CONCEPT PAPER FOR AN INTEGRATED CAPITAL MARKETS ARCHITECTURE IN AZERBAIJAN
Dr. Fred Reinertz EU Short term expert capital markets architecture Baku, February 2010
Table of Contents
1. Introduction.......................................................................................6 2. Definitions.........................................................................................7 3. Information flows and information systems for securities trading.......18 4. Securities trading information flow ...................................................18 4.1. Pre-trade........................................................................................................18 4.2. Trading........................................................................................................... 18 4.3. Post-trade.......................................................................................................18 4.4. Clearing-Settlement-Custody ........................................................................19 5. Categories of capital markets information systems............................19 5.1. Information collection and distribution ..........................................................19 5.2. Trading tools..................................................................................................20 5.3. Order-routing systems ...................................................................................20 5.4. Order-presentation systems ..........................................................................23 5.5. Settlement and custody systems ..................................................................23 5.6. Surveillance systems......................................................................................25 6. The prevailing legal and regulatory framework in the EU....................25 6.1. The main EU Directives on capital markets....................................................25 6.2. The institutional links among capital markets operators................................25 6.3. The role of professional capital markets participants.....................................26 6.4. The role of the Capital Markets Regulators....................................................27 7. The prevailing capital markets architectural models in the EU.............27 7.1. The Euroclear model .....................................................................................27 7.1.1. IT Architecture..........................................................................................27 7.1.2. Organisational links among various capital markets stakeholders...........28 7.1.3. Institutional links among various capital markets stakeholders ..............28 7.2. The Clearstream model .................................................................................30 7.2.1. IT Architecture..........................................................................................30 7.2.2. Organisational links among various capital markets stakeholders...........30 7.2.3. Institutional links among various capital markets stakeholders...............30 7.3. Comparisons between the two.......................................................................32 8. The prevailing capital markets architectural models in emerging markets...............................................................................................33
8.1. The Turkish model..........................................................................................33 8.2. The Russian model.........................................................................................34 8.3. Benchmarking vis a vis the EU capital markets architectures........................35 9. The proposed architecture for Azerbaijan..........................................37 9.1. Action plan and time frame for implementation.............................................37 9.1.1 Global Strategy.........................................................................................37 9.1.2 Main general task......................................................................................37 9.1.3 Main actions and priorities........................................................................38 9.1.4 Ancillary tasks...........................................................................................40 9.2. The capital markets operators’ positions........................................................41 9.2.1. The Baku Stock Exchange .......................................................................41 9.2.2. The National Depository Centre...............................................................43 9.3. The Capital Markets Regulator.......................................................................45 9.4. The professional capital markets participants................................................45 9.4.1. The Investment firms...............................................................................46 9.4.2. The Banks licensed to provide investment services.................................46 9.4.3. The Custodian Banks................................................................................46 9.4.4. The professional capital markets associations.........................................47 9.5. Linkages among them....................................................................................47 9.6. The necessary reforms from the legal and regulatory point of view..............47 9.6.1 the operational aspects of the capital market in Azerbaijan.....................47 9.6.2 Important..................................................................................................48 9.7. The necessary organisational and institutional reforms.................................49 10. Conclusions (benefits from the proposed model).............................51
0. Executive summary The concept proposal for an architecture of a capital markets structure in Azerbaijan is placed in the more general frame of the overall objective of the project , that aims at improving the economic development of Azerbaijan and to reduce the dependence on the oil sector, (cit. the TOR’s, the terms of reference of the project). In this context, the mission of the consultant when defining the sketch of an integrated new capital market design and structure did focus also on analysing and formulating recommendations to improve the existing domestic Azeri capital market with an end-state analysis. This concept paper should also serve the purposes of a later subsequent technology evaluation and the development of a standard electronic IT platform for the implementation of the structural proposals as issued. The capital market architecture presented in this paper is feasible with the current technology, It is based on the end-to-end functionalities of the in the actual present capital markets embryonic elements, It takes into account all internal requirements of the market participants. Various architectural and ethical issues are broached as well and discussed, sketching a framework for further project work in the matter under review. The structure itself as proposed is compliant with the actual prevailing EU regulations in matters of capital markets organizational set-up and the due Regulatory supervision. The consultant did seek “EU acquis communautaire” adhesion of the present proposal as the necessary foundation of the architecture. In compliance with the requirements as outlined in the TORs, the projects’ terms of reference the paper will encompass: An action plan for the Azeri capital markets proposed architecture, with emphasis on the capacity building and/or strengthening process for its key components as well as a structured transition action plan for the existing present Azeri capital markets elements. The action plan will contain recommendations for recommendable capital markets architecture in Azerbaijan. It puts the emphasis on the role of the Depository House as the pivotal core element. It also recommends the establishment of custodian banks. It will issue recommendations on the organizational and operational structure of the NDC with emphasis on the Risk Management system. It will opine also on the establishment of a reliable Delivery Versus Payment (DVP) system, and the functioning of the clearing and settlement operators in the market. The consultant’s intervention will also address the following issues: Recommendations on the organisational structure of the capital markets organizations with emphasis on: a comprehensive diagnosis of current trading, settlement and supervision infrastructure of Securities market in Azerbaijan on institutional, normative and operational level,
benchmarking against best practices adopted in developed and other emerging markets, a significant GAP analysis and elaboration of conceptual recommendations for an optimum infrastructure.
as only a comparative study with pros and cons would be a meaningful tool to opine on that issue. as the MTF’s.6
1. It was elaborated by a project team member and is known to the project beneficiaries. in a capital markets architecture proposal that wants to take into account the best practice as prevailing in the EU capital markets. it would require an allocation of project man days to be performed. Although the final beneficiaries of the proposed capital market architecture are the market participants. SCS. In Annex 1 the consultant has attached a schematic presentation of the status quo of the structures as prevailing in the different European capital markets. bonds. The first issue to be addressed is how to structure adequately. Traditional stock exchanges. Their efficient. the project as such was designed for duly perusal by the Regulator. NDC and the Baku Stock Exchange BSE as the first involved parties. The functionalities to structure. This EU directive also explains the
. commodities. the relevant capital market functionalities. It would exceed the scope of this paper to pass in review in full details the different architectures. are well known. while still vitally important in major cities around the world. It must be outlined that there is no uniform structure or type of capital markets set-up in the European Unions’ capital markets. or to whom to allocate. and currency. the National Depository Centre. safe and sound operation depends on the three key types of infrastructures – exchanges. in the process. central counter-parties and central securities depositories. the Member State’s diversity is nevertheless always taking into account the in the “EC acquis communautaire” given rules and requirements. this in view to determine the usefulness of the proposed structure for the beneficiaries and the different stakeholders of the project. now compete with such over-the-countertrading organizations and other similar systems that allow computerized trading. The consultant intends to recommend a more specific and tailor made capital market architecture for Azerbaijan. linking investors with brokers and dealers both on a domestic and an international level. Needless to say it is the starting point for elaborating a capital markets structure proposal. Securities trading are a financial activity involving transactions of property such as stocks. The advent of new technologies. has brought about a new era in securities trading. 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. Introduction
The elaboration of a proposal for a capital market structure requires. the multilateral trading facilities (they are mentioned in the MiFID directive. the State Committee for Securities. the examination and evaluation of the basic components such a common structure. by poaching in the different structural set-ups as used in Europe. particularly in computers and telecommunications.
launched 4th September 2009.7
whereabouts and set up’s functionalities in more details. NYSE Arca Europe.
2. bond and rights issues. a Client that has been authorized by one or more Parties to send instructions in the name of. launched in August 2008. They often use a so called “dark pools” approach in matters of securities trade processing. and the info may be useful in the context.launched in 11th December 2009 by Nomura Securities Ltd. A Account operator In the context of ESES.in the system and in accordance with non-discretionary rules . QUOTE MTF . A Multilateral Trading Facility (or MTF) is a multilateral system. launched in 1998. a cash account opened by a Settlement Bank with a central bank in accordance with the Cash Account Documentation. Equiduct-Berliner Börse. In the EU. 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. each of such other Parties in relation to the latter's Securities Account(s) and the Cash Account linked thereto. the list is long but the subject is complex. NX MTF . launched in March 2009. Chi-X. a pure dark-pool MTF operated by ITG. operated by an investment firm or a market operator. Turquoise. launched in October 2008. NASDAQ OMX Europe. 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.in a way that results in a contract in accordance with the provisions of Title II in MiFID. C Cash Account In the ESES context. BATS Europe . which is operated by the Euroclear CSDs
. there are several MTFs operational now: POSIT. launched in September 2008. launched in March 2007. which brings together multiple third-party buying and selling interests in financial instruments . and on behalf of. 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.
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. In order to be able to settle the novated transactions. Central CCPS must also have direct or indirect access to the SSS. those executed on a particular exchange). Cross-quality payment
. CCPs typically interpose themselves between the counterparties to trades. in the context. 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 Accounts may also be referred to in the Euroclear Contractual Documentation as 'cash positions in Central Bank Money (CeBM). as the Liquidity position. Cash position in Central Bank Money Balance in a central bank money account on a settlement platform operating the integrated settlement model.g.
Cash Correspondent A financial institution that executes cash transfers on behalf of its clients. Securities Settlement Systems where transactions are ultimately settled and securities held. Central Securities Depositary (CSD) An entity which operates a system enabling clients to hold.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. 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). acting as the buyer to every seller and the seller to every buyer (“novation”). Also referred to.
with final transfer of the securities
. Furthermore.g. Default Failure to complete a funds or securities transfer according to its terms for reasons that are not technical or temporary. DVP model 1 One of the three DVP schemes. Debtor The party that owes assets to the creditor. CSD Central Securities Depositary D Dark pool Dark pools of liquidity (also dark pools or dark liquidity) are crossing networks that provide liquidity that is not displayed on order books in an MTF context. e.9
Payment between a Euroclear group customer using central bank money and another Euroclear group customer using commercial bank money. In the payment chain. 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 are recorded as over-the-counter transactions. 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. 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. usually as a result of bankruptcy. The debtor may also be the debit account owner. Dark Pools in funds to line up and move large blocks of equities without tipping their hands as to what they are up to. 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. gifts. In model 1. as defined by the G10. it may be an agent or the debtor. Dark liquidity pools avoid this risk because neither the price nor the identity of the trading company is displayed. or charity payments.[ 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. for each pair of consecutive parties in the payment chain. as a result of receipt of goods or services. Modern trading platforms and the lack of human interaction has reduced the time scale on market movements. transfer instructions for both securities and funds are settled on a trade by trade basis.
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).
. 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. 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). See Beneficiary of money (Securities Industry). Ultimate beneficiary (Payment Industry). Hence. The final party is mentioned when different from the creditor. 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 party The party that is the ultimate beneficiary of the cash transfer. particularly systems connected via the internet. Final settlement The discharge of an obligation by a transfer of funds and a transfer of securities that have become irrevocable and unconditional. Its primary purpose is to facilitate the sharing of data across different systems. 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. The eXtensible Markup Language (XML) is a W3C-recommended general purpose mark-up language for creating special-purpose mark-up languages. whose account will be credited by the final agent. and posts the transaction to the account.
(French acronym) Infrastructure The party that provides. through common membership. a dictionary of data fields and
. usually through direct or indirect (through local agents) links to local CSDs. 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. Within Euroclear group.ISO 10962 classification of a security. all or part of. Internaliser In the context of the EU’s basic capital market directive MiFID. the ICSD offers its services in the Full Service. 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. securities' holders registered on the custodians’ books. and processes the instruction. An ICSD also settles trades in international securities and in various domestic securities. Instrument category The second qualifier in the CFI . and which enables transactions to be processed by book entry.11
First agent A financial institution of the debtor that receives the payment transaction from either the account owner or authorized party. Synonym: security family. These tools consist of a set of syntax and message design rules. it is a service in Euroclear France that allows an issuer of bearer securities to request and obtain a list of.ISO 10962 classification of a security. I ICSD International central securities depository Identifiable bearer security (TPI) Based on the French legal framework. Instrument family The first qualifier in the CFI . International Central Securities Depository (ICSD) An entity in which securities are held and managed. and the creation of settlement obligations.
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. the basic capital market directive MTF a Multilateral Trading Facility is a multilateral system. Issuance Account In the ESES context. L Legacy platform One of the current input. Issuance Accounts are not considered as Securities Accounts for the purposes of the Terms and Conditions. all securities of the relevant issue will be recorded on the debit of the Issuance Account.newly published standard which provides the usage of a common platform for the development of messages. 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. ISO 20022 Financial Services It is a Universal Financial Industry message scheme (UNIFI) . any account opened in the name of an issuer in the books of the CSD on the debit of which all securities of a same issue which are admitted by the CSD are recorded. operated by an investment firm or a market operator. N Netting
a catalogue for present and future messages built by the industry with the above mentioned fields and rules. in the case of dematerialized securities. matching.in the system and in accordance with non-discretionary rules .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. which brings together multiple third-party buying and selling interests in financial instruments .
O Omnibus account A single Securities Account within which the Securities Account Holder co-mingles the assets of two or more underlying clients. It prepares and distributes account statements (holdings and transactions) to the investor and/or its intermediary. 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). and administers investor accounts and related records. See 'Trustee'. P Payment settlement agent An agent that executes the cash transfer upon the request of either an agreement party. rather than in separate accounts with designation. or a clearing agent. Registrar The party that is responsible for keeping track of the owners of securities. In the context of investment funds. the investor. as required to all parties involved in the trade transaction including counterparties. These records represent the liability accounts of the fund management company. and settlement parties. Nominee A person or entity named by another to act on his behalf. the party appointed by the fund management company that keeps the investor registry of the fund. It may provide tax information to the
Stands for an agreed offsetting of positions or obligations between counterparties. Netting may take several forms. Post-trade administrator The party ensuring that all the details of the trade have been collected and reported. on a periodical or upon request basis. 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). A nominee is commonly used in a securities transaction to obtain registration and legal ownership of a security. The netting reduces a large number of individual positions or obligations to a smaller number of obligations or positions. Also referred to as a liquidity provision.
if there is a guarantee. Securities Settlement System (SSS) A system which permits the holding and transfer of securities. either free of payment (FOP) or against payment (Delivery Versus Payment-[DVP]). custody. (I)CSDs and banks. Settlement Bank
. Settlement agent The party that provides settlement. 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. which is thus registered with its central bank for the purpose of processing payments. possess a banking license and are regulated by existing banking law. and accounting services for its own. or someone else's. Settlement account An account held by a direct participant of a national RTGS system. Settlement Delivering securities and/or making payments in the performance of obligations between the counterparties to a transaction. and can appoint the sub-registrar. Securities lending is mostly facilitated by CSDs. The lending of securities in an exchange for a fee. such as custodians that directly offer securities lending.14
investor and/or to its intermediary. reports to the regulator on shareholder identity. at an agreed price and date. but not offered directly. with a contractual agreement that the seller will repurchase the securities in return for the guarantee. can be the corporate secretary for the proxy voting. assets. 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.
Settlement liquidity indicator The liquidity position of a client in the system that uses the services of a settlement bank (i. also known as TARGET2. 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. which will be shared by a number of participating national central banks. SLAB Delivery by mutual consent settlement service SSS
.e.e. Single Settlement Engine (SSE) The first building block of the Single IT Platform. 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. Single Shared Platform (SSP) The new platform of European Central Bank. the liquidity position of a settlement bank’s client. Settlement date Date at which the financial instruments are to be delivered or received. concentrating on the core settlement (i.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. as above). positioning and booking of cash and securities transfers). It reflects the liquidity resulting from the settlement bank client’s activity in the Securities Settlement System (SSS). Single Platform The long-term solution. Settlement Bank Client A Client who has appointed a Settlement Bank to provide cash services in connection with the Domestic Service. an IT platform shared by all Euroclear group (I)CSDs hosting the (I)CSD Systems.
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. a post trade administrator. it is the party that negotiates and executes the treasury transaction. Trading party The party that plays an active role in planning and executing the transactions that create or liquidate investments of the investors’ assets. Two-leg settlement instruction Settlement instruction which can be used to settle bilateral repo. buy-sell back and sell-buy back transactions. A trading party is a trade instructor.Time Gross settlement Express Transfer 2 TPI Identifiable bearer security.should be taken to mean all institutions. 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. In the context of treasury. on an organised. the concept stems from the EU’s MiFID directive T TARGET2 Trans-European Automated Real. an investment decision-maker. Systematic internaliser It means an investment firm which. Transaction In a Euroclear context. a service in Euroclear France that allows an issuer of bearer securities to request a list of beneficial owners registered in the custodians’ books. it is the result of the matching and execution of either a purchase or sale order with compatible opposite orders. Trade date The date on which a market trade is executed. performing the Pre-settlement. securities lending & borrowing. frequent and systematic basis. Settlement and custody functions except custodians. in particular CSDs.
. or a trader.16
Securities Settlement System.
collection of voting instructions. implying that the central bank calculates the market value of the underlying securities. notably their residual maturity.
. The Eurosystem (European Central Bank.17
U UNIFI Standard See 'ISO 20022 Financial Services'. (I. reduced by a certain percentage (haircut). V Valuation haircut A risk control measure applied to securities used in reverse transactions. Voting service provider (VSP) A service provider mandated by the Client to act on its behalf. ECB) applies valuation haircuts that also reflect certain characteristics of the securities. instructing the system agent.e. receipt and sending of meeting notifications.
depending the nature of their systems must provide mandatory the following data information: . for professional and individual investors through various communication channels (e. fund administration. financial analysis. all market operators.
4. statistics and analysis). These so called Data providers are also a source of financial information. likelihood of execution and likelihood of settlement and any other factors deemed relevant. Information flows and information systems for securities trading
There are several large professional provider of financial information in Europe. -for quote-driven markets.3. facts. processing and distribution of international financial information for investment advisory services. and in the US. portfolio management. 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. This best possible result or best execution as it is called by the operators.CUSIP etc. is not limited to execution price but also includes cost. NDC is the member in ANNA for Azerbaijan.1) operators in the market must provide full pre-trade transparency. the best bids and offers of market makers must be made available. who are specialists in the procurement.18
3. Securities trading information flow
4. the internet. They very often act also as official numbering agency responsible for allocating security identification numbers. speed. Pre-trade
Compliant with the EU requirements in its specific MiFID directive (see below for more details under 6.g.) There is an Association of National Numbering Agencies (ANNA) which leads the way in introducing standards aimed at simplifying trading and securities administration. ISIN. they provides financial news and data (e.
4. As outlined later. aggregated order information on "liquid shares" available at the five best price levels on the buy and sell side.1.g. magazine). Post-trade
.(NNAs.Continuous order-matching systems. They maintain database of structured. securities trading and securities administration.2. 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.
volume and time of all trades executed in listed shares. an automated ISO-based STP interface to exchange structured data with custodian banks via a CCI. i. Prior to this. Clearing and Settlement. activities of the group were disrupted after that period.
4. PTEG. settlement and custody the core directive for capital markets in the EU MiFID remains silent. like AutoFlow. The second important initiative followed by the PTEG on behalf of CESR is the ESCB-project TARGET-2-for-Securities (T2S). This group does focus on post-trading activities in the EU. does only focus on a number of regulatory initiatives going on in the area of post-trading. given the responsibilities of national securities regulators for post-trading activities in the respective Member-States. where relevant for CESR and its members. CESR had decided to create a platform to follow these initiatives more closely. Following other emerging initiatives in the area of post-trading. In 2007.19
MiFID the basic capital market directive in the EU requires from all professional capital market operators to publish the price. the CESR Members decided to establish a group of CESR experts only. But disclosure is required mandatory by the directive. It is up to the member States in the EU to act in the matter. It is a
.4. 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. Between 2002 and 2005. the group established by the European Commission with the mandate to review the compliance with the Code by the signatories. unless certain requirements are met to allow for deferred publication. market abuse.
5. Also the other directives regarding prospectus. to respond to these initiatives. The political support for these regulatory initiatives was reflected in the conclusions of the EU Council on Clearing and Settlement of 9 October 2007. the PostTrading Expert Group (PTEG). Common communication interface. in particular with regard to the envisaged role of regulators in this Code. Stock Exchanges. with the objective to enhance a level-playing-field and the safety and soundness of post-trading activities within the EU. Central Clearing Parties and Central Securities Depositories within and outside the EU-area.e.1. establish a place to share supervisory experiences and. where appropriate. and transparency are only focusing of the trading not the post-trade aspects. Categories of capital markets information systems
5. CESR is a member of the Monitoring Group. 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. run by the Euro-system. The first major point on the agenda of the PTEG is the Code of Conduct for Clearing and Settlement. The Code of Conduct was developed and signed by the providers of infrastructures for Trading. even if executed outside of a regulated market. Clearing-Settlement-Custody
It can be mentioned that in matters of clearing. Information collection and distribution
There are IT systems.
Euroclear Trade Capture and Matching System (ETCMS). foreign exchange settlement systems. It is strategies. 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. can be easily included in the order routing module later. qualitative algorithms designed to monitor market changes. It continuously scans different liquidity pools in order to get the best price. In addition a host of other parameters such as aggression levels.20
communication interface with the external world that provides users with a single access to a common integrated trading platform. …to be aggregated in a feed handling infrastructure for connection with the trading platform for processing. these include retail payment systems. clearing houses and securities settlement systems (SSSs). using a variety of networks. A key tool in this practice is the in an order routing system to find the National Best Bid or Offer (NBBO) across markets. CNS centralizes the settlement of matched transactions and is maintaining an efficient flow of security and money balances.
5. An optimized order routing system will slice and route orders with ultra-low latency. They can derive custom indicators based on the order or trade information. Continuous Net Settlement (CNS / RNC) are automated book-entry accounting systems. These indicators.3. liquidity management tools and advanced technology to execute trades. Tools. supports multiple order types. order execution through a suite of global. execution quality. securities settlement systems activity. it will have an embedded custom routing logic that takes multiple factors into account. Trading tools must have the following capabilities: direct execution to every major global exchange. It must also ensure MiFID compliance and run in parallel with the OMS system. that show momentum or compare executed liquidity versus displayed liquidity over a time window on a per venue basis.
5. It enables also clients to send instructions and receive reports in industry standard formats. the data providers etc. Sophisticated liquidity management and advanced DMA products. speed and costs can also be considered in the routing logic. dynamically optimize performance and avoid market impact. 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). It uses multiple in and output FIX connections. Trading tools
Global electronic trading is technology based. 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. a standardized interface of the common shared IT platforms which control and distribute the information pertaining to Ancillary Systems and. 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. leverages low latency market data including custom indicators. 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. maintains and persists all order states. Trading platforms remain the core of all the central integrated IT system In particular. control of order flow while maintaining anonymity. access to ConvergEx ATS for block crossing and aggregating dark liquidity (dark pools) tools. Below the consultant provides a
. in particular.2. money market systems. but there are ancillary systems (AS). large-value payment systems.
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.
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. in some cases. whereupon the instruction is either registered when the trade is novated or rejected when the instruction does not meet all of the validation criteria. Users can access brokers' direct-market-access (DMA) capabilities and algorithms to carry out electronic trading strategies.
5. With an OMS. which offers netting at both user and security eligibility level. crossing networks and multiple brokers. Order-presentation systems
In this area we find now since recently now EMS. Today's OMSs have emerged as portfolio management systems with functionality that ranges from pre-trade through post-trade support. An EMS offers multiple destinations to which to route a trade. The delivery of securities takes place by book entries in computerized systems. connectivity. the older traditional order management systems (OMSs) were designed as tools to allow firms to manage and document their trading activities electronically. DMA platforms either are single. • the CCP then undertakes a local validation process. transactions settled in SSSs are considered final and irrevocable (i. The platforms enable both single-stock and portfolio trading capabilities. If the instruction is deemed to be valid. Since this modest beginning of OMSs as trading blotters with FIX engines. adding analytics. Both legs must be simultaneous and linked to limit risks.5. typically through the Financial Information exchange (FIX) protocol. Moreover. users can connect to major exchanges. instructions are sent to the CCP for netting. Real-time market data enters the system from a combination of external feeds from exchanges and market data providers and. Through the EMS platforms.23
5. they will continue to substitute for OMSs more and more. they have extended the breadth and depth of their functionality significantly.or limited-destination systems. the following occurs: • instructions are entered by clients for matching purposes. EMSs have four key features: a trading blotter. there should be a differentiation between an EMS and a pure DMA platform. Settlement and custody systems
Securities Settlement Systems enable the transfer of securities. alternative trading systems (ATSs). unless the delivery is free of payment. In comparison.e. electronic communication networks (ECNs). it will be given a Euroclear reference ID and will enter the matching process. It is worth pointing out that.4. 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 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. multiple destinations and real-time market data. unconditional)
. There are also automated matching and routing service for over-the-counter transactions with a Central Counterparty (CCP). internal proprietary data from the EMS provider. for instance following trading on a stock-exchange or over the counter. The trading blotter is composed of an order entry screen where users initiate and monitor trading activity. firms easily can look back in order to analyse their orders. In practice. portfolio staging capabilities and tighter systems integration. by definition. an execution management system (EMS). • once matched. As a result.
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. CSDs enable securities’ mobility as they operate securities settlement engines. Next to the safekeeping function. streamlined workflow) in its custody system. In settlement there is an internal transaction category. Securities are held with central securities depositories (CSD). This largescale financial application demonstrates the substantially lower costs and higher return on investment possible with only processing software. There is usually at least one CSD and one SSS in each EU country. 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. Custody systems are most of the time in-house developed as this kind of service is not provided by Euroclear given its horizontal structure. Interfaced settlement model: transactions are settled using an interface between the payment system and the SSS. they constantly communicate with each other. The security leg is settled in the SSS while the cash leg is settled in the RTGS in the EU. Clearstream and other global custody provider have most of the time their own traditional IT architectures. Euroclear France and Euroclear Nederland) with an integrated settlement solution and harmonized custody service for stock exchange and over-the-counter activities. Deutsche Bank did add front-office grid applications to support "straight-through processing" (automated. manage the Securities Accounts balances and the Purchasing Powers and provide reporting to the Clients. one party is using a Domestic operational securities account and the other is using a Full securities account). SSSs either settle on a gross basis or on a net basis. Full-Domestic transactions when one party is using the Full Service and the other is using the Domestic Service (i. As two systems are involved. Deutsche Bank's Securities Custody System is one of the earliest successful examples of commercial grid computing. who are notably responsible for ensuring securities’ integrity. In a single platform context. in Euroclear this transaction category includes: Intra-entity settlement transactions when both parties to the transactions are members of the same (I)CSD. Integrated settlement model SSSs settle transactions directly in their own system without the constant involvement of the payment system. as compared to the traditional architectures. An interface is used at the request of clients when they want to transfer cash into the SSS or back to the payment system. These systems process the settlement of instructions.24
when they meet certain conditions.e. There are also settlement sub-Systems.
. 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. ESES will provide the Euronext-zone market CSDs (Euroclear Belgium. intra-Full transactions when both parties are using the Full Service and transactions settle then on the books of the custodian Bank.
1. At the first level.2. establishing the core values of a law and building guidelines on its implementation. The institutional links among capital markets operators
. Under European law. The law then progresses to the second level. national regulators work on coordinating new regulations with other nations. a Broker to custodian trade affirmation system that is widely used in the market. At the third level.
5. MiFID is the cornerstone of the European Commission's Financial Services Action Plan whit some 42 measures that did change significantly how the EU financial service markets do operate. The fourth level involves compliance and enforcement of the new rules and laws. a Directive has to be transposed into national law: as all the 30 States of the EEA have done.25
In the context there is also SBI. where sectorspecific committees and regulators advise on technical details. There are three other Directives' in the context of the “Lamfalussy” procedure that the EU did also needed to issue: the Prospectus Directive. 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. 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. The prevailing legal and regulatory framework in the EU
6. they are designed to identify trader behaviour and activities that could be related to fraud or unauthorized activities. 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. Norway and Liechtenstein). All these directives compose the legal frame for capital markets in the EU. The main EU Directives on capital markets
The main EU directive governing the capital markets is the Markets in Financial Instruments Directive (MiFID). These solutions do combine trading surveillance and employee fraud detection this requires a proven technology and domain expertise in the institutional and proprietary trading market.
6.6. They are mostly based on a core analytics and profiling engine and a set of flexible enterprise case management and investigation applications. the Market Abuse Directive and the Transparency Directive. 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. then bring it to a vote in front of member-State representatives. the EU adopts a piece of legislation.
The institutional links among capital market operators are defined in 3 aspects: authorization. The role of professional capital markets participants
MiFID requires professional capital markets participants to categorize their clients as "eligible counterparties". 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. regulation and pass-porting Firms covered by MiFID will be authorised and regulated in their "home State" (broadly. That said.3. they now have the possibility (and in some cases the obligation) to collect information from a multitude of multilateral trading facilities. MiFID considers Systematic Internalisers as miniexchanges. That part of an investment firm's (capital market operator) business that is not covered by the above is not subject to MiFID. Systematic Internalisers and other exchanges from around the European Economic Area. This is a professional capital market participant that executes orders from its clients against its own book or against orders from other clients. hence. which were not covered by the former EU investment services directive ISD that now is now superseded by MiFID. they are subject to pre-trade and post-trade transparency requirements as above mentioned. but caused in fact a fragmentation of trading venues. the appropriateness of any investment advice or suggested financial transaction must still be verified before being given. Once a firm has been authorised. MiFID distinguishes between "investment services and activities" ("core" services) and "ancillary services" ("non-core" services). Comments: MiFID intended to increase transparency for prices. MiFID has introduced the concept of this Systematic Internaliser. This includes therefore commodities and derivatives but also such as freight. the country in which they have their registered office). These services will be regulated by the member state in their "home State". professional clients or retail clients (these have increasing levels of protection). MiFID covers almost all tradable financial products with the exception of certain foreign exchange trades.
6. climate and carbon derivatives. 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). However if a firm only performs ancillary services.
. for example. To determine which firms are capital market operators under the legal MiFID frame and which are not. it will be able to use the MiFID passport to provide services to customers in other EU member States. Systematic Internaliser. it is not subject to MiFID (but cannot benefit from a MiFID passport). Clear procedures must be in place to categorize clients and assess their suitability for each type of investment product. If a professional capital market operator performs investment services and activities. Where once a financial institution was able to see information from just one or two exchanges.
'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. 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. The Euroclear model
7. which will replace each CSD’s current client interfaces. they have to take care of compliance and enforcement of the in national rules and laws transposed MiFID directive. The capital market Regulators are. is automatically binding throughout all member states.1.27
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. as previously mentioned the fourth level in the “Lamfalussy procedure”. the Prospectus Directive.4.1.
7. But it intends to integrate all in the Euroclear group CSDs’ legacy systems in one Single IT Platform. a Directive has to be transposed into national law: an EU Regulation. The Single Platform intends to offer a number of important benefits in terms of additional services and more automation and consolidation. 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.
. The prevailing capital markets architectural models in the EU
7.1. including: Enhanced levels of Straight-Through Processing (STP) More streamlined processing as a result of harmonization agreements on dates and the classification of corporate actions Increased efficiency due to real-time credit and reporting of cash proceeds Clients will connect to the Single Platform using Euroclears’ Common Communication Interface (CCI). the Market Abuse Directive and the Transparency Directive.
6. 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. on the other hand. Under European law. when issued. The role of the Capital Markets Regulators
MiFID retained the principles of the EU 'passport' introduced by the old investment services directive ISD but innovated by introducing the concept of 'maximum harmonization' which places more emphasis on home State supervision.
3. Organisational links among various capital markets stakeholders. Euroclear match up the two instructions. the Paris-based CSD for France Euroclear Nederland. the London-based CSD for the United Kingdom and Irish equities
. with accounts in different ICSD’s. how and with whom they want them to settle their securities transaction. the Euroclear group is a horizontal organized structure that comprises Euroclear Bank in Brussels. the Amsterdam-based CSD for The Netherlands Euroclear Sweden. if against payment. At the time of the settlement. Institutional links among various capital markets stakeholders
As providers of settlement services.28 7. Settlement as the final step in securities transactions is vital for a good functioning of financial markets. and make sure the seller has the securities and. the Stockholm-based CSD for Sweden Euroclear UK & Ireland. the buyer can pay. as well as six other CSD in the Euro currency area: Euroclear Belgium. Clients of Euroclear submit an instruction telling Euroclear when. EMXCo is the provider of funds order routing.
Euroclear is a Settlement service provider only.
7. a simple book-entry transfer is made enabling the required simultaneous exchange of cash and securities. The settlement process is also largely determined by the type of asset and market. order routing is an essential step prior to the settlement phase for fund orders. usually against payment.2. Where the trade is between two counterparties in different countries. The counterparty in the trade also submits an instruction. which vary from market to market as there is diversity in the EU capital markets. to complete a trade between two parties. 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).1. Settlement is only the delivery of securities. an ICSD (International Central Securities Depository) headquartered also in in Brussels. Within the Euroclear group. the proprietary ownership becomes effective for the purchaser from a legal point of view. the Helsinki-based CSD for Finland Euroclear France. settlement is achieved through local market settlement structures. Usually this is done electronically through a fast and low-cost form of processing known as Straight-Through Processing (STP). the Brussels-based CSD for Belgium Euroclear Finland.1. For example. unlike for bond and equity transactions.
Horizontal structured providers of settlement and custody and horizontal providers of clearing function
Universal Banks Brokers
Stock exchange A Trading &Settlement Settlement
Stock Exchange C Trading & Settlement
Stock exchange B Trading& Settlement
ClearingL CH Clernet
Below a schematic graph to illustrate this capital market organization.
The Clearstream model
7. It also operates now the Link Up Markets. fully electronic derivatives trading and clearing system. 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. introducing efficient cross-border processing capabilities.2. Clearstream is developing also a new globalized standard IT platform using open source components. the other electronic trading platform for the cash market allows the trading of stocks on one platform – everywhere in the world. Cyprus Stock Exchange (Cyprus).2. VP SECURITIES (Denmark) and VPS (Norway). Hellenic Exchanges S.
7. The design will be modular base on a shared technical infrastructure which combines extremely low latency with high volume. Link Up Markets is the joint venture by nine leading Central Securities Depositories (CSDs) – Clearstream Banking AG Frankfurt (Germany). SIX SIS AG (Switzerland).30
7. IBERCLEAR (Spain). Xetra . Institutional links among various capital markets stakeholders
Clearstream is a vertically integrated supplier of all post-trading services. Organisational links among various capital markets stakeholders
Clearstream is a wholly owned subsidiary of the Deutsche Börse. joint venture by nine leading Central Securities Depositories (CSDs) – a common infrastructure allowing for easy implementation of links between CSD markets. Oesterreichische Kontrollbank AG (Austria). the clearing and custody functions. It provides after trading and settlement.1.2. commercial third parties soft-ware and internally developed software. “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.A. The Eurex clearing functionality also supports clearing of equities.3. IT Architecture
Clearstream uses three trading platforms: Eurex. Below a graphical scheme representing this capital market architecture type in Euro
. 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. bonds and repos traded on the Frankfurt Stock Exchange. This platform will favour algorithmic trading by mitigating towards an Itanium platform to boost output with new enhances broadcast solutions.2. STRATE (South Africa). 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. (Greece). an integrated.2.
clearing and global custody.
Brokers Stock exchange A Trading Stock exchange B Trading
Stock Exchange C Trading
Clearing Settlement Custody Custody
Vertical structured single provider of settlement.
. in September 2009. In addition both are Global Custody services providers world-wide and competitors in the European capital markets post trade value chain services. while as users they want to pay the lowest handing fees. clearing and custody. while clearing and custody is always mandatory provided by third parties. areal advantage) could offer clearing through collateral management during the Financial crisis 2009. settlement. 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. From an economic point of view there may be a conflict of interests. in addition the MTF are now also more and more a competitor capital markets structure. as . 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. many banks did found it difficult to borrow cash. brokers and investment banks. 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.as shareholders they want the best possible return. The issue is that Clearstream is owned by a single shareholder Deutsche Börse. it is owned by the Deutsche Börse Group. making Clearstream services valuable in improving liquidity: Eliminating counterparty risk by using the CCP(central counterparty) service. From this fundamental organizational difference also stems the difference in their respective functionalities: Euroclears provides settlement only.32
7. Due to the credit crunch. 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. But both architectures compete in the market to provide the lowest global processing fees. But in the last Financial crisis. ascertaining the superior quality of underlying securities by limiting the assets to those which the ECB (European Central Bank) accepts as collateral. only Clearsteam with its vertical structure (enabling them to have control of collateral through all the post-trade cycle.3. while Euroclear is owned by its users the different stock exchanges. 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). Clearstream does provide the whole range of services from trading to all integrated post trading services. 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. who in most cases of the time are also its shareholders of Euroclear. only Clearstream was able to offer automated lending and borrowing of securities as well as tripartite collateral management services.
This may also explain. That major point was for Clearstream in the competition game on the European capital markets. The Settlement Centre is operating with book entries.
8. In this paper the consultant will broach the Turkish capital market architecture through the ISE. The prevailing capital markets architectural models in emerging markets
8. 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. the capital market structure is based on the ISE.
. SIX SIS AG (Switzerland). It is the central settlement institution authorized by the ISE for the finalization of cash and securities transfers of transactions made in existing markets within the ISE. The Turkish model
In clear the systemic risk of horizontal capital market architecture was revealed to be higher than that of the vertical structured capital markets architecture. as mentioned previously already by the consultant. 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. compared with the horizontal capital market architecture. Trading is taking place at 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. Systemic risk considerations do explain the choice in favour of Clearstream in the opinion of the consultant.1. are also vertical structures for the same obvious reasons. Istanbul Stock Exchange for transferable securities whereas derivatives are dealt on in the Izmir Mercantile Exchange. Oesterreichische Kontrollbank AG (Austria). It must also be mentioned that the new MTFs in the capital markets worldwide. that CSDs from eight leading Central Securities Depositories (CSDs) – Cyprus Stock Exchange (Cyprus). IBERCLEAR (Spain). whereas clearing and settlement takes place through TAKASBANK ISE Settlement and Custody Bank Inc. the handling of the flux of assets and cash is easier to process in a vertical structure. so operational risk results to be less than in a horizontal structured architecture. (Greece). Hellenic Exchanges S. 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. STRATE (South Africa). Therefore a vertical capital market model has a better operability and a better risk management capacity.3.A. From a strictly operational point of view.2.
the circulation of which is supervised by the Bank of Russia. It is a regulated market in Russia. which will be transferred. "RTS Clearing Centre". There is also the well-known RTS. is the largest stock exchange in the CIS countries. Dematerialized transfers vary according to institutions being party to the transfer. transfer and other related transactions of dematerialized securities in an electronic environment and in an integrated manner with EFT. The Russian model
In Russia we have the MICEX Stock Exchange Within the MICEX Group. which are members of TETS (Takasbank Electronic Transfer System) can join this system through Takasbank. and information services. In clear a vertical architecture type of an emerging market capital market organisational set-up. the CJSC “MICEX Stock Exchange”. Brokerage houses. NDC functions as a central settlement depository and a centre of technical support of dealer’s sub-depository in Russia’s federal securities. corporate.
Free transfer The Stock Transfer Transactions between members vary in respect of whether the security. the Russian Trading System. Petersburg Stock Exchange. and derivatives market. "Open Joint Stock Company "Russian Trading System Stock Exchange". currency market. RTS is an integrated trading and settlement IT platform in a structure consisting of Not-for-profit partnership "Russian Trading System Stock Exchange". 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. is dematerialized or not.2. The National Depository Centre (Closed Joint Stock Company) NDC was established as a central settlement depository for the servicing of state securities. or Capital Markets Board of Turkey. The MICEX Group provides financial market participants with a complete set of trading. or Electronic Security Transfer (EMKT) Transactions EMKT is a system established within the framework of CBT Central Bank of Turkey. " RTS Settlement Chamber" and "St. in accordance with the regulations of Capital Markets Board regarding dematerialization of securities. facilitating the real-time execution of buy-sell. MICEX covers a stock market. The Regulator in Turkey is the CMB. sub-federal and municipal securities. issuer companies and corporate investors is continued to be provided. countries of Eastern and Central Europe.
8. settlement. TAKASBANK does also provide custody and banking services. Physical custodian services towards the members of ISE. depositary.
8. it completes cash settlements on participants’ transactions on the day of trading. (whereas RTS is of the vertical capital market organisational set-up). regardless their organisational structures: horizontal or vertical. The Moscow Interbank Currency Exchange Settlement House (MICEX SH) is a credit organization that provides settlement banking services. including cash settlements on trades made by financial market participants. its’ capital market structure was pre-scrutinized by the European Commission and would need to introduce the full range of the “acquis communautaire
. a horizontal organizational capital market structure type. interacts with clients throughout the entire trading day. it performs cash settlements in real time.
The MICEX Settlement House guarantees timely settlements and the safety of its clients’ funds because active operations are not performed on clients’ funds. offers its clients a full range of settlement services. Clients’ payment orders are handled and executed immediately after their delivery to the MICEX SH. The MICEX Settlement House: acting as a settlement bank. Turkey has applied to join the EU. is one of the main exchanges trading infrastructure. 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. The Regulator in the Russian Federation is the Federal Financial Markets Service. it provides reliable and prompt cash settlements on trades made in MICEX financial markets.Both structures competing for market shares in the Russian market. it guarantees timely settlements and the safety of its clients’ funds. the currency market. Since January 1. In clear. the derivatives (standard contracts) market. the corporate securities market. 1997. it provides settlement services in all of the MICEX financial markets: the government-backed securities market.35
Currently NDC is Russia’s largest settlement and safekeeping provider.
“to meet the adhesion criteria. market abuse. transparency and corporate governance
. In the case of Russia the actual structure is rather cumbersome (as resulting from the fact that it is a horizontal structure. market abuse and transparency: the operational aspects of the capital market structure. Actually the vetting procedure is frozen by the EU and accession talks are suspended because the unsolved Cyprus issue. which is an absolute prerequisite requirement in an EU type of capital market structure. In the end both organisational set up do not provide full DVP. Deficiencies were detected in the areas of prospectus directive. except the RTS who is a vertical structured type) with many entities intervening in the market. Deficiencies do also exist in matters of prospectus directive.
to be the day the decision is taken to accept the proposal and to start the implementation of the proposal as such. indicate the time and means to achieve this recommended structures and institutional frame.1. to be ready in the future.
9.Define the operational aspects of this new capital market architecture that must be put in place and indicate the time required.1.1 Global Strategy
The action plan starts with a day T. Action plan and time frame for implementation
9. Sub strategy C-in addition the proposed set-up capital market structure will need an appropriated IT-tool/platform.1.37
9. The proposed architecture for Azerbaijan
9.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. and Sub strategy B. 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.
. 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. 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. The consultant intends to recommend a modular base on a shared technical infrastructure to combine extremely low latency with high volume.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. once trading will start for real at the BSE and Sub strategy D. Based on the experience as gained in the EU. to enable the institutions and all other capital market participants to operate in the new proposed structure. 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. 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. 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 brokers. This will require a time period of 18-24 months to achieve. The consultant has elaborated a graph showing in details the time allocated to achieve the proposed implementation. again this will require elaboration of regulations and an appropriated reporting frame to the Regulator. Also capacity building for the institutions involved (SCS. Participation in an investors’
. This is a prudent estimate based on experience as gained with the elaboration of the latest capital market law in Moldavia. (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. BSE.3 Main actions and priorities
As resulting from the information of the consultant in Azerbaijan. NDC and BSE) should be done in parallel.3 The structural aspects for a capital market architecture in Azerbaijan.External auditing. Capital base . Capacity building to exercise the prudential supervision of the market would accompany the consultants’ action. There is also a draft law for domestic investment funds under scrutiny. would require a simultaneous implementation of all the EU directives mentioned under 9. it encompasses also elaboration of supervisory reporting frame to the Regulator SCS regarding compliance. custodians and all other market participants in the capital market. this would require also elaboration of regulations and an appropriated reporting frame to the Regulator. 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 . This is also reflected in the detailed graph in the graph in Annex 2. as an example. 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. This capital market frame law should contain all requirements as below stated in more details.
To create a legal coherent frame in Azerbaijan. Participation in a deposit guarantee scheme .38
In the case of Azerbaijan to set-up the legal frame the consultant recommends. The required time: at least 18 months for elaboration and 6 months for implementation. Banks should also be enabled to act as custodians banks. Authorization procedure. This from a capital market point of view is a piece meal structure. banks. This would require the consultant to elaborate detailed proposals for rules and regulations to be implemented.
9. The graph illustrates the time necessary to achieve these objectives as well. 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 legal form of the institution.3. the legal frame for capital markets transactions is based on some specific articles in the civil code. Professional standing and experience . It would take the form of a financial services action plan encompassing all institutions: SCS. Central administration and infrastructure .1.6 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. DNC.
9. Shareholdings.1. It does not allow for the development of a coherent capital market.
Obligations of credit institutions and investment firms when appointing tied agents. Financial intermediation firms. Exchange of information with other Regulators. Distributors of units/shares in investment funds. Form and extent of consolidation. 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. Internal control mechanisms and risk management processes. Financial position. Relationship between the Regulator and external auditors. Identifying a financial conglomerate. Risk concentration. Obligation to execute orders on terms most favourable to the client. Authorization of holdings. 2-Authorization for the establishment of branches and freedom to provide services 3-Professional obligations. Cooperation and exchange of information between competent authorities. Scope and parameters of supervision on a consolidated basis. Investment advisers.39
compensation scheme for all professionals such as: Investment firms. Content of supervision on a consolidated basis. Market makers. Professional obligations of the financial sector as regards combating money laundering and the financing of terrorism. Obligation of professional secrecy 5-Prudential supervision of the capital market -The competent authority responsible for supervision and its tasks. Underwriters of financial instruments. Purpose of supervision. Cooperation with the other authorities responsible for prudential supervision regarding consolidated supervision. Exchange of information with third countries. Conflicts of interest. Professional secrecy of the Regulator. Professional custodians of financial instruments. Enforcement measures. Verification. Parent undertakings having their head office in a third country. Commission agents. Intra-group transactions. Private portfolio managers . Scope of supplementary supervision of investment firms. Brokers in financial instruments. Professionals acting for their own account. Obligation to cooperate with the authorities . -Supplementary supervision of investment firms in a financial conglomerate:: Definitions. Provision of services through the medium of another credit institution or another investment firm . Registrar agents. Investment firms operating an MTF in Azerbaijan. Coefficients. -Supervision of investment firms on a consolidated basis: Definitions. Capital adequacy.
. Powers of the Regulator. Powers of injunction and suspension. Conduct of business rules when providing investment services to clients. Means used to exercise supervision on a consolidated basis. -Means used to exercise prudential supervision: Official lists and the protection of titles. Client order handling rules .Transactions executed with eligible counterparties . thresholds for identifying a financial conglomerate. Complaints by clients. Miscellaneous firms other than investment firms.
Protection of third parties. proof of the appointment and powers of administrators and liquidators. OMV plans to make the Central European Gas Hub CEGH. Reservation of title. 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. Professional secrecy. Opening of proceedings for suspension of payments. He did meet with banks. Set-off. He gained the impression that actually there is a lack of adequate tradable products in the stock exchange. Lawsuits pending. Winding up: Voluntary winding up. simultaneously. Regulated markets. assuming the proposed architecture is accepted. 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). Provision of information to known creditors . Suspension of payments: Provisions governing the opening of proceedings for suspension of payments. The time frame is 6-12 months for the development of such a platform.Winding-up proceedings. the Central bank and the State Fund. Registration in a public register. 6-Deposit-guarantee schemes: Compensation schemes for investors in credit institutions and investment firms 7-Penalties: Administrative fines. Netting agreements . At present the gas flowing through the
.: Provisions governing proceedings for the judicial winding up of establishments .1. according IT duly consulted. This is the technical component. Third parties’ rights. During his first mission in Azerbaijan the consultant had meetings with market participants regarding the launch of a capital market in Azerbaijan. -Provisions common to reorganization measures and winding-up proceedings: Effects on certain contracts and rights . Detrimental acts.40
-Reorganization and winding up of certain professionals in the capital market: Definitions. 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. corollary to the set-up of the legal and regulatory architecture of capital markets in Azerbaijan. Repurchase agreements. Lodgement of claims. Another part time task for the consultant would be. 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. Scope. Competent jurisdiction and applicable law.4 Ancillary tasks
The consultant recommends the set-up of an integrated IT platform for the BSE and NDC (deemed to become a CSD in the proposed architecture. brokers. insurance companies. Therefore he recommends undertaking a formal capital markets needs analysis and a market acceptance and absorption evaluation together with the project team. Withdrawal of an establishment’s authorization. Criminal sanctions
9. This is also duly reflected in the graphical scheme in Annex 2. the leading gas exchange in Central Europe within the next years.
that are currently on a case by case dealt in. the State Committee for Securities. 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.2.41
hub at Baumgarten covers 10% of Europe’s gas requirements. for lack of adequate products for the potential investors. commodities and currencies that could be eligible at a later stage. already sporadically now. This percentage is expected to rise further when Nabucco and the South Stream gas pipelines will be connected. This initiative seems to be an attempt to emulate the actual existing Caspian Oil & Gas Exchange. SCS. 1977. This encloses also private deals done on listed equities that should and must be duly notified to the Baku Stock Exchange compulsory. 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 core element of any capital market. The consultant recommends to formulate policy recommendations as mentioned under 9. 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 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. The execution of these duties must be under the duly Supervision by the Azerbaijan capital market Regulator.
9. 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. once the market develops. to derivatives. which would require the elaboration of a stock exchange handbook containing the rules and regulations. (Refer for more details to the consultants’ previously elaborated preliminary report “Reflection paper on an “ad hoc” capital market architecture in Azerbaijan” December 2009). 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.
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. a trading manual and implementing the EC recommendations dating July 25.2. This will require building up the capacity to handle transaction with EU conform regulatory requirements. concerning the European code of conduct relating to transactions in transferable securities. 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.1. These tasks are mentioned in the graph of the action plan. mainly those as mentioned in the EU MIFID directive.
the BSE should initiate the settlement/clearing while the CDS should finalize it. CCPs require collateral for the settlement of trades with them. therefore the settlement is guaranteed. The consultant would favour the later.
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. training of handling staff must been foreseen as an underlay of the capacity building exercise when and where necessary. Trade processing by the Baku Stock Exchange will require a post-trade model. which presupposes the existence of a central market organization for the processing of orders. A stock exchange under EU rules must be regulated. this issue is rather irrelevant. 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). “Reflection paper on an “ad hoc” capital market architecture in Azerbaijan” December 2009) and open to the public. To ascertain compliance. 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. operating regularly (no sporadic trading as actually in the Baku Stock Exchange ref. under EU rules the essential characteristic of a regulated market is the clearing. 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 in an integrated IT system/platform encompassing the whole capital market structure that the consultant intends to recommend to be implemented. 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 a market may also be distinguished by multilateral order matching (general matching of bids and offers enabling the setting of a single price). CCPs require netting of transactions and collateralization. such as a professional Association. NDC for instance(upgraded to a CSD). this function could. but must not be outsourced to another institution like the National Depository Centre. as the depository of the collateral securities. “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. In addition EU rules require a stock exchange to be “recognized”. This is defined in more details as meaning: The stock exchange must be “regulated”. transparency (maximum information distribution amongst buyers and sellers giving them the possibility to follow the evolution of the market.
The messaging standard should normally be SWIFT.2. The institution empowered to act under the decree being the State Committee for Securities.
9. These recommended reforms to be addressed as outlined under NDC by an appropriated presidential decree approach in matters legal handling. At record date for the purpose of AGM. The modus should be DVP mode 1.e. In order not to fall in the pitfall of the retail business as previously mentioned. CSDs do have relations with other ICSD and
technically speaking: as deals/transactions cannot fail. is involved in supervising custodian banks in the EU/EEA area. This is good practice in all CSD. Central Securities Depositories (Settlement & Custody) and Central Banks (cash settlement. Investment Managers and Brokers are also important participants but only as initiators of Clearing & Settlement activity through trading and investment. Therefore this eliminates any failed trades at the end of the post-trade value chain. CSD are wholesale transaction processing entities. and brokers in case of Azerbaijan tentatively) to handle. 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. they come under the Regulator of capital markets. collateral etc. In the EU the key participants in any reform of Clearing & Settlement are those. the operational working standard should be only the omnibus account procedure for NDC. 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). whose roles are integral to the process. No CSD.2. It carries as corollary a compulsory dematerialization to be the standard for those securities seeking a listing and trading at the Baku Stock Exchange. This is stemming from an operational facility point of view shared by other CSD. NDC in the Azerbaijan capital market architecture should have the pivotal role. However. i.) that means in matters of all Azerbaijan securities. All securities traded in Azerbaijan (inclusive State or Government securities should fall under the jurisdiction of the CSD). The National Depository Centre
The National Depository Centre. Euroclear etc. as all transaction elements (cash/ securities) must be present before initiating the dealing in the stock exchange. 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. 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. Central Counterparties (Clearing). as recommended by the G10 and achieved by STP in the integrated common platform that the consultant proposes. (aggregation of same asset type) leaving the retail for the other market participants as mentioned (custodian banks. as in the EU capital market structural architecture. This recommendation is within the scope of actual project aims. CSD is not concerned by attendance in person or by proxy as this is at the retail level of the entitlement beneficiaries.
after a specified date. NDC in the Azerbaijan capital market architecture should have a pivotal role. CSD should provide processing services for trades of those securities that it holds in final custody. and in this function it is referred to as “the issuer Central Securities Depository”. as opposed to individual custody. Parliament etc. the same as the other trades. so called “EU reforms” were simply addressed by issuing a presidential decree enacting all EU legislation to be applicable in Romania. 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. based on the experience in other emerging markets with failing company registrars as in Russia. but as a separate entity from the CSD. In Azerbaijan its home country. The transformation from NDC to CSD status could result from a simple rule issue based on the presidential decree from the SCS. The consultant would like to recommend also the introduction of a Central Registrar for securities in Azerbaijan. OTC falls under the jurisdiction of the CSD as well as mandatory these transactions must be reported to the CSD. OTC transactions must be mandatory under the jurisdiction of CSD. CSD should hold securities and enable securities transactions to be processed through book entry. The separation is to avoid conflicts of interests. A CSD can also process services as an intermediary in crossborder clearing and settlement. issued and superseding these rules. in matters of corporate governance as experienced by the consultant during an EU project assignment with the Federal Financial Markets Service. In collective safe custody. which is an important mandatory attribute of a CSD beside netting. As outlined. 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. unless an extension of the present project with allocation of new resources could be granted. Thereby Romania did gain the time to elaborate detailed organic laws. securities which are intended for trading are safe-kept in collective safe custody (omnibus account principle). without physical movement of the securities. Based on the example in Romania.44
domestically with brokers and banks. all. and the settlement. where the primary deposit of securities is in another country. fungible securities of the same type are kept in a single collective holding. The setting up of such an institution would nevertheless exceed the present mission of the consultant as not enough time and resources could be made available. as in the EU capital market structural architecture as the central clearing house. This would require time to elaborate. The customer acquires fractional co-ownership in the CSD’s collective holdings and transactions can be settled by book entry. that needed to meet the EU criteria in matters capital market organization for not delaying the EU accession further. time to go through the legislative procedure. The National Depository Centre. For instance in Germany.
. 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. ministerial decrees and regulations to implement in domestic law all the EU acquis communautaire.
The main argument is to ascertain the title for shareholders/investors and guarantee corporate governance in all aspects. The professional capital markets participants
All recommendations under 9. In France this is handled under TPI as an example: (TPI stands for Identifiable bearer security in French. the presidential decree approach could also be used to address the creation of a National Central Registrar in Azerbaijan. The Capital Markets Regulator
The role of the SCS as capital market Regulator in the proposal of the consultant must be enhanced considerably.
As outlined previously. A Central Registrar could also extend its registration to bondholders (public or private).
9. 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.
. the argument in favour is again corporate governance: bondholders are entitled to certain rights in an EU context. the Committee of European Securities Regulators in that regard. to reduce the transition time and resulting legal insecurity. In case all joint stock companies shares should be kept only in dematerialized form at the Central Registrar as done for instance in France.) 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. no custodian bank. but restricted to the domestic market in Azerbaijan. a service that allows an issuer of bearer securities to request a list of beneficial owners registered in the custodians’ books. 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. no fronting possible. The institution in charge of the changes would be as principal the SCS again. to be formalized at a later stage by the consultants’ elaboration of a specific basic law for later implementation.4.1 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. 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. 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. In this case the Central Registrar deals with final owners no broker.3.
The Investment firms
Brokers should be duly licensed and apply the MiFID criteria in their clients relationship. rather than safe-keeping of the deposited assets. The granting of the status is subject to vetting by the SCS in agreement (maybe under a formal MOU.
9. It entails reporting duties. The requirements to be a custodian bank can be cumulated with a brokerage license. OTC transactions must be mandatory reported to the CSD for all domestic Azerbaijan securities. They are linked up with the CSD through the market IT platform as professional users. It must be understood that the legal concept is versus supervision of assets. that are foreign CSD acting as global custodians for these assets if they are in custody with them. 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. Custody of assets is the main duty under EU regulations.1. This is at discretion of the capital market Regulator alone. as it is not a Regulator. Custodian banks have also specific duties. The consultant would recommend seeking inspiration from the E so called UCITS directive in that regard. 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. collection of dividends. The CSD is not involved in supervision or in license granting for brokers or for Custodian banks. (Council Directive 85/611/EEC on the coordination of laws. assuming the draft law is approved and such funds would become operational then. when acting as investment fund custodian banks as resulting from the investment fund law.2. as recommended by the consultant. exercise of options etc.4. but the overall responsibility remains with the custodian bank. interests and proceeds of matured securities. Therefore custodian banks can make use of correspondent banks (sub-custodian banks) to fulfil this main task. for operational reasons. In matters of domestic investors investing abroad the link is with CSD that is then in connection with the foreign CSD and/or ICSD.
. from relevant EU directives implementation resulting. but always with due consideration of the. Ancillary carrying out all day-to day-administration of assets under custody: corporate actions. regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS).
9.3. The Custodian Banks
Custodian banks are mandatory for safe-keeping of assets of the domestic Azerbaijan investment funds. new legal Regulatory frame in Azerbaijan. 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. 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. inclusive Government and State titles. subject to a formal application with the capital markets Regulator SCS.4. All transactions done to be mandatory only through CSD for domestic operations.46 9.4. The will have domestic clients and may as well have direct foreign clients if the MIFID legal frame is duly in place. This is a request.
4. 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. this should be exercised nevertheless in close co-operation and concert with the Banking Regulator.
9. 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. how the market will function. the form under which this information is required usually consists of the publication of listing particulars.
9.6.6. as the duly appointed capital market Regulator.
9.(a MOU would be recommendable. as regards elements related to prospectuses and advertisements.47
Needless to say that although custodian bank status granting is a prerogative enshrined with the SCS on request. The professional capital markets associations
No professional capital market association is involved directly in the proposed capital market architecture.1 the operational aspects of the capital market in Azerbaijan
It is necessary now to precise and to define. after the structural institutional aspects are given in the new basic capital market law. appointment of mechanisms for the central storage of regulated information within the meaning of transparency requirements for
. as done in some EU countries. 1-Basic organic law taking into account the Commission Regulation (EC) No 1289/2008 of 12 December 2008. 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. 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.5. 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. 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.1 plus some specific capital market basic organic laws to reflect all other EU capital market directives. either at the time of their offer or of their admission to official stock exchange listing.4. 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. 2-Basic organic law for a Central Registry in Azerbaijan. 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. in case).
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). 6 months implementation guide line issuing). transaction reporting. and admission of financial instruments to trading.2 Important
Regardless all these specific recommendations. incorporation by reference and publication of such prospectuses and dissemination of advertisement. on markets in financial instruments. 3-Basic organic law reflecting Commission regulation (EC) No 1287/2006 of 10 August 2006 as regards record-keeping obligations for investment firms. 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.2.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. 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. This should be merged together with the actual draft law of investment funds in Azerbaijan. implementing also the requirements of Directive 2004/25/EC of 21 April 2004 on takeover bids. there should be a basic operational organic law reflecting: The Council Directive 85/611/EEC on the coordination of laws.6.1 setting the institutional structural frame. 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
. . 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).48
issuers of securities whose securities are admitted to trading on a regulated market. market transparency. regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS).
9. 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. and Insider Trading The basic capital market law under 9. 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. 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).(18 months discussion and elaboration. 2-Directive 2003/6/EC on insider dealing and market manipulation (MAD) (market abuse).
in charge to implement these EU requirements rapidly through immediate transitional appropriated measures and rules.7. Below a diagram to show the relationship and the resulting flows. Luxembourg just to mention some) as well as custodian banks for investment funds assuming the legislation id introduced in Azerbaijan. (means and ways as under 9.
9. 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. 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. based on the universal banking principle e as existing in some of the EU member States (Germany. the basic organic laws to follow later in time. 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.
.2 outlined) The existing banks.
FDI FDI buy security x
Bank A A/C securities FDI A/C cash Investor A Invesrtor A local A/C cash FDI Central Registrar of securty X
Bank B A/C cash Investor B Investor B local
Sale security X security X fromInvestor A /sell securit X to FDI Broker A A/C investor A security X
CSD / Exchange common integrated IT pCSD / CSD / Exchange common integrated IT platform Omnibus accounf securties X Brokers A&B Banks A&B latform Omnibus accounf securties X Brokers A&B Banks A&B Central Registrar of securty X
Broker B A/C Investor B securty X
but it I will be an open architecture. and likely may finally generate an effective take-off of the new capital market architecture. All horizontal organisational capital market set-ups need such an entity that is the buyer to every seller and the seller to every buyer of a specified set of contracts/obligations executed on a particular exchange. The main argument to choose vertically integrated capital market architecture. Bulgaria’s Central Depositary is now seeking to join forces with an international settlement and clearing institution in line with a long-term
. It is the main argument for the consultant to recommend this solution. The consultant also intends to give precise hints regarding products to be traded in the new capital market structure as proposed. without adding any additional value to the transaction processing. enabling it to encompass new products later.51
10. clearing to custody in the new CSD in STP modus as previously already stated. 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. whereas the operational aspects of the new capital market structure are defined in the basic organic law proposals. the common platform guarantees STP processing of transactions. the Clearstream model. this is eliminated as no need for a separate CCP entity. This means another entity handling the post-trade transactions with an additional cost factor and possibility of errors generating failed trades. One should avoid setting up separate entities for post trade processing and go for the centralized vertical single entity handling the transactions from trading. From an organizational IT point of view. 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. especially in the context of a single market structure as in Azerbaijan. 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. separate clearing providers as a horizontal architecture set-up provides only trading and settlement. stems from the necessity of the CCP. 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. settlement. In the vertical organised capital market structure. In a horizontal architecture there are different. The institutional aspects are as defined in the basic capital market law. These will result from the study and market analysis the consultant proposes to perform in the context of this project.
The unique characteristics of Clearstreams business.52
development strategy aimed to guarantee free trade by foreign investors on the Bulgarian market and vice versa. systemic risk in case of a crisis.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.5% for Clearstream). In clear in an emerging market the Clearstream approach . (Clearstream as a bank is subject to this accord) aspects of the new frame did affect Clearstream more than had perhaps been intended. is also an argument not to neglect. the structural pattern being pursued throughout the EU is one of increased vertical integration. 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. and they have less failed
. implies that their risk profile is atypical from that of other providers. Clearstream International has probably have not so much to contribute beyond that which any other bank may be expected to make. by definition. does particularly focused on operational risk issues for itself and for the global capital markets. As also outlined. Before deciding for the options in the market the Bulgarian CSD want to thoroughly discuss the strategy with all stakeholders including the investment intermediaries’. The discussion is to either join Clearstream. asset managers’ and banks’ associations as well as the Bulgarian Stock Exchange (BSE) itself. In the field of Credit Risk. Therefore. In reducing settlement risk in the international and domestic securities markets by “internalizing” (technical term for the vertical processing structure) Clearstream. is much higher when using horizontal capital market structures. allowing for economies of scope. as the assets are always under the control of one single processing entity. The consultant did also explain that the processing of transactions and the general operability in vertical structured capital market architecture is higher. Besides. Clearstream can offer some particular expertise and insight in matters Operational risk managing capacity. 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. When discussing the new Basel II capital agreement. as in 2009. on which they expand. 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. which is pervasive and remains the industry standard. this in addition. It is vital for the post-trade industry as a whole to ensure that the measures for operational risk are appropriate and achieve their desired goals of increasing financial safety and soundness in the system. This is an additional argument in the opinion of the consultant to strongly recommend this architecture type for the Azerbaijan capital market. “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. and the Second (Supervisory review) and Third pillars(market discipline). the Straight Through Processing ratio for vertical capital markets structure is so high (98. Euroclear or Link Up Markets (which is again Clearstream).
keeping the trading and settlement functions running at cost. as the scope of horizontal capital market operators is to earn most while performing the clearing. In the vertical structure the fees are not so transparent. The proposed vertical integrated architecture will enable the Azeri CSD to establish e a working relationship with other CSD in the EU and worldwide. 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. As some non EU CSD in Europe such as Switzerland.
. that the new Azeri CSD joins as well the system as the proposed capital market set-up is compliant with all EU regulations. 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. and custody fees thereafter. It is clear that this is not conditional to opt for the horizontal or vertical capital market organisational set-up. while keeping its own assets under control in the post trade area. but both structures do compete successfully in the EU capital markets. Norway did also join the Target 2 securities system it should be possible.53
trades to report then horizontal organized architecture where multiple entities are handling the post-trade transactions. 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 matters cost efficiency there is no data. as both are possible and acceptable structures in the EU.
ANNEX 1 Capital market structures in the EU
Area/ Details 1Main TASK with Common CSD/Exchan ge IT platform SCS Tasks Ancillary part time with technical assistance projects Coordinati on With IT developers Coordinati on with IT developers Coordinati on with IT developers Coordinati on with IT developers Main full time coordinatio n with technical assistance projects MiFID & other EU Supervisor M M M M M M 1 2 3 4 5 6 M M M M 7 8 9 1 0 M 1 1 M 1 2 M 1 3 M 1 4 M 1 5 M 1 6 M 1 7 M 1 8 M 1 9 M 2 0 M 2 1 M 2 2 M 2 3 M 2 4
NDC BSE 3rd Parties market participants 2Main TASK Capacity building /training /coaching
y& Regulatory complianc e issues Custodian/ depositary bank regulatory and supervisor y Legal frame change to CSD Implementa tion/risk managemen t procedures EU complianc e assessmen t Dematerial isation Issues/ omnibus A/C National securities depositary issues OTC transaction
s Recording issues CBA and Governme nt securities handling Exchange rulebook Trading manual Implement EU code of conduct transaction s Implement EU Code of conduct Settlement / clearing Testing/ launch assistance OTC transaction s reporting/h andling Linkage with common IT platform
.needs analysis b.market acceptanc e absorption assessmen t c.products recommen d d.58
3rd parties: market participants Products developmen t for the AZ Capital Market
“brokerage ” enabled banks/ MOU Regulatory requireme nt/CB advisory FDI issue Awareness raising exercise Ancillary part time with other LT expert a.