S&P: The Depository Trust & Assigned To Five Classes From Voya CLO 2012-4 Ltd. In Connection With Refinancing
"The downgrades of FICC and DTCC reflect our opinion that FICC's liquidity resources, even including the proposed capped contingency liquidity facility program, are weaker than U. S. and European peers'," said S&P Global Ratings credit analyst Olga Roman. "This weakness weighs on our assessment of clearing and settlement risk at FICC and at the group level, DTCC."
FICC is planning to introduce a CCLF at its Government Securities Division (GSD) to supplement its liquidity resources in stressed market conditions whereby one or several large clearing members default. The proposal bears some resemblance to the existing CCLF facility at FICC's other clearing division, Mortgage-Backed Securities Division (MBSD). Under this program, once GSD declares a CCLF event, GSD members will be required to enter into repo transactions with FICC, up to a predetermined cap. This will provide committed liquidity for FICC, even under stressed market conditions. The repos will subsequently be closed when FICC liquidates the securities or if GSD is able to obtain liquidity from the repo markets. The company will derive caps based on liquidity risks that members have exhibited over a six-month period. GSD intends to use the CCLF process only in the event it is not able to obtain its own financing via its existing repo agreements and other funding resources.
In our view, the proposed CCLF program will strengthen FICC's liquidity through the addition of committed resources and will decrease the company's reliance on uncommitted repo facilities. Combined with existing cash margins, we expect the CCLF proposal to provide FICC with enough committed liquid resources in a stress scenario whereby the largest clearing member (and its affiliates) defaults ("cover 1"). However, the plan falls short of aligning FICC with U. S. and European peers that meet a "cover 2" in practice (at a high confidence level, based on "committed" liquid sources). According to our estimations, the peak shortfall of committed liquid resources to meet a "cover 2" could be around $60 billion in extreme but plausible market conditions.
The depth of the U. S. repo market and potential demand for U. S. Treasuries during periods of market turmoil only partially offset this weakness, in our view. Therefore, we continue to view FICC's liquidity framework as a weakness versus peers, and we incorporate a negative one-notch adjustment into our analysis of FICC and at the group level (DTCC) through the clearing and settlement risk assessment. Additionally, we believe that the proposed CCLF program could place a significant liquidity burden on FICC's nonbank members, and it is possible that regulators could fail to approve the current proposal.
In our view, potential group support from the holding company (DTCC) or from other parts of the group would be insufficient to offset the potential liquidity shortfall at FICC. DTCC has generally less than $1 billion of accessible liquidity (composed of unrestricted cash in the group and $500 million in committed lines of credit) that could be mobilized to support liquidity needs at FICC. Moreover, we believe there is only limited fungibility between resources at DTC, NSCC, and FICC, so potential support from DTC and NSCC would be limited.
While NSCC does not formally meet a "cover 2" (from a liquidity standpoint) under extreme but plausible conditions, we believe NSCC's liquidity framework is not significantly weaker than U. S. and European peers. NSCC's liquidity resources include:Cash margins (or cash clearing funds contributions, because margins for NSCC are akin to clearing fund contributions);$5 billion commercial paper funding (only $2 billion was outstanding under the program as of June 30, 2016);The cash that would be obtained from NSCC's committed 364-day credit facility with a consortium of banks ($10.9 billion); andAdditional cash deposits (supplemental liquidity deposits, SLDs) designed to cover the heightened liquidity exposure arising around monthly option expiry periods, required from those members whose activity would pose the largest liquidity exposure to NSCC. NSCC's committed liquid resources would have provided the clearinghouse with sufficient liquidity to meet potential liquidity outflows had the largest two clearing members defaulted jointly, considering market conditions in the past 12 months (actual payment obligations). However, back-testing results show some instances whereby committed liquid resources would have fallen short of potential "cover 2" liquidity outflows in extreme but plausible market conditions (estimated payment obligations). We expect NSCC to continue ramping up its commercial paper (CP) issuance, which would strengthen the company's liquidity resources. Overall, we do not view NSCC's liquidity framework as materially weaker than U. S. and European peers. (European clearinghouses are required to meet a "cover 2" standard under the European Market Infrastructure regulation.) We continue to assess NSCC's clearing and settlement risk as neutral for the ratings.
Like other central securities depositories globally, DTC is held by its regulators to a "cover 1," not "cover 2," standard. Therefore, it sizes its liquidity resources so that it would have sufficient liquidity to satisfy the single-largest family default under stressed but plausible conditions. The company's two key liquidity resources are the Participants Fund of at least $1.15 billion and the committed line of credit of $1.9 billion, which represents DTC's allocated portion of a $12.8 billion committed line of credit by a consortium of commercial lenders. Nevertheless, DTC's liquidity shortfall in a "cover 2" scenario is small, and indeed smaller than for FICC and NSCC. This is because DTC caps its intraday lending to any of its members (and its affiliates) at $2.85 billion. Therefore, we believe that, given the limited size of the shortfall relative to the size of U. S. repo markets, DTC would be in a position to monetize noncash collateral using uncommitted repo facilities even in extreme but plausible conditions, achieving a "cover 2" in practice. We continue to assess DTC's clearing and settlement risk as neutral.
We view NSCC and DTC as insulated from a potential default of FICC and/or DTCC. In our view, NSCC's and DTC's financial performance and funding are independent from the group. Even though there is significant member overlap among NSCC, DTC, and FICC, we believe DTC's and NSCC's stronger liquidity frameworks in a stress scenario could insulate these entities from a default of FICC and/or DTCC. Each subsidiary has its own clearing fund and cannot use its clearing fund assets for the benefit of its affiliates or parent company, even though each subsidiary can contribute or receive any excess resources that it may have as part of the closeout of a common defaulted member's transactions. Moreover, it is our understanding that a default at the parent company (or at any subsidiary) won't trigger the legal default at other subsidiaries.