INDEVAL: Mexican Financial Markets Benefit from Novel Application of Operations Research
The Problem
INDEVAL is the Mexican Central Securities Depository for all financial securities. It offers the safekeeping, custody, management, clearing, settlement, and transfer of securities. It manages the Securities Settlement System (SSS). Currently, SSS settles securities operations that average over US$250 billion daily, more than 70% of the value settled in the Mexican payments system.
Settlement systems are the core of the financial infrastructure; therefore, it is important that they are robust and solid enough to absorb shocks and ward off the negative effects of a financial crisis. INDEVAL plays an unnoticed but mission-critical role for the Mexican economy because it is the main provider of intraday liquidity to the whole financial sector. The SSS is important for the stability of the financial system, so it must be secure and efficient. One of the most attractive characteristics of a financial system is high liquidity. High liquidity means (a) that banks can meet their cash obligations promptly without having to resort to such expensive solutions as large deposits that yield no interest in the Central Bank, and (b) that securities holders can convert their securities to cash quickly and at market prices.
The Analytics Solution
In 2005, INDEVAL, the Central Bank, and Instituto Tecnológico Autónomo de México (ITAM) began implementing a safer, reliable, and efficient SSS. The two key requirements for the new system were (1) efficient management of resources through “netting,” because having an SSS that can function with minimal resources is invaluable during financial crises when liquidity is scarce, and (2) real-time settlement to meet ever-increasing demands for intraday liquidity and for better risk management tools. With these premises, communication protocols, business rules, and best market practices were revised, and a new settlement
solution was created.
The main benefits that INDEVAL management sought were providing financial markets with generate liquidity and reducing the resources needed to settle transactions. A major challenge for implementing a new solution was to get the support of the whole industry and persuade more than 100 direct market players (including authorities and institutions such as HSBC, Bank of America, and Citibank) to change their operating procedures for handling transactions. Usually, the handling of financial transactions relies on data management and information technology approaches, which do not take into account critical factors such as the order in which settlement instructions are executed. Considering this, analytics techniques were applied and were critical for the success of the project.
In particular, the team used business process modeling notation to redesign all business processes; designed and tested a new rule-based SSS to improve the quality, reliability, and safety of the service; and developed a simulation model to evaluate the performance of the new SSS in liquidity usage and settlement time. The core of the SSS is an analytics-based engine that is executed automatically (currently configured to run every two minutes, or more frequently if there is enough traffic) and offers a continuous and secure operation, ensuring that settlement is irreversible. This single clearing and settlement engine incorporates a linear programming (LP) model that chooses which pending operations can be settled with the depositors’ available balances, maximizing the value of the transactions settled.
The Value
Thanks to the LP model, many transactions that would remain pending if they were processed individually are settled together, thus reducing liquidity requirements dramatically, by 52% in cash and 26% in securities. Financial intermediaries save over US$150 million per year by not having to provide daily liquidity (in the order of US$130 billion to settle over US$250 billion in securities transactions).
The most important benefit of the implementation of analytics in INDEVAL’s SSS is the enhancement and strengthening of the Mexican financial infrastructure. Additional benefits include a safe mechanism to transfer money from the Central Bank to meet obligations in other payment systems and an effective tool for depositors to close their risk positions swiftly for better risk management. This analytics solution benefits the entire Mexican securities and financial market because it includes the best of two worlds: the fast circulation of liquidity of near real-time settlement and efficiency in the use of financial assets of a deferred net settlement scheme. Both advantages could not have been accomplished without the novel analytics applications at the heart of the Mexican financial sector.
