The impact of Dodd Frank and EMIR on clearinghouses is an ongoing topic of discussion and while it does offer opportunities, it also imposes huge technological challenges. One company that has direct experience of a complex post-trade integration project is Sweden’s Cinnober. Their CEO, Veronica Augustsson, spoke to Best Execution about helping Brazil’s BM&FBOVESPA – one of the largest exchanges in the world – to integrate their clearing operations.
BM&FBOVESPA is a vertically integrated multi-asset exchange that operates both listed and over-the-counter (OTC) markets, and also acts as a clearinghouse and central counterparty. However, since the 2008 merger of the two Brazilian exchanges Bovespa and BM&F into BM&FBOVESPA, they have been managing four separate clearinghouses – equities and corporate bonds, derivatives, foreign exchange and federal government bonds – for its different markets.
This means four separate sets of rules and procedures, four separate risk management systems, four collateral pools that do not communicate with each other, and four distinct IT environments that require constant maintenance and affect time-to-market for new products and functionalities, as well as lead times to comply with regulatory requirements.
The integration initiative
The Post-Trade Integration Project (IPN) is BM&FBOVESPA’s initiative to combine their four existing clearinghouses into a single integrated entity, for which Cinnober supplies the clearing system. A modern and flexible real-time, cross-asset clearing system will allow BM&FBOVESPA to strengthen the robustness of their risk management process while achieving more efficient capital allocation for their participants and adopting a common risk model for all markets.
By integrating a very complex and costly post-trade structure into one multi-asset clearinghouse using one clearing system, there are a lot of wins to be made. Benefits for participants include a new margin calculation model which will allow risk to be offset across different asset classes, as well as between open interest and pledged collateral; more efficient use of capital to meet intraday liquidity requirements; and real-time information on open interest, mark-to-market and risk analysis.
Faster processing and increased capacity, plus BM&FBOVESPA’s improved ability to innovate and launch new products, will in turn promote further growth of the Brazilian markets.
The exchange has developed a highly innovative risk management model called CORE (Close Out Risk Evaluation). While estimating the maximum potential loss in a portfolio in case of a default, it also proposes the optimal way to liquidate the portfolio and estimates the worst potential cash flow scenario. CORE is more intelligent than traditional models which primarily aim at closing a defaulted portfolio as quickly as possible, and BM&FBOVESPA expects that CORE will become of interest to other CCPs in the future.
BM&FBOVESPA also has the intention to grow quite radically; from 600,000 to 10 million accounts. In Brazil, clearing takes place on the level of the individual final beneficial investor. While this offers a strong model for transparency and precise risk management, it puts very high demands on the clearing system, especially when managing risk in real time; this means that the system needs to have real-time information about positions, margin requirements and collateral for each account. As far as we are aware, handling this number of accounts in a clearing system is unique in the industry.
As it is the least interdependent market, derivatives will be the first asset to go live in the new system in Q1 2014. The equities, bonds and foreign exchange markets will follow and soon after BM&FBOVESPA can create one single CCP, pending regulatory approval.
Second-guessing the market
At Cinnober, we started developing a real-time clearing solution shortly after the Lehman crash, which had made it painfully clear that the industry’s post-trade and risk management systems hadn’t kept pace with the remarkable innovation and developments in the trading industry. We understood that tougher requirements would come, and also identified the need to utilise market participants’ capital/collateral as efficiently as possible, which can only be done by managing risk in real time, and net exposures when possible. Our clearing solution is based on the same technical platform as our exchange system, which is designed to meet the extreme requirements of the most demanding exchanges on performance, speed and robustness.
BM&FBOVESPA carried out comprehensive assessments and tests before choosing our organisation as the supplier. We were selected after a “proof-of-concept” in which we demonstrated both the capabilities of our organisation in delivering mission-critical solutions of this major scope, as well as the capacity and flexibility of our technology.
Cinnober is also benefiting from the project. Being such a big exchange, BM&FBOVESPA has developed a huge portfolio of instruments across all asset classes. This has been the best proof we could ever get of our system’s completeness as a multi-asset, multi-instrument global clearing system.
BM&FBOVESPA is an inspirational organisation and is far ahead of the clearinghouses in Europe and the US when it comes to cross-asset clearing, as well as with the usage of end client clearing, which serves transparency very efficiently. We know that the big clearinghouses globally follow BM&FBOVESPA’s initiatives with great interest and we are of course well positioned to also deliver the systems needed in Europe and the USA where there is an urgent need to modernise clearing services.
For us the biggest challenge is to get clearinghouses to dare to make this shift from legacy systems onto modern and flexible technology. Many think it is too risky a project, but the truth is that it will become necessary for their continued success and survival. Thanks to BM&FBOVESPA, we think we have proved that even very large and complex system infrastructures can be replaced quite smoothly by breaking down the assignment and using tried and tested methods and procedures.©Best Execution 2013