The US Securities and Exchange Commission (SEC) has adopted a rule designed to reduce risk in the US Treasury market by ensuring that more trades are covered by clearing houses.
The reforms will impact all repo and reverse repo agreements collateralised by US Treasury securities entered into by a member of the covered clearing agency, unless the counterparty is a state or local government or another clearing organisation or the repo is an inter-affiliate transaction, all purchase and sale transactions entered into by a member of the clearing agency that is an interdealer broker; and all purchase and sale transactions entered into between a clearing agency member and either a registered broker dealer, a government securities broker, a government securities dealer.
SEC chair, Gary Gensler, said clearing houses are “vital” to capital markets. “Standing in the middle of the securities markets, clearinghouses are the buyer to every seller and the seller to every buyer,” Gensler said in a statement.
The regulator said that while central clearing does not eliminate all risk, it does lower it, firstly by sitting in the middle and reducing all the risks among and between counterparties. They also provide multi-party netting, which helps lower the overall margin (collateral) needed to be posted in the system. Further, central clearing reduces risks through the robust rules of the clearinghouses themselves, including for the collection of initial and variation margin.
By 2022, however, only around 20% of all repo and 30% of reverse repo was centrally cleared via FICC, according to the Federal Reserve. As relates to cash transactions, by 2017, only 13% of Treasury cash transactions were fully centrally cleared, according to a Treasury Market Practice Group white paper.
Other trades covered under the new rule are all purchase and sale transactions entered into by interdealer brokers; and all purchase and sale transactions entered into between a clearing agency member and either a registered broker dealer, a government securities broker, or a government securities dealer.
Announcing the reforms, Gensler said, “The $26 trillion Treasury market — the deepest, most liquid market in the world — is the base upon which so much of our capital markets are built. Having such a significant portion of the Treasury markets uncleared — 70 to 80 percent of the Treasury funding market and at least 80 percent of the cash markets — increases system-wide risk.”
“Today’s adopting release addresses clearing of Treasury securities in two important ways. First, the final rules make changes to enhance customer clearing. Second, the final rules broaden the scope of which transactions clearinghouse members must clear. I am pleased to support these rules because they will help to make the Treasury market more efficient, competitive, and resilient,” Gensler added.
Talking to The DESK, BNY Mellon’s head of market structure, Nate Wuerffel, said the reforms constituted the most significant day for US Treasury market structure in decades.
“The SEC’s final rule will reassemble the way that the Treasury market functions by requiring market participants to clear all repo and interdealer cash trades and will require many market participants to find ways to clear their transactions, adjust their risk management processes, and change their operations and systems.”
“It will make liquidity less continuous than market participants have come to expect in normal times but should make the market more resilient in times of stress by reducing counterparty credit risk. Some of the adjustments in the final rule are improvements, like the exclusion of inter-affiliate repo transactions that are important in managing liquidity within firms.”
“The phased timeline is better than expected, giving market participant roughly two years to centrally clear eligible cash trades, and two-and-a-half years to centrally clear their repo transactions. It will be really important that the implementation goes smoothly given how important the Treasury market is,” Wuerffel added.
The new rules permit broker-dealers to include customer margin required and on deposit at a clearing agency in the US Treasury market as a debit in the customer reserve formula, subject to certain conditions. In addition, the amendments require covered clearing agencies to collect and calculate margin for house and customer transactions separately. Finally, the amendments outline policies designed to ensure that the covered clearing agency has appropriate means to facilitate access to clearing, including for indirect participants. The amendments also include an exemption for transactions in which the counterparty is a central bank, sovereign entity, international financial institution, or natural person.
The new reforms will come into effect in different phases, with the changes regarding the separation of house and customer margin, the broker-dealer customer protection rule, and access to central clearing required to be completed first, by 31 March 2025.
After that time, the requirement to clear specific transactions would go into effect in two parts, with cash transactions being required to be cleared before repo transactions are required to be cleared. US Treasury securities central clearing agencies with requirements to clear eligible secondary market transactions will not be required to do so until 31 December 2025, and for cash and repo transactions, 30 June 2026.
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