In an order entered October 29, 2021, the Securities and Exchange Commission (“SEC”) fined Fixed Income Clearing Corporation (“FICC”) $8,000,000 and set additional documentation and compliance requirements for FICC’s operation over the next three years. FICC is a wholly owned subsidiary of The Depository Trust & Clearing Corporation and the only central counterparty for securities issued by the United States government. According to the FICC, on average it settles over $1.7 trillion dollars in trades on U.S. government securities a day. FICC must have sufficient liquidity to settle trades on the same day if an affiliate group that obligates FICC to make the largest payment defaults under “extreme but plausible market conditions”. FICC must have policies and procedures testing its own liquidity and its liquidity providers’ ability to perform.

For at least eighteen months, FICC relied on uncommitted repurchase agreements and failed to conduct testing on whether those agreements or the liquidity providing counterparties to them would perform in “extreme but plausible market conditions”. And for over eighteen months FICC failed to correct SEC-identified errors in FICC’s margin models that had FICC under collecting margin.

Under this order from the SEC, FICC has until April 29, 2021 to establish a regulatory committee with oversight responsibility for FICC’s compliance that meets at least quarterly or revise FICC’s audit committee charter so it assumes oversight responsibility for FICC’s compliance efforts and demonstration of those efforts. Once that regulatory committee exists or the audit committee’s mandate has changed, for three years FICC shall give it copies of deficiency letters from SEC staff and a briefing on them within ten business days. FICC shall also give copies of any FICC responses to deficiency letters to the regulatory committee or audit committee within ten business days. Further, FICC shall brief the regulatory or audit committee on FICC’s responses and remediation plan at the committee’s next meeting and at least quarterly until FICC’s remediation is complete. By October 29, 2022, FICC will have reviewed its policies, procedures, and internal controls for designating resources as qualifying liquid resources and filed any necessary rule changes for its own operation with the SEC. Then, by October 29, 2023 FICC will retain a board-approved independent compliance consultant unobjectionable to the SEC’s staff. That consultant will review and test FICC’s policies for what resources constitute qualified liquidity and which agreements and counterparties would provide qualified liquidity despite “extreme but plausible market conditions”. That consultant will give FICC written recommendations for improving FICC’s policies and the ways FICC follows those policies within 180 days of beginning review. FICC’s process for disputing any of the consultant’s recommendations is set forth in the SEC’s order, and default to the consultant’s recommendations. FICC’s principal executive officer must then certify to the regulatory committee or audit committee and the SEC that FICC has implemented the consultant’s recommendation and provide documentation of compliance. Within one year of that certification and documentation of compliance, FICC must test its liquidity models and report to the regulatory or audit committee and FICC’s board. That report must be given to the SEC’s staff within thirty days and they may ask for further evidence of compliance.

Although FICC’s fine may have smarted and the extra compliance requirements add to operations, compliance, and board workload, the true impact of FICC’s failures may be felt in ways this SEC order doesn’t discuss.

On two public occasions this fall SEC Chair Gensler has declared that SEC staff will be recommending regulatory changes for clearing agencies and traders in the Treasury market. First, Chair Gensler testified to the House Financial Services Committee on 14 September 2021 that he’d asked SEC staff to work with the Department of Treasury and Federal Reserve on enhancing “resiliency and competition” in Treasury markets. Second, Chair Gensler emphasized increasing Treasury market resilience, competition, and transparency again in a speech to the Securities Industry and Financial Markets Association on 2 November 2021. Those regulatory changes will almost certainly require more investment in compliance and operations from FICC and might add to trading options for Treasuries by producing competitors to FICC.

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