CMI in Focus

In July 2014, the Target2-Securities Advisory Group (T2S AG) published for the first time a mid-year report on the progress made by T2S markets in implementing various harmonisation standards. Usually the T2S AG issues one harmonisation report every year, however, the group considered that an additional mid-year review was needed in order to identify potential issues prior to the tests starting in October 2014. One of the main findings was the lack of harmonisation in the area of settlement finality, one of only two Priority 1 activities still with a Yellow colour status. In March, the activity was still on Red.

Securities settlement, unless undertaken free-of-payment, has corresponding money settlement which could proceed using central bank money, commercial bank money or internal cash settlement when the CSD acts as a bank and undertakes cash settlement. Although there have not been a bankruptcy from a settlement bank that has caused a loss to a participant or investor, this issue has become more relevant recently due to the exposure that participants have to face when settling in commercial bank money.

The continuation of vital business processes in the event that a disaster occurs is fundamental in ensuring that a company remains operational in any situation. Disaster recovery and business continuity (BC) are essential for financial market infrastructures (FMIs) given their systemic importance. For instance, the incapacity of a central securities depository (CSD) to continue operations in a market following a major event means that settlements may have to be discontinued for a period of time bringing significant disruption and probably losses to market participants and investors.

Partial settlement is an important feature of the settlement process to mitigate liquidity risk. It allows the settlement of part of a trade in case of a shortage of securities on the intended settlement date and, therefore, reduces the value at risk of failure. This process can be complementary to the shaping which splits settlement instructions into lower quantities.

This CMI in focus follows from a previous article, Pre-Funding Settlement Models: Account Setup and Associated Risks where issues related to the account structure at the depositories were analysed. This second article will discuss the impacts of pre-funding models in terms of liquidity risk management.