responding to the challenge - training: all staff in the basics; each functional unit in its...

Managing Market Event Risk

Responding to the Challenge

The Americas Securities Leadership Forum 2013

Table of Contents

1. Managing the Unexpected: Ken Porcaro, CTS North America Intermediaries Client

Management Citi

2. When an Exchange Member Fails: Juan Pablo Cordoba, President Bolsa de Valores de

Colombia BVC

3. Facing a Natural Disaster: Antonio Blazquez, Trust and Custody Head Banco De Chile

4. Market Technology Gone Wrong: Managing a Flash Crash Arturo Navarro, Head of

Operations Mexican Central Counterparty /Head of International Business Indeval

5. Market Events: The Global Custodian Perspective: Michael Perkins, State Street Bank and

Trust Company

1

1. Managing the Unexpected

2


Market Event Risks - An increasingly Challenging Environmental

Landscape

Intensifying weather patterns Globally have created increasing Challenges for Continuity of Business planning.

– Climate Change???? There may be something to this notion after all………..

– Tornadoes, Hurricanes ,Typhoons, Draught, Floods, Landslides, Mega Storms, Snow in London

Hitting new areas

Impacting larger areas across typical regional divides

Occurring more frequently

More intense and sustained

Having greater Impact

We need to be prepared for whatever nature has in store for us.

3


Mother Nature is unpredictable

• Increasing frequency of Global and Regional Natural Disasters

– Chile 8.8 Earthquake February 2010

– Eyjafjallajökutl eruptions in Iceland shut down Air Travel for 6 days across Europe April 2010

– Fukashima Earthquake, Tsunami and Meltdown – March 2011 Major Power outages Tokyo

– Hurricane Irene August 2011 shuts down NYC

– Bangkok worst flooding in 50 Years November 2011

– Hurricane Sandy October 2012 Shuts down NYC Again

In spite of our best schemes to predict natural disasters, they occur as THEY will….

4Source: The Washington Post, Financier Worldwide, CNN, NY Times, NY Daily News


Effects of Natural Events

Impact of Natural occurring events

– Europe 2010: Air Traffic shut down for 6 days, disruptions continue for 2 months

Stranded Employees

Cancelled Business forums

Disruption in courier services

– Repeated Hurricanes and Storms in NYC and Northeast US region

Closing of the NYSE

Massive Power outages sustained over period of 1 week

Telecommunication disruptions

Temporary and permanent damage to transportation hubs

Loss of many buildings for prolonged periods

– Fukashima disaster

Long term impact on Power generation in Tokyo

Environmental risks impacting work areas

Natural events have far reaching impact on our ability to service our clients and significant implications for

Contingency planning!

5Source: Financier Worldwide, US News and World Report, CNN


Social and Political Events

Social unrest and dissatisfaction with the Status Quo has increased in many regions of the Globe

– Arab Spring

Egypt, Morocco, Kuwait, Jordan, Saudi Arabia, Syria, Lebanon and many more nations across the

region

– The UK Riots

– Argentina Nationwide Labor Strike

– Greece Labor Strikes GIIPS Crisis

– European Airline Workers strikes

– India National Strike

Instability of Political systems, Social unrest, Labor disruptions have deep impact on operations.

6Source: The Guardian UK, The Guardian UK, Wall Street Journal, Bloomberg, Wall Street Journal, Times


Social and Political Events disrupt orderly business

environment

These events can have Local, National and even Regional impact

– Disruption of Transportation services

– Unsafe environment for employees to come to the office

– Sympathetic impact on local staff

– Interruption to many or sometimes all public services needed to conduct business

– Overall Instability of the business environment

Paralyzing effect of political instability can shut down operations for prolonged periods

7


Financial Market Events

Global Players have significant impact on local Markets

– Lehman Bankruptcy September 2008

– MF Global Melt Down October 2011

– Peregrine July 2012

Specific Local Market events cause disruptions and risk for Global participants

– US Market Flash Crash May 6, 2010

– Mexico Market Flash Crash April 13, 2012

– Knight Trading error 8-1-2012

Market Participant financial events have far reaching implications on the orderly settlement of Financial

Transactions

8Source: Times, Bloomberg, Reuters, CNN


Effective COB relies on a solid plan and then Constant

Review, Training and Testing

The Continuum of Citi‟s Business Continuity Program

Citi maintains a business continuity program that protects Citi,

its staff, its assets, and the interests of our clients. The

program is robust enough to cover a wide range of business

disruptions that may range from the inability to operate from a

single building to more widespread events that impact a city

or region. Citi‟s primary focus in contingency planning is to

provide continuous operation in any circumstance and to

minimize client impact, so that, in the event of a disaster,

processing can resume as quickly as possible without

disruption to our clients‟ business. Each business unit has to

comply with stringent requirements in documenting and

testing a comprehensive disaster recovery/business

continuity plan. The building blocks for developing a robust

continuity program comprise the program components in the

diagram to the right.9


Overview of CTS Global Approach to COB

Fully redundant data center locations for primary and failover sites

Disk mirroring between primary and failover sites

Multiple continuity of business locations in North America, South America, Europe, and Asia

Robust remote computing available for all Citi staff

Mandatory, annual COB test of all applications

Dedicated COB teams work with application and business owners to ensure proper failover environments, procedures, test

plans, and compliance with Citi COB policies

Robust program addressing single building outage to widespread events impacting cities or regions

All Citi branches and subsidiaries conform to regulatory standards and internal guidelines and policies, regardless of

location

But…….WHAT ABOUT FINANCIAL EVENTS???

Citi CTS has a robust Business Continuity Program that is also in compliance with all applicable regulations.

10


CTS approach to managing Financial Event Risk

Create a Virtual Global or Regional work team as needed

– Include: Client Management, CTS Risk Management, Operations, Product, Credit Risk Management, Legal

Determine regional team leaders and schedules calls to follow the sun if needed

Team produces Ad Hoc reports to capture the exposure: Balances at risk, Open Trades , Positions etc.

Any internal controls needed to prevent loss of value are immediately put in place

Client communication process is evaluated and set in place as needed using all the tools we have at our disposal

– Market Watch, Service Watch, Webinars, One on One Calls, Email chains etc

Process is maintained until the All Clear is sounded

At first notice of a Financial Event impacting a market or multiple markets the CTS Client Management and

DCC Teams move into action to contain the impact:

11


Implications for Business Contingency Planning

Post 9-11 and the financial crisis of 2008 BCP has gotten major attention Globally, but is it enough??

Potential areas of weakness

▲ Are Email and Network Access solutions robust

enough for the scope and length of these events

▲ Are back up sites equipped for long term

outages

▲ Is there enough capacity to house an entire

building‟s occupancy

▲ Do communications plans reach a broad

enough audience

▲ Is training comprehensive and regularly

conducted

Possible Action Steps to resolve

▼ Increase Network capacity

▼ Reevaluate Contingency sites with updated

criteria to deal with greater needs

▼ Ensure remote working capabilities are robust

and encouraged as contingency to lack of space

▼ Ensure affirmative testing is in place and

regularly completed

▼ Mandatory Training programs to increase

awareness and preparedness12

2. When an Exchange Member Fails

2


Interbolsa’s Market Share And Market Size

Other Brokers

82%

Interbolsa18%

Equity Market

Other Brokers

83%

Interbolsa17%

Fixed Income Market

Other Brokers

86%

Interbolsa14%

Derivatives Market

The average of Interbolsa‟s market share in the Colombian Capital Markets was 17%

Assets Liabilities Equity Revenues

33% 37%15% 21%

67% 63%85% 79% Interbolsa

Interbolsa Size


Clients Exchange CSD

• Custody: Final

beneficiary scheme.

• BVC manages the OMX Trading platform

• BVC Clears the transactions.

• The clearing and settlement process is

gross on the securities side, and net in

the cash side.

• BVC is not a central counterparty

Colombian Capital Market Structure Cash Equities

• The Clients access

the market through a

broker

The BVC assisted the authorities in the least traumatic, most efficient and

quickest way possible:

• Isolating the problem.

• Minimizing the systemic risk.

• Supervising the transfer of pending operations to other brokers

• Transfer of clients assets to other broker


Crisis Solution of Interbolsa

Nov 2nd 2012 SolutionEQUITY MARKET:

On Nov 7th, 2012: 100% of the

transactions were cleared and

settled

REPO TRANSACTIONS:

Pending Transactions 3.278

Amount (USD Millions) $84

75% of transactions have been

cleared and settledPending Transactions 1.587

Amount (USD Millions) $346Pending Transactions 204

Amount (USD Millions) $84,8

SELL BUY BACK TRANSACTIONS:

Pending Transactions 416

Amount (USD Millions) $231

19.306

14.466

75% of Interbolsa's clients have

been transferred to other

brokerage firms

Nov 2012 Feb 2013

79% of portfolios have been transferred to other

brokerage firms

USD $2,1

billion

In Dec 2012: 100% of the

transactions were cleared and

settled

USD $0,6

billion

DERIVATIVES MARKET:On Nov 7th 2012: 100% of the

transactions were cleared through

the CRCC.

Interbolsa‟s Open Interest on Nov

2012 31: USD$106 million

FIXED INCOME MARKET: On Nov 6th 2012: 100% of the

pending transactions were

transferred to other brokerage firm.

Interbolsa‟s Gov Bonds transactions

(TES class B and UVR): USD$835

million

Clients

The Americas Securities Leadership Forum 20133.50%

4.00%

4.50%

5.00%

5.50%

6.00%

6.50%

Oct-12 Nov-12 Dec-12 Jan-13 Feb-13

Gov Bond TES24 Colombian Interbank Rate IBR

1,650

1,700

1,750

1,800

1,850

1,900


COLCAP Index

Interbolsa‟s

Liquidation

Var 5,14%

Colombian Macroeconomic Indicators

The Colombian Financial System was not affected

with the Interbolsa‟s crisis

1,750

1,770

1,790

1,810

1,830

1,850


FX RATE: COP / USD


•This event, which could have become a systemic risk was completely

contained thanks to the effective and decisive action of the authorities,

BVC and the Liquidating Agent.

Conclusions:

•Through this process, BVC was able to provide all participants with the

certainty that the market was operating normally, and little by little their

confidence has returned.

•These actions ensured, in record time, the settlement of pending trades

at the moment of intervention and the execution of guarantees of the

term transactions.


Thank You


Appendix

3. Facing a Natural Disaster


Facing a Natural Disaster – Continuity of Business Approach

Banco de Chile uses a continuous improvement approach, very similar to Citi’s:

– Four contingency scenarios are considered:

Physical infrastructure failure

Technological infrastructure failure

Massive absence of staff

Critical supplier failure

– Key impacts can be financial, reputational, regulatory and on the staff.

– Management tools:

Continuity of Business Policy

Continuous generation and update of Business Impact Analysis reports

Continuous generation of Continuity Plans

Generation and test of DRP

Staff evacuation drills

We need to be prepared for whatever nature has in store for us, but the approach is comprehensive.

2


Continuity of Business plans methodology

• Get to know the business perfectly, its priorities, process, system and staff criticalities, recovery

times and minimal resources to keep the operation

• Strategy planning for the four defined scenarios (physical and technology infrastructure, staff

availability and critical suppliers)

• Continuity Plans, documenting alternate processes, call trees, recovery tasks and teams

• Training: ALL staff in the basics; each functional unit in its contingency plans; and coordinators

in the CoB Program

• Testing and Maintenance: plan and coordinate tests; simulate contingencies; test all plans;

evaluate results and strategy; update and improve plans

This is a continuous process, which must cover all changes in the environment and internal

2


Continuity of Business Master Plan

Some Milestones:

– Redefinition of teams and governance

– Complete reformulation of Business Impact Analysis reports

– Testing: Citi infrastructure, tsunami simulation in coastal branches

– Data Center consolidation from 9 to 2 world-class sites

– CoB plan verification for all critical suppliers

– Real application of strike contingency plans

– Improve visibility of the subject with a dedicated Intranet site, e-learning capabilities, „trivia‟, Continuity of

Business and Operational Risk weeks and conventions and a continuous awareness plan for all staff

– Pandemic scenario testing

– Critical supplier visit and assessment on CoB plans and preparedness

– Data Center loss simulation tests

– Extension to medium and low criticality processes to complete coverage

Since the earthquake, a Master Plan has been deployed to improve response and coverage

2


Securities and Fund Services: distributed processing approach

As it is well known, we distribute our services by making use of the ARSC capabilities and keeping local

services as required by the market or convenient:

– The ARSC covers Database and Front-End, Client Trade Processing, Asset Services and Billing

– Banco de Chile processes settlement and street-side activities, taxes and regulatory reporting

– Market/product support is kept locally

In general terms, natural disasters tend to have very little correlation between Florida and Chile (unless

we have a hemispheric or global catastrophe, of course), while market events are handled on site

A distributed approach has proven to have positive results; as a matter of fact, cross-border clients were

slightly less impacted in terms of timeliness to recovery and service availability than local clients, as some

duties and activities had no impact as they were performed in Tampa

Likewise, some ARSC contingencies support can be helped from the country

Distributing processing and service duties and responsibilities improves CoB results

2

4. Market Technology Gone Wrong: Managing a Flash Crash


Mexico: very good news, positive environment, stable scenarios

Mexico is becoming very attractive to investors

– Stable economy with deficit under control, low inflation, expected GDP growth of between 3 and 4%

– A 50% increase in foreign cash inflow into government peso denominated bonds (50 to 76 billion)

– Good expectations to raise Moody´s current rating for sovereign bonds from BBB+ to A scale

– Important structural reforms (energy, labor, tax) being seriously negotiated at Congress for the new

administration with an expected goal of a 5 or 6% of GDP for the next years.

– Local equity market playing an important role: positive performance of 27% in dollar terms of the IPC

Index, MKT Cap. $550 billion with $900 million in new IPO´s, $18 billion in long term debt and $30

billion in revolving debt.

– Fifth largest economy in 2050 (Goldman Sachs)


Mexico: New technology at BMV Group

New trading platform (MONET), one of the world´s five fastest, with latency below the 90

microsecond mark

Allowing easier and faster “plug in” to high frequency and algorithmic tools

Bringing standardization used by US exchanges

Regulatory changes to allow greater access and connectivity (Direct Market Access)

Investment of $12 million


Transactional Performance Mexican Stock Exchange

Mexican Stock Exchange (BMV): Transactional growth


Last spring, BMV received 1,752 sale orders of the IPC Index basket with wrong prices from a small

brokerage house in less than 2 minutes. As a result of this input, another 524 orders were generated.

The total economic value of these trades was USD $160 million, setting alarms and automatic

mechanisms off at The Stock Exchange and The Central Counterparty:

– 13 of the 35 shares comprising the IPC Index had distorted quotes, prices and market

values and were suspended for trading in accordance with the breaking price range

policy.

– Central Counterparty made an immediate margin call of USD $ 6.6 million in order to

novate trades and mitigate risk.

– Another 923 pre-assigned sale orders with a value of USD $300 million were deleted

from the system

Impact: Erroneous orders caused a percentage drop of 2.32% in the IPC Index

Not everything is happiness


The broker recognized the programming of its HFT mechanism had failed and formally asked the BMV to

delete trades

With a consensus decision made by the Mexican Stock Exchange, all brokerage firms and authorities,

the 2,276 trades with wrong prices were cancelled from The BMV system

After cancellation, the IPC Index was recalculated showing a marginal drop of 0.56%

If this decision had not been taken and the Safety net of the Central Counterparty had not been

activated, the result would have been:

An expected final lost of USD $20 million at the end of T+3 covered by guaranty funds (one of them

mutualized among CCP´s settlement agents)

Consumption of a portion of the CCP equity.

Implementing a quick and effective solution to correct an

isolated mistake?


The Central Counterparty (CCV)) along with other entities of BMV Group have been working on a

common strategy to mitigate financial and operational risks in a more effective way.

The objectives of each of the components under this Plan are aligned to the fulfill the requirements for

safety and efficiency contained in the Principles for Financial Market Infrastructures that were issued last

year by the International Regulators.

The three pillars that will continue guiding the strategy for the Central Counterparty are:

Strengthening the Safeguards Network;

Strengthening Technological Infrastructure

Improving legal sustainability through adjustments, provisions and procedures.

The Mexican Stock Exchange is analyzing the incorporation into its trading system of filters of variation in

price and amount in order to prevent and mitigate mistakes.

Surely not an isolated mistake


Strategic Plan Pillars

PILLAR 1: STRENGTHENING OF THE SAFEGUARD NETWORK

• Capitalization and reinforcement of guaranty funds with a joint contribution from BMV Group and Settlement

Agents for the amount of Mxp $204 million

• Daily stress test of unsettled open positions in accordance with IMF‟s Principles

PILLAR 2: TECHNOLOGYCAL INFRASTRUCTURE

• A Transactional Risk Control (CRT) mechanism to optimize the novation process, based on settlement

agents financial capacity indicators (capital) and encouraging to the agents to establish their own controls.

• New system for clearing and settlement in accordance with the technological advances of Bolsa Group

(MONET- BMV, DALI- Indeval)

• PILLAR 3: LEGAL SUSTAINABILITY

Explicit responsibility regarding the obligations and guarantees of settlement agents

Closure of open positions according to international practices


Worldwide Initiatives and just one conclusion

• Market Infrastructures such as ASX (Australia), CME, Eurex, HKex (Hong Kong), ICE, NYSE, SGX

(Singapore), etc. have recently implemented pre and post transactional controls in response to new

market dynamics such as DMA, HFT, Dark Pools

• Recommendations have been issued (CFTC, Futures Industry Association) which include among others

the following controls: size / number of orders, Position / Total Risk (purchases / sales), price, stop button,

fat finger, etc.

• Any control implemented at any market must consider efficiency and safety while protecting the

shareholder/investor wealth, but at the same time NOT:

increase latency

impact market/prices

hinder development or Implementation of new technology

5. Market Events: The Global Custodian Perspective

2


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