The DTCC has issued a white paper identifying a number of developing trends that would impact the industry’s ability to protect itself against unidentified threats to the worldwide financial system.
- Cyber Security: This issue has emerged as arguably the top systemic threat facing global financial markets and associated infrastructures, including the threat of Distributed Denial of Service attacks, attacks against systems containing transaction records, and risk of disclosure of restricted, confidential or Material Non-Public Information via compromise of internal systems.
- Impact of New Regulations: The financial industry has expressed concerns that even though the regulations are well-intentioned and necessary, there is a danger that their scope and complexity may actually be creating unintended consequences or an entirely new set of risks.
- Counterparty Risk: There is still ongoing industry debate as to whether the “too-big-to-fail” issue has been sufficiently resolved. Today, the top U.S. banks still control the vast majority of total assets within the sector and just a few provide some of the most critical services.
- Collateral Risk: There are growing concerns globally about potential risks associated with a future shortage of high-quality collateral, possible pro-cyclical impacts of collateral requirements, along with operational challenges related to collateral management.
- Interconnectedness Risk: Inter-linkages among financial firms and infrastructures greatly improve the effectiveness and efficiency of clearance and settlement activities and processes. They also create a complex network of interdependent legal, credit, liquidity, and operational risks. This presents a possible source of systemic risk by increasing the potential for operational and other disruptions to spread quickly and widely through the financial system in a worst-case scenario.
- CCPs as Single Points of Concentration: More and more business is being forced through central counterparties, including DTCC.
- Business Continuity Risk: The problems created by Hurricane Sandy are cited as an example.
- Market Quality: DTCC points to the numerous compliance violations being cited by regulators and increased levels of fines and other penalties, which may be significant enough to drive firms out of business.
- High-Frequency Trading: While DTCC acknowledges the benefits of the high-frequency trading, it also says that this activity creates technology risks.
Lofchie Comment: One primary goal of government regulation is to make the financial regulatory safer. The DTCC has identified many issues either created or exacerbated by government actions. For example, (i) the very high fixed costs of complying with Dodd-Frank derivatives rules will knock medium-sized firms out of some of the swaps business, exacerbating concentration in the financial industry, (ii) the rate of change in financial regulation is simply too great for the regulators or firms to be confident that they are not causing further problems; and (iii) the size of the transaction flow that is being pushed through a few clearing corporations and through a small number of FCMs is too large to understand the consequences. The most interesting risk in this regard is what DTCC refers to as “market quality,” or what the industry might refer to as “enforcement risk.” One can make a reasonable case that with so many federal and state regulators – all enthusiastic to bring enforcement actions – the very machinery is less significant as a means to discourage or punish misdeeds, than it is as an independent source of wildcard risk.
See: DTCC White Paper; DTCC Introductory Video.
See also: DTCC Press Release.