The Depository Trust & Clearing Corporation’s (DTCC) Systemic Risk Roundtable held in Minneapolis, MN, earlier this month brought together more than 20 senior-level risk managers from across the securities industry to discuss the top concerns driving the discussion on systemic risk, and what financial services firms are doing to strengthen and enhance their systemic risk capabilities.
“The financial system has gotten more complicated and interconnected causing the remit for risk managers to change as well,” said Michael Leibrock, DTCC Managing Director and Chief Systemic Risk Officer. “In conjunction, skill sets and capabilities of risk management professionals need to adjust to coincide with this expanded remit of risk management.
“These roundtables offer an open discussion to facilitate the exchange of ideas among risk management professionals on how to mitigate current and emerging risks facing the industry,” he added.
Paradigm Shift in Systemic Risk
Paul Jordan, DTCC Director, Systemic Risk Office, noted in his opening remarks that ahead of the 2008 financial crisis, the universe of organizations that were studying systemic risk and analyzing the interconnections across the financial services industry was relatively small and concentrated within think tanks, academic organizations and central banks.
“Systemic risk analysis did not receive great prominence across the financial services industry,” he said. “Nor was it a discipline that would typically appear within the comprehensive risk management framework of financial institutions.”
In the aftermath of the crisis, Jordan noted, the industry has experienced a paradigm shift with an increasing number market participants starting to analyze and monitor systemic risk. Specific efforts have focused on identifying and mapping all of the interconnections across the global financial ecosystem to quantify and better understand interconnectedness risks and overall systemic risk.
Jordan added that DTCC established its Systemic Risk Office as an expansion of its risk management capabilities following the 2008 financial crisis. DTCC’s Systemic Risk Office consists of a team of risk management professionals in a separate vertical and risk discipline, specifically dedicated to identifying, monitoring and containing potential systemic threats.
Further, a multi-year industry wide trend has emerged to increase both financial investment and resource investments at financial services institutions to enhance systemic risk capabilities. Bringing the trend full circle, Yale University recently announced their plans to initiate a one-year masters program in Systemic Risk Management, starting in the 2017-2018 academic year targeting employees of central bank and regulators.
In closing, Jordan provided an overview of the results of the DTCC Systemic Risk Barometer Survey. The presentation facilitated an interactive discussion with attendees to solicit perspectives on the risks identified, as well as an understanding on the risks that are impacting their respective firms and the techniques being employed across respective risk management departments.
Trends and Risks in Bond Market Liquidity
The Minneapolis Systemic Risk Roundtable represented an expansion of one of DTCC’s member outreach initiatives, which has been increasing in momentum and gaining broader adoption since initiated in 2015. The event reinforced DTCC’s leadership role in the area of risk management and increased exposure for regional firms and clients to important industry topics. The event was the first Systemic Risk Roundtable conducted outside of New York and DTCC is pursuing opportunities to expand its member outreach initiatives in locations outside of New York.
Liquidity in global financial markets has become a top concern for market participants who fear that changes in market structure and new regulations may be leaving markets more fragile and susceptible to elevated volatility, instability and systemic risk. In particular, constrained liquidity within U.S. bond markets has been debated across the financial industry, particularly after the October 15, 2014, Flash Crash in U.S. Treasuries.
Dan McElligott, Head of DTCC’s Market Analytics team and co-head of DTCC’s Counterparty Credit Risk team, led the group in a discussion on the impact of regulations (Basel III, Dodd Frank, etc.) and other market structure changes on activities and functions associated with liquidity (all asset classes), within banks or across the financial services industry as a whole.
Opinions on whether or not market liquidity is becoming constrained differ. Some market participants believe new regulatory requirements are causing banks to have much less flexibility than they did prior to the financial crisis. Regulators, on the other hand, cite other factors, such as electronic trading and exchange-traded funds (ETFs), as drivers of liquidity challenges.
McElligott cited findings from DTCC’s analysis of corporate bond data at the National Securities Clearing Corporation (NSCC), which revealed trends in interdealer trades of corporate bonds over the past five years:
- Interdealer trade volumes have not kept pace with a surge in issuance activity;
- Trade size has decreased, which could indicate more difficulty in conducting larger trades;
- The number of counterparties has fallen (for firms submitting interdealer trades to NSCC), which leaves liquidity more fragile; and
- The credit default swap (CDS) market has shrunk (per data published from DTCC’s trade repository).
Collectively, McElligott said, “these observations suggest a potential deterioration of liquidity in the U.S. corporate bond market that warrants further analysis.”
He concluded his presentation with a list of initiatives and solutions DTCC is pursuing that relate to market liquidity, including a Centrally Cleared Institutional Tri-Party (CCIT) Service and a Margin Transit Utility and Collateral Management Utility.
Shortening the Settlement Cycle: The Move to T+2
In 2012, DTCC led a robust due-diligence process, which included considerable industry discussion, risk studies, and a cost-benefit analysis facilitated by the Boston Consulting Group (BCG). In April 2014, DTCC announced its recommendation for a move to a two-day settlement period, or T+2.
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The research indicated that “time equals risk” and that a shortened settlement cycle could substantially reduce risk across the securities industry and for underlying investors. It’s a move that will represent a critical step in fostering greater certainty, safety, and soundness in the U.S. capital markets.
In his presentation, John Abel, DTCC Executive Director, Settlement and Asset Servicing, provided an overview of the industry-wide effort aimed at shortening the settlement cycle to T+2 for U.S. equities, corporate bonds, municipal bonds and unit investment trusts (UITs). In addition to highlighting current readiness efforts completed to date, he previewed remaining timeline ahead of the scheduled T+2 go live date in September 2017.
The timeline includes a robust industry-wide testing plan to ensure firms have the adequate resources and infrastructure in place to mitigate operational and implementation risk.