Kathryn Zhao
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Closing Volume Discovery

In this article from sister publication Global Trading, Cantor's Zhao focuses on the closing volume discovery process over time and identify key differences for this process on NYSE and NSDQ.

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February 22, 2010

The Clear and Present Danger of Risk

By Gregory Bresiger

Lower the risk of counterparty blowups, and do it now.

Such blowups are the critical issue facing clearing brokerages these days, according to officials of the industry's utility, the Depository Trust & Clearing Corp. The officials say they constantly hear requests for improved counterparty risk programs for all asset classes--apparently, everybody fears everybody else in a market in which so many big financial institutions have either perished or been on the verge of death.

This is happening at a time when DTCC members are trading more non-listed securities, or over-the-counter derivatives. And, by the way, this is also happening at a time when clearing firms, the same as almost every other business, face a tough fight for survival.

These were some of the subjects on the agenda when Susan Cosgrove, a CPA as well as DTCC's managing director for equities product management, recently sat down with CQ&D.

CQ&D: What is the state of the clearing business? I understand the number of transactions has declined compared with this point late in 2008.

Cosgrove: The ongoing economic problems have impacted trading activity across the markets, and as a result, our volumes are down considerably this year, from an average of 146 million transactions per day in 2008 to about 133 million so far this year. In fact, this will also be the first year in recent memory that the previous year's peak volume, which was 209 million transactions, does not become this year's average.


CQ&D: Whether you're comparing the peak or a daily average, that's a significant drop.

Cosgrove: Yes, but the number of shares we are processing, which is how a liquidity platform measures activity, is up significantly. Since January 2009, the average number of shares per transaction has jumped almost 115 percent-from 345 to 737. Actually, we hit a peak in August 2009, when we processed a record 97 billion total shares in a single day.


CQ&D: So there are fewer trades, but the average trade is bigger?

Cosgrove: Yes, it appears that trading patterns have shifted away from fewer shares at higher dollar values, which is typically what you'd see with the blue chips, to trades with more shares being traded at lower values.


CQ&D: Why are you seeing this trend of less activity in the blue chips and more in the small stocks?

Cosgrove: Traders would be in a better position to answer that question, but from feedback I heard at the recent Security Traders Association annual conference, they see opportunities in these stocks. And the platforms that support trading the Pink Sheets and sub-penny stocks have said that activity is strong in these types of securities.


CQ&D: Looking ahead toward next year, what are the types of products and services your members say they want?

Cosgrove: Our members are speaking virtually in unison on this issue-risk mitigation, risk mitigation and risk mitigation. We are in an environment where everybody is concerned about the solvency of their trading partners. Hedge funds are afraid of their prime brokers. Prime brokers are afraid of their hedge fund customers. Clearing firms are afraid of their correspondents. As a clearing agency, our priority is to mitigate risk for the industry and ensure the stability of the capital markets. In this type of environment, the importance of our role is magnified because firms are looking to us to protect them in the event that one of their counterparties defaults.


CQ&D: Recently, members of Congress asked you to give advice on new rules that would prevent abusive short selling. What has happened here?

Cosgrove: DTCC has historically provided aggregate fail data to regulators, which can be used to assess the effectiveness of new regulations. For instance, since the implementation of Rule 204T last year (which has since been made permanent), our data indicates that fails have dropped dramatically-from 1.09 percent of total daily value processed in CNS in July 2008 to an average of about 0.23 percent over the last three months of 2008. This trend has continued throughout 2009, with the fail rate sliding to 0.16 percent in July 2009.


CQ&D: And I would think that this kind of trading--short sales, trading more Pink Sheets, etc.--would undoubtedly entail more regulation. Complying with those new rules will be another concern of your members?

Cosgrove: Many in the industry have expressed concern over new regulations that are likely to be enacted. We've heard that quite a bit from our members That's why we have been trying to demonstrate to the industry and regulators over the past year that the infrastructure can play an important role in mitigating potentially more draconian regulatory measures. We are always looking for ways to centralize a regulatory or reporting function to help our customers comply with regulatory mandates in the most cost-effective way possible.


CQ&D: Which means?

Cosgrove: One of the roles we can play is mitigating the costs associated of that compliance. So, to the extent that we can centralize a regulatory function or a reporting function that helps our customers, that can mean making information more transparent in the market.


CQ&D: You will also be trying to provide members with better record keeping with the introduction of the universal trade-capture (UTC) program.

Cosgrove: The goal of UTC is to consolidate and modernize the trade-capture and reporting process to bring greater efficiency, reduced risk and cost savings to the industry. And because UTC will provide real-time output to firms, it dovetails with our plans to accelerate the trade guarantee for equity transactions. Once UTC and the accelerated trade guarantee are implemented, firms will have confirmation that their trades are guaranteed within minutes of execution.

CQ&D: So you're changing the way trades are processed?

Cosgrove: Right now, we accept trade data from more than 50 exchanges and other trading platforms, but they use their own unique formats for submitting the data to us. As a result, we employ four different applications to accommodate this lack of standardization. The purpose of UTC is to replace these different applications with a single real-time validation and reporting engine.


CQ&D: So they'll get it all together and in a universal data language?

Cosgrove: Yes. But, importantly, we're not mandating a universal data language for the industry. Instead, we're designing the system with flexibility in mind so that marketplaces and firms will be able to migrate to the new universal format at their own pace or continue to use the legacy formats.


CQ&D: Universal trade capture will begin next year?

Cosgrove: It will be rolled out in the second half of 2010. While we've built flexibility into the system, we anticipate that firms will want to transition to the common format quickly because they have told us they are excited to get standardized trade data and to have access to this information in real time instead of batches.


CQ&D: I take it that universal trade capture is also designed for firms in hard times?

Cosgrove: Exactly. Firms are always looking for ways to reduce their own internal costs-and we are committed to developing solutions that help them achieve this goal. In the case of UTC, firms said if we could give them output in one format and in one real-time stream, it would increase their own efficiencies, which would help them reduce costs.


CQ&D: Ms. Cosgrove, thanks very much.

Cosgrove: You're welcome.



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