THOMAS MURRAY RISK RATING REPORTS – STRUCTURE AND CONTENT AND METHODOLOGY CAIRO October 2011

THOMAS MURRAY RISK RATING REPORTS – STRUCTURE AND CONTENT

AND METHODOLOGY

CAIRO

October 2011

© 2011 Thomas Murray Ltd.Page 2 PRIVATE AND CONFIDENTIAL

Agenda

• Why TM has developed Risk Reports?

• Risks Assessed

• Risk Weights

• Risk Factors


Investor Exposure

TM CSD Risk – Why TM Risk Reports are required?


Risk Definitions

Asset Commitment Risk - The period of time from when control of securities or cash is given up until receipt of counter value.

Liquidity Risk - The risk that insufficient securities and or funds are available to meet commitments; the obligation will be covered some time later.

Counterparty Risk - The risk that a counterparty (i.e., a participant) will not settle its obligations for full value at any time.

Asset Servicing Risk - The risk that a participant may incur a loss arising from missed or inaccurate information provided by the depository, or from incorrectly executed instructions, in respect of corporate actions and proxy voting.

Financial Risk - The ability of the CSD to operate as a financially viable company.

Operational Risk - The risk that deficiencies in information systems or internal controls, human errors or management failures will result in losses.

Risks Assessed


CSD Services

CSD Risk changes as they move up the value chain


Risk Definitions

Two New Risks

Asset Safety Risk - The risk that assets held in custody at the CSD may be lost or misappropriated, either due to a default or an omission, misuse, or breakdown of controls (legal, operational or other).

Governance & Transparency Risk - The risk that losses will occur due to poor governance and management arrangements and inadequate disclosure of information.


Overall Risk

Average Rating - ACSDAAverage Rating – EU/EEAAverage Rating – Eurasia

Average Rating – Asia PacificAverage Rating – AfricaAverage Rating – Middle East

Key Issues The Overall Risk rating is a weighted average of the

other six risk types. The risks are divided into 3 groups; Settlement, CSD Operation and Asset Servicing and each group is given equal weighting.

Settlement group comprises of Asset Commitment, Liquidity and Counterparty Risk.

CSD Operation comprises Financial and Operational Risks.

The weights can vary depending on the degree to which the CSD undertakes Asset Servicing activities.

The weights will need to be revised with the inclusion of Asset Safety and Governance & Transparency Risks.

AAA

AA+

AA

AA-

A+

A

A-

BBB

BB

B

CCC

CC

C

Rating

Risk Weights


Risk Weights

Weights

Asset CR

Liquidity R

Counterparty R

Financial R

Operational R

Asset Service


Asset Commitment Risk

Risk Factors Asset commitment risk is a quantitative measurement

of the asset commitment period for every type of settlement process

Most depositories have different ways of settling transactions, which could depend on place of trade execution (e.g. on-exchange or OTC), different markets, choice of processing cycle (Batch or real-time) or even asset class

The weighting given to each process is determined by the value percentage of transactions going through each settlement process.

AAA

AA+

AA

AA-

A+

A

A-

BBB

BB

B

CCC

CC

C

Rating




Liquidity Risk

AAA

AA+

AA

AA-

A+

A

A-

BBB

BB

B

CCC

CC

C

Rating

Risk Factors The settlement processing model adopted by a CSD

usually follows either Gross or Net settlement. The number of settlement cycles and the netting efficiency of the processing is a key component in assessing the effectiveness of the settlement model.

The appropriate fails management regime operated by the CSD hinges around the range and timing of approaches used, factored by the actual settlement rate

The ability of clients to access credit facilities is critical to their ability to provide timely funding of a trade

Securities borrowing and lending (SBL) provides for securities shortfalls.

Matching processes in the market for CSD settled transactions assess both client side matching and market side matching and are given equal weighting.

Also take into account the registration arrangement and the proportion of securities on issue held within the CSD. Average Rating - ACSDA

Average Rating – EU/EEAAverage Rating – Eurasia



Counterparty Risk

AAA

AA+

AA

AA-

A+

A

A-

BBB

BB

B

CCC

CC

C

Rating

Risk Factors The most important principle to control counterparty

risk is the use of Delivery versus Payment (DVP) settlement; which is the interdependent transfer of securities against cash.

Participants should have minimum capital requirement specified and appropriate technical resources.

Some surveillance should be undertaken on participants activities and their exposure levels.

The ability to manage a default is assessed in terms of the structure and financial resources available to guarantee all open obligations of the party that has defaulted (a guarantee fund).

Where a CCP is available, these are assessed as the ultimate counterparty in a market




Asset Servicing Risk



AAA

AA+

AA

AA-

A+

A

A-

BBB

BB

B

CCC

CC

C

Rating

Risk Factors Asset servicing is undertaken to various degrees by

CSDs Where the CSD is not involved in executing voluntary

corporate actions or does not play a primary role in asset servicing, the weighting of this risk is reduced.

There are two key focal points to this risk – the first involves the collection and dissemination of information and the second is the receipt and execution of instructions.

There are other areas such as proxy voting and other related services eg tax services that are also included where these are (rarely) pursued by the CSD.


Financial Risk



AAA

AA+

AA

AA-

A+

A

A-

BBB

BB

B

CCC

CC

C

Rating

Risk Factors Capital adequacy is an important criteria in ensuring the

financial stability of a company. Profitability and revenue generation is assessed over a

5 year period. The strength and quality of ownership of the CSD

becomes increasingly important were the CSD to be under duress.

The standard of liability a depository assumes in relation to any claims against it by participants who may have suffered losses due to the actions or omissions of the CSD.

The primary way a CSD can cover any claims is through acquiring adequate insurance.

Another avenue of funds is through secured credit lines Also examine outstanding investments by the CSD in

infrastructure (building, computer systems etc.)


Operational Risk



AAA

AA+

AA

AA-

A+

A

A-

BBB

BB

B

CCC

CC

C

Rating

Risk Factors Identification of the risks and the key controls used to

manage those risks. Documented procedures are required for all

processes. All operations including IT operations should be subject

to both internal and external audit. Appropriate DRP and BCP arrangements that have

been fully and regularly tested are essential. Automation of processes reduces the risk of manual

errors. Reporting arrangements to clients is also taken into

account. Staff training helps manage risks when manual

intervention is required.


Asset Safety Risk

Segregation of Securities

Legal Conventions

Forms of Securities

Liens

Reconciliation and Audit

Account Control

Cash Deposits

Risk Factors


Governance & Transparency Risk

Board Arrangements

Establishment of Risk Management

Disclosure of Corporate Information

Disclosure of Statistical Information

User Group Arrangements

Risk Factors


CSD Public Rating

Operational Risk RatingsRating

AAA

AA+

AA

AA-

A+

A

A-

BBB

BB

B

CCC

CC

CLess important Important Critical

Established procedures

Identification of key controls

Operational Audit

Processing

Reporting

Disaster Recovery procedures

Business Continuity Plan

Staff training

Indicates likely direction of any change in this factor.

O1

O2

O8

O1

O2

O3

O4

O5

O6

O7

O8

O3

O5

Comparative Chart

Average Americas - TM Proprietary Rating

Average Eastern Europe – TM

Proprietary

Avge West Euro – TM Proprietary

Avge Asia Pac – TM Proprietary

Average Africa – TM Proprietary

Avge Mid East – TM Proprietary

S Public RatingCSD

O4

O6

O7

O4

Example

Documents

THOMAS MURRAY RISK RATING REPORTS – STRUCTURE AND CONTENT AND METHODOLOGY CAIRO October 2011