United States of America: The National Securities Clearing Corporation 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 National Securities Clearing Corporation (NSCC) observes or broadly observes most of the CPSS-IOSCO Recommendations for CCP (RCCPs).1 The system properly addresses legal, credit, custody, and operational risks. Some measures to improve resilience against financial risks have been identified, including measures to enhance governance arrangements. It is however important that NSCC effectively addresses issues concerning financial resources, money settlement (including DVP arrangements), and links between CCPs. It would also be beneficial that the Securities and Exchange Commission (SEC) require NSCC’s compliance with RCCPs and that the Federal Reserve is provided with a legal mandate to oversee the NSCC, which is a systemically important system, as a complementary function to the existing SEC regulation and supervision.

2. The assessment of the NSCC was undertaken in the context of the IMF Financial Sector Assessment Program (FSAP).2 Prior to the mission, NSCC conducted a self-assessment following the methodology of the RCCPs 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 the NSCC and some major participants in the system.3 Relevant authorities and the operator of the system have been very co-operative in providing additional confidential information and organizing additional meetings, when required.

3. Given the organization of the Depository Trust & Clearing Corporation (DTCC), the assessment of the three entities belonging to the group: The Depository Trust Company (DTC), the NSCC, and the Fixed Income Clearing Corporation (FICC) is almost identical for the 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

4. The NSCC is registered as a clearing agency with the Securities and Exchange Commission (SEC) and subject to the SEC’s oversight. It was established in 1976 as a New York business corporation, and since 1999 it became a wholly-owned subsidiary of the Depository Trust & Clearing Corporation (DTCC).

5. NSCC provides central counterparty services for certain transactions for the vast majority of broker-to-broker trades involving equities, corporate and municipal bonds. In addition, NSCC provides a range of other services to its members, namely wealth management and insurance services, automated customer account transfer services and risk management. As of December 2009, NSCC had 206 clearing members, including 3 foreign institutions Table 1.

Table 1.

Key Statistics of NSCC, 2007–09

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Source: DTCC.

Includes the value of cash and securities.

III. Main Findings

Legal Framework (Rec. 1)

6. NSCC’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, which are publically available and readily accessible to system participants.

Participation requirements (Rec. 2)

7. The NSCC’s access and exit criteria are publicly disclosed. NSCC requirements for participants’ financial resources and credit worthiness are based on the legal nature of the participating entities as well as the services that these entities will use. The NSCC also assesses the participants’ financial strength and operational reliability.

Financial risk management (Rec.3–6)

8. The NSCC measures its exposures to participants daily and requires payment of contributions to the clearing fund. It can, when deemed appropriate, conduct intraday calls for additional clearing funds. The NSCC mitigates its credit exposures on the basis of the clearing fund requirements as well as cross-guarantee and cross-margining arrangements. The NSCC conducts stress testing monthly, on the basis of scenarios selected from the past ten years together with specific historic events. NSCC’s liquidity resources are composed of cash and securities and committed credit facility by some banks. In case of insufficient cash resources, the NSCC seeks to liquidate the available collateral via repo arrangements. NSCC’s default procedures are clearly stated in the system’s rules and procedures.

Custody and investment risks (Rec. 7)

9. NSCC’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 outlines principles for mitigating the risk of losses stemming from unsecured investments. The NSCC assets are held under tri-party custodial arrangements. When repos are not available, the assets are invested in overnight commercial paper in bank sweep accounts.

Operational risk (Rec. 8)

10. NSCC business continuity arrangements are developed at the level of DTCC holding company, including all sites, networks control centres, 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 mitigate the sources of operational risk. Contingency plans and back-up facilities are regularly tested and maintained to ensure the resilience of NSCC.

Money settlements (Rec. 9)

11. The NSCC settles its money obligations in commercial bank money.

Physical deliveries (Rec. 10)

12. The NSCC rules clearly set forth its obligations with respect to securities deliveries. In order to protect itself from principal risk linked to market movements, NSCC continuously monitors participants’ exposures and collect margins when required. The NSCC uses a “modified” DVP mechanism, under which securities are delivered with finality to the participants only if the NSCC has received the cash or is in a credit position vis-à-vis the relevant clearing member.

Risks in links between CCPs (Rec. 11)

13. The NSCC has established three links to the Option Clearing Corporation (OCC) and the Canadian Clearing and Depository Services Inc (CDS). According to the NSCC, an assessment of the associated risks with these links has been conducted.

Efficiency (Rec. 12)

14. The NSCC regularly reviews its pricing levels, which are based on cost recovery. The cost allocation methodology is part of a regular review by both internal and external auditors. NSCC also conducts benchmark studies to assess cost effectiveness in the market. According to DTCC, internal auditors ensure that each service provided by 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)

15. There is a single governance structure for all DTCC subsidiaries, including the NSCC. 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)

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

Regulation and oversight (Rec. 15)

17. 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 the NSCC given its status of a registered clearing agency. In conducting its responsibilities, the SEC applies other standards than the RCCPs, although some of the issues covered by the RCCPs are also addressed by the standards under the securities laws that are applied by the SEC. The Federal Reserve has the authority to examine the NSCC as an affiliate of DTC. The SEC and the Federal Reserve have signed exam-specific information sharing arrangements regarding the oversight of NSCC. A cooperation framework (MoU) between the SEC and the Canadian authorities has been set for the supervision of the links, while there is no such arrangement with the Monetary Authority in Singapore (MAS).

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

18. The U.S. authorities welcome the IMF’s assessment of the NSCC against the RCCP. 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 the NSCC with the RCCPs, and will work with the NSCC in considering the assessment’s specific comments and recommendations. Again, the authorities appreciate the significant undertaking associated with the assessment of the NSCC and the contribution that the assessment process makes to the stability and effective regulation and oversight of systemically-important payment, clearing and settlement systems.

Notes

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=23871.0.

2

For further discussion see the accompanying Financial Stability Assessment (FSSA), (www.imf.org).

3

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