The Depository Trust and Clearing Corporation’s (DTCC) subsidiary, the Fixed Income Clearing Corporation (FICC), intends to seek regulatory approval to provide central clearing for the $1.6 trillion institutional tri-party repo market.
The FICC will submit a proposed rule change to the Securities Exchange Commission (SEC) and an Advance Notice filing to both the SEC and the Federal Reserve to allow the submission of institutional tri-party repo transactions between existing members of FICC’s Government Securities Division (GSD) and registered investment companies (RICs or buy-side) where the RICs are the cash lenders in the transactions.
Protecting from Fire-Sale Risk
Fire sale risk remains a critical policy concern of the Federal Reserve and other members of the U.S. regulatory community. A solution to this problem is central liquidation (which FICC already offers in all of its clearing arrangements). RICs receive securities as collateral, so the concern is that if there is turbulence in the market resulting in dealer defaults, the RICs will need to sell large amounts of securities, which could dramatically reduce the value of the securities they are looking to sell.
The FICC provides the only central clearing function for tri-party repo trades in the U.S. and is the only platform ready to serve this market. The intended rule filing will outline FICC’s proposal to leverage its existing risk management and trade guarantee services for the institutional tri-party repo market in the U.S.
"Centralizing the clearing and settlement of repo transactions through FICC could potentially help to prevent another squeeze in tri-party funding such as the one observed in 2008 when Funds sharply reduced their lending during the run up to the Lehman failure," said Murray Pozmanter, DTCC Managing Director and Head of Clearing Agency Services. "It would also provide regulators with a broader and more comprehensive view of the repo market for the monitoring and management of systemic risk as well as mitigate risks associated with a fire sale in the tri-party marketplace."
Central clearing would play a key role in providing stronger participant and systemic safeguards for the tri-party repo market. Implementing FICC’s central counterparty (CCP) services for these transactions would increase operational efficiencies, guarantee completion of eligible trades, and lower the risk of a liquidity drain in the event of a dealer failure by extending its netting services.
Key Benefits of FICC’s Proposed Service
- Reduction of counterparty risk by guaranteeing the completion of settlement in a member default scenario.
- Existing members could be eligible for balance sheet offset.
- FICC’s guarantee may mitigate risk of a large-scale exit by cash investors in a stress scenario.
- Centralized liquidation of a failed counterparty would reduce the potential for market disruption and fire-sale risk (see sidebar).
- Decreased settlement and operational risk via CCP netting, novation and risk management.
The intended rule filing remains subject to regulatory review and approval by the SEC and the Federal Reserve Board in all respects.