To improve risk controls, different systems across the industry need to start working together.
December 20, 2013
New York, NY
Last month, the DTCC announced a real-time limit monitoring system to alert brokers if they approach pre-set capital limits. Could this help to standardize risk limit notifications across all participants? And, can we connect the spine to the hands and the feet of the industry?
Obligations to Inform Counterparties
But before we start to dive connecting the spine to the brain, shouldn’t every participant have an obligation — in real time — to inform their trading partner of impending risk limits? How should we communicate and integrate these messages and third party checks? Don’t say a phone call or an email. It’s not good enough.
Integration at the Message Level
No participant can ‘fly on its own’ and neither can a broker’s risk system operate without third party inputs. Yet, imagine this interconnected world where every exchange, CCP and broker implements different methods to communicate risk parameters?
In a highly connected and high-speed industry, all participants need to integrate at a message level. APIs, use of extended FIX message formats and risk limit notification standards are needed for us to evolve the ‘risk nervous system’ of the industry.
DTCC Limit Notifications
The announcement by the DTCC to offer a real-time Limit Monitoring Tool is an important advancement for real-time risk management.
The tool generates intraday alerts of impending capital breaches by member brokers. The ability to track the clearing broker’s position is a result of the new real-time trade submission requirement. Approved by the SEC in June (PDF), it will be fully mandated in February 2014 when it is expected to capture 97% of member executions in real time. The technology behind this capability is the NSCC Universal Trade Capture (UTC) platform.
Need to feed a variety of ‘Risk Brains’
However the DTCC only receives executions notices. The post-trade tools can never replace a broker’s pre-trade and real-time risk obligations. But, the DTCC limit alert can make the broker’s system more robust.
When integrated with the broker’s market access risk system, the DTCC alerts provide these benefits:
1) Independent ‘back up’ alert: The SEC clearly states that brokers avoid a ‘single point of failure’ for market access risk controls. The DTCC notification provides an ‘independent’ risk calculation and a ‘back up’ to a broker’s internal system. This can also be a check between the broker, the exchange and the DTCC systems.
2) Intraday escalation procedures: This tool prompts the clearing brokers to establish intra-day supervisory and escalation procedures — for the aggregate of the firm. What will they do when they get an alert? What trading do they limit and how?
3) Firm-wide limits: Although this does not include a notional value for open order exposure (which is mandated by Market Access 15c3-5 Rule), this will be an important data point to establish aggregated broker limits over time. It prompts brokers to build and maintain an intraday file of limits, changes and incidents, for the aggregate firm.
4) Establish a limit notification format: As the DTCC evolves the messaging scheme and the use of FIX formats to communicate limit breaches, this could lead the industry toward a more automated and standardized approach to communicate impending risk limits.
UTC: The Spine
Ultimately the real jewel for the industry is the UTC platform. It is the ‘spine’ upon which many real-time studies can be conducted. Going forward, if the settlement messages incorporate the LEI identifier, intraday surveillance across brokers could be possible. Eventually, we may see the UTC do some heavy lifting for FINRA’s consolidated audit trail and it may take a more active role in a broker’s trade surveillance programs as well.
Connect the Collective Brain to the Hands and Feet
As the industry implements more sophisticated trading risk checks, we need to simultaneously create a ‘nervous system’ to integrate and connect these tools across participants. It’s time the industry connects the spine to the collective brain, as well as to the ‘hands and feet’ of the market. It is a challenge we all need to tackle to keep our markets the most transparent, robust and liquid markets in the world.
About The Author: Anthony Masso, CEO Succession Systems
Anthony Masso is founder and president of Succession Systems, provider of market access controls and risk systems. Masso has more than 15 years experience in the securities industry, previously holding positions as a trader, general counsel and CEO of a broker/dealer catering to electronic and high frequency trading.