Ever since the Securities and Exchange Commission adopted its rule in December 2023 to require the clearing of US Treasury repo and cash security transactions, FIA has taken a keen and active interest in this new market structure.
Some folks have asked why? They point out that the mandate addresses cash Treasurys and repos, not futures or options. They are correct.
At the same time, when it comes to central clearing, futures markets stand out as the gold standard for client clearing. Our industry serves as a model for what is being built, and we have decades of lessons learned that we can contribute.
And remember that US Treasurys serve as the reserve currency for trading in derivatives. Any adverse outcome from the clearing mandate on our industry’s ability to margin our markets or move collateral would have a devastating effect.
THAT’s why we have engaged in this effort.
Last month, we held FIA’s second forum on US Treasury clearing. It included a variety of perspectives, including clearing members, vendors and venues, and the outstanding needs. Based on that rich discussion, I wanted to dive into what this means, why it matters and the impact it will have on the US Treasury market.
Understanding the market
With $36 trillion in bills, bonds and notes outstanding, the US Treasury market is the largest and most liquid government debt market in the world. This is, literally, how the US government funds itself.
The yields on U.S. Treasurys serve as reference rates for many other interest rates in the economy. And our industry and its participants utilize Treasury securities and repo contracts every day in the collateralization, settlement and cash management of futures positions.
Given the significance of the market – both its size and the role it plays in the financial system – it makes sense to reduce risk wherever practicable. Having intermediaries assume the responsibility and risk for the financial integrity of the transaction accomplishes that. And it builds on the time-tested model futures have relied upon for more than a century.
A complex swap
“Isn’t this the same as when you had to clear swaps under the Dodd-Frank law?” is another question I often hear.
The short answer: yes and no.
Yes, this is a government mandate that introduces client clearing to a new asset class. Yes, it will require a lot of work to rearrange the post-trade workflow. Yes, some participants welcome it and some do not.
But no, it’s not a copy/paste of systems to replicate the client clearing of swaps. There are some important differences in market structure that require fresh thinking and fulsome dialogue among all of stakeholders, including, most importantly, the many different types of institutions that participate in the US Treasury market.
The current landscape
At present, only one clearinghouse clears US Treasurys: the Fixed Income Clearing Corporation, a subsidiary of trade processor Depository Trust & Clearing Corporation.
FICC clears over $10 trillion in daily activity. And it estimates that it clears nearly half of the outstanding Treasury repo covered by the SEC’s clearing requirement.
The rest of the market relies on the bilateral model for trading. And many participants have little familiarity with the operational, financial and technological requirements of central clearing.
Competition brings a different approach
With FICC holding the advantage today, CME Group and Intercontinental Exchange have announced plans to offer clearing services by the end of 2025.
This competition will benefit all market participants and introduce different options and methods for how they may want to clear their Treasurys.
At a forum FIA hosted last fall on this mandate, then-head of the markets group at the US Federal Reserve Michelle Neal offered a succinct description of the model used by FICC.
“The current Treasury market practice is for trade clearing and execution to be bundled together. This is referred to as “done-with” clearing, since the trade is done with the dealer that sponsors it into central clearing,” she said. “Done-with clearing provides balance sheet and capital efficiencies for the sponsoring dealer and may carry less operational risk overall.”
The other model will feel more familiar to those in our industry. The “done-away” model is how we trade client cleared futures and options. While a similar name, this process involves trading by one broker and clearing by another. The name comes from the fact that the execution is "done away" from the clearing broker.
FIA, with its primary members serving as futures commission merchants that clear futures, options and swaps, has focused on the need to support done away clearing. This approach will open a lot of opportunity in the Treasury clearing space by offering participants a variety of options on where to clear their trades. It also helps mitigate risk in the process by clearing members requiring credit checks.
Our industry knows it well, and it has stood the test of time.
We believe strongly in market participants having this model as an option in clearing US Treasurys and repos.
Clearing more hurdles
Much work remains to meet the SEC mandate. FIA had advocated for and welcomed the initial delay the agency granted. And we believe the industry may need additional grace periods to fully build out the capacity and processes needed for the entire trade flow.
Additionally, many US Treasury market participants are subject to regulation by both the Commodity Futures Trading Commission and the SEC. These agencies will need to work together to ensure that the SEC’s Treasury clearing mandate does not conflict with CFTC regulations.
With collaboration from the regulators and within the industry, we know we can accomplish this tall task and significantly reduce risk in this critical marketplace.
