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SEC Open Meeting

Securities and Exchange Commission  

Open Meeting

Wednesday, September 14, 2022

 

Topline

  • The Commission voted 5-0 to propose amendments to the standards applicable to covered clearing agencies of the U.S. Treasury securities regarding their membership requirements and risk management and to propose amendments to the broker-dealer customer protection rule regarding margin held at covered clearing agencies of U.S. Treasury securities.
  • The comment period for the proposal is 60 days.
  • Commissioner Uyeda expressed preference for a 90-day comment period.

 

ITEM 1: Treasury Clearing Standards for Membership Requirements and Risk Management

The Commission voted 5-0 to propose amendments to the standards applicable to covered clearing agencies of the U.S. Treasury securities regarding their membership requirements and risk management and whether to propose amendments to the broker-dealer customer protection rule regarding margin held at covered clearing agencies of U.S. Treasury securities.

 

Staff Discussion

Haoxiang Zhu, Director of Division of Trading and Markets

Zhu outlined the Division of Trading and Markets’ recommendations meant to facilitate and incentivize additional central clearing in the Treasury market. He said the proposal would increase risk management in Treasury markets and that it is important to make sure clearing agencies improve their risk management practices. He outlined different components of the recommendations, adding that they will ensure that clearing agencies have the proper means to facilitate access to central clearing, including those of indirect participants.

 

Jessica Wachter, Chief Economist and Director of the Division of Economic and Risk Analysis

Wachter discussed how eligible secondary market transactions can be divided into two categories, cash transactions and repurchase transactions. She said the proposal requirements differ for repo and cash, adding that the Division believes the proposed rule change would increase the use of central clearing either through the membership proposal or indirectly to incentive effects. Wachter said a primary use of clearing is the benefit of netting. She said the Division believes that central clearing will increase the competition for liquidity, resulting in lower trading costs. She also acknowledged that the proposal comes with cost as there may be direct costs of increased clearing and the need to establish clearing relationships.

 

Elizabeth Fitzgerald, Assistant Director, Division of Trading and Markets

Elizabeth Fitzgerald provided an overview of each proposed change to the Exchange Act Rule 17Ad-22. She said the Division recommends a rule that would impose a new membership requirement on covered clearing agencies that provide central counterpart services to Treasury securities. Specifically, she said the proposal would build on existing rules in place at the covered clearing agencies in the Treasury market and would require that covered clearing agencies have written policies and procedures reasonably designed to establish objective risk-based and publicly disclose criteria for participation. She added that in return, this would require the direct participants of covered clearing agencies to submit all secondary market transactions in which they are a counterparty. Fitzgerald said the proposal would also define what constitutes an eligible secondary market transaction and what would be subject to the membership requirement.

 

She discussed the proposed definition of an eligible secondary market transaction and its four separate categories. First, it would include all repurchased agreements under Treasury securities to which a direct participant of a covered clearing agency is a counter party. Second, it would include all purchases and sales of Treasury securities entered into by a direct participant of a covered clearing agency that is serving as an Inter-Dealer Broker (IDB). Third, the definition would include any purchase or sale between the direct participant of the covered clearing agency and a registered broker-dealer, government securities dealer, or government securities broker. Finally, it would include any purchase or sale transaction between a direct participant and hedge fund or a particular account that can take on specified amounts of leverage.

 

She said a hedge fund would be defined the same as it is under Form PF. She noted that secondary market counterparty transactions would not include transactions with central banks, international financial institutions, or natural persons. She said the proposal will also require that covered clearing agencies have policies and procedures reasonable designed to identify and monitor their direct participants submission transactions for clearing, including how the clearing agency would address the failure to submit those transactions. She concluded by saying clearing agencies would be required to establish policies and procedures reasonably designed to calculate, collect, and hold large amounts for direct participants for proprietary securities.

 

Randall Roy, Deputy Associate Director, Division of Trading and Markets

Randall Roy said increases in margin would result in the increase in the need for brokers to use their own cash to meet requirements and added that the Commission intends to address this by proposing amendment to 15c3-3a to free up resources to allow covered agencies to meet margin requirements and incentivizes additional central clearing.

 

Commissioner Discussion

Commissioner Hester M. Pierce

Commissioner Pierce expressed support for the proposal because it seeks to observe issues in the Treasury market, not because she necessarily embraces the solution proposed. She noted that Treasury issuance has exploded in the last two decades and outlined reasons for the attention paid to Treasury markets. She said that regulators have a responsibility to examine the market and that the proposal is the product of careful consideration. She then outlined a list of questions to consider for the proposal and engaged in a colloquy with Fitzgerald.

 

Commissioner Caroline A. Crenshaw

Commissioner Crenshaw began by discussing the importance of the Treasury market and explained both the primary and secondary markets. She said Treasuries serve as investor instruments and hedging vehicles and as a mechanism for monetary policy, among other purposes. She highlighted a few statistics to demonstrate the importance of the Treasury market and said confidence in the Treasury market is essential to the function of the U.S. financial system and to the global economy. Crenshaw noted recent disruptions in the Treasury market that triggered intervention by the Federal Reserve. She said the proposals are designed to promote central clearing in the Treasury market in four ways. First, the proposal would require covered clearing agencies that clear Treasury securities to require all of their direct participating members to submit eligible secondary market transactions in Treasury securities for clearing and settlement. Second, the proposal would require certain changes to strengthen risk management practices at covered clearing agencies that clear Treasury securities. Third, the proposal would require a covered clearing agency that clears Treasury securities to ensure that it has appropriate means to facilitate access to clearing and settlement services of all eligible secondary market transactions in Treasury securities. Lastly, the proposal would amend the broker-dealer customer protection rule. Crenshaw concluded by discussing the potential benefits of central clearing and acknowledged the possible increased costs in participating in the Treasury market brought by the proposed Amendment.

 

Commissioner Mark T. Uyeda

Commissioner Uyeda discussed the broad use of treasury markets and said the proposal should be subject to thorough study to assess both its costs and benefits. He also said the proposal is an important step in seeking an improved regulatory framework for the central clearing of Treasury securities and providing additional transparency, more comprehensive data on trading, and in certain instances, sounder risk management practices. He expressed interest in whether increasing access to central clearing can be achieved without leading to the entrenchment of larger firms and whether there are mechanisms and incentives that would increase the amount of Treasury security transactions that are centrally cleared without imposing a mandate, whether there are approaches that promote competition, and how robust risk management practices can be achieved. Lastly, Uyeda expressed his preference for a comment period of at least 90 days.

 

Commissioner Jaime Lizarraga

Commissioner Lizarraga began by discussing how the Amendments would help strengthen the Treasury market and make it more resilient to unexpected shocks. He next discussed how the structure and size of the Treasury market has changed over time. He noted that between 2007 and2022, debt held by the public increased significantly and cash trades decreased. He said the proposed Amendment will increase much need transparency. He concluded by saying the proposal today is an important step in enhancing visibility into central clearing and lowering risks in the Treasury market.

 

Commissioner Chair Gary Gensler

Commissioner Chair Gensler expressed support for the proposals because, if adopted, they would help to make Treasury markets more efficient, competitive, and resilient. He discussed why clearing houses are important and how they lower risk for buyers and sellers. He then outlined changes in the Treasury markets over time including a significant increase of principal trading firms (PTFs) trading in Treasury markets market and IDB taking on some clearinghouse-like functions without being regulated as clearinghouses, leaving our system potentially vulnerable to risks. Gensler added that the proposals would put forward changes in two areas: the scope of what is cleared, and a set of reforms related to customer clearing. He also said the proposals would promote greater competition and resiliency, promote clearinghouses establishing new models to bring in indirect participants’ trades for clearing in a way that increases access to clearing and settlement services in the Treasury markets, help free up broker-dealers’ resources, and enhance competition throughout the Treasury markets. He concluded by stating that these rules would reduce risk across Treasury markets, both in normal and stress times. Gensler said the proposal will be out for public comment for 60 days from the date it reaches the Federal Register and will be on the SEC’s website later today.

 

For more information on this hearing, please click here.

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