The UK Settlement Agency and the Euroclear Process Operation - Case Study Example

THE UK SETTLEMENT AGENCY AND THE EUROCLEAR PROCESS Executive Summary The clearing and settlement process for the private sector in the UK is overseen by the APACS, a non-statutory entity established in 1985. The Bank of England also plays a big role in the clearing and settlement process considering that it has a general responsibility to ensure risk reduction and management in the country’s banking system. The clearing and settlement process is handled by clearing companies and clearing houses and among the big players are the CHAPS and CREST. The former is a British company dealing in sterling fund transfer whilst CREST is the primary clearing house of UK. CREST is operated and owned by Euroclear, a leading cross-border settlement services provider operating in several countries in Europe. The UK Settlement System In the UK, the primary sector entity for the private payments industry is the Association Payments Clearing Services (APACS hereinafter), which is the counterpart of the government’s Financial Services Authority (FSA). The APACS, which was established in 1985, is a non-statutory association that offers banks and building societies a forum for money transmission, among others. Falling under its wing are three clearing companies: the Clearing House Automated Payment System (CHAPS hereafter) Clearing Company; BACS Ltd, and; the Cheque and Credit Clearing Company Ltd (CPPS 2002 p. 1). The CHAPS RTGS system, which usually takes on high value wholesale payments albeit no lower limit on transaction values is set, has two separate clearings: CHAPS Sterling, and; CHAPS Euro. The CHAPS Euro, which began operation in 1999, allows domestic member banks to route both local and cross-border transactions through CHAPS because of the latter’s connection to the pan-EU TARGET system. The service, however, has been discontinued. The other two clearing houses are involved in retail-oriented payment arrangement. BACS Ltd offers services on electronic payment orders whilst the Cheque and Credit Clearing Company Ltd. Both clearing houses follow the two-tiered structure of access where direct members settle across accounts held at the Bank of England (CPPS 2002 p. 1). The Bank of England plays an important role in the clearing and settlement processes being a member of all three clearing companies aside from APACS. It also maintains the RTGS processor, which settles payments on a bank-to-bank basis without subjected to waiting periods and where transactions become irreversible as soon as they are processed (bank of England 2010). In addition, it provides CHAPS banks with intraday liquidity through repo (for repurchase) agreement or short-term borrowing for a smooth payment flow. It has also a general oversight responsibility over the payment system and the maintenance of risk reduction and management in the process (CPPS 2002 p.1 ). Aside from the clearing companies, the UK has also Recognised Clearing Houses: the London Clearing House (LCH); the European Central Counterparty (EuroCCP), and; CREST. The LCH provides services to exchanges such as the London International Financial Future Exchange (LIFFE), the London Stock Exchange, the London Metal Exchange and the International Petroleum Exchange. The EuroCCP, on the other hand, deals with Nasdaq Europe whilst CREST is UK’s primary settlement system (Loader 2002 p. 4) CREST handles settlement for both money markets and securities and bonds, both UK and international, which includes equities, bonds, unit trusts and shares in open-ended investment companies (OEICs). Fig. 1 shows the settlement structure of equities by CREST prior to EquityClear, the new system of settling equities through a joint effort by LCH and CREST. [6] CREST is operated by Euroclear UK and Ireland. Since 2001, Euroclear UK and Ireland began using the real-time Delivery versus Payment scheme with respect to transactions and payments of UK securities such as gilts, money market and equities instruments. The settlement process being used by CREST employs a series of very high-frequency cycles during the day where after every end of a cycle, debits and credits are made to the CREST settlement banks as per advise by the RTGS system (Bank of England 2010). The Euroclear System The Euroclear System (ES hereafter) covers a network of 31 domestics markets all over the globe and functions as a settlement agent for domestic securities, with the Eurobond constituting as its core market. Since 2005, ES has been restructured with Euroclear SA/NV set up as the holding company directly owning the Euroclear Bank, which gave up ownership and became a sister company only of Euroclear France, CrestCo and Euroclear Nederland (IMF 2006). ES makes three kinds of settlement: internal; bridge; and external. Internal settlement takes place through simultaneous book entries of debit and credit in one Securities Clearance Account to another via valid internal instructions. Internal settlement takes place every business day. Instructions are validated, matched (through matching fields like account numbers, quantity of securities, security code, cash counter-value and settlement date), submitted for processing or recycled if unmatched, positioned as to securities, cash or collateral, and executed or recycled (Euroclear 2006). Bridge settlement, on the other hand, occurs when Clearstream, another cross-border settlement operator is involved. A bridge agreement was signed between them in 2003, where risk management procedures have been ironed out. On the other hand, external settlement entails the processing of clearing and payment of transactions in accordance with a valid instruction from a remote market outside the domestic market. Both bridge and external settlements also go through the same process of validation, matching, positioning and execution (Euroclear 2006). Conclusion: The UK clearing and settlement process is overseen by the Bank of England, whose responsibility is to maintain the RTGS system, which allows real-time settlement of bank-to-bank without any waiting period, and the APACS, the non-statutory entity whose membership include the three clearing companies of UK. On the other hand, there are three clearing houses in the country: the LCH; the EuroCCP, and; CREST. It is however the latter, which is UK’s primary settlement clearinghouse. CREST is owned by the cross-border settlement services provider operating in several European countries. The ES operates by offering three kinds of settlement: internal settlement; bridge settlement, and; external settlement. Internal settlement occurs when all parties are account holders of member banks of CREST whilst bridge settlement takes place when CREST deals with account holders of member banks of Clearstream, a competitor of CREST. Lastly, CREST also handles settlement of remote accounts transactions with account holders of member banks. Generally, the CREST process involves validation of instruction, matching, positioning and execution. References: Bank of England, Payment and Settlement Systems, http://www.bankofengland.co.uk/markets/paymentsystems/index.htm. CPSS-Red Book, Payment System in the United Kingdom, http://www.bis.org/cpss/paysys/UnitedKingdomComp.pdf. IMF 2006, Belgium: Financial Stability Assessment , Including Reports on the Observance Of Standards and Codes on the Following Topics : Banking Supervision, Securities Regulation, Insurance Supervision and Regulation, and Securities Settlement Systems, Issues 6-75 International Monetary Fund. Loader, D 2002, Clearing, Settlement, and Custody. Butterworth-Heinemann. Read More