Options Clearinghouse Lobbies for Access to Fed Funding During Emergencies
Options Clearing Corp., the firm responsible for guaranteeing and settling all U.S. options trades, is seeking access during times of distress to emergency Federal Reserve funding.
The Chicago-based clearinghouse would exchange U.S. Treasuries for cash using the Fed’s discount window should a liquidity crunch develop because one of its member brokers is unable to meet its financial obligations from buying and selling derivatives contracts, according to Chairman and Chief Executive Officer Wayne Luthringshausen. Every morning, OCC has an hour to collect and then distribute funds to about 120 firms.
While OCC never needed help during the financial crisis that intensified after Lehman Brothers Holdings Inc. collapsed in September 2008, the firm wants another source of financing just in case a future crisis causes a shortfall, Luthringshausen said. The financial-industry reform legislation under consideration in the U.S. Congress may prevent the Fed from giving emergency financing to clearinghouses.
“Providing us with secured liquidity for a short period of time could help the financial system -- it wouldn’t compound a crisis,” said Luthringshausen, who has run OCC since it was founded in 1973. “The most logical place to take U.S. Treasuries, pledge them and receive cash is at the Fed discount window.”
The central bank relied on its authority for emergencies to let securities firms such as Goldman Sachs Group Inc. and Morgan Stanley use a lending facility starting in March 2008 after Bear Stearns Cos. neared collapse. The Fed was trying to eliminate concern that Wall Street faced a cash shortage.
Cutting Risk
Clearinghouses are funded by their members and guarantee all transactions. They reduce the risk that one firm’s failure will bring down others by serving as the buyer to every seller and vice versa. To join, securities firms must meet capital requirements and pass operational and technology tests.
The OCC collects margin from its members at 10 a.m. New York time, based on positions held at the end of the prior day, and pays companies owed money at 11 a.m. If a member defaults, the clearinghouse can cover that firm’s obligations by first using its daily collateral and then its share of a $3 billion Clearing Fund. If that’s not enough, OCC can tap lines of credit at banks totaling $1.3 billion.
“This happens in a very quick timeframe,” said Susan Milligan, the Washington-based senior vice president in charge of government relations and communications at OCC. “If we couldn’t raise sufficient cash fast enough, we’d then go to the Fed because there would be a liquidity event. We’d have plenty of collateral from the defaulting clearing member to make good on what they owed us and we’d have their Clearing Fund deposit, which is only in cash or Treasuries.”
Banks With Deposits
The reform bill in the U.S. House, passed in December, limits the Fed’s ability to extend emergency financing to institutions that aren’t deposit-collecting banks. The legislation would allow lending only when the Treasury secretary expects 99 percent of the money lent to be repaid.
While the legislation adopted by the Senate in May has a provision allowing the central bank to fund “systemically important financial market utilities” including clearinghouses, the derivatives portion, written primarily by Senator Blanche Lincoln, said these entities couldn’t receive Fed help.
Lincoln, an Arkansas Democrat who heads the Agriculture Committee, modified her position last week. She said clearinghouses could be eligible for “collateralized lending” through the Fed’s new broad-based liquidity facility, according to Courtney Rowe, a spokeswoman for the committee.
Gensler, Schapiro
U.S. clearinghouses are overseen by the Commodity Futures Trading Commission or Securities and Exchange Commission, depending on the products they guarantee. While CFTC Chairman Gary Gensler and SEC Chairman Mary Schapiro told lawmakers on May 20 that the firms shouldn’t be able to get routine Fed funding, they said they supported emergency access.
Terrence Duffy, the chairman of CME Group Inc., said during the same hearing that his firm, which runs the world’s biggest futures exchange, should have rights to the Fed discount window even when there isn’t an emergency. OCC isn’t lobbying for that, Luthringshausen said.
Emergency access is insufficient for clearinghouses, said Jeremy Kress, who received a law degree from Harvard University and in April wrote one of the first papers highlighting the risks associated with centralized clearing. The organizations should always be able to tap into Fed funding because of their central role in enabling financial markets to operate, he said.
‘Lulled Into Complacency’
“We’ve been lulled into complacency because clearinghouses have been so successful in the past,” he said. “But with Congress mandating the clearing of more derivatives, they may not be as safe as they’ve been. Clearinghouses shouldn’t have to get to exigent circumstances before they can go to the Fed.”
While the OCC has never needed Fed help, Luthringshausen said the financial crisis altered his view of how fast losses can spread. The same week in September 2008 that Lehman Brothers filed history’s biggest bankruptcy, American International Group Inc. required a U.S. government bailout.
“We’ve never needed access to the Fed, and we don’t want a bailout,” Luthringshausen said. “There is a significant difference between a bailout and needing liquidity temporarily with Treasuries as our collateral.”
To contact the reporter on this story: Nina Mehta in New York at nmehta24@bloomberg.net.
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