Who Safeguards the Industry?
The business of Wall Street trading is often viewed as glamorous — fancy suits, expensive restaurants, talk of big bonuses and handsome young people — everything that makes for great Hollywood imagery. But there’s more to trading than just the actual execution and the bragging rights that go along with it. What happens after the trader pushes the execute button or clicks his mouse? How does the security get transferred between the buyer and seller? Who ensures the risk between buyers and sellers is managed at an adequate level? And does the buyer or seller have enough cash or capital to hold up their end of the trade?
Don’t know? It’s the clearinghouse.
And for 100 million transactions, representing over $4 trillion of market value in securities, processed every single day, it’s the job of The Depository Trust & Clearing Corporation to ensure a smooth and orderly back office. DTCC’s function and guardianship of the trading process ecosystem, while not the stuff of movies, is nonetheless vital and important.
According to DTCC’s Head of Clearing Agency Services, Murray Pozmanter, the DTCC system is akin to that of a lineman in American-rules football who protects the ball-handling quarterback or running back – you really only hear about them when something goes awry.
“To most people who aren’t market professionals, we remain a relative unknown,” Pozmanter began. “We do a lot of the behind-the-scenes work that is probably never apparent to the retail investor who opens a brokerage account.”
Pozmanter’s mission is to educate both the public and Wall Street alike to the critical role DTCC plays daily in reducing market risk, developing and implementing new technologies designed to increase efficiency and provide more stability in an increasingly changing market environment.
“People should know about the clearing agency: how it secures the market, how the infrastructure works and impacts the retail investor community,” he said. “We might never directly engage with theend investor, but they should know we are here – and even as the nature of risk has become more complex, interconnected and unpredictable, we are protecting the system.”
DTCC, like any functional public utility, has been around for quite some time, but operated much like the water or electricity in a residential system – always in the background, silently doing its job, and one would only think about it if the lights went out.
Public awareness of the clearing and settlement system increased in the aftermath of the Financial Crisis of 2008/9, when the nation’s financial system was teetering. The industry, regulators and government turned their attention to risk management and decreasing counterparty risk, which escalated during the crisis. And DTCC, which effectively touches all aspects of the markets and their players, stepped up to play a more high-profile role in ensuring the smooth operation of daily market activities.
“Now, DTCC’s role is more in the forefront,” Pozmanter said. “Three of our core subsidiaries are designated as Systemically Important Financial Market Utilities (SIFMUs), which is a recognition of DTCC’s systemic importance to the entire U.S. economy.”
Pozmanter told Traders Magazine about DTCC’s important role in helping to restore trust in the financial system, with the firm helping to ensure the stability of the markets on a daily basis. DTCC does this by working with industry participants and regulators to provide the proper amount of risk oversight, and creating an environment where trust can be rebuilt.
DTCC is also partnering with the industry – vendors, broker/dealers, banks, investment managers, etc. to help spearhead new uniform technology solutions designed to bring greater safety and efficiency to the markets. Whether it be Blockchain, the Cloud or Big Data, DTCC is working to create a less fragmented technological ecosystem and integrate universally-implemented systems that bring security, safety and efficiency.
“DTCC is uniquely positioned to work with the industry to develop new solutions,” Murray said. “For example, the benefits of moving to the T+2 settlement cycle may not be apparent to an end investor, but it will vastly reduce risk in the system.”
Bringing Clearing into the 21st Century
Another key goal for DTCC is to continually improve the market infrastructure to ensure trades get processed quickly and efficiently.
“We must always balance today’s needs with tomorrow’s expectations,” Pozmanter said. “What we’re seeing now, the pace of change is accelerating in financial markets with new technologies emerging that have never been used in such scale. Above all else, the system needs technological reliability.”
Over the course of the past year, DTCC’s core processing engines handled more than $1.5 quadrillion in financial transactions. It goes without saying: the stakes are very high, and DTCC knows it needs a highly scalable and reliable system.
“Now, you’ve got so much new technology coming to the market, so many different forces looking to drive costs down, we see ourselves as an intermediary helping technology firms bring proven technologies to the market,” Pozmanter continued. “We see a role for us here, helping markets to implement technology on a grand level and reducing technology fragmentation.”
And that is where emerging technologies like blockchain hold so much promise – a universal digital solution that can bring real cost savings to the trading community. Not only will information be easily accessed and shared – on the cloud – but the potential exists to also reduce the duplicate storage systems in place now.
But like all things, technology and change for the sake of change is not always good. Pozmanter and others know there must be consistent and adequate cost savings to be had when investing in any new technology. Luke Mauro, a clearing market veteran and Instinet’s Global Head of Operations, said he wants to see significant technological savings from blockchain and other technologies.
“People aren’t looking to blockchain and other technologies for small 5% to 10% fee reductions,” Mauro began. “They want to see them drive costs down by 50% to 60%.”
It is possible, Mauro said, as he is optimistic on the technology. But he wants to see whatever new technology is going to be implemented used for more than just the basic clearing system, especially since the current system works just fine. He wants to see a wholesale application of this new technology.
A switchover to the digital ledger, he added, could be as revolutionary as when DTCC moved to book-entry for settlement and clearing, from physical delivery and entry of securities.
The use of Blockchain-like technology can also help solve collateral issues, Mauro continued, explaining that as overall trading volume increases it currently requires more collateral (money) to fund operations. Blockchain could reduce the amount of collateral needed to settle and clear securities.
“Commission compression and lower volumes are driving firms to look for ways to clear at a lower cost basis,” Mauro said. “Blockchain-like solutions can be the centerpiece of new technology that can reduce costs and increase efficiency.”
But the question Mauro and others are asking is how long will it take to get blockchain or other new technologies into use. While DTCC wants to drive new technology usage, will it take one year, three years or five years to get systems online? And will the major firms invest in it and pledge commitment to use it?
“You need the largest buy-side players and clearing firms to buy into Blockchain or whatever the technology will be,” Mauro said. “If they don’t buy into it and back its usage, then it won’t work.”
Furthermore, implementation of new technology should be seamless across all asset classes, Mauro pointed out.
“The question is whether Blockchain can work in other classes and still provide big savings – such as in contracts, settlement instructions and KYC information – things that the buy-side needs to share,” Mauro wondered.
It was a point that Cobalt CEO Andy Coyne brought up in a recent conversation with industry consultant Larry Tabb. “As the industry increasingly becomes cost-focused, FX post-trade services, which represent about $20 billion of industry expense, are ripe for shared industry infrastructure via distributed ledger technology,” Coyne said.
The Final Word
DTCC’s mission , Pozmanter said, is to continue to safeguard the markets and the industry. It looks to achieve this by ensuring all the moving pieces in the clearing system work and exist in harmony – regulation, capital requirements, operational efficiencies and cost reduction.
“I see our role as helping firms use capital more efficiently, and reducing the cost of compliance and technology, with automation playing a big role in this,” Pozmanter said. “Our efforts are rooted in the belief that DTCC represents a social good.. And as such, we must continually pursue improvements in how markets function and enable efficient growth for our clients’ business.”
Blockchain eliminates the need for a manual or semi-automated reconciliation.
The newly published report expects the technologies to boost efficiencies.
Working group's concludes DLT-based settlement is 'feasible'.
Counting and confirmation of votes can currently take two weeks.
Source code of the smart contracts is publicly available on Github.