Risk Management by Securities Settlement Agents

As developing countries search for ways to promote capital formation through the establishment of organized exchanges, they will need to pay more attention to the role of risk management in the securities settlement process. The delivery‐versus‐payment (DVP) agents that facilitate the process of exchanging securities for funds in most world markets have both the incentive and comparative informational advantage to monitor, measure, and manage risks inherent in the securities settlement system. Unfortunately, most DVP agents have accomplished this task to date through the cumbersome use of position and net debit limits, capital requirements, and collateral requirements. Such limits and requirements are almost everywhere based on relatively arbitrary criteria that may have no relation to the actual replacement cost, principal, or liquidity risk of the transaction, portfolio, or participant on which they are imposed. To remedy this shortcoming in the current state of risk management at DVP agents, this article holds out the possibility of integrated, comprehensive risk management processes that emphasize and rely on forward‐looking measures of risk for individual brokers and across brokers. Many risk measures could serve the settlement agent's purposes, including “value at risk” (or “VaR”), “below target risk,”“below‐target probability,” and “downside semi‐variance.” The actual summary risk measure used for risk monitoring and control is not as important as the methodology used to generate that risk measure. “The goal of such a process,” as the authors put it, “is to ensure that the risks to which a settlement agent and its residual claimants are exposed are those risks to which the agent's shareholders think they are and want to be exposed.”