Margarida Baptista November 15, 2002
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Transcript of Margarida Baptista November 15, 2002
ACSDA SeminarNext Challenges in Depository, Clearance
and Settlement Services
- CCP Opportunities -
ACSDA SeminarNext Challenges in Depository, Clearance
and Settlement Services
- CCP Opportunities -
Margarida BaptistaNovember 15, 2002
AGENDA
NET SETTLEMENT SYSTEMSNET SETTLEMENT SYSTEMS
THE CCP SOLUTIONTHE CCP SOLUTION
CBLC MODELCBLC MODEL
CONCLUDING REMARKSCONCLUDING REMARKS
AGENDA
NET SETTLEMENT SYSTEMSNET SETTLEMENT SYSTEMS
THE CCP SOLUTIONTHE CCP SOLUTION
CBLC MODELCBLC MODEL
CONCLUDING REMARKSCONCLUDING REMARKS
Securities Settlement SystemsSecurities Settlement Systems
Real Time Gross Settlement System
Deferred Net Settlement System
DNS x RTGS
RISK
LIQUIDITY
Trade-off: Risk x Liquidity
Minimization of liquidity requirements
Decreasing of participants exposure to credit risk
High reduction of settlement instructions
Netting: advantagesNetting: advantages
Cut down on transaction costs
Decreasing in operational risk
BUT: potential problems ….BUT: potential problems ….
How to handle a participant’s default :
Systemic Risk
Netting: potential problemsNetting: potential problems
The contamination effect depends
on:
the defaulter’s debit value
the number of its counterparties
1st. alternative
Unwinding Procedures
In case of a participant’s
default: contamination of
the debit/credit chain
2nd. alternative
Third Party
Pays
Socialization of losses
Moral Hazard
How to handle a participant’s default :
Netting: potential problemsNetting: potential problems
CCPCCP
International recommendation for risk mitigation in DNS Systems
Allows the benefits of netting without increasing systemic risk
CCP: the third alternativeCCP: the third alternative
Provided that: adequate risk management controls and
systems should be adopted.
AGENDA
NET SETTLEMENT SYSTEMSNET SETTLEMENT SYSTEMS
THE CCP SOLUTIONTHE CCP SOLUTION
CBLC MODELCBLC MODEL
CONCLUDING REMARKSCONCLUDING REMARKS
CPSS-IOSCO: « A central counterparty (CCP) is an entity that interposes itself between the counterparties of trade, acting as a buyer to every seller and a seller to every buyer »
BUYERBUYER SELLERSELLER
Trading
BUYERBUYER SELLERSELLER
CCPCCPCCP assumes the role of the
seller
CCP assumes the role of the
seller
CCP assumes the role of the
buyer
CCP assumes the role of the
buyer
What is a CCP ?What is a CCP ?
Measure;
Manage; and Assume the
counterparty risk
CCP: main function and advantagesCCP: main function and advantages
CCP
RISK ARISK A
RISK BRISK B
RISK CRISK C
RISK DRISK D
RISK HRISK H
RISK GRISK G
RISK FRISK F
RISK ERISK E
CCPRISK
AA
BB
CC
DD
EE
HH
GG
FF
Main advantages:
Guarantee of anonymity
Supports multilateral netting
Absorption of risks between trade and the settlement period
Protection of market participants in the event of a participant default
Prevents the spillover of securities settlement risks to the payments system
Systemic Risk Reduction
Barriers to be overcome in order to implement a robust risk management system
High initial investments
Human resources
Risk management systems
IT systems (both hardware and software)
High ongoing expenses to maintain the system
CCP: main disadvantagesCCP: main disadvantages
High fixed costs Minimum Scale Requirements
AGENDA
NET SETTLEMENT SYSTEMSNET SETTLEMENT SYSTEMS
THE CCP SOLUTIONTHE CCP SOLUTION
CBLC MODELCBLC MODEL
CONCLUDING REMARKSCONCLUDING REMARKS
CBLC: main risks to be managedCBLC: main risks to be managed
Principal Risk
Credit risk
Liquidity risk
Principal Risk
Replacement cost Risk
DELIVERY vs. PAYMENT
SFI-DVP model 3 - multilateral netting for both securities and cash legs
For cash leg, multilateral netting across different markets and instruments
Settlement cycles:
Equities: T+3
Corporate Bonds: T+0 and T+1 Same day finality in central bank money (allowed by the Brazilian Payment System implemented in April 2002)
STR: Central Bank Money Transfer System (RTGS)CBLC: Transitory settlement account at STR
Adequate legal basis: Enforceability of multilateral netting and novation of tradesCBLC lien on securities posted as collateral
CBLC ModelCBLC Model
CBLC ModelCBLC Model
Equities (cash and derivatives)
Corporate debt instruments
BTC – Securities Lending Service
CBLC acts as a CCP: When CBLC becomes a CCP?
CBLC
Trades are automatically reported to CBLC
CBLCCBLC
CCPCCPCLEARING AGENTCLEARING AGENT A A B B CLEARING AGENTCLEARING AGENT
Information is sent to Brokers and Clearing Agents: CBLC BECOMES CCP
AABROKERBROKER
BBBROKERBROKER
Trading Systems Trading
MatchingSell
Order
Buy
Order
Trading and matching
CBLC credit risk: layers of protectionCBLC credit risk: layers of protection
Participants’ requirements
Collateralization
95% confidence level under historic scenarios
Settlement fund 99% confidence level under
stress scenarios
Segregated Net worth
LAMFALUSSY PLUS
Hybrid Loss Sharing model
• defaulters pay
•survivors pay
1st: collaterals posted by the defaulter2nd: defaulter’s contribution to the settlement fund 3rd: settlement fund 4th: segregated net worth
Dealing with payment failures...Dealing with payment failures...
LIQUIDITY PROVISIONLIQUIDITY PROVISION
Financial credit lines provided by a pool of banks
CBLC has only a short time period (3:30 to 3:55 pm) to execute collaterals
Dealing with securities delivery failures
Fundamental mechanism to prevent delivery failures
1st: Securities Lending:
CBLC acts as principal
Full collateralization
Risk management tool: CM–TIMS (OCC system)
Fully integrated in the settlement process
2nd: Buy-in procedures:
T+4: CBLC releases a buy-in order
The buy-in order can be canceled until T+6 should the defaulter delivers the security;
Buy-in order execution: the buyer´s broker buys the security in the market
Market price difference: covered by the collaterals posted by the defaulter
Same day finality in Central Bank Money
Participants requirements
Collateralization
Segregated Net Worth
Multilateral netting supported by a CCP
SFI – DVP 3
Settlement Fund
Securities Lending
Summing up ...
AGENDA
NET SETTLEMENT SYSTEMSNET SETTLEMENT SYSTEMS
THE CCP SOLUTIONTHE CCP SOLUTION
CBLC MODELCBLC MODEL
CONCLUDING REMARKSCONCLUDING REMARKS
Concluding RemarksConcluding Remarks
The choice and design of a suitable model depends on several key variables:
International recommendations and best practices Particularities of each country:
National Payment Systems Legal environment Profile and characteristics of the financial market
Size Regulations Market practices Participant’s size, concentration, profile and business strategies Type and diversity of financial instruments
Strong cooperation between the market and the regulators
Concluding RemarksConcluding Remarks
That is: it is not wise to support an optimal model, regardless the specific context in which it is going to be put in place
Volume and value of financial transactions
Trading patterns among counterparties
Opportunity costs to implement risk management robust systems
RTGS x DNS systems: the choice of adopting one or the other (or a combination of the two of them) has to be addressed, case by case, taking into account:
the trade-offs between the RTGS and DNS systems
cost x benefit analysis
Concluding RemarksConcluding Remarks
CPSS-IOSCO Recommendation n.4:
“The benefits and costs of a CCP should be evaluated. Where such a mechanism is introduced, the CCP should rigourously controls the risks it assumes.”
If a DNS system should be chosen, it is worth considering the implementation of a CCP in order to capture the benefits of netting without jeopardising the systemic risk reduction goal; otherwise, it can be more suitable to settle in a gross basis
Nevertheless: it is possible to outline one general conclusion: