DTCC coaxing HFTs to become clearing members

US Treasuries CCP concerned about contagion risk threat to existing members

Murray Pozmanter, the Depository Trust & Clearing Corporation

The Depository Trust & Clearing Corporation (DTCC) is trying to convince high-frequency trading (HFT) firms to clear their US Treasury trades at its clearing house to mitigate possible contagion risk.

The DTCC's securities clearing house, the Fixed Income Clearing Corporation (FICC), is the main central counterparty (CCP) for the US Treasury market. Its clearing members comprise banks, broker-dealers and trading platforms, but the FICC is now pushing to sign up HFT firms as well, given their significant presence in the market.

"The FICC has been reaching out to us to try and bring more HFT firms into clearing," says a source at a HFT firm in New York. "We had a call last month with a bunch of different firms. [The DTCC] made the case as to why clearing directly at the FICC was a good thing, and we discussed the reservations we had."

Another HFT executive tells Risk.net the DTCC contacted his firm in April to pitch the merits of FICC membership.

A spokesperson for the Futures Industry Association's Principal Traders Group, which represents HFTs, says the discussions with the DTCC are still at an early stage. "We've just begun discussing this issue and starting the preliminary work necessary to develop a position on it."

The DTCC is understood to be concerned that the failure of a HFT firm could pose a risk to FICC member firms that transact with it.

The fact that proprietary trading firms do not clear their cash trades through a CCP leaves market participants exposed to bespoke risk margining and reduced transparency
Murray Pozmanter, Depository Trust & Clearing Corporation

"The fact that proprietary trading firms do not clear their cash trades through a CCP leaves market participants exposed to bespoke risk margining and reduced transparency. This could increase the likelihood of the failure of a non-CCP member impacting a dealer who is a member in the CCP if that failure is large enough and the exposure is not appropriately margined," Murray Pozmanter, head of agency clearing services at the DTCC, wrote in a March 18 comment letter responding to the US Treasury Department's request for information (RFI) on US Treasury market structure.

Unlike swaps, US Treasuries are not subject to a clearing mandate, although the Federal Reserve Bank of New York does require primary dealers to be FICC members. An estimated 50% of all US Treasury trades are cleared at the FICC, according to industry sources.

The FICC currently has 148 clearing members, including banks, broker-dealers and interdealer trading platforms such as BrokerTec and DealerWeb.

HFTs are major players on these platforms. Last September, Risk.net revealed that eight of the top 10 firms ranked by volume on BrokerTec over May and June of 2015 were non-banks, with a big contingent of HFTs.

Icap-owned BrokerTec accounts for an estimated 65–70% of interdealer trading in US Treasuries.

Trading venues run by interdealer brokers (IDBs) such as BrokerTec facilitate anonymous trading between clients by serving as counterparties to all transactions executed on their platforms.

Trades between FICC members are cleared at the CCP, with the platform acting as a clearing member. As the risk of these transactions is offset at the clearing house, IDBs are usually not required to post margin against trades.

However, many of the HFTs on IDB platforms – including Jump Trading, Teza Technologies and XR Trading – are not members of the FICC. Trades between these firms stay outside the FICC. But when an HFT trades with an FICC member, the platform must clear its leg of the trade with the FICC member, while its trade with the HFT sits outside the clearing house,

As the HFT position can't be netted by the CCP, it can leave the trading platforms with an open position at the clearing house, which generates an intra-day margin requirement.

We believe there is risk in this situation – specifically, there is risk that a Knight Capital event in the interdealer cash markets could present asymmetrical risk to an IDB
Mike Zolik, Ronin Capital

That worries some FICC member firms. "IDBs are assuming the credit risk of non-member [HFTs]," Mike Zolik of Ronin Capital, a Chicago-based broker-dealer and FICC member, wrote in the firm's response to the Treasury Department's RFI. "We believe there is risk in this situation – specifically, there is risk that a Knight Capital event in the interdealer cash markets could present asymmetrical risk to an IDB or even to FICC and its membership."

IDBs work with clearing agents to mitigate some of these risks. Clearing agents provide netting and settlement services to HFTs on IDB platforms. These firms act as agents and do not take on clients' credit risk, which remains with the platforms.

Clearing firms also help IDB platforms to manage their margin exposure at the FICC. BrokerTec had an arrangement whereby Pershing, an FICC member, would enter into offsetting trades with BrokerTec to flatten its positions at the clearing house, according to sources familiar with the matter.

Nasdaq-owned eSpeed is said to have a similar arrangement with Cantor Fitzgerald, while Dealerweb pays Societe Generale a monthly fee to clear its trades and satisfy all necessary margin requirements at the FICC.

However, Risk.net understands the arrangement between BrokerTec and Pershing was terminated at the end of 2015. As a result, BrokerTec could face potentially sizeable intra-day margin calls from the FICC, and has asked non-FICC member firms to put up more collateral to cover these costs. BrokerTec declined to comment.

Reluctance to sign up

HFTs are reluctant to become FICC members, however. Some cite the clearing house's fee structure as the main barrier to joining. The FICC charges separate fees for matching and netting trades in addition to a per-ticket fee based on volume. Taken together, those charges can add up to 60 cents per trade, according to an executive at an FICC member firm. HFTs that do tens of thousands of trades a day could quickly run up a hefty tab.

"Going through a clearing agent means you don't pay a per-transaction fee; you just pay a clearing fee," says the source at the HFT firm in New York. "Considering the FICC is there to mutualise risk, rather than process messages, it does not seem right to charge a per-ticket fee that expensive. Whether or not we join the FICC will depend on how attractive they are going to make it for us to join. Right now, it's not an attractive thing to do."

The FICC's membership requirements are another impediment to HFTs. "A lot of HFT firms would not qualify as members today because they are not registered as broker-dealers or futures commission merchants," says a source familiar with the FICC's requirements. "Even if there was a regulatory mandate to clear US Treasuries, there would still need to be some work done on the market structure side to get HFTs into clearing."

But in its RFI submission, Wells Fargo noted that HFTs gain a cost advantage over clearing members by remaining outside FICC, while contributing additional risk to the system: "Allowing certain market participants the ability to avoid clearing directly through a CCP gives those market participants a potential cost advantage versus market participants that are required to clear directly through a CCP. This settlement bifurcation could be very detrimental to the US Treasury marketplace and potentially result in unintended asymmetrical risk."