Clearing Thrust Into Spotlight

Terry Flanagan

DTCC responds to MF Global news report.

The process by which trades are cleared and settled has been thrust into the spotlight by recent events, such as the MF Global scandal.

Depository Trust & Clearing Corp. (DTCC), responding to a published report that said that MF Global improperly transferred customer funds to DTCC, issued a statement clarifying the clearing and settlement process.

According to the published report, federal authorities are reviewing whether MF Global used customer money to pay DTCC as part of a margin call.

DTCC said that when a firm sends funds through DTCC to complete its transactions and settle trades, DTCC does not “hold back” any funds for purposes of collateral or margin — all funds are remitted to the parties to whom they are due.

In the normal course of business, DTCC handles member firms’ payments of funds related to two key activities: the settlement of transactions entered into by members on behalf of both their customers and their own accounts, and the deposit of collateral (“margin”) in relation to DTCC’s subsidiaries’ role as the central counterparty for the U.S. securities markets.

Clearing Fund deposits and payments relating to transaction settlements are handled through completely separate processes and are not commingled; all deposits and payments are kept separate and distinct, DTCC said.

DTCC’s depository provides custody and asset servicing for 3.6 million securities issues from the United States and 121 other countries and territories, valued at almost $34 trillion. In 2010, DTCC settled more than $1.66 quadrillion in securities transactions.

DTCC constantly reviews and assesses the amount of collateral (cash and/or securities) required to be posted from each firm. As DTCC’s subsidiaries guarantee each trade, the amount of collateral required can vary throughout the day, depending on trading volume, market volatility and a view of the potential risk of a default by a particular member firm.

DTCC is a holding company for several regulated subsidiaries, including The Depository Trust Company (DTC), Fixed Income Clearing Corporation (FICC) and National Securities Clearing Corporation (NSCC).

These subsidiaries provide centralized clearance, settlement and information services for equities, corporate and municipal bonds, government and mortgage-backed securities and money market instruments traded in the U.S. capital markets.

As a central counterparty, NSCC or FICC guarantees a member’s performance on trades reported to the clearing house. To provide underlying security for this guaranty, NSCC and FICC require members to post Clearing Fund deposits (or margin) collateralizing their guaranteed trades.

Centralizing the process of clearing and settling transactions through NSCC or FICC is a critical component of securities markets. Through these centralized processes, trades are cleared and settled, with the buyer receiving securities and the seller the related payment for the transaction). Similarly, the payments for transactions are processed through a centralized system.

After a transaction is executed, the details are reported to NSCC (for equities, corporate and municipal bonds and money market instruments) or FICC (for government and mortgage-backed securities). The applicable subsidiary becomes the “central counterparty” to the trade, guarantying completion of the transaction if either the buyer or seller is unable to fulfill its part of the contract.

NSCC settles trades through DTC’s centralized book-entry system (FICC settles trades through the Federal Reserve’s National Book Entry System). Selling parties deliver securities to buying parties through DTC against an obligation to pay funds for the transaction.

Counterparties cannot withhold cash or securities from trades, or no settlement occurs. DTC itself is not involved in deciding how payments are processed or who receives what amounts; further, the total of settlement moneys received from members by DTC equals the total settlement payments DTC makes to other members, with none of these moneys retained at DTC.

Payments may relate to transactions settled on behalf of a member firm’s customers or transactions for the firm’s own account; this transactional information is not reported to DTC.

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