At the recent DTCC Client Risk Forum, a panel of DTCC senior executives shared insights on the risk management implications of a number of current industry initiatives.
Murray Pozmanter, DTCC Head of Clearing Agency Services and Global Business Operations, led the panel, which featured Tim Cuddihy, DTCC Managing Director, Financial Risk Management; Laura Klimpel, DTCC Head of SIFMU Business Development and General Manager of Fixed Income Clearing Corporation (FICC); Jennifer Peve, DTCC Managing Director, Head of Strategy and Business Development; and Brian Steele, Global Head of Digital Transformation, Goldman Sachs.
Related: Extreme Risk and Tail Events
Gaining Capital Efficiency
Pozmanter started the panel discussing one of the most notable industry initiatives: shortening of the settlement cycle. Cuddihy reflected on events a decade ago when the industry was working to shorten the settlement cycle from three days to two. At that time, the S&P 500 was at 1,200 and on a peak volume day the NSCC clearing fund was just over $7 billion. Fast forward 10 years — the S&P 500 is trading around 4,500, volatility, volume and regulatory expectations are higher, and the clearing fund is, on average, at $13.2 billion, while peaks have gone as high as $36.5 billion.
Steele noted that while the present technology and infrastructure today can support a move to a shortened cycle, the transition will force the industry to rethink traditional market conventions, including processes between execution and settlement today. Firms that allocate late into the trading day and into T+1, for the matching, shaping and allocation process, will need to adopt industry solutions.
Moving Past T+1— Challenges and Opportunities
As the industry moves toward T+1, many discussions have turned to an even shorter cycle. Cuddihy noted that one of the biggest challenges to a T0 cycle is the loss of some level of netting efficiencies. To optimize, the industry needs to look at intraday liquidity — which is both scarce and expensive and an important consideration in an accelerated settlement cycle.
A move to T0, Steele said, will require transformative technology and a thoughtful redesign of existing market practices, whereas a real-time settlement model, similar to how crypto markets operate today, will require a substantial change in market practices. The industry cannot simply adopt DLT or blockchain technology — there is a need for common data standards, and common taxonomy.
Projects Ion and Whitney
DTCC has been working to understand the impacts and challenges of both natively issued and re-represented digital securities. In 2019, Project Ion was created to explore the digitalization of assets on DLT, while paving the path to modernized infrastructure and facilitating a more accelerated settlement process. This resulted is a proof of concept in 2020 that was designed and informed on key concepts from accelerated settlement discussions and modeled on a T0 settlement.
Through Project Ion, DTCC engaged the industry in meaningful discussions around T0 and
in 2021, moved into prototype phase, which was used to experiment with alternative settlement scenarios, including T0, T+1, T+1/2. The prototype allowed stakeholders to better understand the implications of each scenario while in an innovation environment, and valuable insights were gained on features and functionality that industry stakeholders wanted to further pursue.
We need to be thoughtful about integrating digital assets and DLT into our transformation journey; these technologies must be vetted, tested and provide the industry with a robust solution.
These efforts informed Project Ion MVP, which is under development and is moving toward production. In this environment, the project will adhere to DTCC’s rigorous regulatory standards across resiliency, stability, security, risk, and controls and will support new features, while at the same time seamlessly interoperating with classic settlement platforms and risk management controls.
While Project Ion was a great way to re-represent assets on DLT with full blockchain capability, the DTCC digital securities management (DSM) platform, informed by Project Whitney, explores what a digital securities platform would look like for the private markets and how to facilitate a digital asset ecosystem. DSM will interface with private and public ledgers via a DTCC token standard.
DSM is introducing a modern platform for private markets for the issuance distribution and secondary transfer of those assets, designed to reduce manual processing, fragmentation, and some silo solutions that exist today, and bring efficiencies to private market operational flows. The goal is to introduce an industry wide, regulatory compliant solution for both traditional and tokenized securities.
“There is a lot of potential, but we need to be thoughtful on how we integrate digital assets and DLT into our transformation journey, and these technologies need to be vetted and tested before broad industry adoption and be as robust as what we provide today,” Peve said.
Central Clearing in the U.S. Treasury Market
Recent periods of extreme volatility in the Treasury repo market have created significant stress on this vital market and its participants, leading many to question if the market, as currently structured, is resilient enough to handle another stress, particularly if the stresses cause one or more participants to default.
Despite the benefits of central clearing, Klimpel said that currently only a fraction of the Treasury repo market clears through FICC, which includes dealer to client activity, as well as intra dealer cash activity that does not clear at FICC.
The risk benefits of central clearing include providing stability to the market in event of a member default through an orderly, centralized liquidation, preventing contagion risk and avoiding fire sale risk. Central clearing also helps to reduce settlement risk through multilateral net settlement — there is only one net deliver or receive obligation, which avoids settling on a gross basis with other market participants. There is also the risk of security settlement failures. Another key benefit is the reduction of counterparty risk as market participants in CCP are able to transact with a diverse array of counterparties.
Pozmanter concluded by commenting on the many events that are going on in the financial ecosystem, “There is a clear view of the digital transformation our industry is setting out on, and the steps needed to ensure the safety and stability of the global financial markets.”