5 Introductionfocus to driving down the related costs;25 studies comparing European andAmerican cross-border securities settlement costs intensified the call to over-haul the European se
Trang 15 Introduction
focus to driving down the related costs;25 studies comparing European andAmerican cross-border securities settlement costs intensified the call to over-haul the European securities clearing and settlement system;26and discussionsabout European stock exchange consolidation also served to put cash equitiespost-trading arrangements into the limelight.27
While the measures detailed in the Code address the areas of transparency
of prices and services, access and interoperability, and the unbundling ofservices and accounting separation, they do not codify a particular industrystructure.28 The Code provides a framework for the future development ofEuropean cash equities clearing, but European clearing houses must still find
a way to implement the Code The solution to creating a more efficient pean post-trade industry remains elusive because it involves highly complexstructural issues.29It is therefore hardly surprising that disagreement vis-`a-visthe optimal structure of the industry continues to prevail European marketparticipants, such as exchanges, clearing houses, banks and investors, havethus been conducting ongoing consultations with the European Commission
Euro-as well Euro-as public discussions on the most preferable future structure of theclearing industry – but stakeholders have not yet reached a consensus.The debate on the efficiency and structure of the European post-tradeindustry – particularly concerning derivatives clearing – has regained signif-icant traction since the Commission invited comments on its endeavour toextend gradually the scope of the Code to include post-trade arrangements offixed income and derivatives instruments in October 2007.30
Finally, the efforts to establish a consensus on the most preferable futurestructure of the post-trade industry have been complicated by the coming-ling of the post-trade services terms ‘clearing’ and ‘settlement’ As outlinedabove, the two terms are frequently – and mistakenly – used interchangeably
in the public discussions accompanying the efforts to create a smoothly tioning post-trade infrastructure; academic and non-academic publicationscommit the same fallacy While this partly results from the lack of generallyaccepted, clear-cut definitions, few people – even within the financial indus-try – understand the complex mechanics of post-trade services and their
func-25 Cf Goldberg et al (2002), p 3; and European Parliamentary Financial Services Forum (ed.) (2006),
p 1.
26 Cf Werner ( 2003 ), p 17. 27 Cf AFEI et al (eds.) (2006), p 1.
28 Cf FESE/EACH/ECSDA (eds.) (2006); and European Commission (ed.) (02.11.2006) Refer to http://ec.europa.eu/internal market/financial-markets/clearing/communication en.htm for details on the European Commission’s communication, the Code of Conduct, and other documents.
29 Cf Lannoo/Levin (2003), p 2 30 Cf European Commission (ed.) (2007), p 3.
Trang 26 Clearing Services for Global Markets
different providers in detail.31However, even among experts, negligent use ofthe terminology is widespread
1.2 Literature and research gap
Since the launch of the European Monetary Union, an increasing number ofacademic and non-academic publications researching the issues of indus-try structure and efficiency of European post-trading arrangements haveemerged Nonetheless, an important – but commonly overlooked – researchgap persists: the majority of these studies analyse cross-border settlement andsafekeeping arrangements between (International) Central Securities Deposi-tories, but neglect CCP clearing issues The common comingling of the terms
‘clearing’ and ‘settlement’ only serves to obscure this major shortcoming,especially in the eyes of non-experts When studies claim to analyse post-trading arrangements, they imply a comprehensive analysis of both clearingand settlement issues; yet most publications have exclusively concentrated
on post-trade services provided by CSDs/ICSDs.32 The often negligent orimprecise use of terminology in this context threatens to erode steadily thediscussion on the most preferable structure of the European post-tradingindustry due to the spurious implication that findings on CSD/ICSD issuescover all relevant clearing issues
The Code was explicitly designed to increase the efficiency of cash equities
clearing and settlement arrangements in Europe, thus giving direction to the development of CSDs/ICSDs and CCPs It should be noted, however, that
due to the aforementioned gap in research, there were no studies on theindustry structure and efficiency of European CCP arrangements to consultfor the Code’s establishment The European Commission has acknowledgedthe gap: ‘In fact, we are not aware of any empirical studies of European CCPactivities.’33
As the limited contributions on the industry structure and efficiency
of European CCP arrangements are essentially by-products of related studies, a brief overview of relevant literature is provided in thefollowing This serves to clarify which studies concentrate on settlementand safekeeping arrangements between CSDs/ICSDs, but leave aside CCP
CSD/ICSD-31 Cf Group of Thirty (ed.) (2003), p 2.
32 Cf EACH (ed.) (2004a), p 1; and EACH (ed.) (2004b), p 1.
33 European Commission (ed.) (2006c), pp 8–9.
Trang 3A significantly larger number of studies have been devoted to the tion of the European post-trade industry, with a particular focus on CSD/ICSDarrangements: Malkam¨aki/Topi (1999) analyse the major trends and driv-ing forces of change in securities settlement systems Various publicationsinvestigate the state and process of the ongoing integration of the Euro-pean securities post-trade infrastructure; these studies identify sources ofinefficiency in the current CSD/ICSD cross-border arrangements and mea-sures to counteract them; see, e.g Russo/Terol (2000), Giovannini Group(ed.) (2001), Giovannini Group (ed.) (2003), Hirata de Carvalho (2004)and Baums/Cahn (2006) Schmiedel/Sch¨onenberger (2005) and the Euro-pean Commission (ed.) (2006c) include CCP arrangements in their respec-tive analyses Schulze/Baur (2006) underscore the importance of integratingand harmonising the European post-trade industry with their finding that an
organisa-18 per cent reduction in securities clearing and settlement costs could increasethe gross domestic product by around 0.6 per cent in the EU
Milne (2005) reviews the role of standard setting as it affects competition
in securities settlement, in the light of the establishment of pan-Europeanand global arrangements for securities settlement L¨ober (2006) presents andevaluates the existing EU legislative framework for post-trade arrangementsand describes current EU initiatives to increase efficiency, with a specificfocus on legal CSD/ICSD-related aspects Huang (2006) examines legal andregulatory issues pertaining to CCPs and explains why the application of CCPclearing could have ramifications for Europe and beyond The author alsobriefly explores the case for a Single CCP at both the European and globallevels, concluding that:
In an ideal world, a single robust and efficient CCP with effective risk management, operating within the EU or even across the globe, would be able to maximise the effect
of transaction offsetting and better risk management with more efficient collateral
Trang 48 Clearing Services for Global Markets
management for the markets In practice, the approach of maintaining a level of competition in financial services may seem more likely, in the EU in particular 34Several contributions to the field analyse and discuss alternative modelsfor European securities settlement Giddy/Saunders/Walter (1996), Giordano(2002), Niels/Barnes/van Dijk (2003), Chabert/Chanel-Reynaud (2005) andChabert/El Idrissi (2005) research frictions in the settlement of Europeancross-border transactions and discuss alternative scenarios for a more inte-grated approach to European settlement arrangements Milne (2002) exam-ines how competitive forces can be harnessed to further the integration andconsolidation of European post-trading arrangements, especially with respect
to securities settlement A number of studies present theoretical modelsdesigned to provide conclusions on the future structure of European set-tlement and safekeeping arrangements Kauko (2002), Werner (2003), Tap-king/Yang (2004), Holthausen/Tapking (2004), Rochet (2005), Kauko (2005),Van Cayseele (2005) and K¨oppl/Monnet (2007) all provide alternative mod-els Kr¨opfl (2003), Van Cauwenberge (2003), Serifsoy/Weiß (2005), Van Cay-seele/Voor de Mededinging (2005) and Knieps (2006) contribute to the debate
on the structure and organisation of European CSDs/ICSDs Milne (2007)provides a detailed review and discussion of many of these and other papers.Increasingly, empirical studies are investigating the existence of economies
of scale in European settlement and depository systems; see Schmiedel/Malkam¨aki/Tarkka (2002), Van Cayseele/Wuyts (2005) and Van Cayseele/Wuyts (2006) Besides these studies, others (many of which were produced
or commissioned by interested stakeholders) aim at identifying and ing the costs of European securities post-trading activities:35 Lannoo/Levin(2001), Giovannini Group (ed.) (2001), London Stock Exchange/Oxera (eds.)(2002), AFTI/Eurogroup (eds.) (2002), Deutsche B¨orse Group (ed.) (2002)and Euroclear (ed.) (2003) focus on CSD/ICSD-related costs, while MorganStanley/Mercer Oliver Wyman (eds.) (2003), NERA Economic Consulting(ed.) (2004) and Deutsche B¨orse Group (ed.) (2005a) also take into accountCCP-related costs Regarding these studies, the European Commission finds:
examin-‘While useful, none of the results have been universally accepted as providing
an accurate description of the prices or costs incurred by investors in acquiringpost-trade services in Europe.’36Oxera (ed.) (2007), which was thus assigned
Trang 59 Introduction
by the European Commission to close the research gap, developed a ology to monitor changes over time in prices, costs and volumes of securitiestrading and post-trading activities (covering services provided by CSDs/ICSDsand CCPs).37Despite Oxera’s important contribution, two important researchgaps continue to persist: no research to date has been provided on derivativesclearing costs Furthermore, no comprehensive analysis of both direct andindirect clearing-related costs has been undertaken.38Because measuring andisolating indirect costs is a difficult and highly complex task, Oxera’s studydoes not incorporate indirect costs
method-To summarise, the existing research on the industrial organisation of thepost-trade industry reveals a major shortcoming: although clearing servicesprovided by CCPs play a crucial role for financial markets integration,39there is
no comprehensive analysis of the industry structure and efficiency of EuropeanCCP arrangements So far, contributions have focused on CSD/ICSD-relatedresearch Regarding the existing literature on CSDs/ICSDs, Milne (2007) findsthat ‘[d]espite the economic importance of this industry it remains under-researched’;40the same is even more true for the area of CCP clearing Thescant research on the organisation of CCPs has thus far only been an off-shoot of CSD/ICSD-related research Furthermore, all of these CCP studiesconcentrate on securities clearing, and exclude aspects relevant for derivativesclearing
Understanding the industrial organisation of clearing therefore requires
a great deal of new work ‘We need thorough descriptive analysis of theindustry so that the profession fully understands the processes and servicesinvolved We need new theoretical models that explore the specific economicfeatures of this industry We need careful empirical studies that recognize theunique features of the industry.’41
38 Refer to section 3.2 for a definition of clearing-related direct and indirect costs.
39 Details on the clearing services provided by CCPs and the associated micro- and macroeconomic benefits are outlined in Chapter 2
40 Milne ( 2007 ), p 2946 41 Milne ( 2007 ), p 2947.
Trang 610 Clearing Services for Global Markets
the efficiency of CCP clearing and clearing industry structure It is the researchobjective to determine the impact that different cross-border integration andharmonisation initiatives between CCPs have on the efficiency of clearing.For the purpose of this study, these integration and harmonisation initiativesare referred to as ‘network strategies’ The results of this investigation allowconclusions to be drawn with respect to the most preferable future clearingindustry structure
Clear-cut definitions designed to avoid any further confusion about CCPand CSD/ICSD issues, together with a concise characterisation and descriptiveanalysis of the current state of the clearing industry, set the stage for thefollowing analytical objectives:
(i) Examine the efficiency of clearing:
r develop a method to assess the efficiency of CCP clearing;42
r identify, classify and analyse the clearing-related direct and indirecttransaction costs that market participants have to bear;
r generate insight into the nature and dynamics of these costs from theperspective of different market participants;
r provide a detailed qualitative and quantitative analysis of directand indirect clearing costs to enable benchmarking to other marketinfrastructure-related costs, such as trading and settlement
(ii) Provide a characterisation of the clearing industry structure:
r identify and analyse characteristics of the current clearing industrystructure
r classify archetypes of different network strategies;
r provide an overview of selected network strategies in the clearing try;
indus-r define potential demand- and supply-side scale effects in clearing;
r collect evidence for the existence of demand- and supply-side scaleeffects in clearing
(iii) Research the impact of different network strategies on the efficiency ofclearing:
r develop an innovative framework for analysis that integrates the spectives of different market participants and provides a graphicalillustration of the complex relationships between economies of scaleand scope, and network effects in clearing, their impact on transactioncosts and industry efficiency;
per-42 The term ‘clearing’ as used throughout this study refers to services provided by CCPs.
Trang 7r quantify the efficiency impact of different network strategies.
These analyses serve to identify the most preferable future clearing industrystructure and to deliver recommendations on the industry’s future develop-ment
The two core issues of research are efficiency of clearing and industry structure Clear-cut definitions together with a concise characterisation and descriptive analysis of the current state of the clearing industry set the stage for the following analytical objectives: besides defining the efficiency of clearing and identifying ways in which to measure it, this study aims to determine the efficiency impact of various cross-border ‘network strategies’, i.e integration and harmonisation initiatives between CCPs, within the clearing industry An assessment of this impact serves to identify the most preferable future clearing industry structure The research primarily focuses on analysing the European exchange-traded derivatives clearing industry In a final step, the research results are applied to European exchange-traded cash equities clearing as well as to Europe with respect to its global positioning.
1.4 Focus area of research
Action to promote financial integration in the field of clearing and settlement needs
to be taken urgently In a fast-evolving global financial system, there is a window
of opportunity to raise the euro area financial infrastructure to the highest levels of efficiency, competitiveness, sophistication and completeness The window of oppor- tunity was opened by the euro, but will not remain open forever The shape of the euro financial system is likely to be determined in the next few years and remain crystallised in that shape for a very long time 43
43 Tumpel-Gugerell ( 2006 ).
Trang 812 Clearing Services for Global Markets
This section briefly outlines the rationale for choosing to focus the research
on the exchange-traded derivatives clearing industry and on Europe
The research centres on exchange-traded derivatives clearing because CCPshave traditionally played a more significant role in this area than in cash equi-ties markets due to the characteristics of derivative trades.44 CCPs thus have
a much longer history in the context of derivatives clearing The rationalefor focusing on derivatives clearing further lies in the enhanced electronicand global market structure related to derivatives trading and clearing, whichsignificantly increases cross-border flows.45 The rapid growth of exchange-traded derivatives in the past decade has been accompanied by an increasinginternationalisation of the markets and their clearing arrangements.46Insti-tutional and individual traders worldwide continue to expand their use ofderivatives instruments Institutional investors in particular are increasinglytrading derivatives, such as single stock futures or options, in lieu of the respec-tive underlying stock.47Derivatives markets are therefore growing faster thanstock market activity The daily liquidity of many equity derivatives is morethan three times higher than the trading volume of the underlying stock,and the derivatives trading volumes continue to grow faster than the secu-rities trading volumes.48The exchange-traded volume of derivative financialinstruments, i.e futures and options on interest rates, exchange rates, cashequities and equity indices, has consequently grown enormously over the pastdecade.49It is therefore useful to study derivatives clearing and subsequentlyapply the findings to cash equities clearing The examination of clearing forcash equities markets will benefit from the derivatives clearing analysis.50
Despite the fact that the US clearing industry is often looked at as a modelfor Europe,51it is in some respects still more fragmented and less integratedthan its European counterpart.52 This is one of the reasons why Europe waschosen as focus area for the study Additionally, in Europe, the cross-borderintegration and harmonisation of the clearing industry has been spurred on
44 Details regarding the role of a CCP in cash equities and derivatives markets are outlined in Chapter 2
45 Cf Hasan/Malkam¨aki/Schmiedel (2002), p 12.
46 Cf Bank for International Settlements (ed.) (1997a), p 5.
47 Cf Deutsche B¨orse Group (ed.) (2005a), p 20 48 Cf Deutsche B¨orse Group (ed.) (2005a), p 20.
49 Cf Bank for International Settlements (ed.) (1997a), p 1 Note that the analysis does not cover clearing services provided for over-the-counter (OTC) derivatives trades CCP services have only recently been introduced to OTC markets Cf Bank for International Settlements (ed.) (2004), p 1 Additionally, the study focuses on financial derivatives and does not include derivatives on commodities such as sugar, cocoa, gold, etc.
50 Cf LCH.Clearnet (ed.) (2004a), p 2 51 Cf Corporation of London (ed.) (2005), p 19.
52 Cf Hart/Russo/Sch¨onenberger (2002), p 8 For more information on the European and American clearing industry, refer to section 2.5.2
Trang 913 Introduction
by the introduction of the euro and the ongoing process of European nomic integration, as outlined in section 1.1 Particularly the launch andimplementation of the Code have lent new momentum for the Europeanclearing industry,53which further underlines the vigour with which Europe
eco-is currently pursuing a fundamental restructuring of its clearing industry.These events serve as unique catalysts; comparable drivers are absent inthe US.54
1.5 Structure of study
This section provides a detailed outline of the study’s structure, including thesequence in which the various analyses will be conducted
The study consists of nine main chapters (Chapters 2 to 10) Chapter 2
sets the stage for the research by providing relevant definitions of clearing,indicating the value-added of CCP clearing and delivering insight into thevarious stakeholders in clearing An overview of the structural set-up of theEuropean and US clearing industries follows
Chapter 3defines the two core issues of research: the efficiency of clearingand the structure of the clearing industry For the purpose of this study, theefficiency is measured by the transaction costs that clearing members have tobear The transaction costs of derivatives clearing are defined and systema-tised to facilitate the analysis The clearing industry structure is researched interms of the different integration and harmonisation initiatives between clear-ing houses, with emphasis on certain inter-institutional arrangements called
‘network strategies’ Four archetypes of network strategies are presented, lowed by an overview of selected network strategies between clearing housesfrom 1973 to 2006
fol-A comprehensive empirical study was conducted to obtain insight intothe transaction costs of clearing as well as to derive a basis for analysing theimpact that network strategies have on clearing costs.Chapter 4introducesthe empirical study by describing the underlying data, the method of datacollection and the structure and component parts The data treatment andquality of the survey are also discussed The results of the empirical study arepresented inChapters 5and8
53 Cf McCreevy ( 2006b ), p 2.
54 Cf Hart/Russo/Sch¨onenberger (2002), p 6; and Sabatini ( 2003 ), p 1.
Trang 1014 Clearing Services for Global Markets
Introduction, Purpose of Study, Focus Area, Definitions and Industry Setting (Chapters 1 and 2)
Definition of Core Research Issues (Chapter 3)
Introduction to Empirical Study (Chapter 4) Basis for Analysis of the Impact of Network Strategies on Efficiency (Chapters 5 and 6)
Transaction Cost Studies
(Chapter 5)
Analysis of the Impact of Network Strategies on Efficiency (Chapters 7, 8 and 9)
Scale Effects in Clearing
(Chapter 6)
Future Development of the Clearing Industry (Chapter 10) Summary, Discussion and Recommendations for Future Research (Chapter 11)
Problem Definition, Research Gap, Purpose of Study and
Focus Area of Research (Chapter 1)
Network Strategies
Case Study Analysis
(Chapter 8)
Figure 1.1. Layout of the study
To evaluate the impact of network strategies on efficiency, it is first necessary
to learn more about the transaction costs as well as the demand- and side scale effects in clearing To this end,Chapter 5examines various aspects
supply-of European derivatives clearing costs, presents findings from the empiricalstudy and provides a number of quantitative and qualitative transaction costanalyses.Chapter 6classifies potential demand- and supply-side scale effects
in clearing and furnishes evidence of their existence
A three-step analysis of the impact of network strategies on the efficiency ofEuropean clearing comes next:Chapter 7establishes an original frameworkfor it The framework builds on the findings of the previous chapters andconsists of four matrices These provide the foundation for an assessment ofthe impact of various network strategies on efficiency The matrices also takeinto account other dynamics impacting the industry structures It is therebyrevealed that although some scenarios are cost-efficient, they are not neces-sarily profit-maximising for all clearing members The analysis conducted inthis chapter delivers preliminary findings on the impact of network strategies
Trang 1115 Introduction
on the efficiency of clearing.Chapter 8compares these conclusions with thecase study findings Final conclusions are then drawn regarding the impact ofnetwork strategies on the efficiency of European clearing Based on these find-ings, a quantitative assessment of the efficiency impact of European networkstrategies is presented inChapter 9
Based on the impact assessment of the different network strategies on theefficiency of European clearing,Chapter 10endeavours to determine the mostpreferable future European industry structure and delivers recommendationsfor its development Additionally, the research results are applied to Europeanexchange-traded cash equities clearing as well as to Europe with respect to itsglobal positioning
closes with a critical discussion of the research results The study concludeswith recommendations for further research
Trang 122 Setting the stage – definitions and
industry setting
The purpose of this chapter is to set the stage for the research conducted inthis study As relevant definitions are a prerequisite for any thorough analysis,the first step is to clarify the terminology used throughout this study (section2.1) Next, the value-added of clearing for individual market participants(microeconomic view) and for capital markets as a whole (macroeconomicview) and according to different asset classes (cash equities and derivatives) isoutlined insection 2.2
At this juncture, the so-called ‘Value Provision Network’ is introduced toilluminate the structural set-up of the clearing industry, including the differentlayers of access to the market infrastructure (section 2.3) The network consists
of the clearing house and market participants, both with direct (the called ‘clearing members’) and indirect access to the CCP (the so-called ‘non-clearing members’), whose access to the clearing house takes place throughintermediaries) An understanding of the Value Provision Network is criticalfor grasping the true underlying mechanisms of the clearing industry, whichinfluence the structural set-up and competitive dynamics relevant for thefuture development of the industry
so-Once this has been provided, the different stakeholders in clearing areintroduced (section 2.4), followed by an explanation and comparison ofthe current clearing industry structures in Europe and the United States
While the remainder of this study primarily analyses the Europeanexchange-traded derivatives clearing industry and its efficiency, the defini-tions provided inChapter 2 apply to both securities and derivatives clear-ing Particularities of securities versus derivatives clearing are identified andexplained
Trang 1317 Setting the stage – definitions and industry setting
SETTING THE STAGE – DEFINITIONS AND INDUSTRY SETTING
Clarifies terminology by providing a definition of clearing.
Outlines value-added of clearing for individual market participants, for capital markets as a whole and according to asset classes.
Defines the ‘Value Provision Network’ of clearing with its different layers of access to the clearing house.
Identifies the different stakeholders in clearing.
Provides an overview of the current clearing industry structures in Europe and the United States.
r The process view refers to clearing as a process that constitutes a vital part ofthe life cycle of a trade (section 2.1.1)
1 Bressand/Distler (2001), p 6.
2 Cf London Economics (ed.) (2005), p 3; and European Commission (ed.) (2005), p 5 Through its Clearing and Settlement Advisory and Monitoring Expert Group (the so-called CESAME Group), the European Commission is currently in the process of establishing a final report on definitions.
Cf CESAME Group (ed.) (2006), p 15 The CESAME Group holds a mandate from the European Commission to monitor and provide advice on European clearing and settlement For details, refer to CESAME Group (ed.) (2004).
3 The provided definition is consistent with and builds upon the view of important industry bodies and policymakers, as expressed in EACH (ed.) (2004c); European Commission (ed.) (2005); and European Commission (ed.) (2006d).
Trang 1418 Clearing Services for Global Markets
r The functional view focuses on clearing as a service and details the variousvalue chain components (section 2.1.2)
r The structural view concentrates on identifying the types and roles of typicalclearing service providers (section 2.1.3)
r The institutional view builds on the institutional characteristics of clearing(section 2.1.4)
In the context of financial services, clearing can refer to the processing ofpayment instruments or financial product transactions Because this studyfocuses on the clearing of financial transactions, the definition of clearingused here refers exclusively to securities and derivatives transactions.4 Thefollowing section provides a definition of securities and derivatives clearingaccording to each of the views outlined above
2.1.1 Process view
Clearing constitutes a vital part of the life cycle of a trade This life cycleconsists of execution, clearing and settlement By executing a trade, buyersand sellers enter into a specific legal obligation to buy or sell securities or, inthe case of derivatives, another underlying There are two sides to every trade:the buy position and the sell position.5
Settlement refers to the fulfilment of the legal obligation In the trading ofsecurities, fulfilment occurs when the ownership of the securities is exchangedfor cash or vice versa In the trading of derivatives, the legal obligation isfulfilled when the duration of a contract expires or when a close-out ofthe position occurs (i.e an offsetting sell contract for the holder of a buycontract is entered into and vice versa).6The process that takes place betweenexecution and settlement, i.e during the respective time lag, is referred to
as clearing.7 Whereas in the context of trading securities, this time lag isusually minimal (between one and five days), it can be substantially longer inderivatives trading (from one day up to several decades) During this time lag,trades need to be processed, managed, monitored and ultimately prepared forsettlement
4 For information on the parallels between derivatives clearing and clearing of payment instruments, refer
to Kroszner ( 1999 ), pp 16–17 Also see Bank for International Settlements (ed.) (2000a), pp 6–8 for further details.
5 Note that the term ‘position’ is commonly employed with reference to derivatives trades, whereas in the context of securities trades, the term ‘transaction’ is used.
6 Cf Edwards ( 1983 ), p 370 7 Cf Lannoo/Levin (2001), p 3; and EACH (ed.) (2004c), p 5.
Trang 1519 Setting the stage – definitions and industry setting
‘Trade is made’
By executing a trade,
buyers and sellers enter
into a specific legal
obligation, i.e to buy or
sell securities, or, in the
case of derivatives,
another underlying A
trade thus consists of two
positions: a buy and a sell
position
The process that occurs in between execution and settlement, i.e during the respective time lag, is referred to as clearing
During this time lag, positions need to be processed, managed, monitored and ultimately prepared for settlement.
When a trade is settled, the legal obligation is fulfilled.
Securities: Fulfilment of the
legal obligation occurs when the securities are exchanged for cash and vice versa
Derivatives: The legal
obligation is fulfilled when the duration of a contract expires and the delivery/cash settlement obligations are fulfilled respectively or through the prior close-out of the position, i.e the holder of a buy (sell) position enters into an offsetting sell (buy) position.
t n e m e l e S n
i u c x E
Clearing
LIFE CYCLE OF A TRADE
‘Positions are
Figure 2.2 Process view on clearing
Source: Author’s own.
r basic clearing services (section 2.1.2.1);
r value-added clearing services in general, with unique CCP services in ticular (section 2.1.2.2); and
par-r complementary clearing services (section 2.1.2.3).
Each of these clearing service levels has a different scope and comprises ferent functions, which are detailed in the next sections
dif-8 For details on different providers of clearing services and the scope of their services offered, refer to
section 2.1.3
Trang 1620 Clearing Services for Global Markets
VALUE-ADDED CLEARING SERVICES
Collateral Management Netting
Novation Risk
Management
Cash Management
BASIC CLEARING SERVICES
Trade
Confirmation
Delivery Management
COMPLEMENTARY CLEARING SERVICES
Transaction / Position Management
UNIQUE CCP SERVICES
Figure 2.3 Functional view on clearing
Source: Author’s own.
2.1.2.1 Basic clearing services
Clearing refers to the process that takes place between the execution of a tradeand its settlement The linking of trading and settlement processes creates theneed for a number of clearing services, which are essential to the life cycle
of a trade, including trade confirmation, transaction/position managementand delivery management These services are categorised as basic clearingservices
2.1.2.1.1 Trade confirmation
Trading entails a specific legal obligation between a seller and a buyer Once thisobligation has been entered into (through the execution of a trade), the tradeproceeds to the clearing process The first step in the clearing process is to assessthe consistency of the buyer’s and seller’s terms of trade in order to preventany unintentional errors.9This service is referred to as trade confirmation.10
Providing trade confirmation means to compare the trade details of the selland buy instructions in order to identify and link the related transactions Thiscommonly includes identifying the security or type of contract, the quantity ofthe security or other underlying, the invoice price and the settlement, delivery
or expiry date.11
9 Cf Moser ( 1998 ), p 4; Bank for International Settlements (ed.) (2001), p 9; Giovannini Group (ed.) (2001), p 4; Kr¨opfl ( 2003 ), p 17; Iori ( 2004 ), p 8; NERA Economic Consulting (ed.) (2004), p 7; and Linciano/Siciliano/Trovatore (2005), p 4.
10 Cf Bank for International Settlements (ed.) (2001), p 9; and Guadamillas/Keppler (2001), p 7.
11 Cf Moser ( 1998 ), p 4; and Iori ( 2004 ), p 8.
Trang 1721 Setting the stage – definitions and industry setting
2.1.2.1.2 Transaction/position management
Positions need to be processed and managed until the respective legal tions are successfully fulfilled The need for and intensity of this managementstrongly depends on the type of asset class It is for this reason that transac-tion/position management can either be classified as a basic clearing service
obliga-or as a value-added clearing service – depending on the scope of managerialservices offered
As outlined earlier, in the context of securities transactions, the legal gation is usually fulfilled within a very short time frame, i.e the standardsettlement period, which is a predetermined date as close as possible to thetrade day (T+ 1, T + 2, T + 3, etc.).12Fulfilment of the legal obligation forderivatives positions, on the other hand, may require much longer time frames.Important managerial services provided between the execution and ful-filment of the legal obligation include corporate action services during thisperiod13as well as any previously announced transfer of pending obligations toanother counterparty (e.g position transfers, give-up and take-up services).14
obli-A counterpart or counterparty is the contracting party in a trade.15
The standardisation of exchange-traded derivatives enables previouslyestablished sell (short) or purchase (long) positions to be offset via appro-priate opposite positions (close-out).16 In this case, the actual fulfilment ofthe contract, i.e the delivery or purchase of the underlying, is no longernecessary.17 When derivatives are traded, there always remain a number ofcontracts – both bought and sold – that are not closed out, settled or delivered
on any given day and thus remain open.18 The total number of outstandingoptions and/or futures contracts that are held by counterparties at the end of
12 T = the day on which the trade is made 1, 2, 3, etc stand for the number of elapsed business days before the legal obligation is fulfilled.
13 ‘Corporate actions covers a wide range of activities including the collection of interest and dividends from the issuer, the allocation of interest and dividends to the legal owner of the securities, and the evaluation and correct processing of issuers’ corporate transactions (stock splits, capital increases, rights, spin-offs, etc.) for the benefit of the legal owner of the financial instrument in question These transactions do not have to be limited to cash securities only, as they may also have an impact on derivatives or other financial products.’ EACH (ed.) (2004c), p 4.
14 Cf EACH (ed.) (2004c), p 5 When a so-called ‘give-up’ occurs, the counterparty A executing a trade relinquishes the trade to another counterparty B This is done because the executing counterparty A placed the trade on behalf of the other counterparty B as if B had actually executed the trade Reasons for this might include capitalisation issues on the part of counterparty B, i.e a thin capitalisation prevents B from maintaining a large order Cf Moser ( 1998 ), p 4 However, various other reasons related to market access customer relationships, etc on the part of counterparty B can motivate a give-up The term ‘take- up’ refers to the reverse process on the part of B; whereas A gives up the trade to B, counterparty B takes
up the trade from counterparty A.
15 Cf Eurex (ed.) (2003a), p 65 16 Cf Eurex (ed.) (2003b), p 11.
17 Cf Eurex (ed.) (2003b), p 11 18 Cf Loader ( 2004 ), p 215.
Trang 1822 Clearing Services for Global Markets
each trading day is referred to as ‘open interest’.19Open interest of traded derivatives is held at and managed by the clearing house Transactionmanagement is particularly important in this context and usually comprisesadditional value-added services related to the exercise of option positionsand expiry of future positions These additional services may also entail theissuance of daily reports pertaining to transactions, modifications and expo-sure components.20
exchange-2.1.2.1.3 Delivery management
Delivery management constitutes the final service within the clearing cycle
It is the process of preparing the settlement instructions21 for securities orcash (which can originate from cash equities, derivatives, bond or repurchaseagreement (repo) trades or swap contracts) or, in the case of derivatives,another underlying Settlement instructions are then sent to the respectivesettlement institutions.22 It should be taken into account that settlementinstructions only result from derivatives transactions if a position has notbeen closed out prior to the expiry of the contract
2.1.2.2 Value-added clearing services
[Clearing] is what must take place before [settlement] is undergone, in order to enable
a proper exchange of ‘good securities’ for ‘good money’ ‘Enabling’ however can also mean ‘adding value’ 23
In addition to the basic clearing services described earlier, clearing oftencomprises a much greater spectrum of services Whereas these additionalservices are not essential to the life cycle of a trade, they offer important value-added to the trade’s counterparties These services are therefore referred to asvalue-added clearing services These comprise unique CCP services, such asnovation, netting and risk management, as well as transaction/position man-agement, collateral management and cash management The scope of nettingand risk management services that a CCP can offer is unique Nonetheless,other clearing service providers can also offer these services, albeit in a more
19 Open interest is not the same as the traded volume of options and futures contracts For each seller of
a futures contract, there must be a buyer Thus, a seller and a buyer combine to create one contract Volume represents the total number of contracts that have changed hands in a given product and during
a given period In contrast to the volume, the open interest relates to a certain fixed point in time For example, if the parties to a trade initiate a new contract, open interest and volume will increase by one contract each If a position is closed out, open interest will decline by one contract and volume will increase by one On the other hand, if a trader passes off his or her open position to another trader, the open interest will not change and volume will increase by one.
20 Cf EACH (ed.) (2004c), p 5 21 Cf Schiereck ( 1996a ), p 189.
22 Cf EACH (ed.) (2004c), p 5. 23 Bressand/Distler (2001), p 6.
Trang 1923 Setting the stage – definitions and industry setting
limited capacity This is why netting and risk management services can either
be classified as value-added clearing services or as unique CCP services –depending on the type of service provider
2.1.2.2.1 Unique CCP services
Due to the nature of derivatives products (especially the leverage effect)24
and the potentially significant time lag between execution and settlement
of derivatives (which can lead to a build-up of large unsettled exposuresbetween market participants),25the evolution of derivatives clearing serviceshas been shaped by the counterparties’ desire to control their risk of lossesfrom non-performance.26This desire led to the introduction of the so-calledcentral counterparty (CCP): ‘[a]n entity that interposes itself between thecounterparties to trades, acting as the buyer to every seller and the seller toevery buyer.’27
Compared to the market structure of bilateral relationships between terparties, CCPs offer a number of important clearing services Some of theseservices are unique to the CCP structure in terms of their scope and nature;they are therefore referred to as ‘unique’ CCP services Although CCPs havelong been solely associated with derivatives clearing services,28 their use inexchange-traded securities markets has also become common Central coun-terparty clearing has become an integral part of modern clearing services29and forms a core part of the financial market infrastructure in most developedeconomies.30
coun-2.1.2.2.1.1 Novation Novation is a crucial unique CCP service It refers to the
legal process of replacing the original counterparties to a trade with a single(thus central) counterparty to both sides of the transaction.31
counterparties A and B to assume their rights and legal obligations, therebybecoming the buyer to every seller and the seller to every buyer The process
of novation replaces the original bilateral contractual obligations by new
24 The leverage effect of derivatives signifies the effect to which the value of a derivative position is greater than the value of the underlying Cf Rettberg/Zw¨atz (1995), p 101.
25 Cf Knott/Mills (2002), p 162.
26 Cf Moser ( 1998 ), p 7; Knott/Mills (2002), p 162; and Ripatti ( 2004 ), p 4.
27 Bank for International Settlements (ed.) (2001), p 45.
28 Cf Bank for International Settlements (ed.) (2004), p 6.
29 Cf Ripatti ( 2004 ), p 4 30 Cf Knott/Mills (2002), p 162.
31 Cf Giovannini Group (ed.) (2001), p 12; Lannoo/Levin (2003), p 3; Wright ( 2003 ), p 2; Ripatti ( 2004 ),
p 5; and BNP Paribas Securities Services (ed.) (2005), p 5.