[ by Howard Haykin ]

The Depository Trust and Clearing Corporation (DTCC), a long-standing player on Wall Street, could conceivably provide the viable solution the industry has searched for to reduce and/or prevent market glitches from threatening to negate all the positive market advancements that characterize today's equity markets in the United States. 

An industry working group that includes all 4 major national stock exchange operators, broker-dealers, buyside firms, and FINRA suggested in its 9/28/12 letter to the SEC that DTCC and its clearing agencies might provide a "consolidated control mechanism" that could help keep trading from running wild, as most recently occurred on 8/1/12 when Knight Capital unleashed a flood of erroneous orders that nearly swamped the large market maker.  DTCC, the utility that provides clearing services for the equities trading industry, could be asked to produce the “control mechanism” that keeps brokerages, market makers and other trading participants from imploding due to flawed technology.

Unique Position to Limit Risks. DTCC's clearing operations are in "a unique position" to limit risks, and thus able to act "as the ultimate receiver of the potential risks resulting from technology-related and similar events," according to the group.  They point to 2 proposals introduced by a DTCC agency, the National Securities Clearing Corporation (NSCC) agency.  Both proposals are already under review at the SEC.

First Proposal. A rule filing that would require amounts, prices and other details on trades be “locked-in” when buy and sell orders are matched and that the “locked-in-trade data” be submitted by market participants to the clearer on a real-time basis.  [C-I Note: This proposal was designed to prevent the hazards of not having up-to-the-moment trade data. Late day trade data now limits NSCC’s ability to "effectively monitor counterparty credit risk and to risk manage those trades on an intra-day basis."]

Second Proposal. DTCC also is calling for accelerated trade guarantees. Currently, the NSCC guarantees trades at midnight the day after a trade takes place.  [C-I Note: If the trade guarantee were moved up, the clearer could become the central counterparty earlier in the trading cycle. This also would reduce intra-day counterparty exposure.]

These proposals, which are designed to prevent the hazards of not having up-to-minute trade data, have to be fleshed out by the industry group and worked out with regulators.  Late-day trade data now limits NSCC’s ability to “effectively monitor counterparty credit risk and to risk manage those trades on an intra-day basis,” according to the industry group.

DTCC Statement. DTCC confirmed that it's discussing faster, more effective trade guarantees, and a spokesperson issued this statement:  “The group is discussing what actions the industry can take to improve the stability of the markets without inhibiting the ability for firms to conduct their normal business. As these discussions are in their early stages, it is premature to determine the direction of the group’s views.”  The spokesperson also said it was too early to go beyond general comments, saying discussions with the working group are ongoing.

Statement From Another Industry Professional Familiar With the Talks. "DTCC suggestions are meant to get the DTCC to a more real-time environment so they could perhaps function longer in some sort of centralized risk management capacity in real time."  The first step is to "get the DTCC systems more real time."

This individual added that the working group is focusing on the idea of using a calculation called "Peak Net Notional Exposure" as the trigger for a shutdown of aberrant activity. That kill switch would be maintained by the exchanges.

About the Working Group. The group was formed this summer after Knight Trading Group’s 45-minute technology trading glitch caused a $440 million loss. That loss that nearly pushed the giant liquidity provider into bankruptcy.  Members include:  (i) Bank of America Merrill Lynch  ..  (ii) Citadel  ..  (iii) Citigroup Global Markets  ..  (iv) Deutsche Bank Securities  ..  (v) GETCO  ..  (vi) Goldman, Sachs & Co.  ..  (vii) IMC Chicago  ..  (viii) ITG  ..  (ix) Jane Street  ..  (x) Morgan Securities  ..  (xi) RBC Capital Markets  ..  (xii) RGM Advisors  ..  (xiii) Two Sigma Securities  ..  (xiv) UBS Securities  ..  (xv) Virtu Financial  ..  and, (xvi) Wells Fargo Securities.

The 9/28/12 letter is signed by: (i) NYSE Euronext  ..  (ii) Nasdaq OMX  ..  (iii) BATS Global Markets  ..  (iv) Direct Edge  ..  (v) Chicago Stock Exchange  ..  (vi) FINRA  ..  and, (vii) the DTCC.

The working group says it is interested in both the DTCC’s accelerated trade guarantee and ensuring trade data is provided to the utility on a real time basis, and it states the following: "If approved, both proposals would contribute to the goal of mitigating counterparty risk and would provide a means for the NSCC to identify cross market credit issues on a timelier basis."

Current Limitations. Today’s standard trade guarantee and settlement standards, critics say, are not fast enough.  That’s because intra day and other kinds of problems can arise. As an example, let’s assume 2 parties trade on Monday, which is T.  The NSCC applies its trade guarantees at midnight at midnight of T+1 (midnight Tuesday into Wednesday).  The trade is settled, with the movement of money and securities, on Thursday (T+3).

Critics complain that, within the trade guarantee and settlement periods  -T+1 to T+3-  many things can go wrong.  These problems can hurt well-run firms that have done nothing wrong.

- e.g.,  say the counterparty of healthy firm is under regulatory review, which can hurt a firm even though it has dome nothing wrong.  Say a firm files for bankruptcy, then your business could be tied up.  Pershing’s Closs cited the Lehman Brothers’ bankruptcy as an example.

For further details, go to:  [Traders Mag, 10/9/12].