United States of America: The Fixed Income Clearing Corporation–Government Securities Division Observance of the CPSS/IOSCO Recommendations for Central Counterparties

The report gives a summary of the detailed assessment report on the implementation of the Basel Core Principles for Effective Banking in the United States and its recommendations, securities and futures market regulatory, insurance regulation, Fixed Income Clearing Corporation -Government Securities Division (FICC-GSD) system, and other recommendations such as Depository Trust Company (DTC) against the Recommendations for Securities Settlement Systems (RSSS), the National Securities Clearing Corporation (NSCC) against the Recommendation for Central Counterparties (RCCP), the Fedwire Securities Service (FSS) against the Committee on Payment and Settlement Systems -International Organization of Securities Commission (CPSS-IOSCO) RSSSs as well. The U.S. authorities welcomed the Financial Sector Assessment Program (FSAP) and independent reviews, and appreciated significant undertaking associated with reviews in the wake of the crisis.

Abstract

The report gives a summary of the detailed assessment report on the implementation of the Basel Core Principles for Effective Banking in the United States and its recommendations, securities and futures market regulatory, insurance regulation, Fixed Income Clearing Corporation -Government Securities Division (FICC-GSD) system, and other recommendations such as Depository Trust Company (DTC) against the Recommendations for Securities Settlement Systems (RSSS), the National Securities Clearing Corporation (NSCC) against the Recommendation for Central Counterparties (RCCP), the Fedwire Securities Service (FSS) against the Committee on Payment and Settlement Systems -International Organization of Securities Commission (CPSS-IOSCO) RSSSs as well. The U.S. authorities welcomed the Financial Sector Assessment Program (FSAP) and independent reviews, and appreciated significant undertaking associated with reviews in the wake of the crisis.

I. Summary, Introduction, and Methodology

1. The Fixed Income Clearing Corporation–Government Securities Division (FICC-GSD) observes the majority of the recommendations and broadly observes the others of the CPSS-IOSCO Recommendations for central counterparties (RCCPs).1 The system properly addresses risks related to clearing, custody, financial resources, operations, and links. Some measures to improve resilience against financial risks, governance arrangements, and transparency have been identified. It is, however, important that FICC-GSD effectively takes additional steps to properly address financial risks. It would also be beneficial that the Securities and Exchange Commission (SEC) requires FICC-GSD compliance with RCCPs, and the Federal Reserve is provided with a legal mandate to oversee FICC, as a complementary function to the existing SEC regulation and supervision.

2. The assessment of FICC-GSD was undertaken in the context of the IMF Financial Sector Assessment Program (FSAP). This assessment only covers FICC-GSD, i.e. the CCP providing services for transactions in U.S. Government Treasury and Agency securities. The FICC Mortgage Backed Securities Division (MBSD), which is not yet providing CCP services, is not covered by this FSAP mission.

3. Prior to the mission, FICC-GSD conducted a self-assessment following the RCCPs methodology published by the CPSS-IOSCO in 2004. The assessment also benefited from discussions with the SEC, the Federal Reserve Board and Federal Reserve Bank of New York representatives, as well as the operator of FICC and some major participants in the system.2 Relevant authorities and the operator of the system have been very co-operative in providing additional confidential information and organizing additional meetings, when required.

4. Given the organization of the Depository Trust & Clearing Corporation (DTCC), the assessment of the three entities belonging to the group i.e. the Depository Trust Company (DTC), the National Securities Clearing Corporation (NSCC) and the Fixed Income Clearing Corporation (FICC) resulted in almost identical recommendations on legal risk (RSSS1 and CCP1), operational risk (RSSS11 and RCCP8) governance (RSSS13 and RCCP13), efficiency (RSSS15 and RCCP14) and links (RSSS19 and RCCP11).

II. Institutional and Market Structure—overview

5. The FICC-GSD, wholly-owned subsidiary of DTCC, is a systemically important CCP for transactions in U.S. Government Treasury and Agency Securities. It was established in 2003 from the merger between the Government Securities Clearing Corporation and the Mortgage Backed Securities Clearing Corporation. Its predecessors were established in 1986 to provide automated trade comparison and settlement services, risk management and operational efficiency to the U.S. Government securities market. Key figures of FICC’s activities are provided in Table 1.

Table 1.

Key Statistics of FICC-GSD, 2007–09

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Source: DTCC.

Includes the value of cash and securities.

6. FICC-GSD is a registered as a clearing agency and regulated and supervised by the SEC (section 17A of the Securities and Exchange Act). Although the SEC has not formally required FICC-GSD to perform a self-assessment with respect to the RCCPs, compliance with SEC rules assures compliance with most of the recommendations. FICC-GSD, as an affiliate of DTCC, is also subject to the oversight of the Federal Reserve.

III. Main Findings

Legal Framework (Rec. 1)

7. FICC’s activities are governed by a consistent set of laws, regulations, and contractual arrangements that form a sound legal foundation for clearing, settlement, and custody activities. This information is publically available and readily accessible to system participants.

Participation requirements (Rec. 2)

8. The FICC-GSD’s access and exit criteria are publicly disclosed. FICC-GSD requirements for participants’ financial resources and credit worthiness are based on the legal nature of the participating entities as well as the services used. FICC-GSD also assesses the participants’ operational reliability.

Financial risk management (Rec.3-6)

9. FICC-GSD daily measures its exposures to participants and requires payment of contributions to the clearing fund. It can, when deemed appropriate, conduct intraday calls for additional clearing funds. FICC-GSD members’ positions are monitored by DTCC risk management system. FICC mitigates its credit exposures on the basis of the clearing fund requirements, as well as cross-guarantee and cross-margining arrangements. The clearing fund is composed of cash and securities. In case of insufficient cash resources, FICC-GSD seeks to liquidate the available collateral via repo arrangements, although they are not committed facilities, and there is no certainty that they would be available in extreme but plausible scenario. The U.S. legal framework ensures the legal enforceability of FICC-GSD’s collateral arrangements.

Custody and investment risks (Rec. 7)

10. FICC-GSD’s securities and cash of the clearing fund are held in dedicated accounts with the two major clearing banks. Cash investments are authorized under a policy, approved by DTC’s Audit Committee, which establishes principles for minimizing the risk of losses stemming from unsecured investments. The Audit Committee policy also establishes credit limits by counterparties to ensure that investments do not exceed a certain level of concentration.

Operational risk (Rec. 8)

11. FICC-GSD business continuity arrangements are developed at the level of DTCC holding company, including all sites, networks control centers and back-up sites as a unified complex. These arrangements are based on the authorities’ requirements. DTCC has in place adequate procedures to identify and minimize the sources of operational risk that may arise in the clearing and settlement process. Contingency plans and back-up facilities are regularly tested and maintained to ensure the resilience of FICC-GSD.

Money settlements (Rec. 9)

12. For its end-of-day funds settlement, FICC-GSD uses central bank money with a tiered settlement arrangement relying on DTC as settlement agent. The end of day money settlement occurs via the settlement banks at the Federal Reserve’s National Settlement Service (NSS).

Physical deliveries (Rec. 10)

13. The FICC-GSD’s rules clearly set forth its obligations with respect to securities deliveries. In order to protect itself from principal risk, FICC–GSD continuously monitors participants’ exposures and collects margin against failed items.

Risks in links between CCPs (Rec. 11)

14. FICC-GSD has set up a cross-margining arrangement with the Chicago Mercantile Exchange (CME) so that eligible positions at the CME are offset against eligible positions at FICCGSD. For the purpose of this arrangement, a cooperative framework between the Commodity Futures and Exchange Commission (CFTC), overseeing the CME, and the SEC, overseeing the FICC-GSD is in place.

Efficiency (Rec. 12)

15. FICC-GSD regularly reviews its pricing levels, which are cost-based. The cost allocation methodology is part of a regular review by both internal and external auditors. FICC-GSD also conducts benchmark studies to assess cost effectiveness in the market. DTCC ensured that each service of the DTCC group does not cross-subsidise the cost and expenses of the others and that the risk management financial resources are not commingled.

Governance (Rec. 13)

16. There is a single governance structure for all DTCC subsidiaries, including FICC-GSD. Although DTCC’s governance arrangements are made public, not all the relevant information is publicly available. DTCC is currently in the process of reviewing its governance arrangements. Public interest is taken into account in a number of ways, including the requirement that all proposed rule changes of NSCC be filed with the SEC and noticed for public comment, and by discussion with industry participants.

Transparency (Rec. 14)

17. Market participants are provided with sufficient information regarding FICC-GSD risk management. The regulations, rules, and procedures governing FICC-GSD are publicly available, as are annual audited financial statements, and participants receive non audited quarterly financial statements. The FICC-GSD has completed and published on its website a self-assessment following the RCCPs assessment methodology.

Regulation and oversight (Rec. 15)

18. The responsibilities and objectives of relevant public authorities with regard to securities clearing and settlement systems are clearly defined and publicly disclosed. The SEC supervises FICC-GSD given its status of registered clearing agency. In conducting its oversight responsibilities, the SEC applies other standards than the RCCPs, although some of the issues covered in the RCCPs are also addressed by the standards under the securities laws that are applied by the SEC. As an affiliate of DTC, the Federal Reserve has the legal power to examine FICC. The SEC and the Federal Reserve have signed exam-specific information sharing arrangements regarding the oversight of FICC-GSD.

Table 2.

Summary of Observance with the CPSS-IOSCO Recommendations

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Table 3.

Actions to Improve Compliance

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IV. Authorities’ Response to the Assessment

19. The U.S. authorities welcome the IMF’s assessment of the FICC-GSD against the RCCPs. We appreciate the significant undertaking associated with an FSAP review of the biggest financial sector in the world, as well as the challenges that accompany the first assessment of a large advanced country in the wake of the crisis. The authorities are pleased to note that the IMF’s assessment reflects the high degree of compliance of FICC-GSD with the RCCPs, and will work with FICC-GSD in considering the assessment’s specific comments and recommendations. Again, the authorities appreciate the significant undertaking associated with the assessment of FICC-GSD and the contribution that the assessment process makes to the stability and effective regulation and oversight of systemically-important payment, clearing and settlement systems.

1

The underlying Detailed Assessment Report was published in May 2010 and is available at http://www.imf.org/external/pubs/cat/longres.cfm?sk=23872.0.

2

This assessment was carried out by Daniela Russo (external expert) and overseen by Elias Kazarian (IMF).

United States: Publication of Financial Sector Assessment Program Documentation: Reports on Observance and Codes
Author: International Monetary Fund