Clearinghouses that were downgraded in an automatic trigger response to the US’ rating being cut to AA+ by Standard & Poor’s say they have no current plans to make changes to their application valuations of securities, or haircuts, required for collateral due to the downgrade.
The Depository Trust & Clearing Corp said its subsidiary, Fixed Income Clearing Corp, has no current plans to make haircuts required for collateral for its Government Securities Division Clearing Fund and its Mortgage-Backed Securities Division Participants Fund at this time due to S&P downgrading the US Friday. The OCC, formerly known as the Options Clearing Corp, the largest equity derivatives clearing organisation, said it also has no plans to adjust its current valuations on Treasury securities used as collateral.
However, DTCC plans to monitor the market developments in the coming days. FICC will operate under its normal schedule for input and reporting this week, it said in a statement.
S&P’s US ratings cut and automatic ratings trigger for certain clearing entities does, however, call into the question the impact of derivatives clearing could have on markets amid the new regulatory environment.
Christopher Perkins, global head of derivatives clearing at Citigroup, said although there are many benefits to the mandatory central clearing of standard derivatives, care must be taken because of the resulting concentration of counterparty risk.
“By concentrating risk through mandatory central clearing, there’s a good part– regulators have visibility and transparency into the system. Because of this transparency, such risk can be mitigated through an effective collaterisation regime. The bad news is, if the collateral construct is wrong, we are concentrating counterparty risk at a single node or point,” said Perkins.
DTCC and other organisations such as clearinghouses that have a direct link to the US government were downgraded to AA+ along with the US ratings since they operate exclusively in the domestic market and the US’ sovereign rating has a large impact on them.
“If the markets are still saying the values are the same, we’re not adjusting that. And no need to change the haircuts. S&P may make its change, but if the markets haven’t made its change, that’s what we are basing our collateral decisions on…Whether its cash or Treasuries, it’s all about that value,” said a spokesperson at the OCC.
“If you are using Treasuries to any large extent like a clearinghouse does, you can’t be rated higher than the government,” he noted. “A major source of collateral for OCC is Treasury securities.”
The OCC updates the value of Treasury securities on a monthly basis. “We have the ability to make changes outside that monthly basis but only if we see something that shows we don’t have proper coverage. That’s what we are monitoring.”
The OCC does, however, use other securities as collateral such as stocks and also cash. “For us as an equity derivatives clearinghouse, stock as collateral works very well for us. The whole reason you hold the collateral is to unwind positions in case of a default. If we’ve got the underlying stocks for the options positions, that puts us, as a clearinghouse, in a very good spot,” he said.
The OCC’s clearing fund, though, is only cash and government securities.
The rating change for the OCC itself is not expected to alter operations much at the OCC or the way it deals with member firms, according to one clearing executive.
“I don’t see it as making much difference. All these firms have a pretty strong position in the market,” he said.
S&P rates the OCC on its ability to meet its obligations for its clearing members. “Frankly, nothing’s changed with that,” added the OCC spokesperson. “The value of Treasuries may or may not change.”
The rating agency has long recognised OCC’s effective monopoly on clearing security options and futures, saying in a report earlier this year that it has a “critical role in the US capital markets”.
But it has flagged OCC in the past for having a business model that exhibits a high degree of operating leverage and operational risk since there is such a significant concentration of trading volume among its largest members due to consolidation in the industry.
Kathleen Hoffelder