Market participants are growing increasingly concerned about the challenges of implementing the mandate to clear US Treasury securities and repo transactions, one of the biggest changes to market structure in many years.
Speaking on a panel at FIA Expo in Chicago, senior executives from across the industry warned that there are several critically important actions needed from regulators in order for firms like theirs to move forward. Those actions include guidance from banking regulators, accounting standard setters, the Securities and Exchange Commission and the Commodity Futures Trading Commission.
New rules from the SEC will require a big step-up in the use of central counterparties in the trading of US Treasuries, including the repo market as well as cash trading. Although some market participants are using central clearing today, the SEC rules will make it mandatory for many market participants that currently rely on bilateral relationships, and the deadlines for compliance are approaching quickly. Cash clearing is required to go into effect by December 2025 and repo clearing by June 2026.
Three clearinghouse operators are preparing to introduce new services to support this mandate —the Depository Trust Clearing Corporation, CME Group and Intercontinental Exchange. Senior executives for all three groups said during the FIA Expo discussion that they plan to roll out those services ahead of the deadlines, but they agreed that the industry will need to engage with regulators and advocate for swift action on several outstanding issues as well as the approvals needed for these clearing services to go live.
One source of uncertainty is timing. Given the outcome of the US elections and the resulting change in administration next year, there will be new leadership at the SEC and the CFTC. It will take time before that leadership is in place, however, which could lead to a slowdown in the review of the service offerings that the three clearinghouses are developing. The change in administration also may lead to more receptivity to the idea of extending the deadlines and giving the industry more time to implement central clearing.
Notwithstanding the possibility of delay, the three clearinghouses are not taking their foot off the gas. Suzanne Sprague, global head of clearing at CME, said that her group is moving “full steam ahead” on its plans, and Laura Klimpel, head of DTCC's fixed income and financing solutions, said she expects all the clearing models that DTCC is developing “will be actionable” by the existing deadlines.
DTCC’s Fixed Income Clearing Corporation already has a clearing service in operation for cash and repo trading, that allows banks to “sponsor” clearing for their clients, and Klimpel said that there are several new firms “in the pipeline” for this service. Going forward, however, DTCC plans to offer several other clearing models, including the agency model commonly used in derivatives markets as well as a direct access model for clients that want to become members of FICC. Klimpel commented that the Treasury market needs multiple models for accessing central clearing because there are so many different “constituencies” in the Treasury market, with different needs and modes of trading.
ICE is taking a different approach, concentrating on building an agency model. Paul Hamill, a veteran rates trader who is advising ICE on its Treasury clearing strategy, said ICE is leaning on the lessons learned from the adoption of central clearing in the over-the-counter derivatives markets after the financial crisis of 2008. He explained that the agency clearing model proved to be the right approach for OTC swaps and actually benefitted those markets by expanding access. Although ICE has not yet spelled out the details of what it plans to offer for Treasury and repo clearing, Hamill said it plans to use its existing clearinghouse for credit default swaps, ICE Clear Credit, as the foundation for its offering.
CME’s strategy is focused on capital efficiencies, according to Sprague. She mentioned two examples. First, CME is designing its clearing services in such a way that the settlement of trades will take place between customers and its clearinghouse. The securities involved in those transactions will not have to go through the clearing member, which will reduce the capital requirements for the clearing member.
Second, CME is looking to expand its existing cross-margining program with DTCC. At present, that program is limited to firms that are members of both clearinghouses, but CME and DTCC are seeking SEC and CFTC approval to extend that to customers. This could be beneficial for customers that trade Treasury futures on CME – Klimpel estimated that a client with offsetting positions in cash Treasuries and Treasury futures could save 80% in margin requirements.
Many of these models will never take off, however, if the members of these clearinghouses are not able to offer these services. Jason Swankoski, global head of strategy and product for derivative clearing at Morgan Stanley, explained that his bank has developed a profitable clearing business for derivatives markets, but there are so many uncertainties and complexities in Treasury and repo clearing that it is difficult at this stage to know whether it will be a viable business.
One example of the uncertainty, according to Swankoski, is related to the treatment of cleared Treasuries under the capital requirements that apply to banks. The current rules make that activity very expensive in terms of capital, and without some relief from the banking regulators, banks will hesitate to make a big commitment to this new line of business. Klimpel echoed this concern, saying capital relief will be “critical” to the success of Treasury and repo clearing.
Another uncertainty is the work flow – the operational procedures and technological systems necessary for a trade to be cleared. Swankoski noted that a significant portion of the Treasury market executes trades via “voice” – meaning telephone or chat conversations between two individuals – and it is not clear how such a trade will be routed to a clearing firm. Another issue is risk limits. In the cleared swaps markets, clearing firms protect themselves from taking on too much risk by screening trades as they come into their systems. That type of risk checking needs to be put in place for cash Treasuries and repos, and for that to happen, trading venues, clearing brokers, execution desks and clients need to come together and decide how to solve that problem. “Those conversations are just starting,” Swankoski said.
Another area where concern is building up is in the cash Treasury market. Roughly half of the trading on the trading venues operated by the interdealer brokers comes from principal trading firms, according to Aaron Friedman, deputy US head of government and regulatory policy at Citadel Securities. Those firms will be required to clear their trades once the deadline arrives, and they will need to use a clearing model that supports “done away” clearing, he said. In that type of model, the trading firm would be able to execute a trade with one counterparty and then use a different entity – a clearing firm – to process the trade and submit it to a clearinghouse. Implementing that approach at scale will be a “big lift”, warned Friedman, but it is essential to ensuring that these trading firms can continue to provide liquidity to the Treasury market.
Friedman joined with the others on the panel in expressing his concerns about the amount of work that needs to be done in a short amount of time, but he also emphasized the potential positives. “We think more competition is great,” he said in reference to the three groups competing to support central clearing to the Treasury and repo markets. He also welcomed the potential for margin efficiencies through cross-margining as well as other improvements in trade processing. But he emphasized the urgency of building solutions.
“We’ve been issue-spotting for months. We need to start solving these problems,” he said. Turning to the many operations experts and industry vendors in the room, he said, “I hope the technology developers in the room are working on it.”
