The US Congress is undertaking an ambitious effort to establish a comprehensive legal and regulatory framework for digital asset markets. In doing so, policymakers have an opportunity to unleash the potential of digital asset technology, while also broadening its use by traditional market participants.
As Congress creates a framework for rules that will govern the unique attributes of digital assets, traditional markets offer important lessons learned that policymakers should consider.
An important role for banks and intermediaries
In the traditional markets for securities, commodities and derivatives, banks serve an essential role as intermediaries. Banks can play an equally essential role in digital asset markets, and policymakers should avoid precluding them from engaging in digital asset related activities such as trading, market making, custody and lending.
Equally important, any rules should clarify jurisdictional boundaries and not create barriers to the efficient use of capital. In particular, the Commodity Futures Trading Commission may regulate digital asset products considered commodities while the Securities and Exchange Commission would regulate those considered securities.
Policymakers have a historic opportunity to address the artificial boundaries between products that fall under CFTC and SEC jurisdiction through cross product margining and cross product netting. Addressing these barriers will help the US continue as a global leader in digital asset markets.
For example, bitcoin ETFs are subject to SEC rules, but the CFTC regulates bitcoin futures. Many investors seek to hedge their risks by holding both types of products. Unfortunately, neither the margin nor capital rules applicable in the US recognize the correlation and risk-offsetting nature of these products. This makes trading these products unnecessarily expensive for investors, disincentivizes managing risk across portfolios and puts the US at a competitive disadvantage.
Cross product margining and netting offers an eloquent and time-tested solution.
By permitting cross-product margining across products regulated by each regulator and cross-product netting for bank capital purposes, lawmakers would avoid importing an inefficiency from traditional markets to the new markets for digital assets, while also enhancing the competitiveness of the US capital markets across all asset classes.
The most important market – US Treasurys – offers a good example of the frictions that exist today because of the lack of cross product margining and netting creates.
A case study from traditional markets: The US Treasury clearing mandate
The SEC’s adoption of the 2023 Treasury clearing mandate has brought tremendous attention to the interconnections between the cash Treasury market and the Treasury futures market. Although the clearing mandates apply to cash market trading Treasurys and repos (not futures), the mandates will force these products into a central clearing model similar to what the futures markets have been using for generations.
Today, there is $36 trillion in outstanding Treasury securities, with an expectation that will grow to $45 trillion within the next decade. The Depository Trust & Clearing Corporation, which operates the primary clearinghouse for the Treasury market, has estimated that the clearing mandates could bring as much as $1.6 trillion dollars into clearing daily.
Essential to the clearing mandate, banks will provide clearing services to their clients. They will function as intermediaries between clearinghouses and clients, which entails collecting margin from the clients, guaranteeing their obligations to the clearinghouses and providing the capital that backstops the clearing system.
Current regulatory capital requirements will constrain this capital-intensive activity, which explains why a substantially fewer banks have offered this service over the past two decades. According to data from the CFTC, 20 banks cleared futures for customers at the end of 2024, down from 30 at the end of 2004.
At the same time, fewer firms have the appetite or balance sheet available to clear US Treasurys and repos today, and this mandate may force them to ration that service to only the largest customers.
Even fewer banks provide clearing services for over-the-counter derivatives. Following the implementation of the OTC derivatives clearing mandate in the Dodd-Frank Act, 22 firms provided OTC client clearing. As of December 2024, that decreased to 18. Furthermore, the market is highly concentrated. The top seven banks hold roughly 94% of the customer funds held to meet the margin requirements on cleared swaps.
Given this concerning trend, policymakers should create laws and rules that ensure a robust number of banks that can facilitate client clearing of US Treasurys and repos. The success of the SEC’s mandate will rest, in part, on finding efficiencies in clearing these trades. And, as mentioned above, cross product margining and cross product netting can play an important role.
Streamlining the complexity of US product regulation across the SEC and CFTC
Margin is the collateral collected from a market participant in derivatives trading to insure against loss on open positions that could fluctuate in value over the length of the contract.
Market participants often seek to hedge the risk of a position by using a related financial product that reduces the risk of their portfolio. This enhances liquidity, stability and efficiency in capital markets. It can also return billions of dollars of idle capital back to market participants and make our markets more affordable for investors and hedgers.
However, many offsetting products fall within the jurisdiction of different market regulators in the US – some in the SEC's jurisdiction and others in the CFTC’s. This subjects US market participants and end users to an array of conflicting margin and customer fund segregation requirements.
Cross product margining helps solve this problem. It allows a single ruleset (such as the securities rules for broker-dealers, or the futures rules for futures commission merchants) to apply to a portfolio of positions composed of different but related product types. This approach leads to more efficient use of capital through a reduction in margin calculated and collected by a clearinghouse based on identifying positions with offsetting risk.
While the SEC and CFTC have addressed cross-product margining in limited circumstances before (most notably, for cleared swaps and cleared security-based-swaps), more work lies ahead. The SEC and CFTC need to provide for cross product margining across SEC and CFTC registered products in a comprehensive way. This will more accurately reflect the risk of the portfolio and mitigate the higher costs market participants currently experience due to the overcollection of margin.
In partnership with other trade associations and market participants, FIA urges the SEC and CFTC to provide for cross product margining in the context of the Treasury clearing mandate. FIA’s President and CEO, Walt Lukken, wrote about this last year in a blog post. Cross product margining would enhance investors’ ability to manage price risk in both crypto and traditional markets. It also would put the US on a more competitive playing field globally.
However, cross product margining will address only one constraint for the success of the Treasury clearing mandates. US banks also will have to hold significant regulatory capital to facilitate Treasury clearing services for clients. This will require cross product netting recognition at the bank capital level to ensure capital levels match the risk borne by the clearer.
The importance of cross product netting arrangements
In April, FIA joined the International Swaps and Derivatives Association and the Securities Industry and Financial Markets Association in publishing a discussion paper highlighting significant concerns with regulatory capital requirements. This included the proposed 2023 revisions that would have substantially revised the US regulatory capital framework applicable to large banks, among other aspects of the bank regulatory prudential framework.
The associations warned that certain provisions in the bank capital rules would constrain the capacity of banks to provide essential intermediation functions in cleared markets. To address these concerns, the trade organizations proposed targeted changes to US regulatory capital rules to more appropriately reflect the economics of, and facilitate firms’ use of, cross-product netting arrangements with customers, particularly with respect to transactions based on US Treasury securities. Cross product netting arrangements include a recognition of risk offsets across derivatives, margin loans and repo-style transactions.
For example, while netting arrangements may be permitted when a bank is using the internal models methodology, cross-product netting is not recognized under the standardized approach used by most large banks. Moreover, the 2023 Basel III endgame proposal would have removed the IMM from the bank capital framework. As a result, it would have eliminated any recognition of the risk-reducing benefits and related efficiencies of cross-product netting agreements.
FIA and the other trade associations believe the US regulatory capital framework should appropriately reflect the risk and associated benefits of cross-product netting arrangements for US Treasury markets by the time market participants must comply with the mandatory clearing requirements, slated for 30 June 2027, for eligible secondary market repo. A lack of recognition of cross-product netting arrangements under the US regulatory capital rules will disincentivize bank facilitation of Treasury and repo client clearing activity.
The importance of capital efficiencies for client clearing
US market regulators and US bank regulators should develop and implement capital efficiencies by permitting both cross product margining and cross product netting. These efficiencies would improve market liquidity and incentivize clearing activity by highly regulated US banks across both emerging digital asset markets and traditional markets.
