Mike Bodson, CEO of the Depository Trust and Clearing Corporation (DTCC) released remarks for a US House Committee on Financial Services hearing on the events surrounding “meme stocks” as they relate to securities transactions cleared by the National Securities Clearing Corporation (NSCC).
During the week of January 25, 2021, the market saw unusually high volumes and price volatility in certain securities that had been popularized on internet message boards, including GameStop. NSCC, the CCP for US equities, actively monitored market developments as volumes and prices rose in these “meme” securities at the beginning of the week.
NSCC experienced the two highest transaction volume days in its history on Wednesday, January 27 and Thursday, January 28. That portion of the core clearing fund requirement that is assessed for purposes of the capital premium charge is described hereafter as the core requirement for simplicity, although it is a specific aggregation of some but not all core component charges, as set forth in NSCC’s rules.
On Wednesday, NSCC processed approximately 474 million transaction sides, exceeding the March 2020 volume record by more than 100 million. Risk at NSCC, as measured by NSCC’s aggregate clearing fund requirement, also increased substantially on January 28, to $33.5 billion, slightly higher than the peak that occurred in March 2020 and just under NSCC’s historical maximum.
Extreme market volatility and even “short squeeze” events are not new phenomena. What was unusual was that activity in the volatile meme securities was also more concentrated in the portfolios of firms that primarily support individual investors.
The concentrated retail interest in purchasing meme securities and the related spike in the prices of those securities was a substantial factor in generating the near-peak aggregate clearing fund requirements at NSCC on January 28. The impact of that increase was more concentrated in the clearing members whose clients drove that activity. The impact of the March 2020 market volatility and the related increase in NSCC clearing fund requirements, by contrast, was more evenly distributed across clearing members.
As volumes and volatility in the meme securities spiked on Wednesday, January 27, NSCC calculated and imposed a special charge under its rules that essentially accelerated collection of a portion of the following morning’s VaR charge for many clearing members with exposure to these securities. The imposition of the special charge, in addition to NSCC’s collection of intraday mark-to-market charges, reflected significant growth in risk in many clearing members’ unsettled portfolios.
Many clearing members whose unsettled portfolios were exposed to volatile meme stocks saw significant increases in the VaR charges that derived from the risk posed by increased volume and price volatility in these securities. Substantial VaR charge increases also generated capital premium charges for clearing members whose core requirements exceeded their capital cushions. Several clearing members were subject to capital premium charges, which were automatically generated by NSCC’s systems based on the formula in NSCC’s rules.
NSCC examined the market activity and clearing member margin requirements to consider whether it would be appropriate to adjust or waive the capital premium charge, as permitted under the applicable rule. NSCC determined that the spike in market volatility, particularly in the so-called meme stocks, was a material contributor to elevated VaR charges for several clearing members, including most of those subject to capital premium charges.
A dramatic increase in a clearing member’s VaR charges over a short period results directly from a correspondingly large increase in the risk presented to NSCC by the clearing member’s portfolio, due to increases in transaction volume, volatility and concentration of the unsettled transactions in the clearing member’s portfolio, and not from any discretionary action taken by NSCC.
NSCC’s role in the market is a neutral one. It does not impose trading restrictions upon its clearing members or their customers, and it did not instruct any clearing member to impose restrictions during the market volatility events of late January. NSCC expects all clearing members to employ effective tools to monitor and manage their risk, and to maintain an appropriate level of capital to support any expansion of or change in their business activities.
Clearing fund requirements are rules-based and subject to limited discretion. NSCC exercises this discretion carefully, often in unique circumstances. In such cases, NSCC’s sole objective is to balance the need to protect the system from a potential clearing member default against the damage and other risks that could result if NSCC were to cease-to-act and liquidate a clearing member’s portfolio.
Non-core charges
NSCC’s rules-based clearing fund requirements also include certain “non-core” charges that address specific issues. These are also set forth in NSCC’s rules. For example, if a clearing member’s portfolio is highly variable from day to day, core charges may not adequately capture the risk. If so, the clearing member could be subject to a backtesting charge that addresses this gap.
Other charges are intended to encourage operational resiliency and reduce settlement risk. One example is the fails charge that applies when a clearing member fails to deliver securities for settlement. One such non-core charge that became important during the week of January 25 is the capital premium charge. This charge was adopted in 2006, following market disruptions caused by the failure of a clearing member of NSCC and other clearinghouses. The capital premium charge is intended to discourage clearing members from taking on more risk in their portfolios at NSCC than their capital levels can reasonably support. Because a clearing member may be obligated to quickly provide funds to NSCC and other clearinghouses, a clearing member that is over-leveraged presents a heightened risk of default.
A clearing member can avoid a capital premium charge by either raising its capital level or reducing the risk in its portfolio. A clearing member that is monitoring market conditions and risk levels in its portfolio may take a variety of steps to reduce risk, including routing executed trades to other NSCC clearing members, limiting submissions from other broker-dealers that clear through it, or imposing other trading restrictions on its clients.
Reducing risk in an unsettled portfolio will typically result in reduced core clearing fund charges, which in turn reduces the likelihood that a clearing member will become subject to the capital premium charge. NSCC does not direct its members whether or how to take such steps, but it does expect members to be able to meet their margin requirements for clearing activity, including the capital premium charge if they incur it.
Accelerated Securities Settlement
DTCC has long worked with the industry to identify ways to enhance efficiency and reduce costs in post-trade processing. Following a multi-year, industry-wide effort, securities settlement was shortened in 2017 from T+3 to T+2, achieving margin savings estimated at 25%. Shortening the settlement cycle beyond T+2 would reduce the risks that drive margin requirements and further reduce costs to clearing members.
Over the past year, DTCC has worked with a cross-section of clients and stakeholders to explore the benefits of moving to T+1 or T+0. DTCC has conducted pilot projects exploring new technologies that could be employed in accelerated settlement or even real-time gross settlement (RTGS).
Engagement with the industry and DTCC’s own assessment indicates that the industry is increasingly prepared to move to T+1. DTCC is working with the Securities Industry and Financial Markets Association (SIFMA) and the Investment Company Institute (ICI) to advance this important effort.