What Is In A Name: Is A Clearinghouse Just A Clearinghouse
Some "purists" seem to have taken offense at our earlier suggestion that standalone clearinghouses (DTCC) could be impaired in some quasi-principal risk taking form. We respectfully disagree and present some perspectives from the conversion of the ICE Trust into the central clearing counterparty for CDS transactions (which will be lucky to ever see even clear even a fraction of the CDS transactions that the DTCC does... which could very well be the Fed's thinking).
Recall that in 2009, the Fed approved the ICE Trust to become a central counterparty and clearing house for CDS transactions. As a "counterparty" it is without question that the ICE trust bears risk of principal. However, the Treasury's OCC issued an interpretive letter allowing a bank to act as a clearing agent in the ICE Trust CDS Clearinghouse. And herein lies the rub, which certainly applies to DTCC: according to the OCC a "clearing agent's" purpose is to substitute its credit for its customers and assume, with respect to the exchange, clearinghouse, and customers, the risk of default. This definition clearly endows the entity with the risk for losing money.
Clearing is a form of extending credit, one of the main functions of banking institutions. A clearing agent substitutes its credit for that of its customers. A clearing agent is liable to a clearinghouse for performance on all submitted contracts, and assumes, with respect to the exchange, clearinghouse, and counterparties, the risk of default. The clearing function is akin to two other traditional bank credit functions, providing bankers’ acceptances and letters of credit. The credit function provided by a national bank in its clearing capacity is part of the business of banking, because a principal business of a bank is to extend credit.
What is not lost to the Fed, and what explains today's action, is that if a clearing house and a clearing agent are regulated by the Fed or the Treasury, then presumably they can be seized if things go sideways in another risk escalation episode. At that point, however, there will be no freely available excuse that the only choice was bankruptcy or bailout.
Yet to settle the debate, things are more nuanced. What is needed, is for a law firm to issue an opinion letter from a major law firm that a bankruptcy court can't apply "substantive consolidation" to throw the DTCC swap clearing entities and the DTCC stock/bond clearing entities into a single bankruptcy, thereby throwing all assets of the various entities (the DTCC org chart is only matched by that of Enron) and thus put virtually every outstanding single stock/bond trade at risk.