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In this Issue
Dear Members of ACSDA,
In the third edition of this Newsletter, we are pleased to present you with three articles about very relevant topics in today’s
financial market landscape.
First, Chris Cononico, President of GCSA LLC , shares with us a reflection about the insurance, which has become an
important topic for a Financial Market Infrastructure for its use as a form of credir risk mitigation and as a possible recovery tool.
Additionally, Clearstream gives us insight on how the Liquidity Alliance can help CSDs in their effort to set in motion collateral
management services quickly and economically.
Finally, The final article of this newsletter deals with Mexico’s Financial Reforms Initiatives and the modifications regarding
electronic custody.
We invite you to participate with any issues of interest, suggestions or comments to our Risk Committee.
Best wRegards,
Gerardo Gamboa Ortiz Jorge Hernán Jaramillo
Head of the Risk Committee of ACSDA ACSDA President
Is Insurance Suitable for the Default
Waterfall of Central Counterparties?
P3
Collateral Management Out of Box
for CSDs
P6
Electronic Custody: Reducing
Operational Risk Through its
Implementation P9

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The concept of insurance as a loss absorption layer in the default waterfall of central counterparties (“CCPs”) has existed for
decades. Our Chairman, David Hardy, who was CEO of LCH.Clearnet for nearly twenty years, recalls structuring an insurance
policy for International Commodities Clearing House (a predecessor to London Clearing House Ltd.) as far back as 1988. While
insurance has had its fits and starts as a risk-transfer partner to CCPs since ICCH, traditionally it had been relegated to a niche
product for a handful of exchange groups. Until now, no coordinated attempt at a true partnership between the insurance and
clearing industries has ever occurred, no matter how advantageous and symbiotic the potential relationship might have become.
Since the recent financial crisis and subsequent G20 mandate to clear OTC derivatives, insurance has once again become
an important topic at financial market infrastructure (“FMI”) related conferences around the world for its use as a form of credit
risk mitigation (CPSS-IOSCO – Principles for Financial Market Infrastructure (“PFMIs”) – Principle 4) and as a possible recovery
tool. At the same time, the insurance industry, as a whole, is now taking more interest in the once esoteric clearing industry
as insurers have become more familiar with the growing importance of central clearing and CCPs look to further bolster their
waterfall resources. Are the insurance and clearing industries finally ready to partner for the benefit of the default waterfall? Can
insurance meet the needs of end clients, FMIs, regulators, and central banks as a dedicated risk transfer partner?
A Consortium – No More Single Name
Counterparty Risk
We believe that one of the key lessons of the
financial crisis and a basic tenet of sound risk
management is diversification of counterparty
risk. Not only should policies be written by a
diversified consortium of insurers, but there should
be mechanisms built within the consortium itself
to offer the best prices to its clients. There should
also be a mechanism within the policy to replace
insurers who are downgraded below threshold
ratings (such as A3/A-) and the coverage provided
by each participating insurer should be sized in
advance relative to its own claims paying ability.
Finally, the participants in the consortium should
themselves be multiline insurers with diversified
business models and domiciled in highly rated
countries.
April, 2014
Is Insurance Suitable for the Default Waterfall of Central Conuterparties?
By Chris Cononico, President of GCSA LLC

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Unambiguous Policy Wording
Oftentimes, poor underwriting by insurers is compounded with
ambiguous policy wording, which has hurt the reputation of the
insurance industry as a whole. For an insurance consortium
to partner with CCPs, the triggers for coverage set forth in
the policy must be very clear and mirror the functioning of the
default fund itself as closely as possible – i.e. once a member
defaults and losses reach a defined threshold, the policy will
pay the claim.
Designated Program and Claims Managers
Insurers, by and large, are not experts regarding the daily
operations of CCPs. Traditionally, this has limited their
understanding of margin systems, default waterfalls, legal
issues, and the need by CCPs for intraday liquidity. The
GCSA Consortium handles this dilemma by relying upon the
expertise of a specialized group of professionals (the GCSA
team) to underwrite, perform surveillance, communicate
with key regulators, and manage claims on behalf of its
consortium. We’ve successfully brought together people with
legal, clearing, markets, regulatory, and insurance expertise
under one organization for the specific purpose of providing a
coherent product for financial market infrastructure.
Insurance and Principle 7 (Liquidity)
Insurance, when structured properly, can be an excellent
tool for credit loss absorption (PFMI -Principle 4) and there is
also an opportunity for it to work within the existing liquidity
framework of the CCP (PFMI - Principle 7) to meet demands
for immediate funds. Some regulators, such as the US
Commodity Futures Trading Commission (CFTC), permit the
coupling of insurance with unsecured liquidity facilities, so that
the combination of tools can work together to meet financial
resource requirements– i.e. the liquidity facility provides
immediate funds and the insurance ultimately pays back the
liquidity facility and absorbs the losses. Other regulators have
more stringent “prefunded” requirements for their default
resources, which require collateral that could ultimately be
posted to committed secured liquidity facilities. We think
there exists an opportunity for an insurance consortium to
post collateral to an independent trust in conjunction with the
coverage afforded by the policy, which can be immediately
released upon the submission of a claim. This form of insurance
would allow CCPs to have immediate access to collateral that
could be posted to their secured credit facilities, committed
repurchase agreements, or ultimately sold in the marketplace
for liquidity. GCSA has dubbed this alternative “Contingent
Convertible (CoCo) Insurance” and it represents an innovation
in the way insurance could potentially support CCPs.
The Cost of Insurance
When GCSA prices the cost of insurance for a default
waterfall, the premium varies by CCP because the risk of loss
is dependent on the risk management practices, historical
performance of the margin system, the credit quality of the
member base, and other underwriting factors such as our
analysis of the legal and regulatory regime.
Quantitatively, statistical tools such as extreme value theory
can be applied to analyze the frequency and severity of
breaches of the margin system, which helps our understanding
of catastrophic scenarios. GCSA also complements its
quantitative work with its own assessment of each CCP’s
compliance with the 24 principles of the PFMIs. As such, the
risk to the insurance policy can be very different from the senior
unsecured credit quality of the CCP itself; hence the cost is
independent of the prices of other capital market instruments.
For example, an insurance policy that sits in the Cover 2
portion of the waterfall (or beyond) would be priced well below
the average cost of capital of both the CCP and its members.
Insurance is also able to augment its offering with reinstatement
features that act as “replenishment tools” for recovery that can
effectively double the available capacity offered to the CCP for
a fraction of the premium cost.
As such, we believe that a properly structured insurance
package can be very cost-effective for market participants.
April, 2014

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Conclusion: So, Is “Insurance” Suitable for the Default Waterfall?
With the right partners, the right policy wording, the right structure, and the right placement in the default waterfall, the answer
is “yes.” We think the right insurance program could meet the needs of CCPs and comply
with CPSS-IOSCO PFMIs, EMIR, and a myriad of other local regulations. Bringing
together the enormous claims paying ability of the insurance industry could
make the financial system stronger. It holds the possibility of reducing
pro-cyclicality and reliance upon member assessments
for replenishment, while also encouraging a more efficient
use of capital, which could allow CCPs to hold larger
buffers against catastrophe.
We estimate that clearinghouses hold
approximately $30 billion in default
funds across the word, which supports
millions of derivative transactions and
helps to backstop many hundreds of trillions
of dollars of notional exposure against
counterparty defaults that could generate
losses in excess of margin collateral.
Initiatives like the GCSA Consortium would
provide further default protection to the
industry, while bringing diversification of
resources, independent surveillance, and
facilitate a true long-term partnership between the
insurance industry and FMIs.
April, 2014
“We believe this relationship will
ultimately prove to be an important
agent for strengthening the fabric of the
financial system.”

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Collateral management out of a box for CSDs
By Clearstream
Across the industry and around the world, banks and other
financial institutions are scrambling to come up with answers
to the causes of the so-called “credit crunch” of 2007-08,
and a widely anticipated shortage of collateral stemming from
regulatory measures taken to deal with that initial shortage of
credit.
Those measures, which include the Basel III capital
adequacy regime, the Dodd-Frank Act, the European Market
Infrastructure Regulation (EMIR) and the Capital Requirements
Directive (CRD IV), were adopted in the aftermath of the
financial crisis, and are now being translated into national
legislation and regulations.
Banks and other financial institutions naturally turn to a market
infrastructure such as a central securities depository (CSD)
for support in dealing with challenges. Developing a workable
collateral management offering for their underlying clients to
avert a shortage of collateral is therefore essential for CSDs to
remain competitive.
April, 2014
With regulatory measures fuelling expectations of a global shortage of eligible collateral, CSDs are under pressure
from local market participants to help them manage and move collateral. Gerd Hartung, senior vice president, client
relations, global securities financing and broker-dealers at Clearstream, explains how the Liquidity Alliance can help
CSDs put sophisticated collateral management services in place quickly and economically.

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As the implementation dates of the various regulatory measures
draw closer, it is becoming urgent for banks and other financial
institutions to optimise their collateral management systems
and to pool their collateral in order to avoid the much-feared
collateral crunch.
While these concerns are now well known throughout the
industry, it is also important to think beyond the operational
details of the problem to find a sustainable, global solution to
the looming collateral shortage.
Market infrastructures such as central counterparties (CCPs),
trade repositories and CSDs are appreciated for the vital
role they played in stabilising markets during and after the
crisis. It is therefore natural that regulators have decided to
strengthen their role - for example, by requiring standardised
OTC derivatives to be centrally cleared.
But while the discussion rightly centres around the risk-mitigating
elements of the CCPs, we should not forget that
the CSDs also played a vital role in guaranteeing stability
during the financial crisis. They achieved this by the provision
of liquidity to the market as confidence dropped and inter-bank
lending almost ground to a halt. Tri-party agent services
in particular experienced a boom as they allowed banks to
better manage and cover their exposures through a neutral
infrastructure provider.
CSDs are therefore particularly well placed to help the market
overcome the potential collateral shortfall by optimising
collateral pools. Clearstream, for example, has longstanding
experience in providing collateral management and securities
lending services via its Global Liquidity Hub. It can leverage
this knowledge to help other organizations overcome collateral
fragmentation.
However, while CSDs around the world are feeling the
mounting pressure of the upcoming regulations through
increased client expectations and demands, not all CSDs
have the funding, resources or international experience to
develop collateral management services of their own within the
required timeframe. It is therefore vital for CSDs to collaborate,
and to adapt already existing services and technologies to
their individual market requirements.
In this spirit, five CSDs formed the Liquidity Alliance in January
2013 to adapt a common approach to the collateral shortage.
Instead of each CSD having to embark on costly and lengthy IT
developments, they will use a common collateral management
platform.
The Liquidity Alliance also serves as a forum for
sharing experiences, identifying common needs
and promoting collateral research. In other words,
the Liquidity Alliance aims to go beyond the purely
technical aspects of the problem. It seeks, through
collaboration, to create a pool of useful knowledge
about how to cope with the global collateral sourcing
and servicing challenge.
The Liquidity Alliance uses the Liquidity Hub GO solution from
Clearstream as its common collateral management platform.
It is currently the only service available which allows assets
to remain in custody in a domestic market while the system
is white-labelled by the local CSD to perform sophisticated
collateral management tasks such as allocation, optimisation
and substitution.
It is vital that the services do not entail moving assets out of
the domestic market, as local custody is a legal requirement in
April, 2014
“Market participants want
services that reduce collateral
fragmentation and lower
inefficient collateral buffers, as
well as improving the accessibility
and mobility of assets useable
as collateral. The ultimate goal is
to improve the capital base and
liquidity flow of the institution.”

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many jurisdictions. Staying in the domestic market also means
that the assets are governed by local laws, and the contractual
arrangements between the CSDs and their customers can
remain unchanged.
In addition to sharing collateral management technology,
members of the Liquidity Alliance come together on a regular
basis to discuss current market developments, partnership
plans and business opportunities in collateral management,
while also investing resources in studies and industry research.
Since the members of the Alliance are drawn from all over the
world, they form a valuable pool of local insights and expertise
that can be used on a global scale. They also act as a trusted
source of information. In this way, the Alliance adds value to
what could easily remain a purely operational and technical
subject.
However, the Liquidity Alliance is much more than a talking
shop. It is already in action. The Brazilian CSD, CETIP, has
gone live with the common collateral management service.
ASX (Australia), Iberclear (Spain) and Strate (South Africa) are
expected to follow suit in the course of this year.
The most valuable aspect of the Liquidity Alliance for these
organizations is that it enables them to develop collateral
management services for their local markets much faster and
more efficiently than on their own. It allows domestic markets
to develop services to customers, while simultaneously
enabling them to meet regulatory requirements within the tight
timeframes set by both domestic and international regulators.
The Liquidity Alliance is now fielding requests from market
participants to extend the offering to include the use of
offshore assets to cover domestic exposures, in addition
to mobilising domestic assets for the coverage of offshore
exposures. Members of the Alliance have already developed
ways of using collateral held offshore for domestic purposes.
The ultimate aim of the Liquidity Alliance is to come up with
effective and cost-efficient answers to the anticipated collateral
shortage by using domestic collateral to cover international
exposures, and vice versa. To attain this objective will not be
the work of a moment. The Liquidity Alliance aims to enhance
its services, and add to its membership.
April, 2014

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As part of Mexico’s Financial Reform initiatives, modifications
and additions where contemplated to allow certain securities
to be issued electronically.
The modifications to the Mexican Securities Market Law
represent for Indeval a major change, who has to provide the
technological infrastructure to process the securities registry,
the actual issuance and storage of these electronic securities.
On the legal front, participants have to adhere to the new
Internal Rules of the CSD, Operational Manual and strictly
follow the outline of a new contract model. In addition, the
new operation model needs to be analyzed, designed and
documented in alignment to the general rules issued by the
Central Bank.
This new system will be available to issue any type of security,
although its use will be enacted gradually.
Modifications to the Mexican Securities Market
Law regarding electronic custody
Article 282. The securities stored in Central Securities
Depositories may be represented in multiple issued securities
or into one that covers part or all of the securities issued. Such
securities may be issued electronically in the form of a data
message with advanced electronic signature in accordance
with the Commercial Code and the general provisions
issued by the Central Bank, including, among other aspects,
securities that can be issued by electronic means, as well as
specific security features needed for such purposes.
For those securities issued in print media (physically), may be
replaced electronically under the terms of this paragraph in
accordance with the general provisions issued by the Central
Bank.
Article 283. Deposit service referred to in this Chapter, shall
be constituted by the delivery of securities to the Central
Securities Depository, which will open accounts for the
depositors. Additionally, in the case of securities deposited
by electronic, optical or other technological means, will be
received under the provisions contained in the Commercial
Code.
April, 2014
Electronic Custody: Reducing Operational Risk Through its Implementation
By Custody Area, Indeval

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us information for the next
edition, do not hesitate to
contact us to:
nbarajas@indeval.com.mx
April, 2014