The Depository Trust Company (DTC) uses risk management controls that identify, measure and monitor the credit and liquidity risks associated with end-of-day net funds settlement of securities transactions.
The Depository Trust Company (DTC) uses risk management controls that identify, measure and monitor the credit and liquidity risks associated with end-of-day net funds settlement of securities transactions. End-of-day net settlement provides many efficiencies, the most beneficial of which is that participants can settle all of their DTC transactions with one net balance at day’s end. To control end-of-day net debit amounts so that the net debit balance of a Participant or affiliated family cannot exceed DTC liquidity resources, each Participant and affiliated family is subject to a net debit cap. DTC also uses a collateral monitor so that the end-of-day net debit balance of any Participant will be fully collateralized.
Who Can Use the Service
All users of DTC’s settlement services are subject to and benefit from DTC’s risk management controls.
- Liquidity and transaction processing efficiency for participants
- Reduced transaction processing costs
- Ability to withdraw allocated principal and income funds or settlement progress payments if its risk controls are satisfied.
- Protection of DTC and Participants from participant failure to settle and from issuer failure and IPA refusal to pay.
How the Service Works
To protect the industry, DTC starts with strict membership requirements. All applicants for DTC membership must meet these requirements in order to conduct business through DTC. To be approved for membership, DTC must determine that an applicant meets reasonable standards of financial responsibility, operational capability and character. DTC monitors its participants for continued compliance with these standards.
Another key element of DTC risk management is the maintenance of sufficient liquidity resources to complete settlement in the event that DTC’s largest Participant or affiliated family fails to meet its end-of-day settlement obligation. DTC leverages two primary sources of liquidity:
- Participants Fund (Pfund): All DTC participants are required to contribute to the Pfund. Contribution requirements start at $10,000 and depend on several factors, including a Participant’s peak debit levels. DTC monitors participants’ net settlement debits during each business day and records the peak debits. Because DTC calculates debit peaks to determine the Participant’s required deposit, the Pfund contribution corresponds to the liquidity requirements generated by that Participant.
- Committed Line of Credit: DTC maintains a 364 day syndicated committed line of credit for $1.9 billion. Under the credit agreement, DTC may borrow an amount up to the total commitment to effect system wide settlement despite the failure to settle of the largest Participant or affiliated family and, by virtue of the net debit cap and collateral monitor controls, the amount to be borrowed will be fully collateralized.
Together, DTC’s Pfund and line of credit total at least $3.2 billion and represent the liquidity resources that DTC may, as needed in the event of a failure to settle, draw upon to complete settlement. In the unlikely event of multiple failures and a consequent depletion of the two liquidity sources described above, DTC could augment its liquidity by borrowing from some or all of its participants up to the amount of their end-of-day credit balance.
Net Debit Caps give DTC an additional tool to prevent the exhaustion of its liquidity resources. A participant’s net debit cap, based on the participant’s 70-day net debit history at DTC and reassessed daily, limits the size of a participant’s debit balances. The debit cap never exceeds $1.8 billion for a single participant or $2.85 billion for a participant and its affiliated family. The net debit cap control prevents the processing of any valued transaction that would cause the Participant to incur a net debit balance exceeding its net debit cap.
Through its Collateral Monitor, DTC tests that each Participant has sufficient collateral for DTC to pledge or liquidate if that participant were to fail to meet its settlement obligation . At the start of each business day, a Participant’s collateral monitor is credited with the participant’s Pfund deposit plus the market value of any collateral designated by the participant as available to support its settlement. Securities that are the subject of DVP transactions for delivery to the Participant also count as collateral. At all times, the value of a Participant’s collateral monitor will equal or exceed its net debit balance. Similar to the net debit cap control, the collateral monitor prevents the processing of any transaction that would cause a participant’s net debit to exceed its collateral value.
Collateral in a Participant’s account associated with the participant (such as the participant’s own commercial paper) increases risk to DTC if that Participant failed to pay DTC and its obligation is supported partly or fully by its own securities. To eliminate this risk, DTC’s system monitors such related collateral received in a Participant’s account through Issuer/Participant Number Collateral Control (IPN).
IPN links to a Participant’s account the securities related to it and withholds from the Participant’s collateral monitor any collateral value for the security.
DTC employs an additional risk management control to mitigate the credit and liquidity risk of Money Market Instrument (MMI) settlement: by withholding the benefit of the Largest Provisional Net Credit (LPNC) from a Participant’s balance, DTC protects itself and its Participants from the possibility that Issuing and Paying Agents (IPAs) will refuse payment and cause the reversal of transactions processed earlier in the day. (For more information, see MMI. To implement this control, a participant’s two largest MMI credits are not credited until the refusal-to-pay cutoff time has passed and the IPA has not refused to pay.
As an added control, each transaction is checked against a participant’s DTC account to verify that sufficient shares exist to process the delivery. Transaction settlement occurs only when each of the checks below is satisfied.
For More Information
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