Latin American Capital Markets

368 A. M. CORCORAN, R. B. HOBSON, G.J. KUSERK, K. K.WUERTZ,AND QWESTto secure the broker's obligations to its customers, including the accruals on their positionsand, as such, is an important protection against the credit risk that the brokerwill default on the payment of profits owed to its customers. 45 Segregation also canassist in managing of market risk and in isolating risk in the event a firm defaults. 46When segregation is maintained not only by the carrying broker firm but alsoby each depository of customer funds, in the event of broker insolvency, customerfunds and positions will be readily identifiable. In some jurisdictions, such funds are heldin actual trust; in others, they are treated as if held in a statutory trust and thereby insulatedfrom a broker's creditors in the event the broker fails or a customer defaultimplicates the broker's capital. In the event of a firm disruption caused by proprietarytrading, segregation and daily settlement can prevent the accrual of losses in the failedfirm as segregation facilitates the movement of positions from one firm to another;thereby permitting solvent customers to preserve their positions and continue to supportdaily settlements on those positions notwithstanding the insolvency of their carryingfirm.The movement of positions isolates the disruption, and possibly expandedfinancial failure that could occur if such customers discontinued payments to the failedintermediary, and thereby reduces risks to clearing organizations, their members, andthe market as a whole.Segregation protects customers not only from a disturbance due to the proprietarytrading of their carrying firm (assuming no fraud or conversion) but also froma destabilizing run on the firm by customers demanding that their accounts be disbursedor transferred. Segregation is easier to calculate than capital, and, thus, segregationcompliance is a good measure of the capacity of a firm to fulfill obligations toits customers and the market. In some markets, customer positions are directly heldat the clearinghouse.This also protects customer funds, but makes the clearinghousedirectly accountable to the customers, which, while less risky for customers of individualbrokers, may compromise the liquidity of the market in a marketwide disturbance.Segregation and similar types of arrangements to protect customer positionsand isolate risks require legal support to be effective. 4745 The variation margin payments required in United States markets facilitate such collateralization of customer claims.As most brokers cannot cover these accruals out of capital, the system facilitates the securing of accruals by requiringthe passing of the necessary cash to do so. When the London Metal Exchange first listed financial contracts, it requiredsegregation of such accruals, in part because of this feature.46 See the Windsor Declaration by the representatives of regulatory bodies from 16 countries responsible for supervisingthe activities of the world's major futures and options markets, made in May 1995, available at http://www.cftc.gov/oia/oiawindsordeclaration.htm.47 However in Spain and Finland, customers are direct participants in clearing (Corcoran and Ervin 1987).Copyright © by the Inter-American Development Bank. All rights reserved.For more information visit our website: www.iadb.org/pub