CONCEPT PAPER FOR AN INTEGRATED CAPITAL MARKETS ARCHITECTURE IN AZERBAIJAN
Dr. Fred Reinertz EU Short term expert capital markets architecture Baku, February 2010
Table of Contents
1. Introduction.......................................................................................6 2. Definitions.........................................................................................7 3. Information flows and information systems for securities trading.......18 4. Securities trading information flow ...................................................18 4.1. Pre-trade........................................................................................................18 4.2. Trading........................................................................................................... 18 4.3. Post-trade.......................................................................................................18 4.4. Clearing-Settlement-Custody ........................................................................19 5. Categories of capital markets information systems............................19 5.1. Information collection and distribution ..........................................................19 5.2. Trading tools..................................................................................................20 5.3. Order-routing systems ...................................................................................20 5.4. Order-presentation systems ..........................................................................23 5.5. Settlement and custody systems ..................................................................23 5.6. Surveillance systems......................................................................................25 6. The prevailing legal and regulatory framework in the EU....................25 6.1. The main EU Directives on capital markets....................................................25 6.2. The institutional links among capital markets operators................................25 6.3. The role of professional capital markets participants.....................................26 6.4. The role of the Capital Markets Regulators....................................................27 7. The prevailing capital markets architectural models in the EU.............27 7.1. The Euroclear model .....................................................................................27 7.1.1. IT Architecture..........................................................................................27 7.1.2. Organisational links among various capital markets stakeholders...........28 7.1.3. Institutional links among various capital markets stakeholders ..............28 7.2. The Clearstream model .................................................................................30 7.2.1. IT Architecture..........................................................................................30 7.2.2. Organisational links among various capital markets stakeholders...........30 7.2.3. Institutional links among various capital markets stakeholders...............30 7.3. Comparisons between the two.......................................................................32 8. The prevailing capital markets architectural models in emerging markets...............................................................................................33
8.1. The Turkish model..........................................................................................33 8.2. The Russian model.........................................................................................34 8.3. Benchmarking vis a vis the EU capital markets architectures........................35 9. The proposed architecture for Azerbaijan..........................................37 9.1. Action plan and time frame for implementation.............................................37 9.1.1 Global Strategy.........................................................................................37 9.1.2 Main general task......................................................................................37 9.1.3 Main actions and priorities........................................................................38 9.1.4 Ancillary tasks...........................................................................................40 9.2. The capital markets operators’ positions........................................................41 9.2.1. The Baku Stock Exchange .......................................................................41 9.2.2. The National Depository Centre...............................................................43 9.3. The Capital Markets Regulator.......................................................................45 9.4. The professional capital markets participants................................................45 9.4.1. The Investment firms...............................................................................46 9.4.2. The Banks licensed to provide investment services.................................46 9.4.3. The Custodian Banks................................................................................46 9.4.4. The professional capital markets associations.........................................47 9.5. Linkages among them....................................................................................47 9.6. The necessary reforms from the legal and regulatory point of view..............47 9.6.1 the operational aspects of the capital market in Azerbaijan.....................47 9.6.2 Important..................................................................................................48 9.7. The necessary organisational and institutional reforms.................................49 10. Conclusions (benefits from the proposed model).............................51
0. Executive summary The concept proposal for an architecture of a capital markets structure in Azerbaijan is placed in the more general frame of the overall objective of the project , that aims at improving the economic development of Azerbaijan and to reduce the dependence on the oil sector, (cit. the TOR’s, the terms of reference of the project). In this context, the mission of the consultant when defining the sketch of an integrated new capital market design and structure did focus also on analysing and formulating recommendations to improve the existing domestic Azeri capital market with an end-state analysis. This concept paper should also serve the purposes of a later subsequent technology evaluation and the development of a standard electronic IT platform for the implementation of the structural proposals as issued. The capital market architecture presented in this paper is feasible with the current technology, It is based on the end-to-end functionalities of the in the actual present capital markets embryonic elements, It takes into account all internal requirements of the market participants. Various architectural and ethical issues are broached as well and discussed, sketching a framework for further project work in the matter under review. The structure itself as proposed is compliant with the actual prevailing EU regulations in matters of capital markets organizational set-up and the due Regulatory supervision. The consultant did seek “EU acquis communautaire” adhesion of the present proposal as the necessary foundation of the architecture. In compliance with the requirements as outlined in the TORs, the projects’ terms of reference the paper will encompass: An action plan for the Azeri capital markets proposed architecture, with emphasis on the capacity building and/or strengthening process for its key components as well as a structured transition action plan for the existing present Azeri capital markets elements. The action plan will contain recommendations for recommendable capital markets architecture in Azerbaijan. It puts the emphasis on the role of the Depository House as the pivotal core element. It also recommends the establishment of custodian banks. It will issue recommendations on the organizational and operational structure of the NDC with emphasis on the Risk Management system. It will opine also on the establishment of a reliable Delivery Versus Payment (DVP) system, and the functioning of the clearing and settlement operators in the market. The consultant’s intervention will also address the following issues: Recommendations on the organisational structure of the capital markets organizations with emphasis on: a comprehensive diagnosis of current trading, settlement and supervision infrastructure of Securities market in Azerbaijan on institutional, normative and operational level,
benchmarking against best practices adopted in developed and other emerging markets, a significant GAP analysis and elaboration of conceptual recommendations for an optimum infrastructure.
particularly in computers and telecommunications. Introduction
The elaboration of a proposal for a capital market structure requires. Needless to say it is the starting point for elaborating a capital markets structure proposal. the State Committee for Securities. as only a comparative study with pros and cons would be a meaningful tool to opine on that issue. SCS. In Annex 1 the consultant has attached a schematic presentation of the status quo of the structures as prevailing in the different European capital markets. It was elaborated by a project team member and is known to the project beneficiaries. NDC and the Baku Stock Exchange BSE as the first involved parties. It could be recommended to be undertaken only if the actual project would require a more enhanced approach.6
1. the relevant capital market functionalities. The functionalities to structure. Although the final beneficiaries of the proposed capital market architecture are the market participants. commodities. This will be based on the respective merits of the in the EU capital markets competing structures. in a capital markets architecture proposal that wants to take into account the best practice as prevailing in the EU capital markets. the project as such was designed for duly perusal by the Regulator. Securities trading are a financial activity involving transactions of property such as stocks. It must be outlined that there is no uniform structure or type of capital markets set-up in the European Unions’ capital markets. Their efficient. while still vitally important in major cities around the world. it would require an allocation of project man days to be performed. and currency. by poaching in the different structural set-ups as used in Europe. the multilateral trading facilities (they are mentioned in the MiFID directive. The first issue to be addressed is how to structure adequately. in the process. as the MTF’s. the Member State’s diversity is nevertheless always taking into account the in the “EC acquis communautaire” given rules and requirements. linking investors with brokers and dealers both on a domestic and an international level. has brought about a new era in securities trading. safe and sound operation depends on the three key types of infrastructures – exchanges. This EU directive also explains the
. It would exceed the scope of this paper to pass in review in full details the different architectures. or to whom to allocate. The advent of new technologies. bonds. this in view to determine the usefulness of the proposed structure for the beneficiaries and the different stakeholders of the project. are well known. Traditional stock exchanges. now compete with such over-the-countertrading organizations and other similar systems that allow computerized trading. the National Depository Centre. the examination and evaluation of the basic components such a common structure. The consultant intends to recommend a more specific and tailor made capital market architecture for Azerbaijan. central counter-parties and central securities depositories.
launched in 11th December 2009 by Nomura Securities Ltd. Chi-X. the list is long but the subject is complex. C Cash Account In the ESES context. A Account operator In the context of ESES. Definitions
This is a list of the most common used terms in the context of capital markets: courtesy from Euroclear and the consultant’s definition data base. NX MTF . They often use a so called “dark pools” approach in matters of securities trade processing. Turquoise. launched in March 2007. and the info may be useful in the context. launched in August 2008.in a way that results in a contract in accordance with the provisions of Title II in MiFID. which brings together multiple third-party buying and selling interests in financial instruments .in the system and in accordance with non-discretionary rules . BATS Europe . launched in October 2008. there are several MTFs operational now: POSIT. and on behalf of. QUOTE MTF . Equiduct-Berliner Börse.launched 4th September 2009.
2. which is operated by the Euroclear CSDs
. launched in 1998. NASDAQ OMX Europe. In the EU.7
whereabouts and set up’s functionalities in more details. operated by an investment firm or a market operator. A Multilateral Trading Facility (or MTF) is a multilateral system. a cash account opened by a Settlement Bank with a central bank in accordance with the Cash Account Documentation. launched in September 2008. B Bridge The 'Bridge' is the name used for the processes established between Euroclear Bank and Clearstream Banking Luxembourg that permit cross-systems settlement of a trade between a customer of one ICSD and a customer of the other ICSD. a Client that has been authorized by one or more Parties to send instructions in the name of. The appearance of MTF’s is one of several actions that aim to improve the access of small and medium sized enterprises to capital through new share. a pure dark-pool MTF operated by ITG. NYSE Arca Europe. bond and rights issues. each of such other Parties in relation to the latter's Securities Account(s) and the Cash Account linked thereto. launched in March 2009.
. Central CCPS must also have direct or indirect access to the SSS. CCP stands for Central counterparty An entity that is the buyer to every seller and the seller to every buyer of a specified set of contracts/obligation (e.g. Securities Settlement Systems where transactions are ultimately settled and securities held. CBA Central Bank of Azerbaijan Central bank money (CeBM) Settlement is described as being in central-bank money if payment moves directly and irrevocably between accounts on the books of the central bank. those executed on a particular exchange).
Cash Correspondent A financial institution that executes cash transfers on behalf of its clients. in the context. Central Securities Depositary (CSD) An entity which operates a system enabling clients to hold. Cash Accounts may also be referred to in the Euroclear Contractual Documentation as 'cash positions in Central Bank Money (CeBM). In order to be able to settle the novated transactions. Also referred to. as the Liquidity position.8
on behalf of the relevant Central Bank in connection with the use of the CSD System or a system operated by another Euroclear CSD. CCPs typically interpose themselves between the counterparties to trades. acting as the buyer to every seller and the seller to every buyer (“novation”). manage and transfer securities by CNS Continuous Net Settlement CoBM Commercial Bank Money (CoBM) Settlement is described as being commercial money if the payment moves between the accounts of banks (in contrast to central bank money). Cash position in Central Bank Money Balance in a central bank money account on a settlement platform operating the integrated settlement model.
Debtor The party that owes assets to the creditor. CSD Central Securities Depositary D Dark pool Dark pools of liquidity (also dark pools or dark liquidity) are crossing networks that provide liquidity that is not displayed on order books in an MTF context.g. transfer instructions for both securities and funds are settled on a trade by trade basis. it may be an agent or the debtor. Dark pools are recorded as over-the-counter transactions. gifts.[ Debit party The party that gives cash or securities. Dark liquidity pools offer institutional investors many of the efficiencies associated with trading on the exchanges' public limit order books but without showing their actions to others. Furthermore. DVP model 1 One of the three DVP schemes. The debtor may also be the debit account owner. Default Failure to complete a funds or securities transfer according to its terms for reasons that are not technical or temporary. usually as a result of bankruptcy. Therefore detailed information about the volumes and types of transactions is left to the crossing network to report to clients if they desire and are contractually obligated. In model 1. as defined by the G10. In the payment chain.9
Payment between a Euroclear group customer using central bank money and another Euroclear group customer using commercial bank money. This is useful for traders who wish to move large numbers of shares without revealing themselves to the open market. as a result of receipt of goods or services. with final transfer of the securities
. or charity payments. Modern trading platforms and the lack of human interaction has reduced the time scale on market movements. This increased responsiveness of the price of equity to market pressures has made it more difficult to move large blocks of stock without affecting the price. Dark Pools in funds to line up and move large blocks of equities without tipping their hands as to what they are up to. Default is usually distinguished from a failed transaction. e. Dark liquidity pools avoid this risk because neither the price nor the identity of the trading company is displayed. one party always plays the role of the debit party and the other the role of the credit party. for each pair of consecutive parties in the payment chain.
F Final agent A financial institution of the creditor that receives the payment transaction on behalf of an account owner or other nominated party.10
from the seller to the buyer (delivery) occurring at the same time as final transfer of the funds from the buyer to the seller (payment). Hence. Escrow balance See 'restricted balance' ESES Euroclear Settlement of Euronext-zone Securities eXtensible Markup Language (XML) Simple and very flexible text format derived from Standard Generalized Markup Language (SGML) (ISO 8879). and posts the transaction to the account. See Beneficiary of money (Securities Industry). Its primary purpose is to facilitate the sharing of data across different systems. Ultimate beneficiary (Payment Industry). whose account will be credited by the final agent. Final party The party that is the ultimate beneficiary of the cash transfer. it is possible to buy stocks without immediately settling and benefit from an anticipated rise of the stock or to short sell the stock not yet purchased. The final party is mentioned when different from the creditor. The eXtensible Markup Language (XML) is a W3C-recommended general purpose mark-up language for creating special-purpose mark-up languages. particularly systems connected via the internet.
. E ECSDA European Central Securities Depositories Association End-of-month settlement (SRD) End-of-month settlement is the opposite from rolling settlement whereby the settlement date of a party's securities transaction instruction is deferred until the end of the month. Final settlement The discharge of an obligation by a transfer of funds and a transfer of securities that have become irrevocable and unconditional.
I ICSD International central securities depository Identifiable bearer security (TPI) Based on the French legal framework. Instrument family The first qualifier in the CFI . services to create a fair and open process for the execution of transactions between trading parties. These tools consist of a set of syntax and message design rules. through common membership. securities' holders registered on the custodians’ books. Certain holders declared by the custodians may have the status of registered intermediary. a dictionary of data fields and
. and the creation of settlement obligations. and processes the instruction. see below systematic Internaliser definition ISO 15022 International standard which sets the principles necessary to provide the different communities of users with the tools to design message types to support their specific information flows. usually through direct or indirect (through local agents) links to local CSDs. (French acronym) Infrastructure The party that provides. An ICSD also settles trades in international securities and in various domestic securities. Synonym: security family.11
First agent A financial institution of the debtor that receives the payment transaction from either the account owner or authorized party. and which enables transactions to be processed by book entry. Internaliser In the context of the EU’s basic capital market directive MiFID.ISO 10962 classification of a security. the ICSD offers its services in the Full Service.ISO 10962 classification of a security. it is a service in Euroclear France that allows an issuer of bearer securities to request and obtain a list of. Within Euroclear group. Instrument category The second qualifier in the CFI . International Central Securities Depository (ICSD) An entity in which securities are held and managed. all or part of.
MiFID Stands for the EU’s Directive 2004/39/EC of the European Parliament and of the Council of 21 April 2004 on markets in financial instruments. L Legacy platform One of the current input. which brings together multiple third-party buying and selling interests in financial instruments .newly published standard which provides the usage of a common platform for the development of messages. in the case of dematerialized securities. Issuance Accounts are not considered as Securities Accounts for the purposes of the Terms and Conditions. ISO 20022 Financial Services It is a Universal Financial Industry message scheme (UNIFI) . any account opened in the name of an issuer in the books of the CSD on the debit of which all securities of a same issue which are admitted by the CSD are recorded.in a way that results in a contract in accordance with the provisions of Title II in the EU’s MiFID capital market basic directive. all securities of the relevant issue will be recorded on the debit of the Issuance Account.in the system and in accordance with non-discretionary rules . settlement and/or reporting systems in the Euroclear group’s (I)CSDs. Liquidity sweep Any automated transfer of cash from a Cash Account to the corresponding RTGS Cash Account M Matching It is the process for comparing the trade or settlement details provided by counterparties to ensure that they agree with respect to the terms of the transaction. N Netting
. matching. Issuance Account In the ESES context. the basic capital market directive MTF a Multilateral Trading Facility is a multilateral system. operated by an investment firm or a market operator.12
a catalogue for present and future messages built by the industry with the above mentioned fields and rules.
Purchasing power A settlement bank's cash position in central bank money and its collateral value of securities that may be used for auto-collateralization with the central bank (when allowed by the relevant central bank). the investor. P Payment settlement agent An agent that executes the cash transfer upon the request of either an agreement party. and administers investor accounts and related records. Nominee A person or entity named by another to act on his behalf. It prepares and distributes account statements (holdings and transactions) to the investor and/or its intermediary. Also referred to as a liquidity provision. Netting may take several forms. O Omnibus account A single Securities Account within which the Securities Account Holder co-mingles the assets of two or more underlying clients. and settlement parties.13
Stands for an agreed offsetting of positions or obligations between counterparties. See 'Trustee'. The netting reduces a large number of individual positions or obligations to a smaller number of obligations or positions. In the context of investment funds. Registrar The party that is responsible for keeping track of the owners of securities. rather than in separate accounts with designation. R Real-time gross settlement system (RTGS / RBTR) Settlement system in which occurs the continuous (real-time) settlement of funds or securities transfers individually on a transaction-by-transaction basis (without netting). on a periodical or upon request basis. or a clearing agent. These records represent the liability accounts of the fund management company. A nominee is commonly used in a securities transaction to obtain registration and legal ownership of a security. as required to all parties involved in the trade transaction including counterparties. Post-trade administrator The party ensuring that all the details of the trade have been collected and reported. the party appointed by the fund management company that keeps the investor registry of the fund. It may provide tax information to the
and accounting services for its own. The lending of securities in an exchange for a fee. and can appoint the sub-registrar. at an agreed price and date. but not offered directly. Settlement agent The party that provides settlement. Settlement Delivering securities and/or making payments in the performance of obligations between the counterparties to a transaction. with or without a guarantee. (I)CSDs and banks. or someone else's. which is thus registered with its central bank for the purpose of processing payments. Settlement Bank
. Securities lending is mostly facilitated by CSDs. either free of payment (FOP) or against payment (Delivery Versus Payment-[DVP]).14
investor and/or to its intermediary. reports to the regulator on shareholder identity. custody. Securities Settlement System (SSS) A system which permits the holding and transfer of securities. can be the corporate secretary for the proxy voting. such as custodians that directly offer securities lending. Settlement account An account held by a direct participant of a national RTGS system. RNC Continuous Net Settlement Rolling settlement A practice in which settlement takes place a standard number of business days after the date of the trade. possess a banking license and are regulated by existing banking law. RTGS Real-time gross settlement system S Securities loan / Securities lending / Securities borrowing Securities finance mechanism that involves transferring full ownership of securities. with a contractual agreement that the seller will repurchase the securities in return for the guarantee. assets. if there is a guarantee.
Single Settlement Engine (SSE) The first building block of the Single IT Platform. Settlement date Date at which the financial instruments are to be delivered or received. positioning and booking of cash and securities transfers).15
A Client which is permitted under the Standard Form Agreement it has entered into with a Euroclear group CSD to make and/or receive payments by means of the (I)CSD Systems as a bank for the account of itself and/or one or more other Clients in connection with the Domestic Service. Settlement Finality Directive Directive 98/26/EC of the European Parliament and of the Council of 19 May 1998 on settlement finality in payments and securities settlement systems.e. Settlement liquidity limit The amount of liquidity or credit which a settlement bank has notified to the CSD as being available to a settlement bank client during each Business Day. as above). Single Shared Platform (SSP) The new platform of European Central Bank. It reflects the liquidity resulting from the settlement bank client’s activity in the Securities Settlement System (SSS). also known as TARGET2. concentrating on the core settlement (i. an IT platform shared by all Euroclear group (I)CSDs hosting the (I)CSD Systems.e. Single Platform The long-term solution. which will be shared by a number of participating national central banks. Settlement liquidity indicator The liquidity position of a client in the system that uses the services of a settlement bank (i. Settlement Bank Client A Client who has appointed a Settlement Bank to provide cash services in connection with the Domestic Service. SLAB Delivery by mutual consent settlement service SSS
. the liquidity position of a settlement bank’s client.
it is the party that negotiates and executes the treasury transaction. buy-sell back and sell-buy back transactions. Systematic internaliser It means an investment firm which. a post trade administrator.16
Securities Settlement System. in particular CSDs. or a trader. frequent and systematic basis. a service in Euroclear France that allows an issuer of bearer securities to request a list of beneficial owners registered in the custodians’ books.
. Two-leg settlement instruction Settlement instruction which can be used to settle bilateral repo. it is the result of the matching and execution of either a purchase or sale order with compatible opposite orders.should be taken to mean all institutions. A trading party is a trade instructor. Settlement and custody functions except custodians. deals on own account by executing client orders outside a regulated market or an MTF. on an organised. Trade date The date on which a market trade is executed. performing the Pre-settlement. securities lending & borrowing. In the context of treasury. or that move the investor's assets from one investment to another. Transaction In a Euroclear context. STP Straight Through Processing System Paying Agent (SPA) The party within the CSD that is responsible for distributing resources relating to a specific distribution to other CSD parties. the concept stems from the EU’s MiFID directive T TARGET2 Trans-European Automated Real.Time Gross settlement Express Transfer 2 TPI Identifiable bearer security. an investment decision-maker. Trading party The party that plays an active role in planning and executing the transactions that create or liquidate investments of the investors’ assets.
instructing the system agent. implying that the central bank calculates the market value of the underlying securities. reduced by a certain percentage (haircut). V Valuation haircut A risk control measure applied to securities used in reverse transactions. ECB) applies valuation haircuts that also reflect certain characteristics of the securities.17
U UNIFI Standard See 'ISO 20022 Financial Services'. The Eurosystem (European Central Bank.
. notably their residual maturity.e. receipt and sending of meeting notifications. Voting service provider (VSP) A service provider mandated by the Client to act on its behalf. collection of voting instructions. (I.
aggregated order information on "liquid shares" available at the five best price levels on the buy and sell side.CUSIP etc. the best bids and offers of market makers must be made available.
4. They very often act also as official numbering agency responsible for allocating security identification numbers. -for quote-driven markets. NDC is the member in ANNA for Azerbaijan. facts. Securities trading information flow
4. These so called Data providers are also a source of financial information. depending the nature of their systems must provide mandatory the following data information: . As outlined later.1) operators in the market must provide full pre-trade transparency. and in the US. portfolio management. magazine).18
3. statistics and analysis). This best possible result or best execution as it is called by the operators. the internet.
4.Continuous order-matching systems.(NNAs. speed. fund administration. Trading
MiFID again requires that professional capital market operators take all reasonable steps to obtain the best possible result in the execution of an order for a client.) There is an Association of National Numbering Agencies (ANNA) which leads the way in introducing standards aimed at simplifying trading and securities administration. encoded securities information based on a global network of market specialists that procures real-time stock exchange information at source from the leading financial Centres. all market operators. who are specialists in the procurement. Pre-trade
Compliant with the EU requirements in its specific MiFID directive (see below for more details under 6. likelihood of execution and likelihood of settlement and any other factors deemed relevant. securities trading and securities administration. is not limited to execution price but also includes cost.g. Information flows and information systems for securities trading
There are several large professional provider of financial information in Europe. for professional and individual investors through various communication channels (e.g. financial analysis. processing and distribution of international financial information for investment advisory services. They maintain database of structured. Post-trade
.1. they provides financial news and data (e.
It can be mentioned that in matters of clearing. Clearing and Settlement. Following other emerging initiatives in the area of post-trading. CESR is a member of the Monitoring Group. CESR had decided to create a platform to follow these initiatives more closely. Also the other directives regarding prospectus. Stock Exchanges.e. This group does focus on post-trading activities in the EU.4. Common communication interface. The Code of Conduct was developed and signed by the providers of infrastructures for Trading. where relevant for CESR and its members. Prior to this. The second important initiative followed by the PTEG on behalf of CESR is the ESCB-project TARGET-2-for-Securities (T2S). Central Clearing Parties and Central Securities Depositories within and outside the EU-area. This long-term project aims to create a single and central platform for the cross-border and domestic settlement of Euro-denominated securities against central bank money. settlement and custody the core directive for capital markets in the EU MiFID remains silent. like AutoFlow. given the responsibilities of national securities regulators for post-trading activities in the respective Member-States.19
MiFID the basic capital market directive in the EU requires from all professional capital market operators to publish the price. the PostTrading Expert Group (PTEG). an automated ISO-based STP interface to exchange structured data with custodian banks via a CCI. where appropriate. with the objective to enhance a level-playing-field and the safety and soundness of post-trading activities within the EU. It is a
. to respond to these initiatives. the group established by the European Commission with the mandate to review the compliance with the Code by the signatories. run by the Euro-system. The first major point on the agenda of the PTEG is the Code of Conduct for Clearing and Settlement. a joint CESR (Committee of European Securities Regulators)/ESCB (European System of Central Banks) working group developed Standards for Clearing and Settlement systems in Europe. activities of the group were disrupted after that period. and transparency are only focusing of the trading not the post-trade aspects.
4.1. Categories of capital markets information systems
5. does only focus on a number of regulatory initiatives going on in the area of post-trading. Information collection and distribution
There are IT systems. volume and time of all trades executed in listed shares. The political support for these regulatory initiatives was reflected in the conclusions of the EU Council on Clearing and Settlement of 9 October 2007. In 2007. unless certain requirements are met to allow for deferred publication. establish a place to share supervisory experiences and. in particular with regard to the envisaged role of regulators in this Code.
5. But disclosure is required mandatory by the directive. PTEG. Between 2002 and 2005. even if executed outside of a regulated market. It is up to the member States in the EU to act in the matter. the CESR Members decided to establish a group of CESR experts only. market abuse.
using a variety of networks. Smart order routing systems decide how an order is split and routed and how many shares are purchased at particular venues while ensuring the in the EU MiFID required compliance. Sophisticated liquidity management and advanced DMA products. clearing houses and securities settlement systems (SSSs). that show momentum or compare executed liquidity versus displayed liquidity over a time window on a per venue basis. It uses multiple in and output FIX connections. liquidity management tools and advanced technology to execute trades. it will have an embedded custom routing logic that takes multiple factors into account. In addition a host of other parameters such as aggression levels. Tools. AS systems do usually settle their net positions either at the end of the day or at several times during the day through an Ancillary System Interface (ASI). large-value payment systems. CNS centralizes the settlement of matched transactions and is maintaining an efficient flow of security and money balances. the data providers etc. These indicators. qualitative algorithms designed to monitor market changes. Euroclear Trade Capture and Matching System (ETCMS).20
communication interface with the external world that provides users with a single access to a common integrated trading platform.2. Order-routing systems
Traders often split orders and route them to different market centres in order to reduce market impact and achieve best prices for their trades. It is strategies. Trading tools
Global electronic trading is technology based. All collected data are aggregated in a layer where all quotes and trade data are put in a feed handler as received from the exchanges. order execution through a suite of global. leverages low latency market data including custom indicators. execution quality. control of order flow while maintaining anonymity. An optimized order routing system will slice and route orders with ultra-low latency.3. maintains and persists all order states. a standardized interface of the common shared IT platforms which control and distribute the information pertaining to Ancillary Systems and. can be easily included in the order routing module later. …to be aggregated in a feed handling infrastructure for connection with the trading platform for processing. securities settlement systems activity. money market systems. access to ConvergEx ATS for block crossing and aggregating dark liquidity (dark pools) tools. dynamically optimize performance and avoid market impact. Continuous Net Settlement (CNS / RNC) are automated book-entry accounting systems. They can derive custom indicators based on the order or trade information.
5. foreign exchange settlement systems. Trading tools must have the following capabilities: direct execution to every major global exchange. A key tool in this practice is the in an order routing system to find the National Best Bid or Offer (NBBO) across markets. Trading platforms remain the core of all the central integrated IT system In particular. but there are ancillary systems (AS). It continuously scans different liquidity pools in order to get the best price. these include retail payment systems. in particular. Below the consultant provides a
. supports multiple order types. It must also ensure MiFID compliance and run in parallel with the OMS system. It enables also clients to send instructions and receive reports in industry standard formats. speed and costs can also be considered in the routing logic.
5. The market data layer captures the BBO best bid of r offer across markets enabling later by order routing to how an order is split and routed and how many titles are purchased.
.. Order Routing Solution consists always of two main layers – the first layer deals with the order flow and the second layer deals containing the market data.
sample of an order routing system set-up and the connections with OMS etc.
adding analytics. portfolio staging capabilities and tighter systems integration. the following occurs: • instructions are entered by clients for matching purposes. In comparison.e. There are also automated matching and routing service for over-the-counter transactions with a Central Counterparty (CCP). The trading blotter is composed of an order entry screen where users initiate and monitor trading activity. in some cases. An EMS offers multiple destinations to which to route a trade. they will continue to substitute for OMSs more and more. which offers netting at both user and security eligibility level.5. Both legs must be simultaneous and linked to limit risks. for instance following trading on a stock-exchange or over the counter. In practice. firms easily can look back in order to analyse their orders. the older traditional order management systems (OMSs) were designed as tools to allow firms to manage and document their trading activities electronically.or limited-destination systems. Today's OMSs have emerged as portfolio management systems with functionality that ranges from pre-trade through post-trade support. Settlement and custody systems
Securities Settlement Systems enable the transfer of securities. transactions settled in SSSs are considered final and irrevocable (i. typically through the Financial Information exchange (FIX) protocol. If the instruction is deemed to be valid. • once matched. Moreover. Although a number of DMA players call their order entry and management portals EMSs. The delivery of securities takes place by book entries in computerized systems. As a result. connectivity. alternative trading systems (ATSs).
5. The new EMSs may follow a path similar to the one OMSs have followed through their evolution: The EMSs will increase the breadth of their functionality. The platforms enable both single-stock and portfolio trading capabilities. Through the EMS platforms. users can connect to major exchanges.23
5. • the CCP then undertakes a local validation process. There are two legs for the settlement of such a trade: the delivery of the securities and the corresponding payment which takes places in a payment system. unless the delivery is free of payment. an execution management system (EMS). It is worth pointing out that. It is a software-based platform that facilitates and manages the execution of securities orders. instructions are sent to the CCP for netting. whereupon the instruction is either registered when the trade is novated or rejected when the instruction does not meet all of the validation criteria. DMA platforms either are single. internal proprietary data from the EMS provider. Users can access brokers' direct-market-access (DMA) capabilities and algorithms to carry out electronic trading strategies. Order-presentation systems
In this area we find now since recently now EMS. Since this modest beginning of OMSs as trading blotters with FIX engines. it will be given a Euroclear reference ID and will enter the matching process. they have extended the breadth and depth of their functionality significantly. multiple destinations and real-time market data. crossing networks and multiple brokers. Real-time market data enters the system from a combination of external feeds from exchanges and market data providers and. unconditional)
.4. With an OMS. EMSs have four key features: a trading blotter. electronic communication networks (ECNs). by definition. there should be a differentiation between an EMS and a pure DMA platform.
intra-Full transactions when both parties are using the Full Service and transactions settle then on the books of the custodian Bank. they constantly communicate with each other. There is usually at least one CSD and one SSS in each EU country. In a single platform context.24
when they meet certain conditions. SSSs either settle on a gross basis or on a net basis. Euroclear France and Euroclear Nederland) with an integrated settlement solution and harmonized custody service for stock exchange and over-the-counter activities.e. Euroclear Settlement of Euronextzone Securities (ESES) Often also custodian banks make use of sub-custodians by means of a service level agreement Euroclear Settlement of Euronext-zone Securities (ESES) is an intermediary step towards a Single Platform that Euroclear want to develop. Deutsche Bank did add front-office grid applications to support "straight-through processing" (automated. Clearstream and other global custody provider have most of the time their own traditional IT architectures. In settlement there is an internal transaction category. Deutsche Bank's Securities Custody System is one of the earliest successful examples of commercial grid computing. in Euroclear this transaction category includes: Intra-entity settlement transactions when both parties to the transactions are members of the same (I)CSD. This largescale financial application demonstrates the substantially lower costs and higher return on investment possible with only processing software. There are also settlement sub-Systems. This covers: intra-Domestic transactions when both parties are using the Domestic Service and transactions settle then on the books of the primary issuer CSD or the CSD of reference of the security. These systems process the settlement of instructions. as compared to the traditional architectures. who are notably responsible for ensuring securities’ integrity. streamlined workflow) in its custody system. manage the Securities Accounts balances and the Purchasing Powers and provide reporting to the Clients. ESES will provide the Euronext-zone market CSDs (Euroclear Belgium. Interfaced settlement model: transactions are settled using an interface between the payment system and the SSS. Integrated settlement model SSSs settle transactions directly in their own system without the constant involvement of the payment system. Securities are held with central securities depositories (CSD). one party is using a Domestic operational securities account and the other is using a Full securities account). CSDs enable securities’ mobility as they operate securities settlement engines. Full-Domestic transactions when one party is using the Full Service and the other is using the Domestic Service (i. Custody systems are most of the time in-house developed as this kind of service is not provided by Euroclear given its horizontal structure. Next to the safekeeping function. Domestic inter-CSD transactions when the security is eligible in several group CSDs and one party is instructing on a depot with the primary issuer CSD and the other is instructing on a depot with the other eligible CSD. The security leg is settled in the SSS while the cash leg is settled in the RTGS in the EU. As two systems are involved.
. An interface is used at the request of clients when they want to transfer cash into the SSS or back to the payment system.
There are three other Directives' in the context of the “Lamfalussy” procedure that the EU did also needed to issue: the Prospectus Directive. Norway and Liechtenstein). The fourth level involves compliance and enforcement of the new rules and laws. MiFID is the cornerstone of the European Commission's Financial Services Action Plan whit some 42 measures that did change significantly how the EU financial service markets do operate. the Market Abuse Directive and the Transparency Directive.6. Under European law. The institutional links among capital markets operators
. national regulators work on coordinating new regulations with other nations. The prevailing legal and regulatory framework in the EU
6. MiFID is the most significant piece of legislation introduced under the “'Lamfalussy” procedure designed to accelerate the adopting of legislation based on a four-level approach as recommended by the Committee of Wise Men chaired by Baron Alexandre Lamfalussy. At the third level. the EU adopts a piece of legislation. where sectorspecific committees and regulators advise on technical details.1.
6. then bring it to a vote in front of member-State representatives. a Broker to custodian trade affirmation system that is widely used in the market.25
In the context there is also SBI. These solutions do combine trading surveillance and employee fraud detection this requires a proven technology and domain expertise in the institutional and proprietary trading market.
6. a Directive has to be transposed into national law: as all the 30 States of the EEA have done. they are designed to identify trader behaviour and activities that could be related to fraud or unauthorized activities. The law then progresses to the second level. It is a European Union law that provides harmonized regulation for investment services across the 30 member states of the European Economic Area (the 27 Member States of the European Union plus Iceland. Surveillance systems
In order to face the challenge in trading surveillance and the need to detect employee fraud the market has developed surveillance systems to prevent unauthorized trading and to avoid risks for Financial Institutions. The main EU Directives on capital markets
The main EU directive governing the capital markets is the Markets in Financial Instruments Directive (MiFID).
5. All these directives compose the legal frame for capital markets in the EU. At the first level. They are mostly based on a core analytics and profiling engine and a set of flexible enterprise case management and investigation applications.2. establishing the core values of a law and building guidelines on its implementation. This kind of transactional risk management software for the financial services industry developed in the US for surveillance and detection of employee trading fraud solution for uncovering rogue trading in securities firms.
for example. However if a firm only performs ancillary services. This includes therefore commodities and derivatives but also such as freight. they now have the possibility (and in some cases the obligation) to collect information from a multitude of multilateral trading facilities.3. professional clients or retail clients (these have increasing levels of protection). regulation and pass-porting Firms covered by MiFID will be authorised and regulated in their "home State" (broadly. the country in which they have their registered office). hence. Where once a financial institution was able to see information from just one or two exchanges. The role of professional capital markets participants
MiFID requires professional capital markets participants to categorize their clients as "eligible counterparties". it is not subject to MiFID (but cannot benefit from a MiFID passport). Clear procedures must be in place to categorize clients and assess their suitability for each type of investment product. the appropriateness of any investment advice or suggested financial transaction must still be verified before being given. To determine which firms are capital market operators under the legal MiFID frame and which are not. but caused in fact a fragmentation of trading venues. If a professional capital market operator performs investment services and activities. This is a professional capital market participant that executes orders from its clients against its own book or against orders from other clients. These services will be regulated by the member state in their "home State". climate and carbon derivatives.26
The institutional links among capital market operators are defined in 3 aspects: authorization.
6. This did results in an additional amount of work for the professional capital market operators to comply with the transparency that MiFID wanted to introduce. it is subject to MiFID in respect both of these and also of ancillary services (and it can use the MiFID passport to provide them to member States other than its home State). Comments: MiFID intended to increase transparency for prices. MiFID has introduced the concept of this Systematic Internaliser. they are subject to pre-trade and post-trade transparency requirements as above mentioned. Systematic Internalisers and other exchanges from around the European Economic Area. MiFID distinguishes between "investment services and activities" ("core" services) and "ancillary services" ("non-core" services). MiFID covers almost all tradable financial products with the exception of certain foreign exchange trades. MiFID considers Systematic Internalisers as miniexchanges. That part of an investment firm's (capital market operator) business that is not covered by the above is not subject to MiFID. That said. it will be able to use the MiFID passport to provide services to customers in other EU member States.
. Systematic Internaliser. which were not covered by the former EU investment services directive ISD that now is now superseded by MiFID. Once a firm has been authorised.
Up to now Euroclear uses two platforms: A Single Settlement Engine (SSE) and a Euroclear Settlement of Euronext-zone Securities (ESES) trading platform.4. the Market Abuse Directive and the Transparency Directive. The prevailing capital markets architectural models in the EU
7. Another regulatory change was the abolition of the 'concentration rule' in which member States could require investment firms to route client orders through regulated markets.27
The number of additional pricing sources introduced by MiFID means that financial institutions have now to seek additional data sources to ensure that they capture as many quotes/trades as possible. This is a change from the prior EU financial service legislation which featured a 'minimum harmonization and a mutual recognition' concept in matters of Regulatory supervision. as previously mentioned the fourth level in the “Lamfalussy procedure”. which will replace each CSD’s current client interfaces.
7. a Directive has to be transposed into national law: an EU Regulation.1.
. The Euroclear model
7. 'Maximum harmonization' does not permit member States to be 'super equivalent' or to 'goldplate' EU requirements detrimental to a 'level playing field' as done previously in some member States when implementing EU directives. the Prospectus Directive. on the other hand.1. is automatically binding throughout all member states.
6. when issued. The role of the Capital Markets Regulators
MiFID retained the principles of the EU 'passport' introduced by the old investment services directive ISD but innovated by introducing the concept of 'maximum harmonization' which places more emphasis on home State supervision. But it intends to integrate all in the Euroclear group CSDs’ legacy systems in one Single IT Platform.1. The capital market Regulators are. Under European law. they have to take care of compliance and enforcement of the in national rules and laws transposed MiFID directive. including: Enhanced levels of Straight-Through Processing (STP) More streamlined processing as a result of harmonization agreements on dates and the classification of corporate actions Increased efficiency due to real-time credit and reporting of cash proceeds Clients will connect to the Single Platform using Euroclears’ Common Communication Interface (CCI). The Single Platform intends to offer a number of important benefits in terms of additional services and more automation and consolidation.
settlement is achieved through local market settlement structures.1. order routing is an essential step prior to the settlement phase for fund orders. Within the Euroclear group. as well as six other CSD in the Euro currency area: Euroclear Belgium. the Brussels-based CSD for Belgium Euroclear Finland.
Euroclear is a Settlement service provider only. the buyer can pay.1. unlike for bond and equity transactions. Organisational links among various capital markets stakeholders. which vary from market to market as there is diversity in the EU capital markets. the Stockholm-based CSD for Sweden Euroclear UK & Ireland. EMXCo is the provider of funds order routing. Settlement as the final step in securities transactions is vital for a good functioning of financial markets. The settlement process is also largely determined by the type of asset and market. For example. Settlement is only the delivery of securities.2. Institutional links among various capital markets stakeholders
As providers of settlement services. usually against payment. the London-based CSD for the United Kingdom and Irish equities
. to complete a trade between two parties. the proprietary ownership becomes effective for the purchaser from a legal point of view. an ICSD (International Central Securities Depository) headquartered also in in Brussels. Usually this is done electronically through a fast and low-cost form of processing known as Straight-Through Processing (STP). the Amsterdam-based CSD for The Netherlands Euroclear Sweden.3. The counterparty in the trade also submits an instruction. They then settle the transaction which can take different forms depending: if it is taking place between two clients of the same Central Securities Depository (CSD) or an International CSD (ICSD). At the time of the settlement. the Paris-based CSD for France Euroclear Nederland. Clients of Euroclear submit an instruction telling Euroclear when. a simple book-entry transfer is made enabling the required simultaneous exchange of cash and securities. if against payment. Where the trade is between two counterparties in different countries.
7. Euroclear match up the two instructions. the Helsinki-based CSD for Finland Euroclear France.28 7. and make sure the seller has the securities and. the Euroclear group is a horizontal organized structure that comprises Euroclear Bank in Brussels. with accounts in different ICSD’s. how and with whom they want them to settle their securities transaction.
Horizontal structured providers of settlement and custody and horizontal providers of clearing function
Universal Banks Brokers
Stock exchange A Trading &Settlement Settlement
Stock Exchange C Trading & Settlement
Stock exchange B Trading& Settlement
ClearingL CH Clernet
Below a schematic graph to illustrate this capital market organization.
joint venture by nine leading Central Securities Depositories (CSDs) – a common infrastructure allowing for easy implementation of links between CSD markets. (Greece).
7.2. Institutional links among various capital markets stakeholders
Clearstream is a vertically integrated supplier of all post-trading services. IBERCLEAR (Spain).3. the clearing and custody functions.A. fully electronic derivatives trading and clearing system.1. commercial third parties soft-ware and internally developed software. VP SECURITIES (Denmark) and VPS (Norway).2. Its key objective is to improve efficiency and reduce costs of post-trade processing of cross-border securities transactions by streamlined interoperability on the CSD layer. This platform will favour algorithmic trading by mitigating towards an Itanium platform to boost output with new enhances broadcast solutions. It provides after trading and settlement. The Eurex clearing functionality also supports clearing of equities. Cyprus Stock Exchange (Cyprus). an integrated. The design will be modular base on a shared technical infrastructure which combines extremely low latency with high volume. Xetra . The Clearstream model
7. the other electronic trading platform for the cash market allows the trading of stocks on one platform – everywhere in the world. Below a graphical scheme representing this capital market architecture type in Euro
. IT Architecture
Clearstream uses three trading platforms: Eurex. “Link Up Markets” the third platform is a common IT infrastructure allowing for easy implementation of links between CSD markets and introducing efficient cross-border processing capabilities.2. It offers two fundamental services to the industry: International central securities depository (ICSD) services and the Central securities depository services (CSD) for German and Luxembourgish domestic securities.2. Organisational links among various capital markets stakeholders
Clearstream is a wholly owned subsidiary of the Deutsche Börse. Clearstream also has an innovative post trade system for investment funds CFF Central Facility for Investment Funds based on its own proprietary order-routing system Vestima +
7. Hellenic Exchanges S.2. SIX SIS AG (Switzerland).30
7. introducing efficient cross-border processing capabilities. Link Up Markets is the joint venture by nine leading Central Securities Depositories (CSDs) – Clearstream Banking AG Frankfurt (Germany). STRATE (South Africa). Oesterreichische Kontrollbank AG (Austria). Clearstream is developing also a new globalized standard IT platform using open source components. bonds and repos traded on the Frankfurt Stock Exchange. It also operates now the Link Up Markets.
Vertical structured single provider of settlement.
Brokers Stock exchange A Trading Stock exchange B Trading
Stock Exchange C Trading
Clearing Settlement Custody Custody
. clearing and global custody.
only Clearsteam with its vertical structure (enabling them to have control of collateral through all the post-trade cycle. But in the last Financial crisis. But both architectures compete in the market to provide the lowest global processing fees. The issue is that Clearstream is owned by a single shareholder Deutsche Börse. while as users they want to pay the lowest handing fees. while Euroclear is owned by its users the different stock exchanges. From an economic point of view there may be a conflict of interests. areal advantage) could offer clearing through collateral management during the Financial crisis 2009.3. Clearstream does provide the whole range of services from trading to all integrated post trading services. as . brokers and investment banks.
. clearing and custody. in September 2009. in addition the MTF are now also more and more a competitor capital markets structure.as shareholders they want the best possible return. Also the posttrade CFF Central Facility for (investment) funds in Clearstream did allow cash and securities to be exchanged synchronously between investment fund distributors and transfer agents despite the financial crisis. Their Euro GC Pooling facility was particularly successful as a reliable liquidity pool whereas Euroclear having not the clearing activities and the underlying assets under control were unable to operate in a similar way. Clients of the Euroclear architecture were not able to be serviced as the different clearing institutions in this set-up could not cope with the situation. From this fundamental organizational difference also stems the difference in their respective functionalities: Euroclears provides settlement only. Due to the credit crunch. who in most cases of the time are also its shareholders of Euroclear. In addition both are Global Custody services providers world-wide and competitors in the European capital markets post trade value chain services. many banks did found it difficult to borrow cash. only Clearstream was able to offer automated lending and borrowing of securities as well as tripartite collateral management services.32
7. making Clearstream services valuable in improving liquidity: Eliminating counterparty risk by using the CCP(central counterparty) service. Comparisons between the two
The fundamental difference is reflected in the structural aspect: Clearstream has a vertical single provider integrated set -up structure whereas Euroclear has a horizontal approach with several providers in matters of capital market architecture. settlement. ascertaining the superior quality of underlying securities by limiting the assets to those which the ECB (European Central Bank) accepts as collateral. The fee earnings therefore are at the level of these shareholders who act as “clearers” in the Euroclear structure leaving Euroclear only the trading and settlement activities to handle and earn less(mostly running the services at cost). There is an electronic bridge between both ICSDs (Clearstream and Euroclear have also both ICSD statuses) this interoperability has significantly contributed to attract liquidity from new customers. it is owned by the Deutsche Börse Group. while clearing and custody is always mandatory provided by third parties.
8.A. SIX SIS AG (Switzerland). whereas clearing and settlement takes place through TAKASBANK ISE Settlement and Custody Bank Inc.
.2. as mentioned above in 7. the handling of the flux of assets and cash is easier to process in a vertical structure. The Turkish model
In Turkey. That major point was for Clearstream in the competition game on the European capital markets. Trading is taking place at the ISE. In this paper the consultant will broach the Turkish capital market architecture through the ISE. Systemic risk considerations do explain the choice in favour of Clearstream in the opinion of the consultant. The Settlement Centre is operating with book entries. Oesterreichische Kontrollbank AG (Austria). This may also explain. Istanbul Stock Exchange for transferable securities whereas derivatives are dealt on in the Izmir Mercantile Exchange. IBERCLEAR (Spain). (Greece).33
In clear the systemic risk of horizontal capital market architecture was revealed to be higher than that of the vertical structured capital markets architecture.3. compared with the horizontal capital market architecture. are also vertical structures for the same obvious reasons.1. Securities transfer transactions are done either trough: Real Time Gross (RTG) DVP Settlement The “RTG DVP Settlement System” provides delivery versus payment for stocks and fixed income. From a strictly operational point of view. The prevailing capital markets architectural models in emerging markets
8. VP SECURITIES (Denmark) and VPS (Norway) did prefer to join Clearstreams’ Link Up Markets joint venture for leading Central Securities Depositories (CSDs) instead of pooling up with Euroclear. It is the central settlement institution authorized by the ISE for the finalization of cash and securities transfers of transactions made in existing markets within the ISE. the capital market structure is based on the ISE. Needless to say the consultant recommends for Azerbaijan the adoption of the vertical structured capital market architecture as the better choice. so operational risk results to be less than in a horizontal structured architecture. that CSDs from eight leading Central Securities Depositories (CSDs) – Cyprus Stock Exchange (Cyprus). STRATE (South Africa). as mentioned previously already by the consultant. Therefore a vertical capital market model has a better operability and a better risk management capacity. During the financial crisis in 2009 clients of Euroclear were obliged to shift therefore their asset from Euroclear to Clearstream to benefit from the Clearstream clearing facility failing Euroclear set-ups’ ability to clear their trading transactions. It must also be mentioned that the new MTFs in the capital markets worldwide. Hellenic Exchanges S.
Free transfer The Stock Transfer Transactions between members vary in respect of whether the security.2. countries of Eastern and Central Europe. TAKASBANK does also provide custody and banking services. clearing. In clear a vertical architecture type of an emerging market capital market organisational set-up. or Electronic Security Transfer (EMKT) Transactions EMKT is a system established within the framework of CBT Central Bank of Turkey. Brokerage houses. currency market. The MICEX Group provides financial market participants with a complete set of trading. facilitating the real-time execution of buy-sell. which will be transferred. sub-federal and municipal securities. is dematerialized or not. issuer companies and corporate investors is continued to be provided. the circulation of which is supervised by the Bank of Russia. MICEX covers a stock market. Physical custodian services towards the members of ISE. " RTS Settlement Chamber" and "St. is the largest stock exchange in the CIS countries. Dematerialized transfers vary according to institutions being party to the transfer.
8. There is also the well-known RTS. the Russian Trading System. It is a regulated market in Russia. depositary. Petersburg Stock Exchange. and information services. in accordance with the regulations of Capital Markets Board regarding dematerialization of securities. transfer and other related transactions of dematerialized securities in an electronic environment and in an integrated manner with EFT. the CJSC “MICEX Stock Exchange”. The National Depository Centre (Closed Joint Stock Company) NDC was established as a central settlement depository for the servicing of state securities. The Russian model
In Russia we have the MICEX Stock Exchange Within the MICEX Group. and derivatives market. Within the framework of central custodian services provided all records relating to the stock certificates and investment fund participation certificates traded in the stock exchange have been transferred to the Central Registry Agency Inc.
. The Regulator in Turkey is the CMB. which are members of TETS (Takasbank Electronic Transfer System) can join this system through Takasbank. "Open Joint Stock Company "Russian Trading System Stock Exchange". "RTS Clearing Centre". corporate. or Capital Markets Board of Turkey. RTS is an integrated trading and settlement IT platform in a structure consisting of Not-for-profit partnership "Russian Trading System Stock Exchange". NDC functions as a central settlement depository and a centre of technical support of dealer’s sub-depository in Russia’s federal securities. settlement.
Turkey has applied to join the EU.
8. Clients’ payment orders are handled and executed immediately after their delivery to the MICEX SH. The MICEX Settlement House: acting as a settlement bank. the corporate securities market. the derivatives (standard contracts) market. it guarantees timely settlements and the safety of its clients’ funds. The Moscow Interbank Currency Exchange Settlement House (MICEX SH) is a credit organization that provides settlement banking services. Benchmarking vis a vis the EU capital markets architectures
From a structural point of view both capital markets architectures in Turkey and Russia area not compliant with EU standards and regulations on capital markets. Since January 1. the currency market. it provides reliable and prompt cash settlements on trades made in MICEX financial markets. a horizontal organizational capital market structure type.35
Currently NDC is Russia’s largest settlement and safekeeping provider.
The MICEX Settlement House guarantees timely settlements and the safety of its clients’ funds because active operations are not performed on clients’ funds. interacts with clients throughout the entire trading day. offers its clients a full range of settlement services. it completes cash settlements on participants’ transactions on the day of trading. The Regulator in the Russian Federation is the Federal Financial Markets Service. its’ capital market structure was pre-scrutinized by the European Commission and would need to introduce the full range of the “acquis communautaire
. it performs cash settlements in real time. (whereas RTS is of the vertical capital market organisational set-up). including cash settlements on trades made by financial market participants. regardless their organisational structures: horizontal or vertical.3. In clear. 1997.Both structures competing for market shares in the Russian market. it provides settlement services in all of the MICEX financial markets: the government-backed securities market. is one of the main exchanges trading infrastructure.
except the RTS who is a vertical structured type) with many entities intervening in the market. Deficiencies do also exist in matters of prospectus directive. In the end both organisational set up do not provide full DVP. which is an absolute prerequisite requirement in an EU type of capital market structure. Deficiencies were detected in the areas of prospectus directive. transparency and corporate governance
“to meet the adhesion criteria. market abuse. In the case of Russia the actual structure is rather cumbersome (as resulting from the fact that it is a horizontal structure. Actually the vetting procedure is frozen by the EU and accession talks are suspended because the unsolved Cyprus issue. market abuse and transparency: the operational aspects of the capital market structure.
to conclude the consultant intends to undertake a marketing study/ market needs analysis to define suitable products to be traded on the capital market that will generate a kick-off of the stock exchange transactions in the end. indicate the time and means to achieve this recommended structures and institutional frame. The proposed architecture for Azerbaijan
9. to enable the institutions and all other capital market participants to operate in the new proposed structure. Sub strategy C-in addition the proposed set-up capital market structure will need an appropriated IT-tool/platform.1. Action plan and time frame for implementation
9. once trading will start for real at the BSE and Sub strategy D. The consultant intends to recommend a modular base on a shared technical infrastructure to combine extremely low latency with high volume. to be ready in the future.1. As the underlying frame should be compliant with the EU rules and regulations the consultant recommends adopting the most important EU directives as relevant to capital markets. Based on the experience as gained in the EU.
. the implementation time for transposing voluminous complex EU directive (like MiFID) in national law requires two years in average: 24 project months to elaborate the legal tools and putting in place the recommended global architecture for the capital market in Azerbaijan.1 Global Strategy
The action plan starts with a day T. to be the day the decision is taken to accept the proposal and to start the implementation of the proposal as such. and Sub strategy B. it requires the establishment of specific regulatory and supervisory requirements relating to investment firms (inclusive banks operating as brokers) and governing the functioning of regulated markets and other trading systems so as to prevent opacity or disruption from undermining the efficient operation of the Azeri financial system as a whole.2 Main general task
The main task for the consultant would be to recommend and co-ordinate all the necessary steps and measures necessary to generate the legal frame for the proposed architecture of the capital market. We have then to differentiate between the broader sub-strategies to be followed: Sub strategy A-Define the structural aspects to achieve the new capital market organisational set-up in Azerbaijan. in which investors are effectively protected and the efficiency and integrity of the overall market are safeguarded.1.Define the operational aspects of this new capital market architecture that must be put in place and indicate the time required. The overall objective of the new proposed capital market structure in Azerbaijan is to create an integrated financial market.37
9. This platform should favour algorithmic trading by mitigating towards a Itanium platform to boost output with new enhances broadcast solutions as developed now by Clearstream.
Also capacity building for the institutions involved (SCS.
To create a legal coherent frame in Azerbaijan.1. NDC and BSE) should be done in parallel. This is also reflected in the detailed graph in the graph in Annex 2. There is also a draft law for domestic investment funds under scrutiny.
9. the legal frame for capital markets transactions is based on some specific articles in the civil code.38
In the case of Azerbaijan to set-up the legal frame the consultant recommends. Banks should also be enabled to act as custodians banks. This will require a time period of 18-24 months to achieve. Participation in an investors’
. It would take the form of a financial services action plan encompassing all institutions: SCS. This capital market frame law should contain all requirements as below stated in more details. It does not allow for the development of a coherent capital market. Professional standing and experience .
9. Central administration and infrastructure .6 below to have the required global legal frame duly set-up: The consultant has drafted a graph showing the time frame for this action to be undertaken to achieve the implementation of this legal frame. as an example. The major work load would be for the consultant to facilitate the required change of status for NDC towards a CSD status enabled institution.3. Authorization procedure. The legal form of the institution. BSE. banks. would require a simultaneous implementation of all the EU directives mentioned under 9.External auditing. custodians and all other market participants in the capital market. The consultant has elaborated a graph showing in details the time allocated to achieve the proposed implementation. this would require also elaboration of regulations and an appropriated reporting frame to the Regulator. it encompasses also elaboration of supervisory reporting frame to the Regulator SCS regarding compliance. (Gantt chart in Annex 2) Another element of the main task for the consultant is the enabling of the banks to act as brokers in the stock exchange. This is a prudent estimate based on experience as gained with the elaboration of the latest capital market law in Moldavia. Capital base . Such a basic capital market law must contain rules and regulations addressing the following issues: 1-Access to professional activities in the capital market : Authorization requirement . Participation in a deposit guarantee scheme . This from a capital market point of view is a piece meal structure. Capacity building to exercise the prudential supervision of the market would accompany the consultants’ action. This would require the consultant to elaborate detailed proposals for rules and regulations to be implemented. the brokers. Shareholdings.3 The structural aspects for a capital market architecture in Azerbaijan. The graph illustrates the time necessary to achieve these objectives as well. the first priority recommended by the consultant would be to create a global integrated legal frame: a capital market law by means of a normative and legal Azeri act with all EU legislation incorporated.3 Main actions and priorities
As resulting from the information of the consultant in Azerbaijan. again this will require elaboration of regulations and an appropriated reporting frame to the Regulator. The required time: at least 18 months for elaboration and 6 months for implementation. DNC.1.
Verification. Investment firms operating an MTF in Azerbaijan. Form and extent of consolidation. thresholds for identifying a financial conglomerate. Relationship between the Regulator and external auditors. Professional secrecy of the Regulator. accounting documents. Powers of the Regulator. Professional obligations of the financial sector as regards combating money laundering and the financing of terrorism. -Supervision of investment firms on a consolidated basis: Definitions. Distributors of units/shares in investment funds. Powers of injunction and suspension. Means used to exercise supervision on a consolidated basis. Financial intermediation firms. Underwriters of financial instruments. Registrar agents. Client order handling rules . Commission agents. Parent undertakings having their head office in a third country. Intra-group transactions. -Means used to exercise prudential supervision: Official lists and the protection of titles. Cooperation and exchange of information between competent authorities. Brokers in financial instruments. Internal control mechanisms and risk management processes.39
compensation scheme for all professionals such as: Investment firms. Complaints by clients. Exchange of information with other Regulators. Cooperation with the other authorities responsible for prudential supervision regarding consolidated supervision. Obligation to execute orders on terms most favourable to the client. Content of supervision on a consolidated basis. Financial position. Market makers. Authorization of holdings. prudential rules and rules of conduct in the capital market 4-Provisions applicable to credit institutions when acting as brokers and investment firms Organisational requirements. Exchange of information with third countries. Conflicts of interest. Coefficients.Transactions executed with eligible counterparties . Enforcement measures. Conduct of business rules when providing investment services to clients. Capital adequacy. Scope of supplementary supervision of investment firms. Professionals acting for their own account. -Supplementary supervision of investment firms in a financial conglomerate:: Definitions. Obligation to cooperate with the authorities . Miscellaneous firms other than investment firms. Purpose of supervision. Scope and parameters of supervision on a consolidated basis. Professional custodians of financial instruments.
. 2-Authorization for the establishment of branches and freedom to provide services 3-Professional obligations. Obligation of professional secrecy 5-Prudential supervision of the capital market -The competent authority responsible for supervision and its tasks. Private portfolio managers . Risk concentration. Obligations of credit institutions and investment firms when appointing tied agents. Identifying a financial conglomerate. Provision of services through the medium of another credit institution or another investment firm . Investment advisers.
Detrimental acts. The time frame is 6-12 months for the development of such a platform. Repurchase agreements. The consultant is of the vested opinion that the issue is to propose suitable products that would allow the take-off of the stock exchange and subsequently give impetus to the entire capital market.40
-Reorganization and winding up of certain professionals in the capital market: Definitions. Protection of third parties. Opening of proceedings for suspension of payments. Lodgement of claims. At present the gas flowing through the
.: Provisions governing proceedings for the judicial winding up of establishments . 6-Deposit-guarantee schemes: Compensation schemes for investors in credit institutions and investment firms 7-Penalties: Administrative fines. Withdrawal of an establishment’s authorization. Therefore he recommends undertaking a formal capital markets needs analysis and a market acceptance and absorption evaluation together with the project team. In this context it is for instance of importance to mention that OMV has launched a gas exchange together with the Vienna stock exchange and natural gas company Gazprom in Baumgarten (Austria).4 Ancillary tasks
The consultant recommends the set-up of an integrated IT platform for the BSE and NDC (deemed to become a CSD in the proposed architecture. brokers. He gained the impression that actually there is a lack of adequate tradable products in the stock exchange. assuming the proposed architecture is accepted. Another part time task for the consultant would be. He did meet with banks. Competent jurisdiction and applicable law. the Central bank and the State Fund. Set-off.Winding-up proceedings. Suspension of payments: Provisions governing the opening of proceedings for suspension of payments. Winding up: Voluntary winding up. Lawsuits pending. This is also duly reflected in the graphical scheme in Annex 2. the leading gas exchange in Central Europe within the next years. Criminal sanctions
9. Scope.1. corollary to the set-up of the legal and regulatory architecture of capital markets in Azerbaijan. -Provisions common to reorganization measures and winding-up proceedings: Effects on certain contracts and rights . This is the technical component. OMV plans to make the Central European Gas Hub CEGH. according IT duly consulted. Registration in a public register. simultaneously. to provide assistance to the project team when elaborating market analysing and when proposing ways and means to start up the capital market in Azerbaijan. insurance companies. proof of the appointment and powers of administrators and liquidators. Third parties’ rights. During his first mission in Azerbaijan the consultant had meetings with market participants regarding the launch of a capital market in Azerbaijan. Reservation of title. Professional secrecy. Netting agreements . Regulated markets. Provision of information to known creditors . This requires that part time the consultant should assist the IT developers to design such an integrated platform until the testing and launch to start after T in parallel.
for lack of adequate products for the potential investors. which would require the elaboration of a stock exchange handbook containing the rules and regulations. The consultant recommends to formulate policy recommendations as mentioned under 9. the Baku Stock Exchange must necessarily be endowed exclusively and compulsory with all securities trading in the Azerbaijan capital market architecture proposal of the consultant. The core element of any capital market.1 on products that could be launched in the stock exchange and allow for a take-off of the transactions that actually are having a low and occasional turn-over only.
. mainly those as mentioned in the EU MIFID directive. The stock exchange to fulfil its trading duties and obligations needs to have the regulatory frame in place and it staff trained to perform the duties according the established rules.41
hub at Baumgarten covers 10% of Europe’s gas requirements. This will require building up the capacity to handle transaction with EU conform regulatory requirements. This initiative seems to be an attempt to emulate the actual existing Caspian Oil & Gas Exchange.2. a trading manual and implementing the EC recommendations dating July 25. the State Committee for Securities. 1977. This encloses also private deals done on listed equities that should and must be duly notified to the Baku Stock Exchange compulsory. already sporadically now. It is understood that under securities’ the consultant regroups all eligible items to be traded on a stock exchange: from plain vanilla securities like stocks and bonds. (Refer for more details to the consultants’ previously elaborated preliminary report “Reflection paper on an “ad hoc” capital market architecture in Azerbaijan” December 2009).
9. The Baku Stock Exchange
The stock exchange should share the common integrated IT platform that need to be put in place to make the capital market operational in Azerbaijan.1. concerning the European code of conduct relating to transactions in transferable securities. The capital markets operators’ positions
The position of the different operators is shown in the context of the proposed new proposal architecture of the capital market in Azerbaijan. The gas exchange should bring transparency and flexibility in the gas prices that actually are resulting from long term contracts between European suppliers and Gazprom.2. commodities and currencies that could be eligible at a later stage. The execution of these duties must be under the duly Supervision by the Azerbaijan capital market Regulator.
9. These tasks are mentioned in the graph of the action plan. to derivatives. SCS. The require time for this task for the consultant is also reflected in the graph in Annex 2 and is scheduled over a period of two years. that are currently on a case by case dealt in. once the market develops. This percentage is expected to rise further when Nabucco and the South Stream gas pipelines will be connected.
the stock exchange must be recognized by a State or by public Authority which has been delegated by that State or by another Entity which is recognized by the State or by that public Authority. NDC for instance(upgraded to a CSD).
. such as a professional Association. but must not be outsourced to another institution like the National Depository Centre. In that regard an assessment of the fulfilment of the before mentioned requirements must be undertaken and an action plan devised to comply with these requirements. this issue is rather irrelevant. training of handling staff must been foreseen as an underlay of the capacity building exercise when and where necessary. which presupposes the existence of a central market organization for the processing of orders. as the depository of the collateral securities. A stock exchange under EU rules must be regulated. To ascertain compliance. In addition EU rules require a stock exchange to be “recognized”. This is defined in more details as meaning: The stock exchange must be “regulated”. under EU rules the essential characteristic of a regulated market is the clearing. CCPs require netting of transactions and collateralization. “Reflection paper on an “ad hoc” capital market architecture in Azerbaijan” December 2009) and open to the public. Trade processing by the Baku Stock Exchange will require a post-trade model. “Operating regularly” as already previously mentioned securities admitted to this market must be dealt in at certain fixed frequency and “open to the public” the securities dealt thereon must be accessible to the public: they must be able to acquire and sell the quoted items. and the consultant would favour a classical guaranteed model such as the CCP or Central counterparty model to be exclusively and compulsory put in place. transparency (maximum information distribution amongst buyers and sellers giving them the possibility to follow the evolution of the market. CCPs require collateral for the settlement of trades with them.42
The Baku Stock exchange necessarily should also be vested to initiate the clearing and settlement functions as these post-trade chains technical functionalities are required to be located under the responsibility of the Stock exchange given the requirements of the EU regulations. this function could. Such a market may also be distinguished by multilateral order matching (general matching of bids and offers enabling the setting of a single price). therefore the settlement is guaranteed. operating regularly (no sporadic trading as actually in the Baku Stock Exchange ref. The consultant would favour the later. the BSE should initiate the settlement/clearing while the CDS should finalize it. so that they may ensure that their orders have been carried out at current conditions) and the neutrality of its organizer (the organizers’ role must be limited to recording and supervision). But in an integrated IT system/platform encompassing the whole capital market structure that the consultant intends to recommend to be implemented.
and brokers in case of Azerbaijan tentatively) to handle. they come under the Regulator of capital markets. CSD are wholesale transaction processing entities. Euroclear etc. The Azerbaijan CSD should exclusively deal with other CSD abroad and with the ICSD and the Global custodians when and where appropriated (such as Clearstream. Central Securities Depositories (Settlement & Custody) and Central Banks (cash settlement. the operational working standard should be only the omnibus account procedure for NDC. The institution empowered to act under the decree being the State Committee for Securities. whose roles are integral to the process. The National Depository Centre
The National Depository Centre. they are not involved with individual investors/clients as they deal only with omnibus accounts.) that means in matters of all Azerbaijan securities. It carries as corollary a compulsory dematerialization to be the standard for those securities seeking a listing and trading at the Baku Stock Exchange.2. Therefore this eliminates any failed trades at the end of the post-trade value chain. Investment Managers and Brokers are also important participants but only as initiators of Clearing & Settlement activity through trading and investment. This is stemming from an operational facility point of view shared by other CSD. These recommended reforms to be addressed as outlined under NDC by an appropriated presidential decree approach in matters legal handling. In the case of Azerbaijan a first pre-requisite would be that the NDC would compulsory become the provider of the custody function in the capital market for all listed securities in Azerbaijan: the CSD for Azerbaijan. At record date for the purpose of AGM. The modus should be DVP mode 1. All securities traded in Azerbaijan (inclusive State or Government securities should fall under the jurisdiction of the CSD). In order not to fall in the pitfall of the retail business as previously mentioned. CSD do not have the status of banks in the EU. In the EU the key participants in any reform of Clearing & Settlement are those. as recommended by the G10 and achieved by STP in the integrated common platform that the consultant proposes. is involved in supervising custodian banks in the EU/EEA area. these are generally not retail service providers and access to their services is provided through wholesale service providers such as Custodians (Global and Domestic) and Clearing Members (Global and Self Clearing).). No CSD. CSDs do have relations with other ICSD and
.e. Central Counterparties (Clearing). as all transaction elements (cash/ securities) must be present before initiating the dealing in the stock exchange. However. This is good practice in all CSD.
9. the shares held in the CSD should be blocked allowing attendance. The messaging standard should normally be SWIFT. as in the EU capital market structural architecture. CSD is not concerned by attendance in person or by proxy as this is at the retail level of the entitlement beneficiaries.2.43
technically speaking: as deals/transactions cannot fail. NDC in the Azerbaijan capital market architecture should have the pivotal role. (aggregation of same asset type) leaving the retail for the other market participants as mentioned (custodian banks. collateral etc. This recommendation is within the scope of actual project aims. i.
issued and superseding these rules. that needed to meet the EU criteria in matters capital market organization for not delaying the EU accession further. To avoid a difficult transition this kind of approach could be recommended by the consultant: the State Committee for Securities becoming the institution to issue instructions rules etc…under a presidential decree pertaining to organize the proposed capital market structure in Azerbaijan. The National Depository Centre. This would require time to elaborate. which is an important mandatory attribute of a CSD beside netting. A CSD can also process services as an intermediary in crossborder clearing and settlement. the same as the other trades. Parliament etc. fungible securities of the same type are kept in a single collective holding. but as a separate entity from the CSD. The customer acquires fractional co-ownership in the CSD’s collective holdings and transactions can be settled by book entry.
. without physical movement of the securities.44
domestically with brokers and banks. OTC transactions must be mandatory under the jurisdiction of CSD. For instance in Germany. Based on the example in Romania. where the primary deposit of securities is in another country. in matters of corporate governance as experienced by the consultant during an EU project assignment with the Federal Financial Markets Service. CSD should hold securities and enable securities transactions to be processed through book entry. CSD should provide processing services for trades of those securities that it holds in final custody. In Azerbaijan its home country. and the settlement. after a specified date. In collective safe custody. NDC in the Azerbaijan capital market architecture should have a pivotal role. and in this function it is referred to as “the issuer Central Securities Depository”. based on the experience in other emerging markets with failing company registrars as in Russia. time to go through the legislative procedure. as in the EU capital market structural architecture as the central clearing house. The transformation from NDC to CSD status could result from a simple rule issue based on the presidential decree from the SCS. ministerial decrees and regulations to implement in domestic law all the EU acquis communautaire. This could be achieved in several steps: the first requirement would be the enactment of the basic new capital market law draft proposal as made by the consultant. Thereby Romania did gain the time to elaborate detailed organic laws. OTC falls under the jurisdiction of the CSD as well as mandatory these transactions must be reported to the CSD. The SCS would be empowered to issue binding rules and regulations that at a later stage could be repelled by specific organic law when elaborated. so called “EU reforms” were simply addressed by issuing a presidential decree enacting all EU legislation to be applicable in Romania. all. The setting up of such an institution would nevertheless exceed the present mission of the consultant as not enough time and resources could be made available. As outlined. unless an extension of the present project with allocation of new resources could be granted. The consultant would like to recommend also the introduction of a Central Registrar for securities in Azerbaijan. as opposed to individual custody. securities which are intended for trading are safe-kept in collective safe custody (omnibus account principle). The separation is to avoid conflicts of interests.
The institution in charge of the changes would be as principal the SCS again. to reduce the transition time and resulting legal insecurity. It is obvious that the Regulator needs assistance to elaborate the global legislative implementation plan to create the global capital market frame as mentioned under 9. In France this is handled under TPI as an example: (TPI stands for Identifiable bearer security in French. the argument in favour is again corporate governance: bondholders are entitled to certain rights in an EU context. no custodian bank.4 could also be obtained by way and means of the presidential decree approach as previously already mentioned. this would result in an enhancement of the SCS role especially when acting as the institution designated under a presidential decree to achieve the transformation. For instance issuing new bonds that could prejudice the bearer of older issue are compulsory required to get approval from a bondholder general meetings in some EU countries. a service that allows an issuer of bearer securities to request a list of beneficial owners registered in the custodians’ books. The Capital Markets Regulator
The role of the SCS as capital market Regulator in the proposal of the consultant must be enhanced considerably. In this case the Central Registrar deals with final owners no broker. It should be noted that if the consultants’ recommendation would be retained in matters legal tool and means to achieve the new capital market structure in Azerbaijan.4. no fronting possible. the Committee of European Securities Regulators in that regard.
9. In case all joint stock companies shares should be kept only in dematerialized form at the Central Registrar as done for instance in France.1 Specifically the Regulator must be endowed with an appropriate structure to cope with the new tasks in matter of compliance surveillance and reporting The consultant would recommend to elaborate guidelines on supervisory disclosure based on the CEBS Committee of Banking Supervision as far as capital markets aspect are concerned stemming from in relation to information about issuers whose securities are admitted to trading on a regulated market. but restricted to the domestic market in Azerbaijan. The main argument is to ascertain the title for shareholders/investors and guarantee corporate governance in all aspects.3.
.) The Central Registrar is also the only institution were liens and pledges over securities can be registered this cannot be done in CSDs as they deal not at retail level. the presidential decree approach could also be used to address the creation of a National Central Registrar in Azerbaijan. The professional capital markets participants
All recommendations under 9. to be formalized at a later stage by the consultants’ elaboration of a specific basic law for later implementation.45
As outlined previously. A Central Registrar could also extend its registration to bondholders (public or private). Capacity building could be provided by the consultant to put in place based on the Standards for Clearing and Settlement systems in Europe as elaborated by the CESR.
regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS).
. collection of dividends. Custody of assets is the main duty under EU regulations. The Investment firms
Brokers should be duly licensed and apply the MiFID criteria in their clients relationship.4. The requirements to be a custodian bank can be cumulated with a brokerage license. rather than safe-keeping of the deposited assets. Banks duly authorized can as well be custodian banks and as such safe keeping their own assets in deposit but under the omnibus account modus with the CSD. This is at discretion of the capital market Regulator alone. from relevant EU directives implementation resulting.46 9.1. when acting as investment fund custodian banks as resulting from the investment fund law. new legal Regulatory frame in Azerbaijan. (Council Directive 85/611/EEC on the coordination of laws. subject to a formal application with the capital markets Regulator SCS. All transactions done to be mandatory only through CSD for domestic operations. exercise of options etc.3. but always with due consideration of the. It entails reporting duties. Therefore custodian banks can make use of correspondent banks (sub-custodian banks) to fulfil this main task. The Custodian Banks
Custodian banks are mandatory for safe-keeping of assets of the domestic Azerbaijan investment funds. The will have domestic clients and may as well have direct foreign clients if the MIFID legal frame is duly in place. interests and proceeds of matured securities. The CSD is not involved in supervision or in license granting for brokers or for Custodian banks. It should be noted that the brokers have to comply also with the EU capital adequacy directive (the Directive 2006/49/EC on the capital adequacy of investment firms and credit institutions) and compulsory under reporting duties to the Azerbaijan capital market Regulator. The consultant recommends that brokers should keep their holdings with the CSD (the upgraded NDC) in omnibus accounts as CSD’s work with this concept only. In matters of domestic investors investing abroad the link is with CSD that is then in connection with the foreign CSD and/or ICSD. that are foreign CSD acting as global custodians for these assets if they are in custody with them.2. inclusive Government and State titles.4. The Banks licensed to provide investment services
The consultant recommends that all authorized and licensed banks in Azerbaijan should have the option to become brokers in the exchange and accordingly as professional users linked up with the IT platform. The granting of the status is subject to vetting by the SCS in agreement (maybe under a formal MOU.
9. but the overall responsibility remains with the custodian bank.
9. It must be understood that the legal concept is versus supervision of assets. as recommended by the consultant. This is a request. The consultant would recommend seeking inspiration from the E so called UCITS directive in that regard.4. They are linked up with the CSD through the market IT platform as professional users. Ancillary carrying out all day-to day-administration of assets under custody: corporate actions. Custodian banks have also specific duties. OTC transactions must be mandatory reported to the CSD for all domestic Azerbaijan securities. for operational reasons. memorandum of understanding) with the banking Regulator in Azerbaijan. as it is not a Regulator. assuming the draft law is approved and such funds would become operational then.
as done in some EU countries. in case). such safeguards require the provision of information which is sufficient and as objective as possible concerning the financial circumstances of the issuer and particulars of the securities for which admission to official listing is requested.(a MOU would be recommendable. either at the time of their offer or of their admission to official stock exchange listing. how the market will function. Therefore we need to have some additional basic organic laws that define the rules and the operational modus of the new capital market set-up. after the structural institutional aspects are given in the new basic capital market law. It was assumed the model to follow for Azerbaijan would be an EU conform capital markets structure without justifications of its relevant merits as opposed to other possible structures.
9. 2-Basic organic law for a Central Registry in Azerbaijan.
Needless to say that although custodian bank status granting is a prerogative enshrined with the SCS on request.
9. as regards elements related to prospectuses and advertisements. The professional capital markets associations
No professional capital market association is involved directly in the proposed capital market architecture.4. It must be clearly stated that the arguments for the implementation of the EU directive would require an exhaustive study that would exceed this modest paper by far. Safeguards for the protection of the interests of actual and potential investors are required in the EU States of undertakings offering their securities to the public. Nevertheless the consultant will try to give some short arguments why EU directives were from time to time duly elaborated and subsequently are implemented by the EU member States.1 plus some specific capital market basic organic laws to reflect all other EU capital market directives. as the duly appointed capital market Regulator.5. the form under which this information is required usually consists of the publication of listing particulars. Linkages among them
The common link of all institutions and market participants will be the integrated common IT platform allowing all of them to communicate and execute transactions according their assigned tasks and respective duties under the regulatory supervision of the Regulator SCS.1 the operational aspects of the capital market in Azerbaijan
It is necessary now to precise and to define. 1-Basic organic law taking into account the Commission Regulation (EC) No 1289/2008 of 12 December 2008. this should be exercised nevertheless in close co-operation and concert with the Banking Regulator. The necessary reforms from the legal and regulatory point of view
The proposed new architecture of the Azeri capital markets will result from the new legal frame stemming from the implementation of the recommended capital market law as under 9.
9.6. appointment of mechanisms for the central storage of regulated information within the meaning of transparency requirements for
1 setting the institutional structural frame. regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS). transaction reporting. Institution specific. and Insider Trading The basic capital market law under 9.2.2 Important
Regardless all these specific recommendations. and admission of financial instruments to trading.6. And ancillary the Directive 2006/49/EC on the capital adequacy of investment firms and credit institutions (only the investment firms aspects to be taken into account).And ancillary also the Commission Directive 2003/124/EC implementing Directive 2003/6/EC as regards the definition and public disclosure of inside information and the definition of market manipulation. 3-Basic organic law reflecting Commission regulation (EC) No 1287/2006 of 10 August 2006 as regards record-keeping obligations for investment firms. implementing also the requirements of Directive 2004/25/EC of 21 April 2004 on takeover bids. 3-Directive 2003/71/EC on the prospectus to be published when securities are offered to the public or admitted to trading and amending Directive 2001/34/EC(Prospectus directive). And the corresponding Commission Regulation (EC) No 809/2004 implementing Directive 2003/71/EC as regards information contained in prospectuses as well as the format. This should be merged together with the actual draft law of investment funds in Azerbaijan. 6 months implementation guide line issuing). on markets in financial instruments. incorporation by reference and publication of such prospectuses and dissemination of advertisement. as well as the Commission Directive 2003/125/EC implementing Directive 2003/6/EC as regards the fair presentation of investment recommendations and the disclosure of conflicts of interest.(18 months discussion and elaboration. the first step would be to enact all EU requirements through the issue of a presidential decree appointing the SCS to be the main actor
. 4-Directive 2004/109/EC on the harmonization of transparency requirements in relation to information about issuers whose securities are admitted to trading on a regulated market and amending Directive 2001/34/EC (Transparency directive) especially the in relation to information about issuers whose securities are admitted to trading on a regulated market. has in its elaboration of this frame law to take also into account the rules and regulations as resulting from older EC capital market regulations as issued in the interest of investor protection such as:: 1-Directive 2004/39/EC on markets in financial instruments (MiFID).
9. market transparency. 2-Directive 2003/6/EC on insider dealing and market manipulation (MAD) (market abuse).48
issuers of securities whose securities are admitted to trading on a regulated market. . All this changes to be realized in a time frame of 18-24 months after the day T as in the attached chart in Annex. there should be a basic operational organic law reflecting: The Council Directive 85/611/EEC on the coordination of laws.
All these professional market participants must have an electronic link in compliance with the new regulatory frame that will establish a common integrated IT platform to allow market participants to perform their duties. Luxembourg just to mention some) as well as custodian banks for investment funds assuming the legislation id introduced in Azerbaijan. duly authorized by the Banking Regulator can apply to the capital markets Regulator to be authorized/licensed to act as broker in the stock exchange.
. based on the universal banking principle e as existing in some of the EU member States (Germany. Below a diagram to show the relationship and the resulting flows. the basic organic laws to follow later in time.49
in charge to implement these EU requirements rapidly through immediate transitional appropriated measures and rules.7.2 outlined) The existing banks.
9.6. The necessary organisational and institutional reforms
The core pivotal institution in the new architecture is the CSD which will result from an upgrading of the actual NDC as explained above. (means and ways as under 9.
FDI FDI buy security x
Bank A A/C securities FDI A/C cash Investor A Invesrtor A local A/C cash FDI Central Registrar of securty X
Bank B A/C cash Investor B Investor B local
Sale security X security X fromInvestor A /sell securit X to FDI Broker A A/C investor A security X
CSD / Exchange common integrated IT pCSD / CSD / Exchange common integrated IT platform Omnibus accounf securties X Brokers A&B Banks A&B latform Omnibus accounf securties X Brokers A&B Banks A&B Central Registrar of securty X
Broker B A/C Investor B securty X
This means another entity handling the post-trade transactions with an additional cost factor and possibility of errors generating failed trades. without adding any additional value to the transaction processing. The institutional aspects are as defined in the basic capital market law. settlement. whereas the operational aspects of the new capital market structure are defined in the basic organic law proposals. clearing to custody in the new CSD in STP modus as previously already stated. Bulgaria’s Central Depositary is now seeking to join forces with an international settlement and clearing institution in line with a long-term
. but it I will be an open architecture. especially in the context of a single market structure as in Azerbaijan. this is eliminated as no need for a separate CCP entity. the common platform guarantees STP processing of transactions. In the vertical organised capital market structure. In a horizontal architecture there are different. The main argument to choose vertically integrated capital market architecture. All horizontal organisational capital market set-ups need such an entity that is the buyer to every seller and the seller to every buyer of a specified set of contracts/obligations executed on a particular exchange. From an organizational IT point of view. These will result from the study and market analysis the consultant proposes to perform in the context of this project. Conclusions (benefits from the proposed model)
The proposed architecture of the capital markets in Azerbaijan could set the foundation of a future development of capital market opportunities for the benefits of international and domestic investors. enabling it to encompass new products later. separate clearing providers as a horizontal architecture set-up provides only trading and settlement. the Clearstream model. stems from the necessity of the CCP. The tools to achieve operations in the best professional way are given as an integrated IT platform that connects all institutions and market participants in the new capital market architecture. In the context of a emerging markets approach the structure the most suitable capital market structure it is interesting to see that the discussion is on. One should avoid setting up separate entities for post trade processing and go for the centralized vertical single entity handling the transactions from trading. The consultant also intends to give precise hints regarding products to be traded in the new capital market structure as proposed. In the vertical structure the CCP stems from the integrated clearing structure: assets are under the control from trading through all the post trade cycle that generates CCP within the system. It is the main argument for the consultant to recommend this solution.51
10. and likely may finally generate an effective take-off of the new capital market architecture.
implies that their risk profile is atypical from that of other providers. Clearstream International has probably have not so much to contribute beyond that which any other bank may be expected to make. the structural pattern being pursued throughout the EU is one of increased vertical integration. This is an additional argument in the opinion of the consultant to strongly recommend this architecture type for the Azerbaijan capital market. as the assets are always under the control of one single processing entity. and the Second (Supervisory review) and Third pillars(market discipline). does particularly focused on operational risk issues for itself and for the global capital markets. Therefore. systemic risk in case of a crisis. is much higher when using horizontal capital market structures. “internalizing” (vertical integration) the entire post-trade processing allows for an optimum operational risk solution that a horizontal approach (Euroclear model) is unable to guarantee. asset managers’ and banks’ associations as well as the Bulgarian Stock Exchange (BSE) itself. The consultant did also explain that the processing of transactions and the general operability in vertical structured capital market architecture is higher. on which they expand. Clearstream can offer some particular expertise and insight in matters Operational risk managing capacity. by definition. The unique characteristics of Clearstreams business. When discussing the new Basel II capital agreement.5% for Clearstream).52
development strategy aimed to guarantee free trade by foreign investors on the Bulgarian market and vice versa. This is witnessed by the vertical silos throughout the EU such as in Germany where Deutsche Börse owns Cleartream and Eurex clearing and by Borsa Italiana’s recent acquisition of control of the Italian settlement service provider Monte Titoli.The Bulgarian CSD suggested that Clearstream could turn out to be the best-suited and possibly the cheapest option for the Bulgarian market but they reiterated that the choice will be made after discussions with all stakeholders. as in 2009. which is pervasive and remains the industry standard. It must be mentioned that Clearstream thanks to its vertical processing is more performing and has less failed trades as Euroclear in the European capital markets in general. Besides. (Clearstream as a bank is subject to this accord) aspects of the new frame did affect Clearstream more than had perhaps been intended. allowing for economies of scope. It is vital for the post-trade industry as a whole to ensure that the measures for operational risk are appropriate and achieve their desired goals of increasing financial safety and soundness in the system. this in addition. In reducing settlement risk in the international and domestic securities markets by “internalizing” (technical term for the vertical processing structure) Clearstream. The discussion is to either join Clearstream. As also outlined. and they have less failed
. In the field of Credit Risk. Euroclear or Link Up Markets (which is again Clearstream). In clear in an emerging market the Clearstream approach . is also an argument not to neglect. Before deciding for the options in the market the Bulgarian CSD want to thoroughly discuss the strategy with all stakeholders including the investment intermediaries’. This also explains that Euroclear will set up a single common IT platform that allows for vertical processing as much as possible despite its horizontal clearing institution providers. the Straight Through Processing ratio for vertical capital markets structure is so high (98.
Norway did also join the Target 2 securities system it should be possible. as both are possible and acceptable structures in the EU. keeping the trading and settlement functions running at cost. that the new Azeri CSD joins as well the system as the proposed capital market set-up is compliant with all EU regulations. It is clear that this is not conditional to opt for the horizontal or vertical capital market organisational set-up.53
trades to report then horizontal organized architecture where multiple entities are handling the post-trade transactions. The proposed vertical integrated architecture will enable the Azeri CSD to establish e a working relationship with other CSD in the EU and worldwide. and custody fees thereafter. having less operational risk in this structure as opposed to a horizontal structure where outsourcing of risk may occur but at the cost of higher systemic risk stemming from that functionality. while keeping its own assets under control in the post trade area. as the scope of horizontal capital market operators is to earn most while performing the clearing. As some non EU CSD in Europe such as Switzerland. In matters cost efficiency there is no data.
. but both structures do compete successfully in the EU capital markets. Azerbaijan could be a precursor in the Caucasus and innovate by launching products such as commodities related investment opportunities for FDI while enabling its domestic investor to gain a secure and safe access to international investment opportunities world-wide. In the vertical structure the fees are not so transparent. and through the ICSD Clearstream and/or Euroclear the CSD Azerbaijan (through the bridge) could be connected internationally as to this new securities settlement system in the Europe.
ANNEX 1 Capital market structures in the EU
Area/ Details 1Main TASK with Common CSD/Exchan ge IT platform SCS Tasks Ancillary part time with technical assistance projects Coordinati on With IT developers Coordinati on with IT developers Coordinati on with IT developers Coordinati on with IT developers Main full time coordinatio n with technical assistance projects MiFID & other EU Supervisor M M M M M M 1 2 3 4 5 6 M M M M 7 8 9 1 0 M 1 1 M 1 2 M 1 3 M 1 4 M 1 5 M 1 6 M 1 7 M 1 8 M 1 9 M 2 0 M 2 1 M 2 2 M 2 3 M 2 4
NDC BSE 3rd Parties market participants 2Main TASK Capacity building /training /coaching
y& Regulatory complianc e issues Custodian/ depositary bank regulatory and supervisor y Legal frame change to CSD Implementa tion/risk managemen t procedures EU complianc e assessmen t Dematerial isation Issues/ omnibus A/C National securities depositary issues OTC transaction
s Recording issues CBA and Governme nt securities handling Exchange rulebook Trading manual Implement EU code of conduct transaction s Implement EU Code of conduct Settlement / clearing Testing/ launch assistance OTC transaction s reporting/h andling Linkage with common IT platform
market acceptanc e absorption assessmen t c. launch assistance
.needs analysis b.58
3rd parties: market participants Products developmen t for the AZ Capital Market
“brokerage ” enabled banks/ MOU Regulatory requireme nt/CB advisory FDI issue Awareness raising exercise Ancillary part time with other LT expert a.products recommen d d.