Reference to Process Transformation

8/10/2019 Reference to Process Transformation

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11 September 2009

09.04.01/2009/004947

CORPORATE ACTIONS SUB GROUP

PROPOSAL FOR PROCESSING OF TRANSFORMATIONS IN THE CONTEXT OF TARGET2-SECURITIES

This document sets out proposals by the Corporate Actions Sub-Group (CASG or the Group) for market standards for the processing of transformations in the

context of TARGET2-Securities (T2S).

In their final form, the standards will be endorsed by the T2S Advisory Group, and will be addressed to all CSDs and NCBs in T2S and to the users, including

CCPs.

The expectation will be that all CSDs and their users, including the CCPs, will abide by these standards for all activity on T2S, and from the first day of such

activity on T2S.

It is also to be hoped that all European CSDs will, where applicable, abide by these standards for non-T2S settlement, so that a single harmonised European

process be achieved.

It is proposed that, following the approval by the AG, the CASG will support and monitor implementation of the standards.


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1. General comments

The proposals set out in this paper are based on a functional approach to transformations processing. The proposals have been drawn up without

reference to the legal and fiscal compliance context in which these proposals will operate and are only understood as best market practices with the

aim of introducing harmonisation in cross-CSD settlement in T2S. At a later stage, an assessment by each national market and T2S committed CSDs

should identify any potential legal and fiscal barriers for their implementation prior to T2S going live.

The T2S standards build on the Standards of the CESAME2 mandated Corporate Actions Joint Working Group (CAJWG). The CAJWG standards

have been endorsed by all relevant industry bodies (July 2009).

The T2S standards are built on the assumption that it is possible to distinguish functionally between the processing related to a corporate action on

stocks or holdings, for example, the distribution of a cash dividend to record date (RD) holders and the processing related to a corporate action on

flows, for example, the generation and processing of a market claim.

The proposals are valid for all transactions on T2S (i.e. both for transactions between two users of the same CSD and for cross-CSD settlement)

Specifically, it is assumed that cash distribution of corporate actions will take place in T2S and not outside of the CSD/T2S environment

The proposals take as working assumptions of the T2S functionalities, the T2S User Requirements Document (URD) v4.2

Definition

Transformation is the process by which pending transactions still unsettled by the end of RD/market deadline are cancelled and replaced in accordance with

the terms of the reorganisation.


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2. Scope of Transformation standards

As per the CAJWG standards, the following types of CA events trigger the transformation of a pending transaction:

Mandatory reorganisations;

Mandatory reorganisations with options (with or without a valid buyer election) as a single event or as the second part of the distribution event with

options;

Voluntary reorganisations where a valid buyer protection has been agreed.

Implementation for CSDs in T2S

It is crucial that the same transformation process applies to all pending transactions in T2S by respecting the principle that per ISIN and per EVENT, one

unique process is applied across all CSDs in T2S. The transformation in T2S will be processed in two technical steps: first the cancellation of the underlying

transaction, followed by the replacement of one or several new transformed transactions (or instructions, which will require matching, cf. 4.5).

Underlying transaction

The transformation concerns a pending (open or non-settled) transaction in T2S i.e.: the relevant instructions are matched irrespective of the location of the

matching (in or outside T2S) 1.

As a reminder, unmatched instructions which are out of scope of transformations, are maintained in T2S for 20 T2S opening days and afterwards they are

cancelled. No instructions can be matched and transformed after that deadline.

Applicable transactions

The scope of application of these standards covers in principle all securities transactions. These are among others, settlement of trades on the spot (or cash)

market transactions (transactions related to a securities trade, either against payment or not) as well as settlement related to stock loans, portfolio/assets

transfers, repos, FoP settlement without matching (dumps) etc. The Group recognised the business need for counterparties in the underlying transaction to

be able to bilaterally opt-out from the market claim procedure on a transaction by transaction base, where relevant.

1 For the distinction between instruction and transaction: a typical OTC DvP transaction involves two settlement instructions sent by the counterparts to the CSD. Once the instructions arematched, they become one transaction which is then proposed for settlement on settlement date.


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The standards are primarily focused on the need to establish a best market practice framework for processing market claims in the cross-CSD settlement

environment of T2S. Market claims management within a single CSD framework is de facto easier to manage and is the sole responsibility of the CSD in

question (with no need to interact with other CSDs on pending transactions) whereas market claims in a cross-CSD environment is more complex. The

challenges for cross-CSD settlement and market claims come from the fact that (at minimum) two CSDs are involved in the transaction chain.

These standards cover all financial instruments eligible for settlement in T2S.


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4. Transformations proposals

Sub-process Proposalnumber

Topic / Question CASG Proposal Explanatory Comment

TransformationManagement

1 Who will manage thetransformation on

pending T2Stransactions?

At the CCP level: When agreed with the Instruction Owner CSDs(IOCs) 2 the CCP itself can manage thetransformation for CCP transactions via aPower Of Attorney (POA) on the participantsaccounts by use of the T2S cancellation andreplacement mechanisms.

At the CSD level (both CSDs of the buyer and the seller are connected to T2S):The IOCs will manage the transformation:1. When the underlying transaction impacts

two accounts in the same IOC. Thecancellation and replacement will bemanaged and instructed in T2S by the IOCitself.

2. In a cross-CSD transaction, each IOC hasto cancel the instruction (bilateralcancellation process in T2S) and to send toT2S the new transformed instruction formatching.

When the transaction is cross-border (oneCSD is in T2S and the other is outside T2S):The T2S connected IOCs/CCP will manage thetransformation. CSDs which are not connectedto T2S can not instruct T2S

2 Instruction Owner CSD (IOC): is defined as the CSD that provides the securities accounts on which the participant has sent an underlying instruction. The definition alsoincludes the case where the CSD participant maintains a direct technical connectivity to T2S. There are always two IOCs per transaction, the IOC can be the same CSD if thetransaction is between two of its participants. This role can be assigned either to the Issuer CSD or the Investor CSD, depending on the settlement chain scenario as described

below. By definition, the IOC is always aware of the pending instructions of its own participants


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2 When will thetransformation take

place in T2S?

The transformation process shall take place byend of record date or market deadline andduring the rest of the transformation detection

period (i.e. 20 T2S opening days after therecord date/market deadline).

On any day during the transformation detection period,transformations settlement instructions should be sent to T2S

between:

the T2S end of day time settlement activity (indicativeT2S time at 18:00 CET) and the start of night time settlement in T2S (indicative

T2S time at 19:30 CET).

3 Will sometransactions beexcluded from thetransformations?

As a general principle, transformations will beapplicable to all eligible transactions.However, counterparties in the underlyingtransaction may choose to opt-out if theywant to deviate from the standardtransformation procedures.

The opt-out will be done on the underlying transaction whenthis is instructed or amended in T2S, i.e. before thetransformation takes place. The opt-out will be instructed by

both parties by using an opt-out ISO transaction condition indicator 3.This needs to be an additional matching field in T2S (if onecounterparty includes it then it becomes a mandatory matchingfield that needs to be matched against the other counterpartysinstruction). Instructions with matched opt-out fields should becancelled by the IOCs in T2S but not transformed.Matching is required and, if included, the opt-out indicatorshould not be matched to blank (i.e. indicator not included) inT2SPossible Scenarios:

1st instruction

2nd instruction

T2S systemaction

blank blank matching

opt-out blank no matching

opt-out opt-out matching

blank opt-out no matching

3 Transaction condition indicator: Specifies the conditions under which the transaction is to be settled


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TransformationGeneration

4 How will thetransformation betriggered? What willbe the formats andreference fields?

IOCs/CCPs managing the transformation willuse the ISO20022 format as specified in theT2S URD.IOCs/CCPs will include in the transformationsettlement instructions the appropriatereferences so that their own participants canidentify and process the transformationsatisfactorily in their own books. Theminimum references required include: T2Sreference of the underlying transaction, andCSD corporate action event reference 4.From a T2S system specification perspective,these references are only for information

purposes (for CSDs/CCPs participants) asthese references do not trigger any specificfunctionality in T2S (other than standardsettlement processing).

A CSD participant may want to be able to identify that a particular pending transaction is the result of a transformation;for example, a CSD participant may want to search all pendingtransactions to find all transformations; in such a perspective,the T2S reference of the underlying transaction and the CSDcorporate action event reference may not be enough. It willtherefore be investigated with the T2S Subgroup on Messagingon whether this would be feasible.

5 Do the

transformationinstructions requirematching in T2S? -When the transactionis done within oneCSD/CCP

CSD/CCP may match locally the new

instructions related to the transformation andsend them to T2S as already matched forsettlement or send them as separateinstructions for matching in T2S.

6 Do thetransformationinstructions requirematching in T2S? -When the transactionis done across twoCCPs/CSDs

Both IOCs/CCPs should send new instructionsto T2S, for matching purposes.

Matching is relevant and applicable to all kinds oftransformations, i.e. securities (Free of payment, and/or DVP)and cash outturns (payment free of delivery - PFOD). Thesematching processes are already covered in the T2S URD.In all cases, matching will be completed within T2S (even ifthe transaction implies one participant outside T2S).

4 The recent harmonisation initiative of the Securities Market Practice Group (SPMG) for the introduction of standardised CA reference codes in the EU should facilitatefurther the question of choice of the appropriate CA reference code to be used when instructing T2S.


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Lifecycle of aTransformation

7 What will be thesettlement date of thenew transformedinstructions in T2S?

The earliest settlement date (SD) of the newtransaction(s) should be the latest between the

payment date (PD) of the entitlement and theSD of the underlying transaction.

Example 1:- Underlying transaction:Trade date: 20 June, SD: 23 June

- Detail of the Reorganisation:RD: 24 June and PD: 25 June- MAX between (23, 25) is 25- New replacement transaction:Trade date: 20 June and SD: 25 June

Example 2

- Underlying transaction:Trade date: 20 June, SD: 30 June- Detail of the Reorganisation:RD: 24 June and PD: 25 June- Max between (30 , 25) is 30- New replacement transaction:Trade date: 20 June and SD: 30 June

TD20

SD30

24RD

25PD

underl in transaction

transformed transaction

TD20

SD 30

24RD

25PD

TD20

21 22 SD23

24RD

25PD

TD20

21 22 23 24RD

SD

underlying transaction

transformed transaction


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10 Transformation intocash

The cash transfer(s) settlement instructionsshould retain the same characteristics as thoseof the underlying transaction. If the instructionof the underlying transaction was against

payment, two new instructions, in oppositedirections, will be created; one for thesettlement amount and one for the cashoutturn. The transfers should not be linked.If the instruction of the underlying transactionwas free of payment, only one transfer, for thecash outturn, will be created

Example related to a final redemption of ISIN A at 100% of thenominalInitial transaction:

DVP1: seller X has to deliver 3000000 ISIN A to buyer Yagainst 3005000

After the cancellation and transformation each CSD/CCPcreates 2 PFOD instructions that will match in T2S.The resulting new instructions will be:PFOD1: X has to deliver 0 ISIN A to Y against 3005 000

PFOD2: Y has to deliver 0 ISIN A to X against 3000 00011 Treatment of

fractions insecurities outturns

In case of fractions in the outturn, the numberof securities should be rounded down to thenearest whole number.

ExampleDetails of the reorganisation:7 ISIN A is replaced by 8 ISIN B and the issuer does notcompensate any fraction.DVP1: X has to deliver 150 securities to Y againstEUR200,000

The new quantity after transformation would be calculated asfollows: 150 x 8/7 = 171.43 rounded down to 171The replacement process will be:DVP1 is cancelled by end of RD and replaced by:DVP2: X has to deliver 171 ISIN B to Y against EUR200,000


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12 Treatment of fractions in cashoutturns

When the issuer compensates the fractions incash, an additional cash transaction should becreated with the same characteristics as theunderlying transaction. In this case thequantities of the securities are set to zero. Thecash amount equals the number of residualfractions multiplied by the compensation

price as announced by the issuer.

Rationale:The reference to the underlying ISIN (zero quantity) wouldfacilitate the reconciliation; in that case the new transactionshould be a PFOD used in all cases, and there should always bematching.

ExampleDetails of the Reorganization are:3 ISIN A is replaced by 1 ISIN B and each ISIN A iscompensated by EUR4.00DVP1: still pending by RD of the reorganisation event.DVP1 is cancelled and replaced by 2 new transactions DVP2and PFOD3 (zero quantity)

13 With which status isthe new transformedtransactioninstructed?

The transformed transaction should beinstructed with the same status as theunderlying transaction.

Rationale:In an omnibus environment, deliveries are frozen/not releasedfor settlement by the account servicer until the underlyingclient has the requisite holding. This is done to prevent one

client from using another client's securities. In case of a marketclaim to deliver securities the omnibus account will most probably have enough securities to settle the delivery, but theunderlying client may not - thus necessitating the delivery to befrozen/not released for settlement until the requisite holding has

been verified.

BuyerMember

Y

SellerMember

X

20 ISIN A DVP1

100

SellerMember

X

6 ISIN B DVP2

100

BuyerMember

Y

SellerMember

X 8 (2X4)

BuyerMember

Y

Before

After

0 ISIN BPFOD3


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14 Are there otherspecific fields fromthe originaltransaction thatshould be replicatedin the newtransformedtransaction?

The new transformed transaction should ensurethat the following indicators are correctlyreplicated:

Partialling indicator of the originaltransaction instruction

Ex/cum indicator Opt-out indicator related to the market

claim creation

The life cycle of the transformed transaction should continueaccording to the several indicators stipulated in the originaltransaction.

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