US Treasury Central Clearing: Industry Considerations Report
Dated: November 13, 2024
Introduction
On December 13, 2023, the SEC voted 4-1 to approve a final rule, “Standards for Covered Clearing Agencies for U.S. Treasury Securities and Application of the Broker-Dealer Customer Protection Rule with Respect to U.S. Treasury Securities” (SEC rule) Among other changes, the SEC rule mandates the clearing of certain eligible secondary market transactions (ESMTs) in U.S. Treasury securities. The SEC rule triggers a significant structural change to the U.S. Treasury market and will have significant impacts on broker-dealers, institutional investors, (e.g., asset managers, hedge funds), interdealer brokers, principal trading firms, banks and covered clearing agencies (CCAs).
The Treasury securities market plays a key role in the US and global economies as a tool for investment and hedging, providing a risk-free benchmark for various other financial instruments and serving as a mechanism for the implementation of the Federal Reserve’s monetary policy. The Treasury securities market is one of the most liquid and reliable markets worldwide. As of July 2024, total outstanding Treasuries was approximately $27 trillion, with an average daily trading volume of $870 billion. Repurchase and reverse-repurchase transactions collateralized by Treasury securities (Treasury repo) also serve as a critical financing tool for market participants to fund their positions or as a way to invest cash. Data shown in the adopting release of the final rule indicated that daily Treasury repo transaction volume was approximately $4.6 trillion as of April 2023.
Transaction clearing involves a clearing agency stepping between a buyer and seller to handle certain elements of transaction processing, manage risk and pay down obligations. A considerable portion of Treasury securities transactions is uncleared today. In a December 13, 2023, statement on the SEC rule, the SEC Chair said that “having a significant portion of the Treasury markets uncleared — 70 to 80 percent of the Treasury funding market and at least 80 percent of the cash markets — increases system-wide risk.”5 Uncleared transactions today have varied risk management and margin practices across different institutions, and trading counterparties are exposed to each other’s creditworthiness.
The SEC also stated that it believes central clearing reduces the risks among counterparties, lowers the overall margin requirement to the system through multi-party netting, and reduces systemic risks — through the robust rules of the clearinghouses themselves as well as through collection of initial and variation margin. The SEC indicated in the adopting release7 that it believes that central clearing broadens the market to a wider group of liquidity providers and can thus improve market liquidity and reliability of access to funding during periods of market stress.
The SEC rule will drive changes to the overall U.S. Treasury market structure and require the integration of market participants, which will now be mandated to centrally clear transactions for the first time. New CCAs may also emerge, and market participants may decide to connect to one or more CCAs to support their trading and clearing strategies. Such changes to the market will require new operations and capabilities to accommodate increased clearing volumes and new relationships between firms. The first SEC rule compliance date (March 31, 2025) is fast approaching and existing participants will have a considerable amount of work to do for the subsequent compliance dates on December 31, 2025, and June 30, 2026. Market participants should have a clear sense of how (and the extent to which) their organization will be impacted. Importantly, there are certain steps where firms do not need to wait
until the compliance dates to act, for example, setting up direct or indirect access to the CCA. Firms should proactively be shifting from impact analysis to implementation efforts so that they are prepared for the transition to mandatory clearing. This report was prepared as a resource to support market participants in implementing the changes required by the SEC rule.