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.

now compete with such over-the-countertrading organizations and other similar systems that allow computerized trading. bonds. 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. are well known. Their efficient. Securities trading are a financial activity involving transactions of property such as stocks. it would require an allocation of project man days to be performed. linking investors with brokers and dealers both on a domestic and an international level. as the MTF’s. and currency. safe and sound operation depends on the three key types of infrastructures – exchanges. the examination and evaluation of the basic components such a common structure. in the process. particularly in computers and telecommunications. SCS. commodities. the multilateral trading facilities (they are mentioned in the MiFID directive. by poaching in the different structural set-ups as used in Europe. Traditional stock exchanges. The advent of new technologies. Needless to say it is the starting point for elaborating a capital markets structure proposal. central counter-parties and central securities depositories.6 1. The consultant intends to recommend a more specific and tailor made capital market architecture for Azerbaijan. this in view to determine the usefulness of the proposed structure for the beneficiaries and the different stakeholders of the project. This EU directive also explains the . the National Depository Centre. while still vitally important in major cities around the world. in a capital markets architecture proposal that wants to take into account the best practice as prevailing in the EU capital markets. It could be recommended to be undertaken only if the actual project would require a more enhanced approach. This will be based on the respective merits of the in the EU capital markets competing structures. the project as such was designed for duly perusal by the Regulator. The functionalities to structure. the Member State’s diversity is nevertheless always taking into account the in the “EC acquis communautaire” given rules and requirements. or to whom to allocate. Introduction The elaboration of a proposal for a capital market structure requires. The first issue to be addressed is how to structure adequately. has brought about a new era in securities trading. It would exceed the scope of this paper to pass in review in full details the different architectures. It must be outlined that there is no uniform structure or type of capital markets set-up in the European Unions’ capital markets. It was elaborated by a project team member and is known to the project beneficiaries. the State Committee for Securities. Although the final beneficiaries of the proposed capital market architecture are the market participants. NDC and the Baku Stock Exchange BSE as the first involved parties. as only a comparative study with pros and cons would be a meaningful tool to opine on that issue. the relevant capital market functionalities.

Equiduct-Berliner Börse. QUOTE MTF . launched in September 2008. A Account operator In the context of ESES. Turquoise. 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. launched in August 2008. A Multilateral Trading Facility (or MTF) is a multilateral system. which brings together multiple third-party buying and selling interests in financial instruments . operated by an investment firm or a market operator. BATS Europe . launched in March 2007. and the info may be useful in the context. NX MTF . 2. launched in March 2009. launched in October 2008.in a way that results in a contract in accordance with the provisions of Title II in MiFID.launched in 11th December 2009 by Nomura Securities Ltd. bond and rights issues. C Cash Account In the ESES context. a pure dark-pool MTF operated by ITG. which is operated by the Euroclear CSDs . a Client that has been authorized by one or more Parties to send instructions in the name of.launched 4th September 2009. the list is long but the subject is complex. there are several MTFs operational now: POSIT. and on behalf of. a cash account opened by a Settlement Bank with a central bank in accordance with the Cash Account Documentation. NASDAQ OMX Europe. Chi-X. In the EU.7 whereabouts and set up’s functionalities in more details.in the system and in accordance with non-discretionary rules . 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. They often use a so called “dark pools” approach in matters of securities trade processing. 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. NYSE Arca Europe. launched in 1998. each of such other Parties in relation to the latter's Securities Account(s) and the Cash Account linked thereto.

in the context. Cash Correspondent A financial institution that executes cash transfers on behalf of its clients. Central Securities Depositary (CSD) An entity which operates a system enabling clients to hold. Cross-quality payment . CCPs typically interpose themselves between the counterparties to trades. Cash Accounts may also be referred to in the Euroclear Contractual Documentation as 'cash positions in Central Bank Money (CeBM). 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. 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.g. those executed on a particular exchange). 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. Cash position in Central Bank Money Balance in a central bank money account on a settlement platform operating the integrated settlement model. Also referred to. Central CCPS must also have direct or indirect access to the SSS. Securities Settlement Systems where transactions are ultimately settled and securities held. acting as the buyer to every seller and the seller to every buyer (“novation”). In order to be able to settle the novated transactions. 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).

Modern trading platforms and the lack of human interaction has reduced the time scale on market movements. DVP model 1 One of the three DVP schemes. Default Failure to complete a funds or securities transfer according to its terms for reasons that are not technical or temporary. This is useful for traders who wish to move large numbers of shares without revealing themselves to the open market. Default is usually distinguished from a failed transaction. Dark Pools in funds to line up and move large blocks of equities without tipping their hands as to what they are up to. 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. 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. it may be an agent or the debtor. 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. usually as a result of bankruptcy. for each pair of consecutive parties in the payment chain.9 Payment between a Euroclear group customer using central bank money and another Euroclear group customer using commercial bank money. or charity payments. Dark liquidity pools avoid this risk because neither the price nor the identity of the trading company is displayed. 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. e. as a result of receipt of goods or services.g. Debtor The party that owes assets to the creditor. gifts.[ Debit party The party that gives cash or securities. one party always plays the role of the debit party and the other the role of the credit party. Dark pools are recorded as over-the-counter transactions. In the payment chain. transfer instructions for both securities and funds are settled on a trade by trade basis. as defined by the G10. with final transfer of the securities . The debtor may also be the debit account owner. In model 1. Furthermore.

whose account will be credited by the final agent. and posts the transaction to the account. Hence.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). The final party is mentioned when different from the creditor. Ultimate beneficiary (Payment Industry). Final party The party that is the ultimate beneficiary of the cash transfer. 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). The eXtensible Markup Language (XML) is a W3C-recommended general purpose mark-up language for creating special-purpose mark-up languages. See Beneficiary of money (Securities Industry). . Its primary purpose is to facilitate the sharing of data across different systems. particularly systems connected via the internet. 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. 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. F Final agent A financial institution of the creditor that receives the payment transaction on behalf of an account owner or other nominated party. Final settlement The discharge of an obligation by a transfer of funds and a transfer of securities that have become irrevocable and unconditional.

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. a dictionary of data fields and . services to create a fair and open process for the execution of transactions between trading parties. Certain holders declared by the custodians may have the status of registered intermediary. Instrument family The first qualifier in the CFI . These tools consist of a set of syntax and message design rules. securities' holders registered on the custodians’ books.ISO 10962 classification of a security. and which enables transactions to be processed by book entry. Within Euroclear group.11 First agent A financial institution of the debtor that receives the payment transaction from either the account owner or authorized party.ISO 10962 classification of a security. all or part of. and the creation of settlement obligations. I ICSD International central securities depository Identifiable bearer security (TPI) Based on the French legal framework. and processes the instruction. Synonym: security family. through common membership. usually through direct or indirect (through local agents) links to local CSDs. An ICSD also settles trades in international securities and in various domestic securities. it is a service in Euroclear France that allows an issuer of bearer securities to request and obtain a list of. Internaliser In the context of the EU’s basic capital market directive MiFID. International Central Securities Depository (ICSD) An entity in which securities are held and managed. Instrument category The second qualifier in the CFI . (French acronym) Infrastructure The party that provides. the ICSD offers its services in the Full Service.

12 a catalogue for present and future messages built by the industry with the above mentioned fields and rules. L Legacy platform One of the current input.newly published standard which provides the usage of a common platform for the development of messages.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. 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. Issuance Account In the ESES context. matching. which brings together multiple third-party buying and selling interests in financial instruments . settlement and/or reporting systems in the Euroclear group’s (I)CSDs. 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. ISO 20022 Financial Services It is a Universal Financial Industry message scheme (UNIFI) . all securities of the relevant issue will be recorded on the debit of the Issuance Account. in the case of dematerialized securities. operated by an investment firm or a market operator. Issuance Accounts are not considered as Securities Accounts for the purposes of the Terms and Conditions. N Netting . 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 the system and in accordance with non-discretionary rules . the basic capital market directive MTF a Multilateral Trading Facility is a multilateral system.

P Payment settlement agent An agent that executes the cash transfer upon the request of either an agreement party. the party appointed by the fund management company that keeps the investor registry of the fund. Post-trade administrator The party ensuring that all the details of the trade have been collected and reported. The netting reduces a large number of individual positions or obligations to a smaller number of obligations or positions. These records represent the liability accounts of the fund management company. the investor. Also referred to as a liquidity provision. It prepares and distributes account statements (holdings and transactions) to the investor and/or its intermediary. Registrar The party that is responsible for keeping track of the owners of securities. See 'Trustee'. 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). Netting may take several forms.13 Stands for an agreed offsetting of positions or obligations between counterparties. and settlement parties. 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). rather than in separate accounts with designation. as required to all parties involved in the trade transaction including counterparties. It may provide tax information to the . In the context of investment funds. A nominee is commonly used in a securities transaction to obtain registration and legal ownership of a security. or a clearing agent. Nominee A person or entity named by another to act on his behalf. on a periodical or upon request basis. O Omnibus account A single Securities Account within which the Securities Account Holder co-mingles the assets of two or more underlying clients. and administers investor accounts and related records.

custody. either free of payment (FOP) or against payment (Delivery Versus Payment-[DVP]). with a contractual agreement that the seller will repurchase the securities in return for the guarantee. possess a banking license and are regulated by existing banking law. reports to the regulator on shareholder identity. assets. but not offered directly. and accounting services for its own. Settlement Bank . The lending of securities in an exchange for a fee. Securities Settlement System (SSS) A system which permits the holding and transfer of securities. if there is a guarantee. Settlement Delivering securities and/or making payments in the performance of obligations between the counterparties to a transaction. (I)CSDs and banks. at an agreed price and date. or someone else's. 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. and can appoint the sub-registrar. which is thus registered with its central bank for the purpose of processing payments. 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. Settlement agent The party that provides settlement. RTGS Real-time gross settlement system S Securities loan / Securities lending / Securities borrowing Securities finance mechanism that involves transferring full ownership of securities. with or without a guarantee.14 investor and/or to its intermediary. Securities lending is mostly facilitated by CSDs.

It reflects the liquidity resulting from the settlement bank client’s activity in the Securities Settlement System (SSS). an IT platform shared by all Euroclear group (I)CSDs hosting the (I)CSD Systems.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. Single Settlement Engine (SSE) The first building block of the Single IT Platform. also known as TARGET2. 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.e. as above). Settlement date Date at which the financial instruments are to be delivered or received. Settlement liquidity indicator The liquidity position of a client in the system that uses the services of a settlement bank (i. the liquidity position of a settlement bank’s client. Single Platform The long-term solution. concentrating on the core settlement (i. SLAB Delivery by mutual consent settlement service SSS . which will be shared by a number of participating national central banks. Single Shared Platform (SSP) The new platform of European Central Bank. positioning and booking of cash and securities transfers). Settlement Bank Client A Client who has appointed a Settlement Bank to provide cash services in connection with the Domestic Service.

Time Gross settlement Express Transfer 2 TPI Identifiable bearer security. or a trader. buy-sell back and sell-buy back transactions. a service in Euroclear France that allows an issuer of bearer securities to request a list of beneficial owners registered in the custodians’ books.should be taken to mean all institutions. deals on own account by executing client orders outside a regulated market or an MTF. or that move the investor's assets from one investment to another. it is the result of the matching and execution of either a purchase or sale order with compatible opposite orders. Settlement and custody functions except custodians.16 Securities Settlement System. . In the context of treasury. Transaction In a Euroclear context. a post trade administrator. in particular CSDs. Trade date The date on which a market trade is executed. on an organised. Two-leg settlement instruction Settlement instruction which can be used to settle bilateral repo. performing the Pre-settlement. it is the party that negotiates and executes the treasury transaction. the concept stems from the EU’s MiFID directive T TARGET2 Trans-European Automated Real. frequent and systematic basis. Trading party The party that plays an active role in planning and executing the transactions that create or liquidate investments of the investors’ assets. securities lending & borrowing. 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. Systematic internaliser It means an investment firm which. an investment decision-maker. A trading party is a trade instructor.

reduced by a certain percentage (haircut). . Voting service provider (VSP) A service provider mandated by the Client to act on its behalf. notably their residual maturity. V Valuation haircut A risk control measure applied to securities used in reverse transactions.17 U UNIFI Standard See 'ISO 20022 Financial Services'. implying that the central bank calculates the market value of the underlying securities. The Eurosystem (European Central Bank. (I.e. ECB) applies valuation haircuts that also reflect certain characteristics of the securities. instructing the system agent. receipt and sending of meeting notifications. collection of voting instructions.

fund administration.CUSIP etc. As outlined later.18 3. the internet.g. Pre-trade Compliant with the EU requirements in its specific MiFID directive (see below for more details under 6. They maintain database of structured. facts.1) operators in the market must provide full pre-trade transparency. These so called Data providers are also a source of financial information. and in the US. portfolio management. NDC is the member in ANNA for Azerbaijan. is not limited to execution price but also includes cost. Securities trading information flow 4. depending the nature of their systems must provide mandatory the following data information: . who are specialists in the procurement. They very often act also as official numbering agency responsible for allocating security identification numbers.2. 4. 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.Continuous order-matching systems. speed.(NNAs. securities trading and securities administration. magazine). 4. they provides financial news and data (e.3. aggregated order information on "liquid shares" available at the five best price levels on the buy and sell side. statistics and analysis). Post-trade . 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. processing and distribution of international financial information for investment advisory services. for professional and individual investors through various communication channels (e. the best bids and offers of market makers must be made available. 4. financial analysis.1. ISIN. -for quote-driven markets. all market operators. This best possible result or best execution as it is called by the operators.) There is an Association of National Numbering Agencies (ANNA) which leads the way in introducing standards aimed at simplifying trading and securities administration. Information flows and information systems for securities trading There are several large professional provider of financial information in Europe.g. likelihood of execution and likelihood of settlement and any other factors deemed relevant.

e. Stock Exchanges. Between 2002 and 2005. The political support for these regulatory initiatives was reflected in the conclusions of the EU Council on Clearing and Settlement of 9 October 2007. 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. does only focus on a number of regulatory initiatives going on in the area of post-trading. Following other emerging initiatives in the area of post-trading. run by the Euro-system. It is up to the member States in the EU to act in the matter. with the objective to enhance a level-playing-field and the safety and soundness of post-trading activities within the EU. given the responsibilities of national securities regulators for post-trading activities in the respective Member-States. Also the other directives regarding prospectus.19 MiFID the basic capital market directive in the EU requires from all professional capital market operators to publish the price. Information collection and distribution There are IT systems.4. The first major point on the agenda of the PTEG is the Code of Conduct for Clearing and Settlement. even if executed outside of a regulated market. i. unless certain requirements are met to allow for deferred publication. Clearing and Settlement. In 2007. 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. CESR is a member of the Monitoring Group. to respond to these initiatives. like AutoFlow. PTEG. the CESR Members decided to establish a group of CESR experts only. settlement and custody the core directive for capital markets in the EU MiFID remains silent.1. Prior to this. the PostTrading Expert Group (PTEG). where appropriate. But disclosure is required mandatory by the directive. Categories of capital markets information systems 5. and transparency are only focusing of the trading not the post-trade aspects. The Code of Conduct was developed and signed by the providers of infrastructures for Trading. It is a . the group established by the European Commission with the mandate to review the compliance with the Code by the signatories. 4. establish a place to share supervisory experiences and. 5. market abuse. Clearing-Settlement-Custody It can be mentioned that in matters of clearing. where relevant for CESR and its members. in particular with regard to the envisaged role of regulators in this Code. CESR had decided to create a platform to follow these initiatives more closely. The second important initiative followed by the PTEG on behalf of CESR is the ESCB-project TARGET-2-for-Securities (T2S). activities of the group were disrupted after that period. This group does focus on post-trading activities in the EU. volume and time of all trades executed in listed shares. Central Clearing Parties and Central Securities Depositories within and outside the EU-area. Common communication interface. an automated ISO-based STP interface to exchange structured data with custodian banks via a CCI.

speed and costs can also be considered in the routing logic. Tools. clearing houses and securities settlement systems (SSSs). 5.20 communication interface with the external world that provides users with a single access to a common integrated trading platform. Trading tools Global electronic trading is technology based. securities settlement systems activity. foreign exchange settlement systems. order execution through a suite of global. 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. They can derive custom indicators based on the order or trade information. 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. dynamically optimize performance and avoid market impact. It must also ensure MiFID compliance and run in parallel with the OMS system. leverages low latency market data including custom indicators. Trading tools must have the following capabilities: direct execution to every major global exchange. it will have an embedded custom routing logic that takes multiple factors into account. in particular. …to be aggregated in a feed handling infrastructure for connection with the trading platform for processing. An optimized order routing system will slice and route orders with ultra-low latency. control of order flow while maintaining anonymity. It uses multiple in and output FIX connections. supports multiple order types. These indicators. Below the consultant provides a . 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). maintains and persists all order states. It enables also clients to send instructions and receive reports in industry standard formats. 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. 5. these include retail payment systems. qualitative algorithms designed to monitor market changes. It is strategies. 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. Euroclear Trade Capture and Matching System (ETCMS). CNS centralizes the settlement of matched transactions and is maintaining an efficient flow of security and money balances. a standardized interface of the common shared IT platforms which control and distribute the information pertaining to Ancillary Systems and. Trading platforms remain the core of all the central integrated IT system In particular. that show momentum or compare executed liquidity versus displayed liquidity over a time window on a per venue basis. the data providers etc.2. large-value payment systems. money market systems.3. liquidity management tools and advanced technology to execute trades. execution quality. can be easily included in the order routing module later. Continuous Net Settlement (CNS / RNC) are automated book-entry accounting systems. Sophisticated liquidity management and advanced DMA products. A key tool in this practice is the in an order routing system to find the National Best Bid or Offer (NBBO) across markets. but there are ancillary systems (AS). access to ConvergEx ATS for block crossing and aggregating dark liquidity (dark pools) tools. In addition a host of other parameters such as aggression levels. It continuously scans different liquidity pools in order to get the best price.

.21 sample of an order routing system set-up and the connections with OMS etc.. . 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.

22 .

by definition. Users can access brokers' direct-market-access (DMA) capabilities and algorithms to carry out electronic trading strategies. users can connect to major exchanges. In practice. As a result. connectivity. an execution management system (EMS). The platforms enable both single-stock and portfolio trading capabilities. Moreover. With an OMS. If the instruction is deemed to be valid. multiple destinations and real-time market data. 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. It is worth pointing out that. for instance following trading on a stock-exchange or over the counter. the following occurs: • instructions are entered by clients for matching purposes. crossing networks and multiple brokers. Since this modest beginning of OMSs as trading blotters with FIX engines. in some cases. firms easily can look back in order to analyse their orders. The trading blotter is composed of an order entry screen where users initiate and monitor trading activity. Although a number of DMA players call their order entry and management portals EMSs. It is a software-based platform that facilitates and manages the execution of securities orders. they will continue to substitute for OMSs more and more. 5. unless the delivery is free of payment. • the CCP then undertakes a local validation process.or limited-destination systems. Real-time market data enters the system from a combination of external feeds from exchanges and market data providers and. unconditional) . adding analytics. portfolio staging capabilities and tighter systems integration. it will be given a Euroclear reference ID and will enter the matching process. there should be a differentiation between an EMS and a pure DMA platform. typically through the Financial Information exchange (FIX) protocol. DMA platforms either are single. There are also automated matching and routing service for over-the-counter transactions with a Central Counterparty (CCP).5. 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. The delivery of securities takes place by book entries in computerized systems. Order-presentation systems In this area we find now since recently now EMS. they have extended the breadth and depth of their functionality significantly. alternative trading systems (ATSs). Through the EMS platforms. Today's OMSs have emerged as portfolio management systems with functionality that ranges from pre-trade through post-trade support. instructions are sent to the CCP for netting. An EMS offers multiple destinations to which to route a trade. Both legs must be simultaneous and linked to limit risks. electronic communication networks (ECNs).23 5. In comparison.4. transactions settled in SSSs are considered final and irrevocable (i. EMSs have four key features: a trading blotter.e. internal proprietary data from the EMS provider. • once matched. the older traditional order management systems (OMSs) were designed as tools to allow firms to manage and document their trading activities electronically. whereupon the instruction is either registered when the trade is novated or rejected when the instruction does not meet all of the validation criteria. which offers netting at both user and security eligibility level. Settlement and custody systems Securities Settlement Systems enable the transfer of securities.

SSSs either settle on a gross basis or on a net basis. one party is using a Domestic operational securities account and the other is using a Full securities account). An interface is used at the request of clients when they want to transfer cash into the SSS or back to the payment system. Integrated settlement model SSSs settle transactions directly in their own system without the constant involvement of the payment system. manage the Securities Accounts balances and the Purchasing Powers and provide reporting to the Clients. . who are notably responsible for ensuring securities’ integrity. There are also settlement sub-Systems. As two systems are involved. In settlement there is an internal transaction category. Deutsche Bank did add front-office grid applications to support "straight-through processing" (automated. Custody systems are most of the time in-house developed as this kind of service is not provided by Euroclear given its horizontal structure. Full-Domestic transactions when one party is using the Full Service and the other is using the Domestic Service (i. CSDs enable securities’ mobility as they operate securities settlement engines. Clearstream and other global custody provider have most of the time their own traditional IT architectures.e. Next to the safekeeping function. in Euroclear this transaction category includes: Intra-entity settlement transactions when both parties to the transactions are members of the same (I)CSD. These systems process the settlement of instructions. Deutsche Bank's Securities Custody System is one of the earliest successful examples of commercial grid computing.24 when they meet certain conditions. 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. intra-Full transactions when both parties are using the Full Service and transactions settle then on the books of the custodian Bank. In a single platform context. as compared to the traditional architectures. There is usually at least one CSD and one SSS in each EU country. streamlined workflow) in its custody system. Securities are held with central securities depositories (CSD). ESES will provide the Euronext-zone market CSDs (Euroclear Belgium. 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. The security leg is settled in the SSS while the cash leg is settled in the RTGS in the EU. Interfaced settlement model: transactions are settled using an interface between the payment system and the SSS. they constantly communicate with each other. Euroclear France and Euroclear Nederland) with an integrated settlement solution and harmonized custody service for stock exchange and over-the-counter activities. 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. This largescale financial application demonstrates the substantially lower costs and higher return on investment possible with only processing software.

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. The institutional links among capital markets operators . where sectorspecific committees and regulators advise on technical details. 5.1.6. The prevailing legal and regulatory framework in the EU 6. 6. 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. 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. the EU adopts a piece of legislation. At the third level. national regulators work on coordinating new regulations with other nations. Norway and Liechtenstein).25 In the context there is also SBI. 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. The main EU Directives on capital markets The main EU directive governing the capital markets is the Markets in Financial Instruments Directive (MiFID). a Broker to custodian trade affirmation system that is widely used in the market. then bring it to a vote in front of member-State representatives. 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 law then progresses to the second level. All these directives compose the legal frame for capital markets in the EU. 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. Under European law. They are mostly based on a core analytics and profiling engine and a set of flexible enterprise case management and investigation applications. At the first level. There are three other Directives' in the context of the “Lamfalussy” procedure that the EU did also needed to issue: the Prospectus Directive. 6. the Market Abuse Directive and the Transparency Directive. establishing the core values of a law and building guidelines on its implementation. The fourth level involves compliance and enforcement of the new rules and laws. they are designed to identify trader behaviour and activities that could be related to fraud or unauthorized activities. a Directive has to be transposed into national law: as all the 30 States of the EEA have done.2.

the appropriateness of any investment advice or suggested financial transaction must still be verified before being given. MiFID has introduced the concept of this Systematic Internaliser. That part of an investment firm's (capital market operator) business that is not covered by the above is not subject to MiFID. Clear procedures must be in place to categorize clients and assess their suitability for each type of investment product. for example. climate and carbon derivatives. Comments: MiFID intended to increase transparency for prices. it is not subject to MiFID (but cannot benefit from a MiFID passport). These services will be regulated by the member state in their "home State".26 The institutional links among capital market operators are defined in 3 aspects: authorization. 6. professional clients or retail clients (these have increasing levels of protection). but caused in fact a fragmentation of trading venues. Systematic Internaliser. they are subject to pre-trade and post-trade transparency requirements as above mentioned. the country in which they have their registered office). it will be able to use the MiFID passport to provide services to customers in other EU member States. If a professional capital market operator performs investment services and activities. 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. Where once a financial institution was able to see information from just one or two exchanges. they now have the possibility (and in some cases the obligation) to collect information from a multitude of multilateral trading facilities. That said. which were not covered by the former EU investment services directive ISD that now is now superseded by MiFID. To determine which firms are capital market operators under the legal MiFID frame and which are not. MiFID covers almost all tradable financial products with the exception of certain foreign exchange trades. However if a firm only performs ancillary services. 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). The role of professional capital markets participants MiFID requires professional capital markets participants to categorize their clients as "eligible counterparties". . This is a professional capital market participant that executes orders from its clients against its own book or against orders from other clients. MiFID distinguishes between "investment services and activities" ("core" services) and "ancillary services" ("non-core" services). regulation and pass-porting Firms covered by MiFID will be authorised and regulated in their "home State" (broadly. This includes therefore commodities and derivatives but also such as freight. MiFID considers Systematic Internalisers as miniexchanges. Systematic Internalisers and other exchanges from around the European Economic Area. hence.3. Once a firm has been authorised.

The Single Platform intends to offer a number of important benefits in terms of additional services and more automation and consolidation. which will replace each CSD’s current client interfaces. the Market Abuse Directive and the Transparency Directive. The capital market Regulators are. But it intends to integrate all in the Euroclear group CSDs’ legacy systems in one Single IT Platform.4. 6.1. is automatically binding throughout all member states. the Prospectus Directive. as previously mentioned the fourth level in the “Lamfalussy procedure”. 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. . when issued. 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.1. The prevailing capital markets architectural models in the EU 7.1. on the other hand. they have to take care of compliance and enforcement of the in national rules and laws transposed MiFID directive. 7. IT Architecture Up to now Euroclear uses two platforms: A Single Settlement Engine (SSE) and a Euroclear Settlement of Euronext-zone Securities (ESES) trading platform. Under European law. The Euroclear model 7. a Directive has to be transposed into national law: an EU Regulation. '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.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. 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). 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.

For example. the Brussels-based CSD for Belgium Euroclear Finland.1. an ICSD (International Central Securities Depository) headquartered also in in Brussels. a simple book-entry transfer is made enabling the required simultaneous exchange of cash and securities. the Helsinki-based CSD for Finland Euroclear France.28 7. 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. Settlement as the final step in securities transactions is vital for a good functioning of financial markets. if against payment. Institutional links among various capital markets stakeholders As providers of settlement services. The settlement process is also largely determined by the type of asset and market.1. 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). and make sure the seller has the securities and. unlike for bond and equity transactions. settlement is achieved through local market settlement structures. with accounts in different ICSD’s. Within the Euroclear group. the Stockholm-based CSD for Sweden Euroclear UK & Ireland.3. as well as six other CSD in the Euro currency area: Euroclear Belgium. the London-based CSD for the United Kingdom and Irish equities . order routing is an essential step prior to the settlement phase for fund orders. to complete a trade between two parties. the proprietary ownership becomes effective for the purchaser from a legal point of view.2. which vary from market to market as there is diversity in the EU capital markets. Euroclear match up the two instructions. Where the trade is between two counterparties in different countries. Organisational links among various capital markets stakeholders. EMXCo is the provider of funds order routing. how and with whom they want them to settle their securities transaction. the buyer can pay. Clients of Euroclear submit an instruction telling Euroclear when. At the time of the settlement. The counterparty in the trade also submits an instruction. the Euroclear group is a horizontal organized structure that comprises Euroclear Bank in Brussels. the Paris-based CSD for France Euroclear Nederland. usually against payment. 7. Settlement is only the delivery of securities. Euroclear is a Settlement service provider only.

29 Below a schematic graph to illustrate this capital market organization. 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 Clearing Euronext Clearing LSE ClearingL CH Clernet .

Organisational links among various capital markets stakeholders Clearstream is a wholly owned subsidiary of the Deutsche Börse. The Eurex clearing functionality also supports clearing of equities. It also operates now the Link Up Markets. Hellenic Exchanges S. STRATE (South Africa). “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.1.2. the clearing and custody functions. introducing efficient cross-border processing capabilities. joint venture by nine leading Central Securities Depositories (CSDs) – a common infrastructure allowing for easy implementation of links between CSD markets. This platform will favour algorithmic trading by mitigating towards an Itanium platform to boost output with new enhances broadcast solutions. Oesterreichische Kontrollbank AG (Austria).A. The Clearstream model 7. Below a graphical scheme representing this capital market architecture type in Euro . Institutional links among various capital markets stakeholders Clearstream is a vertically integrated supplier of all post-trading services. VP SECURITIES (Denmark) and VPS (Norway).2. IBERCLEAR (Spain). The design will be modular base on a shared technical infrastructure which combines extremely low latency with high volume. the other electronic trading platform for the cash market allows the trading of stocks on one platform – everywhere in the world. (Greece). Clearstream is developing also a new globalized standard IT platform using open source components. bonds and repos traded on the Frankfurt Stock Exchange. 7.2. IT Architecture Clearstream uses three trading platforms: Eurex. SIX SIS AG (Switzerland). 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. Xetra . an integrated.3. Link Up Markets is the joint venture by nine leading Central Securities Depositories (CSDs) – Clearstream Banking AG Frankfurt (Germany). Cyprus Stock Exchange (Cyprus).2.2. It provides after trading and settlement. fully electronic derivatives trading and clearing system.30 7. 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. 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. commercial third parties soft-ware and internally developed software.

Universal Banks Brokers Stock exchange A Trading Stock exchange B Trading Stock Exchange C Trading Clearstream Clearing Settlement Custody Custody . clearing and global custody.31 Vertical structured single provider of settlement.

In addition both are Global Custody services providers world-wide and competitors in the European capital markets post trade value chain services. From this fundamental organizational difference also stems the difference in their respective functionalities: Euroclears provides settlement only.3. 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. 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. . 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. settlement. The issue is that Clearstream is owned by a single shareholder Deutsche Börse. 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). as . areal advantage) could offer clearing through collateral management during the Financial crisis 2009. clearing and custody. in September 2009. only Clearstream was able to offer automated lending and borrowing of securities as well as tripartite collateral management services. many banks did found it difficult to borrow cash. But both architectures compete in the market to provide the lowest global processing fees. it is owned by the Deutsche Börse Group. in addition the MTF are now also more and more a competitor capital markets structure. But in the last Financial crisis.32 7. 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. who in most cases of the time are also its shareholders of Euroclear. while Euroclear is owned by its users the different stock exchanges. Due to the credit crunch. while as users they want to pay the lowest handing fees. while clearing and custody is always mandatory provided by third parties. Clearstream does provide the whole range of services from trading to all integrated post trading services. making Clearstream services valuable in improving liquidity: Eliminating counterparty risk by using the CCP(central counterparty) service. brokers and investment banks. From an economic point of view there may be a conflict of interests.as shareholders they want the best possible return. 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. only Clearsteam with its vertical structure (enabling them to have control of collateral through all the post-trade cycle. ascertaining the superior quality of underlying securities by limiting the assets to those which the ECB (European Central Bank) accepts as collateral.

Oesterreichische Kontrollbank AG (Austria). This may also explain. Systemic risk considerations do explain the choice in favour of Clearstream in the opinion of the consultant.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. The Settlement Centre is operating with book entries. The prevailing capital markets architectural models in emerging markets 8. that CSDs from eight leading Central Securities Depositories (CSDs) – Cyprus Stock Exchange (Cyprus). (Greece). as mentioned above in 7. 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. the handling of the flux of assets and cash is easier to process in a vertical structure. That major point was for Clearstream in the competition game on the European capital markets.3. 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. In this paper the consultant will broach the Turkish capital market architecture through the ISE. Trading is taking place at the ISE. 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. are also vertical structures for the same obvious reasons. SIX SIS AG (Switzerland). The Turkish model In Turkey. IBERCLEAR (Spain). Hellenic Exchanges S.1. Therefore a vertical capital market model has a better operability and a better risk management capacity. whereas clearing and settlement takes place through TAKASBANK ISE Settlement and Custody Bank Inc.A. the capital market structure is based on the ISE. 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. STRATE (South Africa). . Istanbul Stock Exchange for transferable securities whereas derivatives are dealt on in the Izmir Mercantile Exchange. as mentioned previously already by the consultant. From a strictly operational point of view. 8. It must also be mentioned that the new MTFs in the capital markets worldwide.2. compared with the horizontal capital market architecture. 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.

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. "RTS Clearing Centre". Physical custodian services towards the members of ISE. Dematerialized transfers vary according to institutions being party to the transfer. It is a regulated market in Russia. and information services. RTS is an integrated trading and settlement IT platform in a structure consisting of Not-for-profit partnership "Russian Trading System Stock Exchange". clearing. The Regulator in Turkey is the CMB. countries of Eastern and Central Europe. settlement. is the largest stock exchange in the CIS countries. " RTS Settlement Chamber" and "St. In clear a vertical architecture type of an emerging market capital market organisational set-up. corporate. Petersburg 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. issuer companies and corporate investors is continued to be provided. . which will be transferred. depositary. currency market. the CJSC “MICEX Stock Exchange”. in accordance with the regulations of Capital Markets Board regarding dematerialization of securities. the circulation of which is supervised by the Bank of Russia. "Open Joint Stock Company "Russian Trading System Stock Exchange". is dematerialized or not. TAKASBANK does also provide custody and banking services. or Capital Markets Board of Turkey. or Electronic Security Transfer (EMKT) Transactions EMKT is a system established within the framework of CBT Central Bank of Turkey. which are members of TETS (Takasbank Electronic Transfer System) can join this system through Takasbank. sub-federal and municipal securities. transfer and other related transactions of dematerialized securities in an electronic environment and in an integrated manner with EFT. facilitating the real-time execution of buy-sell. The Russian model In Russia we have the MICEX Stock Exchange Within the MICEX Group. There is also the well-known RTS. The National Depository Centre (Closed Joint Stock Company) NDC was established as a central settlement depository for the servicing of state securities.2.34 Free transfer The Stock Transfer Transactions between members vary in respect of whether the security. The MICEX Group provides financial market participants with a complete set of trading. Brokerage houses. the Russian Trading System. 8. MICEX covers a stock market. and derivatives market.

the derivatives (standard contracts) market. including cash settlements on trades made by financial market participants. regardless their organisational structures: horizontal or vertical.  it performs cash settlements in real time. The Regulator in the Russian Federation is the Federal Financial Markets Service.  it completes cash settlements on participants’ transactions on the day of trading.3. The Moscow Interbank Currency Exchange Settlement House (MICEX SH) is a credit organization that provides settlement banking services. the corporate securities market.35 Currently NDC is Russia’s largest settlement and safekeeping provider. the currency market. (whereas RTS is of the vertical capital market organisational set-up). it provides reliable and prompt cash settlements on trades made in MICEX financial markets. Since January 1. its’ capital market structure was pre-scrutinized by the European Commission and would need to introduce the full range of the “acquis communautaire . Turkey has applied to join the EU. 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. In clear. offers its clients a full range of settlement services. 1997. The MICEX Settlement House:  acting as a settlement bank. Clients’ payment orders are handled and executed immediately after their delivery to the MICEX SH.  it provides settlement services in all of the MICEX financial markets:     the government-backed securities market. a horizontal organizational capital market structure type.  is one of the main exchanges trading infrastructure.  interacts with clients throughout the entire trading day.  it guarantees timely settlements and the safety of its clients’ funds. 8.Both structures competing for market shares in the Russian market. The MICEX Settlement House guarantees timely settlements and the safety of its clients’ funds because active operations are not performed on clients’ funds.

36 “to meet the adhesion criteria. Deficiencies do also exist in matters of prospectus directive. In the case of Russia the actual structure is rather cumbersome (as resulting from the fact that it is a horizontal structure. Deficiencies were detected in the areas of prospectus directive. which is an absolute prerequisite requirement in an EU type of capital market structure. Actually the vetting procedure is frozen by the EU and accession talks are suspended because the unsolved Cyprus issue. transparency and corporate governance . market abuse and transparency: the operational aspects of the capital market structure. except the RTS who is a vertical structured type) with many entities intervening in the market. In the end both organisational set up do not provide full DVP. market abuse.

37 9.1. indicate the time and means to achieve this recommended structures and institutional frame. 9.1 Global Strategy The action plan starts with a day T. Based on the experience as gained in the EU. The consultant intends to recommend a modular base on a shared technical infrastructure to combine extremely low latency with high volume.1. once trading will start for real at the BSE and Sub strategy D. Action plan and time frame for implementation 9. . to be ready in the future. Sub strategy C-in addition the proposed set-up capital market structure will need an appropriated IT-tool/platform.Define the operational aspects of this new capital market architecture that must be put in place and indicate the time required.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.1. to enable the institutions and all other capital market participants to operate in the new proposed structure. 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. 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. 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. 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. to be the day the decision is taken to accept the proposal and to start the implementation of the proposal as such.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. 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. The proposed architecture for Azerbaijan 9. The overall objective of the new proposed capital market structure in Azerbaijan is to create an integrated financial market. in which investors are effectively protected and the efficiency and integrity of the overall market are safeguarded.

Capital base . this would require also elaboration of regulations and an appropriated reporting frame to the Regulator.External auditing. NDC and BSE) should be done in parallel. (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.3. 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. Authorization procedure. as an example. This from a capital market point of view is a piece meal structure.1. This is also reflected in the detailed graph in the graph in Annex 2.1. 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. The consultant has elaborated a graph showing in details the time allocated to achieve the proposed implementation. It does not allow for the development of a coherent capital market. It would take the form of a financial services action plan encompassing all institutions: SCS. Participation in a deposit guarantee scheme . 9. Professional standing and experience . To create a legal coherent frame in Azerbaijan. This will require a time period of 18-24 months to achieve. again this will require 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. This is a prudent estimate based on experience as gained with the elaboration of the latest capital market law in Moldavia. Also capacity building for the institutions involved (SCS. This capital market frame law should contain all requirements as below stated in more details.3 The structural aspects for a capital market architecture in Azerbaijan. would require a simultaneous implementation of all the EU directives mentioned under 9. custodians and all other market participants in the capital market.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.3 Main actions and priorities As resulting from the information of the consultant in Azerbaijan. 9. the legal frame for capital markets transactions is based on some specific articles in the civil code. The required time: at least 18 months for elaboration and 6 months for implementation. This would require the consultant to elaborate detailed proposals for rules and regulations to be implemented. The major work load would be for the consultant to facilitate the required change of status for NDC towards a CSD status enabled institution. The graph illustrates the time necessary to achieve these objectives as well. There is also a draft law for domestic investment funds under scrutiny. the brokers. The legal form of the institution. Participation in an investors’ . DNC. 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 . Shareholdings. Capacity building to exercise the prudential supervision of the market would accompany the consultants’ action. banks. BSE.

Brokers in financial instruments. Scope and parameters of supervision on a consolidated basis. Client order handling rules . Underwriters of financial instruments. Capital adequacy. Obligation to cooperate with the authorities . Relationship between the Regulator and external auditors. Professional secrecy of the Regulator. Identifying a financial conglomerate. Purpose of supervision. Powers of the Regulator. -Supplementary supervision of investment firms in a financial conglomerate:: Definitions. Coefficients. Internal control mechanisms and risk management processes. Financial position. Cooperation and exchange of information between competent authorities. Obligations of credit institutions and investment firms when appointing tied agents. Professionals acting for their own account. Professional obligations of the financial sector as regards combating money laundering and the financing of terrorism. Authorization of holdings. Market makers. . Investment firms operating an MTF in Azerbaijan. 2-Authorization for the establishment of branches and freedom to provide services 3-Professional obligations. thresholds for identifying a financial conglomerate.Transactions executed with eligible counterparties . -Supervision of investment firms on a consolidated basis: Definitions. Conduct of business rules when providing investment services to clients. Financial intermediation firms. Intra-group transactions. Professional custodians of financial instruments. Distributors of units/shares in investment funds. Content of supervision on a consolidated basis. Private portfolio managers . Powers of injunction and suspension. Miscellaneous firms other than investment firms.39 compensation scheme for all professionals such as: Investment firms. Verification. Cooperation with the other authorities responsible for prudential supervision regarding consolidated supervision. Enforcement measures. 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. accounting documents. Obligation of professional secrecy 5-Prudential supervision of the capital market -The competent authority responsible for supervision and its tasks. Investment advisers. Conflicts of interest. Risk concentration. Obligation to execute orders on terms most favourable to the client. Exchange of information with third countries. Registrar agents. Means used to exercise supervision on a consolidated basis. Parent undertakings having their head office in a third country. Complaints by clients. -Means used to exercise prudential supervision: Official lists and the protection of titles. Provision of services through the medium of another credit institution or another investment firm . Exchange of information with other Regulators. Commission agents. Form and extent of consolidation. Scope of supplementary supervision of investment firms.

proof of the appointment and powers of administrators and liquidators. 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. Detrimental acts. Criminal sanctions 9. Another part time task for the consultant would be. During his first mission in Azerbaijan the consultant had meetings with market participants regarding the launch of a capital market in Azerbaijan. the leading gas exchange in Central Europe within the next years. Reservation of title.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. assuming the proposed architecture is accepted. Repurchase agreements. the Central bank and the State Fund. -Provisions common to reorganization measures and winding-up proceedings: Effects on certain contracts and rights . simultaneously. Scope. Winding up: Voluntary winding up. Lodgement of claims. Third parties’ rights. Registration in a public register. corollary to the set-up of the legal and regulatory architecture of capital markets in Azerbaijan. Suspension of payments: Provisions governing the opening of proceedings for suspension of payments. brokers. 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. according IT duly consulted. Lawsuits pending. Set-off. Netting agreements . At present the gas flowing through the . insurance companies. He gained the impression that actually there is a lack of adequate tradable products in the stock exchange. Regulated markets.1. 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). Protection of third parties. This is also duly reflected in the graphical scheme in Annex 2. Opening of proceedings for suspension of payments. Therefore he recommends undertaking a formal capital markets needs analysis and a market acceptance and absorption evaluation together with the project team.: Provisions governing proceedings for the judicial winding up of establishments . Provision of information to known creditors .Winding-up proceedings. This is the technical component. 6-Deposit-guarantee schemes: Compensation schemes for investors in credit institutions and investment firms 7-Penalties: Administrative fines. Withdrawal of an establishment’s authorization. Competent jurisdiction and applicable law. The time frame is 6-12 months for the development of such a platform. 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. OMV plans to make the Central European Gas Hub CEGH. Professional secrecy. He did meet with banks.

the State Committee for Securities. for lack of adequate products for the potential investors. 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. The consultant recommends to formulate policy recommendations as mentioned under 9. SCS. These tasks are mentioned in the graph of the action plan. (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. concerning the European code of conduct relating to transactions in transferable securities. to derivatives. that are currently on a case by case dealt in. The execution of these duties must be under the duly Supervision by the Azerbaijan capital market Regulator. This encloses also private deals done on listed equities that should and must be duly notified to the Baku Stock Exchange compulsory. The core element of any capital market. which would require the elaboration of a stock exchange handbook containing the rules and regulations. 9.1 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. This will require building up the capacity to handle transaction with EU conform regulatory requirements. This percentage is expected to rise further when Nabucco and the South Stream gas pipelines will be connected.41 hub at Baumgarten covers 10% of Europe’s gas requirements. once the market develops.2. 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 Baku Stock Exchange must necessarily be endowed exclusively and compulsory with all securities trading in the Azerbaijan capital market architecture proposal of the consultant. already sporadically now. a trading manual and implementing the EC recommendations dating July 25. 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. 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. 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. 1977. 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. This initiative seems to be an attempt to emulate the actual existing Caspian Oil & Gas Exchange. .2. commodities and currencies that could be eligible at a later stage. mainly those as mentioned in the EU MIFID directive.1.

The consultant would favour the later. In addition EU rules require a stock exchange to be “recognized”. CCPs require netting of transactions and collateralization. . training of handling staff must been foreseen as an underlay of the capacity building exercise when and where necessary. under EU rules the essential characteristic of a regulated market is the clearing. therefore the settlement is guaranteed. NDC for instance(upgraded to a CSD). “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. this function could. as the depository of the collateral securities. Trade processing by the Baku Stock Exchange will require a post-trade model. But in an integrated IT system/platform encompassing the whole capital market structure that the consultant intends to recommend to be implemented. which presupposes the existence of a central market organization for the processing of orders. Such a market may also be distinguished by multilateral order matching (general matching of bids and offers enabling the setting of a single price). To ascertain compliance. A stock exchange under EU rules must be regulated. “Reflection paper on an “ad hoc” capital market architecture in Azerbaijan” December 2009) and open to the public. CCPs require collateral for the settlement of trades with them. This is defined in more details as meaning: The stock exchange must be “regulated”. 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. such as a professional Association. the BSE should initiate the settlement/clearing while the CDS should finalize it. transparency (maximum information distribution amongst buyers and sellers giving them the possibility to follow the evolution of the market. this issue is rather irrelevant. 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. but must not be outsourced to another institution like the National Depository Centre. operating regularly (no sporadic trading as actually in the Baku Stock Exchange ref. 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).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.

The modus should be DVP mode 1. as all transaction elements (cash/ securities) must be present before initiating the dealing in the stock exchange. Central Counterparties (Clearing). 9. CSDs do have relations with other ICSD and . In the EU the key participants in any reform of Clearing & Settlement are those. 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.). the shares held in the CSD should be blocked allowing attendance. CSD are wholesale transaction processing entities. Investment Managers and Brokers are also important participants but only as initiators of Clearing & Settlement activity through trading and investment. i. At record date for the purpose of AGM. Euroclear etc. whose roles are integral to the process.2.) that means in matters of all Azerbaijan securities. Therefore this eliminates any failed trades at the end of the post-trade value chain. the operational working standard should be only the omnibus account procedure for NDC. This recommendation is within the scope of actual project aims. and brokers in case of Azerbaijan tentatively) to handle. is involved in supervising custodian banks in the EU/EEA area. These recommended reforms to be addressed as outlined under NDC by an appropriated presidential decree approach in matters legal handling. they are not involved with individual investors/clients as they deal only with omnibus accounts. CSD do not have the status of banks in the EU. as in the EU capital market structural architecture.e. However. they come under the Regulator of capital markets. Central Securities Depositories (Settlement & Custody) and Central Banks (cash settlement. CSD is not concerned by attendance in person or by proxy as this is at the retail level of the entitlement beneficiaries. 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). In order not to fall in the pitfall of the retail business as previously mentioned. as recommended by the G10 and achieved by STP in the integrated common platform that the consultant proposes. The National Depository Centre The National Depository Centre. The institution empowered to act under the decree being the State Committee for Securities. No CSD. collateral etc.43 technically speaking: as deals/transactions cannot fail. The messaging standard should normally be SWIFT. All securities traded in Azerbaijan (inclusive State or Government securities should fall under the jurisdiction of the CSD). NDC in the Azerbaijan capital market architecture should have the pivotal role. This is good practice in all CSD. (aggregation of same asset type) leaving the retail for the other market participants as mentioned (custodian banks. It carries as corollary a compulsory dematerialization to be the standard for those securities seeking a listing and trading at the Baku Stock Exchange. 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. This is stemming from an operational facility point of view shared by other CSD.2.

as in the EU capital market structural architecture as the central clearing house. unless an extension of the present project with allocation of new resources could be granted. Parliament etc. CSD should provide processing services for trades of those securities that it holds in final custody. 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. This would require time to elaborate. that needed to meet the EU criteria in matters capital market organization for not delaying the EU accession further. and in this function it is referred to as “the issuer Central Securities Depository”. For instance in Germany. In Azerbaijan its home country. Thereby Romania did gain the time to elaborate detailed organic laws. time to go through the legislative procedure. OTC falls under the jurisdiction of the CSD as well as mandatory these transactions must be reported to the CSD. ministerial decrees and regulations to implement in domestic law all the EU acquis communautaire. . where the primary deposit of securities is in another country. all. The National Depository Centre. The separation is to avoid conflicts of interests. 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. but as a separate entity from the CSD. NDC in the Azerbaijan capital market architecture should have a pivotal role. The customer acquires fractional co-ownership in the CSD’s collective holdings and transactions can be settled by book entry. The consultant would like to recommend also the introduction of a Central Registrar for securities in Azerbaijan. CSD should hold securities and enable securities transactions to be processed through book entry. fungible securities of the same type are kept in a single collective holding. the same as the other trades. after a specified date. in matters of corporate governance as experienced by the consultant during an EU project assignment with the Federal Financial Markets Service. 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. In collective safe custody. Based on the example in Romania. As outlined. so called “EU reforms” were simply addressed by issuing a presidential decree enacting all EU legislation to be applicable in Romania. based on the experience in other emerging markets with failing company registrars as in Russia. OTC transactions must be mandatory under the jurisdiction of CSD. and the settlement. which is an important mandatory attribute of a CSD beside netting.44 domestically with brokers and banks. 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. as opposed to individual custody. The transformation from NDC to CSD status could result from a simple rule issue based on the presidential decree from the SCS. without physical movement of the securities. securities which are intended for trading are safe-kept in collective safe custody (omnibus account principle). A CSD can also process services as an intermediary in crossborder clearing and settlement. issued and superseding these rules.

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. 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. no fronting possible. . to reduce the transition time and resulting legal insecurity.3. The institution in charge of the changes would be as principal the SCS again. In this case the Central Registrar deals with final owners no broker. 9. 9. The main argument is to ascertain the title for shareholders/investors and guarantee corporate governance in all aspects. 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. but restricted to the domestic market in Azerbaijan. the argument in favour is again corporate governance: bondholders are entitled to certain rights in an EU context.) 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. 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. to be formalized at a later stage by the consultants’ elaboration of a specific basic law for later implementation. the Committee of European Securities Regulators in that regard. a service that allows an issuer of bearer securities to request a list of beneficial owners registered in the custodians’ books.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.4 could also be obtained by way and means of the presidential decree approach as previously already mentioned. no custodian bank. The Capital Markets Regulator The role of the SCS as capital market Regulator in the proposal of the consultant must be enhanced considerably. In case all joint stock companies shares should be kept only in dematerialized form at the Central Registrar as done for instance in France. In France this is handled under TPI as an example: (TPI stands for Identifiable bearer security in French.45 As outlined previously. The professional capital markets participants All recommendations under 9. the presidential decree approach could also be used to address the creation of a National Central Registrar in Azerbaijan.4. 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. A Central Registrar could also extend its registration to bondholders (public or private).

They are linked up with the CSD through the market IT platform as professional users. 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. Custody of assets is the main duty under EU regulations.1. (Council Directive 85/611/EEC on the coordination of laws. collection of dividends.46 9.2. The Investment firms Brokers should be duly licensed and apply the MiFID criteria in their clients relationship. that are foreign CSD acting as global custodians for these assets if they are in custody with them. 9.3.4. subject to a formal application with the capital markets Regulator SCS. inclusive Government and State titles. but the overall responsibility remains with the custodian bank. The will have domestic clients and may as well have direct foreign clients if the MIFID legal frame is duly in place.4. It must be understood that the legal concept is versus supervision of assets. Ancillary carrying out all day-to day-administration of assets under custody: corporate actions. rather than safe-keeping of the deposited assets. but always with due consideration of the. regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS). This is a request. . for operational reasons. It entails reporting duties.4. 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. 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. as it is not a Regulator. as recommended by the consultant. memorandum of understanding) with the banking Regulator in Azerbaijan. 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. Therefore custodian banks can make use of correspondent banks (sub-custodian banks) to fulfil this main task. All transactions done to be mandatory only through CSD for domestic operations. The requirements to be a custodian bank can be cumulated with a brokerage license. assuming the draft law is approved and such funds would become operational then. new legal Regulatory frame in Azerbaijan. This is at discretion of the capital market Regulator alone. The consultant would recommend seeking inspiration from the E so called UCITS directive in that regard. In matters of domestic investors investing abroad the link is with CSD that is then in connection with the foreign CSD and/or ICSD. OTC transactions must be mandatory reported to the CSD for all domestic Azerbaijan securities. The Custodian Banks Custodian banks are mandatory for safe-keeping of assets of the domestic Azerbaijan investment funds. when acting as investment fund custodian banks as resulting from the investment fund law. The granting of the status is subject to vetting by the SCS in agreement (maybe under a formal MOU. The CSD is not involved in supervision or in license granting for brokers or for Custodian banks. 9. from relevant EU directives implementation resulting. interests and proceeds of matured securities. exercise of options etc. Custodian banks have also specific duties.

6.4. appointment of mechanisms for the central storage of regulated information within the meaning of transparency requirements for . 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. 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. either at the time of their offer or of their admission to official stock exchange listing.1 the operational aspects of the capital market in Azerbaijan It is necessary now to precise and to define. 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. 2-Basic organic law for a Central Registry in Azerbaijan. 9. 9. 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.5.6.4. in case). 1-Basic organic law taking into account the Commission Regulation (EC) No 1289/2008 of 12 December 2008. 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.1 plus some specific capital market basic organic laws to reflect all other EU capital market directives. after the structural institutional aspects are given in the new basic capital market law. 9. the form under which this information is required usually consists of the publication of listing particulars. how the market will function.47 Needless to say that although custodian bank status granting is a prerogative enshrined with the SCS on request. as the duly appointed capital market Regulator. 9. as regards elements related to prospectuses and advertisements.(a MOU would be recommendable. as done in some EU countries. 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. 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. this should be exercised nevertheless in close co-operation and concert with the Banking Regulator. 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. The professional capital markets associations No professional capital market association is involved directly in the proposed capital market architecture.

incorporation by reference and publication of such prospectuses and dissemination of advertisement.2 Important Regardless all these specific recommendations. 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.1 setting the institutional structural frame. 6 months implementation guide line issuing). transaction reporting. implementing also the requirements of Directive 2004/25/EC of 21 April 2004 on takeover bids. and admission of financial instruments to trading.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. 9. 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 . 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). This should be merged together with the actual draft law of investment funds in Azerbaijan. and Insider Trading The basic capital market law under 9. on markets in financial instruments.(18 months discussion and elaboration.48 issuers of securities whose securities are admitted to trading on a regulated market. Institution specific. 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. 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). 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). 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. . 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. 3-Basic organic law reflecting Commission regulation (EC) No 1287/2006 of 10 August 2006 as regards record-keeping obligations for investment firms. there should be a basic operational organic law reflecting: The Council Directive 85/611/EEC on the coordination of laws. market transparency.2. regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS). 2-Directive 2003/6/EC on insider dealing and market manipulation (MAD) (market abuse).6.

Luxembourg just to mention some) as well as custodian banks for investment funds assuming the legislation id introduced in Azerbaijan. 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. 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. 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.6. 9. 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. the basic organic laws to follow later in time.7.2 outlined) The existing banks. (means and ways as under 9.49 in charge to implement these EU requirements rapidly through immediate transitional appropriated measures and rules. .

50 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 Buy 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 .

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. enabling it to encompass new products later. It is the main argument for the consultant to recommend this solution. but it I will be an open architecture. especially in the context of a single market structure as in Azerbaijan. clearing to custody in the new CSD in STP modus as previously already stated. The institutional aspects are as defined in the basic capital market law. the common platform guarantees STP processing of transactions. this is eliminated as no need for a separate CCP entity. Bulgaria’s Central Depositary is now seeking to join forces with an international settlement and clearing institution in line with a long-term . without adding any additional value to the transaction processing. This means another entity handling the post-trade transactions with an additional cost factor and possibility of errors generating failed trades. 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. 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. 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. the Clearstream model. The main argument to choose vertically integrated 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. The consultant also intends to give precise hints regarding products to be traded in the new capital market structure as proposed. From an organizational IT point of view. stems from the necessity of the CCP. whereas the operational aspects of the new capital market structure are defined in the basic organic law proposals. settlement. and likely may finally generate an effective take-off of the new capital market architecture. In the vertical organised capital market structure.51 10. These will result from the study and market analysis the consultant proposes to perform in the context of this project. One should avoid setting up separate entities for post trade processing and go for the centralized vertical single entity handling the transactions from trading. In a horizontal architecture there are different. separate clearing providers as a horizontal architecture set-up provides only trading and settlement.

on which they expand. 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. Before deciding for the options in the market the Bulgarian CSD want to thoroughly discuss the strategy with all stakeholders including the investment intermediaries’. Therefore.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. and the Second (Supervisory review) and Third pillars(market discipline). As also outlined. 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. The unique characteristics of Clearstreams business. When discussing the new Basel II capital agreement. Besides. Clearstream International has probably have not so much to contribute beyond that which any other bank may be expected to make. which is pervasive and remains the industry standard. This is an additional argument in the opinion of the consultant to strongly recommend this architecture type for the Azerbaijan capital market. is also an argument not to neglect.52 development strategy aimed to guarantee free trade by foreign investors on the Bulgarian market and vice versa. implies that their risk profile is atypical from that of other providers. The discussion is to either join Clearstream. Euroclear or Link Up Markets (which is again Clearstream). is much higher when using horizontal capital market structures. systemic risk in case of a crisis. by definition. as in 2009. 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. “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. does particularly focused on operational risk issues for itself and for the global capital markets. Clearstream can offer some particular expertise and insight in matters Operational risk managing capacity.5% for Clearstream). the Straight Through Processing ratio for vertical capital markets structure is so high (98. 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. this in addition. 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. as the assets are always under the control of one single processing entity. In the field of Credit Risk. allowing for economies of scope. and they have less failed . In reducing settlement risk in the international and domestic securities markets by “internalizing” (technical term for the vertical processing structure) Clearstream. (Clearstream as a bank is subject to this accord) aspects of the new frame did affect Clearstream more than had perhaps been intended. the structural pattern being pursued throughout the EU is one of increased vertical integration. In clear in an emerging market the Clearstream approach .

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. It is clear that this is not conditional to opt for the horizontal or vertical capital market organisational set-up. 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. as both are possible and acceptable structures in the EU. In matters cost efficiency there is no data. As some non EU CSD in Europe such as Switzerland. but both structures do compete successfully in the EU capital markets. as the scope of horizontal capital market operators is to earn most while performing the clearing. 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 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. In the vertical structure the fees are not so transparent. keeping the trading and settlement functions running at cost. and custody fees thereafter. that the new Azeri CSD joins as well the system as the proposed capital market set-up is compliant with all EU regulations.53 trades to report then horizontal organized architecture where multiple entities are handling the post-trade transactions. while keeping its own assets under control in the post trade area. Norway did also join the Target 2 securities system it should be possible.

54 ANNEX 1 Capital market structures in the EU .

55 ANNEX 2 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 SCS .

56 NDC 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 .

57 BSE CB 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 .

needs analysis b.market acceptanc e absorption assessmen t c.products recommen d d. launch assistance .58 3Main TASK 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.

59 .

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