Cetip

Providing transparency through mark-to-market with IBM Algo Market Risk

Published on 29-Oct-2012

"Cetip is the first institution, which is not a central counterparty, to offer a solution to mitigate risk in the OTC derivatives market, and it wouldn’t have been possible without IBM Algo Market Risk. Moreover, because we are able to calculate exposure, we can introduce other new services and products." - Wagner Anacleto, Chief Operating Officer, Cetip; Algorithmics software

Customer:
Cetip

Industry:
Financial Markets

Deployment country:
Brazil

Solution:
Algorithmics Solutions, BA - Business Analytics, BA - Risk Analytics

Overview

Created by financial institutions and the Central Bank of Brazil, Cetip currently operates the leading marketplace for private fixed income securities and OTC derivatives in Latin America, in addition to acting as Brazil’s largest private asset clearing house. In operation since 1986, Cetip supports the entire cycle of operations for fixed income securities and OTC derivatives.

Business need:
Implement a standardized system for calculating exposure associated with OTC derivatives positions.

Solution:
Cetip chose IBM® Algo One Market Risk Base (Algo Market Risk) because of the expertise and experience of IBM in modeling exposure for OTC derivatives, as well as its global reputation with clearing houses, particularly in the Brazilian financial market.

Benefits:
By introducing the mark-to-market service, and launching the collateral management service, Cetip is maintaining its position at the forefront of the OTC derivatives market. By opting to use Cetip’s service, firms can avoid the need to invest in their own collateral management systems and further cut costs. Cetip’s members also gain credibility through the company’s reputation and relationship with regulators. Regulators can now be confident that all OTC market participants understand their exposure and what collateral is needed to cover it.

Case Study

Created by financial institutions and the Central Bank of Brazil, Cetip currently operates the leading marketplace for private fixed income securities and OTC derivatives in Latin America, in addition to acting as Brazil’s largest private asset clearing house. In operation since 1986, Cetip supports the entire cycle of operations for fixed income securities and OTC derivatives.

The firm, which became publicly held in 2009, serves approximately 15,000 participants across a broad range of financial institutions, such as banks, brokers and dealers, leasing companies, insurance, and more.

Since 1994, Brazil’s Central Bank and Comissão de Valores Mobiliários or CVM (the Securities and Exchange Commission of Brazil) have mandated that all OTC derivative trades must be registered in a clearing house to provide centralized transparency to regulators. In Brazil, two entities have been authorized to perform this registration service for OTC trading: Cetip and BM&FBOVESPA.

As of December 2010, Cetip S.A. has managed 75 percent of the Brazilian OTC market, providing registration, custody, trading, and processing services for approximately 31 billion reais of derivatives on a daily basis. Cetip’s trustworthiness and reliability are so widely recognized that the expression “Cetiped” is commonly used within the Brazilian financial markets as a seal of guaranteed quality. Cetip operates a real-time, interconnected, online financial network to power its OTC Clearing House.

The organization’s participants include the majority of Brazilian banks, as well as certain real estate companies, broker dealers, investment funds, insurance companies, pension funds and non-financial companies who issue securities, and others authorized to operate in financial and capital markets.

Seizing an opportunity in the OTC derivatives market
Although financial institutions have always had an imperative need to understand their exposures for the purposes of accurately determining collateral needs, the financial crisis of 2009 further emphasized the importance of such requirements. During this period, regulators in international markets began wondering how they could report their OTC transactions to achieve more transparency for financial systems and thus mitigate systemic risk.

With no public system for calculating mark-to-market and risk or managing exposures, Cetip recognized an opportunity and decided to first deliver insight into exposures for participants. With the awareness that many of its participants would have to make considerable investments to develop their systems in order to be able to evaluate their exposures, Cetip then released a solution that manages the assets used to cover that exposure. By providing a rigorously calculated exposure applicable to the broad OTC derivatives market, participants would be better equipped to understand their positions and collateral needs.

With the breadth of this offering, Cetip recognized its need for a system that enabled the flexibility in modeling that was required in order to reach its objectives.

According to Wagner Anacleto, Chief Operating Officer of Cetip, “We saw the opportunity to become the market reference for OTC derivatives pricing. So we began looking for a flexible system for exposure calculation and collateral management. The goal was to provide more services to market participants while helping them gain visibility into the exposure – and reducing the systemic risk – of each transaction.”

Making a strategic choice in IBM
In 2001, Anacleto had worked on the IBM market risk implementation project at Bovespa. It was therefore natural for him to consider IBM Algo Market Risk as he evaluated potential solutions in his new role at Cetip.

However, this experience alone did not dictate Cetip’s decision to adopt the IBM solution – there were two other important reasons. First, it considers IBM to offer the best solution in the industry for risk calculation. Second, many financial institutions and clearing houses, including major banks and the Brazilian stock exchange, use IBM solutions for risk management.

Due to IBM’s local experience in the Brazilian market in combination with global experience with clearing houses, it could provide the immediate value that Cetip required. In fact, the strengths of such local and global expertise with clearing and settlement services proved invaluable in helping the firm determine how it should calculate the exposure for OTC derivatives.

With such substantial responsibilities, Cetip recognized that the process for calculating exposure is complex for some OTC derivatives, especially since banks frequently create new structures using the different types of derivatives.

As Ancleto explains, regulators want transparency in exposures, but calculating them for non-standard offerings can be challenging. “Since some of these new structures using derivatives have been traded in other countries, IBM’s proficiency in modeling these calculations globally enabled us to quickly model them for mark-to-market here in Brazil.”

Satisfying market participants and regulators
The implementation of IBM Algo Market Risk – including developing the calculation models for mark-to-market – was a straightforward process that took about six months, which met Cetip’s expectations for a short project timeframe. At the outset, Cetip’s collateral management department calculated the mark-to-market of derivatives registered in Cetip’s OTC environment.

Cetip’s management team then met with many participating banks and institutions to explain how it was arriving at the mark-to-market numbers. In June 2010, the collateral management group started calculating mark-to-market exposure every day for each transaction. All Cetip participants that subscribe to the mark-to-market service receive reports and files containing these prices.

Some large institutions use the information from IBM Algo Market Risk to verify the numbers that they have calculated in-house. Now that this service is available from Cetip, many of these larger organizations can see these numbers on a more regular basis.

“On the other hand, some of the medium- and smaller-sized firms were only able to calculate mark-to-market prices weekly or monthly. Now they are able to do so more often as a result of the IBM Algo Market Risk implementation,” explains Anacleto.

Some of these smaller institutions would even employ a team or hire a provider to create a system for calculating the mark-to-market position. With Cetip providing these numbers on a daily basis, these firms can reduce their costs.

For some entities, access to these calculations is extremely valuable for a different reason. “Many firms don’t have the means to calculate these prices in-house. Our intent is to provide all participants with this information based on standard modeling,” says Anacleto.

Brazil’s financial regulators also appreciate this standardized approach. He goes on to explain, “On our website, we fully clarify how the prices are determined, using formulas recognized by the market, which is the type of transparency that regulators are seeking. Furthermore, regulators can now be confident that all OTC market participants understand their exposure and what collateral is needed to cover it.”

Introducing additional services built on IBM Algo Market Risk
“Cetip is the first institution, which is not a central counterparty, to offer a solution to mitigate risk in the OTC derivatives market, and it wouldn’t have been possible without IBM Algo Market Risk. Moreover, because we are able to calculate exposure, we can introduce other new services and products,” says Anacleto.

Cetip will be building on the success of the mark-to-market service to offer a collateral management service that will control the assets that participants pledge to cover their exposure. The mark-to-market numbers calculated by IBM Algo Market Risk act as the input for the collateral system that Cetip will implement early in the second quarter of 2011 through a partnership with Clearstream, a leading European supplier of post-trading services.

Many institutions develop their own collateral management systems at a huge expense. By opting to use Cetip’s service, these firms can avoid the need to invest in these systems and further cut costs. As Anacleto explains, Cetip’s members also gain credibility through the company’s reputation and relationship with regulators: “We have connections with all participants in the OTC derivatives market. Our system will also be approved by the Central Bank and the Brazilian Securities and Exchange Commission (CVM) because they are already familiar with our model.”

Launching this collateral management service is an important step for Cetip, and according to Anacleto, IBM Algo Market Risk plays a critical role. “Participants wouldn’t use the collateral management service if they didn’t know their exposure. Since we can provide that information via IBM Algo Market Risk, these firms will know the total amount of collateral needed to cover their exposure.”

Maintaining a competitive edge
By introducing the mark-to-market service, and launching the collateral management service, Cetip is maintaining its position at the forefront of the OTC derivatives market.

“The opportunity for growth in the OTC derivatives market is enormous in Brazil, and we’re prepared to continue being a major provider,” states Anacleto. “While our participants can choose to use just one of these services, we’re confident that many of them will opt to use both.”

Moving forward, Cetip plans to extract further value from IBM Algo Market Risk. “Our participants will be able to visualize their risk in the OTC derivatives market under different scenarios, not just mark-to-market. This is yet another way that IBM Algo Market Risk will help set us apart,” concludes Anacleto.

About IBM Business Analytics
IBM Business Analytics software delivers data-driven insights that help organizations work smarter and outperform their peers. This comprehensive portfolio includes solutions for business intelligence, predictive analytics and decision management, performance management, and risk management.

Business Analytics solutions enable companies to identify and visualize trends and patterns in areas, such as customer analytics, that can have a profound effect on business performance. They can compare scenarios, anticipate potential threats and opportunities, better plan, budget and forecast resources, balance risks against expected returns and work to meet regulatory requirements. By making analytics widely available, organizations can align tactical and strategic decision-making to achieve business goals.

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Products and services used

IBM products and services that were used in this case study.

Software:
Algo Market Risk

Legal Information

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