Published on 17-Dec-2010
Validated on 20 Dec 2012
"There was really no question of selecting anything other than ILOG. There was no other algorithm that we could rely on and not have to worry about." - Jaime Villaseñor, Chief Risk Officer, INDEVAL
S.D. Indeval, S.A. de C.V.
INDEVAL, Mexico’s central securities depository, was operating with 9-14 different settlement systems that complicated near real settlement of transaction. And it also limited liquidity and forced financial institutions to reserve substantial financial resources in order to settle securities transactions, raising costs for smaller players and making it difficult for them to participate.
Mexican financial institutions were challenged by reserve requirements and high borrowing costs necessitated by INDEVAL’s securities settlement system, and smaller institutions could not afford to participate in the financial markets.
New securities settlement system adopting international settlement best practices using operations research to maximize the value of settled trades which come from myriads of securities transactions in near real time.
·240 million USD in 18 months saved in borrowing costs for Mexican financial institutions ·52% reduction in liquidity requirements for banks ·26% reduction in securities required for settlement ·Strengthening of Mexican financial system, especially during 2008 financial crisis
Central securities depositories (CSDs) are the hub of financial markets worldwide. They perform two vital functions. They provide services related to the custody and management of securities retained on behalf of the financial community and the investing public. And they provide for the efficient settlement of securities transactions.
The settlement system itself has a tremendous impact on the liquidity and efficiency of the financial markets. For instance, INDEVAL, Mexico’s CSD, was operating with 9-14 different settlement systems that complicated near real settlement of transaction. And it also limited liquidity and forced financial institutions to reserve substantial financial resources in order to settle securities transactions, raising costs for smaller players and making it difficult for them to participate.
A new strategic partnership
Beginning in 2005, INDEVAL began working closely with the Banco de Mexico, Mexico’s central bank, and the Instituto Tecnológico Autónomo de México (ITAM), the country’s top technological university, to adopt international best practices developed by the Bank of International Settlement (BIS) in a new securities settlement system (SSS).
The result is quite possibly the most innovative SSS in the world today. Developed using operations research and IBM® ILOG® optimization software, the new settlement system, called Dalí, settles 250 billion USD in securities per day—one fifth of Mexico’s GDP—in near real time. It has raised liquidity levels, lowered capital requirements for financial institutions and provided added stability to Mexico’s financial system.
Raising liquidity and decreasing costs
Early on, INDEVAL had to decide what type of SSS it would develop. Securities settlement systems are generally conducted according to one of three models as identified by the BIS and the Committee on Payment and Settlement Systems, as follows:
• Model 1: real-time gross settlement for all operations
• Model 2: real-time delivery of securities and net settlement of cash at the end of the settlement cycle, usually at the end of the day
• Model 3: net settlement of both securities and payments at the end of the settlement cycles
Previously, INDEVAL (like most CSDs around the world) operated with a Model 1 system. In the Model 1 gross settlement system, the individual seller (or its bank) delivers the securities to the individual buyer (or its bank) and the cash flows in the opposite direction. It is easy to link the delivery of securities to the corresponding payment but it requires depositors to have adequate financial resources available to settle their trades. Financial institutions must borrow funds to support transactions if they do not have sufficient funds to settle transactions, which raises borrowing fees and limits liquidity.
With Model 2 type of settlement, a bank settles trades of a particular security among its own customers and then transfers the net number of shares still outstanding to a counterparty bank to settle trades between customers. Settlement of the cash is treated the same way, however it is not done until the end of the day which is riskier. As in the first model, banks may have to borrow securities to settle the transfers.
Model 3, which nets the settlement of both securities and payments at the end of the settlement cycle, is the most desirable solution, if the time between settlement cycle can be reduced to a short amount of time.
To develop the optimal solution, INDEVAL built a Model 3 SSS which nets securities and cash in near real time, settling trades as quickly as possible after they occur, without incurring borrowing costs.
Maximizing settlement value
The solution has three modules. The first coordinates all the settlement procedures. The second is the settlement module which modifies all of the accounts of the participants in money and securities. And the third is the clearing module in which the IBM ILOG optimization algorithm works.
Dalí goes into action every two minutes. “Every time we run the clearing module, we create a linear programming model that maximizes the settlement value of all the transactions pending in our system,” says Arturo Palacio, senior operations manager, INDEVAL. “We interact with the IBM ILOG CPLEX Optimization Studio® very frequently, approximately 270 times a day. It’s the core of our settlement system. It’s very important because it optimizes the flow of money and securities for our participants and they save a lot of resources. Otherwise, they would have to maintain high balances in their account to settle their daily transactions.”
ITAM was central to the effort. The role of the university was first to generate all the business process modeling with use cases, sequence diagrams and all the documents for the implementation process that would come afterward.
“We were in close relationship with ITAM,” says Palacio. “They also checked the optimization algorithms and the interaction with CPLEX Optimization Studio.”
According to Jaime Villaseñor, chief risk officer at INDEVAL, “There was really no question of selecting anything other than ILOG. There was no other algorithm that we could rely on and not have to worry about.”
240 million USD reduction in costs
The Dalí clearing and settlement module using optimization models reduces by 52 percent the liquidity requirements and by 26 percent the volume of securities required for settlement. The intraday financing costs for financial intermediaries have been reduced by more than 240 million USD in Dalí’s first 18 months.
The most important benefit of Dalí is the enhancement and strengthening of the Mexican financial system. Additional benefits include a safe mechanism to transfer money from the central bank to meet obligations in other payments systems and an effective tool for depositors to close their risk positions for better risk management.
Warding off financial risks
As the core of the financial infrastructure, it is important that settlement systems be robust and solid to ward off the negative effects of a financial crisis. As a main provider of liquidity to the whole financial sector, INDEVAL helped minimize the risk involved in settling transactions and diverting the worst effects of the banking crisis and subsequent drying up of liquidity of the 2008-2009 recession. “There’s no telling how much the effect was because of the many factors that enter into these calculations,” says Villaseñor, “but there’s no doubt that Dalí helped provide a higher level of liquidity than would have been possible during the recent crisis, thanks to the ILOG product from IBM.”
Says Jaime Villaeñor, chief risk officer of INDEVAL, “Market participants throughout the world have a renewed focus on closing transactions as soon as possible.” The importance of this was graphically illustrated by the exposure that resulted from the failure of Lehman Brothers in November of 2008. That event highlighted the importance of settling open transactions as quickly as possible. Thanks to IBM, Dalí delivers continuous and near real time settlement which substantially reduces the average duration in which trades remain unsettled on settlement date and the related counterparty risk.
“In just one minute in a recent settlement cycle, Dali settled more than $70 billion,” Anaya concludes. “We believe that INDEVAL holds the unique distinction of being the only CSD in the world that has achieved near real time Model 3 settlement. This will certainly be applied broadly by other CSDs, including corporations, as they become aware of our success.”
In recognition of its excellence in operations research, Indeval won the 2010 Edelman Award from INFORMS Institute for Operations Research and the Management Sciences.
For more information
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Products and services used
IBM products and services that were used in this case study.
IBM ILOG CPLEX Optimization Studio
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