BM&FBOVESPA s Post-Trade Infrastructure

Transcription

1 BM&FBOVESPA s Post-Trade Infrastructure Integration Opportunities and Challenges

2 This White Paper was prepared by the Clearing, Risk Management and Central Depository Executive Officer team of BM&FBOVESPA working in collaboration with Bruce Butterill, an Independent Capital Markets Infrastructure Consultant. January 2010

3 BM&FBOVESPA s Post-Trade Infrastructure Integration Opportunities and Challenges

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5 Integration Opportunities and Challenges CONTENTS EXECUTIVE SUMMARY...9 INTRODUCTION PART I ENVIRONMENTAL REVIEW The Brazilian Marketplace BM&FBOVESPA in a Snapshot PART II CORE POST-TRADE INFRASTRUCTURE THE BASIC BUILDING BLOCKS BM&FBOVESPA Central Securities Depository BM&FBOVESPA Securities Settlement Systems BM&FBOVESPA Central Counterparty Services Central Securities Depository, Settlement System and Central Counterparty - Best Practices PART III INTERNATIONAL EXPERIENCES IN POST-TRADE OPERATIONS INTEGRATION Australian Stock Exchange (ASX) Integration Case Study Depository Trust and Clearing Corporation (DTCC) Integration Case Study Hong Kong Exchanges and Clearing Limited (HKEx) Integration Case Study Main Conclusions of the International Experiences in Post-Trade Operations Integration PART IV INTEGRATION OPPORTUNITIES Creation of a unified vision for portfolio risk to enhance participants and investors risk monitoring and management Adoption of common risk management for all systems, combining two or more Central Counterparties (CCPs) with a common margin calculation, adopting a common loss sharing approach and integration of different financial instruments across CCPs More efficient use of collateral, with the introduction of a collateral pool Improved liquidity and cash management with netting of payment obligations, fostering harmonization of settlement processes during the day Availability of a more diversified suite of products and services to a broader range of potential customers Provision of a financial information hub and electronic platforms, facilitating the delivery of information in a standardized manner through a single portal to support a variety of traded products and services PART V INTEGRATION OPPORTUNITY CONSIDERATIONS Need for Consensus Market and Functional Segmentation Risk and Collateral Management Considerations Changes in the Participants modus operandi Regulatory Models and Risks The Stakeholders Equation APPENDIX

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7 EXECUTIVE SUMMARY

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9 Integration Opportunities and Challenges EXECUTIVE SUMMARY Introduction It is our hope and expectation that the development of this White Paper will prompt an active and informed dialogue among our stakeholders regarding both the opportunities and challenges associated with an increased level of integration of BM&FBOVESPA s post-trade infrastructure. Much has happened in the months since the merger of BM&F with Bovespa in May of During this time the management team at BM&FBOVESPA has focused its energies on bringing about the smooth and effective amalgamation of the two organizations into one that provides an integrated group of services, ranging from listing services through trading, clearing, risk management, depository and other support services. Over the past year we have done a great deal to enhance and streamline our operations, and during the latter half of 2008 we faced the added challenge of managing the impact of the financial crisis. Following the second quarter of 2009 we turned our attention to examining how a greater integration of our post-trade systems environments and processes could benefit BM&FBOVESPA, our participants and the Brazilian market as a whole. Up until now there has been a great deal of internal discussion on this subject, but we feel the time is right to move the discussion of how we can bring about the achievement of a more efficient post-trade environment to the broader public forum. Although integration opportunities might exist within BM&FBOVESPA s different business lines, this White Paper will focus only on those related to the post-trade environment; more specifically the integration opportunities related to central depository, clearing and settlement and risk management systems, processes and procedures. Through this White Paper we strive to: 1. Present to our various stakeholder groups the opportunities which are believed to exist from the further integration of post-trade systems and operational activities; 2. Assist in furthering the knowledge of stakeholders regarding our business model; 3. Stimulate informed discussion on the subject; 4. Act as a catalyst for action; 5. Provide a framework for any integration actions that are undertaken; 6. Outline what we believe to be viable options for integration. The Brazilian Capital Market and BM&FBOVESPA In order to better understand the integration opportunities we foresee in BM&FBOVESPA s post-trade infrastructure, it is important to understand the context in which these changes might take place. Over the past two decades, we were witness to a dramatic evolution of the Brazilian economic, regulatory and market environments that has had, and will have, an impact on the discussion of integration opportunities and options. Brazil has evolved into a very important financial and capital market, both in terms of its size and level of sophistication. The Brazilian financial and capital markets have a high quality and prudent regulatory 9

10 BM&FBOVESPA s Post-Trade Infrastructure environment, and the changes that were implemented in the payments infrastructure were absolutely crucial in achieving the current level of excellence in the clearing and settlement process. The Brazilian capital market has also seen the consolidation of the exchanges, in a process that began with the demutualization of Bovespa and BM&F in 2007, followed by each company going public and listing their shares on Bovespa, and then ultimately, to the merger of the two organizations resulting in the establishment of BM&FBOVESPA in May of In this sense, it is important to bear in mind that BM&FBOVESPA is a vertically integrated exchange providing the Brazilian capital market and its participants with a wide range of services: Listing services for local and international issuers with differentiated levels of corporate governance (Novo Mercado); Electronic trading solutions for intermediaries and Direct Market Access (DMA) for local and international investors, including co-location connectivity; Electronic registration environment for OTC derivatives, with or without the interposition of the Central Counterparties (CCP); Central counterparty clearing and DVP settlement: A Central Securities Depository (CSD) platform with a beneficial owner account structure; Securities lending services where BM&FBOVESPA acts as the central counterparty to borrowers and lenders; Banking infrastructure BM&F Bank offers settlement bank and custodial services to market intermediaries and provides the Clearinghouses access to the Brazilian Central Bank rediscount; and Integrated and modular IT solutions for intermediaries front, middle and back office activities (Sinacor). BM&FBOVESPA is also a multi-asset class exchange, offering a wide array of products in the various markets and presenting solid growth in the number of trades and overall volumes during recent years. It should also be mentioned that BM&FBOVESPA provides the infrastructure and systems that make up the foundation of the post-trade processing environment in Brazil. Post-Trade Core Infrastructures The Basic Building Blocks BM&FBOVESPA s post-trade infrastructure can be divided functionally into three core units: a Central Securities Depository (CSD), Securities Settlement Systems (SSS) and Central Counterparties (CCP). We consider these units to be the building blocks upon which BM&FBOVESPA will further develop its post-trade infrastructure. They will serve as the foundation for future advancements as part of our committed efforts to meet the continually evolving needs of our market. Here at BM&FBOVESPA we operate a world class Central Securities Depository (CSD) that services the full breadth of the Brazilian securities markets. We have implemented a holding model where the custody records are maintained based upon beneficial owner registration, representing the official record of ownership as prescribed under Brazilian Regulation. Securities held within our custody have been completely dematerialized (where no physical certificates exist) for holdings of equities, corporate bonds, mutual fund units, exchange-traded funds, agri-business bonds and mortgage-backed securities. This efficient Central Securities Depository (CSD) infrastructure provides the foundation upon which it is possible for market participants to initiate and complete large volumes of transactions that would not otherwise be operationally feasible. 10

11 Integration Opportunities and Challenges Within the post-merger organization we are currently operating four distinct settlement processes as well as four distinct Central Counterparties (CCPs) in support of the equity, corporate bonds and stock derivatives, financial derivatives, government bonds and foreign exchange markets. BM&FBOVESPA has put in place settlement systems and processes of the highest caliber, compliant with prevailing international standards and thus provide market participants with reliable and secure transaction settlement. For example, we directly control both the movement of funds and related securities without the use of intermediaries in the process 1. We have also put in place sophisticated risk management systems and processes which are designed to effectively safeguard each of the CCPs (Central Counterparties) against the risks associated with the default of a participant. The Central Counterparties (CCPs) have mechanisms for managing market risk, liquidity risk, credit risk, legal risk and operational risk. The varying structures of our systems reflect the nature of the markets they serve, providing participants with efficient risk management tools. The various Central Counterparty (CCP) risk models within BM&FBOVESPA, while differing in their underlying structure, share a common philosophy of providing BM&FBOVESPA and our participants with an extremely high level of confidence that the risks inherent in the clearing and settlement processes are effectively managed. BM&FBOVESPA s Central Securities Depository, Settlement Systems and Central Counterparties have been strongly influenced by the recommendations issued by a number of organizations, such as The Group of Thirty, International Organization of Securities Commissions (IOSCO) and Bank for International Settlements (BIS). BM&FBOVESPA s compliance with these recommendations is described in the Appendix of this White Paper. International Experiences in Post-Trade Integration Stemming from the strong belief that there is a much to be learned from the experiences of other countries, we included in the White Paper a set of case studies which illustrate how some other markets have gone about the process of integration. These case studies were developed in consultation with our peers in the respective markets and provide some valuable insights into their experiences, particularly in relation to: What extent these organizations have integrated processing for various instrument types or markets serviced by their organizations; What were their motivations were in pursuing an increased level of integration; What challenges they experienced along the way; How the benefits they realized compared with those they envisioned at the outset. The analysis of these markets illustrates that, as their infrastructures pursued an increased level of integration of their operations, a variety of challenges were encountered which needed to be addressed. From a very general perspective, the most relevant challenges faced by the infrastructures in their interaction with market participants related to one or more of the following aspects: 1 The only exception is the Foreign Exchange Clearinghouse that settles USD through settlement banks in the USA. 11

12 BM&FBOVESPA s Post-Trade Infrastructure There was a marked difference in the perception of various participant groups with respect to initiatives being considered. Differences and issues tended to grow through analysis, rather than getting smaller. The market view was at times different than that of the infrastructure with respect to the potential benefits of various initiatives. In some situations the complications and risks associated with integration of systems outweighed the potential benefits. Integration of legacy market systems was a highly complex undertaking as it involved not only technical preparation and migration, but also operations integration, rules and operational procedures changes, market readiness, a period of parallel processing and fallback arrangements, etc. Integration Opportunities Immediately following the merger of BM&F and Bovespa, we embarked on our path towards everincreasing levels of integration. The company has now been organized within a single legal entity and operating units across the various markets have been consolidated, generating synergies and providing the foundation upon which we will achieve greater levels of integration and efficiency. A more advanced degree of integration of the post-trade environments across the various BM&FBOVESPA markets presents the opportunity to build a business and service center for the Brazilian and international markets with greater opportunities for: Creation of a unified vision for portfolio risk to enhance participants and investors risk monitoring and management activities; Adoption of common risk management for all systems, combining two or more CCPs (Central Counterparties) with a common margin calculation, adopting a common loss sharing approach and integration of different financial instruments across CCPs; More efficient use of collateral, with the introduction of a collateral pool; Improved liquidity and cash management with the unification of two or more settlement windows (specific time during the day to arrange the DVP); Availability of a more diversified suite of products and services; e Improvements in the operating efficiency of participants, through the harmonization and standardization of BM&FBOVESPA s information and process. These opportunities comprise a set of initiatives that can be classified as actions; that are currently underway, planned, and actions being considered.. Integration Opportunities Considerations There are some elements of the integration opportunities presented in the previous section that are a natural byproduct of combining our infra-structure, such as the construction of a unique portal for accessing BM&FBOVESPA s services, as well as the potential to combine existing tools and products to better serve our customers. There are other elements, however, that require a deep understanding of our market s functioning as well as a thorough analysis of the changes being contemplated in order to ensure that the outcomes will be beneficial for the various categories of market participants and stakeholders. 12

13 Integration Opportunities and Challenges Those potentially more controversial aspects of integration will probably require deeper reflection and consultation in order to build an appropriate level consensus on the best way forward with the various integration opportunities. Among these considerations are: Need for Consensus among stakeholder groups on the best approach to adopt regarding the integration opportunities. Market and Functional Segmentation necessitates consideration of the differences in the various markets and market participants. While there is a substantial level of overlap, participation in each of the different markets is not identical. Risk and Collateral Management Considerations will raise important questions as we examine the various integration options. Changes in the Participants modus operandi which might be required as a result of various integration opportunities. Careful consideration will need to be given to the potential impacts on participant operational processes, whether they are expected to be potentially positive or negative. Regulatory Models and Risks, because the market segments supported by BM&FBOVESPA operate under a variety of regulatory frameworks. The goal behind all of the integration opportunities we have outlined is to create value for all stakeholders in a balanced way. BM&FBOVESPA has the responsibility to seek technical solutions considering, at the same time: improvements in service quality, excellence in risk management, cost-efficiency for market participants, regulatory reliability, and, returns to shareholders. The considerations identified are aimed at encouraging stakeholders to take a broad market view in building an ever more efficient post-trade infrastructure in support of advancing the attractiveness and competitiveness of the Brazilian capital market. Next Steps Based upon the input received from stakeholders following review of the material in this White Paper and the ensuing exchange of ideas, BM&FBOVESPA will formalize a plan of action that will likely include an examination of one or more of the integration options outlined within this paper, or possibly another variation which emerges from the dialogue. 13

14 BM&FBOVESPA s Post-Trade Infrastructure 14

15 Integration Opportunities and Challenges INTRODUCTION 15

16 BM&FBOVESPA s Post-Trade Infrastructure 16

17 Integration Opportunities and Challenges INTRODUCTION It is our hope and expectation that the development of this White Paper will prompt an active and informed dialogue among our stakeholders regarding both the opportunities and challenges associated with an increased level of integration of BM&FBOVESPA s post-trade infrastructure. Much has happened in the months since the merger of BM&F with Bovespa in May of During this time the management team at BM&FBOVESPA has focused its energies on bringing about the smooth and effective amalgamation of the two organizations into one that provides an integrated group of services ranging from listing services through trading, clearing, risk management, depository and other support services. Over the past year we have done a great deal to enhance and streamline our operations, and during the latter half of 2008 we faced the added challenge of managing the impact of the financial crisis. Following the second quarter of 2009 we turned our attention to examining how a greater integration of our post-trade systems environments and processes could benefit BM&FBOVESPA, our participants and the Brazilian market as a whole. Up until now there has been a great deal of internal discussion on this subject, but we feel the time is right to move the discussion of how we can bring about the achievement of a more efficient post-trade environment to the broader public forum. Although integration opportunities might exist within BM&FBOVESPA s different business lines, this White Paper will focus only on those related to the post-trade environment; more specifically the integration opportunities related to central depository, clearing and settlement and risk management systems, processes and procedures. Through this White Paper we strive to: Present to our various stakeholder groups the opportunities which are believed to exist from the further integration of post-trade systems and operational activities; Assist in furthering the knowledge of stakeholders regarding our business model; Stimulate informed discussion on the subject; Act as a catalyst for action; Provide a framework for any integration actions that are undertaken; Outline what we believe to be viable options for integration. In order to discuss the future design of BM&FBOVESPA s post-trade infrastructure, we believe it is essential to begin by building a comprehensive understanding of the context in which these changes might take place. For this reason Part I of the White Paper addresses our perceptions on the Brazilian capital market s current stage of evolution. After having provided an overview of the Brazilian market place and BMF&BOVESPA s role in it, we proceed to Part II which presents an outline of the building blocks that make up the foundation of our post-trade infrastructure: Central Securities Depository (CSD), Securities Settlement Systems (SSS) and Central Counterparties (CCP). Part II also presents a general overview of the relevant international best practices that have heavily influenced the development of BM&BOVESPA s current model. Part III explores some case studies of international infrastructures that undertook integration initiatives in their post-trade environments and the results they obtained. The case studies cover the markets of Australia, United States and Hong Kong. 17

18 After providing a picture by detailing the aspects of the post-trade basic building blocks, an overview of the prevailing international standards, and an analysis of international experiences regarding post-trade operations integration, Part IV addresses a variety of possible post-trade integration options within BM&FBOVESPA. Finally, Part V explores some aspects of the integration that would likely require deeper reflection and consultation with our stakeholders in order to build an appropriate level of consensus on the best way forward with the various integration opportunities.

19 PART I THE BRAZILIAN MARKET PLACE AND BM&FBOVESPA

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21 Integration Opportunities and Challenges PART I THE BRAZILIAN MARKET PLACE AND BM&FBOVESPA In order to better understand the integration opportunities we foresee in BM&FBOVESPA s post-trade infrastructure, it is important to understand the context in which these changes might take place. Over the past two decades, we were witness to a dramatic evolution of the Brazilian economic, regulatory and market environments, which has had and will have an impact on the discussion that will follow. This section of the White Paper will present a view of this evolutionary road and highlight the accomplishments that were significant in contributing to the transformation of our market. We are especially interested that our readers reach a common understanding that: Brazil is now a very important financial and capital market, both in terms of its size and level of sophistication. The Brazilian financial and capital markets have a high-quality regulatory environment. The changes that were implemented in the payments infrastructure were absolutely crucial in achieving the current level of excellence in the clearing and settlement process. In this context, BM&FBOVESPA has followed its own evolutionary pathway and this section of the paper also aims to provide a brief overview of BM&FBOVESPA before going on to a more detailed discussion of the post-trade infrastructure. 1. The Brazilian Marketplace Throughout the latest decades, Brazil underwent a period of inflation stabilization. The stability which was achieved, coupled with the opening of Brazil s economy strengthened its financial sector, providing the catalyst for greater integration with the international financial system, and positioning Brazil as a much more attractive market for foreign direct and portfolio investment. During this same period, Brazilian regulatory authorities became more actively engaged in the international debate on the formulation of best practices for the world s financial and capital markets. Over the past 15 years, the Brazilian financial system has also brought about substantial improvements in its operational efficiency, and even more so in the soundness of its macroeconomic fundamentals. The transformation of the Brazilian financial system has included the important following developments: The end of the inflationary period with the implementation of Plano Real in 1994; The Central Bank of Brazil adopted the Basel Accord with capital requirements that were more conservative than the international standard (11% instead of 8%); Adoption of professional conduct rules which included a requirement for asset management firms and bank divisions to observe Chinese Wall principles; Development of innovative and diversified financial products and banking services, as financial institutions sought to establish new sources of revenue; Growth in foreign investment in the capital and financial derivatives markets; Development of a domestic investment fund industry; Reform of the Brazilian Payment System; and, Investment grade credit rating granted by the Standard & Poor, Fitch Ratings and Moody s in 2008 and At Basel financial forums, the Central Bank of Brazil has emerged as an active participant on a number of fronts, including; as a member or participant of the Global Economy Meeting, the BIS Markets 21

22 BM&FBOVESPA s Post-Trade Infrastructure Committee and the BIS Committee on the Global Financial Stability. More recently, Brazil has become a member of the Financial Stability Board, which now includes all the G20 countries. These entities comprise the principal forums for advancing in-depth understanding of the structural underpinnings and evolution of financial markets and for initiating improvements to their functioning and stability. In 2009 the Brazilian Securities Commission (CVM) also became a member of the Technical Committee of the International Organization of Securities Commissions (IOSCO). Brazil s increasingly important position on the global economic landscape is clearly related to the market s relevance. Not only is Brazil a large country in geographical and demographic terms, but it also represents the 8th largest economy in the world. GDP growth has increased from 0.5% in 2003 to 5.4% in 2007 and now, despite global turmoil the economy is forecasted for 2010 to grow at a rate of 4.5%. Similarly, the per capita GDP has grown from USD2940 in 2003 to USD6680 in 2007 and is now approaching USD7350. Reserve balances have grown from USD 17 billion in 2003 to USD 189 billion in 2007 and in September of 2009 reached USD 224 billion. As the largest fund industry in Latin America, representing 85% of the entire region, assets under management reached USD 455 billion in 2007 and now, with clear signs of recovery in sight following the 2008 crisis, they amount to USD621 billion. Another aspect of great importance that is contributing to the positive attention the Brazilian financial markets have been receiving from the international community relates the quality of Brazilian regulation and the scope of regulatory oversight. The Brazilian financial and capital markets do not allow unregulated institutions or instruments regardless of their nature or size. All institutions operating in the financial sector fall under the supervision of the Brazilian Central Bank, the CVM or, in some specific cases such as BM&FBOVESPA, both. It is also mandatory that all transactions, including those involving OTC derivatives, be registered in centralized systems that provide full disclosure of information to both regulators 1. The regulations also apply where conglomerates use a holding company approach, requiring all entities within the structure to be included within the regulatory perimeter. Also of considerable importance is that capital and liquidity requirements have been applied more conservatively than in most other markets, and immobilization limits and diversification credit risk rules are further inhibitors to over-leveraging behavior. The Brazilian Payment System, which was implemented in April 2002, represents one of the cornerstones of our country s financial system. In July 1999, when the Central Bank announced the new model for the Payment System, one of the primary drivers for this initiative was the desire on their part to lay a foundation that would underpin the development and strengthening of both the domestic financial system and the Brazilian capital markets. A solid and reliable legal and regulatory framework was then established which allowed for the operation of Clearinghouses as integral and interacting parts of the Brazilian Payment System. Accordingly, the legislation recognized that Clearinghouses perform multilateral settlements, requiring every systemically important Clearinghouse to act as a central counterparty (CCP). This legislation also established mechanisms to ensure that the insolvency, restructuring procedures, bankruptcy, or extrajudicial settlement of a market participant would not affect the outcome of transactions within the clearing and settlement system. All systemically important Clearinghouses in Brazil were given settlement accounts at the Central Bank and direct access to the Reserve Transfer System in order to manage payments related to the settlement of transactions in Central Bank funds. This feature has allowed Clearinghouses to eliminate credit risk in the payment leg and to settle transactions on a delivery-versus-payment (DVP) basis, resulting in final and irrevocable exchange of assets versus payment. 2 The level of disclosure depends on the regulator s mandate. 22

23 Integration Opportunities and Challenges 2. BM&FBOVESPA in a Snapshot Over the past decade, the Brazilian capital market has seen the consolidation of the exchanges, in a process eventually leading to the demutualization of Bovespa and BM&F in 2007, followed by each company going public and listing their shares on Bovespa, and then ultimately, to the merger of the two organizations resulting in the establishment of BM&FBOVESPA in May of BM&FBOVESPA is a vertically integrated exchange, which acts as a central securities depository, securities settlement system and central counterparty, providing the Brazilian capital market and its participants with a wide range of services: Listing services for local and international issuers with differentiated levels of corporate governance (Novo Mercado); Electronic trading solutions for local and international market intermediaries, including Direct Market Access (DMA) and co-location connectivity; Electronic registration environment for OTC derivatives, with or without the interposition of the Central Counterparties (CCP); Central counterparty clearing and DVP settlement: A Central Securities Depository (CSD) platform with a beneficial owner account structure; Securities lending services where BM&FBOVESPA acts as the central counterparty to borrowers and lenders; Banking infrastructure BM&F Bank offers settlement bank and custodial services to market intermediaries and provides the Clearinghouses access to the Brazilian Central Bank rediscount window ; and Integrated and modular IT solutions for intermediaries front, middle and back office activities (Sinacor). BM&FBOVESPA Broker Securities, Commoditiesand Futures Exchange Issuer Investors Clearing Member Central Counterparty (CCP) Register Custodian Securities Settlement System (SSS) Bank Central Securities Depository (CSD) Fig. 1: BM&FBOVESPA Trading environment, post-trade building blocks and main external relationships 23