The upcoming U.S. Treasury clearing mandate involves one of the most significant changes to the largest and most liquid market in the world.
Following several periods of heightened volatility in the U.S. Treasury market—the flash rally of 2014, repo market volatility of 2019, Covid-19, and the regional banking crisis last spring—U.S. regulators began to consider the safety and liquidity of the Treasury market. The central clearing mandate could be seen as part of a broader set of U.S. Treasury markets reforms, and this one in particular was proposed by the Inter-Agency Working Group on Treasury Market Surveillance to improve market resiliency.1
Related: FICC Launches CCLF Calculator to Support U.S. Treasury Clearing Expansion
The final rule was adopted by the Securities and Exchange Commission (SEC) in December 2023, and is scheduled to come into effect in December 2025 for cash transactions and June 2026 for repo transactions. Interestingly, the U.S. ruling is agnostic to geography; it may therefore impact transactions that involve FICC members in Europe.
Today, only about 15% of the interdealer cash market is centrally cleared at FICC. But it wasn’t always that way. The introduction of high frequency trading firms in the interdealer markets in the early 2000s saw a dramatic drop in centrally cleared trades and a subsequent increase in risk.
The amount of non-cleared trades poses a serious contagion risk to the centrally cleared market in the event of a default of a non-cleared member. Likewise, in the $4.5 trillion per day repo market, only about $1 trillion is centrally cleared, presenting leverage risks, particularly in bilateral trades where there is no margin collected. The new mandate aims to increase the amount of central clearing in these markets.
FICC Clearing Models
By acting as a central counterparty, FICC guarantees every transaction it clears. To help facilitate clearing, FICC offers four broad models to both direct participants of its Government Securities Division (GSD) and eligible clients of those participants:
- Netting Membership (Direct): Including registered dealers, banks or trust companies, and foreign entities that meet the applicable membership requirements.
- Central Cleared Institutional Triparty: Limited Direct membership for triparty cash lenders.
- Sponsored Membership (Indirect): For eligible clients that are not Direct members, FICC offers central clearing through sponsored membership with a Direct member.
- Agent-Cleared Models (Indirect): A rebranding of the FICC correspondent clearing/prime broker services, which allows for indirect access in an FCM-style cleared model.
For more information, please refer to USTClearing.com.
Challenges & Benefits of Central Clearing
Central clearing provides U.S. Treasury markets with greater resilience. The benefits of clearing outweigh the costs: the more clients come into clearing, the better DTCC can manage the cost component.
While the debates in Europe are not as mature as in the U.S., several authorities have been considering the effects of the U.S. Treasury central clearing mandate. A recent Bank of England research study on the potential impact of mandatory clearing on gilt (U.K. government bond) and gilt repo trading during March 2020’s “dash for cash” showed the effect of central clearing. While there would’ve been little impact on cash trades, the impact on repos was significant: adding approximately 40% more balance sheet, while standardized dates would free up balance sheet by 60%.
Even though U.S. Treasuries are seen as relatively risk free, in a T+1 world there could still be settlement risk in times of market stress. Central counterparties offer risk transparency that helps with default management, counter credit party risk, margin, and liquidity resources. To reap these benefits in times of stress, the costs of central clearing are necessary during the regular cost of business. Central counterparties make the system safer, more resilient, and allow trading for a longer time before official intervention is needed.
The cost of this added resiliency is the margin premium that is paid even during normal circumstances. As the rule targets high volume, low margin transactions, these trades will be more expensive in interdealer markets. Additionally, there will be changes to legal documentations and to the GSD Rules, adding that FICC will work with members to clarify these changes.
European Debate on Margin Predictability
Margin should be predictable and not reactive. In times of crisis, margin deposits act as a buffer at all times to make margin more predictable.
The debate in Europe is about margin transparency and predictability; the DTCC clearing agencies have been publishing their VAR methodology and calculations to bring stability and predictability to participants as we communicate the margin methodology to our members – and eventually to a broader set of constituents.
As a systemically important financial market infrastructure, FICC is heavily regulated, and as a self-regulated organization, is subject to additional rules and regulations. To implement best practices, FICC has proposed enhancements to its margining practices to enhance predictability, which were not mandated in the U.S. We believe the scrutiny, governance, and oversight, adds to our unique ownership structure gives a longer-term perspective on risk.
Implications to Europe
Despite their differences, the European markets are very much connected with the U.S. markets. The clearing mandate in the U.S. will inevitably affect market participants in Europe and across the globe. The EU rules on clearing, through the latest EMIR 3.0 legislative texts and upcoming UK EMIR deliberations, may eventually involve discussion on repo clearing.
In fact, the U.S. central clearing mandate has multiplied discussions from supervisors, central banks, corporates, custodians, agents, broker dealers and investment managers about the possibilities of central clearing mandates in Europe. There is momentum already underway as political discussions in Europe place clearing at the heart of capital markets integration.
The U.S. final rule has a broad scope not bound by the geographical location of the counterparties. It will therefore impact FICC members and their customers regardless of their location. The impact reaches into Europe as well, as dealer to dealer trades will need to be cleared. In a way, firms attempting to avoid central clearing will be subject to added regulatory risk.
Preparation is necessary as the implementation dates are just around the corner. FICC has submitted its proposed rule change filings around access models, account segregation rules, and the rules-based trade submission requirement and related monitoring and enforcement.
1Securities and Exchange Commission, “SEC Adopts Rules to Include Certain Significant Market Participants as ‘Dealers’ or ‘Government Securities Dealers’” (Feb. 6, 2024), available at https://www.sec.gov/news/press-release/2024-14.
Federal Reserve, “Principal Trading Firm Activity in Treasury Cash Markets” (Aug. 4, 2020), available at https://www.federalreserve.gov/econres/notes/feds-notes/principal-trading-firm-activity-in-treasury-cash-markets-20200804.html.
Securities and Exchange Commission, “SEC Proposes Rules to Extend Regulations ATS and SCI to Treasuries and Other Government Securities Markets” (Sept. 28, 2020), available at https://www.sec.gov/news/press-release/2020-227.
Securities and Exchange Commission, “SEC Proposes Amendments to Include Significant Treasury Markets Platforms Within Regulation ATS” (Jan. 26, 2022), available at https://www.sec.gov/news/press-release/2022-10.