Hi! I am Nina Lasala, former Treasurer of the Philppines. This blog is meant to be an open forum for investors, fellow finance professionals, and other interested parties to discuss the state of Philippine Debt Management.

Sunday, March 13, 2005

Comments on BSP Response to Third Party Custodianship Issue

My response to the BSP article published in BW last Friday, March 11, 2005 is three-fold:

1. Understanding RoSS
2. The Technical issues
3. Points to Ponder

Comments posted on March 12, 2005, dealt on RoSS, its history, functionalities and its significant role in public debt management.

ON THE TECHNICAL ISSUES

BSP Statement: '"actions and securities balance reports are also not given directly and are instead coursed through the same dealer banks. for all intents and purposes, investors remain out of the loop and can only hope that they are treated fairly by their dealer bank.

RESPONSE/COMMENT:

The BSP conveniently neglects to state that coursing the securities account statement through dealer banks is only one of several options available to investors in RoSS. The investor has two other options available in RoSS-having a regular statement mailed to his designated mailing address, or having statement or queries "on demand" but without any regularly generated statements.

BSP statement: "What this means is that, in the case of government securities, the investor may take direct delivery of securities bought by instructing the dealer to instruct RoSS to credit his securities account. This is perfectly acceptable, provided that RoSS has the capability to directly confirm to the investor his transaction on a timely basis.

However, the ClientInterface System of the RoSS is deemed non-compliant at the moment because of this material deficiency, as well as its inability to render periodic securities statements directly to the investor. It will be considered compliant as soon as these deficiencies are remedied.

So it is not tru that business is being taken away from RoSS to be substituted by third party custodians.,


RESPONSE/COMMENT:

First, while the BSP circular explicitly states that RoSS can be used to house the investors account, subsequent pronouncements made by BSP are not consistent with this - e.g. the unsigned e-mail from Deputy Governor Reyes addressed to the banks, circular 457 sec 1 letter c, and subsequent press release , e.g. article written by a reporter of a leading daily, Maricel Burgonio titled "RoSS falls short of requirements, says BSP".

Second, the "client Interface system" referred to here is the front -end value added service offered by a service provider that supports only certains functionalities of RoSS.As stated in previous comments, RoSS is demonstrably and fully capable of independent investor accounts and varios modes of securities statement delivery, but BSP has never bothered to examine it (at least the BTR has never received such request).

BSP Statement :" Unfortunately, the oppositors want to deny this option and insist on a RoSS monopoly and is forcing RoSS to rapidly upgrade, whether ready or not, just to pre-empt the entry of private sector custodians.

RESPONSE/COMMENT:

This is false. Historical records will clearly show that the functinoality of independent investor accounts has been in existence since 1998 when the Small Investors Program (SIP) was launched.

BSP Statement: "We expect that the RoSS having a "state-of-the-art" computer system can easily interface with any system without fear of intrusion. The issue of security breach can well be addressed by the appropriate computer security systems and technology, like firewalls, which the RoSS is expected to already have in place.

RESPONSE/COMMENT:

The BSP seems to equate computer security with purely external threats and fail to consider the possible threat to the integrity of the system coming from connected comuters and even authorized users, as if they have not heard the age-old maxim- garbage in, garbage out.

The Ross database currently contains data on OWNERS and DEALERS of government securities. Allowing entry into the system of custodian's holdings and transactions will effectively "contaminate" the database, without the BTR having the ability to determine for itself the real owners of the securities it has issued. This is the "intrusion" that the BTR is trying to avoid, among others.

BSP Statement: "As for the connectivity of the trading platform of the Fixed Income Exchange, the PDEX, it will not connect to the settlement system. It is the PDEX backoffice settlement server that will connect to the RoSS and all such connections are pre-conditioned on the observance of the security protocol that will be dictated by the BTR.

It should be noted that it is a global standard for exchanges to achieve straight-through-processing (STP). Given that done deals (trades) are already captured in the exchange trading system (in this case PDEX), the trades would be sent electronically to the clearing agent (in this case, RoSS) for clearing and settlement, without the need for any re-encoding of the trade details in the Telerate terminal.


RESPONSE/COMMENT:

RoSS has always operated in STP mode, from auction, through trades and coupon payments, to maturity. IN all of its interfaces-with the auction system, with Telerate, with PSE, and with other service providers it has dealt with in the past-it has avoided any re-encoding of data.

However, the kind of STP envisioned by PDEX will require modifications to ensure that the sellers of GS actually have the securities they are trying to sell BEFORE these are actually sold. This is to ensure compliance with the G20 recommendation on RTGS and DVP, which are international best practices for securities trading. How PDEX hopes to achieve this by having only their settlement server connected to RoSS is a big issue.

Further , there will still be Over the counter trades(OTC), how to capture these trades to get to anywhere near STP mode is the bigger issue.

Lastly, to mandate whether OTC should altogether be abolished is the biggest issue.


POINTS TO PONDER

1. BSP article in BW says its circulars are market reforms which aim at:

a. delivery of securities to investors;
b. acceptance of thrid party custodians as a critical agent for protecting investor interest to lead to deepening of the market;
c. migration to formally organized trading of debt securities in secondary market for efficient price discovery and transparency.

RESPONSE/COMMENT:

I.. This is for certificated money market issuances of banks and private corporations, not for Tbills and Tbonds which are uncertificated. BSP had this rule under CBP circular 437-74 since November 4, 1974 but BSP was not able to prevent the Bancap scam - WHY?

BTr's shift to scripless government securities has not seen the scam repeated. could it be that delivery is not the key to scam-less trading?

2. BSP should detail to the public its safeguards/guarantee that third party custodians (who are also banks and dealers) will not engage in practices they ascribe to the other banks (whom they have not accredited as custodians)

3. Why cannot BSP detail to the public hoe FIE and the custodians hope to provide "price discovery and transparency" so we are not just enamoured by the phrase but have a basis for evaluating the statement.

II. BSP on current situation: risky to bank customer who trust banks; securities investors are exposed to abusive bank dealers; investors incur opportunity costs; risky to financial system because unscrupulous dealers freely engage in undocumented buy-back to avoid reserves and reduce their supervision fees.

RESPONSE/COMMENT:

It is understandable that BSP does not trust banks. An IMF consultant once quipped to BSP's Superintendent of Banks (back then):"Whenever I talk to you, I get the impression that banks exist to be supervised". But does not the BSP exist, among others, to assure the public clients of banks that banks can be trusted because they are supervised by the BSP? If BSP can't trust its banks, who else should?

There was mention of opportunity cost to investor and this was not explained.

III. BSP wants some paper (not necessarily the securities subject of transaction to be delivered to investor for his protection, via:

a. book entry to investor account, then confirmation of t sale shall be delivered to investor.
b. book entry transfer to securities account of investor-designated custodian who will hold securities in investor's name, then confirmation of sale shall be delivered to investor.

RESPONSE/COMMENT:

For all the words used, the thought is still the same as what is being done now for investors in Tbills and Tbonds. Investor's acquisition of treasury bills/bonds/, if you will, in a RoSS account in investor's name.

BSP concludes that RoSS in non-compliant with the above requirements simply by saying it is deficient because it is unable to give securities statement directly to investor. I dispute that for reasons cited in the second part of this paper , but also because my own experience showed that I get my securities statement from RoSS signed by BTR officer, but after the first confirmation statement, I do not need periodic reports on my 5-year bonds anyway I get credited in my LBP account for the coupons as regularly as the sun rises in the east each morning. I can also opt to simply get a regular statement from the BTR but whatever for, as I hold my small investments to maturity anyway.

Yesterday, a friend called me to complain that she went to a Bank (who shall be nameless) to put her (millions) in government bonds. she was given two papers to sign. One was to designate a custodian and the other was to authorize the dealer bank to transfer the bonds to the custodian. Both documents would waive any and all courses of action against the dealer and the custodian should there be a liability arising from the handling of the securities. She did not like the seeming absolute exoneration of the bank dealer and the bank custodian so she decided to put her money in tme deposit!

I also went to a universal bank and a commercial bank to place my little amount in Tbills. While the rate for 52 days of 6.5% was acceptable, the account officer advised me to ready and understand two documents I will have to sign and have notarized:

a.) A Special Power of Attorney to the universal bank to (among others) transact with a securities registry and/or custodian to open a settlement account for the proceeds of the securities, etc.

b.) A letter to the universal bank certifying that as long as I have outstanding securities not delivered to a BSP accredited third party custodian, I shall not be allowed to enter into securities transactions with the universal bank thereby freeing the universal bank of any and all liabilities arising from the universal bank's implementation of my instruction.

IV. BSP says PDTC does not lend money nor trade in securities so it does not need capital for credit and market risks.

RESPONSE/COMMENT:

How about personnel risk,legal, technological , and other oprating risks? Why issue PDTC a quasi-banking license? Does this not render PDTC a competitor of the banks it is going to serve? Consider the unfair disadvantage it has over banks since it is not even capitalized like the banks?

Business Continuity plans, Contingency risks?? even FIE has not yet obtained its SRO license...

V. BSP pontificates that security can be addressed by appropriate computer system and technology (referring perhaps to BTR when the staff raised technological risks)

RESPONSE/ COMMENT:

This shows that FIE and PDTC do not have the security configured because they leave it to "BTR-Custodian Agreement"

VI. BSP says "PDEX will not connect to Settlement (presumably RoSS). Only PDEX back-office (will presumably connect to RoSS) preconditioned on BTR security protocol that BTr will dictate.

RESPONSE/COMMENT:

This is a play of words to assuage BTR personnel . PDEX back-oofice is not PDEX? RoSS is doing STP now with the burden of PDEX on its back. Why should RoSS take on additional layers?

7 Comments:

Blogger donj said...

without the custodian rule, is the investor not protected if the bank double sell him government securities? can the bank claim no liability even if the investor has the bank certification?

1:44 PM

 
Anonymous Anonymous said...

As long as investors choose the RoSS as their custodian, they can force the banks to credit their RoSS account for the securities that they bought. This can safeguard against double selling. Of course, there are fees to be reckoned with in the maintaining of a RoSS account but I think there is a way to skew this in favor of small investors by charging a very small percentage of the Face Value as custody fees so that those who trade big will pay big and those who are small traders will pay small. We can also put a cap on the fees so that the market is not unduly pressured by the cost of custody.

5:04 PM

 
Blogger donj said...

ross can safeguard against multiple selling if the investor is well-informed of the system. is there a simple/convenient way to confirm your ross account ie., online access like the sss or gsis, telebanking etc. having nationwide coverage?

6:40 PM

 
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