DTCC paves way for all roads to lead to its warehouse

By Michael Mackenzie in New York Published: July 1 2009 03:00 Last updated: July 1 2009 03:00 At the sharp end of Manhattan island, near Wall Street, an important player in the business of clearing and settling trades is fighting for a large role in the planned revamp of the financial system. Last year, the Depository Trust & Clearing Corporation, or DTCC, settled a staggering $1.88 quadrillion - a million billion - in transactions across a range of asset classes. Indeed, so large are its operations the DTCC uses eye-catching images to convey their size. A recent annual report notes that a one-mile stretch of beach, 100ft wide and 1ft deep, contains close to a quadrillion grains of sand. But while the "quadrillion" tag might seem more than enough to guarantee the DTCC a central place in the future shape of the US financial system, the current political environment is leaving it - like almost every institution - gearing up for a fight. With the Obama administration having recently released a blueprint for reforming the financial system, it is clear that a tussle is breaking out between exchanges, dealers, politicians and investors about who should control trading and settlement flows. And while the DTCC could benefit from some of those battles, it could also potentially lose out from some of the proposals floating about. One idea is that credit derivatives should be placed on a central clearing platform that is not automatically linked to the DTCC. This month, the DTCC expressed concern in Congressional testimony about regulatory efforts to impose a central counterparty, or CCP, for standardised over-the-counter derivatives trades at the expense of the DTCC's warehouse. "In the event of a firm failure, a central repository ensures that regulators can see the underlying position data from a central vantage point," says Donald Donahue, chairman and chief executive of the DTCC. "We support the idea of central counterparty clearing of OTC derivatives . . . but we still want clearers to feed back these trades into the warehouse." In many respects, this proactive lobbying role is not something that comes naturally to the DTCC. The body was set up 1999 through the merger of the Depository Trust Company and the National Securities Clearing Corp - two companies that emerged in the 1970s as Wall Street struggled with the paperwork of processing equity trades. The DTCC is owned by banks, broker/dealers, mutual funds and other financial institutions, and excess revenue from transaction fees are returned to its member firms. Partly because of that complex ownership pattern - and its near-monopoly position in many corners of the US market - the DTCC has often been perceived as a sleepy, bureaucratic organisation, rather than a nimble business. In the past two years, however, the group's activities have suddenly shot into the spotlight in a manner that few inside - or outside - the DTCC foresaw. That was partly because it played a crucial and stabilising role last year in the wake of Lehman Brothers filing for bankruptcy, the collapse of AIG, the government takeover of Fannie Mae and Freddie Mac, and the demise of Bernard Madoff Investment Securities. For example, the DTCC unwound more than $500bn in open trading positions across equities, mortgages and Treasuries between Lehman and a multitude of other banks and investors, without incurring losses for the various counterparties. "DTCC is a firewall to stop contagions, in the event of a firm failure, across each of the financial asset classes we support," Mr Donahue says. However, it was arguably the DTCC's move in November 2006 to start warehousing a record of credit derivative trades that played the most significant role in bolstering the teetering financial system last year. The trade information warehouse for credit derivatives provided regulators with a record of trades. Last October, the DTCC decided to inform the market that, based on its warehouse records, the exposure to Lehman's was close to a net notional value of about $6bn. This was done to stem speculation that the credit derivative exposure from Lehman was $400bn. Subsequently, when the Lehman exposure was closed out, the actual value was $5.2bn. Mr Donahue says the move was a "transformative moment" for the organisation. "We realised that creating this type of transparency would be an important tool in helping regulators and the public at large better understand the OTC derivatives market." In spite of that seeming success, the DTCC fears that efforts to create a plethora of central clearing houses could undercut its position. Consequently, it is trying to convince US politicians that it is essential to ensure that any future clearing house remains tightly entwined with the DTCC. At the same time, the group is trying to spread its wings by moving into another crucial area of infrastructure, the tri-party repurchase or repo market. During the credit boom, US investment banks relied heavily on overnight repo funding. Lenders of cash, including money market funds, used the custodial clearing banks, the Bank of New York Mellon and JPMorgan, to provide dealers with cash in exchange for collateral. As the New York Fed, in conjunction with the clearing banks and dealers, looks at ways of improving the system, Mr Donahue says having the buy side as members of the Fixed Income Clearing Corporation will allow the DTCC to extend the benefits of a CCP to all parties in tri-party repo transactions. "We are looking at how to expand the safeguards of our existing structure for both tri-party and bilateral repos," he says. A year of more but smaller events Already this year the DTCC has handled more than 30 credit events from the credit derivatives market. At present the warehouse holds at least 95 per cent of all credit default swap contracts. To meet a commitment dealers made to the Federal Reserve, tailored credit derivative transactions are to be placed in the warehouse by July 17. Donald Donahue, DTCC chairman and chief executive, says: "The warehouse now holds north of 95 per cent of all CDS contracts, and we have significant experience processing credit events. "Last year was an enormous stress test, managing 11 major credits, including Lehman, Washington Mutual, Freddie Mac and Fannie Mae. "This year, while most of these are smaller in size, we've handled more than 30 credit events."