The Changing Role of CSDs in the Post-Trade Industry in Europe

In this chapter Central Securities Depositories (CSDs) are analyzed, in playing an essential role in the European post-trade market. The background is presented, describing their services both on domestic level, and in a cross border context in Europe. CSDs have introduced (self) regulation and this chapter outlines the efforts they are making to remove existing barriers in a still fragmented European post-trade market, in order to achieve more efficiency. Particular attention is given to the changes and challenges the CSDs face with respect to the Central Security Depository Regulation (CSDR) and Target2-Securities (T2S), which is an initiative of the Eurosystem and is expected to go live as of June 2015. T2S will connect CSDs within the European area, performing as a cross border securities settlement engine.

Ownership, Incentives and Regulation of CCP Risks

This chapter develops a framework to analyse the factors influencing central counterparties' (CCPs') risk controls and the role of regulation. The framework illustrates the importance of sound regulation of CCPs and helps to explain why different CCPs may make different risk management choices. Key factors include ownership, governance and the profile and preferences of participants. International standards for the design and operation of CCPs and other financial market infrastructures (FMIs) are reflected in the Principles for Financial Market Infrastructures (PFMIs). Modelling key elements of these standards, the chapter demonstrates the importance of a flexible regulatory framework that achieves the desired level of stability while allowing the mix of risk controls applied by each CCP to vary according to its particular incentives and operating environment. The chapter goes on to discuss the emerging trends towards competition and interoperability between CCPs and cross-border provision of clearing services, and consider the implications for CCPs' risk management choices.

CCPs: A Challenge for Practical Oversight

As a first step a short summary of the historical development of CCPs is provided, followed by an outline of the concept and core functions CCPs. Then an illustration of the main risk management safeguards of CCPs is provided. This includes an excursus regarding the hier-archical structure of clearing and regarding procyclical considerations with respect to CCPs. The outline of CCP counterparty risk management is complemented by a brief overview of other risks, including liquidity risk, legal risk, and operational risk. The consideration of the risk profile of CCPs is concluded with some insight into the main factors determining the oversight of CCPs' governance. The full picture of CCPs from an oversight perspective is given by placing the CCPs in the clearing process and the outlining the resulting challenges for regulatory oversight. The chapter concludes with a description of the manifold layers of today's oversight of CCPs.

FMIs – Knights in Shining Armour?

Great hope is being pinned on FMIs. They lie at the heart of the financial system and enable the post-trading business by successfully completing trades and concentrating as well as mitigating risks. This end of the payment and securities settlement business does not usually attract much attention: It is expected to be there and function. In this respect, it is comparable to oxygen in the air – most people do not think about it, however, if something is wrong with it, things can turn bad extremely quickly. Such was the case with the Lehman crisis of 2008, playing a major role in the unfolding of the global crisis of the late 2000s. It became apparent just how vital these FMIs were in enabling the continuation of the globe's securities & derivatives exchanges. In particular, CCPs played a major role in keeping transaction processing ticking over. It became evident which knock on effects the downturn of one institution can have on the global financial landscape. As such, we all depend on those markets and on the performance of what can only be described as ‘knights in shining armour'.

The role of Financial Market Infrastructures in Financial Stability

Financial Market Infrastructures (FMIs) are essential for the well-functioning of the financial system, as they play a central role in facilitating clearance and settlement of financial transactions such as payments, securities, and derivatives contracts. Nowadays, it is widely acknowledged that the proper functioning of systemically important FMIs is also vital to maintain financial stability; their failure for solvency reasons or operational disruptions could almost certainly lead to systemic instability. As a consequence, the adequate supervision of FMIs is inherent to the function of preserving financial stability. The aim of this chapter is to provide a general overview of the different FMIs; discuss their role in financial stability and to give an overview of the efforts made by some financial authorities towards the supervision, risk assessment and reinforcement of FMIs.

Intraday Liquidity Flows within the Financial Market Infrastructures in Mexico

In this chapter, the authors present a methodology to study the flow of funds in large-value payment systems (LVPSs). The algorithm presented differentiates the flow of payments into two categories: 1) external funds, i.e. funds transferred from other financial market infrastructures (FMIs) or provided by the central bank, and 2) the reuse of incoming payments within the same FMI. Using individual transaction data, the algorithm evaluates to what extent incoming payments are used to cover obligations. The method also studies the flow of intraday liquidity under the framework of its provision within Mexican FMIs. The aim is to evaluate the impact of intraday liquidity provision, and understand how liquidity is transmitted to participants in the Mexican Large Value Payment System, or SPEI®.

Overconfidence in the Credit Card Market

High credit card debt default has been symptomatic for the U.S. and other countries in the last decades. Different explanations for this situation exist in the literature. One explanation is overconfidence, which has become a key concept in behavioural economics for explaining anomalies in financial markets such as excessive trading volume. There is also the idea that overconfidence is to blame for high credit card debt. In this paper, an agent-based model is presented that examines the effects of overconfidence on credit card usage. Overconfidence is used here to explain why people who never intend to borrow on their credit card(s) do so anyway. The model contains consumption, two means of payment (credit card and cash), and a distortion to agents' income expectations via overconfidence. It was found that overconfidence leads to more “accidental” borrowing and higher interest rates.

Using FMI Transaction Data in Simulations

In this chapter the authors provide a method to aggregate large value payment system transaction data for executing simulations with the Bank of Finland payment simulator. When transaction data sets get large, simulation may become too time consuming in terms of computer power. Therefore, insufficient data from a statistical point of view can be processed. The method described in this chapter provides a solution to this statistical problem. In order to work around this problem the authors provide a method to aggregate transaction data set in such a way that it does not compromise the outcome of the simulation significantly. Depending on the type of simulations only a few business days or up to a year of data is required. In case of stress scenario analysis, in which e.g. liquidity position of banks deteriorates, long time series are preferred as business days can differ substantially. As an example this chapter shows that aggregating all low value transactions in the Dutch part of TARGET2 will not lead to a significantly different simulation outcome.

Mind the Gap: Undercollateralization in the Global and Canadian OTCD Markets

We provide estimates of the collateral gap in the global and Canadian OTCD markets. Using the latest available data as of December 31 2011, it is estimated that current exposures after netting are $3.9T globally and $71B in Canada. The estimated amount of available collateral after correcting for re-hypothecation in each market is $767B and $48B, respectively. Thence, the current gap in variation margins stands at $3.1T globally and at $23B in Canada. The initial margin that would be required to centrally clear OTCD is estimated at $4T globally and $104B in Canada. The rate of collateralization has increased globally, but specially in Canada. In 2001, 92% of global and 72% of Canadian current exposures were undercollateralized; currently, the figures are 80% for global and 30% for Canadian current exposures. The high level of collateralization and the lack of re-hypothecation could make the Canadian market more resilient to systemic shocks. Further, it is likely that the upcoming regulatory reforms will have a more subtle impact on Canadian banks than on banks elsewhere.

Payment System Analysis

Together with the growing importance of stable and efficient payment systems, payment systems analysis has gained importance in the recent years. Central banks play the most prominent role in this field since they have unique responsibilities but also unique opportunities. This chapter will systematize the different aspects of payment system analysis and show their respective importance from a central bank perspective. This will be done both from a theoretical but also from a practical point of view by giving examples of actual work in this field. Three types of Payment system analysis will be distinguished: Payment system analysis in the broad sense of the term, the analysis of particular payment systems and the use of payment system data.