FICC Receives OK to Ban Pre-Netting Practices; Move Will Reduce Risk in U.S. Government Securities Market
In a move to bring added safety and soundness to U.S. government securities processing, Fixed Income Clearing Corporation (FICC) has received regulatory approval from the Securities and Exchange Commission (SEC) to prohibit certain affiliates of FICC netting members from pre-netting their government securities trades outside of FICC. FICC is a subsidiary of DTCC.
Pre-netting involves any trade submission practice other than submitting transactions directly to FICC on a trade-by-trade basis as executed, and which identifies the actual parties to the trade. The ruling, which is effective immediately, expands FICC’s trade submission requirements to all netting-eligible trades executed by certain affiliates of FICC netting members, who are U.S.-registered broker-dealers, banks, or futures commission merchants. Failure to comply with the new ruling could lead to fines or termination of FICC membership.
“This change validates what DTCC has long known, and that is the risk caused by pre-netting poses a considerable threat to the safety and soundness of FICC’s clearance and settlement services and the market itself,” said Jeff Ingber, managing director and general manager for DTCC’s Fixed Income Clearance and Settlement.
Indeed, it was recognition of this risk by the industry that was the driving force behind the creation of the Government Securities Clearing Corporation, a predecessor company of FICC, almost 20 years ago, he noted.
“That some FICC members and their affiliates are engaging in pre-netting runs counter to the spirit and intent of why FICC was formed in the first place,” Ingber continued. “With FICC ultimately guaranteeing the settlement of each government securities transaction it accepts into the net, members gain assurance about the accuracy of settled trades and any potential credit losses associated with unsettled trades.”
On average, FICC’s netting process safely eliminates some $2.8 trillion a day in settlement risk posed by more than 100,000 government securities transactions a day.
Industry Input
FICC consulted with a number of industry organizations and members before its SEC filing to prohibit pre-netting and broaden trade submission and reporting requirements.
Eric Foster, vice president and associate general counsel of The Bond Market Association, said, “As the only U.S. government securities clearing agency registered under the Securities Exchange Act of 1934, FICC plays a crucial role in maintaining the proper functioning of one of the largest fixed income markets in the world: the primary and secondary market for U.S. government securities. Anything that takes away from FICC’s internal risk management and dilutes the FICC guarantee that is a cornerstone of the government securities market is a serious threat, and one that the SEC has rightly defused with its ruling.”
Ending Pre-Netting Risks
The issue with pre-netting is that it masks member trading activity and information and undermines the transparency that is at the heart of FICC’s clearing and settling process.
For example, one form of pre-netting, called “compression,” allowed a clearing member to submit netted trade data to FICC’s Government Securities Division (GSD) in a way that conceals the party that executed the transactions. Another form of pre-netting is “internalization,” whereby a clearing member executes affiliates’ trades within its own record-keeping system and fails to report data on those trades to FICC.
Yet another example of pre-netting is “summarization,” a technique under which a clearing member delays submitting individual trades to FICC when they occur and holds them until additional trades can be combined and submitted as a single trade.
“With the huge and growing market in government securities, the failure of FICC members and affiliates to submit all eligible trading activity could impede FICC’s ability to accurately identify its risks and collateralize its exposure,” explained Tom Quaranta, managing director, FICC Client Support. “That’s why it’s imperative for FICC members to promptly stop any pre-netting and start working immediately on identifying their covered affiliates and determining how those affiliates will be submitting their trading activity to GSD.”
“The new affiliate trade submission and reporting requirements are a necessary change and should pay dividends to FICC, our members, and the broader government securities market,” added Bob Trapani, vice president, FICC Marketing. @