FICC Advances Plans to Expand And Upgrade Membership
In its drive to bring increased risk management and efficiency to buyside firms, DTCC’s Fixed Income Clearing Corporation (FICC) is taking steps to expand membership and redefine capital requirements in its Mortgage-Backed Securities Division, and to add new membership categories in the Government Securities Division. The membership changes are subject to approval by the Securities and Exchange Commission (SEC).
FICC has set August 17, 2009, as the date when it will require banks and broker/dealers, as well as mutual funds, hedge funds and other buyside firms, to have their technology and membership status prepared for participation in the new central counterparty (CCP) for mortgage-backed securities that FICC plans to launch in the third quarter of 2009.
This follows a December 2008 SEC filing by FICC’s Government Securities Division (GSD) seeking authority to extend its clearing and risk management services for government securities trading to mutual and hedge funds. Such firms are currently not eligible for membership in FICC’s GSD.
At the heart of these initiatives, according to Murray Pozmanter, DTCC managing director, Clearance and Settlement Group, is an effort to expand the number of financial entities that can make use of FICC’s trade guaranties while ensuring they have sufficient resources to meet FICC’s stringent capital requirements.
Enhancing risk protection
“We’re taking these steps to bring additional risk protection to the industry,” Pozmanter said. “Since the onset of the financial crisis, and particularly since the bankruptcy of Lehman Brothers, hedge funds and other buyside firms have been looking more closely at how they can mitigate risk through DTCC’s various central counterparties the way broker/dealers have been able to do for the last 20 years.”
Under FICC’s proposed new rules, all firms would have to meet higher capital standards while registered investment companies, such as mutual funds, and unregistered investment pools, or hedge funds, would be able, for the first time, to submit government securities trades to FICC for clearance and guaranteed settlement.
In addition, FICC’s Mortgage-Backed Securities Division (MBSD) intends to open membership to insurance companies and will revise its proposed rules to do that.
Mortgage-backed securities
“Since our plan is to have the new CCP for mortgage-backed securities operational in the third quarter of 2009,” Pozmanter said, “the August 17 date sets a target for members to meet FICC requirements to participate in the CCP, including completion of mandatory operational testing.”
In the market for mortgage-backed securities, where FICC only accepts trades involving securities issued on the secondary market by government agencies or government-sponsored enterprises, the company cleared trades in 2008 valued at more than $111 trillion.
Government securities
New GSD members will likewise be able to take advantage of FICC’s rigorous risk management process, which includes daily portfolio monitoring, intra-day collateral requirements and a guarantee that trades will be settled, said Pozmanter.
“Many buyside firms now feel that putting funds aside to meet FICC’s margin requirements is a wise allocation of their capital,” Pozmanter said. “Our trade guarantee sharply reduces their counterparty credit risk and our netting procedures help lower their cost of operations. In addition, the more that fixed-income trades are cleared and netted through our systems, the more that all the trading partners are able to trim operating costs and lower risk management expenses.”
As a central counterparty, FICC’s GSD guarantees that a government securities trade will be completed even if one of the parties to the trade defaults. In 2008, FICC handled U.S. Treasury trades valued at more than $1 quadrillion, or an average of more than $4.1 trillion each day.
Capital requirements
Under the rule changes filed with the SEC by both divisions of FICC, banks, thrifts and government-sponsored enterprises will need a minimum of $100 million in equity capital, while broker/dealers will have to maintain $10 million in excess net capital – in other words, liquid capital – and $25 million in net worth.
Mutual funds seeking to become customer-members will need a minimum of $100 million in net asset value. Unregistered investment pools seeking to join FICC must have a U.S.-based investment advisor. If the fund’s advisor is not registered with the SEC, the fund has to have $1 billion in net assets and will be subject to a two-year “lock-up” period or some other mechanism, such as “gates,” preventing the rapid outflow of the fund’s assets. Unregistered investment pools whose advisor is registered with the SEC would have to maintain $250 million in net assets.
Unregistered investment pools that are already customers of FICC’s MBSD and have assets of at least $1.5 billion under management will be able to begin clearing through GSD immediately if they maintain a net asset requirement of $100 million, once SEC approval is obtained.
These capital requirements are applicable to firms whose financial statements are prepared in accordance with U.S. Generally Accepted Accounting Principles (GAAP). Funds and firms that prepare their statements using other accounting principles will be subject to higher minimum financial requirements, FICC said.
Risk measures
If FICC ever sustains a loss as a result of maintaining its trade guarantee, its customers will be called upon to help make up the loss. To protect its entire membership, FICC is stepping up its risk management measures.
For example, under proposed rule changes, FICC will be able to assess a premium when an unregistered investment pool’s margin requirement is greater than its specified net assets.
“We will also review unregistered investment pools according to our own credit risk rating matrix,” Pozmanter said, “and we will hold them to a particularly high standard in our daily value-at-risk management assessments, which we use to determine how much margin companies are required to put up against their outstanding trades.”
Additional evaluations of the funds will be based on their capital, strategy, valuation procedures and internal controls.
Because mutual funds are prohibited by law from “loss mutualization,” FICC has established a separate loss allocation process for them that recognizes and handles loss on a bilateral basis between the fund and its trading partner.
“In light of what’s happened in the last year,” Pozmanter said, “we expect the effort to extend our risk management services more broadly throughout the securities industry will be warmly welcomed.” @