Delayed deadlines for compliance with the Securities and Exchange Commission’s U.S. Treasury clearing mandate are allowing more time for market players to adjust operationally and for new competitors to hone their offerings.
The year-long extensions announced in February – to December 31, 2026, for eligible cash market transactions, and June 30, 2027, for repurchase agreement (repo) transactions – were meant to “facilitate an orderly implementation” of rules adopted in December 2023 to mitigate risk and enhance resilience in what then-SEC Chair Gary Gensler described as “the deepest, most liquid market in the world.”
Scott O’Malia, CEO of the International Swaps and Derivatives Association, one of many voices advocating delay, called the move “very welcome” but also “the absolute minimum extension that is necessary – several critical operational, regulatory and legal issues need to be resolved, and this will take time.”
“With $36 trillion in bills, bonds and notes outstanding, the U.S. Treasury market is the largest and most liquid government debt market in the world. This is, literally, how the U.S. government funds itself,” Futures Industry Association president and CEO Walt Lukken said in June.
“FIA had advocated for and welcomed the initial delay the agency granted,” Lukken added. “And we believe the industry may need additional grace periods to fully build out the capacity and processes needed for the entire trade flow.”
The one current central counterparty (CCP) for Treasuries, Depository Trust & Clearing Corp.’s Fixed Income Clearing Corp., has been thriving both pre- and post-extension. FICC’s Government Securities Division reported a peak volume of $11.8 trillion in cleared transactions on June 30, breaking the April 9 record of $11.4 Trillion.
DTCC Managing Director Laura Klimpel
“FICC’s long track record of successfully processing persistent volatility in U.S. Treasuries is a testament to our steadfast commitment to risk management and resiliency,” Laura Klimpel, managing director and head of DTCC’s Fixed Income and Financing Solutions, said in a statement. “At the same time, we are also providing increased balance sheet capacity to our members due to the value of central clearing with FICC.
“We are not only protecting one of the world’s largest financial markets by managing volatility and market stress but also enabling significant capital and liquidity efficiencies for our members.”
Meanwhile, CME Group and Intercontinental Exchange (ICE) are preparing to challenge FICC this year, pending regulatory approvals and resolution of certain outstanding issues.
“This competition will benefit all market participants and introduce different options and methods for how they may want to clear their Treasuries,” FIA’s Lukken remarked.
Paul Hamill, chief commercial officer of ICE Clear Credit, said in a March podcast that more clearing options will give market participants more choices, and clearing competitors will be able to “test the operational pipes, look at the risk management outcomes, look at the costs, and have that window of time to figure out where they want to see the market go.”
In May 15 testimony to a House Financial Services Committee task force, Nathaniel Wuerffel, BNY’s head of product for the Global Collateral Platform and head of market structure, spoke of a “reassembling” of the Treasury market structure.
“Because CCP risk management includes margin, liquidity and default management processes, counterparty credit risk in the Treasury market should be lower,” explained Wuerffel, a former head of domestic markets at the Federal Reserve Bank of New York. “This should enhance financial stability by improving the willingness of market participants to continue trading in the Treasury market, even in times of stress when they might otherwise back away from their counterparties for fear of credit risk.
BNY’s Nathaniel Wuerffel
“Central clearing also should offer improved intermediation by providing some balance sheet relief through netting of offsetting transactions,” the BNY executive continued. “However, the rule will require market participants to change the way they interact in the Treasury market, including significant process, systems, legal and operational changes required to centrally clear their transactions.”
Among operational and regulatory hurdles still to be addressed, Wuerffel mentioned assurance of “a level playing field for all market participants,” and limiting implementation “to Treasury securities transactions and not inadvertently capture non-Treasury trades.”
The latter is a potentially “huge” issue, said Audrey Costabile, a senior market structure and technology analyst at Crisil Coalition Greenwich, as an entire basket of securities could be pulled into the clearing mandate even if Treasuries account for just 1% of the collateral.
The Institute of International Bankers (IIB) noted in a 2024 comment letter to the SEC that central banks and sovereign entity counterparties were left outside of the clearing mandate, suggesting “that the commission did not properly contemplate the cross-border application of the mandate or evaluate and address the additional challenges that may arise in this context.”
The FICC has since proposed requiring a foreign bank and its U.S. branch to apply for a netting membership together, as the same legal entity, requiring both to clear Treasury transactions.
The extraterritorial issues “could lead foreign counterparties to question their participation in the U.S. Treasury security market when they have alternative government bond markets in which they could invest without raising these issues or more generally incurring the costs of central clearing,” IIB said.
Wuerffel of BNY, whose global operations could position it as a sponsor for non-U.S. entities clearing through the FICC or other CCPs, expressed it differently: “The rule should apply to eligible transactions by CCP members wherever they are conducted and should not allow transactions to avoid central clearing simply because they are conducted in non-U.S. jurisdictions or settlement venues.”
“The current Treasury market practice is for trade clearing and execution to be bundled together,” said former New York Fed head of markets Michelle Neal, as quoted by Lukken. “This is referred to as done-with clearing, since the trade is done with the dealer that sponsors it into central clearing. Done-with clearing provides balance sheet and capital efficiencies for the sponsoring dealer and may carry less operational risk overall.”
The other model, done-away, is more familiar in client clearing of futures and options, Lukken said. Done-away “involves trading by one broker and clearing by another.”
Ponting out in an April white paper that the FICC currently permits done-away, Citadel Securities said neither the FICC nor SEC prohibit execution and clearing bundling – executing and clearing trades through the same clearing member. Bundling would require clients to establish clearing relationships with each executing counterparty, an untenable situation in the cash market where interdealer brokers account for half of daily volume but are not clearing members.
In repo, Citadel said, bundling would fragment cleared portfolios, increasing cost, complexity and contractual and operational risk, while limiting competition among trading parties.
“Ensuring that done-away clearing is made available well in advance of the implementation date sets the foundation for successfully implementing broader central clearing in this critically important market,” said the market-making giant. It also criticized as arbitrary the SEC’s limiting the clearing exemption for inter-affiliate transactions to banks, broker-dealers and futures commission merchants (FCMs).
“With the additional time granted by the SEC on the expanded clearing deadlines, FICC remains firmly committed to supporting the cleared U.S. Treasury market as it continues to evolve and grow, including by collaborating with the industry to roll out enhancements to FICC’s done-away capabilities for Treasury cash and repo activity,” DTCC’s Laura Klimpel said in March. “The significant growth in membership and volumes is a testament to the value of central clearing with FICC, and we expect this growth to continue.”
J.P. Morgan timeline shows a September date for covered clearing agencies’ implementation of enhanced practices with FICC’s Government Securities Division.
In his House testimony, Wuerffel said that more than 70% of non-centrally cleared bilateral repo trades are transacted with no margin. The SEC’s clearing rule requires margin from CCP members but not other participants, leaving a gap that could “result in a commercial race to the bottom in risk management practices.”
The voluntary, New York-Fed-sponsored Treasury Market Practices Group (TMPG) in May released best-practices recommendations for Treasury repo risk management, including “the application of haircuts (or margin) on the value of the securities, in concert with other risk management techniques, as appropriate.”
Imposing margin on Treasury trades, however, could be problematic for investors engaged in basis trades and other transactions with thin profit margins that rely on significant leverage.
“The resilience of Treasury markets depends on preserving the ability of market participants to apply flexible, risk-based margining on repo transactions,” Jennifer Han, chief legal officer at the alternative investment management association MFA, said regarding an April 30 comment letter to the TMPG. “Imposing rigid margin standards could disrupt well-functioning repo markets, reduce liquidity and increase systemic risk. TMPG’s best practices should support flexible, proportionate risk management so firms can effectively manage exposure across portfolios and help maintain the strength and stability of Treasury markets.”