trust strong local presence

and ABN-AMRO Mellon client base in Asia. HSBC Morgan Stanley Global Custody MeesPierson

Regional networks of global custodians - continued

But there are differences among them. E.g., State Street: presence in regional hubs only but not in each

individual country nor does it directly participate in local CSDs. Citibank: presence in each individual country (i.e., local as

well as global custodian) and directly participate in local CSDs.

Their business strategies differ. State Street: serving for global investors and interested in

serving as a regional hub for international and intra-regional settlement.

Citibank: not interested in being a regional hub because it directly participate in local CSDs and can directly serve local clients (i.e., able to internalize regional settlement).

Agent sub-custodiansin East Asia

1999 2000 2001 China (mainland) 5 4 5

(Hong Kong) 6 7 7 Indonesia 4 4 5 Japan 6 5 9 Korea 12 4 10 Malaysia 10 5 9 Philippines 5 4 5 Singapore 6 5 8 Thailand 9 5 9 .

Q.How many of them are branches or subsidiaries of global custodians?

Networks & linkages among clearing houses and CSDs

Clearing houses and CSDs in the region.

China CGSDTC and CSDCC Indonesia BI-SSSS, KSEI and KPEI Japan BOJ-Net and JASDEC Korea KSD Malaysia MCD, SCANS Philippines ROSS, SCCP and PCD Singapore Central Depository Ltd. Thailand Bhatnet 2 and TSD

Risk management

Issues: How to ensure cross border DVP?

Systemic risks in links among settlement systems. Local sub-custodians under pressure to receive and

redeliver securities on the same day. How to settle back-to-back trades?

Links have been being built among CSDs and between CSDs and ICSDs. Local CSDs built to meet local needs only. Different modes of DVP even when they are said to be

achieved over electronic books.

Multi-currency cross-border fund settlement

Are continuous linked settlement and CLS Bank needed to support the settlement in regional currencies? CLS bank has an account with each central bank in the region. Participating banks have an account with sub-accounts for

different currencies at CLS bank (as well as accounts at the central bank).

Participating bank pays to CLS bank account at the central bank by use of RTGS system, or instructs its nostro agent to pay to CLS bank account at the central bank of the agent’s economy.

Is use of CLS Bank possible? CLS Bank does not provide settlement in Asian currencies other

than Japanese yen. Create a regional CLS bank?? Does it make business sense??

Multi-currency cross border fund settlement - continued

If a regional CLS bank should be created,

Who should own / govern / participate in it (I.e., governance)? Should it be another subsidiary of CLSS? Global custodians serving for the settlement in regional

currencies. Local custodians Central banks as well?

Where should it be located? Center of the regional time zone? In a jurisdiction whose legal framework is acceptable to as many

participants as possible?

Multi-currency fund settlement - continued

Cross-border DVP is essential. National CSD must achieve DVP domestically in order to enable

cross-border DVP. DVP settlement instructions must be sent to the central bank and

custodian.

How to ensure settlement finality? Between banks and between a bank and CLS bank at each

central bank. Under what law? Law of the jurisdiction in which CLS bank is

located? Laws of the jurisdictions of the central banks involved in each transaction? English law?

Legal & Regulatory Infrastructure

Conflict of laws and legal risks in defining settlement finality and managing cross border collateral. Most government securities in the region are demeterialized and

recorded as electronic entries. They are registered in domestic registries (central bank registries

or CSDs), but where are they kept in custody? How can legal finality of settlement of offshore transactions in

such securities be achieved and ensured? Need a common legal basis to which all the jurisdictions and

market participants in them can agree?

Article 9(2) of EU Settlement Finality Directive

Legal & Regulatory Infrastructure

Definition of settlement intermediaries.

Legal status of “securities” differ across countries.

Finality of delivery and payment

Concept of “bankruptcy”

Capital account liberalization

Exchange control on capital account transactions

Role of central banks in implementing the exchange control and its implications for cross border securities trading.

Taxation of cross-border securities transactions.

Business, political and technical feasibility

Is it politically feasible to establish a new regional ICSD? Does it make business sense?

Information technology (IT) enables Building bilateral links among national CSDs Building bilateral links between ICSDs and national CSDs. Global custodians to provide sophisticated customer services for

institutional investors, alluring them to outsource not only backoffice but also some midoffice functions while global custodians themselves to outsource “core clearing” to ICSDs.

Substantial IT investment is required, and communication protocol and messaging standards need to be established.

Requires training of staff.

Strategy Make various channels of competition open. Policy support to encourage competition among national

CSDs to become a regional ICSD. Coordinate to ensure system connectivity. A CSD owned by and serving for a national stock exchange will

be out and can only be a spoke? A CSD serving for government securities has competitive

advantage from economies of scale and scope? A CSD operated by the central bank cannot compete for profit

and beyond the national border?

A national CSD open to direct participation by global custodians may become a regional ICSD?

A country that is to house a regional ICSD must have a liberal capital account.

Links with other initiatives

Mutual acceptance of regional sovereign bonds as collateral for central bank intra-day credit.

Use of ABC bonds as such collateral?