Implications of Final Beneficiary Model for Exchange and Clearing Processes Cícero Vieira Chief Operating Officer 2012, March 27th CLASSIFICATION OF INFORMATION (MARK WITH A “X”): RESTRICTED CONFIDENTIAL CONFIDENTIAL INTERNAL USE X PUBLIC 1 Implications of Final Beneficiary Model for Exchange and Clearing Processes Agenda Introduction to BM&FBOVESPA Implications of Final Beneficiary Model for Trade and Post-Trade Processes Benefits and Costs 2 Implications of Final Beneficiary Model for Exchange and Clearing Processes Agenda Introduction to BM&FBOVESPA Implications of Final Beneficiary Model for Trade and Post-Trade Processes Benefits and Costs 3 Introduction to BVMF 1. BVMF is a multi‐asset vertical exchange created in 2008 by the merger between BM&F and BOVESPA 2. BVMF is the 4th largest exchange in the world by market capitalization as of Mar/23 Market Capitalization (US$ billion) 19,6 18,6 13,0 12,9 10,5 7,7 CME HkEx Deutsche Bourse BVMF ICE Nyse Euronext 5,9 SGX 5,8 ASX 4,7 4,3 3,3 2,6 Nasdaq LSE TMX CBOE 4 Introduction to BVMF 3. BVMF accounts for more than 85% of listed derivatives market volume in Latin America Latin America Volume (ADTV) ‐ Derivatives Markets 100% Latin America without BVMF 80% 60% BVMF 40% 20% 0% 2003 2004 2005 2006 2007 2008 2009 2010 4. BVMF accounts for more than 80% of total stock trading volume in Latin America Latin America Volume (ADV) – Equities Market 100% Latin America without BVMF 80% 60% BVMF 40% 20% 0% 2003 2004 2005 2006 2007 2008 2009 2010 5 Introduction to BVMF 5. BVMF manages for 4 CCPs considered systemically important by the Brazilian Central Bank Cash equities and cash equity derivatives Futures and options on futures Interbank FX cash transactions Corporate bonds and national treasuries 6 Introduction to BVMF 6. BVMF manages the Brazilian Central Securities Depository (CSD) for stocks and bonds *Updated until Aug 31st, 2011 7 Introduction to BVMF 7. BVMF develops and supports the middle and back‐office system used by Brazilian brokers to process and manage their activities, called SINACOR SINACOR offers everything that a broker needs to run its business from a middle and back‐office perspective • • • • • • • • Account registration and KYC Registration of orders Alocation of trades to customers Mark‐to‐market Fee calculation Settlement calculation and processing Custody management Financial statements Completely integrated to BVMF clearinghouses Facilitates the launch of new products Facilitates changes in CCP, SSS, CSD processes Facilitates changes in fee calculation methods Business model oriented towards strategic value creation, not revenue creation • Extremely competitive pricing • • • • • CASH EQUITIES CASH EQUITY DERIVATIVES FUTURES OPTIONS ON FUTURES FIXED INCOME 8 Introduction to BVMF 8. BVMF owns and manages the BVMF Custody and Settlement Bank to Leverage International Investors Activity in Brazil as well as Independent Brokerage Activity Leveraging International Investors Activity in Brazil •2689 account openning and KYC process for equities, derivatives and fixed income •Legal and fiscal representation •Reconciliation of trades •Custody of securities, derivatives and fixed income •FX transactions for settlement purposes •Settlement with local clearing member •Financial statements Leveraging Independent Brokerage Activity in Brazil •Bank provides services mainly for brokers not connected to large financial institutions •Completely integrated with CCP, SSS, CSD and SINACOR infrastructure •Settlement and custody services for brokers and their customers •Focus on BVMF markets •Competitive pricing •Neutrality The BVMF Bank reduces the liquidity risk of BVMF’s 4 CCPs since it has direct access to the Central Bank repo facility 9 Implications of Final Beneficiary Model for Exchange and Clearing Processes Agenda Introduction to BM&FBOVESPA Implications of Final Beneficiary Model for Trade and Post-Trade Processes Benefits and Costs 10 Trade and post trade processes Customer Registration Trade Trade Management Position Management Settlement Risk Management THE FINAL BENEFICARY MODEL HAS IMPORTANT IMPLICATIONS FOR ALL PARTS OF THE TRADING CYCLE Collateral Management Default Procedures Central Securities Depository Information Services 11 Trade and post trade processes 1. Centralized Customer Registration Before any trade is done... BM&FBOVESPA (Exchange, CCP, CSD) Broker Customer Maintains a centralized registration system of customers Only name, tax id and address Sets exclusive customer account number Broker provides basic customer information to the exchange, CCP and CSD Keeps updated customer documentation Complies with KYC and suitability requirements Customer provides information and documentation to its broker Signs intermediation agreement with broker 12 Trade and post trade processes 2. Trade Customer orders can be transmitted to the trading platform in two different basic ways Via the broker’s trading desk, ie, broker manually inputs the order into the system Via sponsored electronic connections brokerage, HFT etc) (DMA, on‐line Orders transmitted via electronic connections must contain customer identification, ie, account number Orders transmitted via broker trading desk must be allocated to customers in the CCP system after the trade is matched, within a given timeframe 13 Trade and post trade processes 2. Trade Customer Access Broker BM&FBOVESPA Access via broker trading desk Trading desk DMA 1 ‐Traditional network Network Pre‐trade Matching Risk check Engine DMA 2 – Customer connection via ISV network DMA 3 – Customer direct connection network DMA 4 – Colocation network ISV Colocation 14 Trade and post trade processes 3. Trade Management Trade Give up Execution Brokers can give up trades to Clearing Brokers for margining and settlement purposes Automatic give up follows registration of give‐up links at different brokers between customer accounts Large Institutional Investors as Clearing Members Large institutional investors can act as clearing members to avoid credit exposure to other clearing members or can use automatic give‐up links to change clearing member 15 Trade and post trade processes 3. Trade Management Automatic trade give‐up between execution and clearing broker BVMF Customer Clearing Member Clearing Member Broker Broker Customer Customer Clearing Member Customer Trade give‐up 16 Trade and post trade activities – Main characteristics 3. Trade Management (cont.) Asset Management Accounts Asset managers may be unable to allocate trades to individual funds before the close of the market since they may want all funds to have the same average price ‐‐ allocation process becomes more complex Individual funds managed by an asset manager are linked to this asset manager’s Master Account Trades allocated to a Master Account can be reallocated exclusively to funds linked to this Master Account Master accounts reduce the time required to identity and to give up trades of asset managers, thereby enhancing intraday risk monitoring by the CCP Master accounts also reduce the risk of rogue brokers cherry picking profitable against non profitable trades between customers 17 Trade and post trade activities – Main characteristics 3. Trade Management (cont.) BVMF Clearing Member Clearing Member Broker Broker Master Account Customer Fund A Fund B Master Accounts are registered at the Exchange’s centralized registration system Individual funds are attached to Master Accounts Orders transmitted by asset managers via customer electronic connections must have the identification of the Master Account in the FIX message 18 Trade and post trade activities – Main characteristics 4. Position Management Given the trade allocation process, the CCP and the CSD are able to register all customer positions and securities on a fully identified and segregated basis BVMF Clearing Member Clearing Member Broker Broker Customer Customer Securities Security derivatives Futures Options on futures Swaps (OTC) 19 Trade and post trade activities – Main characteristics 4. Clearance The CCP and the CSD know in almost real time: Who holds what; How much; and Where This represents a substantial improvement in terms of: CCP and systemic risk management; Customer protection; and Information that is readily available for regulators 20 Trade and post trade activities – Main characteristics 5. Settlement The settlement system calculates net settlement rights and obligations at all levels of the account structure: customer, broker and clearing member BVMF Clearing Member Clearing Member Net settlement rights and obligations Broker Broker Net settlement rights and obligations Customer Customer Net settlement rights and obligations 21 Trade and post trade activities – Main characteristics 5. Settlement The CCP has an account at the Brazilian Central Bank for cash settlement purposes – central bank money cash settlement No credit exposure to commercial banks CCP Central Bank Account (R$) Net financial obligation Net financial obligation Central Securities Depository Segregated customer accounts at the CSD level BVMF Clearing Member Clearing Member Broker Broker Customer Customer Net customer security obligation Net financial obligation 22 Trade and post trade activities – Main characteristics 6. Risk Management (cont.) RISK MONITORING PROCESS PRE‐TRADE RISK LIMITS INTRADAY RISK SYSTEM POSITION LIMITS QUALITY OF COLLATERAL COLLATERAL CONTROL • Pre‐trade risk check is mandatory for DMA. • In case of HFTs, use of risk software provided by the exchange is mandatory. • Exchange/CCP can monitor pre‐trade risk limits established by brokers. • Full calculation of portfolio risk at customer and broker levels every 3 minutes during the day. • Intraday risk leads to intraday margin calls if necessary. • CCP measures customer consolidated exposure independently of broker • Risk concentration limits are applied to customer consolidated exposures in the market • Additional margin call from customers with concentrated positions. • Liquidity and quality of collateral is managed at clearing member, broker and customer levels. • CCP has control/possession of customer collateral on a fully segregated basis • In the case of customer default, brokers have to ask the CCP to unlock the collateral 23 Trade and post trade activities – Main characteristics 5. Settlement The CCP has control/possession of all customer assets deposited as collateral The CCP holds collateral accounts at different CSDs Government Bonds (Central Bank) Customers transfer collateral to BVMF account at CSDs after broker authorization Corporate Bonds and Bank CDs (CETIP) Stocks and Gold (BVMF) International Bonds & Stocks (Euroclear/DTCC) BVMF Clearing Member Clearing Member Broker Broker Customer Customer 24 Trade and post trade activities – Main characteristics 5. Settlement The CCP has control/possession of all customer assets deposited as collateral The CCP holds collateral accounts at different CSDs Government Bonds (Central Bank) Corporate Bonds and Bank CDs (CETIP) Stocks and Gold (BVMF) BVMF In the case of broker default, customer collateral is transfered to another broker Clearing Member Clearing Member Broker Broker Customer Customer International Bonds (Euroclear/DTCC) In the case of customer default, BVMF unlocks collateral for broker’s use, monitoring the process 25 Trade and post trade activities – Main characteristics 8. Default Procedures (cont.) The final beneficiary model allows the CCP to identify, segregate and control customer positions, securities and collateral Misuse of customer collateral by rogue brokers becomes highly unlikely In the case of a broker’s default, the CCP can easily transfer non defaulting customer positions and collateral to non defaulting brokers Positions and collateral of non defaulting customers will not be affected by the default of other customers under the same broker 26 Trade and post trade activities – Main characteristics 9. Central Securities Depository The final beneficiary model at the CSD level allows: Clear investor identification Incontestable ownership of the security Information transmitted directly to investor (warnings, statements) Control and fraud prevention Each account at CSD has a subaccount structure that can be used for multiple purposes General subaccount Collateral subaccount Court Attachment subaccount Securities lending subaccount IPO and Tender Offer subaccount Options and Forwards subaccount 27 Trade and post trade activities – Main characteristics 10. Information Services (cont.) Information Disclosure for Final Investors Customers’ Electronic Channel Information through Internet on customer holdings Information on pending corporate actions Information on open positions in derivatives market and securities lending program Statements Directly Transmitted to Customers Trading warning ‐ every two weeks Transfer warning – t+1 Address modification warning – t+1 Customer holdings declaration ‐ monthly 28 Implications of Final Beneficiary Model for Exchange and Clearing Processes Agenda Introduction to BM&FBOVESPA Implications of Final Beneficiary Model for Trade and Post-Trade Processes Benefits and Costs 29 Final Beneficiary Model Benefits and Costs BENEFITS COSTS Reduction of Systemic Risk Larger IT and Business Processes Investments Robust and centralized pre‐trade risk limits monitored by the exchange/CCP, including for HFTs Consolidation of customer exposures under different brokers and clearing members Additional margin calls from customers with concentrated positions Management of quality and liquidity of collateral at broker and customer levels Control/possession of collateral by the CCP Enhanced default procedures Allocation, position management, settlement, risk management, collateral management and CSD processes become more IT intensive with the final beneficiary model Less Flexibility for Brokers Brokers cannot lend customer collateral and securities Increased Customer Protection Robust trade allocation process mitigating the risk of trade cherry picking Improvement of reconciliation procedures Reduction of risk of customer collateral and securities misuse Periodical issuance of warnings directly to customers: trade, holdings, transfer, and change of address Complete and Consolidated Information for Regulators on a Daily Basis 30 www.bmfbovespa.com.br 31
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