1001730978 ( .pdf )

1001730978_pdf.txt

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Collection of expert papen on cleari~ ~d~~:l:} l~;_?>~~rOf<-papr are part of Study of Intemational Clearing and settlement. Vol. I, Banker Tru.t Company, 259 pp., October 1989. Thi collection is organized as follow: North America, Parta land 2; Europe; Northeast Aaia/Australia: and Supra llegional Topics. VOLUME III: EUROPE 1. Th Euro-Clear System, Euro-Clear, undated. 2. clearance and Settlement in Germany, Hana-Joachim Hoessrich and Heinz Klaus Ruetzel, the Deu:scher Auslandkassenverein, AG, circa 1989. 3. ICCH: the Independent Unified Clearing House, International Comaodities Clearing House, Ltd., undated, circa 1989. 4. The International Stock Exchange London: A Perspective of Clearing and Settlement, The International Stock Exchange London, Kay, 1989. 5. cEDEL' Principal Activities in International Securities Clearing and Settlement, George Muller, CEDEL, 1989. 6. Key Recent Developments in France: the RELIT Settlement Reform,", Jacques Nouvel and Philippe Andrieu, SICOVAK, Nov. 1989. 7. CHAPS: A New Approach to Payments Systems," prepared for the CHAPS Project Office by R. T. Clark, April 1982, reprinted Karch 1987. Thia document vu prepared for the OTA lackaround Paper, Trading Around th Glpek; Qlqlpal swJct11 HagkC 114 Infon,ctgn Tac;hnglog. July 1990 and the report 1 1s&t9D&S lplla ID4 ltli p.a. lc;pglti KagkC 1D4 Information %tsJm91AU, Sepuaber 1990. this docuaent do not necessarily reflect the an&lytical findina of OTA, lta Advlaory Panel, or it Technolol)' Aaae11ment Board.

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Euro-clear~ TID EUB.O-CI&U. SYSTP.M This contractor document was prepared for the OTA Background Paper, Trading Around the Clock: Global Securities Markets and Information Technology, July 1990, and OTA Report, Electronic Bulls and Bears: U.S. Securities Markets and Information Techno .!2.&I, Sept. 1990. This document does not necessarily reflect the analytical findings of OTA, its Advisory Panel, or its Technology Assessment Board.

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Euro-clear THE BUllO-CLEAR. SYSTEM I. PB.OP'ILE AND IDSTOB.Y The Euro-clear Sytm 1 the lar1er of the two clearance systems for lnternaUonally-traded debt and equity intrumenta. Since lb inception In 1968, it baa been a catalyat of chan1e and 1rowth, and Instrumental to the development of the international securit1e1 market.. The Euro-clear System ha close to 2,500 Participants worldwide, all of which are bank, broker-dealers and other institutions professionally en1a1ed In mana1ln1 new issues of securities, market-making, trading or holdtn1 the wide variety of ecurltie1 accepted in the System. Euro-clear PartJclpanta can contlrm, clear and settle trades by book-entry 1n any of 26 currencie on a 1lmultaneoua delivery versus payment baI. Once ecurltJea are delivered versu payment in the Euro-clear Sytem, aettlement la final. Delivery a1alnat lmultaneous payment provide Participants with effective risk management for all ecurltiea tranaactlon. The market aerved by the Euro-clear Syatem are diver. The System accept. over 27,000 different Hcurlti, coverln1 a broad ran1e of Internationally-traded fixed and floatln1-rate debt intrwnents, convertible, warrants and equltlea. Included are domestic 1overnment debt tnatrumenta from ten countrl and more than 2,400 equity aecurltles from fifteen countrlea. lmmoblllzatlon of aecurlti i achieved throu1h an extenalve network of depoaltary bank, national clearln1 ayatems and central bank. The network alao facWtate, link with domeatic markets to effect external deliverle and receipts of securities thereby reducin1 the rlak Involved In croaa-border settlement. The efficiency of the aettlement proce In the Euro-clear Syatem I enhanced by an automated aecuritle borrowtn1 and lendln1 facWty and a

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l:.uroclear 2. multi-currency money tranafer service. Extensive custody services are also provided throu1h a centralized custody mana1ement facility. Participant. communicate throu1h one central point In Brusaels, the Euro-clear Operation, Centre ("EOC"). EUCLID, a proprietary telecommunication, ayatem, provide efficient, secure and reliable input and report1D1 for aecurltle tranaactlona. EUCLID provide for comprehenalve Input of trade and 1ettlement data for confirmation, and reportln1 of matchlnl re1ulta and 1ettlement Information. Ninety-five per cent of all 1ecurltlea lnatructlona In the Syatem are sent via EUCLID. EUCLID has been approved a, a reporting mechanism for the purpoaes of The Securities Aaaoclatlon rule under the U. K. Financial Services Act. Participants may alao communicate throu1h S. W. I. F. T. and telex. For the market, the System's success ls measured by its 1rowlng volwnea and multiplyln1 services. The value of securities held on behalf of Euro-clear Participant was USD 610 bllllon at the end of 1988. The System cleared tranuctlons valued at approximately USO 3 trlllion In 1988, with dally Instruction volwne avera11n1 over 30,000 and peaks exceedln1 40,000. Avera1e securltle loans outstandln1 were USO 2. S billion 1n 1988, with peak1 excNdlnl USO 3 bWlon. A hl1h priority on inve1tment 1n research and development and In advanced technolo1y 11 maintained to meet the constantly chan11n1 and complex requirements of Euro-clear Participants. The System ls operated by a hl1hly 1k11led, multWn1ual staff, trained and dedicated to the standards of excellence a11oclated with Ill contract operator, Mor1an Guaranty Trust Company of New York, Bru11els office ("Morgan Guaranty Brussels"). Securities depo1lt1 and the operation of the System are governed by Bel1lan law lncludlnl 1peclal provisions regulatln1 deposits of securities on a fun1lble basl1. Mor1an Guaranty Brus1el1 ls fully re1ulated by the Bel1tan Bankln1 Commission, the Federal Reserve Board as well as the State of New York Banklnl Department. In Its capacity as Operator of the

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Eurocaear tt 3. Euro-clear System, Mor1an Guaranty Brussels 11 also authorized as a Service Company by the Securities and Investments Board under the U. K. Financial Service, Act. The "putatlon of the Euro-clear System has been built on quality of service, Innovation, anticipation of market nNda and a steady emphasis on advanced and reliable technololY. This commJtment to excellence can be Wustrated by summarlzln1 some important event, In Euro-clear history. The E,ro-clear System was founded In December 1968 In Brussels by Mor1an Guaranty Trust Company of New York ("~or1an Guaranty"). From the start, the System was based on the concept or book-entry against payment aetUement, ln lieu -of physical movement of securities. In December 1972, Euro-clear Clearance System Public Limited Company ("ECSplc") purchaaed the Syatem from Mor1an Guaranty. Mor1an Guaranty Bruaael continued to operate the Syatem under contract. ECSplc Is owned by 124 banks, brokers and Investment lnstltuttons, none or whom hold more than 3.25\. In 1978, the Euro-clear bondlendln1 aervlce was launched to facilitate timely settlement and Improve markot Uquldlty. Computer communication via the EUCLID ayatem be1an ln the followln1 year. By Introducing local data entry throu1h tlme-sharln1 systems, EUCLID reduced the costs and lnc"ased the efficiency of communlcatln1 settlement instructions from every corner of the 1lobe. In 1980, the electronic brld1e between the Euro-clear System and Central de Llvralson de Valeurs MobWires S.A. ln Luxembour1 ("Cedel") automated the Unka1e between the two systems. This has allowed the Eurobond market to expand at minimal cost while preservln1 the competitive choice of clearln1 systems for users.

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Euro-clear" 4. Since the mJd-19801, the Euro-clear ~ystem has accepted a ran1e of new instruments, includin1 forel1n and domestic debt Instruments, money market lnatrumenta such as commercial paper a, well as warrants and convertible. In April 1986, the Euro-clear System launched Its international equities service. In January 1987, Euro-clear Clearance System Soclete Cooperative was fonned to 1lve all Participants an opportunity to participate in ownership and decialon-makinl. Shares in the Cooperative were offered to all Participants, and more than 2,000 are now member The Board of Director of the Cooperative represents the interests of all Participants and not Just ahareholders. Mor1an Guaranty Brussels continues to operate the Syatem under contract with the Cooperative; however, the Cooperative, throu1h ita Board of Director has the aole power of establishin1 matters of policy relatln1 to the Euro-clear System lncludin1 such matters as the approval of new Participants, the establishment of fees to be paid by Participant. and of any rebates to be paid to Participants and determination of the aecurltles to be included 1n the System.

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Euro-clear 5. II. GlLOWTII OP THE BUllO-CLP.AJI. SYSTDI The key 1tatl1tlc1 of the Euro-clear Sy1tam are 1ecurltle1 turnover, value of 1ecurltl held, avera1 dally value of securities loans, number of tran1actlon1 aettled and number of Participants. The table below 1how1 the trend ln th fl1ure1 over the past five year1. Annual OapJiiid lW 1 1 Hl7 1 Groltb Tliw <111 llilliCII) 1.an.s 1.457.2 2.336.3 3.cm., 2.IJ9.S ,a1. af .... iti bald far hrtieipatl 112.1 27f.0 a.o SZ7.2 610.0 .._. .. u,va1. of -=-riti loal ca billim> ., 1.f 2.3 3.1 2.f -lalllrof trwtiall llttllll 3.om.a t.a>.C&t s.a.ca 7.217.192 6.661.530 211 .... of hrtic:ipatl 1.a 1.111 2.m 2.241 2.f56 lll

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.. ,o-clear 6. Ill. QISCBJPTION OP THE COU EUB.0-CUAR. SER.VICES Participant. ln the Euro-clear Sy1tem are able to make u1e or the followln1 four baalc Hrvlc throu1h one central point at the Euro-clear Operation Centre In Bru1ael1 : ( 1) 1ecurltle1 clearln1, ( 2) 1ecurltles lend1n1 and borrowln1, (3) cu1tody and (4) money transfer. 1. SECURITIES CLEARING Before conslderln1 the 1ettlement process, It 11 Important to under1tand the dally proce1sln1 cycle and the matchlnl of trade Information. ACE, the aucceaaful Euro-clear trade confirmation and matchln1 rvlce, waa developed lD cooperation with Cedel, and with the 1upport of the A1aoclatlon of International Bond Dealer, ( "AIBD") ln 1987. ACE was de1l1ned to meet th market', nNd for a simple, 1ecure and fast confirmation and matcb.ln1 1ystem for International securities tranaactions. ACE allow confirmation and matchlnl of trades amon1 Participants as early aa trade date. Euro-clear Partlclpantl can now obtain reports showln1 the 1tatu1 of their tran1actlon1 four Um a day 1tartln1 on trade date. ACE deliver more than Juat trade confirmations : matched trades can, if so deal,nated, enter the Httlement procea1ln1 without any additional Input. Furthermore, contract note, lf needed, can be produced from ACE directly, 1ubatantlally reducln1 the costs of c01M1unicatlon1 and reconclllatlon. Over 97\ of sattlement ln1tructlon1 sent to EOC now contain the requlalt ACE trade data. Participants provide EOC wh:, ln1tructlona to receive 1ecurltle1 lf they are purchaser or to deliver 1ecurltle1 1f they are seller,. EOC validates such Instructions for proceaaln1. Invalid ln1truction1 are Immediately rejected. EOC attempt to match a Participant', valid receipt Instruction with a counterparty Partlclpant' delivery lnatruction to en1ure that the

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l.&aroclear 7. term of the trade are Identical. Matchlnl I done continuously throu1hout the day, aa valid lnatructlons are received. Information required For matchlnl include (1) account number, (2) settlemttnt date, (3) nominal amount, ( 4) the 1ecurlty code number of the l11ue traded, and ( 5) currency and caah countervalue. Unmatched ln1tructlona remain in an inventory of valid lnatructlons and continue to be put throu1h the matchln1 process until they either match or are cancelled. Participants can obtain dally reports of matched and unmatched lnatructlon. EOC take matched ln1tructlon for a 11ven aettlement date alon1 with any unsettled transactions from previous days and paaaea them Into the next step, settlement. The Euro-clear aecurltlea aettlement proce takes place during the nl1ht prior to the relevant value date for settlement. Transactions refiected ln matched inatructlona havln1 reached their aettlement dates Httle overnl1ht, If the aeller ha sufficient securities ln its account and if the buyer has adequate caah or credit. Delivery versus payment ls aasured by the fact that settlement cannot occur unless the seller has curltles and the buyer has caah available to exchan1e. Sellers may specify the priority ln which their trades are cleared. In order to finance net purchaaea, Participants may, ln advance of the ttlement proclnl, preadvlae funds for the value of the settlement. When accepted by a lendlnl officer at EOC, such preadvlces wW represent a form of credit available ln the overnl1ht procesaln1. Sellers who, prior to the aettlement proce11ln1, identify a shortage ln their securities poaltlons, may attempt to borrow the securities needed for acheduled ttlements. The poatln1 of aecurltle and of the related caah countervaluea occur aa a reault of the overnJ1ht procea1ln1 cycle. Interest paymenta and

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luro'-r 8. redemption proceed, are al10 credited durln1 thl1 cycle. The value dates or ca1h and 1ecurlUe1 deblh and credits are directly related to type or ln1trument and whether or not the ln1trurnent mu1t be delivered outside the Euro-clear Sy1tem. Th most notable ca1e1 where th value date 11 not that of the 1etUement day ror th proce11ln1 cycle are tranHctlon1 lnvolvln1 tranfer to and rrom dome1tlc market, and dl1trlbutlon1 of new l11u Ca1h and 1ecurltJe1 po1IUon1 re1ult1n1 rrom the overnl1ht settlement are reported to the Participant In the early mornln1. The advanta1e or overnl1ht proce111n1 I that It 11ve1 Partlclp11nt1 efrectlve cash mana1ement capabWtle In nme day currencle1. At the end of the 1ecurltle1 proce11ln1 cycle, at the be1lnnln1 of each buln day, EOC provide each Participant with report, U1tln1 which 1ecurltJe1 tranactlon 1etUed and which did not and re1ultln1 cash and 1ecurltl poltlon. Participant. with 1ecurltle1 fall may borrow the required 1ecurltJe1 throu1h the Euro-clear Sy1tem durln1 the day for the next securltle1 procelnl cycle either (1) automatically or (2) by provldln1 1peclflc lntructlon to EOC. 2. SECURITIES LENDING AND BORROWING The Euro-clear Securities Lendlnl and Borrowln1 Pro1ram was de1l1ned 1n 1978 to Improve the efficiency of ecurltle ettlement and lncrea market liquidity. The 1ervlce allow, Partlclpantl with a portfolio of curltle1 to Increase the overall yield (without 1011 of ownership benefit.) by lendln1 ecurltle1 to other Participant. who ek to avoid falls becaue of a lack of Inventory.

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9. Borruwer 1n the pro1ram are uually active trader such a market maker or dealer. Participant. may be either Automatic Borrowers, provldlnl 1tandln1 ln1tructlon1 to EOC both to Identify and, lf po11lble, mNt their borrowln1 nNd1 followln1 th well documented rule, of the pro1ram, or Opportunity Borrower, retalnln1 the re1pon1lbWty for 1ubmlttln1 their own borrowln1 requeta. In addition, Opportunity Borrower may 1ub1crlbe to report, that Identify borrowln1 nNd. Borrower may alo benefit from the automatic relmbur1ement pro1ram, where borrowln1 an automatically relmburd a 100n ufflclent curltls are credited to the account of the Borrower. All Borrower may choo the rla of curltle, currencies and specific Issues for which they wlh to borrow. Lender 1n the pro1ram are malnly portfolio mana1ers and cu1todlans who are not active tndr. TheH Participant may become either Automatic Lender or Opportunity Lender. Automatic Lender provide standlnl lntructlon to EOC to lend certain portion of their portfolio when opportunltl arl and authorize EOC to determine the ecurltle available for lendln1 under pro1ram rule. Lender may alo exclude certain ecurltle, type of lntrumenh or currencle. Opportunity Lender, may be requeated by EOC to lend curltJ whenever the 1upply of ecurltle from Automatic Lender appear inadequate to mNt all borrowtn1 need. To protect a1alnt concentrated borrowln1 either In a 1ln1le lue or by a ln1l Participant, borrowln1 are limited to a pecltled percent of the ouhtandln1 lu. The nominal amount of curltl lent to all borrower, ln a sln1l lu may not exCNd 10\ of the total outatandlnl nominal amount ln the ca of tral1ht debt lu and 5\ for a convertible lue. In addition, no Participant may borrow more than 5\ oi a ln1l stral1ht debt lsue or 1\ of a convertible Issue. Mor1an Guaranty Bruel 1uarantHa the return of ecurltle lent (or the cah equivalent) If a borrower fall to return the ecurltle. Lenders are automatically credited with lnteret procNd a If they stW held uch

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k. .. roclear 10 aecurltle1. and may recall any lo,,n on 10 day11' notice. Lenders retain th collateral value of aecurltle lrnd out ln order to cure their own borrowln1 throu1h the Sy1tem. EOC provide Participant with comprehenalve reportln1 In npect of their lendln1 and borrowln1 activity. Report are available throu1h EUCLID. telex and mall. 3. CUSTODY Euro-clear Participant have acce to exten1ive cuatody-related Nrvlce, lncludln1 aafekNpln1, admlnltratlon or coupon. dividend and redemption payment, related tax aervlce1, exercl or warrant., converk>n and other option and aaalatance with corporate actions. The entln cuatody operation of the Euro-clear Sy1tem 11 deal1ned to minimize the nNd to move phyalcal aecurltlea. Securltlea are lmmobWzed in the Euro-clear depoaltary network, which Include major depoaltary bank, national clearln1 ay1tem and central bank In more than 20 countri around the world. Th network I mana1ed centrally by EOC. which Include eff ect1n1 and monJtorln1 external recelph and deUverl of NCurltlea. Securltl accepted Into the Buro-clear Syatem are al1ned to the most conveniently located depoaltary ("apeclalJzed depoaltary") and aub-depo1lted with auch depoaltarl which act aa a1enta. Once depo1lted into the Sy1tem, all 1ecurltl are held on a fun1lble baI. If a depoaltary accept, the delivery of a phy1lcal 1ecurlty for which It I not the peclallzed depoaltary, It abWty to authenticate that aecurlty may be Umlted. For that reaaon, the particular aecurlty I "frozen until It I authenticated by the apec!aUzed depoltary. In addition, the number of entry point. where particular typea of 1ecurltl can be accepted ha recently DNn reduced. Th rul help determine clear reaponlblllty for

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Euro-clear 11. dpoalted aecurlt and, by nhancln1 control, protct both th Sytm and It Participant. Virtually all new lue1 of lntrnatlonally traded curltle and CG1111Mrelal paper, and many Important L'"ltrnatlonal equity tran1actlon1 aN cloNd and dlatrlbuted on a ume-day a1aln1t-payment ba1l1 throu1h th two clearance 1y1tema. Distribution of Hcurlta.1 either a1aln1t payment or frN of payment facWtat centralized control of allotment pa)'IMnt from ParUclpanta to the lead mana1r. Approximately 7S percent ot all 1ecurltle1 laaued In the Euro-market, aN dlatrlbuted throu1h th Euro-clar Sy1tN1. Aa1l1tance In connection with the admlnl1tratlon of th xchan1 or 1lobal certlflcatea for definitive certificate, I alo provided throu1h th Euro-clear Sy1tem. Morpn Guaranty maintain a number of lnurance poUcla1 with re1pect to aecurlU.1 held ID the !UJ"OclNI' Syatem. A USD 300 mllllon tranalt and location policy provide protctlon aplnat all rlk of phyalcal lo or dama1 from whatever cauH lncludlnl but not limited to ne1otlable and no" ne10Uable aecurlt held on the pNIIIIH of Morsan Guaranty or at tany dpoaltary or aub-depoltary. Covera1 applle anywhen lD the world In tran1lt or at reat. Morpn Guaranty alao ma1Dtaln1 USD 102 mWJon fidelity covera1 under a Nparate banker' blanket bond which cover lo from dlahonest or fraudulent act1 of an employ. Finally, on behalf of the Participant. of th Euro-clear Sy1tem, lnaurance covera1 I maintained In the amount of USD 15 mllllon for aecurltlea Hnt by any depo11tary of th Euro-clear Sy1tem by Nlltered mall.

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luroc-1ear 12. 4. MONEY TRANSFER In order to 1upport their 1ecurltle1 1ettlement proce111n1, Participants al10 open a ca1h account with Mor1an Guaranty Bru11els. Thl1 cash account I 1ubdlvlded Into 26 1ub-account1, one for each of the 26 currencies accepted In the Euro-clear Sy1tem. The ca1h account l u1ed prbnarlly for 1ettlement of securities tranaactlon. In addition, the followln1 money tran1fer tranaactlons can be executed In reapect of Participant' caah account : book tran1fers of funds between Participants, win tran1fer1 effected by the debit of a cash account for payment out of the Sy1tem, pre-advices of fund, to be received, forelp exchan1e conver1lon1, a11re1at10n or disa11re11tton of special drawln1 rl1hta, and credltln1 of fund received by a correspondent Participant, are able to UH S. W. I. F. T. telex or mall for purposes of cammunlcat1n1 money tran1fer lnatructlon,

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Euru~lear' 13. IV. TIii IPl,O-I:MI: SYSTDl'S STANDING IN THE INTD.NATIONAL 114Jlrn In March 1988, the Group of Thirty, a private ector aroup concerned with laue alfectJn1 the international financial Ytem, convened a ympolum 1n London on clearance and ettlement 1n the world' principal ecurltle market. Thi d1acu1lon led to the formation of a hl1h-level commlttN repreent1n1 broad lndutry experience to define a et of tandard and pracUce for major market.. The Group of Thirty released It Report contalnln1 nine .bnportant recommendations on March 20, 1989. The publication of the Group of Thirty Report on International clearance and Httlement wa a welcome development to all ~ncerned with lncrealnl the efflclenC)' and lowerln1 the rlk of International markets. The report' nine recommendation and tbelr lmpllcaUon have been carefully conaldered and, If Implemented 1n the principal International markets as prop~Md, would brln1 Important efflclencl and benefit to market Participant.. The Euro-clear Syatem not only mNt, but exceeds 1n ome cae, the atandard tabllahed b)' the Report' recommendation, ahown In the anal)'ala Ht forth In the Appendix.

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Euro-clear" APPENDIX ROW EUB.0-CIBQ MEE'l"S GROUP OP THIRTY STANDARDS: AN ANALYSIS The nine Group of Thirty recommendations are quoted verbatim below. Followln1 each recommendation is an analysis showln1 how the Euro-clear System mNta the recommended level of sophistication and scope of aervlcea. 1) By 1990, all caaparlaan or trade betwwen dlNct market putlclpulb (1. e., brokan, brobr/c:IMJan and other excb.uap DmDben) aboald be acc+EiiiiiipU.bad T 1. In September, 1987, Euro-clear introduced a comparison service which now allow confirmation and matchln1 of trades amon1 participants aa early aa trade date (T) Thia aucceaaful rvlce, called "ACE, was developed 1n cooperation with C.del S. A. and the Association of International Bond Dealers. Euro-clear participants can now obtain reports showln1 the status of their tranNctlon four times a day startln1 on trade date and into the mornln1 of trade date plua one (T+l). ACE delivers more than Juat-trade confirmation: th aame matched trades can, If so deallJl&ted, enter the Nttlement proceasln1 without any additional Input. Furthermore, cont.,ct note, If needed, can be produced fram ACE directly, substantially reducln1 the costs of communication and reconcllement. ACE l only part of Euro-clear' sophisticated communications aervlce, which are in the process of beln1 shifted toward a realtime environment. 2) c11nat -.rat partlclpanta (a11ch u IDaUtutkmal IDveaton, or any tndba1 counterputliN wblcb an DOt broker/dealan) ahould, by 1992, be _._... of a tram caaaparlaon ayat.m wblch achieve poalUve .rnn.t1an of trade detalla Euro-clur' trade comparison system (ACE) I currently available only to participant of Euro-clear to confirm and match trade details with another Euro-clear or Cedel participant. However, lt could certainly be adapted to Include an affirmation service for Indirect market participant. If market demand develop. Custodian can confirm trades throu1h ACE and use their own cammunlcatlon 1yatema to relay tran1actlon information to their client on a tJmely baala.

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Euro-clear' 2. 3) :Each CDUDtry hould have an effective and fully developed central NClll'ltlea depository, orpnlaed and manased to encourap the broadeat poalbla Industry participation ( directly and Indirectly) 1D place by 1992. The Euro-clear System has performed the role of a central securities depositary for international securities since its founding ln 1968. Euro-clear provides centralized custody and book entry settlement for a wide ran1e of internationally traded fixed and floatin1 rate debt and money market lnatrwnenta, convertibles, warrants and equities. The System provides extensive custody-related services, lnclud1n1 safekeepin1, administration of coupon, dividend and redemption payments and corporate actions, exercise of warrants and other options and conversions and tax service. Securities are immobWzed in the Euro-clear depositary network, which includes major custodian banks, national clearing systems and central_ banks. The network ls mana1ed centrally by the Euro-clear Operations Centre 1n Brussels. Central mana1ement includes effectln1 and monltorin1 external receipts and deliveries of 1ecurltles. 4) Bach ooanb7 bould tudy Its market valumn and participation to determine whether a tram nett1n1 Ystam would be beneficial In tel'IIIS of raducln1 risk and pramot1n1 efficiency. If a nett1n1 ayatam would be appropriate, 1t should be lmp ...... nted by 1992. Euro-clear has already achieved a low risk and high efficiency environment with lb almultaneous delivery versua payment setUement method. The Euro-clear aetUement method has been designed to maxlmlze the number of trades that can be aettled on the basis of each participant' caab and aecuritles poalUons. Caah proceeds of a sale of securltle1 can be instantaneously recycled to pay for the purchase of other securities. In addition, simultaneous delivery versus payment ellminates many of the counterparty risks that nett1n1 Is Intended to control 1n other systems. Other 1ettlement methods have been studied 1n detail, lncludin1 varlou1 fonn1 of nettln1. These 1tudlea concluded that the present method ls the most effective for the type of businesses and markets supported by Euro-clear.

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Euro-clear 3. 5) Dallvery varsu payment (DVP) should be employed u the ... tbod far ..tt11n1 all NCUl'ltlas tranaactlons. A DVP system should be ID place by 1992. Euro-clear already provides t:he facility to settle, on a simultaneous DVP basis, transactions betwel"n two Euro-clear participants In any of 25 currencies. Once securities are delivered versus payment 1n Euro-clear, the settlement ls final and irrevocable. Euro-clear has also established DVP llnks with domestic markets such as Germany, France, the Netherlands, Spain, Sweden, Switzerland and Canada, reducln1 substantlally the risk Involved In cross-border settlement. 6) Papmata uac,clatad with the Nttlamant of aecurlU.s tranaactlona and the aerYiclDI al NCUrltle porUolloa ahould be made aonalatant aaroaa all ID.atrumanta and aarkets by adopt1n1 the ... day' funda can,,...tlaa. Settlement 1n the Euro-clear System ls accomplished by simultaneous exchan1e of ca1h and aecuritles. The settlement process not only provide the facWty to 1ettle on a simultaneous DVP basis, It also allows the cah proceeds of a sale of securities to be recycled lntantaneouly for the purchase of other securities. In addition, net proceeds from sales, Interest or dividends and redemption, can be withdrawn the 1ame day for four currencies (US Dollar, Canadian Dollar, Bal1tan Franc and ECU). The feaslbWty of provldlnl the same facWty for other currencies depend on the cah clearln1 deadlines In the relevant countrle1, the operational abWty of cash correspondents to meet tho deadline and the Jmpact of tbne zone differences. 7) A 'JlnlJtn1 S.W..nt' aytam hould be adopted by all market.. Pinal Nttlammt should occur OD T+3 b~ 1992. As an Interim tar1et, final ttlanmt aboald occur OD T+5 by 1990 at the Jataat, uve only where It blnden the acbla.-nt al T+3 by 1992. Euro-clear ls already technically capable of provldln1 settlement as early a T+l. Tran1actlon Instructions received by Euro-clear before 7:45 p.m. Brussels time on trade date can be ettled on T+l provided the settlement conditions are met. The1e conditions require that the trade be matched, the seller have sufficient securities and the buyer have 1ulficient funds ( or credit available) Euro-clear provide settlement facWtle1 with a ran1e of settlement periods, lncludJn1 instruments which 1ettle on T+2, such as German dame1tic curitles and Euro-commercial paper.

PAGE 19

Euro-clear 4. 8) Secarttte Jandln1 and borrowtn1 should be encourapd u a -tbod al. expad1tln1 the .w .... nt of aacurltle t:ranactlon. Exlat1n1 replatoey and taxation barrlera that lnblblt the practice or landlnc NCUl'IU. bould be NIDOV8d by 1990. Euro-clear introduced a securities lendln1 pro1ram in mld-1978; it was the first such facility made widely available in the international curlti market. Th preent curltles lendinl pro1ram is hJ1hly automated and Includes a broad ran1e of instruments. Dally avera1e loan volume of 12. 4 bWton 1n 1988 (with peaks of up to S 3 .1 bllllon) attests to the market demand for this service. The Euro-clear securities lendln1 pro1ram has enhanced market llquldlty and maximlzed usa1e of resources for borrowers and lenders alike, thereby supportln1 the recommendation to reduce exlat1n1 local barriers to securities lendln1 and borrowln1. 9) Bach CD11Db7 abould adopt the standard for aecurltlaa messap devalDped by U. lntarnattanal OrpnlptJon for Standarduatkm (ISO ~tanderd 7T15). In partlcular, C011Dtrlea should adopt the ISIN nlllllberlal for wurltle lllaue u defJned ID the ISO Standard 11U, at ..t for croaa border t:ranaactlau. The standards boalcl be appllad by 1992. Euro-clear la actively partlcipatln1 in these two ISO projects and supports further international standardization. Euro-clear la a member of the ISO Standard 7775 workln1 1roup which la responsible for establlshJn1 a standard format for securities maI Euro-clear wW also soon be one of two ISIN numberln1 a1ents for Eurobonda and ha a1reed to move to a common numberln1 sytem with Cedel by the end of 1989.

PAGE 20

CLIWlANCE AND SETTLEMENT IR GDJWff CIRCA 1989 BY IIABS-JOACHDI HOESSll.ICH AND HEINZ KLA~S ll.UETZEL DEUTSCHEll AUSLANDICASSERVEll.EIR, AG This contractor document was prepared for the OTA Background Paper, Trading Around the Clock: Global Securities Markets and Information Technology, July 1990, and OTA Report, Electronic Bulls and Bears: U.S. Securities Markets and Information Techno.!I., Sept. 1990. This doc\lDent does not necessarily reflect the analytical findings of OTA, its Advisory Panel, or its Technology Assessment Board.

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CLEARANCE AND SETTLEMENT IN GERMANY CURRENT STATE Wertpapiersannelbanken / Kassenvereine (Central Securities Depositories) From the customer's order to trading on the stock exchange Data processing Entering of transactions and subsequent handling Checking of business data by banks and brokers (Makler) Return route of the customer's order Settlement of stock exchange transactions The delivery list Survey of not yet settled securities transactions Administration of undelivered securities transactions Cash clearance and settlement of securities transactions Transfer of securities by means of security cheques Cross-border transfers of securities by means of book entries Safe custody and administration of securities Deutscher Auslandskassenverein AG -AKVTRENDS AND CHALLENGES Transfer of securities and settlement of stock exchange transactions -terminalisation and on-line-access Matching Same-day-settlement Primary-market..settlement Securities lending Deutsche Terminborse EXHmITs Exhibit 1: Timetable for the settlement of stock exchange transactions 2: Timetable for the transfer of securities by means of security cheques 3~ Timetable for the settlement of cross-border transfers of securities by means of book entriet 4: Collective safe custody -international links

PAGE 22

Wertpapiersannelbanken / Kassenvereine (Central Securities Depositories) The beginnings of the collective safe custody date as far back as 1882. The pattern for the book entry transfer of securities was borrowed frc~ the system of cashless payment transactions, in which payments are effected without physical use of bank notes and coins. At that time, the "Bank des Berliner Kassen-Vereins", as it was called, assumed the functions of a central securities depository in Berlin. The year 1949 then saw the foundation of new central securities depositories, one at every stock exchange place except Bremen, which were given the legal form of joint stock companies. The registered shareholders are banks that are domiciled in the area servised by the Kassenverein. Within the system of collective safe custody the individual certifi cates are no longer kept apart, under their respective owners' names, but are held collectively instead. The aggregate amount of all the securities of the one and same category such as, for instance, all the ordinary shares of the Volkswagen Werke held in custody by the Kassenvereine, constitutes what is known as the collective nolcing in that particular security. The moment an account-holder deposits securities in the collective holding of 9 Kassenverein, he (or his security-depositing customer) loses his former title to ownership of specific securities as was evidenced in the serial numbers of the items whilst at the same time acquiring a co-ownership fraction, perfectly e~uivalent in value, of the rele;ant collective holding, which is proportionate to his deposit and calculated on the basis of the total amount obtained once his items have been added. This type of collective safe custody is indeed the prerequisite that permits transfer of ownership from the seller to the buyer, by means of a simple book entry. The importance w,,ich the central securities depositories have acquired, is well illustrated by a few statistical data:

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-2-The number of categories of securities admitted to collective custOCj came to appro~. 18,300 at the end of 1987. -The number of securities transfers in 1987 came to~ total of some 6,842,000, of which around 3,620,000 = 53 per cent resulted from stock exchange transactions. -The cash equivalent reached some OM 1,277 billion. These are data for the Frankfurt region, and only one side, that of tne giver of the order or seller, has been taken into account. From the customer's order to trading on the stock exchange In Germany, the buying and selling of securities on behalf of a customer is done by banks. Hence, any customer wno wishes to buy or sell securities must give his order to the bank where he maintains an account. Unless he has given other instructions, his order will be carried out on the nearest stock exchange. Most orders are still transmitted by telephone or telex. The bank's dealer instructs a broker at the stock exchange -either oy calling out to him, or in wri!ing -to find a matching order to the one he has. A number of stock exchange participants are already availing themselves of the advantages of electronic data processing in order to transmit their customers' orders right up to their office rooms at the stack exchange; this route, however, still ends short of the broker's own desk. Within the framework of the presently developed BOSS program (stock exchange order service system) it will be possible, by making use of the central processor of the stock exchange, to transmit a stock exchange order which is in the EDP system, directly to the broker's desk, that is, onto his own terminal.

PAGE 24

-3-Data processing -Entering of transactions and subsequent handling As soon as a deal has been concluded, the relevant data are fed into the electronic data processor by means of a simple recording method, via terminal. It may be a transaction which a broker has arranged for between stock exchange participants; or it could be a transaction whicn was effected between banks as a "direct transaction". Transactions which are carried out through the intermediary of a broker are fed 1, by the broker, and "direct transactions" are fed in by the seller. Whatever the type, they are subsequently processed exactly the same way. The data fed into the computer are first subjected to manifold controls, which would immediately pick out any error to be corrected. The stock exchange program then immediately coordinates every sale wi~h the corresponding purchase. This way of bringing the business partners together follows the principle of optimization, i.e. it aims at producing as few deliveries as possible per bank involved. Both the buyer and the seller are given confirmations of the deals which have been carried out, in the form of contract notes. Business :s still going on at the stock exchange when the first contract notes are printed. Data processing adds certain information to data fed in by the broker, while at the same time carrying out all necessary calculations. A contract note thus comprises all the data which are requirea for the confirmation of a transaction and the further processing. Data processing also enables all stock exchange participants to call up information on the completed transactions, directly and immediately via terminals.

PAGE 25

-4Once the transactions have been recorded by computer, the banks ~a,, if they wish, receive all the data pertaining to the transactions and/or all the stock exchange prices, either on magnetic tapes or else directly through a computer-to-computer connection. They are therefore in a position to check, reconcile, and effect internal bookings at short notice with respect to those transactions, without the need for manual intervention. Checking of business data by banks and brokers (Makler) Both the buyer and the seller are reQuired to check whether their contract notes are correct and complete. Any error found has to ce reported either to the respective broker, or, in the case of a direc~ transaction, to the contracting party, at the latest wnen tne stocK exchange opens on the following business day. Faulty transactions are cancellea in the data processor, i.e. t~ey annulled, a procedure which also and automatically cancels all obligations to deliver in respect of those transactions. If no objections to the contents of a business confirmation are r3lsea within a fixed time limit, it will be considered to be correct anc to have been accepted by both partners as binding. The settlement ~rocess will then be initiated. Stock exchange transactions in Germany co not require confirmation between partners the so-called "Matching". At the end of each stock exchange business day, every broker receives a list of all his transactions, including all the cash settlements to oe effected between the broker and the banks.

PAGE 26

-5-Retum route of the cust0111er's order The customer receives a confirmation of execution of a stock exc~ange transaction, as well as of full and final payment, from the bank involved. As far as official trading or regulated unofficial dealings are concerned, the customer has a claim to exec~tion of his order; in other words, as soon as a quotat1on reaches er exceeds the customer's limit, his order must be executed. It follows that settlement for the customer may be effected as soon as the price is known. In most cases this will automatically take place via the bank's data processor. Settlwnt of stock exchange transactions One of the main practical effects of the German collective eustacy of securities is that transfers from one account-holder to another are effected by book entries. A stock exchange transaction can thence settled (that is, the securities are delivered to the buyer by t~e seller) by means of a simple transfer between accounts. Moreover. it is quite irrelevant whether the receiver has an account at the same central depository, or whether he is at another central depositor,. The system therefore offers a number of striking advantages: -no physical transfers of stock certificates, hence -no risk of loss through transport, very l\ttle time involved for banks in processing transactions, minimal transaction and handling fees, delivery of securities occurs only against simultaneous payment of cash equivalents, the system ensures a hign standard of safety for ~11 parties concerned. This method of settling transactions is facilitated by Article 24 of the German Securities Deposit Law, which states that the buyer of securities must accept a credit of securities in collective safe custody as good delivery.

PAGE 27

-6-The fact tnat all tne German central securities ae00s1tor1es ~a1~ta1n accounts with one anatner en10les paperless transfers of securit.es a~a the perta1n1ng cash clearing ta be carried out in due time, even ~f purchasing and the selling banks are located at different stack exchange places, thus being accaunt-nalders at aifferent central dep0s1t0r1es. All 1nf0rm1ti0n related ta security transactions is camouter-stored so that 1t can be used any time, at a later date, far settlement and accounting purposes, via I central securities depository. The delivery list -Survey of not yet settled securities transactions The computer centre compiles an every stack excnange 0us1ness day a so-called delivery list, 1.1. a 11st of open stock exchange t~ans actians caff1rinat10ns), in which every stack excnange particl~a~t finds I detailed account of the tr1nsact10ns separated accora.~g purchases end sales handled but still unsettled. Tne lists enaole :~e selling banks ta ascertain which of the orders tney still Mave to fulfil within the fixed settlement period (in Germany tnis 11 tNO full bank working days). With the delivery list at hand, the seller 1110 gives h1s orders far 11ttllfflent of hi1 tr1n11ction1. To that end he will either nana 1n nis list 1t the central 11curitie1 dep011t0ry he belongs ta, or else cannunicate the tran11ct1on1 that have been released to tne central processor of the central 1ecurit1e1 depositary an magnetic t3ces or over the terminal. Moreover, orders which I selling bank 11 not able ta fulfil through the booktransfer system, an settlement day, because, for instance, the 1ecur1tie1 are not yet 1v11l1bl1 an the seller's deposit account, are marked out and deferred 11 to th11r delivery.

PAGE 28

-7With the transaction numoer and the security coae numoer (ldent:f: c1t1on number) nav1ng been recorded, it 1s possible to call uc :ne original business particulars tnat were fed 1n on a given trace date :n order to reconstitute the transaction for settlement purposes. Orders for delivery which could not be executed are carried along as suspense items in the central processor for the depository involved -and conse~uently, also on the lists of open items that will follow for as long as the reasons for which they have been held back have net ceased to be. When transactions are released for execution, the first step that follows 11 to check the disposal side and make sure there is suffic:~r.t securities coverage available on the seller's deposit account or co~:rg 1n with other business deals. The Securities Deposit Law aces not allow a central securities aepos1tory to grant credit facilities 1n the form ct securities. If coverage 11 inadeQuate, the deals will not be settled but will automaticall1 :e carried forward on the lists of open items, that is, the dellvery lists. All other transactions are settled in that they are simultaneously entered into the deposit accounts of tne buyer and the seller, ~1:h :ne respective adjustments of the balances Adlliniatration of undelivered 1ecuritie1 transactions D1t1 proce11ing 11 also used to effect all administrative oper!t1cns 3t given reference dates for securities transactions which have not yet been st ~led in line with the holdings maintained at the central 11curit111 d1po11tori11. So it i1 that interest and dividends are automatically settled between the selling and purchasing banks whenever deals which were still tradea cum coupon could not be delivered until after the record date, that 1s, coupon. r

PAGE 29

-8When subscription rights or fractional rights are establisnec, :nese additional deliveries are entered on the lists of transactions tcge~~e~ with the original transactions. In the same way, any other measure which affects the holdings, such as the conversion of new snares to aid, is automatically carried out by data processing, as at the relevant reference date. Data processing ensures that, when transactions are executed, they retain all the rights pertaining to them. The former manual supervision and handling of administrative operations as at the relevant reference dates, which was most time-consuming and prone ta many errors, has been replaced by a fully automated service. Cash clearance and settl81Nnt of securities transactions At the same time as it delivers securities in execution t>f a transaction, the central securities depositary effects the correspondirg cash clearance, thus ensurir1g a securities-against-cash mode of settle ment. On settlement day, the net balances of the countervalues of 31: the transactions, as determined for each account-holder of a central securities depository, are settled directly througn the cash accounts which the banks involved maintain with the Landeszentralbank (regior.al main office of the Deutsche Bundesbank -German Federal Bank). To facilitate the di1position for the account-holders of both cash ana securities, they receive in the morning of the settlement day itemizea documentation in the form of a so-called "settlement list" which sno\,s every item that has been booked. After the cauntervalues have been entered on the books of the relevant Landeszentralbanken, the central securities dep0s1t0r1e1 hand out th! computer-printed daily statements of account to their. account-holders, in the early afternoon of the settlement day; these daily statements reflect all the movements having taken placa on the collective deposit 1ccount1. At the same time, they evidence the passing, from the seller to the buyer, of the co-ownership rights to those securities.

PAGE 30

-9-Delivery against payment has proved its value over many long years, arc never given rise to any risks in respect of the settlement of deals. Transfer of securities by ans of security cheques Apart from the settlement of stock exchange transactions on the basis of the delivery lists, the central securities depositories' account holders can also draw an their deposit accounts by means of security cheques. Any bank which maintains an account with a central securities depositary may be designated as the recipient. This type of order placing also permits clearance of the cash equivalent. It has not been considered necessary so far to provide for a matcnl~g procedure far the settlement of security cheques that entail payments, in other wards, ta obtain the consent of the beneficiary prior to completion of the security transfer. However, on cash-clearing day (X-day + 1) the beneficiary is entitled to refuse acceptance of the delivery. In such a case, the central securities depository immeaiately cancels the book entries of both the securities and the cash equivalent, so that the transaction is annulled with correct value cay, on the said X-day + 1. It is necessary, however, to enhance the efficiency of the proceaure cy making still greater use of electronic data processing and having the central depositories' account-holders install terminals at their end. The project is now under work.

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-10-Cross-border transfers of securities by means of book entries Since the amendment of the Securities Deposit Law in the year 1986, German central securities depositories have been alloweo to maintain direct account-relationships with foreign securities depositories a~d to have certain eligible securities held in safe custody at those institutions. A prerequisite, however, is that under the legal regulations in those countries protection of the investor's co-ownership status is also guaranteed. At present, it is possible to hold foreign securities in collective safe custody in their countries of origin, through FKV, with the following institutions: Nederlands Cen~raal Instituut voor Giraal Effectenverkeer 8.V. (NECIGEF), Amsterdam Oesterreichische Kontrollbank (OEKB), Vienna Societe Interprofessionelle pour la Compensation des Valeurs Mobilieres (SICOVAM), Paris These institutions act as third-party custodians in respect of securities which are deposited with FKV and thus continue to const1:~:e good delivery in Germany. Conversely, FKV may keep German securities in collective safe custody in Frankfurt, on behalf of foreign securities depositories. Foreign institutions may not become direct account-holders with a Kassenvere1n in Germa~y. They can, however, gain access to the German system of collective safe custody through the intermediary of Deutscher Auslands kassenverein AG (AKV). In order to achieve this, AKV maintains accounts with FKV, thus making it possible for German securities to be kept in safe custody in Germany on behalf of its foreign account-holcers. At present, this is the case for the following institutions: Centrale de Livraison de Valeurs Mobilieres (CEOEL), Luxembourg, Euro-clear, Brussels, Caisse Interprofessionelle de OepOts et de Virements de Titres (CIK), Brussels, Japan Securities Clearing Corporation (JSCC), Tokyo.

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-11-Safe custody and administration of securities The depositors of securities expect of the central securities deoos1t:r~es that all accrued interest and dividends, as well as capital repayments. ce collected punctually at the main paying agents, and be credited to the relevant account-holders' accounts at value date, in proportion to their individual holdings. On the main interest dates, up to 2,600 different categories of bonds are handled, and in 1987, in Frankfurt alone. around 60 million coupons ,-,ere processed. Apart from the collection and distribution of cash proceeds, a consicerable amount of labour and administrative expenditure is aue to decisions taken by the issuers, requiring changes in and adjustments to the holdings: new shares have to be placed on par \llth the old. capital increases entail the opening of subscription or fractional rights accounts, and fixed-interest-bearing securities have to ce split into series or groups when redemption begins. A program-package, "KADI -Kapitaldienste", offers, in every field of work, a very high standard of automation, thereby enabling the central securities depositories to concentrate their st6ff fully on t~e con:~ol and security tasks required by their wide range of activit1es. The basis of all these administrative operations is providec by a securi ties information system that is comprehensive, perfectly up-to-date, and which offers immediate evaluation facilities. The programs ano the data banks required to support the system are furnished by the new programpackage "WSS ~ertpapier-.ervice-_ystem" (Securities Information System). It enables users to query up to 700 different basic cata anc reference dates per type of security on EDP-terminal; all these particu lars are mainly supplied and up-dated by the WM Wertpapier-Mitteilungen (Securities Inf ormat1on Gazette) \,ho, for their part, obtain them fro., the ba~ks, central securities depositories. and stock exchanges. In its data banks, the WSS-system also provides the quoted prices of all securities and currencies traded on German exchanges. plus a great number of.quotations of foreign listed securities. All in all. there are around 45,000 different quotations displayed each day.

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-12-Deutscher Auslandskassenverein AG -AKV Foreign securities which are admitted to official trading or to t~e regulated market on German stock exchanges must be held in custody arc be good delivery in Germany. Securities which are exclusively held in custody abroad are traded in the so-called "unregulated market" seg~ent of the stock exchanges, or over the phone from bank to bank. In the past, this type of business was time-consuming and subJect to much uncertainty, all of which represented great drawbacks. At the suggestion of banks which were actively engaged in the international securities business, the German central securities depositories founded the Deutscher Auslandskassenverein AG -AKV -on July 17, 1970. Its involvement in settling securities transactions is briefly described hereunder: 1. Transfer of security-rights by book entries -AKV maintains deposit accounts abroad, with one depository -and :re only per country concerned. The securities which the German accourt holders have had transferred in favour of AKV are held there 1n c~stc:; on said accounts. In return, the account-holders are creaitea on ~KV's clients' accounts, thereby acQuiring a claim to aelivery of the secw~~ties held, on their behalf, in custody abroad. Contrary to the co ownership participation arising from the collective safe eustacy ~aintained by FKV abroad, AKV's involvement creates contractual claim to delivery only. However, since this type of custody is legally structured as a trustee business, it is ensured that, here too, the depositors' holdings are fully secured against losses. When account-holders of AKV trade securities which are held abroaa. among themselves, the deals can be implemented as rapidly and eas1l1 as any stock exchange transaction in domestic securities. The transijcti:rs are fed into the stock exchange's computer. which prints the relevant confirmations for both the buyer and the seller, and processes the cata required for settlement. Since the securities are transferred from the seller to the buyer solely by book entries on the deposit accounts maintained at AKV, settlement involving delivery against simultJneous cash-clearing is guaranteed.

PAGE 34

-13-With this accounting system, AKV saves its customers much ti~e arc effort-consuming pnysical movements of securities, transfers of deposited holdings, and re-registration of snare certificates aor=ac. By the end of 1987 some 11,500 foreign categories of securities from 23 different countries had been admitted to AKV's system of security-rights transfers by book entries. 2. Nomineeship for the introduction of foreign registered snares to official trading on the German stock exchanges For various reasons of a legal or practical nature, the registerea shares of foreign companies cannot be admitted in their original =~r~ to official trading on the German stock exchanges. According to tne German stock exchange regulations, English registered shares, for instance, do not meet requirements to qualify as securities: Japanese securities, on the other hand, do qualify as securities, but they a~0 printed in characters and in a language which are not familiar tows. It is AKV's task to hold the original certificates in safe custccy :~ the country of issue, under its own name, and to issue a glooal oearer certificate (in short: GBC) for this cover holding. The GBC is tnen deposited -as a share certificate with one of the German central depositories, and a collective holding of securities that are gooc delivery in Germany is thus provided Hence, one of the main requirements for admission to official tracing on the stock exchanges is fulfilled, and the foreign securities can ce processed and settled within the collective safe custody system for securities transactions by book entries in exactly the same ~ay as the domestic ones. As of the end of 1987, AKV had contributed as nominee to the admission of 146 foreign r,gistered shares, from eleven different countries. to official trading ~n German stock exchanges.

PAGE 35

-14-3. Participating in cross-border transfers of securities by means of book entries The ever-increasing importance of cross-border trading made it imperative to look for adeQuate ways of developing the "delivery ve~sus payment" procedure into a safe and rational instrument. Two institutions, CEOEL in Luxembourg, and Euro-clear in Brussels, who have specialised in settling international securities transactions, offered their services in this context. AKV was one of the founders of the "Centrale de Livraison de Valeurs Mobilidres S.A." (CEDEL) in Luxembourg, and it acts as a depository for German securities on behalf of both the aforementioned clearing houses. However, since it does not indulge in safe custody itself, it maintains an account with Frankfurter Kassenverein AG and is thus in a position to have the German securities of foreign account-holders held and administered witn1r. the German system of collective safe custody. This relationship offers the German banks who are engaged in cross border trading the great advantage of enabling them to deliver securities abroad directly to the debit of their collective safe deposit accounts with the central securities depositories. Conversely, in the case of crossborder purchases, the items are directly creditec to their collective safe deposit accounts. When items are delivered, or received, the OM-countervalue is simultaneously accounted for At the end of 1987, around 1,750 bonds and some 350 categories of shares and mutual fund units were held on behalf of AKV within tne German system of collective safe custody, through FKV as intermeciary.

PAGE 36

-15-TRENDS AND CHALLENGES By introducing automation in the field of collective safe custody transfers for securities, of settlement of stock exchange transactions, and of administration of securities, an instrument was created that has proved highly efficient over the years. In the turbulent phase the stock exchange went through in October 1987, it was automation that made it possible to settle the huge quantity of business transactions safely, free from disturbances, and within the set time-limits. All around the financial institutions, and especially in the securities business, changes have taken place faster and more drastically in the last few years than in the past decades. Greater changes still are looming ahead in the 1990's. There is a worldwide trend towards international diversification of securities investments, which is gaining ever-greater importan~e. Following the liberalisation of the capital markets, international business connections and networks are being systematically extended. A development such as this demands a worldwide communication and information structure, offering well harmonised and mutually coordinated settlement facilities. The demands which this makes on the settlement of business transactions do not allow us here in Germany, to be content with ~hat we have achieved so far. Just as securities trading and market conditions undergo permanent changes, so must automation in the securities business continue to develop through innovation. An up-to-date, efficient and functional system of data processing, well adapted to the needs of the securities industry, will also be of decisive importance for the future development and competitiveness of Germany as a financial market place.

PAGE 37

-16-Hence, in December 1987, the.Arbeitsgemeinschaft deutscher Kassen vereine (association of all German central securities depositories) agreed to have a future-oriented system of data"processing developed for their use. Frankfurter Kassenverein and its DP-organisation were entrusted with the conceptional design. The current settlement practice of the central securities depositories is that securities transfers are executed on the bank working day that follows the placing of the order. Financial institutions are now asking for additional means of settlement which, quite apart from the question of the individual fields of application, should mainly comprise the following functions: 1. A settlement system with short through-put times, that is, securities transfers and cash accounting takes place the very day the order is placed with the central securities depository. 2. A settlement system with long through-put times, that is, execution of securities transfers at a predetermined later value date. Between the time the order is recorded and the time it is executed, it should be possible for the beneficiary to examine and reconcile the positions. 3. Early information with regard to movements of securities, that is, calling up movements of securities on a terminal at any time during the whole of the working day, matching, and disposition processing of securities transfers against payment, prior to their being booked, immediate transmission of advised receipts of securities. The additional settlement systems would enable account-holders to include transactions in the delivery against payment process, which, at present, have to ba settled separately. At the same time, they could reduce the settlement risk as well as the potential for loss of interest. The different fields of application are:

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-17-Transfer of securities and settle11ent of stock exchange transactions ter11inalisation and on-line-access -It is necessary to improve on the use of electronic data processing for the input of and inquiry for information related to securities through terminalisation. On-line access should go hand in hand with extended deadlines for the acceptance of orders from participants of the central securities depositories. Mandatory particulars to be provided wit~ each order should be sufficient to meet international requirements and standards. The execution time must be shortened; i.a. through new methods of disposition processing, to facilitate the chaining of transactions. In all this, it will be essential to provide the international clearing organisations and national central securities depositories with the respective data transmission interfaces on the basis of the ISO standards and the existing or planned networks. Matching At present, when securities transfers against payment are carried out by means of security cheques, it can happen that the transferee refuses to accept the securities. This is in particular the case when foreign institutions are involved as beneficiaries and their instructions have not yet reached the recipient of the delivery. It is necessary to develop a technical procedure which by and large prevents such refusals and eliminates the present delays, potential for loss of interest, and the settlement risks. The solution to the problem is seen in the matching of securities transfers via terminals.

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-18Sw-day-settlement At present, when banks enter into transactions with value trade date, that is, when execution should be an the same day, these bargains cannot be settled in time through the central securities depositories. t The same often applies in the case of transactions originated by foreign banks and executed through the int~rmediary of a business partner and depository bank located in Germany, 1.e. the execution of orders with same day value creates problems and potential for loss of interest. Settlement of securities transfers on the day the order is given the so-called same-day-settlement -must therefore be made possible. ~iaary-urket-settlSlleflt The lead manager of new issues presently makes use of the collective safe custody system for security transfers only once deliveries can be effected by means of security cheques. Cash settlement sometimes takes place outside the system and is thus separated from thedelivery of the securities. This involves settlement risks and creates potential for loss of interest. Transferees who are located in foreign countries and who settle their business through CEDEL or Euro-clear often cause refusals of accept ance, because they have either failed to give the necessary instructions to their clearing houses or else they have given intructions that do not correspond. This results in delays and potential f~r loss of interest. The lead manager must be given the possibility to enter his delivery instructions into the system at an early stage, providing for a later settlement date.

PAGE 40

-19-Such a solution would enable the beneficiaries to be advised 1n good time of the day on which the respective deliveries are to be made. They would thus be able to give instructions regarding further delivery of the securities on the same reference day (same-day-turn-around). Sea,rities lending It often happens that the seller of securities, who he is depending on the receipt of securities from other counter parties, 1s not able to deliver such securities in time. This applies to transactions with normal settlement periods (two days), and especially so to transactions with shorter settlement periods for delivery against payment. Delays in delivery mean loss of interest. By enabling a seller to borrow securities, it would be possible to settle transactions within the agreed time-period. The lending of securities is not yet possible in Germany. However, the banks and their associations are endeavouring to establish the necessary legal and organisational framework. Once the regulations are there, they will enable the market to create the data processing system required to deal with offers, inquiries, provisions of safety, fees, etc. The activities of the Deutsche Tarminborse, which is now being set up, will have to be taken into account while creating the new settlement system of the central securities depositories.

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Extub1t 1 Tilletable for the 1ettlaent of stock exchange transactions Da X X + 1 X + 2 Time 11 30 -13 30 11.00 15.00 12.00 15.30 15.30 7.30 Ooerations Business hours of the Stock Exc~an;e Stock exchange transactions and over-~~! counter deals are recoraed in tne comouter Trade confirmations in the form of con:rac: notes are computed and issuea in 0r1nte~ ~or'!I or for display on terminals Delivery of data-carrying tapes. or aata transm1ss1on (data files) from comouter to computer The delivery lists. containing all transact ions which are still open. are nanaea o~: until about 14.00 The selling banks give their orcers tc :~e central securities ae0os1tory on :ne 0as1s c! the delivery lists in the evening Disposition processing of security :ellvtrles and provisional booking on ae0os1t acc=~~t 7.30 12 .00 14.00 Transmission of data between the cent:ai secur1tie1 aepos1tories The Httlement lists containing al: tne trans actions and movements of s1cur1t1e1. 1nclua1ng particulars on the cash amounts to be clearea. are handed out Cash cl1ar1ng v11 the accounts of the banks at the L1nde1z1ntr1lbank Once the cash entr111 have been comoletea ... ... the central 11cur1ti11 depository nanas out the d11l y statements of account ana .. 1 tn th11; the change of awn1r1h1p 11 ef!ectea.

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Exhibit 2 Tilletable for the transfer of securities by means of security cheques Frankfurt H8111burg Day X X 1 Time UD to 1 l.00 up to 16.00 in the evening, in Frankfun: in the evening, in Hamburg 7.30 approx. 12.00 up to 12.00 approx. 14. 00 Operations Bank FFM gives tne oraer to Frankfurter Kassenverein by means of a security cne~~e or by data carrier, terminal, or from c:>::,:~ter to computer disposition processing of the securltles and provisional booking to the debit of Bank FFM transmission of data between tne central securities depositories provisional booking of the securities to the credit of Bank HBG The settlement 11st of all the regulatec transactions and movements of securitles are handed out to Bank FFM 1n Frankfurt. and Bank HBG 1n Hamburg Cash clearance via the ac~~unts of t~e Landeszentralbanken in Frankfurt= credit entry for Ba~k Hamcurg = aeoit entry for Bank MSG Following a centralized cash clearance operation, the central securities cecosi:orles settle t~~ir cash balances by means of telegraphic transfers Once Hamburg's cash account has been ceoited ... the central securities aepositorles ln Frankfurt ana Hamburg nana out t~e ca1:1 statements of the deposit accounts. anc .-,1:r, this. the change of ownership of tne secur1t1es 1s effected.

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Exhibit J T:iJletable for the settlent of cross-border transfers of securities by ans of book entries Day X X + 1 up to 10.00 up to 11.00 up to 16.00 up to 17.00 X + 2 up to 12.00 approx. 14.00 Operations Transaction concluded by phone Bank S, Vienna, is the seller, Bank P, London, is the purchaser, and set::es through CEOEL Confirmation of business by telex or similar Bank S instructs OEKB in Vienna to deliver t~e securities against payment OEKB, Vienna, provisionally makes the securities available and blocks them to the debit of Bank S OEKB passes on the delivery order by telefax to FKV Bank P, London, informs CEDEL of the conclusion of the deal and confirms accectance of delivery from Bank S against payment CEOEL transmits the business data to AKV/FKV who then match the data CEOEL is notified that the delivery. t~at 1s the matching, is correct CEOEL thereupon credits the secur1~ies :c Bank P and debits the casn eauivalent :n D~. value X 2 OEKB, Vienna, definitively debits the deocs1t account of Bank P with the securities FKV credits the securities to the accounts it operates for AKV/CEOEL and OEKB, thereoy crediting AKV/CEOEL and aebiting OEKB FKV enters the OM eQuivalent of OM 1,250,000.--to tne aeb1t of t~e LZB-account of the bank where CEOEL maintains a OM-cash account in Ger~any At the same time, FKV credits the eauivalent to the LZB-account of the bank with hnicn OEKB. Vienna, or its customer maintains a OM-cash account in Germany The change of ownership of the securities 1s effected.

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Accaunt holder OEKB VIENNA SICOVAM PARIS NECIGEF AMSTERDAM Collective Safe Custody International Links uintained by FKV / AKV FKV H AKV H FRANKFURT ,r-, .. GERMAN KASSENVEAEINE CENTRAL SECURITIES DEPOSIT~IES 1 I I I Banks in Germany Exhibit 4 Account holder CEDEL LUXEMBOURG EURO CLEAR BRUSSELS JSCC TOKYO CIK BRUSSELS

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ICCB: THE INDEPENDENT UNIFIED CLEAllING HOUSE UNDATED, CIRCA 1989 BY INTEIRATIONAL COMMODITIES CLEAllING HOUSE, LTD. 'Ibis contractor document was prepared for the OTA Background Paper, Trading Around the Clock: Global Securities Markets and Information Teclmology, July 1990, and OTA Report, Electronic Bulla and Bears: U.S. Securities Marketa and Information Techno !2n, Sept. 1990. This document does not necessarily reflect the analytical findings of OTA, its Advisory Panel, or its Technology Assessment Board.

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ICCH; THE INDEPENDENT UNIFIED CLEARING HOUSE The Brady Conmission's recommendations are sound. In periods of rapid market fluctuations, mi 11 ions -indeed bi 11 ions of dollars must move quickly, sometimes within minutes, to meet margin demands. A unified clearing system would facilitate that movement and greatly simplify the monitoring of market participants .. The technology for a unified clearing house exists. In fact, the International Conmodities Clearing House in London acts as a clearing house for exchanges located around the world".<1> ICCH enjoys a unique position in derivative markets clearing. Since its incorporation in 1888 (as the London Produce Clearing House) ICCH has been the principal source of clearing services to most of the London derivative markets<2> while developing a significant and still expanding role in markets worldwide.<3> Unlike many clearing.corporations in other centres such as Chicago which operate on a mutual basis, ICCH is an independent clearing house owned by its shareholder banks<4> which provides for its London members a comprehensive service including registration, clearing and settlement of contracts, central banking and treasury, th~ management of physical deliveries and risk management. Unified Clearing Both the Brady report<5> and the Working Party Report<6> highlighted the fundamental importance of efficient clearing in the financial marketplace. Brady threw into particular relief the issue of the desirability of unified vertical clearing procedures (i.e. joint clearing arrangements for the derivative and underlying markets). "What is needed is unified clearing with stock, stock index futures and stock options all cleared through a single mechanism11<1>. Although in London we cannot boast of such an idealised system, our position as a horizontally unified clearing house across derivative markets combined with our recently redrawn regulations and procedures and our risk management strategies does provide tangible benefits to our members and to the markets themselves. e.g. 1. The diversity of market clearing functions means lower overall risk and enhanced risk management through highly accurate assessments of intermarket exposure. 2. The central overview created by multi-market clearing has allowed ICCH to develop as a centre of excellence for risk management research and development. 3. Our independent status enables maximum attention to be paid to the paramount objective of market security. 4. The lack of a mutual guarantee reduces the costs and liabilities of members in the event of a member default.

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-2 -5. Cover in the form of e.g. one bank guarantee can be used for liabilities across multiple markets. 6. Single settlement payments for multiple markets reduces back office costs. 7. Single clearing and accounting systems reduce back office costs. Since April 29th 1988 the London Clearing operations of ICCH have enjoyed the status of being a 'recoGnised clearing house' under the provisions of the 1986 Financial Services Act. This statute was the outcome of a fairly tortuous legislative process which was instigated in the early 1980's by the commissioning of a review of the then existing law on investor protection and other related issues. The terms of reference were:-(1) To consider the statutory protection now required of (a) private and (b) business investors in securities and other property including, investors through unit trusts and open ended investment companies operating in the United Kingdom. (2) To consider the need for statutory control of dealers in securities, investment consultants and investment managers. (3) To advise on the need for new legislation. Several reports and a government White Paper were to follow in the next few years which culminated to the Financial Services Act. This act has created a hierarchical regulatory structure headed by the Secretary of State for Trade and Industry, whose powers to authorise and regulate investment business granted to him under the Act could be, and have since been, delegated to the Securities and Investments Board, a private sector agency, which is in turn empowered to recognise self-regulating organisations, investment exchanges and clearing houses. Under S.39 of the Act the SIB may recognise a clearing house if it has:-(1) sufficient financial resources (2) adequate monitoring and compliance arrangements (3) can provide investment exchanges with clearing services required for their recognition (4) will maintain high standards of integrity and fair dealing (5) will co-operate in the sharing of information with the Secretary of State and other relevant regulatory agencies<9>. As part of the process of application for recognition to the SIB under the Act ICCH undertook a radical overhaul of its general regulations and procedures. One of the issues which was of particular concern was the legal status and capacity of the clearing house. In contrast to the legal regime in the USA, in the UK clearing houses do not enjoy any particular status under existing insolvency law. There is however a bill currently going through Parliament which aims to do exactly th1s<10>.

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-3 -Legislation in this area is to be welcomed as one manifestation of a global movement towards removing the legal and other obstacles to effective netting and clearing systems development. f the issue is legal and volume and other considerations indicate that some form of netting should be employed, then the laws must be changed to permit a netting system"<11>. However in the absence of such statutory protection, contractual strategies have been employed to deal with the problems raised by member default and insolvency. In the new regulations<12> and in the agreement signed by clearing members the clearing house's status on trades is stated clearly to be that of principal to the contract. This issue of capacity is important because under existing insolvenc~ legislation a right of set-off is contingent on mutuality of dealings< >. This means that the clearing house must be contractually a party to a trade if it wishes to exercise a right of set-off in the case of an insolvent member. Furthermore, the provision of principal status provides enhanced security for the individual member and ultimately for the markets themselves by means of the elimination of counterparty risk concomitant with such a provision. The means by which ICCH becomes party to the trade is the process of novation. Regulation 3:-upon registration of a market contract by the Clearing House, such contract shall be replaced by novation (without prejudice to the Clearing House's rights to effect further novation under paragraph (b) below) by two open contracts, one between the seller and the Clearing House as buyer as principals to such contract, and one between the buyer and the Clearing House as se 11 er, as principals to such contract." In addition to this clarified status ICCH has greatly strengthened the financial safety net provided by the shareholder banks by the introduction of discrete backing of ISOM provided by the shareholder banks and the insurance market. One of the cornerstones of the new regime of investor protection under the FSA is the requirement placed on brokers to segregate their clients' money into client bank accounts which are held on trust for the client<14>. At clearing house/exchange level, however, the law requires the members' money paid to the clearing house/exchange to be dealt with according to its own regulations<15>_ ICCH under its new regulations and procedures has provided for members to use up to four different types of sub-account, including a segregated client account which is margined separately. The sub accounts are:-1. Segregated client margined separately 2. House

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-4 -3. Non segregated client (under UK law business clients may choose to opt out of segregation) 4. Non clearing members/locals ) ) ) ) ) All margined under the 'house' cover account ICCH currently offers three al+ernative methods of settlement viz:-1. Settlement to market 2. Mark to market 3. Settlement.by request On completion of the settlement process members will be called daily for cover through the protected payments system and any profits will be payable on request. 1. settlement to market The process take place after the close of trading and after confinnation and registration as follows. (i) for each delivery month the brought forward net position in tenns of lots and value is added to the business of the day. (ii) for every sold or bought open contract an opposite settlement contract priced at the official quotation is effected and registered. (iii) the aggregated contract values of these settlement contracts are then added to the aggregated total of the contract values of the existing open positions. (iv) the total lots and values of the gross bought and sold positions are netted out. The settlement amount is therefore arrived at. (v) The net position is then registered in the form of open contracts at the official quotation price. The settling of such open contracts with settlement contracts (subject to accounting for price differences) constitutes a complete discharge of all obligations owed on these contracts. 2. Mark to Market The mark to market process differs from settlement to market only in the fact that the gross open position is carried forward at the previous evening's closing settlement/quotation price. 3. settlement by Request A contract may remain open at the original traded price and contract date until the final trading day of the month, when each member is obliged to make net delivery as a seller or take net delivery as a buyer. However if at any time prior to maturity a Member has a balanced position he may request in writing from ICCH a liquidation of those contracts and

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-5 -a final settlement will be generated by ICCH'16>. Debit balances are placed to the debit of the Member's account, and in the event of a Member having insufficient cash cover inmediate cash payments will be requested. (This system only applies to the house sub account) Margining at ICCH is carried out on a net basis. Gross margining systems as practised by the CME and NVMEX are seen to be undes i rab 1 e for the following reasons:-(!) They add administrative costs as major concessions have to be claimed for spreads etc. (2) They do not mean enhanced client protection since SIB rules require proper segregation of funds by brokers in their own books. (3) They result in cash flow problems for members. (4) They do not provide any greater security to the clearing house whose margining procedures reflect only the net position of members without liability to clients. Net margining ensures that the margin held is directly proportional to the risk inherent in a member's position. ICCH does not monitor its members' relationships with non clearing exchange members or c 11 ents but does work c 1 ose 1 y with the exchanges and appropriate regulatory authorities to ensure the viability of its members. Variation margin represents the reactualisation of a market position up to the current quoted closing prices, and the settlement of any positive or negative cash flow generated. This efficiently limits position risk up to a given moment in time. During periods of extreme volatility, ICCH will call for variation margin to be paid during the day within an hour of a call being issued. Debits and credits arising from the settlement to market process are posted daily to members' accounts. If there is any shortfall a call to his bank will be made by 7.00 a.m. The majnr exception to the daily settlement process is the London Metal Exchange which cannot be settled before the prompt date. However each open contract is compared with that day's closing price and a contingent variation margin is calculated. If this is a credit (e.g. current market prices are above that when the contract was bought), this may be used to offset contingent debits. Net debits must be covered in the same way as initial margins. These procedures are also applied to contracts on other exchanges that are to be fulfilled by physical tender. Initial margin is designed to provide the clearing house with a security pre payment of future potential losses. This should allow the Clearing House to close out a position (in the case of a default) without sustaining uncovered trading losses, even if the Market is moving against the position whilst it is being closed. Initial margin rates are set with pri~ary reference to daily price

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-6 -moves and are usually set to cover 90-98S of observations. Reference is also made to other market data e.g. spread of open interest and implied volatility. Rates are set to cover outright positions. Separate rates for spreads (straddles) are determined in the same way. ICCH also has the power to call extra initial margin for a whole market or in individual cases where the view is taken that positions are substantial in relation to the financial standing of the firm concerned, or to impose other conditions such as the lodgement of a buffer amount in addition to normal cover. Increased in1tial margin payments are frequently imposed just before delivery partly to offset the risk and partly to alart members to impending delivery. Another aspect of the system is that since 1985 ICCH has been providing futures style margining for options. Rates are set with reference to the underlying instrument taking account of offsetting risks. Buyers of options are assessed for initial margins. Cover for margin is provided in cash in sterling or in certain other currencies. The payments are debited directly to members' accounts at designated banks in the City of London. Alternatively members may put up cover in the form of UK Treasury Bills or a bank guarantee. ICCH is currently exploring the feasibility of widening the choice of cover to incl~ue, inter alia, UK Gilts and UST Bills although there remain some legal issues involved in such an extension which are under consideration both in the context of existing law and in the liaht of the provisions of the Companies Bill currently going through parliament<1n. Settlement and margining procedures form an integral part of risk management. ICCH has developed a highly sophisticated system of risk management covering counterparty risk, market risk, compliance and quality control. Market risk is the most technical area of risk management which is subjected to a multi-factoral analysis of market conditions, liquidity, positions and deliveries. ICCH maintains comprehensive statistical information that enables the monitoring of historical volatilities, implied volatilities, seasonal price moves and correlations between delivery months or different contracts. The margining system is used to produce basic measurements of risk and it is important that the system allows parameters to be adjusted eUher for all members or selectively by member depending on prevailing market conditions. A close watch 1s also kept on the futures basis, in particular as delivery periods approach. As counterparty to all open contracts ICCH has the obligation of administering positions and on occasion (in case of default) liquidating those positions in the market. The current 1 iquidity of a futures contract or option series influences ICCH in two ways. Firstly, it will dictate the time necessary to close out a defaulting position, hence the amount of time to be covered by the initial margin. Secondly, the liquidity of a contract will influence the potential of a particular member to be squeezed or cornered and therefore can create extraordinary market conditions.

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-7 -The most important aspect of risk management is the ability to assess instantly, without calculation which positions may have the most risk and to known intuitively where that risk lies. For example, by the use of the derivative indicators of options pricing models one can reduce complicated futures and option positions to simple terms. This, together with continual monitoring of members' financial resources allows the Clearing House to know, almost instantly where risk may be given certain types of market evaluation. Where futures contracts are settled by normal physical delivery the risks involved are no longer marginal risks, but represent fully deliverable value. ICCH therefore manages the risk of delivery against payment and in addition the quality of the delivered product is controlled. Compliance is a crucial part of our risk management strategy encompassing the fulfilment and monitoring of outside regulator~ requirements such as those specified by the Securities and Investments Board< a, and the checking of members' compliance to regulatory standards. Apart from physical quality control of delivery products ICCH views the control and checking of all internal processed and external contracts as an important aspect of risk management. One of the main aspects of counterparty risk management is the system employed by a clearing house for vetting its clearing members. Membership is open to companies and partnerships who can fulfil certain criteria concerning financial integrity and policy, net worth and Exchange and SRO membership (if relevant). Other criteria include management reputation, parentage, type of business and administrative efficiency. All clearing corporations maintain minimum net worth requirements usually varied according to the size of the Exchange and the type of business being undertaken. However, the aim of ICCH systems and procedures including mark/settlement to market, (which in itself is a risk containment procedure) intra-day margin calls and a requirement for initial margin, is to ensure that ICCH is not relying on the net worth of a clearing member to make good any market movement. The amount required should already be within the clearing system. It has become axiomatic that clearing systems should provide up to the minute real-time infonwation for members including trading and payment related information. This was noted by the working group. The Working Group believes that the capacity of market participants to satisfy the large cash demands generated in volatile markets such as occurred in October 87, may be materially affected by their ability to monitor their exposures on a daily and intra-day basis and consequently to ascertain their payment obligations on a timely basis. In addition, such data should enhance the security of clearing organisations by permittina them to respond to intra-day position changes that incre~se financial risk<19l.

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-8 -ICCH real-time systems cover trade matching, confirmation, clearing, risk management and banking. Trade matching and confirmation systems record details of transactions executed by members with rea 1-t i me matching of counterparty deta i 1 s, to which members have on-line access. This service streamlines the process of allocating and confirming trades. ICCH has adopted a continuous approach to the actual clearing process, maintaining a continuous feed of new business done. Members through their on-1 ine access may input settlement, exercise and deli very. ICCH maintains a complete and comprehensive record of new business together with positions after they have been updated. This progressive monitoring and amalgamation of liabilities together with the calculation of margin calls on a routine end of day basis, including intra-day margin calls in instances of adverse market or member movements provides the basic risk management system. The system's banking functions facilitate the automated collection and payment of liabilities in addition to covering all matters associated with call determination, payments and receipts, interest and acco11111odation charges and money market investments. Other functions include real time price and positions monitoring, collateral assessment, markets monitoring, member assessment, risk ranking and risk analysis research. In the event that a contract does result in physical delivery, the systems also provide automated administration and management of deliveries. This includes the monitoring of positions under tender and the smooth transfer of rights combined with the collection and payment of monies due. ICCH's vantage point in the market and the real time systems at its disposal place it in an ideal position to provide market monitoring services either independently or in co-operation with the Exchanges and the other regulatory agencies in the field such as SIB and the Association of Futures Brokers and Dealers (with all of whom memoranda of understanding for the mutual exchange of information have been or are currently being drawn up) in accordance with the requirements of the FSA<20>. This enhanced system of information interchange on matters of crucial importance to the efficient and orderly functioning of the markets should help to mitigate the effects of unusual market volatility. ICCH has been at the forefront of trading developments in many areas, not least that of screen trading. ICCH introduced the world's first automated trading system in 1985 for the New Zea 1 and Futures Exchange. Th 1s system was subsequently adopted by London Fox for the reintroduced white sugar contract in 1987. A further development of the system, ATS 2, has been taken up by the Dublin based Irish Futures and Options Exchange which will shortly open. The original system, ATS 1, provides a mechanism for price dissemination, order entry and automatic matching of orders typically based on a price and time sequence. Order matching is prioritised by the best bid or offer available and

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-9 -then by time of entry into the system, which precludes anything but the most rigorous protocol for order execution. OrdErs may also be entered prior to the market opening. The system offers traders a wide variety of types of order enabling a range of trading strategies to be employed. The new system, ATS 2, being used in IFOX has been completely re-designed and is a fourth generation system using relational data base techniques which give a highly flexible solution capable of interfacing with m1ny other applications. The system is based on the order matching principle but has been enhanced to include the features such as time expiry of bids and offers, limit prices or negotiation capability. There is no significant distinction in real terms between this system and automated pit trading systems. One of the major distinguishing features of the APT system is that the screen 1s made to look like the pit environment. Concomitant with the growth of screen trading has been the decline of International Exchange links. However, in the field of international clearing links ICCH has scored a success with that which operates between ICCH in London and BCC (Banque Centrale de Compensation), the Paris Clearing organisation in which ICCH has a 101, interest (the remaining 901, being held by leading French banks). The link enables ICCH members in London to trade directly through Paris floor traders who allocate the trades on to the London members. The clearing process itself takes place in Paris but the relevant data is transmitted overnight on the day of trade by computer link to London and cover is then called directly on the member through the PPS system. Trading is in French Francs but the BCC operates a facility for conversion into US dollars at the prevailing rate. Reciprocal facilities are available for BCC members in Paris trading London contracts. Another area of potential co-operation between exchanges is that of cross margining between futures and options which has been the focus of attention in several post crash studies. The SEC Report asserts that a system of cross margining between futures and options would reflect net risks more accurately. Cross margining would enhance the integrity of a clearing system because an increase in risk associated with one portion of hedged position could off-set a corresponding increase in value of an opposite position. Further cross margining could offer net cash settlement for activity in different markets which would deiriease the need of members to transfer funds among the clearing organisations< >. In London discussions are currently in progress between The London International Financial Futures Exchange and the London Traded Options Market concerning the feasibilit~ of providing cross margining facilities to traders in the footsie< > index contract between LIFFE's Footsie future and LTOM's footsie option. ICCH is playing a major role in these discussions, particularly in the development of the technique for calculating initial margin offsets. The project is, however, at this stage, limited to house business (as in the US). In Paris, ICCH.France and ICCH lnformatique have been engaged in a similar project in the

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-10 developaent of an initial mat;1in offset for the CAC 40 Index<23> between the MATIF future and the MONEP option< >. Initially this offset was to be available to market aakers only, but the proposal now encompasses all accounts, including client accounts. The working group report also recomends the development of futures style aargining for options, which ICCH instituted in 1985. The efficiency of clearing, netting and settlement systems in world markets were thrown into sharp focus by the events of October 87 and have since that time beAn the subject of aany reports such as those of the Groui of Thirty<2s>, the BIS' > and the forthcoming report of the EC Comi ss ion< 7>. These reports have emphasised the perhaps hitherto undervalued role of such systems in the markets. The subject of this report -Clearance and Settleaent systems in the world's securities markets -cannot clai to be illllediately glamorous or eye catching. Indeed it has co111110nly been thought of as a matter only for the technical experts in back offices. Experience has shown how aistaken and indeed dangerous such an attitude 1s. For the subject 1s conrerned with the core processes which underly the workings of the securities markets and determine their effectiveness or otherwise. 't') The issues were addressed in some depth in the Working Party Report<29> which rec01111ncled, inter alia, improved clarity, certainty and security of clearing obligations, iaproved clearing 'guarantees', more effective real-time on-line infonution, matching and clearing systems, improved liquidity and security of clearing organisations and developaents in margining systs such as futures style argining for options and cross margining between futures and options. As a first step towar~s the long term objective of integrated clearing ICCH endorses the philosophy Jehind many of these recommendations some of which are already in place in London as will be apparent from this paper. Having just completed our first century of clearing for the London markets we look forward to maintaining our place at the forefront of global clearing into our next.

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-11 -NQJES 1. Jerry W Markhu and Rita Mccloy Stephanz fhe Stock Market Crash of 1987 -The United States Looks at New Recoaendat1ons Georgetown Law Journal Vol 76 No 6 August 88 P.2038 2. With the exception of wheat and barley futures traded on Gafta, the RCH provides a coaprehens1Ye clearing and 'guarantee'* service for all the derivative ~rkets 1n the City of London with contracts ranging from metals and oil to agriculturals and financials. Exchanqas cJaarad by tb RCH The Baltic Futures Exchange Cattle, Pigs, Soyabean Meal, Potatoes, Freight Index The International Petroleum Gas 011, Crude 011, Heavy Fuel Exchange 011 and Leaded Gasolene The London Futures and Coffee, Cocoa, Sugar Options Exchange London International Range of 20 contracts including Financial Futures Exchange Currencies, Interest Rates, Bonds and Indices The London Metal Exchange Aluminium, Lead, Copper, Nickel, Zinc and Silver The RCH aanages the London Options Clearing House on behalf of the International Stock Exchange 3. ICCH provides its services worldwide through branches and subsidiary and associated coapanies 1n Auckland, Hong Kong, Kuala Lumpur, Paris and Sydney. For exaaple ICCH International Financial Markets is a subsidiary of ICCH in the UK which offers products and services tailored to the needs of the futures and options industry worldwide. It is responsible for the Aut011ated Trading Systems installed 1n New Zealand, Londo~ Fox and IFOX in Dublin; provides settlement systems to cover 2,000 brokers worldwide and produced the operational infrastructure for both the MATIF and MONEP Exchanges 1n Paris. 4. National Westminster, Barclays, Lloyds, Midland, Royal Bank of Scotland and Standard Chartered. 5. Report of the Presidential Task Force on Market Mechanisms -January 1988. 6. lnteria Report of the Working Group on Financial Markets. Submitted to the President of the United States -May 1988. 7. Brady (supra) p.69.

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-12 -8. Financial Services Act 1986 s39(1). 9. Financial Services Act 1986 s39(4) and Schedule 4 paragraph 5. 10. The Companies Bill 1989 Part VII. 11. Clearance and Settlement Systems in the World's Securities markets. Group of Thirty 1989 p38. 12. General Regulations of the International Commodities Clearing House Limited -April 1988. 13. Insolvency Rules 1986 Rule 4.90 14. Financial Services Act 1986 S.55(1) Financial Services (Clients' Money) Regulations 1987. 15. Clients' Money Regulations 3.7(4) 16. This does not apply to contracts cleared for the London Metal Exchange which can only be settled on the relevant prompt date. 17. Supra. 18. (Inter Alia} Financial Services (Notification of Recognised Clearing Houses) Regulations 1988 19. Working Group Report -Supra Appendix D P.6. 20. Financial Services Act 1986 Schedule 4 Paragraph 5 21. Markham and Stephanz Supra p2039 22. Financial Times Stock Exchange 100 23. Compagnie des Agents de Change 24. Marche a Terme d'lnstruments Financiers Marche des Options Negociables de la Bourse de Paris 25. Supra. 26. Bank of International Settlements "Report on Netting Schemes" Basle 1989 27. Study on Improvements in the Settlement of Cross-Border Securities transactions ir, the European Economic Community. For the Commission of the European Communities. Directorate General XV. 28. Forward to the Group of Thirty Report 29. Supra. HMW/JP/8950 5.5.89

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THE INTERNATIONAL STOCK EXCHANGE LONDON A perspective of clearing and settlement for The Office of Technology Assessment sponsored study on Clearing and settlement of Financial Instruments worldwide MAY 1989 r This ,ntractor document was prepared for the OTA B~ckground Paper, Trading Around ~h: Clock. Global Securities Markets and n ormation Technology, July 1990, and OTA Report, Electronic Bulls and Be~rs US Securities Markets and Information.T hn. lnov s 19 ec o-.:.=.,;:u.., ept. 90, This document does not necessarily reflect the analytical fin 0 D of OTA, its Advisory Panel, uc its dings Technology Assessment Board.

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THE INTERNATIONAL STOCK EXCHANGE LONDON A perspective of clearing and settlement for The Office of Technology Assessment Sponsored Study on Clearing and Settlement of Financial Instruments Worldwide 1 INTRODUCTION This paper has been produced by the International Stock Exchange London (ISE) in response to a request from Bankers Trust on behalf of the Office of Technology Assessment (OTA) to describe, in general terms, the scope of the clearing and settlement processes within the United Kingdom, and the ISE's perspective of these procedures, both current and future. It is understood that this paper will be used to provide background information in the preparation of a report to the us Congress. The aim of the report will be to examine the facilities which exist worldwide for the clearing and settlement of securities. 2 STRUCTURE OF THE UK MARKET 2.1 Background The Stock Exchange in London is one of the oldest established stock exchanges in the world and has long served the needs of government, industry, commerce and investors by providing the central market place for the trading of securities. In 1973, all the stock exchanges in the United Kingdom and the Republic of Ireland merged to provide the first unified stock exchange across national borders. The merged exchanges adopted the name The Stock Exchange. In 1984 The Stock Exchange embarked upon programme of radical reforms to abolish fixed commissions, permit Member Fina to deal in dual capacity, i.e. agent or principal and introduce an electronic, screen-based trading system. These reforms were implemented in October 1986 and were known as "Big Bang". Also during this period, in order to comply with the regulatory framework to be established by the UK Financial Services Act (FSA) in 1987, The SE reorganised its operations. The SE became a Recognised Investment Exchange (RIE) and continued to operate the its markets. MAY 1989 037 Paga 1

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ISE LONDON The regulatory supervision for the SE's markets and members was separated out to a Self Regulatory Organisation (SRO) called The Securities Association (TSA), a limited liability company set up by The SE. Later in 1986, in order to respond to the demands from the international marketplace, The Stock Exchange merged with the London-based International Securities Regulatory Organisation (ISRO). As a result of this, The stock Exchange changed its name and constitution to become The International Stock Exchange of the United Kingdom and the Republic of Ireland Limited. This title is abbreviated to the International Stock Exchange London (ISE) and the ISE now operates four distinct markets:-* The UK Equity Market The Gilt-Edged and Fixed Interest Market The International Equity Market The Traded Options Market The ISE is governed by an elected Council of ISE members. Each of the four markets is managed by a committee of Council members and administered by practitioners with expertise in each particular market area. Jointly they are responsible for the ISE rules and regulations specific to the particular market. The services provided by the ISE range from front end dealing and information services through to back office settlement services. In particular, unlike many exchanges throughout the world,it supervises and operates the domestic settlement system -TALISMAN. The following paragraphs briefly describe the structure, purpose and trading mechanisms employed within the four markets operated by the ISE. 2.2 The UK Equity Market There are three tiers to the UK Equity Market. Companies wishing to raise finance adopt the tier most suitable to their own needs as follows:-2.2.1 The Listed Market The listed market is the principal market for domestic equities. It exists for well established companies which must comply with criteria which are amongst the world's most stringent relating to all aspects of their operation. They must submit MAY 1989 r Page 2

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2.2.2 2.2.3 ISE LONDON to extensive scrutiny and undertake to keep shareholders informed regarding the company's progress and prospects. The ISE requires at least 5 years' trading records and accounts before it will admit a company to listing. The Unlisted Securities Market (USM) Disclosure requirements are less stringent than required for a full listing; in addition, initial flotation expenses are considerably cheaper. The ISE requires a 3 year trading history prior to admitting a company to the USM. This is a young market, having been established in 1980. Many companies on this market progress to a full listing. The Third Market Smaller companies with short, or even no, trading record may obtain access to equitf capital through this market. It was established in 1987 for young companies which are and have good prospects for growth. UK equities are normally in registered form; however, there are a few old established securities where a bearer option is available. The traditional trading floor for this market ha-s been replaced by an electronic system known as SEAQ -Stock Exchange Automated Quotations system. This allows market makers to display continuous two way prices to the market in order to attract custom. These prices are displayed on TOPIC and other ISE information services throughout the world. In most cases, completed deals have to be reported to the ISE within 3 minutes of execution. At the close of the trading day, market makers and brokers are required to report details of their bargains to the ISE's Checking (comparison) service. This system validates details in order to produce a matched trade for settlement. (This practice is similar to that carried out in the USA by the National Securities Clearing Corporation (NSCC) but input of transactions takes place on trade date and not on T+l as is currently the practice in the USA.) A report of each matched trade is automatically forwarded to the TSA for regulatory purposes. For most transactions, settlement takes place in TALISMAN (see section 3.2). MAY 1989 Page 3

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ISE LONDON 2.3 The Gilt-Edged and Fixed Interest Market In order to fund its excess of spending over revenue from taxation (known as the Public Sector Borrowing Requirement) the tJ1( Government issues loan stocks through the Bank of England which also acts as registrar for the stocks, known as gilt-edged stocks. Certain of the stocks are optionally available in bearer form. These instruments are regarded as risk free and pay a fixed, variable or index-linked rate of interest. In addition to gilt-edged stocks, this market also includes "Bulldog" stocks (Sterling denominated stocks issued by overseas governments and corporations) and fixed interest stocks (debt issues) issued by UK public companies. Unlike the US Government bond market, the gilt-edged market has a large retail sector. The value of the retail business is small compared to the value of the large institutional and professional trades although the volumes of trades are similar. As with the UK Equity Market, trading takes place off floor and the trades are submitted to Checking for comparison and regulatory reporting. Settlement occurs for the institutional and professional trades in book entry form through the Central Gilts Office (CGO) Service, developed and funded jointly by the Bank of England and the ISE (the CGO itself is an Office of the Bank of England). The retail trades are settled through physical delivery of documents between market members via facilities provided by the ISE. 2.4 The International Equity Market In recent years, international equities have become an increasingly important investment area for UK firms and institutions. London has become the world's leading marketplace for trading the securities of the leading international companies. Prices for the International Equity Market are displayed on SEAQ International (SEAQ-I) and trading is conducted off floor. International securities do not have to be listed in London to be traded on SEAQ-I. Certain European securities have seen a major proportion of their trading activity moving from their home market to London. The ISE has recently introduced an on-line trade comparison system (SEQUAL) for trades in this market. Firms can now achieve a matched trade within minutes of the trade being executed. Settlement of international equities normally occurs using an agent bank in the home country of the security. However, the ISE has implemented systems which provide the capabilitf for its members to have direct access to settlement facilities within Australia and South Africa MAY 1989 r Page 4

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ISE LONDON (through extensions of the TALISMAN service) and within the USA through links with the Midwest Clearing Corporation in Chicago and the International Securities Clearing Corporation in New York. Further initiatives are currently underway with the intent to provide this market with the most efficient settlement systems possible. 2.5 The Traded Options Market The Traded Options Market is extremely active in London and provides a forum for investing firms to control their risks irrespective of prevailing market conditions. It is the only ISE market which remains floor-based. Prices for this market are collected and displayed on TOPIC screens. Throughout the day the ISE runs a trade matching service for this market and automatically passes the resulting matched bargain to the London Options Clearing House (LOCH), a subsidiary company of the ISE, for settlement through facilities provided by the International Commodities Clearing House (ICCH). 3 SE'rl'LEMENT IN THE UK EQUITY MARKET 3.1 Background As mentioned in section 2, each of the four markets has its own settlement practices, procedures and systems. The most comprehensive service, known as TALISMAN, is that operated within the UK Equity Market and which will be used as the basis for discussion in this paper. A securities market is only as good as the settlement system supporting it. An effective and reliable settlement system is essential if the benefits of an efficient dealing system are to be realised. Settlement in London was criticised in the Summer of 1987 due to the significant backlog of unsettled transactions as a result of the heightened market activity. It should be noted that there was not any failing in the ISE's TALISMAN service. The backlog was resolved by mid 1988 and there is now no significant problem in settling current equity business levels. TALISMAN (Transfer Accounting and.Lodgement for Investors, !tock ~agement for principals) is the ISE's computerised central settlement system. It settles transactions between member firms in UK, Irish, Australian and South African registered eligible securities and provides:-the Checking trade comparison and matching service. (This is available for any security in the world.) MAY 1989 Page 5

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ISE LONDON holding of dematerialised principal stock within a central nominee. the settlement of bargains on a settle as dealt (trade for trade) basis. the netting of cash amounts for member firms and institutions and settlement with the ISE. the facility to settle in multiple currencies (in Sterling, US$ and Irish pounds). the deposit and withdrawal of physical stock. the processing of stock situations. the processing of benefits. the collection of taxes and duties. 3.2 Trade Detail Processing Before settlement through TALISMAN all member firms must report details of their transactions to the Checking system. This will compare the details of the transaction overnight in order to achieve a locked in trade prior to settlement. This submission can be achieved by either direct computerised input from firms' back offices or through the services of a bureau. The Checking process involves two distinct stages -validation and matching. At the validation stage the system independently examines the records input by the buyer and the seller to ensure that they are of the correct format and contain certain values. If they both pass this process they are forwarded on for matching with the counterparty's input. The processing that this service performs is very sophisticated, e.g. comparison on value tolerances, one to many and many to one matching, etc. If any records fail the validation or subsequent matching stage then details are reported back to the member firms the following morning. It is then the responsibility of the two parties to amend and resubmit, or delete, their records accordingly. It should be noted that the Checking process is independent of TALISMAN and is also used as the trade matching and confirmation service for non-TALISMAN eligible securities. When transactions have passed through the Checking system, those eligible are automatically passed to TALISMAN for settlement. MAY 1989 r Oo2 Page 6

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ISE LONDON 3.3 Settlement Processing The underlying mechanism used to facilitate settlement is a limited liability, uncertificated, nominee company called SEPON Ltd (Stock Exchange POol Nominees). Principals maintain uncertificated trading accounts within this nominee in eligible securities in which they deal. When a broker undertakes an agency sale the underlying stock and transfer form are deposited at the ISE before the settlement is due to take place and the stock is transferred into the name of SEPON Ltd. No certificate is issued at this stage. Whilst the stock is in SEPON the underlying owner retains all legal rights to the stock and is entitled to receive any benefits due. On settlement day the stock is credited by b~ok entry transfer to the buying principal's account within SEPON. When a broker has conducted an agency purchase the stock is transferred from the selling principal's account within SEPON into an interim account pending re-registration into the buyer's name. In the situation where a principal to principal transaction is involved the stock simply moves by book entry transfer within SEPON without the use of transfer forms or certificates. During the whole of the settlement period, the service ensures that the entitled parties receive any benefits (cash or stock) that are due to them; claiming such benefits from parties who should not have received them. Settlement normally takes place in accordance with a two week account cycle although settlement can and does occur on every day during the period. The vast majority of the trades settle on the specified account day subsequent to the account period. However, brokers may specify any settlement period from a minimum of T+2. 3.4 Centralised Payment TALISMAN maintains payment accounts on behalf of all member firms. On any day that settlement takes place, member firms selling stock are credited with the sale proceeds on their payment accounts automatically. A corresponding debits appear on the buyers' payment accounts. Payments for an individual member firm are netted together in order that they need only make or receive one payment to or from the ISE each day. Transactions can be settled in Sterling, Irish pounds and us dollars. MAY 1989 Page 7

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ISE LONDON The ISE also operates the Institutional Settlement Service (INS). This service is similar to the DTC's ID system and enables institutions to affirm details and settle their transactions on a net money basis with the ISE instead of with a number of individual brokers. 3.5 Volumes The attached publication provides considerable statistical information relating to the level of business conducted in each of the ISE's four markets. 4 ANALYSIS OF PROBLEMS AND RISKS The ISE, as the operator of TALISMAN and other settlement services, attempts to isolate itself from assuming any risk. Those risks associated with the settlement process are borne by the participants in the process, not by the operator of the process. There remain just a few instances in UK settlement where the ISE does assume a policy of "central absorption" of risk to ensure that certain processes are practicable. All such risks are quantified and, where possible and economical, insurance cover is obtained. The most commonly observed elements of risk in the settlement process in the UK are market and counterparty risks associated with the relatively long period of time between trading and eventual settlement of bargains (normally varying from six to sixteen days) in the Account cycle. These risks have been largely mitigated by the introduction of a counter party risk assessment system. Also buying in procedures have been enhanced in recent months. In addition, the ISE is proposing to introduce a rolling settlement cycle for equity bargains after the introduction of the TAURUS service (see section 5). Under the Financial Services Act, the ISE as RIE and the TSA as SRO have a large surveillance department which monitors the performance of each member firm in many different aspects including capital adequacy and outstanding settlement positions. Additionally, the ISE's Performance Monitoring Unit provides guidance and monitors the settlement performance of all member firms. The ISE is also looking at a Central margining system similar to the mark to market systems in place in clearing systems in the USA. The ISE recognises that it is important to have an agreed trade as soon after execution as possible to reduce risk. Since 1974 the ISE has operated a trade date input comparison service (Checking) that matches transactions overnight. However, the ISE has just introduced an on-line trade comparison service called SEQUAL which will achieve a MAY 1989 r 064 Page a

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ISE LONDON successful trade match within minutes of the actual trade taking place. While currently aimed at the International Equity Market, a bridge into Checking is now being built so that it will include UK equities. It is believed that firms will, in due course, migrate from overnight matching to on-line matching for all their business. The SEQUAL service is also available to non-member organisations for affirmation of trades. 5 TRENDS The ISE is currently developing an electronic depository service called TAURUS which is scheduled to commence operation in mid 1990 and will permit participants to hold stock in fully dematerialised form. It will facilitate movement of stock both intra TAURUS and with the existing TALISMAN service by book entry transfer. Payments will initially be effected through the existing member firm and INS procedures but these will be enhanced to permit delivery versus guaranteed payment. The attached paper outlines the proposed service in more detail. Also, post TAURUS, the ISE will introduce a rolling settlement system for the UK Equity Market. 6 GENERAL PERSPECTIVE The ISE jointly with the major USA clearing corporations has implemented bilateral settlement linkages whereby us Broker Dealers can participate in the UK domestic settlement services (TALISMAN) and UK firms in the USA domestic system (both comparison and CNS and the services of the depositories). These linkages have not been fully supported by the respective potential users, who appear to be reluctant to move away from the established procedures, despite the fact that they are often expensive and inefficient. Further, the banks have identified the development of these linkages as a competitive threat to their own custody services and, in some cases, have reduced their custody charges accordingly to retain the business. It is difficult for non-US bodies to appreciate the reasons why DTC has not moved down the path of providing custody services for non-US (and Canadian) securities, holding the underlying securities with local depositories in the country of origin. The progress in this area made by CEDEL and Euroclear, and AKV in West Germany, is particularly notable. It is clear that the long term goal is that national depositories and clearing houses should work towards the establishment of linkages, thereby giving their respective membership access to efficient cross-border settlements. MAY 1989 Page 9

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ISE LONDON Moves along these lines within the European Economic Community are already being proposed by the European Commission. However, to achieve this, the securities industry must have the full support of all the parties. In such a scenario there will be winners and losers. Banks in particular, because of their many and varied roles in the securities industry, recognise that they will could lose or gain profitable services. Participants should look towards the increasing level of cross-border trades to increase their profits and not short term advantages or opportunities. The ISE fully supports the Group of Thirti recommendations but is cautious about the concept of nett ng which can hide the underlying problems with a particular failed trade. If this route is followed it is important to further develop systems, similar to those in place in the USA, to look behind these net positions, whereas a trade for trade approach would not require such a capability. To minimise the risks within settlement the reduction in the period of time involved in the settlement process must be one of the immediate goals. This is assisted by the introduction of comparison as soon after dealing as possible. Allied to this is the use of some form of guaranteed payment mechanism to reduce the risk that, despite delivery of securities, the money settlement is refused. Payment must be made available in good funds if delivery versus payment has any meaning. However,this is normally difficult to achieve in practice. The more organisations that can be encouraged to participate in a central system the greater the reduction in the degree of risk. This is the concept embodied in the proposal within the Group of 30 recommendation for the linking of Central Securities Depositories (CSDs). Expansion of the London market into international equities has highlighted the need for an efficient cross-border settlement service. currently settlement in many major centres is expensive and inefficient. The ISE is urgently evaluating the best possible solution for its membership and their clients; the proposed TAURUS system will undoubtedly bring great benefit to the UK marketplace in terms of reduced risk, reduced costs and improved facilities for the settlement of trades both within the UK and internationally. MAY 1989 r Page 10

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CEDEL'S PRIRCIPAL ACTIVITIES IR IlffDRATIORAL SECURITIES CL!ilIBG AID SETTLEMDT BY GEORGE IIULLD CEDEL 1989 This contractor document was prepared for the OTA Background Paper Trading Around the Clock: Global Securities Markets and Information Technology, July 1990, and OTA Report Ele~tronic Bulls and Bears: U.S. Securities Markets and Information Technology, Sept. 1990. This document does not reflect the analytical findings of OTA, its Advisory Panel, or it's Technology Assessment Board.

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o o cedel 1. CEDEL'S PRINCIPAL ACTIVITIES IN INTERNATIONAL SECURITIES CLEARING AND SETTLEMENT The Foundation and Development of Cedel in Keeping with the Deaands of the Market The fcundat1on of Cedel in 1970 was largely a response to the challenges presented by the developing Euro-market at that time. Despite a relatively modest outstanding issue level of less than 15 billion us dollars in 1969, the mecanisms for ~ettlin9 trades in the Euro-market were usually inefficient, e::pensive and, above all, risky, due to the .ibsence of adequate clearing facilities, and in particular the need for physical movement of securities. o,at of dis3atisfaction with the contemporary settlement system, a group cf 71 prestigious banks from 25 different countries created Cedel, an international clearing system, which was entirely neutral and independent. It was in view of this unique situation that we then adopted our motto, "FOtnlDED DY THE MARKET FOR THE MARKET". Cedel 'S ne11t1ality and independence were (and still are) assured by its cooperative struct~re: none of Cedel's 108 shareholders may hold more than si of the company's shares; Cedel's personnel .ire employed e~clusively by Cedel itself and have no obligations except to Cedel. Sin~~ 1,aJ, Cedel has operated under the supervision of the Lu~embourg Monetary Authority, which also supervises all banking operations in Luxembourg, in order to ensure conformity wi~h the rules and conventions of the international finan~ial marketplace. In th'! time since 1970, Cedel' s 1apid development has been in cc,nnection with the market, which, for us, is an indication of 1 ts appreciation of 1:>u1 system. The following table concretely illustrates the growth of Cedel. l

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TABLE 1: THE GROWTH OF CEDEL YEAR: 1971 1988 ...... --.. -. .. ---............ ---... ..... --... ----.. __ .,. ........ .... .. Number of Sharebolders NUllber of Participants Humber of securities Admitted in the system Turnover Volume in Billions of us Dollars Nominal Value of Securities Deposited in Cedel in Billions of us Dollars 71 292 484 2.66 0.60 2. Description of the Cedel System 108 2,251 21,953 1,717.8 278.9 The cedel system is based primarily on four fundamental se1vices: safekeeping and Administ1ation of Secu1 i ties -settlement of secu1ities T1ansactions Management of Funds as part of the securities settlement Process. -Provision of Links to Other Systems and Domestic Markets. 2.1. Safekeeping a11d Administration of Securities As a means of reducing risk to a minimum, Cedel's safekeeping services were designed to eliminate the physical movement of securities whe1eve1 possible. The foundation upon which this service is built is a book-entry system, which, on the one hand, makes the individual certificates of an issue interchangeable, thus 1educi11g physical movement, and, on the other, enables both securities and cash movements to be controlled simultaneously, thus allowing true delivery against payment ( DVP) In the Cedel safekeeping system, individual certificate numbers are registered in the central computer, which enables Cedel to verif~ the authenticity of each ce1tificate num.be1 by checking it against a list of lost, stolen or forged securities. The 1egistration of ce1tificate numbe1s also increases flexibility, since it enables participants to keep securities in fun91hle or non-fungible form. 2

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Fungibility implies the flexibility to transfer holdings within or out of the system, regardless of specific certificate numbers. Non-fungibility, on the other hand, means that Cede! can attribute specific certificate numbers to a participant's accoLuit and guarantee delivery of the same certificate numbers. All securities accepted in Cedel are kept with one of approximately fifty different depositary banks throughout the world. Each issue is assigned to one single depositary. As part of its safekeeping services, Cede! also administe1s securities for its participants free of charge, which includes: -p1esenting coupons fo1 payment; -crediting proceeds from coupons and/or dividends to participants' accounts; e:tercising wa1ra11ts or co11ve1sions fo1 participants, upon request; -informing pa1ticipants of splits, changes in capital, etc. 2.2. Settlement of Securities Transactions Cedel's principal service is settling trades in internationally traded securities. ~1is service is executed by means of a sophisticated computer-based, book-entry system. Included in the settlement operations performed by the Cedel system are: -validity checking of the inst1uctions received from participants; matching the trading parties' instructions; -verifying the securities and/or cash provisions of the two parties; -once the instructions are matched, provisions checked and settlement date has arrived, debiting securities and funds from the corresponding party's account and crediting them to the appropriate counterparty; -daily reporting of securities and cash movements, pending transactions, and securities and cash positions. By virtue of its structure, Cedel's system can settle transactions on a "same-day" basis; it also allows the settlement of "back-to-back" trades and multi-currency transactions. 3

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All aspects of settlement, such as coupon payment dates, credit lines, pre-advised funds, collateral, etc., are considered by the system before a transaction is executed. 2.3. Management of Funds Since every Cedel account has a cash as well as a securities component, Cedel provides participants with cash management services for all 27 currencies accepted in the system. Simila1 to its global custody of securities through depositary banks, Cedel relies upon a network of approximately 40 correspondent banks to administer its money transactions. The operations carried out by Cedel's correspondent banks include the acceptance of funds remitted by pa1ticipants, the execution of participant money transfers, currency conversions and the placing of funds. Cedel has at least one correspondent bank for each of the 27 currencies accepted in the system. All of these banks are major financial institutions in the local markets which they represent. Cedel provides cash management services by paying credit interest on balances in most currencies, regardless of size or duration of deposit, at near-market rates.On the last day of each month, the interest distributed for that month is credited to participants' accounts. 2.4. Provision of Links to Other Systems In order to enable Cedel participants to'settle trades with counterparties in Euro-clear, a "Bridge" joining the two systems was created in 1980. Procedurely, "Bridge" ~ettlements are treated in a similar way to internal Cedel-Cedel transactions, i.e. on a book-entry basis and with against paiemeut. Although the transfer of securities over the "Bridge", i.e from a Cedel account to a Euro-clear account or vice-versa, does not entail any physical movement, re-alignments of securities deposited in each system are carried out periodically. Cedel also provides its participants with access to various domestic markets through efficient links with different national clearing systems and local depositaries. Through these links, Cedel pa1ticipants anywhere in the wo1ld can settle t1ansactions in a wide va1iety of domestic and international securities with counterparties in diverse domestic markets. The following table summa1izes the links and instruments which are currently available in Cedel. 4

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ISO country Code CEDEL LINKS TO DOMESTIC MARKETS Clearing system/ Depositary I I Instrument I Inter-Domestic I national Bonds Term -.. ..................................... -................... .L .... Bonds ........ ............................ __ ............................ ... ......................... ..In.s.t1 ... AT BE CH DE DK ES FI FR OEKB/GIROWIEN CIK/BBL SEGA/UBS AKV VP/Den Danske Bilbao-Vizcaya UBF SICOVAM Sq. de France FP DVP DVP OVP FP FP DVP OVP FP FP DVP FP DVP DVP DVP FP FP FP FP DVP GB Chase, Citi FP Barclays,Bankers Trust Bk. of England FP HK BNP, Hong Kong FP IT Monte Titoli/BCI FP JP BOT, IBJ, Sumi-DVP tonao Trust & Bk. LU NL SE us Different Depos. NECIGEF/KAS NEDBANK VPC/Svenska DTC/Citi, Chase FP FP DVP FP FP DVP FP FP DVP FP DVP DVP 5

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ABBREVIATIOHS The following ab1eviation are used in the table: AKV BBL BCI BNP BOT CIK OTC DVP FP GIROWIEN IBJ KAS NECIGEF NEDBANK OEKB SEGA SICOVAM Svenska UBF UBS VP VPC Auslandskassenverein, Frankfurt Banque Bruxelles Lambert, Brussels Banca Commerciale Italiana Banque Nationale de Paris Bank of Tokyo Caisse Interprofessionale de Depots et de Virement de Titres Depository Trust Corporation Citibank, Chase delivery versus payment free of payment Girozentrale, Vienna Industrial Bank of Japan KAS-Associatie Nederlands centraal Instituut voor Giraal Effectenverkeer B.V. Nederlandsche Bank oesterreichische Kontrollbank Schweizerische Effekten-Giro AG societe Interprofessionnelle pour la Compensation des Valeurs Mobilieres, Svenska Handelsbank Union Bank of Finland, Helsinki Union Bank of Switzerland Vaerdipapircentralen Vardepapperscentralen AB 6

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3. Risk Management in Cedel 3.1. The Main Risks The principal types of risks in international securities trading are: -trading risks (i.e. whether buyer and seller agree on the conditions of a trade); -settlement risks (i.e. risks arising from the transfer of securities and money betwen buyer and seller). -risks att1ibutable to the global market; the two basic risks mentioned are increased by the enlargement of the market and the differences in market p1actices In today's global market, in which buyer and seller are often thousands of miles apart, all of these risks are combined, facing traders and clearing systems alike with a seemingly insurmountable challenge. 3.2. Risk-Reducing Services Developed by Cedel I~ is in response to the aforementioned challenge that Cedel has concentrated on reducing all risks, for both itself and its pa1ticipants, to an absolute minimum. central Safekeeping system The reduction of risk was one of the principal considerations in the development of the Cedel central safekeeping system, which, as mentioned previously, 1educes 1isk by eliminating the physical movement of securities as much as possible. The registration of certificate numbers in Cedel's computer also is an effective means of reducing risk arising from forged certificates. Delivery against paiement The most important risk-reducing element in Cedel is its insistence on delivery against payment, which drastically reduces settlement risks for both buyer and seller in the global market by simultaneously debiting and crediting the corresponding accounts. Financing Since Cedel is not a banking institution, participants can arrange financing through a so-called Tripartite Financing 7

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Agreement. This financing facility is arranged between the participant and a lending bank, Cedel monitoring the participant's collateral for the lending bank. Bondlending Similar to its financing facility, cedel also offers pa1ticipants a bondlending service, through which the risk of a settlement failure caused, for example, by a late delivery of securities can be reduced. Like its financing facility, Cedel's bondlending service is fully collateralized and all securities loans are guaranteed by a syndicate of 8 major banks which are presently: Citibank N.A. (Lead Manager) Banque Bruxelles Lambert S.A. Banque Generale du Luxembourg Banque Internationale~ Luxembourg credit commercial de France Kredietbank N.V. Kredietbank S.A. luxembourgeoise Union Bank of Switzerland Brussels Brussels Luxembourg Luxembourg Paris B1ussels Luxembourg zu1ich 4. Improvements in Matching and settlement Procedures 4.1. Importance of Matching and Settlement Procedures To a large extent, the amount of risk involved in the settlement process depends upon the efficiency of the matching and settlement procedures used. The early recognition of problems that could lead to a failure in settlement is, in this sense, a crucial preventive measure. An effective tool f01 achieving this end is t1ade matching, i.e. the comparison of trade conditions before settlement. 4.2. Development of the ACE Trade Hatching and Confirmation System one of Cedel's more recent innovations in the area of risk management has been the implementation of the ACE Trade Matching and Confirmation System (ACE standing for AIBD (*), Cedel and Euro-clear, the founders of the system). ACE has proved to be an important tool in managing settlement risks, since the exchange of trade matching data one day after trade date enables the early identification of discrepancies between trading parties. By means of this "early warning system", each partner in a trade has enough time before settlement to take any corrective measures that might be necessary. In the Eurobond Market, in particular, the seven calendar day tradedate cycle provide ample time to correct any discrepancies. A further advantage of ACE is the reduction of information handling and paperwork between front and back offices since s

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the need for separate confirmation notes sent by telex is eliminated through the ACE Trade Confirmation Service. In September 1988, ACE was enhanced to include four processing cycles per day, flexible grey market trading and provisional reporting. All of these improvements were aimed at making ACE more powerful, while enabling traders to react quickly to changes in the marketplace on a 24-hour basis. (*) AIBD stands for Association of International Bond Dealers. Its basic aims are to study and resolve technical problems affecting themarket and to implement and enforce rules governing the orderly functioning of the market. S. Accessibility to Domestic Markets 5.1. Need for Links to Domestic Markets The existence of a global ma1ket is founded upon a basic tenet, which has two sides: on the one side, players in local domestic markets want to be able to transcend their own market and deal with foreign counterparties; on the other side, actors in an international market not only want to deal on an international level, they also want to have access to specific domestic markets. These two requirements, which actually are like two sides of the same coin, represent a major challenge to an international clearing system. 5.2. Existing and Future Links to Domestic Markets Cedel's creation of links to various domestic systems, some of which, like the link to AKV, date back to the mid-70's, can be seen as a response to this need. At the present time, we have links to domestic clearing systems in 16 different countries (See table on page 5). Wherever possible, these links include a delivery-againstpayment system, thus enabling participants to settle transactions on domestic markets with the same efficiency as on the international market. In entering a domestic market, however, there is always the constraint that our own link can only be as efficient as the local market practices allow. In this sense, there still remains a major task for all of us to tackle, namely the standarization of procedures and regulations in the service of the global market. 9

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6. Cedel's Contribution to Market Standarization Although there already are numerous supranational organizations, like the FIBV, ISSA, the EC, etc., which are studying the problem of standarization, we still have a long way to go before a truly global market with the same procedures and regulations can exist. While each national government is, and should remain, sovereign in determining its own fiscal and monetary policies, we nonetheless must learn to cooperate and, where necessary, comp1omise in establishing international guidelines fo1 trading and settling transactions in capital markets. Some of Cedel' s accomplishments in the a1ea of standa1dization have been: The "B1idge11 with Eu1-clea1 in 1980; Adaptation planned for 1989, in cooperation with Euroclear, of ISIN security numbers for all securities admitted in the two systems. Cooperation with AIBD, FIBV, etc. to standardize market practices; Standardization of procedures through the connection of domestic systems to the global market. 10

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KEY RECENT DEVELOPMENTS IN FRANCE: The RELIT Settlement Reform November 1, 1989 Jacques Nouvel Directeur Central Direction de l'Ex_p_loitation SICOVAM PhifiP.pe Andrieu Directeur Direction de la CofflJ)ensation et de la Ciarantie Societe des Bourses Francaises This contractor document was preo~red for the OTA Background Paper T~a~ing Around the Clock: Global Securities Markets and Information Technology~ July 1990, and OTA Re~ort Ele~tronic Bulls and Bears: U.S. Securities Markets and Information Technoloqy, Sen~. 1990. This document does not necessarily reflect the analytical findinqs of OTA, n""l3!ts Advisory Panel, or its Technology 1 ~ssessment Board.

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As you might know. the Paris Bourse has been undergoing a major restructuration over the last 4 years. As it is in many stock exchanges in the world. back office operations are at the forefront of our mind. Let me first tell you the situation as it stands today : the development of an excessive number of procedures. 23 I believe. which hos created confusion and required back office employees to master a needlessly high number of techniques ; the lock of real guidelines for delivery versus payment In Fronce ; the practice of delivery at the seller s pace. placing the buyer ot his mercy and ruling out rapid back and forth trading. This particular situation hos been agravoted by the spectacular expansion of the French securities market in the so s.

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This II why we have Identified the back office operattons aa our number one prtortty. There are two major aspects to the reform being canted out. The total etlmlnatlon of paper which Jacques Nouvel wlll tetl you about In a few minutes. The Relit system. our new computerized settlement and deltvertes system. What are the Objectives of Retlt. The goal Is to Improve IUbstonttolly the performance of the bock office of the French market In five ways : Accelerating deliveries Simplifying procedures Increasing the security of transactions settlements creating a -flexible system that can be adapted to meet new market's requirements and doing all that ; as economically as possible both for intermediaries and central clearing organizations. Two basic principles hove been established : Cl The simultaneous exchange of securtttes and cash the same day. with no subsequent opposition of arr, kind. Cl The establishment of standard deadlines for trading and settlement In order to eHminote all remaining uncertainties. We can sav that all recommandotlons of the group of thirty ore being Implemented with Relit. except perhaps -our monthly market which Is sttll surviving. 2 -

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M UICttonl cf hit system are to be organized around tour data proceutng systems reftecilng the char0CtertltlCI ol the Fr8I ict, martcet : 581: ISB: which II the Trade confirmation system llke ID. between banks and brokers. the cleartng house which handles the netting and the guarantee be1Ween brokers. In addition : GIG: which Is the OTC-s trades confirmation system. Before the presentation of those different systems. let me tell you about the start-up. Setting up the Relit system will take nme. especially for participants to adopt their internal back office. This Is the reason of a simulatlon phase being carried out bv o limited number of participants. Start up Is currenttv set for 1990. fuming to the four systems. S81. OTC and DENOUEMENT ore monitored end under the responsibility of SICOVAM and Jacques Nouvel will tell you about it In a few minutes. IS8 Is under the responsibility of the French Stoek Excnange : Sod6t6 des Bourses Fr~ises. The broker to broker system. called ma. handles 011 trades between stock exchange' s members. such as : CAC trades (our computerized QUOtatlon system) Option exercises Floor trades -3 -

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CAC, tradeS which represent more or less 8S Clb are locked-I,,. trades. M tar as. the remanlng floor trades are concerned ; our system wtll enforce that they should be matched at T + 1. When matChed. all trades flow Into IS8 clearance and netting system. our Continuous Net Settlement System : All trades are netted to one polltlon (castt and quantity) per aecurfly per Nttlement day All positions short and long -are sent to SICOVAM for accounttng at T + A In the evening for the cash market and monthly for our fo,ward market. Between T + 1 and T + A
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Phlllppe Andrteu has Just descrtbed the general frame of the new post-trading process In France. and especially the role ptayect by the Sodtt6 des Bourses Franeralses. acting as a cleartng Institution for the netting and guaranteeing of transactions between brokers. and this being performed In the preparation and aJustment system called "ISB". It will be SICOVAM' s responsibility to manage : the two other adjustments and preparation systems. the settlement of all transacttons. @ The two other ad,lustments and preparation Mt.ems are known u "$81" and "OTC" 0 Let me explain first the SBI -,stem. Its aim Is to obtain. for trades made on the stock exchange. an explicit agreement between the acting brokerage firms on one hand. and the financial intermediaries banks as o rule -at the ortgln of the orders on the other hand. The S81 system Is globally designed on the same pattern as the omericon ID system. with only one difference : It does not distinguish the roles Identified In the ID system as "agent" and "institution". The orders executed by a brokerage firm on the Stock Exchange on behalf of a bank are put in SBI by this firm and transmitted through an electronic network to the customer bank. It has to be noted that SBI Is the only entity authortzed to Introduce. on the whole market. a standard sales slip containing the terms of negotiation as well os the fees. The banks will then have to check the details of all sales and to send to SBI a standard message of acceptance or refusal. Refusal means cancellatton of the sales slip concerned. meaning that the brokerage firm will have to Input the correct sales Information In a new sales slip. SBI will transmit automattcalty agreed transactions In the form of DVP /RVP Instructions. to the settlement system which will have to perform their execution. This will occur. as a rule. five working days otter the trade date. 5 -

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Access to the S8I system Is Hmlted to SICOVAM members (banks and brokers); It will manage stock exchange tronsacttons made on the following markets : cash market. secondary market. forward market. For the last one. sett1ement will occur at the end of the month. five days after the netting of all trades executed during the month. D For tnnactlom dealt outllde Stock Exchanae marketa (primary market. repurchase contracts. operaflons on mutual funds. transfer orders trades mode on Government Bonds with or by market ma"ers the -SVT" ... ) a spectflc preporatton ond adjustment system If foreseen: the so called ...,. l ..,... l)'Stem coTC" apt.em) Is also operated by SICOVAM. Its principle Is : Input of trade detalls by the two parties Involved In the tronsoction. matching of these Instructions. ond Issuance of OVP/RVP Instructions for the agreed trodes. Transactions to be settled on a given day will be matched. at the latest. on the evening of that day : all OVP /RVP Instructions will be transmitted. after this last matching process. to the settlement system for their execution. Like SBI. the OTC system performs also on lnformotton function. giving the results of eoch matching of transactions. The standard settlement lead time for operations flowing through the OTC system is two days : however. the system Is In a position to let trodes being settled one day otter the negotio,lon. provided the necessary Information Is Input Into the system In due ttme (on the evening of the value dote). D All four Relit aystems (ISB. SBI. OTC. Settlement systems) and all participants (brokers and banks) will be connected together through on electronic netwof1<. the "SIT &oune. designed In such o manner that It will be able to route more than 600 000 messages a day over more than 300 participants. This network. besides other functtonallttes. will : provide guarantee of transport and supply proof of transmission. connect highly diversified computer eQulpments. 6 -

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oDow bilateral os well os multl destlnatton relattonshlps. provide a real time seNlee. by routing of messages within a few seconds. It has been derived from another network. the srr moyens de palement" (cash messages network) developed by the banking community. This solution hos permitted to reduce drostlcally the development costs and other operating e,cpenses. The SIT Bourse performs two tunctlons : Routing of orders and answers between banks and brokers. A first version was already operattonal In mareh 1989 for 4 Banks and 14 brokerage firms; Transportation of all messages between all participants and all systems In the new Relit environment. There wtll not be any other communicatton link to be used. The comptete network wtll be launehed at the end of 1989. @ The settlement or all transactions Before presenting to you the core of the new French organization os regards delivery of securities known as the setttement system. let me soy a few words about the Company which wtll operate It: SICOVAM. Created in 1941. during the world war II and redesigned In 1949 In order to fit better to the needs of that ttme. SICOV AM extended step bv step Its operations to oil securities traded on the Stock Exehonge. The setttement of oil stock exehonge transactions hos to be made through book entry In SICOVAM. and the bearer form. largely adopted bv French Issuers. was very mueh In favor of the lmmobillzotton of securities with a central depository. SICOVAM Is a prtvote company, but Its by-kJws hove to be approved by the Ministry of Finance ; Its lhareholders are banks. the French stock exchanges Society. and some professional entities. Among. more than 300 members are all brokerage firms and the majority of banks. os well os seven foreign central Institutions. As a matter of fact. SICOVAM's acttvtty didn't change o lot between 1950 and 1984 ; but Its Increasing role as security custodian and administrator made possible the dematertallzatlon process. total elimination with o few exceptions -of paper certificates as of November 2nd. 1984. -7 -

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The salient feature of the new organization Is the total ellmlnotton of physical aecurtttes. the handling of which Is costly, detracts from processing securtty. and slows delivery. Under the new system. ownership of aecurtttes Is entered In securtttes occounts opened bv ftnancial Intermediaries for their clients. To ensure the overall seeurtty of the system. two basic prtnclples have been estobllshed by law : only lntermediortes duly approved by the French authortttes may open securtttes accounts; the entire accounting structure Is consolidated by SICOVAM. which continually monitors the numerical adequacy between securtttes positions of Intermediaries. who ore de facto members. and total outstanding securtttes for each given Issue. It provides bOok-entry transfers for deliveries of securtttes between professionals. Indeed. the elimination of certtflcates was only the culmination of a long process during which the large majority of certificates were Immobilized at SICOVAM. It hos also helped to eliminate archaic procedures which even In rare circumstances required the presence of full-time staff. The elimination of certificates Is now being completed. In accordance with the low. issuing bodies are now selling off the ffM securities that have not been deposited with SiCOVAM. Tons of certificates prtnted In post decades. which no longer have any ftnonclal value. ore currently being destroyed. M such, the elimination of certtftcates has not resolved and wtll not resolve the problems related to the modernization of delivery systems. tt Is already a very poslttve first s;ep. since It considerably slmpllftes seeurtttes management by making book-.ntry transfers the only legal system. and by organlztng It In such a Waf as to dertve all the adVantages related to securtty. speed. and economic efficiency. tt Is parttculartv useful for International transacttons. because It greatly enhances the notion of depositories. Presently. SICOVAM opens and moves securffles accounts by book-entry. but only on a free of payment ~sis. Its present accounting system wlll be replaced bv the Relit -8 -

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settlement system, whose aim la to receive delivery lnStructtons, either against or free of payment. from ftnanclal lntermedlartes. and to perform accordingly movement of securities and cash. Concerning lnstructtons against payment, they wtll be transmitted to SICOVAM excluslvety through the three preparatton Relit systems ISB, 581 and OTC, In the normal time frame which wlll be the rule for stock exel KJnge negottattons. DVP /TNP lnstructtons ore transmitted to the setttement system In the evening of the day preceedlng the settlement dote. lnstructtons free of payment can be delivered at any ttme. up to the settlement day Itself at noon. A first processing, designed to Indicate provtslonal securities and cash balances to participants. Is run early In the moming : the aim of this processing is to allow participants with on insufficient position to find necessary cash or securities and so to avoid foils. The second and definitive processing Is mode In the afternoon. through the chaining of all Instructions. Each ttme. position In cash and securities Is checked and operations wtth defaulting balances ore postponed for recycling on the next day. At the end of the process. the netted position In cash and securities Is booked. In SICOV AM accounts for securities and In Banque de Fronce cosh accounts opened to each participant. The checking of cash positions during Chaining Is mode by using the so called net outhortzed purchasing positions. pona. maximum amount to be debited In Banque de Fronce accounts for a given day. Information about pono value for each participant is given to SICOVAM at the beginning of each day bv Banque de Fronce. Although the system Is designed to multk:urrency settlement. It wtll be operated only In Ecus and French Fr11ncs at the beginning. At the end of the day, all movements, 1ettled or not. and the new security position will be reported to participants through the SrT networ1<. The vast. costly efforts undertaken as port of the Relit reform should hove substantial lntemottonol consequences. 9 -

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These efforts wlll go on with steps taken bv the stock exchange authortttes to modernize the French market. lndudlng the lmplementatlon of conttnuous trading. development of market making. Inauguration of the MATIF and MONEP exchanges. and the reform of the status of stodc brokerage ftrms. This coordinated serte of measures to promote the market and to Inc. rease the rellablllty of the post-trading process are Intended to restore and enhance the reputation of France as a ftnandal center. The Infrastructure thus created should serve as the basic loglsttca for establishing relatloN with foreign depOsltortes. adjustment and preparation systems can be used to harmonize both domestic and lntemattonal transactions. settlement can be. made In local or toretgn currency. the remote transmission network con serve as the national communications loop for foreign transactions. This is why the Implementation of the Relit reform should be considered as a fundamental step and a prereQuisite for the globallzatton of the French mar1cet. -10 -

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i!D-O~ [Fl~lru Wl~~ i\OO ij[}=J~ [F~~~[M [IDti\%Q~~Ji

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THE FRENCH BACK-OFFICE Efficient trading is possible only if both front and back-office opsrate smoothly and effectively. Therefore, a major concern en the Paris Bourse has been to improve back office procedures. This reorganization was necessary in light of the participants' difficulties in controlling the settlement of domestic transactions. Today, statutory deadlines are not respected. There are numerous unsettled trades, and short-term speculation is made diHicult by tangled operations and chain reactions caused by delays. Firms' cash flow is affected by the unpredictability of securities deliveries, and large staffs are necessary to handle largely uncomputerized deliveries. This was brought about by a number of causes : the development of an excessive number (up to 23) of settlement delivery channels which has created confusion and required back-office employees to master a needlessly high number of techniques ; the lack of real guidelines for delivery versus payment in France : the practice of delivery at the sellers pace, placing the buyer at his mercy and ruling out rapid back-and-forth trading. This situation worsened with the expansion of the French marlcet and international trading of French securities in the 1980s. C''"' ., ._; l,' 1

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THE REFORM OF THE BACK OFFICE This situation has prompted banks and stock market professionals to carry out a vast reform of the securities processing system in order to avoid disappointment with the French market. By setting new settlement and delivery procedures for securities, the current reorganization aims at : solving problems encountered by parties dealing on national markets, maintaining the. competitiveness of the Paris Bourse. Two steps were necessary for this reform : the elimination of paper certificates for French securities, the Relit system ELIMINATION OF PAPER CERTIFICATES An important factor in this reform has already been achieved : the almost total elimination of paper certificates for French securities since November 1984. The salient feature of the new organization is the total elimination of physical securities, the handling of which is costly, undermines process security and slows delivery. The new system we are developing builds upon the fact that book entry has already been put into practice and that the overall security of the clearing process relies on the two following principles : only duly approved participants may open securities accounts, SICOVAM monitors the correspondence between the positions of participants, and the total outstanding securities In each issue. As such, the elimination of certificates has not completely resolved the problems related to the modernization of delivery systems. It Is however an Important step since it has considerably simplified securities management by making book-entry transfers the only legal system, and by organizing It in such a way u 10 derive all the advantages related to security, speed, and economic efficiency. 2

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THE RELIT SYSTEM The second stage, which we are currently carrying out, is the creation of a new and coherent set of computerized systems to handle all market back-office operations for stock exchange as well as over-the-counter transactions. This is known as the RELIT Reform. Our goal is to improve substantially the back-office performances of the French market in five ways : accelerating delivery, simplifying procedures, increasing the security of transaction settlement, creating a flexible system that can be adapted to meet new market requirements, and reaching this goal in the most cost-effective way, both for participants and central clearing organizations. THE PRINCIPLES Two basic principles have been established : Delivery versus payment which calls for the simultaneous exchange of securities and cash the same day. Standard deaclines for trade comparison and settlement. Four functions were considered essential : Trade comparison, whereby the settlement agreement between parties is finalized. Trades are confirmed through different techniques depending on which parties are involved. Clearing, whereby participants prepare to meet their obligations on the basis of lhe provisional information at their disposal. Lending/borrowing facilities, whereby securities and cash reserves are made available to participants in order to avoid the spreading of fails. Settlement, which calls for delivery versus payment in a rolling process. 3 -

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TRADING SYSTEMS CLEARING AND NETTING ISB .... s---BROKERS BANKS TRADE MATCHING OTC

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THE SYSTEMS Those functions are to be organized around four data processing systems reflecting the characteristics of the French market. Three of them are to handle trade comparison and ctearing, and the fourth is to handle settlement. The Socittt des Bourses Fra~ises is in charge of developing and operating the clearing system between brokerage firms (I.S.B. lnter-Socittts de Bourse). SICOVAM is operating the others : Broker-to-Bank system Over-the-counter system Settlement system (SBI -Socittts de Bourse-lntermtdiaires) (G G Grt i Grt) (Dtnouement) The Broker-to-Bank 1y1tem will carry out trade comparison between stock brokerage firms and banks ; its purpose is to advise banks of market trading on their behalf and 10 seal definite delivery agreements. Trade confirmation, may eventually be implicit. Unless trades are rejected within 3 days after being entered by the brokers, they settle at T + 5. Otherwise. a slipping agenda provides for trade correction by the brokers until confirmation by their counterpart. The Over-the-Counter 1y1t1m will carry out similar tasks for direct trading between participants outside the exchange based on trade matching, whereby each party enters the trade information. The Broker-to-Broker 1y1tem handles all trades between members on the stock exchange. The Broker-to-Broker system is concerned with : CAC trades (computerized trading) Options exercises. Floor trades. 5 -

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We plan that, by beginning 1990, over 80% of trades on the stock exchange will be computerized (CAC) so that they match real time. As tar as the remaining floor trades are concerned, our system will enforce that they be matched by T + 1 The Broker-to Broker system is also the system the Socijtt des Bourses Fra,ic;aises clearing organization will be built upon. The system nets its members' trades so that members handle positions vis-a-vis S.B.F. acting as the Clearing Corporation. By interposing itself between the selling and the buying members, the Clearing Corporation can step in and manage fails to deliver as well as fails to pay. Should a buyer fail to pay or a seller fail to deliver, the Clearing Corporation supplies the missing securities or cash. Intervention costs are borne by the defaulting party which is also required to meet daily margin calls. This new organization together with new rules that will apply to the Paris guarantee fund will bring about important changes. Especially, it requires that, as opposed to the current mutual guarantH, members cover their own risks. Risks are computed daily and the Clearing Corporation requires that its members maintain sufficient cash deposits in their accounts. In addition, fails are marked to the market. In addition, the system will provide an automatic stock loan facility that will allow, after a fail, to deliver the missing securities faster to the buyer. Should an efficient lending and borrowing market be put together, this will help stop the spreading of fails. In our system, the only borrower Is the Clearing Corporation, which allows it to keep track of fails and make sure the missing securities will be delivered in the end. It is also a means to provide lenders a guarantee that the boffowed securities will be returned to them. Since securities are boffowed from special accounts where they have been deposited prior to the settlement process, the Stock loan facility is handled by SICOVAM on behalf of the Clearing Corporation. 6

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The uttlement 1y1tem will handle the exchange of securities and cuh and control the existence of the usets to be delivered. It will credit or debit the appropriate securities accounts at SICOVAM as well as cash accounts at the Bank of France (first tn French Francs, and later in foreign currencies) In a safe, coordinated fashion. It will receive Instructions either from the olhur three systems or directly from SICOVAM participants for book-entry deliv.iries. Tho 1ettlement process relies on the following principles : In the morning, based on all transactions it received and available assets, It runs a simulation of the deliveries that would be made if accounts were actually credited or debited, so that participants may in the morning time frame eventually borrow the securities they are missing. in the afternoon, the actual chaining process ts run.Delivery versus payment is guaranteed by the system itself, and is accompanied by irrevocable cash transfers to the Bank of France. At Relit start-up, securities and payment will be calculated on the same accounting day. within a standard five-day period starting from the trade itself. Since payments are not effective until the end of the day, funds will not be actually available for reinvestment on the market until T + 6. Relit has already anticipated how to trim this 5-day period to 3 days, and may do so once institutions have mastered the new procedures involved. In addition to the four systems presented above, Relit has conducted the development of a network, SIT, to allow all participants to connect to the systems as well as 10 provide them with reference data through a centralized data base. Setting-up the Relit system will take time, especially for participants to adapt. According 10 our planning, the use of the Relit system will become mandatory after a simulation phase lo be carried out by a limited number of participants (all stock brokerage firms and some ma;o, banks). 7 (. ,. 4 't"'\ ... ~ ,.

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START -uP IS CUAAENTl Y SET FOR 1990. The vut, 0011ty efforts undertaken u part of the Relit reform should have substantial lntematlonal consequencn on the Paris BourN. They art part of a global trend to modlmlze lie French martlet, Including the creation of continuous trading, development of martlet making, Inauguration of the MA TIF and MONEP exchanges, and the reform of the status of stock brokerage firms. Thia coordnattd 11riel of meuur11 to promote lie market and to lncrea11 the reliability of the post-trading proceu ar, Intended 10 rntore and enhance the reputatton of Parts as a financial center. The Infrastructure thus created should build grounds for establishing relations with foreign dlpolttorin and clearing organizations. Trade comparison and deartng systems can also bl used to some extent to handle international transactions. Settlement can bl done In local or foreign currency. TIie remote transmission network can 11rve u the local communications carrier for foreign transactions. The Reiff retorm Is seen by Its promoters u a fundamental step and a prerequisite for the lntemationalizatlon of the French market. For further information, please contact : r @ ,. r-7 'I,.,~ SOCIETE DES BOURSES FRANCAISES ,. ~CE OE LA IOURSE r,oo2 P,111s TtL tJJ-ll,I0411000TELtCOPIE 11J,11.ao2011.ao-TtW 21Ho1F

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CHAPS A New Approach to Payment Systems Prepared for the CHAPS Project Off ice by : This contractor document was prepared for the OTA Back~round Paper Tradina Around the Clock: Global Securities Markets and Information Technology, July 1990, and OTA Report Electronic Bulls and Bears: U.S. Securities Markets and Information Technology, Sept. 1990. This document does not necessarily reflect the analytical f i n di n g s o f OT A i ts Adv i so r y Pane 1 or its Technology Assessment Bo~rd. ,. RT Clark April 1982 Re -printed March 1987 Aaaociation for Payment Clearin11 Services Mercury House. Triton Court ,. "B ~-:. 14 Finsbury Square London EC2A lBR Telephone 0 1-628 7080 T,lu 268885

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Pirst published by Inter-Bank Research Organisation, April 1982 Re-printed (with additions) by APACS, March 1987

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PREFACE cHAPS A New Approach to Payment Systems provides a basic description of the CHAPS system, which went live on 9 February 1984. Over the three years since it becaMe operational, CHAPS has handled 6.8 million payments to a value of 27,683 billion. In 1986 the average daily volume of CHAPS transactions was 12,500, to a value of 216.4 billion. The chart overleaf shows the rapid growth of CHAPS since its inception. Initially, CHAPS operated under the auspices of the Bankers' Clearing House, but in 1985 the structure of payment clearing systems was changed and operatio~al control of CHAPS passed to the CHAPS and Town Clearing Company Limited, which was set up for that purpose. The Company has 14 members, all of whom are settlement members of the CHAPS clearing. The members are set out below:Bank of England Bank of Scotland Barclays Bank PLC Citibank NA Clydesdale Bank PLC Co-operative Bank plc Coutts & Co Girobank Lloyds Bank Plc Midland Bank plc National Westminster Bank PLC Standard Chartered Bank The Royal Bank of Scotland plc TSB (England & Wales) plc The CHAPS and Town Clearing Company Limited is a company within the structure of the Association for Payment Clearing Services (APACS). APACS oversees money transmission and payment clearing services in the UK. It became fully operational in December 1985 and covers the bulk electronic clearing (BACS), the London bulk paper clearings (the Cheque and Credit Clearings), the currency clearings, the cheque card and uniform eurocheque schemes and EFT-POS. All the members of the CHAPS and Town Clearing Company are members of APACS. Up-to-date statistics on the volume and value of traffic through CHAPS are available from the Statistical Unit at APACS, which is located at:-Mercury House, Triton Court 14 Finsbury Square London EC2A lBR Tel: 01-628 7080 Further copies of this Report may be obtained from the Librarian, APACS, at the above address.

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CHAPS: A NEW APPROACH TO PAYMENT SYSTEMS Information technology year baa focussed attention on the many positive ways microelectronics and computing can be used to provide real benefits to individuals and to companies. It is therefore appropriate that during IT82 the London and Scottish Clearing Banks are putting the final touches to a new automated payment system, CHAPS (Clearing House Automated Payment System). It is hoped that CHAPS will provide a service to customers which in its flexibility and efficiency will be much better than anything available previously, and which will help reaffirm the po&!tion of London as the world's leading financial centre. CHAPS is scheduled to begin operation in 1983, and while retaining the strengths of the paper system it will replace, it embodies a new flexible approach to payment systems whic, seems likely to be the pattem for more and more of auch developnents in the 1980's. What does it do? how does it do it? and in what way is it special? Payments in the City before CHAPS Every financial centre must have at its core a means by which lar~e payments can be made quickly, reliably and with confidence. The City of London is no exception, and for many years bankers, stockbrokers, foreign exchange dealers, insurance brokers and commodity dealers have relied on the Town Clearing to make large payments where the funds can be made available the same day. The Town Clearing, as the name suggests, operates only within the boundaries of the City of London, and is a traditional paper clearing system but with a difference. Each item is for a high value, and indeed there is currently a lower limit of ,000. As a result, although the volmea passing through the Town Clearing daily are only a fraction of those in the normal cheque clearing, the total value dealt with is more than twenty times greater. Payments for several millions of pounds are commonplace, and the value of some payments would cause even the most hardened banker to look twice and count the zeroes. At three o'clock every day the Town Clearing closes for normal business, and the process of reconciliation and settlement begins. As already mentioned, if say a bankers payment (essentially a special cheque used between banks) is presented today, funds will normally be made available to the beneficiary this afternoon at close of business. However, payment is not guaranteed. Even bankers payments can "bounce", al though it is a very rare event indeed. 1

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The Idea of an Automated Same Day Clearing In the early 1970'1, di1cuasion amongst bankers started on whether the time had come to create the really up to date automated payment system for the City which it wa1 believed it might require to maintain its poaition u an international financial centre to the end of the century and beyond. The belief waa that 1uch a 1yatem would supplement and might eventually replace the paper Town Clearing. Why this intere1t in an automated same day clearing? The Town Clearing continued to run amoothly and efficiently, in large part due to the underatanding and expertise which had developed over many decades in the Treasurers' Departments of the banks involved. However, it was clear that a purely manual system had limitations. If volumes were to grow subatantially, some form of automation would be required to prevent the operation bec011ing unwieldy. As labour coats continued to riae, the coat per payment using purely manual methods seemed likely to become unacceptably high. To enable same day value to be given, it was necessary to restrict the service both to within the boundaries of the City of London, and to a normal cloaing time of J.00 p.m. In both cases these restrictions were a source of irritation, for example to people like aolici tors who wished to have a cheap same day payment service outside the City, or to those who would have found it an advantage to continue business after the normal 3.00 p.m. closing time. Although there were reasons why the possibility of automating the Town Clearing would have been kept under review, it was perhaps a development in New York which really tipped the balance. 'nte Clearing House Interbank Payment System (CHIPS) was already in operation there, and, although it did not at that time provide full "same day" value, it appeared to be well received and extensively used. This, together with the success of SWIFT, which had given many banks in London the ability to send and receive automated payment instructions for the first time, persuaded the major UIC banks that the time had come to create a really up to date, efficient automated same day payment service for the City and ultimately for the country. The Initial Development After a period of study, a decision was taken by the UK Clearing Banks, who together have the vast majority of the payments business in the country, to build a new purpose built computer system to handle high value same day payments. In concept it was to be fairly traditional, with a large central processor and an operating organisation allowing all the various potential users of the service to connect to it, either via a specially provided terminal or via a direct link between the uaer'a own computer system and the CHAPS central machine -the so-called "network accesa" method. 2

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In rtropct it 11 po11ible to why difficultie1 were likely to art, but at that ti, 1n the firat half of the 197011, a deci1ion to concntrate on a aingl large computer 1y1tem 1eemed virtually the only poaaibility. The technology then available wa1 1uch that there were undoubted economie1 of 1cale in uaing a 1ingle large 1y1tem, and indeed thia vu the approach adopted for the Clearing Bank' own 1ystems, and al10 for SWIFT, and for CHIPS. Aa the development of the first CHAPS system proceeded, a number of problem areu eaerged. Firstly, u there was a coitment to make the 1ervice available widly throughout the City and outside, to whoever aight require it, the one sy1tn was required to 1upport a large number of different requirement, and a number which seemed to increase day by day. Aa a re1ult the complexity of the sy1tem, and therefore its coat e1calated rapidly. A aecond problem aroae in trying to obtain the level of security nece1sary in a syatem which would deal with auch enormous 1uma of money, while at the aame time retaining the flexibility necessary to aatisfy all requirements. The introduction of an automated syatem not only raised new security worries but also tended to call into question the adequacy of existing procedures which had grown up over the years. As attempts to solve these problems were made, it began to be clear that 1n 1ome casea it would not be poasible to maintain security of the level considered necessary without imposing unacceptable constraints on some users. The result, as well as a further increase in coats, was a drop in the projected traffic for the system and a resultant increase in the charge per transaction necessary to make the service economic to provide. With the normal technical modifications and difficulties which seem inherent in any computer development of this size and complexity, the viability of the project began to be questioned. Something clearly had to be done -but what? CHAPS 11 In a decision of some courage, the Chief Executive Officers of the Clearing Banks decided that the temptation to struggle along with the old centralised concept must be resisted. A decision was made to make a clean break and, as a matter some urgency, to consider how a new CHAPS development might benefit from the work done on the old, but without repeating 1 ta mi1takes. Behind the belief that a new approach was both necessary and possible, lay perhaps an appreciation that development in computer technology and in the provi1ion of public data networks might now make practical a much more diatributed approach with much greater potential for competition and innovation. It waa felt that the system would be more succe1sful 3 J ') 3 .J. 'U

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if it had the minimum of central development and control, and allowed each Clearing Bank to deal largely independently with queationa of aervice proviaion, of Ncurity and of tariff. 111 pioneering nature of thia approach wu recogniaed but the original requirement remained, and it waa believed that, with care, aucce waa po11ible. We are now 1uf ficiently cloae to the atart of a CHAPS 1ervice to have confidence thclt thi1 belief waa juatified. It i1 therefore time to look in more detail at the new CRAPS 1y1tem and how it will operate. The Shape of the New CHAPS The clearing 1y1tem1 in the UK are operated by a group of large comercial bank.a known collectively and unsurprisingly, aa the Clearing Bann. Each of theae banka maintains a special clearing account with the Bank of England and thi1 account is used according to agreed procedures at the end of each day to make the payments due to or from other Clearing Bank.a which are the nett result of all the payments dealt with during the day. Such an arrangement, where a group of the largest banks operate the country's clearing sy1tem1, is not unique and occurs in a number of other countries. Although the Clearing Banke operate the core clearing systems, this is not to aay that only Clearing Banke can offer payment services. There is a long history of agency agreements with a wide variety of other financial institutions which allow them the access to the various clearing systems. Thia "two tiered" structure where the Clearing Banks together operate clearing systems for other organisations, including other banks, has a long and honourable history and indeed 11 essential for orderly development in this area. A deciaion was therefore made at a very early atage that this two tier 1tructure should be perpetuated in CHAPS. Indeed, it1 exiatence waa seen as a eaaential pre-requisite if the necessary flexibility and freedom to compete wa1 to be retained. The idea vu that a group of Clearing Banks, would be known as CHAPS settlement bank because of their ability to settle one with another at the Bank of England (aee Figure 1), and would each provide what has come to be known aa a CHAPS Gateway. These Gateways would be able to exchange payment me1aage1 via Britiah Telecom' Packet Switching Service (PSS), and at the same time would provide a standard interface to each bank' own payment ayatema. These in tum would support connections to cuatomera. The Gateway was seen aa providing only those audit, routing, and coaaunicationa control functiona necessary to enaure the orderly and ~ecure operation of the overall service, and a decision was made that the production of standard Gateway software, to be used by all settlement banks, was the moat coat effective approach. 4 r 1.J4

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PICURI la LIST OP CHAPS SETTLDIENT BANKS Bank of England Bank of SCotland Barclay Bank PLC Central Truatee Saving Bank Ltd Clydeadale Bank PLC Co-operative Bank plc Coutta, Co Lloyd Bank Plc Midland Bank plc National Girobank National Westminster Bank PLC The Royal Bank of Scotland plc Willia, Glyn's Bank plc Notes Thia list shows the propoaed CRAPS settlement bank as at April 1982. Por the liat of CHAPS Settlement Members as at March 1987 pl aee the Preface. 5 r

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After a lenathy evaluation proce11, Tandem "Non-Stop" computer were cho1en u beat able to provide tha very hiah level of tolerance to failure, which a Nrvice of th11 laportance deunded. It wa1 al10 reco1ni1ed that 1ome of the Clearina Banka aht not have the volme of CIAPS payment which would ju1tify a Gateway. Specific prov111on va1 therefore made for more than one clearina bank to 1hare the 1ame Gateway, while at the Nae ti retainina the complete independence of each bank. For exaaple, quite 1eparate audit trail and 1ettlement total were to be maintained. flle core of the current CHAPS 1y1tea 11 1hown in Figure 2. Al already noted, joint development by the Clearing Banka 11 llaited to the c01111on aoftware in the Gateway, while the uae of PSS to connect toaether the Gatewaya avoid tha need for the development of a jointly owned network, Al a re1ult, it ha1 not proved nece11ary to have any inter-bank a1rN11ent about the way each 1ettlement bank' 1y1te ahould operate; about the type of Nrvice to be offered; and the way connection can be made between a aettlement bank and IAY another financial inatitution wi1hing to uae a aa day payment service. The Ba1ic Principles The ability to leave many important matters to be 1pecified by each 1ettleaent bank in accordance with its own view of market needs wa1 conaidered paramount and was achievable because CHAPS 1tands squarely on four firm principle1. 1. 'ftlere will no central organisation to operate CHAPS and the minimm of joint development. 2. When a settlement bank Gateway sends a payment me11age to another Gateway, u 1000 u the me11Age haa been properly acknowledged, the fund are guaranteed by the aettlement bank and auat be made available at tha end of the day. Thia 11 10 even if a payment ia 1ub1equently found to have been fradulently initiated. J. Each' aettlement bank auat en1ure that it 11 in a po1ition to receive CRAPS payment me11&ge1 during the normal bu1inesa day de1pite all but the moat catatrophic failure,. 4. The CHAPS Gateways will impoae the minimum of re1trictions on each settleMnt bank. Mattera such u cut-off time will be defined in CRAPS Operating lulea agreed by all the settlement banks, and to which each will promiae to adhere. Aa can be Geen, each of the four baaic principle baa the aame flavour. Each ia de1igned to maximiae the ability of each aettlement bank to c011pete in the proviaion of aa day payment 1ervice1. Because there 6 r

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la a mini .. of joint development, the dan1r 11 much reduced of each aettlnent bank beina forced, for 1y1t ... reaaona, to offer ntially the UM anlc at v1ry aiailar tariffa. Becau each aettlement bank 1tanda unequivocally hr.hind each pa,aent m11aa1 at out from itl Gateway, it can have coaplete freedom to d1cid1 on who behalf, in vhat circuaataacea, and vith vhat 1ecurity procedure pa,aeata 1hould be initiated. qain, ;he coaaitMDt to take all reaaonable atepa to receive payaenta ea~ur that other banka vill not be embarraa1ed by beiaa unable to carry out their cuatoaera inatructiona throuah no fault of their own. Finally, becauae the principal operatiq rule are aareed by the HttleMDt baaka, and are not prograed riaidly into th Gateway caaputera, it 1 poaaible, vith the agreaeat of the bank concerned, to chaqe the normal procedure or cut-off ti at very abort notice to tau account of unexpected operating conditiou. It 11 alao poaaibl to aodify and update the CHAPS Rule aa condition change 1D the loqer ten. So much for the principle which underlie CHAPS. How exactly would a typical pa7111nt be made? A CRAPS Payment The firat ataae in a CRAPS payment come when a cuatomer of one of the ttlaent banu aaka for a pa,aent to be made on a .... day baa11. Tbe cuatoaer uy be a corporate treaeurer who wiahea to make aure that ca.pay fund are not left lyina idle. It uy be a aolicitor c011pleting the Nllin1 and purchaaina of property. It uy be another bank which bu MID aaked to make a aterling payment by one of its cuatoaen on the other aide of the world. It could even be your favourite Tu Inapector ukina you a large refund although given the well known reluctance of the Inland Revenue to part with monies collected, perhapa thia laat exaaple la unlikely. In principle, anyone can uk hia aettlement bank to make a aame day payment, providad or.ly that he baa aot the fund and he can find an acceptable vay of gttiag the inatructiona to th bank. For the bank or larp company a wide range of different method are poaaible. Telex could be uaed, or perhapa a direct telecounicat1ona link, the packet n1tch1na 1enic1 (PSS), or even a telephone call. Banka might wi1h to u the SWIFT international banking ay1tem to which many are connected. Any method can be u1ed long it ia acceptable to both the cu1tomer and the HttleMnt bank. Bavina received inatructiona to uke a payment on a aaM day baai1, let ua NY that the aettlnent bank decide to carry them out by meana of 1 CHAPS payment. However, firat it will carry out whatever procedure are neceaaary 1D thia particular caN to enaure that the pa7111nt 1 in order. Becauae uch uttle11111t bank parant uch CHAPS payment it ukea, bow a payment 1 author1Nd 1 a utter only for the aettlement bank and ita cuatoaer. 1 r 137

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noon 2: TR! H!ART OF TR! CHAPS SYSTEM SEm.EM!NT BANK SYSTEMS CHAPS GATEWAY S!m.EMENT BANl SYSTEMS CHAPS GAT!WAY SEm.EMENT BANK SYSTEMS ~:Tso I GA AY IRI n SH TELECOM PACKET SWITCHINC SERVICE (PSS) CHAPS GATEWAY SEm.EHENT BANK SYSTEMS 8 ,. ., .. .~ SETTLE ME NT BA?lK SYSTE~S CHAPS GATEWAY SETTLEMEm' BANK SYSTEMS

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One apeclal problea ha to be dealt with before many CHAPS me1aagea can be aent. Say a requeat 1 received to uke a payment to a cuatomer of a bank other than a -~~tleMDt bank. With which aettlement bank doe this participant bank hold lta account? Unle thi 1 known, it 1 not poaalble to Nnd the CRAPS payment, becauae the Gateway which should receive thia payment 1 not known. The a1tuat1on ia further complicated becauae uny participant banka have account with more than one aettleaent bak, and often operate through theH banka in succession, on a rota baaia The anner to th11 problea 1 to uintain a routing table which 11 replarly updated and 1a aade available to the CHAPS payment process in each NttleMnt bank' ayatea. It 1a anticipated that the updating and d1atr1but1011 of thia routina table would be under the control of the Chief Inapector of the Bankers' Clearing Hou1e. The 1ta1e 1D the handlina of a CHAPS payaent are shown in outline in r11ure J. Firatly the payaent age, in the defined CHAPS format, is created 1D the aettleaent bank' aystea and, after the addition of a aecret authentication code, 1a Nnt to the bank' Gateway where it will be accepted by the apecial Gateway software. The Gateway, havina accepted and acknowledged the payment message, has reapouibility for enauriaa that it 1 delivered to the Gateway of the correct recelv1D1 Nttleant bank for onward tran1mi1sion to t~,e beneficiary. Hovever, before it does ao, a copy of the payment message auat be 1tor1d Ncurely on the appropriate audit trail of messages sent, and the aaount added to the total due to the receiving settlement bank which will be clald at the end of the day. Finally, the message is encryptad or acraablad before being 1ent. OD receipt by the Gateway of the other Nttlement bank, the payment P 1a carefully checked to 1n1ure that, after decryption, all the varioua total and tran1action nuaber1 appear aa expected. A copy of the ae1u1e 1 added to the audit trail of incoming me11ages, and only then doe1 the receivlna Gateway acknowledge receipt of the payment and accept re1pon11b111ty for it. Pl,: .. 11:,, the recl1vin1 Gateway pa11e1 on the payment message to the CRA1S pa,-ent proce11 within the 1y1t of the receiving 1ettlement bank. Thia bank ha the re1pon11bil1ty of advi1in1 it customer, whether participant b,ak, corporate cu1toaer, or individual. How quickly and b:, what r .. n thi1 advice 11 aiven 11 entirely a matter to be aareed between the bank aad !ti cu1toaer. In the caae of a very larae paJMDt, advice aay be Nnt al1101t 1natantaneoualy by a 1pecial telecounicatiou link or via SWin. In other ca1e1, a notification at the end of the day or even later uy be quite acceptable. 9 r ') 9 -\J

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FIGUII 3: TRI STAGES IN A CRAPS MESSAGE S!TTLIM!NT BANl BRANCH OTRD BANIC CORPORATE CUSTOMER SE'l'TLEM!N'l' BANI PA YMINT PROCESS SENDlt: CHAPS GATEWAY RECEIVING QUJS GATEWAY SETTLEMENT BANK PAYNDl' PROCESS S!TTL!M!NT BANI BRANCH OTIIII BAIi COIPOIAT! CUSTOMER Requeat for aame day payment Payment requeat accepted and deci1ion made to create a CHAPS payment Authentication added to CHAPS meaaage Deatination aettlement bank ,elected Settleaent total incremented Meauge aent and acknowledged Mea1age logged on audit trail Hea1age received and acknowledged Meaaage logged on audit trail Settlement total incremented CHAPS payment mea1a1e checked Correct authentication confirmed Accountina detail captured Step taken to adviae beneficiary by aareed procedure and to agreed timeacale Advice of receipt of fund received 10 !10

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Reconciliation and Settlement After the complex flows of payments between the various Gateways during a CHAPS day, how is reconcilation and settlement achieved? Reconciliation involves each pair of settlement banks agreeing together the total value of all the payments during the day whic~ have flowed from one to the other and vice versa. Having done this they can calculate the nett difference which has arisen between them as a result of the day's business. It is to cover this nett difference that a settlement transfer is required at the Bank of England. The process of reconciliation is assisted by two things. Firstly, each Gateway has kept a complete audit trail and if discrepancies arise the audit trails can be used to isolate the problem. Secondly, and perhapa more iaportantly, every payment contains details, not only of the amount of that particular payment, but of the total value of such payments sent by this Gateway to the other during the day. This running total is checked as part of the validation on receipt of each payment, and thus any discrepancy is identified as soon as it happens, and appropriate remedial action can be taken at once. Settlement can take place when each pair of settlement banks has agreed the nett difference between them as a result of the day's business through CHAPS. Settlement is accomplished rather neatly by each settlement bank which owes money to others sending CHAPS payment messages to the Bank of England, which is itself of course a settlement bank. '11lese payment messages cause transfers to be made between the settlement accounts held by the Banlt of England, and another day's business has been successfully completed. It is important to note that the CHAPS Gateways, while able to assist in the reconciliation and settlement process, do nothing to initiate it. A time for the normal close of business will be specified in the CRAPS Rules, but it will be up to each settlement bank to carry out its reconciliation with other settlement banks and to make whatever payments are necessary for settlement, as soon as possible after the agreed tiM. The only imediate effect of reaching the agreed close of normal buainess, is th~t the commitment of each settlement bank to receive payment messages no longer applies. Payment Mssages time-stamped after the close of normal business can be sent only with the agreement of the receiving settlement bank. Such mesaaaea can be used only where it is necessary to "tidy up" the day's business, and cannot be used to initiate completely new transactions. 11 ,.. 111

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In special circumstances, say after a major Gateway or PSS failure durina the day, it may be necessary to extend the normal hours of business in an attempt to clear a backlog of payments. In such circumstances, the lack of a rigidly imposed system "cut-off" is a major advantage, as is the ability of each pair of settlement banks to agree their totals independently from the others. The same flexibility will also allow the time chosen for the end of normal business to be changed as operational circumstances allow. For example, in the future it may prove possible to work with a later time, thus improving the service that can be offered to customers. Security and Reliability Let us look at how the integrity of the CHAPS service is maintained against both failures and deliberate manipulation. Given the huge sums of money that will flow through CHAPS every day, and the expectation that it will quickly become indispensable to the City, it is clearly necessary that every precaution be taken. The lengths to which this has been carried is perhaps beat illustrated by the coament of the banker who, when the various measures were explained to him, was reminded of the man who wore both belt and braces to avoid any possibility of embarrassment. In his view, CHAPS had two pairs of braces, two belts and probably some string and glue as well. Protection against failure is achieved firstly by the selection of Tandem computers which have every part fully duplicated, and are designed to continue operation even after multiple failures. As if this were not enough, provision is being made by each settlement bank to switch to an alternative site in the event of a complete Gateway f~llure, and on top of that, alternative procedures have been defined which will enable service to continue even if the second Gateway fails. Similar special arrangements to protect against failures in British Telecom' PSS network have been made, thus giving a high level of confidence in a continued service. Raving taken every possible step to ensure the possibility of system failure is very small indeed, the next step is to protect against the accidental or deliberate deletion, insertion, or modification of payment messages. Clearly all the normal comaunications control and checldn1 procedures must be uaed, but, as these are designed mainly to detect and correct errors rather than deliberate manipulation, they are not enough. 12 ,. t n .;..i...:..

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Aa mentioned earlier, every payment message is authenticated by a special procedure carried out by each settlement bank itself, rather than in the Gateway. To ensure the security of this process great care has been taken in selecting the algorithm the special calculation process used. Steps have also been taken to restrict knowledge of the details of this authentication and in particular to avoid any risk that information would be available on this subject to those developing the overall system. Aa well as the encryption of every payment message passing between Gateways, security is enhanced, by keeping secure audit trails at several stages in a message's progress through the system, by including a time-stamp and a total value sent to date in every payment message, and by having an elaborate system of message numbering and "handshaking" procedures both between Gateways, and between each settlement bank's own systems and its Gateway. When one considers that these security precautions must remain "watertight" even during all possibilities of system failure and recovery, some idea may be gained of the complexity of the procedures involved. It is a truism that no security can claim to be completely fool-proof but the measures taken in the CHAPS system do seem comnenaurate with its importance. Coats, Volumes and Regulation How much will a CHAPS payment cost to process? What volume of business is expected? How is CHAPS controlled? It is interesting that, while there is a satisfactory answer to the last question which will be dealt with in a minute, answers to the first two questions on costs and volumes -are much more difficult. Let us look at why this is so. It has been stressed several times already that the design of CHAPS is such as to minimise joint development and to allow each settlement bank to develop the services which it believes its customP.rs require, and to do 10 in the moat cost effective manner possible. As a result, there may be wide variations between settlement banks both in terms of their volume estimates and the costs they think will be incurred in providing services. However, some estimates suggest that during the first few years CHAPS could aim for say 15,000 to 20,000 payments per day with costs being considerably below those associated with the current largely manual and paper based methods. It is expected that, over the years, the CHAPS system will be modified and extended to cope with new operational and business requirements. Because the essential agreements on CHAPS operation are incorporated in rules and not built into the Gateway software, or even into the settlement banks' own systems, it is much easier to make changes than 13

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in many other systems. However, changes cannot be made unilaterally by one settlement bank if the change will affect the others. Thus a settlement bank will always be free to introduce new services as long as the CHAPS rules are not broken, but it could not change unilaterally say the cut off time. In the latter case it is anticipated that there will be some form of steering committee where changes can be agreed which will affect all the settlement banks. The Effect of CHAPS and its Future CHAPS is a credit transfer system but a credit transfer system with a difference. Firstly, it is fully automated. CHAPS will not add one item to the growing mound of paper with which banks must deal. Secondly, unlike the existing Town Clearing, and because CHAPS can be connected both to bank branch networks and to participants' systems (see Figure 4), CHAPS will provide a same day payment service over the entire country and perhaps even outside. Also, because CHAPS is designed to cope with the expected volumes, there is no absolute need to have a El0,000 lower limit on same day payments as is necessary with Town Clearing. Lastly, it seems likely that, with CHAPS, banks will be able for the first time to supply a cheap same day payment service wherever there seems to be a market demand. The current CHAPS system will be able to cope with anticipated volumes and has provision for growth. However, it is clear that there must be limits. For example it would not be possible for CHAPS, as currently designed, to deal with large scale "bulk" credit transfers. There is also a possibility that it would prove necessary to deal with large numbers of credit transfers on a next day rather than a same day basis. The reason lies in the question of control and authorisation. A credit transfer cannot bemade unless there is confidence that funds are available to cover it. If same day value is to be given, every payment must be checked before it is sent. With next day value, there is the ability to introduce a recall procedure which could be implemented after the normal end of day accounting is complete and if funds are not available on a given account. However, it is possible that the principles and much of the development of CHAPS are directly applicable to the creation of an automated general purpose next day credit transfer system, which could help the banks in their attempts to cut down the ever growing piles of paper based payments. Another speculative but interesting thought is that, although CHAPS deals with sterling payments, the alterations to allow it to cope with other currencies might be quite small, thus raising the possibility of an efficient, fully automated, multi-currency service. 14 ,.

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FIGURE 4: VIA SWIFT FROM BANKS OVERSEAS OTHER PARTS OF THE SE'lTLEMENT BANK -SETTLEMENT BANK BRANCHES -POSSIBLE SOURCES OF CHAPS PAYMENTS SETTLEMENT BANK PAYMENT PROCESSES CHAPS GATEWAY BRITISH TELECOM PACKET SWITCHING SERVICE ,.. 15 OTHL:'.R? CORPORATE CUSTOMERS PARTICIPANT BANK SYSTEMS

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Finally, it must not be forgotten that the current CHAPS design specifically makes provision for settlement banks to exchange messages other than payment message. There are many applications where an inter-bank teleco1111lunications link would be useful, but where the cost of a dedicated link could not be justified. CHAPS provides just such a link for those aorta of applications, and at very low additional cost. Right at the start of our look at CHAPS, it was claimed that it could well prove to be the first of a new breed of payment systems. Perhaps what has been said helps substantiate the claim. What is impressive 1a the ability of the CHAPS system to change gracefully to meet changing requirements, as well as the ease with which the system could be modified to provide other services such as a general purpose credit transfer service, or the handling currencies other than sterling. Perhaps for the first time, the necessary delicate balance between competition and co-operation in payment systems has almost been achieved enough co-operation to ensure the integrity of the service, but the maximum room for the competitive innovation from which stems progress and substantial improvement in customer service. 16


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