Risk Management- It’s Everyone’s Job

It’s 2008 at the NYSE and we have just learned over the weekend that Lehman has failed. They are an order flow provider; a trading floor brokerage operation; a specialist firm; a clearing firm; a listed issuer and much more. What does this all mean -- will DTCC stand up for Lehman’s trades?; do they have the funds to clear and settle?; what should we do?

The answers are clear: communicate, and act quickly.

We hoped at the time we would never see another firm collapse as Lehman and Bear Stearns did in 2008. But those difficult experiences were important and valuable, because they resulted in a new set of procedures for situations such as these.

Flash forward three years, and MF Global fails. What did we do?

First we communicated and coordinated with our regulators, DTCC, customers and the firm. When we determined the firm’s standing with DTCC, the first act was to update our databases to remove MF Global as a member firm with order- entry capabilities, and then to remove them as a clearing firm. By doing that, no new trades could be committed by the firm in the market, which would have possibly exposed other customers to contra-party risk. We also communicated to the trading floor members that MF Global could not be used verbally as a contra-party to any trades.

We then communicated these actions to the community at large. In addition, we restricted access to certain services like the NYSE Post Trade system OCS, which allows clearing firms to manage trades through the clearing process.

These actions were carried out quickly and by employees across the NYSE Euronext business lines and service centers. By knowing what to do and doing it quickly, NYSE Euronext was able to contain both its own risk exposure to a failed member firm, as well as that of our members and customers.

What does the future hold? As with all of our work, we continue to use what we have learned to enhance our processes. DTCC is working on a new automated message type to the industry to “cease to act” on behalf of a member. Exchanges such as ours will be required to read that message and take appropriate action. MF Global was a simpler case than Lehman and Bear Stearns. What if MF Global were a DMM, responsible as primary dealer for 500 stocks? An automated message could not simply shut down trading during the day for 500 companies. But the movement is toward mitigating risk as quickly as possible and as rationally as possible.

In the future, risk mitigation will be built into every system we operate. Even then, it will continue to be everyone’s job.