Custody Risk Management: The Role of JCSD Trustee Services Limited

Custody Risk Management:The Role of the JCSD in Retail Repo Reform

Robin Andrew Levy

General Manager

Jamaica Central Securities Depository

A Presentation to the

Global Association of Risk Professionals

11 May 2016

2

The views expressed in the following material are the

author’s and do not necessarily represent the views of

the Global Association of Risk Professionals (GARP),

its Membership or its Management.

3 | © 2014 Global Association of Risk Professionals. All rights reserved.

Jamaica’s Retail Repurchase Market - c. 2012

Distinct from Outright Repos

• Dealer uses Investor funds to buy securities. Sells securities to pay RR Investors out.

• Security Dealer retails ownership and control of both cash and securities.

• Withholding tax implications make transfer of securities to Investors on “Open Leg” difficult.

• Client effectively issued a certificate of participation.

• Dealer retains option to swap out comparable securities, often shorter-term than RR.

• Dealer makes a margin on Interest Rate.

• Many RR Investors treat RR like a savings or call deposit account.

Large and Active Market

• Over J$300 billion in local and global securities.

• Hundreds of transactions of hundreds of millions of J$ daily.

• Dominated by GOJ and BOJ securities.

• Held in custody at BOJ JamClear CSD and with Overseas Custodian Bank.

• Significant line of business for several Security Dealers.

• No losses for decades.


A3

Old RR Model

INVESTORS

Dealer AFront Office

New Funds/ Requests/

Instructions

Receipt, RR contract, Investment proceeds

A1

A4

Dealer ABack

Office

JamClearCSD

Information

Reconciliation

FSC

A5

Reports

Dealer B

Buy/Sell Securities

A2


Legal

• Assets remain in name of “Selling” Dealer

• RR Investor has no real proof of ownership

• Imperfect trail to current underlying security

• RR Investor has no better legal claim than any other creditor

Operational

• Possible for a Dealer to “overtrade” a security

• Errors, embezzlement, fraud, act of God all jeopardise RR Investment

Interest Rate

• JDX and NDX highlighted risks to Dealers and by extension to RR clients

Counterparty Default

• Dealer has claim to all entitlements (interest and principal)

Risks Identified


More Risks

Issuer Default

• GOJ or BOJ may default

Concentration

• Some Dealers have over 50% of their total assets in repo’ed securities

• Most dealers use a single international custodian (Oppenheimer)

Systemic

• Highly inter-connected Money Market.

• Dealers rely on each other to meet downstream obligations, including to Banking

system

The Government of Jamaica agree to reform the RR sector, structural benchmarks

placed under the IMF agreement


FSC tasked to spearhead the reform under direction of the Executive Director

• Steering Committee and Work Teams formed

• Consultants contracted by IMF to guide and assist

Overarching Objective

• Reduce systemic risk and Improve investor protections

Methodology

• Reduce size and complexity of RR sector

• Addressable risks - legal, operational and default

• Determine models and consult with stakeholders

Model determined

• No exactly comparable international structure

• Tri-partite trust to be established with securities moving to a trustee

• Dealer to provide securities and liquidity on open and close legs respectively

• JCSD/JCSDTS asked to provide custody and trustee services to sector

Legislative amendments to support model

The Reform Process


Implement minimum RR size

• Phased in over several months

• To J$1m or FX equivalent

Restrict securities that can be FSC approved for RR

• Investment grade corporates, GOJ/BOJ, certain foreign sovereign

• ISINs required

RR contracts not to exceed tenure of underlying securities

Legislative amendments to ring-fence RR securities

• Securities Act, SIPPS, Insolvency Act and other Acts and Regulations examined

• Amendments passed Dec. 2014 (1st benchmark achieved)

First Wave of Reform


The New Model

INVESTORS

Dealer A

Dealer AOwn A/C

JCSDTS Dealer A Client A/c

Dealer AOwn A/C

JCSDTS Dealer A Client A/C

JCSD/JCSDTS

JamClear-RTGS

JamClear–CSD or

JCSD/Intl. Custodian

Bank

FSC

Batch Settlement File with DvP & FOP

messages for each dealer (securities out)

Dealer A Transaction File

Reconciliation, Notification of

exceptions and failures

DvP & FOP single messages

(securities in)

Notification of failures

New Funds/ Requests/

Instructions

Receipt, Investment proceeds, contract note

A1

A2

A3A4

A5b

A5a

A6

A7

A5a

A5b

Reconciliation, Notification of exceptions and

failures

A8A5b

A5a

Netting Advice


The Model Implemented

DESCRIPTION 2:00pm

New Funds

Roll Overs

Encashments

Substitutions

8:30am

Daily Repricing Check

*Assumption is all clients have a JCSD account.

* The Settlement Assurance Fund and process to access it are not yet defined

*Possible scenario is to force retention of funds in SA 36 Act as well as return of funds to clients after 3 days.

*Funds received should be paid into/deposited in the SA 36.

OVERVIEW OF RETAIL REPO TRANSACTION STRUCTURE

After 3 days

End

Advises trustee of

action

Settlement

Instructions

Yes

No

Security available for allocation?

Dealer

DDetermines fix and resubmits (at

Box 17 or 12)

Dealer

End

Reconciliation Process

Refer to Flowchart 3

DReceives funds and

gives receipt

Dealer1 DIdentifies & allocates

security

Dealer

11

DPrepares rollover

details

Dealer

6

Prepares & uploads transaction file to

JCSD

Dealer

12

2

DPrepares payment instructions

Dealer

7

DPerforms netting of securities & cash

per ISIN

Trustee

13

Identifies securities

and accounts affected

Dealer

9

Determines

securities and accounts affected

Dealer

10

D Performs settlement of

securities

Trustee

Settlement

Instructions

18Sends securities and

proof of available cash balance

Dealer

17

DSends notice of failure to dealer by

email

Trustee24

DPrepares & sends reconciliation

report to dealer & FSC

Trustee22

26

Flag event for settlement assurnace.

or unwind failed transaction. Notify

dealer by email and FSC by exception

report.

Trustee

27

DPrepares & sends netting advice to

dealer

Trustee14

Generates & sends

contract note to RR client

Dealer23DFlag event as one

necessitating a regulatory response

FSC

28

Notify Trustee by email & determine fix

Dealer

16

Retains funds

(SA.36) until security is sourced

Dealer

3

D Returns funds

Dealer

5

Yes

Confirm netting advice?

Dealer

No15

No

Cash obligation balance

remaining?

Dealer

Yes

8

Settlement Failed?

Trustee

Yes

No

20

Yes


Dealer

No

4

2:00pmSettlement Process Refer to Flowchart 2

19

21Has time for fix (3:30pm)

passed?

Trustee

No

Yes

25

Yes


Dealer

No

6b

Prepare payment

instructiions. Payout Client

Dealer

6c


Legal

• Dec 2014 legislative amendments to ring-fence RR securities

• Gives RR investors claim on securities held in trust if Dealer defaults

Counterparty Default

• Trustee may intercept entitlements in case of SD default

Operational (2nd benchmark achieved)

• Adequate security in trust for RRs continuously assured

• Dealer/Trustee record redundancies reduce possibility of error

• RR investor and FSC have on-line viewing access

• 3rd party (trustee) validation for approved securities, RR tenure, all transactions

Interest rate and Issuer default unaffected

Systemic

• Reduced risk due to all the above

Concentration, settlement and liquidity risk somewhat increased

How Risks Have Been Mitigated


Continue to improve the model

• Incremental adjustments – overseas securities movement, FSC report writing, etc.

• More automation, SWIFT messaging?

• More transparent price determination of securities – trading GOJ/BOJ securities on the JSE

Prudential tightening

• To a systemically manageable prudential level

• Reduce RR as a % of Dealer’s balance sheet

• Raise liquidity and capital requirements for Dealers who offer RR

Thank you for your attention

What’s Next?

C r e a t i n g a c u l t u r e o f

r i s k a w a r e n e s s ®

Global Association of

Risk Professionals

111 Town Square Place

14th Floor

Jersey City, New Jersey 07310

U.S.A.

+ 1 201.719.7210

2nd Floor

Bengal Wing

9A Devonshire Square

London, EC2M 4YN

U.K.

+ 44 (0) 20 7397 9630

www.garp.org

About GARP | The Global Association of Risk Professionals (GARP) is a not-for-profit global membership organization dedicated to preparing professionals and organizations to make

better informed risk decisions. Membership represents over 150,000 risk management practitioners and researchers from banks, investment management firms, government agencies,

academic institutions, and corporations from more than 195 countries and territories. GARP administers the Financial Risk Manager (FRM®) and the Energy Risk Professional (ERP®)

Exams; certifications recognized by risk professionals worldwide. GARP also helps advance the role of risk management via comprehensive professional education and training for

professionals of all levels. www.garp.org.


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Custody Risk Management: The Role of JCSD Trustee Services Limited

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