The Depository Trust & Clearing Corporation (DTCC), whose fixed-income subsidiary clears-and guarantees-trades each day in the multi-trillion-dollar market for U.S. government securities, has asked regulators for approval to extend the subsidiary's clearing and risk management services to include direct participation by non-U.S. broker/dealers and banks.
Although many foreign financial firms are major participants in the U.S. government securities market, only overseas firms with U.S. branches or agencies are currently eligible for membership in DTCC's Fixed Income Clearing Corporation (FICC). In a filing with the Securities and Exchange Commission (SEC), the corporation proposed that non-U.S. financial companies be allowed to join FICC directly so that the companies can take advantage of the risk management, balance-sheet netting and cost savings that membership provides.
Currently, just about half of the outstanding debt securities issued by the U.S. government are held by governments, institutions and individuals outside the United States.
"Foreign purchases of U.S. government securities are critical to the market," said Murray Pozmanter, managing director, DTCC Fixed Income Clearance and Settlement Group. "This a global market that trades 24 hours a day, and the easier and safer we can make it for foreign firms to have their U.S. government securities trades cleared with guaranteed settlement within FICC, the better it will be for all participants."
In 2008, FICC cleared U.S. government securities trades worth more than $1 quadrillion, or an average of more than $4.2 trillion each day. Additional trades coming in from the proposed expansion of netting members, FICC estimated, might push clearing volume up by 15-20%.
When firms settle their U.S. government securities trades outside FICC, the transactions have to be completed on a trade-for-trade basis without the benefit of a trade guarantee or the optimum use of capital that netting provides. This raises cost and risk not only for non-U.S. firms, but also for U.S. firms that are the counterparties to the trades.
Through its Government Securities Division, FICC currently clears and nets trades involving U.S. government issues for nearly 900 broker/dealers, banks and other financial firms. Because most non-U.S. broker/dealers are currently precluded from joining FICC's government securities unit, the firms typically have to bear higher risk and operational costs.
Legal Questions Resolved
Legal uncertainties about FICC's rights in the event of a foreign member's insolvency have historically limited membership in the company only to non-U.S. banks with U.S. branches or agencies. But FICC says amendments to U.S. bankruptcy statutes have eased these uncertainties.
Because FICC becomes the counterparty to all netted trades, trading firms are able to record the net rather than the gross value of the trades on their balance sheet. This difference, Pozmanter noted, reduces the amount of capital they must set aside for the trades and frees up additional capital for other investments.
"With more netting members" Pozmanter said, "FICC will be able to free up more capital by netting out the offsetting financial obligations across a larger pool of trades.
"If we expand the number of firms that are direct netting members, each individual firm will have, on average, less risk, lower clearing costs, more balance sheet relief and more capital released for additional investment," Pozmanter said. "That's a worthy goal, especially during this period of acute capital shortages for many institutions."
FICC's rule filing with the SEC follows the agency's decision last year to permit, for the first time ever, "well qualified" foreign broker/dealers and banks to become members of two other DTCC subsidiaries, National Securities Clearing Corporation and The Depository Trust Company. Membership will allow foreign firms to utilize the post-trade clearance and settlement services of the two companies for transactions in U.S. equity markets.
"Extending our membership to foreign firms for equity trading is really just a reflection of how global the securities industry has become," said Susan Cosgrove, DTCC managing director, Equity Clearance and Settlement Group. "We're simply preparing to operate in a world where it may be possible to execute trades in European markets, for example, and settle them in the U.S. market."
FICC filed its request with the SEC Dec. 3, 2008.