In January, The Depository Trust & Clearing Corporation’s (DTCC) wholly-owned subsidiary, Fixed Income Clearing Corporation (FICC), announced that the Securities and Exchange Commission (SEC) approved FICC’s proposed rule change to establish minimum financial requirements for Registered Investment Companies (RICs) – “buy-side” market participants – to become members of its Government Securities Division (GSD).
Kevin Lewis, DTCC Vice President, Head of FICC, recently spoke with @dtcc about the rule change and what it means to the industry.
1. In early December, FICC filed a proposed rule change with the SEC to establish minimum financial requirements for RICs to become members of the GSD. What was the impetus for that filing?
FICC has traditionally offered its guaranteed services to the sell-side through the Mortgage-Backed Securities Division. However, we realize that the buy-side represents a vital segment of the financial community and they too stand to benefit from GSD membership. Buy-side activity represents a significant portion of the non-cleared activity in the U.S. Government securities market. In an effort to further protect the industry, it is imperative to widen access to GSD services where the benefits of inclusion advance our mandate of reducing risk, fostering operational efficiency and reducing costs. To this end, RIC participation in GSD will enable new and existing members to submit more activity, further strengthening the value proposition of central clearing.
2. What is the benefit to the U.S. Government securities market of enabling buy-side firms to become members of the GSD?
Reducing counterparty and systemic risks are the greatest benefits to the U.S. Government Securities market and the markets we serve at large in the clearance space. Upon completion of a trade and confirmation by both members of the validity of the transaction, GSD interposes itself as the legal counterparty to both sides of the trade. In doing so, this bilateral counterparty risk is replaced with a trade guarantee -- all backed by the operational strength, risk management capabilities and financial resources of the GSD as central counterparty. This assurance helps to promote trading in both normal and volatile periods.
In the event of a member default, systemic risks are reduced given the centralized liquidation of the defaulted member’s portfolio versus disjointed market action. Absent centralized liquidation, firms will be disposing (via market action/trading) of portfolios against the defaulted firm on their own – not having insight into what may be natural offsets or hedges in the portfolio. This may result in unnecessary trading, which could drive further panic or volatility. Widening the cleared activity pool with the inclusion of RIC activity allows for greater member portfolio transparency, which lends itself to the application of prudent risk management oversight and action. Centralized risk management with such a vast view of the market allows for the realization of trade offsets, position concentrations or market aberrations that may otherwise go unnoticed. As RICs are legally prohibited from participating in loss mutualization, they are only subject to loss allocation based upon their trading activity with the defaulting member that resulted in a loss. This “tier two” membership type allows GSD to extend its services to RICs without compromising our risk management vigilance.
Another key benefit is operational efficiency. RICs will benefit from GSD netting services, which greatly reduce security and corresponding cash movements. The reduction in these movements supporting the trade lifecycle reduces costs for all members. Fails activity is also automatically re-netted, which assists in the reduction of aged fails. Automated reporting is available to support all GSD operational and risk management processes.
3. RICs will not be permitted to utilize the GCF Repo® service, which falls within the scope of GSD services. What is FICC doing to advance the opening of this service to the RICs?
This is definitely something FICC will pursue in close coordination with the industry and our supervisors in line with ongoing tri-party market reforms. One of the main concerns around the tri-party market is the risk of fire sales. We think the introduction of a CCP to the market would greatly reduce this risk.