Financial Risk Management

Managing Financial Risk

Financial Risk Management (FRM) refers to the set of disciplines responsible for managing financial risk, particularly with respect to the Clearing Agencies. These disciplines include credit risk, market risk, liquidity risk, quantitative risk, and model risk. Underpinning all FRM activities is a strong emphasis on data quality — accurate, timely, and complete data is essential to the integrity of decision-making processes.

FRM operates under the oversight of key governance bodies, particularly the internal Management Risk Committee and the Board Risk Committee, to ensure alignment with the firm’s risk appetite and regulatory expectations.

Financial Risk Management

Click on the tabs below to learn more about Financial Risk Management.

Counterparty Credit Risk Management

Overview

In performing its role in the financial markets, DTCC undertakes a number of crucial oversight activities, including the assessment of new applicants and the performance of ongoing client and market surveillance. Participation in the Clearing Agency Subsidiaries provides Participants with access to the services the Clearing Agency Subsidiaries offer but also exposes the Clearing Agency Subsidiaries to counterparty exposure. The Clearing Agency Subsidiaries maintain strict membership standards, including minimum financial requirements and Participants are subject to ongoing review following admission. When a new applicant seeks to become a Participant of one of the Clearing Agency Subsidiaries, FRM performs a detailed assessment of the applicant, which includes a review of its organizational structure, management, regulatory oversight, business plan, risk controls and financial position. Based on this review, a recommendation is made as to whether the applicant should be accepted as a Participant. The assessment may be presented to the Management Risk Committee and, in certain circumstances, to the Board Risk Committee, for a final decision. In general, Participants are regulated financial institutions, including broker-dealers, banks, mutual fund companies, investment banks, commercial banks, exchanges and other market participants.

DTCC monitors its credit exposures with respect to the risk that a client defaults through the ongoing surveillance of its financial strength and default risk. On an ongoing basis, clients are required to provide financial and other information to DTCC to ensure that they meet our standards on an ongoing basis. In addition, FRM reviews publicly available information such as earnings releases, equity prices and news as part of its surveillance.

Market Risk Management

Overview

The Clearing Agencies maintain comprehensive market risk management programs designed to, among other things, effectively:

manage market risk exposures to their clearing participants.
manage market risk exposures arising from their payment, clearing and settlement processes.
limit the assets they accept as collateral to those with low credit, liquidity and market risks.
set and enforce appropriately conservative haircuts and concentration limits on the assets they accept as collateral.

In addition, as central counterparties, NSCC and FICC also include risk-based margin systems in their risk management programs designed to, among other things:

cover market risk exposures to their clearing participants.
produce margin levels commensurate with the risk and attributes of each product, portfolio and market.
mark participant positions to market.
calculate margin sufficient to cover the potential future exposure to their participants in the interval between the last margin collection and the closeout of positions following a participant default.

The Teams

The Equity Risk team is responsible for the market risk management program at NSCC and DTC. The FICC Market Risk team is responsible for FICC’s market risk management program.

A core objective of these programs is for each Clearing Agency to maintain sufficient financial resources to cover market risk exposures to participants fully, with a high degree of confidence and under a wide range of foreseeable stress scenarios.

Clearing Agency Specific Programs

How market risk presents itself and is managed is unique to each Clearing Agency. Click on the NSCC, FICC and DTC tabs above for more information about their specific market risk management programs.

To learn more about market risk management at the Clearing Agencies, see their respective CPMI-IOSCO Disclosure Frameworks – Principles/Standards 4 (Credit Risk) and 5 (Collateral); and for NSCC and FICC, also Principle/Standard 6 (Margin).

NSCC’s Trade Guarantee

Market risk management is the foundation supporting NSCC’s trade guarantee to members.

As central counterparty, NSCC:

serves as buyer for every seller, and seller for every buyer, for settlement purposes.
ensures completion of trades if one of the trading partners defaults.
through multilateral netting, significantly reduces (i) security movements, (ii) value of trade obligations requiring settlement, and (iii) capital requirements.

Equity Risk Team

The Equity Risk team monitors risks presented to NSCC by its clearing members.

Monitoring takes a variety of forms, including:

start of day and intraday (15 minute) Clearing Fund assessment and collection.
daily margin and collateral backtesting and stress testing.
market and portfolio risk monitoring; including intraday exposure and projected liquidity sufficiency.

NSCC’s Clearing Fund

NSCC’s Clearing Fund provides a liquidity and loss resource in the event of a member default. Clearing Fund Requirements are calculated and collected daily based on each member’s net unsettled positions.

Some key components of the Clearing Fund Requirement include:

volatility charge – which is either a model-based VaR charge or a haircut-based charge depending on asset type and liquidity profile.
margin requirement differential – which mitigates the risks from day-over-day fluctuations in a member’s portfolio.
mark-to-market – which is the difference between the contract price and the current market price.

NSCC Market Risk Resources

NSCC Haircut Schedule

FICC’s Trade Guarantee

Market risk management is the foundation supporting FICC’s trade guarantee to members.

As central counterparty, FICC:

serves as buyer for every seller, and seller for every buyer, for settlement purposes.
ensures completion of trades if one of the trading partners defaults.
through multilateral netting, significantly reduces (i) security movements, (ii) value of trade obligations requiring settlement, and (iii) capital requirements.

The FICC Market Risk Team

The FICC Market Risk team monitors risks presented to FICC by its clearing members.

Monitoring takes a variety of forms, including:

start of day and intraday (hourly) Clearing Fund assessment and collection.
daily margin and collateral backtesting and stress testing.
market and portfolio risk monitoring; including cycle over cycle exposure, projected liquidity sufficiency and indirect participant activity.

FICC’s Clearing Fund

FICC’s Clearing Fund provides a liquidity and loss resource in the event of a member default. Clearing Fund Requirements are calculated and collected daily based on each member’s net unsettled positions.

Some key components of the Clearing Fund Requirement include:

Value at Risk (VaR) volatility charge which uses (i) a 3-day liquidation horizon – i.e., the estimated length of time to liquidate or hedge a defaulted member’s portfolio – and (ii) a 99% confidence interval.
Portfolio Differential (PD) an exponentially weighted moving average of the increase in a member's VaR charge calculated twice each business day to address portfolio variability risk.
Margin Liquidity Adjustment (MLA) margin liquidity adjustment which addresses FICC’s risk of cost increase from liquidating a defaulted member’s concentrated portfolio.

FICC Market RIsk Resources - GSD

FICC Market RIsk Resources - MBSD

DTC Risk Controls

DTC employs risk management controls to protect against a participant’s failure to settle. The Equity Risk team is responsible for monitoring DTC’s risk controls throughout the day to ensure:

each participant’s posted collateral is equal to or greater than its Net Debit Balance, as managed through DTC’s Collateral Monitor.
each participant’s net debit settlement balance remains at or below its assigned Net Debit Cap.

Collateral Monitor

DTC’s Collateral Monitor:

tracks a participant’s collateral sufficiency to cover its settlement obligation.
prevents completion of transactions that would cause the participant’s net debit settlement balance to exceed its available collateral.
applies a percentage haircut to the collateral’s market value.

Collateral haircuts are determined by factors such as security type, ratings, market price, and security exchange listing. Haircuts are at least as conservative as the haircuts set under DTC’s committed line of credit, so that collateral will be sufficient to secure a borrowing if necessary.

Intraday price declines are monitored, and intraday prices and/or haircut adjustments may be made effective immediately. Daily backtesting and stress testing is conducted to determine haircut sufficiency and Collateral Monitor adequacy.

Net Debit Cap

DTC’s Net Debit Cap limits the net debit settlement balance a participant can incur.

The maximum Net Debit Cap for Affiliated Families and Unaffiliated Participants is $3.844BN – the Net Debit Cap of any Participant is based on the Participant's three largest peaks average over a rolling 70-business day period.

Transactions causing a participant’s net debit settlement balance to exceed its assigned Net Debit Cap will pend. Settlement funds may be sent intraday to DTC’s account at the Federal Reserve to lift the pend order and permit the transactions to process.

DTC Market Risk Resources

Liquidity Risk Management

Overview

The DTCC Liquidity Risk Management (LRM) program is responsible for measuring, monitoring and managing the liquidity risks that arise in or are born by each of the DTCC Clearing Agencies: The Depository Trust Company (DTC), National Securities Clearing Corporation (NSCC) and Fixed Income Clearing Corporation (FICC). LRM monitors the sufficiency of each of the Clearing Agencies’ liquid resources in all relevant currencies to ensure they are able to effect same-day, intraday and multi-day settlement of payment obligations, as applicable, with a high degree of confidence under a wide range of foreseeable stress scenarios that includes the default of all members of the Affiliated Family with the settlement obligation that would generate the largest aggregate payment obligation in extreme but plausible market conditions (Cover One standard). One of our flagship products - the Liquidity Optimizer - assists firms in monitoring changes in liquidity needs in near real-time for NSCC and GSD. The NSCC Liquidity Optimizer estimates the sufficiency of available liquidity resources and anticipates potential Supplemental Liquidity Deposits (SLD) at these clearing agencies, ensuring treasury desks and traders are aligned on expected funding needs. The GSD Liquidity Optimizer monitors a firm’s liquidity sufficiency and evaluates CCLF obligations, helping members understand and manage their required liquidity resources. Overall, both tools offer greater transparency into the firm’s liquidity obligations.

Objectives

The objective of Liquidity Risk Management at DTCC is to prepare for the potential insolvency of a member or affiliated family with the largest aggregate liquidity exposure (i.e., complying with the Cover One standard). LRM monitors liquidity risk by performing daily simulations that measure liquidity needs over the settlement cycle and seeks to assess and maintain qualifying liquid resources in an amount sufficient to cover and manage this risk under a wide range of foreseeable stress scenarios. The liquidity risk team actively monitors future settlement dates and conducts outreach as needed. These simulations utilize regulatory and informational stress scenarios which represent a wide range of historic and hypothetical events with various levels of stress applied. These scenarios are developed either by LRM or in collaboration with the Stress Testing and Systemic Risk Office, following a defined governance process to create, modify, and retire scenarios.

Liquidity Risk is presented differently in each Clearing Agency; therefore, the risk management practices are unique for DTC, NSCC, and FICC:

DTC Liquidity Risk

DTC provides depository and book-entry services, including custody of securities certificates and other instruments, and settlement and asset services for types of eligible securities including, among others, equities, warrants, rights, corporate debt and notes, municipal bonds, government securities, asset-backed securities, depositary receipts and MMIs. LRM’s activities assume that DTC operates on a fully collateralized basis and limits its members’ settlement obligations to the amount of available liquidity resources such that potential secured borrowing needs are supported by sufficient collateral. DTC’s liquidity resources are an all-cash Participants’ Fund as well as a committed 364-day credit facility with a consortium of lenders.

NSCC Liquidity Risk

NSCC provides centralized clearing and settlement services for equities, corporate bonds, municipal bonds, and Unit Investment Trusts. NSCC maintains a liquidity risk management framework for the measurement, monitoring and management of its potential liquidity needs, which is designed to ensure that NSCC maintains sufficient liquid resources to timely meet its payment (principally settlement) obligations in the event of a Participant default. On a daily basis, LRM measures the amount of liquidity that would be required by NSCC in the event that the Participant or Participant family with the largest aggregate liquidity exposure fails to settle (Cover One standard). NSCC then seeks to maintain qualifying liquid resources in an amount sufficient to cover this risk. NSCC’s liquidity resources include (i) cash in its Clearing Fund; (ii) cash that would be obtained from NSCC’s committed 364-day credit facility with a consortium of lenders; (iii) supplemental liquidity deposits, which are designed to cover the heightened liquidity exposure, required from those Participants whose activity would pose the largest liquidity exposure to NSCC; and (iv) a default liquidity facility comprised of cash from the sale of commercial paper, extendible notes and term debt to institutional investors.

NSCC provides daily reports to its members to view their current liquidity obligations and available resources via PBS.

FICC Liquidity Risk

LRM manages FICC Government Securities Division (GSD) and Mortgage Back Securities Division (MBSD) liquidity risks with the objective to maintain sufficient liquidity resources to be able to fulfill obligations that have been guaranteed by FICC to non-defaulting members in the event of the default of the largest individual member or affiliated family of a GSD and/or MBSD member. LRM calculates member-level liquidity needs for GSD and MBSD and aggregates the amounts to the affiliated family level assuming all affiliates fail simultaneously.

MBSD provides clearing services for Agency to-be-announced (TBA) securities, Agency TBA options, and Agency specified pools. A Funds only Settlement (FOS) charge is also included in the liquidity need calculation when applicable.

TBAs generally settle on four TBA SIFMA class settlement days per month (A, B, C, D). Mortgage-backed securities in the U.S. are generally traded on TBA basis, meaning the identity of the securities to be delivered to the buyer is not specified exactly at the time of the trade.

GSD provides clearing services for eligible U.S. Treasury bills, notes, Treasury STRIPS, government Agency securities, General Collateral Facility (GCF) and repurchase agreement transactions (repo). A Funds only Settlement (FOS) charge is also included in the liquidity need calculation when applicable.

GSD’s peak liquidity needs are generally observed around quarter-end and year-end as well as in line with treasury auction dates.

FICC’s qualifying liquid resources include (i) cash in its Clearing Fund and (ii) the Capped Contingent Liquidity Facility (CCLF), which allows FICC to obtain short term financing (subject to a cap per member) collateralized by the incoming securities being delivered to the defaulter and securities deposited to the FICC Clearing Fund (see GSD Rule 22A, Section 2a and MBSD Rule 17, Section 2a).

FICC provides daily reports for GSD and MBSD via RTTM to allow members to view their current and rolling CCLF obligations and to manage and track their projected obligation for the upcoming reset.

Stress Testing

Overview

The DTCC Stress Testing program is responsible for evaluating whether each of the DTCC Clearing Agencies (DTC, FICC and NSCC) has sufficient financial resources to cover potential losses during extreme but plausible market conditions in accordance with the SEC’s Covered Clearing Agency Standards (CCAS). CCAS Rule 17Ad-22(e)(4) sets forth the requirements for stress testing the sufficiency of each Clearing Agencies’ total prefunded financial resources. CCAS Rule 17Ad-22(e)(7) sets forth similar requirements for liquidity stress testing.1

1 While CCAS Rule 17Ad-22(e)(4) refers to “credit risk”, the Clearing Agencies generally refer to it as “market risk” because the Clearing Agencies measure and review stress deficiencies based upon the difference between the stressed market price movements in the measured Member’s portfolio (or, in the case of DTC, its collateral) against that Member’s required Clearing Fund deposit or collateral requirement (the deficiency), and then compare that deficiency against the aggregate Clearing Fund or Participants Fund, as applicable.

The Stress Testing program now offers a new flagship product, the Stress Testing Analytics platform, which provides clients with transparency into monthly max Cover‑1 Ratios and stress testing deficiencies across a range of historical and hypothetical scenarios. The platform also highlights the corresponding risk drivers at the legal entity level, enabling clients to better understand sufficiency levels under each scenario for every CCP.

Objectives

The overarching objective of stress testing is to measure the impact of stress scenarios on the credit and liquidity exposures and financial resources for each Clearing Agency. Each of the Clearing Agencies (1) tests the sufficiency of its prefunded financial resources by stress testing each such Clearing Agency’s total prefunded financial resources, exclusive of assessments for additional contributions or other resources that are not prefunded but that may be available to the Clearing Agencies, and (2) determines the amount and regularly tests the sufficiency of their respective liquid resources.

Each Clearing Agency employs stress testing to determine whether it will have sufficient financial resources to cover potential losses in a wide range of scenarios including, at a minimum, the default of the clearing member (and its affiliates) with the largest aggregate credit exposure in extreme but plausible market conditions (often referred to as a “Cover One standard”).

Scenarios

The scenarios used to conduct these stress tests fall into two broad categories: historical scenarios and hypothetical scenarios. The scenario generation process is unique for these two types of scenarios.

Historical Scenarios

Each Clearing Agency’s historical scenario set includes at least 50 stress scenarios selected from an expanding look-back window with a fixed starting date, encompassing over 10 years of historical data including the 2008 financial crisis, that represent extreme but plausible market events relevant to the applicable risks of each Clearing Agency. Additionally, these scenario sets are supplemented with historical stresses outside the look-back period, such as the volatile market situation in the Fall of 1987 and the volatile bear market in US Treasuries in 1994.

Hypothetical Scenarios

The hypothetical scenarios are constructed according to potential market conditions and may include macroeconomic scenarios or other scenarios designed to stress certain model risk factors and assumptions. The design of macroeconomic scenarios, which is done in coordination with the Systemic Risk Office, within the Group Chief Risk Office, involves considerations of potential future events and their perceived impact to portfolio market risk factors. Hypothetical scenarios that are not linked to macroeconomic events are designed to stress model risk factors and assumptions such as concentration risk, extreme correlations, and risk factors that are not explicitly or adequately captured in margin models. Other ad hoc scenarios may be considered for risk management informational purposes.

New or changed stress scenarios applicable to market risk stress testing and liquidity risk stress testing are provided to a monthly cross-functional working group for collaboration and challenge. The cross-functional working group also reviews material from key subject matter experts to identify emerging and new risks that may be added to a risk inventory used to inform the stress scenarios.

The appropriateness of both the historical and hypothetical scenarios are reviewed monthly and more frequently than monthly when the products cleared or the markets served by the applicable Clearing Agencies display high volatility or become less liquid, or when the size or concentration of positions held by Members increases significantly, such as during the early period of the COVID-19 pandemic.

Reporting & Governance

Stress testing results are reviewed monthly by DTCC’s Enterprise Stress Testing Committee (ESTC), which is responsible for the review, oversight, escalation, and governance of stress testing related activities at each Clearing Agency and is comprised primarily of senior management from DTCC’s risk management, business, and control functions. The committee meets at least monthly, and its responsibilities include (but are not limited to): reviewing stress testing policies, procedures, methodology, and test results; approving stress scenarios; and ensuring stress testing activities meet the risk tolerance requirements applicable to each Clearing Agency. Updates to stress scenarios are escalated for review by the Management Risk Committee (MRC) on a quarterly basis, or more frequently if appropriate.

The Clearing Agencies maintain written policies and procedures that describe their processes for calculating and monitoring stress test metrics. Current positions in a portfolio are used in the daily stress tests. Threshold breaches or substantial changes in stress test results are reviewed by Financial Risk Management in order to identify the causes and formulate responses, as needed. To the extent that stress tests indicate a potential impact on the sufficiency of each Clearing Agency’s prefunded and/or liquidity resources, management may consider options available to supplement resources. These options may include but are not limited to a request to certain Members to fund an additional clearing fund deposit or cash deposit to cover the liquidity exposures presented by those Members’ activity. (For NSCC Members, this additional cash deposit is defined in the NSCC Rules & Procedures as “Supplemental Liquidity Deposit”). The results of these reviews and related metrics are aggregated, reported, and discussed monthly with the MRC and shared monthly with the Board Risk Committee (BRC) and DTCC’s regulators.

Annually, the DTCC Market Risk Management and Liquidity Risk Management (LRM) teams present an overview to facilitate Management and the Boards’ oversight responsibilities for the Clearing Agencies’ risk management programs as required by the CCAS that includes, but is not limited to, an annual compliance assessment for each of the Clearing Agencies of the applicable provisions of Rule 17Ad-22 to the stress testing program with a view of the control environment, as well as initiatives and material changes undertaken by the Clearing Agencies. As part of that assessment, LRM also performs an annual liquidity assessment to review the sizing of liquid resources relative to peak liquidity needs of each Clearing Agency to assure the maintenance of sufficient liquid resources under a wide range of foreseeable stress scenarios that include both historical and hypothetical market scenarios selected from an inventory of risk factors. This assessment is presented to the MRC and the BRC.