(l to r): Stephen Pecchia, Michael McClain and John Abel.
Operations, risk and cybersecurity experts from The Depository Trust & Clearing Corporation (DTCC), the U.S. Department of the Treasury and from across the financial services industry came together on Nov. 1 at DTCC’s 4th Annual Client Risk Forum to discuss collaborative efforts to strengthen the industry’s risk management framework.
Held at the New York Marriott Downtown, the panelists at the half-day forum covered critical topics ranging from modernizing the U.S. post-trade infrastructure, the impact of advancements in fintech on risk management, and the trends shaping the cybersecurity landscape.
The first panel of the day, moderated by Murray Pozmanter, DTCC Managing Director and Head of Clearing Agency Services, presented both a look-back at the industry’s move to shortening the settlement cycle to T+2 in September, as well as a prospective look-ahead to the possibilities for further reducing risk by accelerating and optimizing settlement, as well as extending central counterparty (CCP) services to a new segment of the market.
The Move to T+2
“The most important lesson that we learned during the move to T+2 was the benefit of doing these large projects as an industry initiative,” said John Abel, DTCC Executive Director and T+2 Project Manager. “It allowed us to define the terms of what would be in scope and timeline. When we originally started, there was a lot of discussion if we should go to T+1, should we go to T+2, should we stay at T+3? It took an awful lot to build industry consensus.”
Of course, with the industry now smoothly and routinely settling transactions in two days, Pozmanter asked Abel if discussion among clients and the industry is getting louder again about shorting the settlement cycle further.
“I think there is momentum out there, and some firms who feel that we have the expertise, people and connectivity all in place to continue to move to shorten the settlement cycle,” Abel responded. “If we let that go to the wayside, we’ll be back in five or six years, starting from scratch to build up the program again.”
Accelerated Settlement and Settlement Optimization
Abel said that while there are no formal plans in the industry to move T+1 forward, there are a number of other initiatives under consideration at DTCC, with various industry working groups putting together ideas and vendors testing new system algorithms.
“For example, is there the possibility to do an accelerated settlement, perhaps not as a whole industry but in segments,” he said. “Could DTCC partner with an exchange and have that exchange submit us accelerated transactions? Is there an opportunity to look at different transaction types? Are there certain transaction types or business processes that would lend themselves nicely to an accelerated settlement?”
“We’re looking at settlement optimization,” continued Michael McClain, DTCC Managing Director and General Manager, Equities Clearing. “A good deal of what we do overnight after trade date and before settlement the next day is done in the night cycle. But right now, the cycle works in such a way where it’s not as efficient as it could be. To the extent you can take a market day out of settlement with settlement optimization, you can actually reduce the capital required in our clearing fund, which is much more efficient for the firms.”
Abel said the settlement rates of the night cycle are relatively low, primarily because of rigid processing rules within DTCC. “We’re considering a way to develop more intelligent, more dynamic processing algorithms that will allow us to bring those rates much higher,” he said.
“We’re working with both our internal technology as well as some fintech providers to see what we can do to accelerate that settlement to the morning,” McClain said. “At DTCC, we can already settle T+0 and T+1 trades today. But what we want is to make sure that we can take systemic risk out of the system while at the same time reducing capital costs, making it more capital-efficient and reducing operational costs.”
“When you accelerate the settlement cycle, it’s not just making your own systems more efficient,” Abel added. “There are other consequences. We’ve got to look at stock loan and asset lending and all of the interconnected things that have to move up, from a timeframe perspective, to make that happen.”
Bringing Buy-Side Financing Activity into the Clearinghouse
The first trades on DTCC’s Centrally Cleared Institutional Tri-Party (CCIT) – which expands the availability of central clearing in the repo market and extends central counterparty (CCP) services and the guaranty of the completion of eligible tri-party repo transactions between dealer members and eligible institutional cash lenders – were executed between Citadel and Morgan Stanley in June. On the panel, Pozmanter asked Jim Hraska, Managing Director and General Manager of DTCC’s Fixed Income Clearing Corporation for an update on CCIT, and the continuing plans for outreach and expansion.
Jim Hraska provides insights during the DTCC Market Infrastructure panel at the 2017 DTCC Risk Forum.
“There’s a lot of take-up and analysis going on,” Hraska said. “Even though the program makes sense, we know some firms are sitting on the sidelines waiting for someone to go in big. There’s a lot of cautious optimism. But from an interest perspective, the uptake has been phenomenal. The phones are ringing off the hook from all types of different cash investors – anywhere from pension funds, insurance companies, corporate and muni treasurer or sovereign wealth funds, alternative asset managers.”
Hraska also addressed possible expansion of CCIT to the Registered Investment Companies (RICs), who represent about one-third of the cash-lending community. “The one place we don’t have a fully approved product yet is for the RICs,” Hraska said. “Right now, it’s sitting with the SEC’s Division of Investment Management, and they’re looking at the initiative. That said, we do have opportunities for them to come into other programs, like the sponsored program.”
The sponsored program, which has been around since 2005, was developed primarily for the registered investment companies. However, while it was initially only for the RICs, DTCC has changed it to any qualified institutional buyer.
“In sponsored membership, a well-capitalized sponsoring bank provides the conduit to take cash from investors looking to be collateralized in high-quality assets, and then passes that liquidity on into the market,” Hraska said. “We want to open up clearing to the market as wide as we can, but we also need to do it in a prudent fashion – and we need to do it in a way so that we can control risk.”
Recovery and Resolution
With three of DTCC’s clearing agency subsidiaries declared as “systemically important financial market utilities” (SIFMUs), Pozmanter said there has been significant effort and discussions this year to update the clearing corporations’ and the depository’s recovery and wind-down plans. Pozmanter said DTCC has been preparing plans and working with regulators to file updated rules and procedures, adding a wind-down rule to each of the four rulebooks that govern the three clearing agencies. He asked panelist Stephen Pecchia, DTCC Managing Director, Recovery and Resolution office, about the updated wind-down rules as well as some of the changes to the clearing agency loss allocation rules.
“The Covered Clearing Agency standards require plans for orderly recovery and wind-down,” Pecchia said. “We would seek to wind-down the failed entity and concurrently, shift our services to a third party that has either stood up within the DTCC enterprise or would be some other third-party acquirer. What will happen is essentially a transfer of services: there would be some assignment of assets, there would be service agreements put in place between the failed clearing agencies as well as between the DTCC holding company and this new entity.”
Pecchia said that while DTCC had the robust risk management practices in place to successfully close out firms like Lehman Brothers and MF Global, never needing to go beyond the resources of the defaulter, the new, updated loss-allocation rules are intended to create greater transparency and certainty.
“Hopefully this is something we will never have to do, but we do need to be prepared,” he said. “As many of you know, what will drive this potentially happening may not be something we’ve seen historically – but the value comes in the planning.”