In 2007, resiliency efforts in the financial services industry were the direct and urgent result of a severe worldwide economic crisis. Fast-forward more than a decade later, and firms have shifted to a much more proactive stance: racing to get ahead – and stay ahead – of potential risk events by building, reinforcing and promoting stability to protect the industry. This means engaging with regulators and supervisory authorities, addressing membership standards and pre-trade controls, and escalating the risks of interconnected events.
Michael McClain, DTCC Managing Director and General Manager of Equity Clearing, moderated a mid-morning panel on Supporting Financial Resilience with Laura Astrada, DTCC Executive Director, Government Relations; Michael Leibrock, DTCC Managing Director, Systemic and Credit Risk; Atul Pawar, Vice President, Risk Management, Goldman Sachs Global Securities Services; and Gino Timperio, Senior Managing Director and Global Head of the Funding and Collateral Transformation initiative, State Street; at the 2019 DTCC Annual Client Risk Forum in October.
Engagement with Regulators
“The crisis in 2007 focused regulatory oversight onto financial resilience, and the subsequent implementation of Dodd-Frank to strengthen the weaknesses that led to the crisis,” Astrada said, kicking off the panel discussion. “At that time, discussions were on understanding the evolution of financial systemic risk and how this understanding could better inform rulemakings and policymaking.”
Astrada referenced a recent discussion paper on operational resilience issued from the Bank of England, the Financial Conduct Authority and the Prudential Regulation Authority. “Today, there’s the recognition of the interdependencies, that the lack of resilience at one firm could potentially impact not just themselves but also the stability of the entire broader financial system,” she said. “And because of this interconnectedness, we’ve seen growing engagement with the supervisory authorities and regulators, who are no longer only focused on operational resilience but are now focused on financial resilience and day-to-day interactions,” she said.
Implementing New Pre-Trade Controls
“We have been advocating for more controls in limiting the exposure at the right point in the life cycle of a trade,” Pawar said. “The limits can be very simple, but there has to be a workflow even in a breach. We need to know what action to take and answer fundamental questions such as: do we cancel all the open order exposure? Or open orders and stop new transactions from happening?”
Pawar said this is one of the key areas of advocacy from clearing firms such as Goldman and others, along with DTCC, to put a structure in place that can help mitigate this risk. “There are some innovative solutions proposed, such as DTCC’s risk limit framework, that make the whole market structure incrementally more stable,” he said.
Know Your Customer, Know your Risks
“Historically, we just looked at our credit exposure and financial analysis,” Leibrock said. “Now we consider every touchpoint we have with members across the company, because there are a lot of synergies with member risk. A large member default could equal a systemic event easily, so we monitor closely, and we escalate when we feel a firm has excessive exposure.”
Leibrock described a comprehensive effort now underway at DTCC to revisit and update membership standards across the NSCC, DTC and FICC Rulebooks, especially since membership standards are one of DTCC’s most important tools of financial resilience.
“We think it’s time to increase the minimum capital requirements of our firms; we’re looking at fines and penalties, and we’re looking at redefining how we surveil weak members,” he said. “We want to tighten up the rules across the board to give us more right to take actions when needed. Given our loss mutualization model, we’re only as strong as our weakest link. We need to make sure that the whole membership is sound.”
Managing Risk in the Sponsored Membership Model
Almost 15 years ago, State Street partnered with FICC to launch the Sponsoring/Sponsored Member Repo Program, whereby a bank netting member of the clearinghouse could sponsor eligible U.S. mutual funds to clear their repos with FICC. With the continued evolution of the FICC program and the rule changes in 2017, and again this year, permitting additional sponsoring and sponsored member client types, FICC’s aggregate cleared repo and reverse repo volumes have risen substantially.
The growth in sponsored-member repo through FICC has been transformational, as Timperio highlighted during the panel. Bringing more participants into the marketplace – insurance companies, hedge funds, money market funds – means more liquidity is made available. “The core offering today is enhanced liquidity in the marketplace,” he said. “The more participants you bring into a centrally cleared solution, the more options you provide.”