“A massive structural shift,” is how Scott O’Malia, CEO of ISDA, referred to the impact on the U.S. Treasury market with the Securities and Exchange Commission’s (SEC) rule changes. The rule changes require many market participants to submit a significant portion of their repurchase transactions on Treasury securities for central clearing as well as certain purchases and sales of U.S. Treasuries.
The comments from the speakers at the ISDA/SIFMA Treasury Forum were clear: firms need to start preparing. The transition is a major undertaking requiring a collaborative effort from regulators and the industry.
As the keynote speaker, Gary Gensler, Chair of the SEC, spoke about the importance of the U.S. Treasury market as the base of the U.S. capital markets and a crucial asset for participants around the globe. However, the market is not without its challenges. The “Flash Crash” of 2014, the 2019 repo market crisis, volatility issues during the pandemic and as Silicon Valley Bank and other regional banks failed last year are all evidence of recent market disruptions. Given the magnitude and leverage afforded to the U.S. Treasury markets, Gensler stated that regulators “can’t ignore repeated tremors.” The leverage in the U.S. Treasury market involves major multiple entities including prime brokers, hedge funds and non-centrally cleared bilateral repo. A 2022 study showed that 74 percent of non-centrally cleared bilateral repo volume covered was transacted at a zero haircut.
Thus, a collection of regulatory bodies, including the U.S. Treasury, the Federal Reserve and the SEC, began to brainstorm on reforms for the Treasury markets that would lower costs, increase efficiencies, improve resiliency during times of stress, increase transparency and facilitate all to all trading. The SEC’s rules aim to bring more Treasury volume into central clearing and ultimately lower risk in the $27 trillion Treasury market.
At the middle of these markets are the clearing agencies, which reduce risk by providing multilateral netting, helping to lower margin. But estimates put the amount of Treasury cash transactions centrally cleared at just 13 percent.
The U.S. equity markets just adopted a one-day settlement period, something that has been in place for Treasuries since 1986. While equities trailed in terms of settlement cycles, U.S. Treasuries are lagging when it comes to other market practices and the rules seek to align them. The new SEC rules will eliminate co-mingling of customer funds with house funds, give clients the ability to rehypothecate margin to the clearing agency, and access central clearing from both sides of the trade, thereby promoting all to all trading.
Gensler closed his remarks by referencing Alexandar Hamilton, the first Secretary of the U.S. Treasury. In 1790, Hamilton told Congress that “the proper funding of the present debt, will render it a national blessing.” The SEC Chair added that while Hamilton “would be pleased with the importance of today’s Treasury markets, he wouldn’t consider the repeated tremors such a blessing.”