3.1 Overview

Chart 2 illustrates the alternative channels through which a non-resident of the country of issue of a security could (in principle, if not in practice) effect a cross-border settlement of a trade in the security. As indicated by the boxes at the bottom of the chart, a non-resident could settle its trades through any of as many as five different channels: (1) through direct access to (membership in) the CSD in the country of issue; (2) through a local agent (a local bank that is a member of the CSD in the country of issue); (3) through a global custodian that employs a local agent as sub-custodian; (4) through an ICSD that has established a direct or indirect (through a local agent) link to the CSD in the country of issue; or (5) through a CSD in the non-resident's own country that has established a link (usually direct) to the CSD in the country of issue.

			Settlement volume
System	Location	Types of securities	US$ billions 1994	Growth rate (%) 1988-94
1. Fedwire	United States	Government	578.8	7.9
2. JGB	Japan	Government	132.1	7.6 3
3. CGO	United Kingdom	Government	93.6	51.34
4. Euroclear	ICSD	Govt.; equities; other	84.7	40.5
5. DTC/SDFS	United States	Other5	81.2	116.0 6
6. CDS/BBS	Canada	Govt.; equities; other	60.0 7	n.a.
7. DTC/NDFS	United States	Equities; other	52.8	8.9
8. RELIT	France	Govt.; equities; other	37.4	19.58
9. LDT	Italy	Govt.; equities; other	31.1	74.6
10. Cedel	ICSD	Govt.; equities; other	27.1	26.8
11. VPC	Sweden	Govt.; equities; other	24.4	n.a. 9
12. DKV	Germany	Govt.; equities; other	23.5	27.7
13. Saturne	France	Government; other	22.0	67.0
14. CMO	United Kingdom	Other	15.6	15.4 4
15. NBB	Belgium	Government; other	8.0	53.1 4
16. SEGA	Switzerland	Govt.; equities; other	2.2	15.3
17. SCC	Netherlands	Govt.; equities; other	n.a.	n.a.

Note: Further information on most of these systems is provided in Annex 3 of the DVP Report; n.a. = not available.

1.   The data on settlement volumes in the different systems are not strictly comparable. For example, in a few systems the sale and repurchase of a security under a repurchase agreement requires only a single transfer instruction and is recorded as one settlement, while in most systems it requires two transfer instructions and is recorded as two settlements.  
2.   In most cases, daily averages were computed by dividing annual turnover figures by 250.  
3.   Represents the combined growth rate of JGB settlements in the JGB book-entry and registration systems; in the period 1988-94, settlements in the JGB BE system grew by 23%, while settlements in the JGB registration system declined by 4%.  
4.   For 1991-94 only.  
5.   Primarily commercial paper, but also other instruments settling in same-day funds.  
6.   Very rapid growth reflects the phase-in of commercial paper issues into the same-day funds system.  
7.   October 1993 to October 1994.  
8.   For 1992-94 only.  
9.   The system was implemented progressively during the second half of 1993.

Discussions with industry participants, as well as the results of a February 1991 survey by the International Stock Exchange and Price Waterhouse, confirm that direct access is very seldom possible and, in any event, probably would not be attractive to non-residents. Nor, with a few exceptions, are CSD-to-CSD links heavily utilised. Historically, local agents have been used most frequently, and the use of local agents probably remains the most common method of cross-border settlement. In recent years, however, institutional investors have increasingly used global custodians, while securities dealers (both commercial banks and broker-dealers) have increasingly turned to the ICSDs to settle trades in European government securities. As illustrated in Chart 3, use of the different channels is not necessarily mutually exclusive. Some of the most active securities dealers currently utilise both an ICSD and a local agent for settling trades in certain European government securities; trades with other ICSD participants are settled through the ICSDs, while trades with local market participants (often repos) are settled through a local agent.

In choosing a settlement service provider, both of the aforementioned groups of traders - institutional investors and securities dealers - evaluate the quality and cost of custody services and of cash management services. But securities dealers place special emphasis on a settlement service provider's ability to settle back-to-back trades, that is, to receive and redeliver the same securities on the same day. This requirement arises from their trading and financing patterns. In making markets, dealers often buy and sell the same security for the same value date. Furthermore, dealers often finance long and short positions associated with market-making, positioning and hedging of securities and related derivative products through repos and reverse repos respectively. Dealers typically seek to settle the repos and reverse repos on the same date on which the related cash positions settle. In addition, repos tend to be short-maturity transactions that are rolled over frequently, and each rollover entails a back-to-back settlement. By contrast, institutional investors historically have not placed heavy emphasis on back-to-back settlements because they tend to buy and hold securities rather than actively trade them. However, back-to-back settlements are becoming increasingly important to those institutional investors that actively lend securities from their portfolios.

3.2 Direct access

CSDs typically prohibit foreign residents from becoming participants. The principal exception to this generalisation is that foreign CSDs and the ICSDs in many (but by no means all) cases have been allowed to establish direct links to local CSDs. Even if direct access were allowed, foreign residents would probably find it unattractive. Local banking arrangements would still be necessary. More important, certain settlement and post-settlement functions, such as matching of settlement instructions or processing of corporate actions, would in many cases be quite difficult to perform effectively without a local presence. Local branches or subsidiaries of non-resident firms are allowed to participate in local CSDs, and that option is sometimes utilised.

3.3 Use of a local agent

As noted at the beginning of this section, the use of a local agent (a custodian) in the country of issue remains perhaps the most common method of settling cross-border trades. Local agents typically offer both residents and non-residents the full range of settlement, banking and custody services necessary to settle trades and service securities holdings. With regard to settlement, an important service provided by local agents in many markets is the prematching of settlement instructions prior to transmission to the CSD, which is usually performed via telephone or telefax rather than through an automated system. Banking services typically include cash management (funds transfer, overdraft facilities, investment of excess balances), foreign exchange transactions and, in many markets, securities lending and borrowing. Custody services include securities safekeeping, collection of interest and dividends and processing of corporate actions (including actions requiring responses by securities owners - options, rights offerings and debt reorganisation plans). Important elements of all of these services are the communications link between the local agent and its customers, the format in which the agent requires its customers to input instructions, and the content and format of reports that the agent distributes to its customers. Ease of communications and the quality, timeliness and accuracy of reports are critical determinants of the choice of an agent.

As will be discussed in greater detail in Section 4 and in Annex 3, the range of services and the terms on which they are provided are a matter of negotiation and contract between the local agent and its customers. At this point it is worth noting that while the services described in the previous paragraph are commonly offered to customers by local agents, local agents in some markets reportedly also settle trades between their customers internally, that is, through entries on their own books rather than on the books of a CSD. A local agent can offer such services only if it attracts a critical mass of customers, so that a significant volume of trades involve its customers as both seller and buyer of the securities. A critical mass is achievable in many markets because markets for custody and settlement services tend to be highly concentrated. In fact, the network economies associated with internal settlements may be a significant reason for the concentration of settlement activity in a few local agents.

3.4 Use of a global custodian

As noted earlier, institutional investors increasingly are using a global custodian to settle trades in a wide variety of countries. A global custodian provides its customers with access to settlement and custody services in multiple markets through a single gateway by integrating services performed by a network of sub-custodians, including the global custodian's own local branches and other local agents. The primary advantage to institutional investors of using a global custodian rather than a network of local custodians appears to be lower costs made possible by the global custodian's realisation of economies of scale and scope. The provision of custody and settlement services requires significant investments in information technology, communications systems and local agent networks. A global custodian, through economies of scale and scope, is able to spread its fixed costs over more transactions and to offer a variety of reporting, information, accounting and credit services to the investor at lower cost than if these services were purchased separately from a variety of service providers and local agents. By using a global custodian, an investor also avoids the burdens imposed by the need to maintain multiple communication links, conform to multiple formats for inputting settlement instructions, and receive and interpret reports from local agents in each local market in which it trades.

Another important advantage to institutional investors deriving from the use of global custodians is the availability of integrated multi-currency banking and cash management services. As will be discussed in the next section, some global custodians eliminate the need for their customers to manage liquidity demands in multiple currencies by providing services that allow daily conversion of all foreign currency denominated receipts and payments into the investor's home currency.

3.5 Use of an international central securities depository (ICSD)

The ICSDs - Euroclear and Cedel - were originally set up to provide settlement and custody services for Euro-bonds. Euroclear was founded in 1968 by the Brussels office of Morgan Guaranty Trust Company of New York (MGT). However, since then its organisational structure has changed in several ways, and it currently has a rather complex structure. The Euroclear system is owned by a UK company, the Euroclear Clearance System Public Limited Company, which, in turn, is owned by more than one hundred of its participants. Policies for the Euroclear system (including admission, pricing and rebates) are set by the board of directors of a Belgian cooperative, the Euroclear Clearance System Société Coopérative, which is owned by the UK company and system participants. However, MGT continues to operate the system (through its Euroclear Operations Centre (EOC)) under the terms of a contract with the cooperative, and MGT maintains all securities and cash accounts for participants, provides banking services (e.g. funds and securities loans and foreign exchange transactions) and bears and manages the risks associated with providing those banking services. Admission to membership is for the most part limited to banks, broker-dealers and their affiliates.

The Centrale de Livraison de Valeurs Mobilières (Cedel) was incorporated in 1970 as a limited company under Luxembourg law. Cedel is owned by more than one hundred financial institutions (banks and brokers). It is currently registered in Luxembourg as a bank. Participants hold their cash and securities accounts with Cedel. Cedel provides some banking services (e.g. intraday credit) but other services (e.g. securities lending) are provided by banking syndicates, which bear the risks of participants' financial difficulties. Participation is generally limited to banks, broker-dealers and their affiliates.

In the last few years, the role of the ICSDs in securities settlements has been transformed as they have developed links to dozens of local CSDs, and securities dealers (banks and broker-dealers) have made heavy use of some of these links, especially those to settlement systems for European government securities. According to these securities dealers, use of the ICSDs offers several advantages. Much like global custodians, ICSDs offer access to multiple markets through a single gateway at costs that reflect the realisation of economies of scale and scope. In addition, the ICSDs have the critical mass of participants that allows them to settle a very large share of their participants' trades internally (on the books of one ICSD or the other) or over the "bridge" that links the two systems. The fees charged by the ICSDs for an internal settlement or a settlement via the bridge are often much lower than the settlement fee charged by a local agent. Finally, the ICSDs are designed and operated in ways that facilitate effective management of both cash and securities positions by securities dealers. On the cash side, by scheduling settlement cycles during the night, the ICSDs are able to provide participants with reports on their balances very early in the European business day. For most currencies, this allows ample time to cover any funds overdrafts or to invest excess balances, thereby allowing dealers to economise on their holdings of cash balances and to limit the associated opportunity costs. On the securities side, through internal settlements and intraday securities loans, settlement of back-to-back trades is quite often possible, even in local markets in which the settlement of such trades through local agents is difficult or impossible. Consequently, the opportunity costs associated with the need to pre-position or accept delayed availability of securities are limited.

3.6 Use of a bilateral link between central securities depositories (CSDs)