Clearinghouses for swap, fixed-income and equities trades along with US central securities depository must now gear up for their new more closely monitored lives as systematically important financial institutions or SIFIs.

Officials at the CME Group, Intercontinental Exchange and Depository Trust & Clearing Corp. confirmed to www.iss-mag.com on Wednesday that their subsidiaries have been notified by the Financial Stability Oversight Council they could be designated as SIFIs.  In the case of DTCC, the letters were received by subsidiaries National Securities Clearing Corp. (NSCC); Fixed Income Clearing Corp (FICC); and Depository Trust Company (DTC), the U.S. securities depository. ICE received the letter on behalf of subsidiary ICE Clear Credit, its clearinghouse for credit default swaps.

The notification represents a warning and not a final decision which is expected to be made this summer, but the clearinghouses and DTC are widely considered to be a shoe-in based on their significant post-trade processing functions and interconnectedness to other financial entities. The designation must be approved by a two-thirds vote of the FSOB's board, including its chairman. Board members include top officials from the Federal Reserve Bank; Commodity Futures Trading Commission and the Securities and Exchange Commission.

The FSOB, created by the Dodd-Frank Wall Street Reform Act to monitor systemic risk, on Tuesday identified an initial list of clearinghouses as "systemically important" and subject to new rules on capital, liquidity and exposure from the Federal Reserve. The FSOB, which made the announcement through The US Treasury, did not identify the clearinghouses and depositories which are among the list of candidates to be officially announced by year-end. That list includes large banks and even non-bank financial institutions such as asset managers and hedge funds, which have lobbied vigorously against the designation. The FSOB says it reserves the right to name any financial organization as a SIFI but none of the firms will know they are under review until they receive the notification letter.

The Dodd-Frank legislation also calls for more clearing of swaps through centralized clearinghouses, prompting concerns about how risk might be concentrated in the hands of fewer financial firms and clearinghouses. Currently, swap trades are typically processed bilaterally -- or between two counterparties -- subject to private agreements on how much collateral and what type of collateral is required.

Neither the clearinghouses nor DTC would provide www.iss-mag.com with any specifics on just how they are preparing or how the potential oversight by the Federal Reserve compares to their current regulatory requirements, but several clearing and settlement experts consulted by www.iss-mag.com insist that clearinghouses and depositories could face an easier ramp up time than even banks or other financial firms. The reason: acting as a central counterparty between two trading partners or in the case of DTC a settlement organization already requires them to impose some pretty strict guidelines for risk mitigation. Clearinghouses, for one, are capitalized by their members to mitigate counterparty risk and the potential risk to the clearinghouse itself in the event of a default or bankruptcy of one or more member firms. The more exacting requirements for SIFIs include risk-based capital an leverage requirements; liquidity requirements; single counterparty credit limits; risk management requirements; stress testing requirements; debt-to-equity limits and an early remediation framework -- a plan for how to wind down operations in case of bankruptcy. 

As the world's largest futures exchange, CME in Chicago operates a clearinghouse for interest rate and credit default swaps. The NSCC clears transactions in U.S. equities; corporate bonds and municipal bonds, while FICC clears transactions in U.S. Treasury; agency and government sponsored mortgage-backed securities. "As the primary infrastructure responsible for the clearance and settlement of nearly all cash traded in the U.S., these DTCC subsidiaries play critical roles in mitigating risk and ensuring the safe and seamless operation of U.S. capital markets," says a spokeswoman for DTCC in a statement to www.iss-mag.com. "We are neither surprised nor do we disagree with the designation being considered by the FSOC."

Written by Chris Kentouris, Editor-in-chief (Chris can be contacted through Chris.Kentouris@hotmail.com)

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