DTCC Will Narrow Industry’s Risk With a Real-Time Trade Guarantee
DTCC has announced two measures that will further mitigate risk for the industry and ensure greater certainty for market participants: 1) the plan to implement a real-time trade date guarantee for all Continuous Net Settlement (CNS)-eligible trades, including equity, corporate bond and municipal bond transactions, and 2) the increase of its equity clearing processing capacity to an unprecedented 500 million transactions per day.
DTCC’s equity clearing subsidiary, National Securities Clearing Corporation (NSCC), will apply its guarantee on trade date upon comparison for non-locked-in trades or validation for locked-in trades instead of T+1, which will reduce credit exposure for trading firms – and systemic risk across the industry.
Stronger risk management
Currently, the trade guarantee is applied at midnight of T+1, which represents a delay before NSCC steps in between the two sides of a trade and assumes the buyer’s credit risk and the seller’s delivery risk in the event either side defaults. NSCC is expected to file a rule change with the U.S. Securities and Exchange Commission (SEC) in the first quarter of 2009 seeking approval for its real-time trade guarantee. The decision to move to a real-time trade guarantee was recently approved by DTCC’s Board of Directors.
“Maintaining confidence and stability in the marketplace and protecting our members under both ordinary and extraordinary circumstances is our highest priority. A real-time trade guarantee significantly enhances DTCC’s already robust risk management process and gives financial firms greater certainty that their trades will settle,” said Michael Bodson, DTCC executive managing director, Business Management and Strategy.
“Recent market events, including firm failures like Lehman Brothers and Madoff Securities, underscore the importance of a real-time trade guarantee – and the value of a central infrastructure provider like DTCC that can manage risk from a central vantage point across asset classes,” Bodson said.
Value of infrastructure
The benefits of DTCC’s risk management experience was evident in October 2008 when the organization, through all of its subsidiaries, successfully closed out $500 billion in open, unsettled trades resulting from the Lehman bankruptcy with no adverse impact to market participants’ clearing fund deposits. In December, NSCC chose to guarantee (although it was not obligated to) all trading activity with Bernard Madoff Investment Securities received as of December 12, 2008, and closed out the account with no loss to member firms.
“We have been working to enact a real-time guarantee for some time because we understand that by speeding up this process, we can reduce counterparty risk for trading firms and protect them from potentially unstable trading partners,” said Marie Rey, DTCC managing director, Enterprise Risk Management. “The firm failures of Lehman Brothers and Madoff Securities demonstrate the value of DTCC’s ability to provide certainty and stability during unforeseen shocks to the markets.”
With the move to a real-time trade guarantee, DTCC expects some change to clearing fund requirements. However, in light of the current economic environment, DTCC is currently reviewing its collateral management methodologies and calculations to ensure adequate coverage to protect the industry while minimizing expenses for member firms.
500 million transactions per day
In the fourth quarter of 2008, NSCC experienced a 25% jump in equity volume, handling a daily average of nearly 170 million total transactions compared to the average daily volume of 128 million for 2008. On October 10, 2008, NSCC processed a peak record 315.6 million total transactions. The number of transactions is different from the number of shares; a single NSCC transaction (also called a side) can be for any number of shares of stock – e.g., 100 shares, 500 shares or 1,000 shares.
The increase in capacity to 500 million transactions per day ensures that DTCC has the ability to handle unexpected spikes in trading volume. DTCC provides clearance and settlement services for virtually all broker-to-broker trades on the nine major and regional exchanges and 50+ electronic communications networks (ECNs) in the United States.
“DTCC’s members pay the lowest equities clearance fees in the world, and baked into that price is our enormous processing capacity, comprehensive risk management process and the netting down of trade obligations requiring financial settlement,” said Susan Cosgrove, DTCC managing director, Equities Clearance and Settlement Group.
“The total cost to provide equity clearing is less than $100 million annually,” Cosgrove said. “If we do the simple math, based on about 300 firms, the average cost per firm is roughly $300,000. DTCC has invested over the years in its technology infrastructure so that we are always prepared to handle trading volumes, including spikes in volume, at no additional cost to financial firms.” In its 30+ year history, DTCC’s family of companies has never experienced a system outage or service interruption that prevented the organization from completing clearance and settlement. @