Issues on Developing Electronic Trading and Efficient Clearing

Issues on Developing Electronic Trading and Efficient Clearing and Settlement Systems Dr. Salman Iqbal Damascus, Syria, 2 -3 December 2007

Presentation Layout The presentation covers Ø Ø Capital Market Structure is based on three key areas: Trading, Clearing and Settlement and Depository Functions Pains and Gains of Electronic Trading, Settlement and Depository Ø Risk Management Areas Ø Operational Challenges in an automated environment Ø Technical Challenges - IT infrastructure, Security and Control

Capital Market Structure There are three basic functions performed while trading in securities Ø Ø Ø Trading Function – Trading of securities through trading interface provided by the Stock Exchange Clearing & Settlement Function – Settlement of securities as well as cash, through the Clearing & Settlement System (CSS) Depository Function – Custody and movement of Securities, through a Depository System (DS)

Participating Entities

Order/Trade Flow in Automated Environment

Depository Network Exchange 1 Network Exchange 3 Network Exchange 2 Network Complete Network

Electronic Trading Features v Diverse Markets can be supported Ø Ø Ø v Ready Market for Cash Trading Carry Over or Financing Market for Leverage Trading Derivative / Futures Market for Hedging Straight Through Order Processing – Highly Efficient Mechanism Ø Ø Ø Access to Live Market Real Time Confirmations - Efficient/Transparent Trading Paradigm Auto Risk Management – Pre-Trade Risk Averse Strategy Real-Time Market Surveillance – Detect Market Manipulation Auto Pay and Collect – Bank Integration with CSS Real-Time Technical Analysis – More Informed Trading Decisions

National Clearing & Settlement Features Ø Ø The outstanding positions of securities as well as cash of the stock broker traded on stock exchange is settled through an automated clearing & settlement system based on settlement cycle, such as T+1, T+2, T+3 etc. The cash is handled through the designated commercial banks, known as the settling banks. The securities are maintained and transferred using the depository system. Normally clearing, settlement and depository functions are with one agency, with trading under the exchange company

Major Benefits of National Clearing & Settlement System Ø It performs netting for both cash & securities. Intra and Cross exchange netting is performed on Clearing & Settlement System (CSS) Ø Settlement of non-broker institution transactions directly with the Clearing Company using the CSS Ø Registration of Unique Identification Number (UIN) of all clients with codes making the market highly transparent Ø Automated Pay and Collect System directly with the Settlement Bank – same day settlement

Money Default Management Actions taken by Clearing Company in case of Suspension or Restriction v Determination of Final Loss when Clearing Member Fails to Pay: Ø Square-up/close out the unsettled positions and determine the final loss Ø Serve final loss notice to defaulter CM to pay such amount by the next business day Ø Declaration of CM a Defaulter by a Stock Exchange or by the Company (Trading rights are suspended)

CSS Risk Management – Controls and Checks Ø Collect Margins on CM’s exposure and mark to market requirements through CSS or by the Exchanges on the trading systems or even both Ø Movement of Securities: Bought securities are delivered to buying CMs’ DS main accounts in blocked status. Blocked securities are available to buying CMs’ DS main accounts after discharging their obligations. Ø Short Deliveries Debits: In case of short deliveries by designated time system additionally debits CMs’ accounts with the previous day Closing Prices (i. e. , System Prices) with 15% margin of late/fail deliveries. Ø Retrieval Securities: In case of money default by CM, blocked securities in his DS main account are retrieved for selling-out.

Central Depository System (DS) Ø Ø Depository System is an electronic book entry system to record and transfer securities. Electronic book entry means that the securities do not physically change hands and the transfer from one client account to another takes place electronically. Participants / Account Holders (Brokers)– Maintaining Accounts in DS for custody and delivery of Securities Issuers – Companies issuing of securities Eligible Pledgees – Banks and other Financial Institution lending against securities

Benefits of Ø DS Reduced workload & manpower requirements due to paperless settlement Ø Instantaneous transfer of ownership Ø No risk of damaged, lost, forged or duplicate certificates Ø No impact in case of sudden increase in settlement volumes Ø Instant credit of bonus, rights and new issues (IPO) Ø Convenient pledging of securities

OPERATIONAL CHALLENGES IN IMPLEMENTING ELECTRONIC TRADING, CLEARING AND DEPOSITORY SYSTEMS v v v Formulation and promulgation of necessary laws – Electronic Trading/Settlement & Depository has set of different challenges e. g. authentication and non-repudiation of transaction should have legal backing, paperless share holding etc. Formulation of comprehensive Regulations & Procedures to serve as SOPs for the relevant body. Confidence building of the different segments being affected by the implementation of the automated systems like the Listed Companies, Stock Brokers, Financial Institutions, Share Registrars and General Public at large.

OPERATIONAL CHALLENGES IN IMPLEMENTING ELECTRONIC TRADING, CLEARING AND DEPOSITORY SYSTEMS v v Develop a well trained Trainer & Support staff for giving training and customer support to all the relevant parties. Impart proper training to the relevant segments listed above. Ensure ample mock sessions for the market players to feel comfortable with the new systems. Ensure proper Customer Support during the mock sessions for proper hands on training of the all the users. A proactive approach by the support staff to ensure users fully utilize the mock sessions.

OPERATIONAL CHALLENGES IN IMPLEMENTING AUTOMATED TRADING, CLEARING AND DEPOSITORY SYSTEM v v Energetic and ample Support force to ensure proper transition to the automated system. Ensuring proper IT support to the relevant segments in setting up the automated systems. Arrange ample seminars and public lectures for educating different market players and masses at large. Proper advertisement in the media for information.

Security / Control Features Some of the Security & Control Features built in the Trading, Clearing & Settlement and Depository Systems are: Ø Contingency Site Ø Terminal Authentication Ø Private-Wire & Firewalls Ø User Id & Password Authentication Ø Segregation of Save & Post mode authorities Ø Access only to authorized users Ø Daily review of logs by department and Internal Auditor Ø Ø Disclosure of information strictly in accordance with the provision of the law Annual review to ensure compliance with the Regulations

Technical Challenges in setting up a new Trading, Clearing and Settlement System v v v v v Highly skilled IT Setup Extensive Hardware / software platform Hardware Redundancy, Backup and Failure Switch Over Capability Extensive database administration and performance tuning Extensive Networking with redundancy and backups IT security – OS, network, DB, viruses etc Highly skilled business users who are proficient with computers Reliability of hardware platform and network Reliability, extensive QA and low bug count in trading / clearing software Provisions of prompt support and fixing in case of live hardware/software problems – service level agreements, service time guarantees

Conclusions v v v Formulation and promulgation of necessary laws for Electronic Trading, Clearing, Settlement and Depository Bring on-board all the participating segments, impacted by the implementation of the automated systems, like the Listed Companies, Stock Brokers, Financial Institutions, Share Registrars and General Public at large. Get feedback to evolve the right application model compliant to business needs Choice of an experienced application and technology partner in capital market segment who is able to handle all the phases of the project from initial design to deployment and training of all the participants

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