3 am Wake Up Call. Now What?
Bemoan the might of Wall St, fine, but the real power lies elsewhere.
Capital Thinking · Issue #778 · View online
“So Thursday morning, right… So I’m sleeping, but at 3.30AM Pacific, our operations team receives a file from the NSCC, which is the National Securities and Clearing Corporation.
So basically as a clearing broker, and this is where Robinhood Securities comes in, we have to put up money to the NSCC based on some factors, including things like the volatility of the trading activity, concentration into certain securities…
So they gave us a file with a deposit, and the request is around $3 billion which is, you know, about an order of magnitude more than what it typically is.”
— CEO of Robinhood talking to CEO of Tesla on Sunday night
WTF is DTCC? The Story of Clearing
Marc Rubinstein | Net Interest:
Power comes in many forms. Last week’s events surrounding GameStop show how power can coalesce in the hands of individual investors when they pool their intellectual and financial resources.
But the events also reveal a different manifestation of power: the power to call a high-profile tech company in the middle of the night and demand $3 billion. That’s quite some power!
The entity wielding that power is the NSCC, which – as Vlad Tenev, the CEO of Robinhood spelled out to Elon Musk – stands for the National Securities and Clearing Corporation.
The NSCC in turn is a part of the DTCC, which stands for the Depository Trust and Clearing Corporation. And the DTCC is perhaps the most powerful entity you’ve never heard of. It’s the engine of the US securities markets; in 2019 alone, it processed over $2.15 quadrillion worth of securities (yes, quadrillion!)
To understand what (and who) the DTCC is, we need to delve a little into market structure, and the best way to do that is with some historical perspective.
In My Liverpool Home
My home town of Liverpool is famous for lots of things. There’s the Beatles, of course; I grew up on the same street that John Lennon did, within walking distance of Penny Lane and Strawberry Fields.
And there’s football; our team is floundering, but we remain – for now – champions of England. Less well known, even among the people of Liverpool, is the city’s role in the development of financial market infrastructure.
In the nineteenth century, Liverpool was one of the busiest ports in the world and a destination for cotton shipments that came steaming across the Atlantic. Before the American Civil War, cotton would arrive at the docks, and the merchants responsible for importing it would then sell it to spinners in Lancashire.
The American Civil War disrupted that.
Volatile price movements in cotton encouraged the development of a ‘to arrive’ or forward market. Rather than waiting until the cotton had reached port, merchants could sell their cotton forward to protect their positions.
Over time, the practice attracted speculators keen to take a view on the price of cotton. Merchants didn’t mind because the influx of speculators increased the range of counter-parties with which they could trade.
There was one issue that needed to be resolved though: because the same cotton could be bought and sold multiple times, a chain of financial obligations would develop which could become unwieldy.
One commentator talked about the “wranglings and heart burnings” of the process. (Not dissimilar to the issues the credit card industry faced at its outset; the founder of Visa, Dee Hock, talked about how “back rooms ﬁlled with unprocessed transactions…and suspense ledgers swelled like a hammered thumb”.)
Back in Liverpool, a local cotton broker Joseph Morgan proposed a solution: to set up a special clearing house where all the trades along the chain could be tidied up. Each day, the clearing house would take in cash from the traders who needed to make a payment for cotton due, and pay cash out to those who had payments to receive.
Opposition arose from some people who thought the process could lead to excessive speculation and some who harboured suspicions the clearing house would have access to sensitive market information.
But it worked.
Over the 1870s and 1880s – when my great great grandparents were arriving in the city – Joseph Morgan and his successors refined the idea. They replaced cash with a system of credit; and they introduced fixed weekly settlement dates which forced a weekly ‘mark to market’ on traders, preventing them from getting overexposed over the duration of the contract. 1
The Liverpool system of clearing laid the groundwork for the modern clearing house, and similar systems popped up in trading cities all over the world. The French port city of Le Havre, on the English Channel, set up a clearing house which went as far as to guarantee the contracts it registered.
If one side of a trade went sour, the other side would have nothing to worry about; the Le Havre clearing house would provide a backstop. To mitigate its risk, buyers and sellers would need to be known to the clearing house and would have to put down a deposit before being allowed to trade; they would also be asked to top-up their deposits if positions swung into a loss.
Le Havre’s innovation in market structure led it to become the leading market for coffee in Europe.
It’s big and ugly enough to be included among a very short list of entities designated by people in Washington as “systemically important financial market utilities”.
Photo credit: Catherine Hughes on Unsplash