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FICC Opens Up to Buy-Side Members

Score one for fixed income mutual fund back-office operations teams.Having received final approval from the Securities and Exchange Commission last month, the Fixed Income Clearing Corp. (FICC) will now permit buy-side firms, including mutual funds and other registered investment institutions, to join as sponsored members on a limited basis - a first for any Depository Trust & Clearing Corp. (DTCC) subsidiary.

State Street, one of the world's largest custodian banks, has signed on as the first sponsoring member and will begin submitting mutual fund client trades to FICC's netting process later this month. Officials at State Street, already an FICC netting member, were unavailable for comment, but according to FICC officials, State Street approached the clearinghouse several years ago with the idea that formed the basis for this new settlement model.

The FICC's new policy, which applies to financing agreements only, appears to be a condensed version of a more far-reaching institutional settlement model floated by the clearinghouse two years ago.

The FICC was created in 2002 from a merger of the Government Securities Clearing Corp. (GSCC) and the MBS Clearing Corp. (MBSCC), which handled mortgage-backed securities.

Full Participation

Buy-side firms have contracted with DTCC subsidiaries for mutual fund distribution, over-the-counter derivatives contract matching and corporate action announcements, but they have never participated as clearing and settlement members. FICC has 17 bank and 94 broker/dealer members.

FICC's original institutional settlement model reserved full clearing membership for fund managers and admitted broker/dealers as sponsored members. Trades from sponsored members have been settled with institutional clients on a trade-for-trade basis using matched instructions sent by an institutional matching engine or an electronic trading system.

Given the difficulty of meeting the requirements for taking part in FICC's netting system, to date, buy-side firms have previously joined the clearing organization as "comparison only' members in order to match trades in government securities with broker/dealers.

FICC officials hope to further open the ranks of eligible sponsoring members to broker/dealers and to add pension funds and other buy-side entities to the list of eligible sponsored members next year. What remains unclear, however, is whether cash trades will be involved, in the event broker/dealers and custodian banks find that the level of balance-sheet relief is not adequate for their needs. This drawback was the reason FICC abandoned its original settlement model proposal.

Some types of buy-side firms, such as mutual funds, are prohibited from mutualizing losses; others do not want to take on the additional risk.

As sponsoring members, banks gain the benefits of balance-sheet relief for financing transactions,' said Jeff Ingber, DTCC's general manager for fixed-income clearance and settlement. As sponsored members [of FICC], mutual funds will receive the benefits of guaranteed settlement enjoyed by the sell side, as well as expanded access to financing opportunities through reverse repos executed from the sponsoring bank.'

To qualify as a sponsor for mutual fund clients, an FICC netting member bank must have at least $5 billion in equity. Interfacing with FICC, the bank acts as a processing agent for the government securities transactions of its sponsored mutual fund clients.

Each fund would be responsible for its own settlement obligations to FICC. However, the sponsoring bank provides a guarantee to FICC for its sponsored mutual funds, which FICC may exercise if those settlement obligations are not satisfied by the fund itself. In addition, the sponsoring bank would be responsible for its share of any losses stemming from nonpayment by a sponsored fund.

In their agency role, custodian banks account for repo and reverse repurchase transactions, a common financing instrument, as assets and liabilities. Buy-side firms use reverse repos to earn income on their excess cash reserves. The FICC processes more than $2.8 trillion in government securities a day, of which $1.9 trillion consists of repo deals.

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