by Jim Conmy
As DTCC’s Fixed Income Clearing Corporation (FICC) continues discussions with regulators on a string of major initiatives, @dtcc asked Murray Pozmanter, DTCC managing director, Fixed Income Clearance and Settlement, to provide an update on FICC’s plans for 2011. Customers in both FICC’s Government Securities Division (GSD) and its Mortgage-Backed Securities Division (MBSD) can expect to see the rollout of some long-awaited new services coupled with broader risk management practices.
FICC has some big projects in the pipeline that target risk reduction. Can you describe them?
We’ve been working on three main initiatives with our customers and regulators – all of which have risk reduction as a major focus. The first one is New York Portfolio Clearing, our joint venture with NYSE Euronext to create a new futures clearing organization that will allow customers to margin their cashmarket trades in U.S. government securities together with their futures trades on NYSE Liffe U.S. Second up, we anticipate moving mortgage-backed-securities trades to a central counterparty, the MBS CCP. Third is the admission of the buyside to the Government Securities Division.
Could you give us an update on New York Portfolio Clearing, or NYPC?
NYPC is a groundbreaking initiative that will reduce risk and deliver capital efficiencies to its members by providing a single margin calculation across U.S. government securities trades cleared at FICC and futures positions traded on NYSE Liffe U.S. We call this capability “one-pot margining.”
NYPC filed with the Commodity Futures Trading Commission [CFTC] for registration as a derivatives clearing organization [DCO] and to engage in one-pot margining with FICC. FICC filed with the Securities and Exchange Commission [SEC] to engage in one-pot margining with NYPC.
NYPC has already received CFTC approval for registration as a DCO and we hope to receive the other approvals by February 28. We expect to launch the new company in late March. [Note: Look for a Q&A with Walter Lukken, CEO of NYPC in the next issue of @dtcc.]
Murray Pozmanter, DTCC managing director, Fixed Income Clearance and Settlement
The launch of NYPC will introduce an intraday margin call for both NYPC and FICC, something FICC has never done before. Are your GSD customers prepared for this change?
Many of our customers have to meet intraday calls from other venues, so this is not new territory for them. We began preparing firms last year through a series of live workshops and in-depth training materials. We’ve also put a video and a lengthy Q&A on DTCC’s website to help customers understand the process. In addition, we’ve conducted live tests for intraday margining, and we’ll do more testing going forward. So all in all, our customers are prepared for the transition.
Could you update us on the central counterparty initiative, or the MBS CCP, to reduce risk in the mortgagebacked securities business?
We hope to transfer our mortgagebacked securities division into a central counterparty structure in the second quarter, subject to SEC approval. We’re confident – and our customers concur – that creating an MBS central counterparty will bring a tremendous reduction in systemic and operational risk. The central counterparty will lower risk by offering guaranteed settlement, and pool netting will lower risk by reducing settlement activity.
You have announced that an original part of the plan for the MBS CCP – portfolio margining – will not be included initially. Why is that?
When we began planning the MBS CCP, our intention was to launch it with cross-portfolio margining against GSD – and our initial rule filing with the SEC included this concept.
However, given the multiple changes we are making to our margining process, we are taking a cautious approach to margining across FICC’s two divisions. First we want to observe single-pot margining between GSD and NYPC. We also want to see the MBS CCP running as a standalone central counterparty. We expect to observe both organizations for six months and, if we are confident operations are functioning smoothly, then we will move towards the inclusion of MBS trades as part of a single pot linked to other clearing mechanisms.
We’re now working on a revised MBS CCP rule filing to the SEC to reflect this change. Once we’ve had sufficient time to observe NYPC and MBS CCP operations, and assuming everything goes smoothly, we expect to submit the revised filing before the end of 2011.
Could you describe other risk controls you are implementing specifically for the MBS CCP?
Yes. Since the MBS CCP will guarantee trades, we’ve added two significant layers of risk control to protect both customers and FICC. First, we will conduct hourly portfolio risk reviews and require more margin intraday, if necessary, even though we will not set a routine intraday margin call for participants in the MBS CCP. Second, we’ve created a Capped Contingency Liquidity Facility.
Let’s start with the Capped Contingency Liquidity Facility, or CCLF. What is it and how will it mitigate risk?
We created the CCLF in response to a request from our regulatory supervisors, who asked us to find a way to have more liquidity available in case of a market crisis. The CCLF achieves this by creating overnight repos between FICC and each of our solvent firms so that, if a firm fails, the funding to offset its portfolio would be sourced across FICC’s membership rather than being dependent on an expensive, long-term line of credit.
We reviewed this idea with our members, and it will be part of our revised MBS CCP rule filing. We plan to have the CCLF in place when we go live with the CCP.
What about hourly portfolio risk reviews – that’s new, isn’t it?
Absolutely! Even though our MBS customers will not have to meet an intraday margin call, we now have the technology to take hourly risk snapshots of members’ positions – and we will seek the authority, as part of our rules, to call for additional margin based on any hourly slice during the day. We plan to submit a rule filing later this year that will codify our authorization, based on these hourly reviews, to call for additional margin during periods of market stress.
Back and stress tests are another aspect of risk management. How does DTCC plan to make broader use of these test results for the participants of all its clearing corporations?
We perform these tests on a regular basis and we want to create a more formal policy for utilizing the results for margin adjustments. If deficiencies noted in the back and stress tests hit a certain threshold, we want to have a formal “escalation policy” for bringing the information to product management, to our Chief Risk Officer and, potentially, to the appropriate DTCC Board committee so they can see why we want to collect additional margin.
You have said FICC may reduce its Clearing Fund requirements for some members by modifying its assumptions about how long it takes to liquidate a portfolio. What will change?
We currently use a three-day liquidity horizon as the assumption behind our VaR [Value at Risk] calculations – and that’s across an entire portfolio. The current calculation doesn’t take into account that, based on either the market depth or liquidity of a specific CUSIP, or based on the concentration of a specific CUSIP in a single firm’s portfolio, we can safely use different assumptions about how long it will take to liquidate the position.
So we’re proposing to look at the three-day liquidation limit both ways – at what might take longer than three days to liquidate, and what might take fewer than three days. Then we would apply a charge or credit based on our intelligence about particular CUSIPs as opposed to looking at liquidation with blanket coverage across three days. In essence, based on either the market concentration or the market liquidity, we can decide if we need more than three days – or fewer – in calculating the liquidity of the position.
How will the new liquidation formula impact capital requirements?
Based on the test data so far, it appears that looking at the data two ways will result in a virtual offset in terms of firms’ Clearing Fund requirements. Across FICC, some firms had reductions, some firms were flat and some firms had increases. The charges incurred by firms with concentrated or illiquid positions were pretty much offset by credits for firms with highly liquid assets. In any case, no firm appears to be facing a material increase, and some firms will see a decrease.
Could you talk about the admission of buyside members to FICC’s Government Securities Division and how it will mitigate risk?
We believe our buyside membership plan has tremendous potential to reduce systemic risk. It will bring more of the overall portfolio of our existing members into the central counterparty, and it will bring more firms into the central counterparty process, which means we’ll be netting and settling more trades under the central counterparty guaranty. However, after talking with our regulators and in view of some changes taking place in the industry, we are now working on a revised rule filing on buyside membership.
What will change in the rule filing?
Under the revised filing, we will not allow buyside members to participate in the GCF Repo™ business, at least for now. Regulators have long been concerned about the intraday extension of credit in the tri-party repo process, and they were particularly concerned that buyside participation would transfer much of that credit risk to FICC. The industry, by the way, is working out a way to begin eliminating that credit risk, but until that’s complete, GCF Repos will remain off limits to buyside firms.
We are also ensuring the revised filing presents an in-depth risk analysis, including a review against the international CPSS-IOSCO standards [Committee on Payment and Settlement Systems/ International Organization of Securities Commissions]. @