São Paolo sophisticate



Uninformed outsiders typically view Latin America as a place where it’s easy for investors to get burnt because markets are vulnerable to disruption. In some countries, this opinion is justified, but it isn’t the whole story.

“There continues to be a perception among some foreign investors that all Latin American markets lack stability and an evolved approach to risk,” says Wagner Anacleto, manager of the risk department at the Brazilian Clearing and Depositary Corporation, a clearing house in São Paolo. The clearing house – referred to as the CBLC (Companhia Brasilieria de Liquidação e Custódia) – is evolving a sophisticated approach on all fronts, ranging from margining to liquidity and transparency.

Since it was spun off from the São Paolo stock exchange – Bolsa de Valores de São Paolo (Bovespa) – in 1996, the CBLC has strived to create a risk framework that would be the envy of any of its clearing peers in Chicago and elsewhere.

The man responsible for spearheading the effort is Francisco Carlos Gomes, CBLC’s head of risk and control. Since his arrival at the CBLC back in August 1997, Gomes has worked with a risk group whose head count never strays far from 10. He claims the “small and skilled team” provides greater flexibility and better results. Alongside Anacleto, Eduardo Ambrósio and the other members of the team, Gomes has worked to overhaul both systems and practices. “Our focus has been to change from more operational risk controls to more managerial-type risk management controls,” Gomes says

In addition to acting as the central counterparty for Bovespa, the CBLC also clears trades from the Rio de Janeiro stock exchange – Soma (Sociedade Operadora do Mercado de Ativos) – and fixed income products traded on the electronic platform Bovespa Fix. But it is equity and equity derivatives that are the CBLC’s bread and butter. Since 1997, it has used a CM TIMS system – bought from the Chicago Options Clearing Corporation – to calculate margins on derivatives trades. The CBLC’s version is customised to allow risk to be calculated at the level of the final investor – as proscribed by Brazilian regulations. A licence was obtained to permit installation of the system by local brokerage houses and clearing members.

The CBLC was satisfied that its margining systems were adequate, but Gomes was aware that there was clearly one area where there was room for improvement: gaining the facility to look at risk in an integrated way across products. By 1999, the need for action was becoming critical.

In the two years since Gomes had joined, the CBLC developed plans to act as a central counterparty for corporate and sovereign bond trades. Risks would become more disparate and numerous. Also, trading activity was being put under the microscope by the Brazilian government. The Central Bank of Brazil was nervous about the potential for systemic risk arising during settlement because of a new payment system it was introducing that year. Finally, added to the mix were persistent calls from the growing number of foreign players that margins should better reflect the risk offsets inherent in the positions they held.

So with the new millennium approaching, the CBLC began to scour the globe for a suitable system. Currently, the daily average trade volume in the markets handled by the CBLC is around 50,000, so obtaining a system that could handle rapidly growing volumes was a necessity. According to Anacleto, the CBLC was keen to buy from a risk vendor with a local presence. Latin American firms were considered, but in the end the CBLC awarded the contract to a global player. Toronto-based Algorithmics – with an existing clearing house client in Mexico – fitted the bill best.

The system purchased in September 2000 was Algo Market, and implementation began four months later. It enabled the CBLC to calculate risk for 30,000 portfolios and mark-to-market 60,000 instruments. Under Brazilian derivatives regulations, the CBLC is compelled to calculate and manage risk at the individual investor level. So even though netting the gains of one investor against another’s losses may reduce the CBLC’s risk at the enterprise-wide level, it is irrelevant from the regulatory perspective.

Such prudence results from the fear of that persistent bogeyman in Latin America: systemic risk. Surprisingly, some exchange members initially baulked at the CBLC’s move towards more risk-sensitive margining. But the selection of a tried-and-tested system and the clearing house’s commitment to transparency has helped quell dissent. “All now have access to the same system we use here,” says Anacleto. “They can see limits on their screens in real time. It’s obvious that collateralisation and risks taken are now aligned,” he adds.

The clearing house has addressed systemic and crash risk explicitly via the creation of its settlement fund – a pool of capital that would be tapped in the event of a market crisis. Clearly, it isn’t feasible for the CBLC to hold cash to cover a situation where, for example, all clearing agents go bust. Instead, after discussions with the Brazilian central bank and the securities commission it was decided that the appropriate worst-case scenario was one where the two largest agents go belly up. Risk calculations are performed daily, and individual firms are informed of how they are contributing to the system’s overall risk profile.

Clearing agents stump up capital for the settlement fund in proportion to the risk they bring to the system, as determined by the CBLC. This formula rather than one where each agent contributes an equal amount – as was the case prior to implementation of the new system – helps avoid moral hazard. Otherwise, an environment could be created where one or two firms take on very large risks to win business – perhaps creating the potential for systemic risk in the event that they encountered difficulties. Under the old regime, the CBLC deliberately overestimated contributions so that it had a capital buffer to cover any imprecision in its calculations.

One of the strengths of Algorithmics’ system is its stress-testing capabilities. There are 62 clearing agent firms and 100 brokerage firms. On a daily basis, the portfolios of all these firms are stressed to see how the risk profile behaves at times of crisis. Monthly back tests are performed and directors of the CBLC have access to daily reports detailing enterprise risk alongside a snapshot of which firms are responsible for most risk.

The desire to back test was an important part of why the CBLC wanted a new system that was capable of handling data-heavy tasks quickly. On an intra-day basis, information is distributed via the internet. Risks are disaggregated into those attributable to clearing agents, brokers and investors. The detailed reports provide breakdowns by derivative and cash instrument type, asset class and settlement date.

Beyond the technology, the CBLC has engaged in other radical efforts to promote liquidity and robustness. Ensuring that traders can short sell without too much hassle is an important aid to general market efficiency and promoting a vibrant derivatives market. On several occasions, the Bank for International Settlements has recommended that countries looking to increase and reinforce their financial markets should foster securities lending. The Brazilian Securities Commission and the Central Bank of Brazil – who jointly regulate the CBLC – agreed, but with the caveat that securities lending should be centralised so that trading activity could be monitored and controlled when needed.

Failures are a natural part of any cash markets, and Brazilian equity markets are no exception. In an effort to minimise voiding of trades, the CBLC began operating a securities lending programme back in 1996. Sellers are assessed to see if they own the stock they are required to deliver for T+3 settlement. If they don’t own it, the CBLC checks its securities lending system to see if the securities in question are being offered. If they are, the CBLC opens a position in the cash market.

The system was initially voluntary, but was made mandatory last year – sellers who appear unable to deliver securities on time are required to take delivery of the securities bought on their behalf by the CBLC’s programme. Anacleto claims the mandatory securities lending programme has reduced risk arising from the settlement cycle by 60%, though he adds that there was already a low level of settlement failures.

Securities can generate a fee of 5% a year for the lender – a figure that can in some cases eclipse stock dividends – a clear economic incentive. “Arbitrage opportunities have opened up,” says Anacleto. “More generally, banks and brokers are discovering that transactions they once did abroad can now be done here,” he adds.

As Risk was going to press, the CBLC was in the final stages of planning implementation of a new version of the Algorithmics software that will allow it to calculate risk in real time. This foray into parallel computing is expected to go live within the next two months.

According to Gomes, the CBLC’s performance during extreme events has proved the effectiveness of their approach to risk. His colleague Anacleto adds: “Our aim is to remain adaptable and provide the market with as much information as possible.”

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