A. Description of Financial Market Infrastructures

5. There are three major FMIs located in Moldova (Figure 1).² They include the Automated Interbank Payment System (AIPS) and two CSDs, the Book-Entry System of Securities (BES) and the National Securities Depository (NSD). The BES and NSD each function as a securities settlement system (SSS) (Appendix III provides a general description of CSD/SSS). Their key features are as follows (Appendix IV provides background information on the CSD/SSS in Moldova):

• The AIPS is a systemically important payment system owned and operated by the NBM. It handles only transactions denominated in Moldovan Leu (MDL). The AIPS has two main components, including a real-time gross settlement (RTGS) system for large value and time critical payments, and a designated-time net settlement (DNS) system for low value payments. The average daily values settled amounted to MDL 2 billion (US$ 214 million), equivalent to 2.7 percent of GDP in 2013. At end February 2014, 18 participants held settlement accounts with the NBM, including 14 commercial banks, the NBM, the State Treasury within the Ministry of Finance (MOF), the Settlement Centre from Tiraspol, the NSD, and one mandated participant that does not hold an account in the AIPS—the Center for Electronic Governance. Central bank intraday liquidity facilities are only available to banks.

• The BES clears and settles government and central bank securities trades, and completes cash settlement by delivery versus payment (DVP) in the AIPS. It is also owned and administered by the NBM. The BES keeps the register of ownership of government and central bank securities at the level of its participants, while BES’ participants keep the register (of beneficial ownership) at the level of their clients. The average daily values settled amounted to MDL 922 million (US$ 73 million) or 1 percent of GDP in 2013 (Table 2). Around 80 percent of total settlement values are central bank securities (Appendix V). There were 17 participants at end February 2014.

• The NSD clears and settles corporate securities traded on the Moldova Stock Exchange (MSE), and completes cash settlement by DVP in the AIPS. There are plans to trade government bonds with a maturity above one year on the stock exchange with clearing and settlement in the NSD (as a sub-register of BES). The average daily values settled amounted to MDL 3 million (US$ 0.2 million) in 2013. Trading volumes are thin (Appendix VI). The NSD is jointly owned by its participants, including the MSE, a registrar company, domestic commercial banks, and broker dealers. Although the NSD is licensed under the Law on Securities Markets to keep a register of corporate securities, no issuer has transferred its share registry from amongst the 11 independent registrars that currently maintain registers for all joint stock companies issued in Moldova. As of March 2014, the NCFM withdrew two registrar licenses and is currently involved in their litigation. Both registrars’ operations have not been suspended, and their cases are being handled by the courts.

Table 2.

Average Daily Volume and Value Processed by FMIs in 2013

Sources: NBM and NCFM.

^1/Equivalent transaction values expressed in U.S. dollars. The average official exchange rate of the MDL against the U.S. dollar was approximately 12.59 in 2013.

^2/GDP for 2013 is based on an estimated growth of 5 percent from 2012 as actual figures have not yet been computed by the National Bureau of Statistics.

^3/This includes transactions handled by the RTGS and DNS systems.

^4/Figures are based on 252 sessions in 2013; n/a is not available as amounts are negligible.

Table 2.

Average Daily Volume and Value Processed by FMIs in 2013

	Value (MDL million)	Value (USD million) 1/	Value (percent of GDP) 2/	Volume
Payment System
AIPS 3/	2,698	214	2.7	55,301
CSD/SSS
BES	922	73	1.0	31
NSD 4/	3	0.2	n/a	5

Sources: NBM and NCFM.

^1/Equivalent transaction values expressed in U.S. dollars. The average official exchange rate of the MDL against the U.S. dollar was approximately 12.59 in 2013.

^2/GDP for 2013 is based on an estimated growth of 5 percent from 2012 as actual figures have not yet been computed by the National Bureau of Statistics.

^3/This includes transactions handled by the RTGS and DNS systems.

^4/Figures are based on 252 sessions in 2013; n/a is not available as amounts are negligible.

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Table 2.

Average Daily Volume and Value Processed by FMIs in 2013

	Value (MDL million)	Value (USD million) 1/	Value (percent of GDP) 2/	Volume
Payment System
AIPS 3/	2,698	214	2.7	55,301
CSD/SSS
BES	922	73	1.0	31
NSD 4/	3	0.2	n/a	5

Sources: NBM and NCFM.

^1/Equivalent transaction values expressed in U.S. dollars. The average official exchange rate of the MDL against the U.S. dollar was approximately 12.59 in 2013.

^2/GDP for 2013 is based on an estimated growth of 5 percent from 2012 as actual figures have not yet been computed by the National Bureau of Statistics.

^3/This includes transactions handled by the RTGS and DNS systems.

^4/Figures are based on 252 sessions in 2013; n/a is not available as amounts are negligible.

Overview of the Trading, Clearing, and Settlement Organization

Citation: IMF Staff Country Reports 2016, 072; 10.5089/9781513504322.002.A001

Source: IMF staff.

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Overview of the Trading, Clearing, and Settlement Organization

Citation: IMF Staff Country Reports 2016, 072; 10.5089/9781513504322.002.A001

Source: IMF staff.

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Overview of the Trading, Clearing, and Settlement Organization

Citation: IMF Staff Country Reports 2016, 072; 10.5089/9781513504322.002.A001

Source: IMF staff.

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B. Past and Ongoing Reforms

6. The Law on Payment Services and Electronic Money (No. 114 of May 18, 2012) came into force in September 2013. By Decision of the Council of Administration of the NBM No. 123 of June 27, 2013, effective as of September 2013, the regulation on the activity of nonbank electronic money issuers and nonbank payment service providers was approved. Regulations on credit transfers, the activity of banks within the international money transfer systems, and payment cards were modified and amended to harmonize with this new law. The amendments have been republished in the Official Monitor of the Republic of Moldova and publicly disclosed on the website of the NBM.

7. The NPC was established. The Council’s statute was adopted in September 2013. It describes the objectives, functions, membership, rights and obligations, organizational structure, power to establish working groups, and meeting arrangements of the Council. The NBM’s Deputy Governor who is in charge of the Payment Systems Department chairs the Council and its Payment Systems Department serves as the secretariat. Council members are represented by senior officials from the NBM, MOF, Ministry of Economy, Ministry of Information Technology and Communications, Center for Electronic Governance, Moldovan Banks Association, and payment services providers and electronic money issuers licensed by the NBM.

8. CSD reforms are ongoing. A coherent reform strategy has yet to be formulated following a range of technical assistance (TA) recommendations.³ Some progress was made in plans to consolidate the share registries held by multiple independent registrars. Under the Moldova Development Policy Operation (DPO), the NCFM and the World Bank have drafted a law to amend the Capital Market (CM) Law. These changes aim to transfer the registers of securities holders of public interest entities to the central depository.⁴ Joint stock companies that have fewer than 100 shareholders (holders of any class of security) and hold capital below MDL 500,000 (US$ 37,000) are not subject to mandatory transfer, and therefore unlikely to be included in the planned consolidation. Adoption by parliament is expected in the first half of 2014 with the transfer process to be overseen by the NCFM. The NCFM is in the process of developing a new database system that will provide a daily backup of all corporate securities from the independent registrars, once the law is passed.

9. The trading of government bonds on the stock exchange is planned. Currently, the NCFM, NBM, MOF, and MSE are in the process of examining the possibility of trading government bonds, with maturities over one year, on the MSE with settlement in the NSD. This is expected to start in April 2014. Government securities are currently traded on Bloomberg. Under the new concept, government bonds would be tradable on the MSE if the NBM accepts the NSD as a participant in the BES. The NBM will be required to open an account in the BES to hold government bonds for those who need to trade bonds on the MSE. Client holdings could be held directly in the NSD instead of indirectly in BES, via primary dealers, as in current arrangements. This would not be compulsory, as any client who does not wish to trade their securities on the MSE could continue to hold their securities with their primary dealer. If primary dealers trade on the MSE then the flows of securities will need to move between the primary dealer’s accounts and the NSD’s account in the BES. The NSD will be required to open personal accounts for clients and maintain a register of client holdings of government bonds, and to provide to the NBM reports on owners in the format prescribed by the NBM Regulation on the BES of Securities. Settlement for government bonds traded on the MSE will be made in real-time based on DVP Model 1 in the AIPS.

A. Effectiveness of the Oversight and Supervision Framework

10. FMIs are subject to the regulation, supervision, and oversight by the NBM or NCFM. The NBM oversees the AIPS and BES. The NCFM regulates the NSD. The FMIs are supervised under their respective legal framework and policy mandates. There is a Memorandum of Understanding (MoU) that establishes cooperation, information sharing, and peer review of assessment results between both authorities.⁵ If assessments or quarterly reports undertaken by the NBM identify noncompliance or gaps in the regulation, supervision or oversight in the AIPS or BES, it may apply measures in the form of modifications or amendments under the NBM/MOF legal framework.

11. The NBM’s role in the payment system is well established, but greater clarification is needed for its involvement in other types of FMIs. The NBM’s statutory objective is to oversee the payments system and facilitate the efficient functioning of interbank payments system to safeguard financial stability and public confidence.⁶ The NBM’s payment systems oversight policy fulfills this task by identifying four major types of payment and settlement systems that are subject to oversight, including the AIPS, SSS, card payment systems, and international money transfer systems.⁷ The oversight policy does not clearly identify the BES as the SSS/CSD or refer to the cooperative oversight arrangements between the NBM and NCFM.⁸ The criteria for FMI oversight are focused on their impact on financial stability and monetary and foreign exchange policies. The PFMIs are not specified as the applicable international standards used to assess the AIPS and BES.

12. The NCFM identifies FMIs under the CM Law. This law establishes the entities and systems that are part of the capital market infrastructure, including the regulated markets, financial intermediaries, multilateral trading facilities (MTF), the CSD, and SSS, and independent registrars. Such entities are authorized and regulated under the CM Law and the NCFM Law. Under Article 79 of the CM Law, the NCFM and NBM jointly issue regulations on clearing and settlement arrangements that support the capital market.⁹

13. The authorities have powers that are consistent with their relevant responsibilities. The NBM’s payment system oversight policy permits it to obtain timely information for the periodic assessment of FMIs under its oversight. Such information includes their architecture and performance, rules and procedures, activity in the FMIs from on-site bank inspections, internal and external audit reports, and regulations and information issued by other institutions. The NBM can also induce change and enforce corrective action by the use of sanctions and/or remedial measures in the form of recommendations or mandatory orders with specific terms of implementation, if it finds noncompliance from its assessments. The NCFM Law and CM Law give the NCFM licensing, regulatory, supervisory, and control powers of the capital market infrastructure, including the NSD. The NCFM’s power to obtain timely information is derived from Article 141 (Supervision and Control of the Capital Market), Article 142 (Investigations), and Article 143 (External Audit) of the CM Law. Under NCFM regulations, FMIs under its oversight are required to submit on a regular basis financial reports to the NCFM.¹⁰ Under the CM Law, the NCFM has the right to approve the methodology for calculating ownership equity for licensed persons and setting capital adequacy requirements. Licensed entities are obliged to immediately inform the NCFM on any material breach of laws relating to operations, manipulation activities, market abuses, or other breaches which may affect market stability. The NCFM can induce change or enforce corrective action in FMIs if it finds nonobservance to the CM Law and other related laws. This includes sanctions in the form of a warning, public warning, suspension or withdrawal of qualification certificates, suspension or withdrawal of officials, suspension or interdiction of activities on the capital market of the natural person, suspension of license, withdrawal of license or authorization, or a fine of up to MDL 1 million. But in practice anything it tries to do can be blocked by court action, including revocation of license. A constitutional court ruling in December 2012 curbed the NCFM’s powers to effectively carry out its functions as a regulator: any regulatory action may be challenged in court and can be suspended immediately, pending the court’s decision.

14. NBM and NCFM staff resources appear to be stretched with increased responsibilities, which could undermine the effectiveness for FMI oversight. Due to an increase in oversight and supervisory responsibilities, the sufficiency of staff resources need to be regularly reviewed, clearly allocated, and increased if necessary. Since September 2013, NBM staff have been tasked with new responsibilities to enforce the Law on Payment Services and Electronic Money and support the secretariat of the NPC.¹¹ Since the PFMIs were published in April 2012, NBM and NCFM staff have also been responsible for the assessment of FMIs under their supervision against the new international standards.¹² As the size and complexity of the assessments and the depth of the review expected of assessors is higher under the new PFMIs, this could require additional resources for full assessments of FMIs in Moldova. Careful allocation of resources and staff training are needed to continue performing assessments of high quality and to ensure the proper identification and monitoring of issues that could compromise the safety and efficiency of FMIs. NCFM staff have not received training on the PFMIs, and would benefit from training on the new international standards. With the planned replication of securities records from independent registrars to the NCFM, staff may be faced with increased workload, particularly in data verification, although this may be on a random basis. Financial resource constraints do not appear to be an immediate issue for both authorities, but as responsibilities increase, resources may have to be increased to support further investments in staff training, for example.

15. NBM and NCFM staff receive some form of legal protection. The NBM Law clarifies the provision of legal protection for NBM officials, including staff in the Payment Systems Department and Market Operations Department, and safeguards against conflicts of interest. Article 38 (paragraph 7, letter d) of the Law on Financial Institutions also affords protection by stating that “the employees of the National Bank, members of the special supervision commission, the special administrator, liquidator and persons employed to assist them shall not be liable for damages, actions or omissions occurred in the course of their duties, except for cases when it is demonstrated that these were intended and illegal.” However, in practice, NBM board members and employees, such as staff appointed as a bank’s liquidator, do not appear to enjoy enough protection against lawsuits while discharging their duties in good faith. Under Article 24 (2) of the NCFM Law, Members of the Council of Administration cannot be detained, arrested or called for administrative or criminal responsibility unless at the request of the General Prosecutor, with due consent of the Parliament. However, NCFM staff have concerns as they have been threatened with prosecution, while every regulatory action that was taken since December 2012 has been challenged in court.

16. FMI policies should be made more transparent. The NBM’s Policy on Payment System Oversight is published in the Official Monitor of the Republic of Moldova and publicly disclosed on its website. Details on the BES, which functions as the CSD and SSS, however, require greater disclosure. FMI developments are reported in separate sections of a combined chapter on the central bank’s activities in the NBM Annual Report. Developments in the BES are described in the money market section. AIPS and oversight activities are reported in the payment systems section. However, improvements are needed in a number of areas. The oversight policy and annual report should clearly describe the systemic importance and strong interdependencies between the major FMIS, including the AIPS, BES, and NSD. For the Annual Report, this could be approached with cross-references to each FMI in the respective sections, or the development of a standalone oversight report. This helps create greater clarity on the roles and responsibilities of each authority on FMIs. The NCFM does not have an explicit FMI policy. This is implied through the CM Law. The NSD and MSE operate under their rules approved by the NCFM. The CM Law grants the NCFM the right to adopt by-laws on their activity. The NCFM is now in the process of adopting regulations under the CM Law, which will also include by-laws on the activity of the CSD and of the market operator. These acts will provide NCFM the necessary policy space in this area. Any NCFM regulation is consulted in advance with all the stakeholders and published in the Official Gazette of the Republic of Moldova and is disclosed afterwards to the public on the official website of the NCFM. An explicit FMI policy statement, based on the CM Law, could be developed for clearer communication and public disclosure. The NBM-NCFM MoU, which contains clear and detailed information on how the authorities divide their responsibilities and cooperate in FMI peer assessments, should be publicly disclosed.

17. The new international standards should be formally adopted within a year. The NBM currently applies internal instructions for the oversight of the AIPS and BES against the PFMIs. The Policy on Payment Systems Oversight does not clearly establish the adoption of the PFMIs. The NBM-NCFM MoU, however, established that the NBM is obliged to perform assessments of the AIPS and BES against the PFMIs for every two years, and the NCFM is responsible to assess the NSD. The NCFM is in the process of developing the regulatory framework under the CM Law where it seeks to adopt the PFMIs. Thus, in the current transition period to the requirements of the new CM Law, the NCFM has informed capital market infrastructure entities that the procedure for issuing new licenses and regulations would be based on their observance of the PFMIs.

18. There appears to be regulatory fragmentation, which may undermine the effectiveness of FMI oversight. The authorities need to adopt and apply consistently the PFMIs, and allocate or share responsibilities according to their mandates and competencies. This may necessitate the amendment of relevant laws to align authorities’ competencies with oversight responsibilities on FMIs. As one way forward, the NBM could apply standards involving issues on systemic risks and financial stability. The NCFM could focus on areas that protect investor rights. The NBM-NCFM MoU provides a good basis for regulatory cooperation, and would benefit from the creation of a joint committee where staff from both authorities work together in drafting FMI assessments and recommendations.¹³ Both authorities currently perform periodic assessments under their competence. The NBM is responsible for assessments of the AIPS and BES. The NCFM is responsible for assessing the NSD. Both parties have agreed to exchange information on the assessment results, and to take into consideration proposals and objections. Revisions to the assessment results are made on a voluntary basis and moral suasion. As both authorities have already established a common working group that meet on an ad hoc basis or when required, this forum could be further developed into a joint committee for the assessment of FMIs.

B. Legal Risk

19. Legal uncertainty remains for the settlement of government and central bank securities, which are being addressed through new draft laws. Specific legal provisions are needed to protect finality, collateral and netting arrangements in case of insolvency proceedings, and investors’ rights in the BES. According to the National Plan for Legislation Harmonization for 2014 (approved by the Government Decision no. 28 of 22 January 2014), the NBM will be responsible for elaborating two draft laws, including settlement finality in payment and securities settlement systems, and financial collateral arrangements. The adoption of such laws is needed. The average daily values handled by the BES amounted to MDL 922 million (US$ 73 million) or 1 percent of GDP in 2013. Implementation of IMF TA advice on legal issues would help address uncertainties on financial collateral arrangements and international law problems.

20. Plans to trade government bonds with maturities of over one year on the stock exchange need to be protected under the CM Law. Article 79 empowers the NCFM and NBM to issue regulations on the procedure of clearing and settlement of transactions with financial instruments that circulate on the capital market. The NSD, in accordance with such regulations, needs to clearly establish government bonds as a financial instrument for which it will carry out clearing and settlement. Article 80 provides finality protection for settlements in the NSD. Plans to adopt explicit legislation on settlement finality and financial collateral may also require further amendments to the CM Law to ensure their consistency.

21. The legal framework requires changes to ensure that registrars do not hamper the process of fully dematerializing the transfer of private securities. Apart from efforts to adopt settlement finality and financial collateral rules in line with international standards, there is also a need to fully dematerialize the transfer of corporate securities. The Civil Code and the Joint Stock Company (JSC) Act implicitly require the intervention of the registrar to enforce a transfer of securities ownership or the creation of a pledge. This does not adequately support the circulation of securities in book-entry form.

C. Comprehensive Risk Management Framework

22. The BES was self-assessed against the PFMIs, while its risk management framework should be strengthened with crisis management arrangements. The NBM has issued the Regulation on Risk Management for the BES. This was approved in August 2013 and came into effect since January 1, 2014. The regulations include specific provisions on risks management mechanisms for operational risk, settlement risk, and custody risk. Under the regulation, the NBM is allowed to assess the effectiveness of policies, procedures, and risk management mechanisms adopted by participants in the BES. BES participants are required to have a governance framework that contains a clear organizational structure with defined responsibilities. They also need to adopt their own policies and procedures to identify, manage, monitor, and report the existing or potential risks, and their internal control mechanisms. The BES does not appear to have developed scenarios that would prevent it from providing critical operations and services, or have a recovery plan.¹⁴ Preliminary self-assessment of the BES against the PFMIs has been completed, in Romanian, and was submitted to the NCFM for peer review on February 20, 2014. Because of the interdependencies between the AIPS and BES, and AIPS and NSD, the NBM should ensure that it has crisis-management arrangements that would allow for effective coordination among the affected entities, including cases in which its own viability or the viability of an interdependent entity is in question.

23. A comprehensive risk management framework is lacking and a self-assessment against the new international standards is needed for the NSD. Current risk management practices are largely focused on operational risks as guided by the Measures to Reduce Risks in Clearing and Settlement Operations of 2010. The NSD was assessed by the NCFM against the CPSS-IOSCO Recommendations for Securities Settlement Systems (RSSS) in 2011.¹⁵ There has been no self-assessment of the NSD against the PFMIs. The current risk policy encompasses measures to manage operational risks and settlement risks (through the guarantee fund). The NSD is also required under the CM Law (18 months after its enactment) to develop and apply internal audit policies to protect the safety, integrity and confidentiality of internal data. The audit would also include risk identification and risk management. The NSD is also required to perform a mandatory audit of its financial condition at least once a year and a technical audit of its information systems at least once every 2 years. There does not appear to be a capacity to aggregate risks or identify scenarios that would prevent it from providing critical operations and services. Recovery plans need to be developed and shift the focus from measures to manage operational risks to those that deal with financial constraints, particularly the holding of sufficient liquid net assets funded by equity to continue operations if it incurs general business losses. Because of the interdependencies between the NSD and AIPS, it should also develop crisis-management arrangements.

D. Credit and Liquidity Risk

24. Potential credit and liquidity risks remain in the NSD. The NSD’s settlement of corporate securities features a delivery versus payment (DVP) mechanism where final cash settlement takes place at the NBM. This is based on DVP Model 3, providing the simultaneous net settlement of securities and funds transfers at T+3. DVP Model 3 limits principal risks. Before trade execution, the MSE checks the availability of securities, resulting in a very low settlement failure rate. However, as settlement is made on the third day following a transaction, where the securities of the seller and the cash of the buyer have been earlier blocked, potentially large liquidity exposures are created if a participant fails to settle its net funds debit position. Some or all of the defaulting participants’ transfers may have to be unwound under this scenario. This would impose liquidity pressures on the non-defaulting participants. If all such transfers must be deleted, and if the unwind occurs during stressed market conditions, the remaining participants could be confronted with shortfalls of funds or securities that would be extremely difficult to cover. The potential total liquidity pressure of unwinding could be equal to the gross value of the netted transactions. NSD rules provide for a sanction of 5 percent of the total value of a transaction in the event of settlement failures, but there has so far been no occurrence of such events. The NSD should evaluate the benefits and costs of a settlement cycle for corporate securities that is shorter than T+3, particularly when settlement activity has heightened. Speedier settlements also need to be balanced with the time and capacity to monitor potential raider attacks on vulnerable companies, which can only be achieved with a reform of the registrars. The NSD plans to settle government bonds with maturities over one year on T+0, which will help remove counterparty credit and liquidity risks.

25. The guarantee fund appears to be insufficient for the NSD. The size of the fee paid into the guarantee fund is fixed at MDL 30,000 and does not appear to be adequate to reduce potential settlement risks.¹⁶ The average daily value handled by the NSD was MDL 3 million (US$ 0.2 million) in 2013. This amount, although marginal, could potentially increase with planned settlement of government bonds with maturities over one year (and the expected increase in the issuance volume of government bonds) and the cross-border trading of securities. The NSD does not offer credit to its participants or permit debit balances for securities. A shortfall of funds is possible in the event of a participant default, resulting in the unwinding of participant positions and a recalculation of their obligations. This could further lead to unexpectedly large funds or securities debit positions for other participants. A second default may result if a participant is unable to cover its new obligations on time. Under Principle 7 (Liquidity Risk) of the PFMIs, the NSD should seek to maintain sufficient liquid resources to effect payment obligations with a high degree of confidence under a wide range of potential stress scenarios that should include, but not be limited to, the default of the participant and its affiliates that would generate the largest aggregate payment obligation in extreme but plausible market conditions.

26. Credit and liquidity risks are well managed in the BES. The cash leg for government and central bank securities trades are settled in the AIPS under DVP Model 1 at T+0. This feature allows for the gross and simultaneous settlement of funds and securities. Transactions become final on an obligation-by-obligation basis during the course of the settlement day, thus reducing credit and liquidity exposures among participants or between a participant and the BES. As the cash leg is settled in the RTGS component of the AIPS, participants are not exposed to any credit risks. The NBM may extend intraday credit by providing collateralized overdrafts to banks participating in the AIPS to ensure timely settlement of securities transfers, while employing various risk controls to limit credit risk to the NBM. The BES does not permit overdraft or debit balances in securities.

E. Central Securities Depository

27. National CSD reforms have progressed at a slow pace, and are undermining the integrity and efficiency of the FMI landscape. Despite the NCFM’s action plan in 2011 for the creation of a modern structure for the NSD, including taking over the function of holding the registers, the necessary legislation has failed to gain parliamentary support. This action plan was approved by Law No. 35 of March 3, 2011 on the approval of the strategy on developing the financial non-banking market for 2011–14, which required implementation by the NCFM. Based on this action plan, the NCFM has provided to the NSD a license for maintaining shareholder registers. Earlier efforts to amend the CM Law with a provision to replace independent registrars with a central depository were excluded from the final version approved by parliament. There have also been mixed reactions from the NCFM and MSE towards the establishment of a single CSD, particularly on the nature of the future entity and details of its implementation.

28. CSD reform efforts should continue under the NPC and include a cost analysis. A possible approach is as follows. First, a Working Group on CSD Reform, co-chaired by the NBM and NCFM, should be formed under the NPC.¹⁷ Alternatively, the authorities may want to create a forum outside the Council if they consider this more appropriate and practicable. Both authorities should establish the terms of reference and representation in the working group. Second, a cost analysis should be conducted, in cooperation with international partners that have similar implementation experiences, to assess the economic feasibility of a single CSD. The analysis should provide estimations of the investment costs, transaction costs, connection costs, and foreseen cost recovery. It could include an estimation of the scale and scope economies, and how this will impact the average cost per transaction. It should address the investment cost for participants, including the connection and network cost. Third, the financial and risk management capabilities of the private sector should be assessed, particularly in meeting minimum capital requirements. As the NSD’s financial condition and risk management practices appear relatively weak, so that it might not be capable of becoming the new CSD (with a modern IT system and appropriate governance arrangements), other feasible arrangements should be considered. This could include central bank involvement, if required, to help establish the single CSD and ensure the safe and efficient settlement of securities. And fourth, the working group should develop a coherent and well sequenced reform strategy, to be approved by the NPC, which will guide implementation and minimize industry impact.

29. Fraud risk continues to compromise the integrity of the corporate securities registration system despite efforts to consolidate and replicate records. Governance of the registrars is weak, back-ups are virtually nonexistent, and procedures for handling and controlling data and records are poorly managed and monitored. Ongoing reforms include proposed amendments to the CM Law to transfer the registers of securities holders of public interest entities to a central depository. Adoption by parliament is expected in the first half of 2014. To strengthen oversight, a new database system is being developed to provide daily backups of all corporate securities from the independent registrars, once the legislation is passed. Data verifications, however, will be on a random basis. The NCFM plans to perform data verifications based on the risk profile of the participant or the register as a result of any complaints. The verification of electronic records of independent registrars against paper documents, which cover a period of 20 years and includes about 3,000 companies, is also expected to demand significant resources. Data reconciliation measures to ensure integrity in the new database also appear to be lacking.

30. The planned transfer of some corporate securities into a single depository is partial. The authorities should aim for fuller consolidation in the medium term. The NCFM plans to enact amendments in the CM Law to consolidate the registration system for corporate securities traded on the stock exchange (or private securities subject to public offering) into a single depository. However, the authorities should review the criteria of limiting mandatory consolidation to public interest entities with the aim of improving integrity for the whole securities registration system, although it clearly makes sense to transfer public interest entities first. The exclusion of non-public interest entities, which form over half of all registered joint stock companies, hampers efforts to prevent fraud risks. The NCFM should take into account the benefits of detecting fraud against the cost of auditing public interest entities. As interim measures, the authorities could strengthen oversight by increasing the frequency of registrar inspections from the current requirement of three years. Information obtained from periodical shareholder meetings in joint stock companies also provides an alternative approach to reconcile securities records. Such measures, however, are not as effective as moving towards the full consolidation of all securities records in a CSD. Many difficulties remain in the transfer process, which need to be addressed on a gradual basis. The independent registrars keep the register of securities holders for about 2,000 joint stock companies out of 3,000 companies held in the state register of securities. The rest of them are inactive. Around 1,000 out of 2,000 joint stock companies are registered at the stock exchange. However, the stocks of only around 200 are traded. Many contracts between the independent registrars and the inactive joint stock companies have expired. Furthermore, as the issuers have not signed new contracts, this forces the independent registrars to keep these databases on their own account. The transfer of these companies’ registers to the central depository will be fairly problematic due to the impossibility of signing new contracts with the central depository, although this is necessary to comply with legal provisions. Also, the central depository may face losses by keeping these registers.

F. General Business Risk

31. Financial constraints could risk operational disruptions in the NSD. There appears to be a potential impairment of the financial condition of the MSE and NSD. Although new capital was raised by shareholders and an increase of fee income has helped the MSE and NSD comply with the minimum capital requirements under the CM Law, they have operated at a loss in some years. The MSE’s income did not cover total expenses during 2009 to 2011.¹⁸ Financial conditions improved in 2012 with a sharp increase in the turnover of transactions on the stock exchange to MDL 623 million from MDL 241 million in the previous year. This corresponded with similar losses for the NSD during 2009 to 2010. The NSD’s shareholders are currently in consultations with the NCFM for further capital increases. This lack of sustainable income constrains further modernization of the system. The lack of general business risk identification, monitoring, and management could result in operational disruptions. As the NSD has strong interdependencies with the AIPS, such risks could spillover to the interbank payment system.

32. Liquid net assets do not appear to be sufficient or readily available to cover potential general business losses in the NSD. The NSD periodically evaluates its financial position to prevent or avoid eventual business risks. The holding of liquid assets, however, is temporary due to the lack of a legal obligation. The resources from the Participants’ Risk Fund exclude the depository’s funds and are used only for participants’ debt amortization regarding their obligations arising at trades settlements. Under Principle 15 (General Business Risk) of the PFMIs, the NSD should hold sufficient liquid net assets funded by equity to cover potential general business losses so that it can continue operations and services as a going concern if those losses materialize. Further, liquid net assets should at all times be sufficient to ensure a recovery of critical operations and services. The NSD should maintain a viable recovery plan and should hold sufficient liquid net assets funded by equity (such as common stock, disclosed reserves, or other retained earnings) to implement this plan. At a minimum, the NSD should hold liquid net assets funded by equity equal to at least six months of current operating expenses.

G. Operational Risk

33. There are clear plans to deal with operational disruptions in the BES, but the close proximity between the main and secondary servers continues to pose as risks. The NBM’s Market Operations Department oversees the BES business continuity plan, which establishes the procedures for mitigating the risks associated to critical events that may affect its normal functioning. This is to ensure the resumption and recovery of critical functions and important processes in defined time intervals for each process so that transactions are processed on the settlement date. The NBM’s Business Continuity Management Regulation has established the maximum possible downtime for critical processes at 2 hours. The estimated recovery time objective for BES is less than 30 minutes. This compliance is tested annually and is mandatory for the most active participants on the BES. As at November 2013, single points of failure have not been identified. The rules on evidence and management of the incidents in the NBM establishes a defined framework to ensure continuity capacity management, monitoring and avoiding incidents, recovery measures are undertaken in a timely manner and with minimal impact on the processes or activities. The main and secondary servers are located in different buildings within the same compounds of the central bank, but are approximately 30 meters apart. The NBM currently has plans to relocate to a new secondary server (approximately 10 to 40 kilometers from the main site) and should address such risks expeditiously. BES operational security was assessed as partly observed against the RSSS.

34. The NSD appears to lack clear recovery time objectives. There has so far been no incident of operational failure to the NSD. However, there is a lack of incident reports by the NSD or NCFM to corroborate this observation. The NSD has internal control procedures and security measures for its automated systems, designed to prevent the limit of its operational risk, by identifying and eliminating system failures, fraudulent personnel activities, as well as disclosure of confidential information. Periodic stress tests are performed. In the event of unforeseen circumstances, the depository system of the NSD is launched on the mirror-server, which allows the immediate update of its activity regarding property rights records and settlement transactions. This server is tested periodically. The NSD has a secondary site located 10 kilometers from the main site. The secondary site is tested every month without participants. Data regarding the operations performed, except electronic evidence, is covered by making paper copies, which allows the possibility to double check the information in cases of system errors. The information regarding the operations performed is also kept electronically in a box leased in the commercial banks, which is periodically updated. Also in accordance with the CM Law, the NSD is required to develop and, if necessary, implement an emergency plan for data recovery to any failure and periodic testing of backup systems. The NSD’s Measures to Reduce Risks in Clearing and Settlement Operations do not specify recovery time objectives. A recovery plan in exceptional cases or force majeure is currently missing. NSD operational security was assessed as generally compliant against the RSSS.