Adopted last December by the Securities and Exchange Commission, with phase-in milestones through June 2026, rules requiring central clearing for much of the U.S. Treasury securities market “will reduce risk across a vital part of our capital markets in normal times and stress times,” SEC Chair Gary Gensler declared. “That benefits investors, issuers and the markets connecting them.”
Among those supporting the structural reform in the world’s biggest and most important government securities market, and whose preparedness would be critical to pulling it off, was Fixed Income Clearing Corp. (FICC), the Depository Trust & Clearing Corp. subsidiary that is the sole central counterparty (CCP) servicing cash Treasury securities.
Citing industry feedback, DTCC said on June 4 that the clearing rules would increase FICC’s daily Treasury volumes by $4 trillion, up from a $1.63 trillion estimate last September. On June12, the industry-owned utility announced the launch of an interactive Capped Contingency Liquidity Facility (CCLF) Calculator, described as a critical tool for managing FICC’s liquidity risk arising from settlement activity.
The incumbent won’t be alone in seeking to capture growth in the Treasuries CCP business.
On June 24, Intercontinental Exchange announced its intention to “leverage its proven track record and expertise in central clearing and the fixed-income market to launch a clearing service for all U.S. Treasury securities and repurchasing agreements.” The offering will build on but be distinct from the SEC-registered ICE Clear Credit, the leading credit default swaps (CDS) clearinghouse.
Executives of CME Group and London Stock Exchange Group’s LCH had previously acknowledged interest in competing for Treasuries clearing.
Brian Steele, DTCC Clearing & Securities Services
Tacitly at least, the SEC is all in favor. As reported by Bloomberg, “Several market participants have reached out to us and want to sort of enter the business,” SEC Division of Trading and Markets director Haoxiang Zhu said in April. “Generally we welcome additional interest from clearinghouses engaging to get into this business. Competition is good for the market.”
“We at the SEC stand ready to consider any applications,” Gensler said in a June 5 speech.
ICE Clear Credit was a case of identifying “a market need that could benefit from modernization,” said Chris Edmonds, ICE’s president of Fixed Income and Data Services. For Treasuries, “we will leverage the successful playbook we developed in the past to offer an industry-trusted clearing solution along with the front-, middle- and back-office workflows our customers rely on to manage their daily business operations.”
“It is not surprising to us to see the incremental volume estimates hardening around $4 trillion daily,” Brian Steele, DTCC managing director and president of Clearing & Securities Services, said with the CCLF Calculator announcement. “While expanding Treasury clearing will be an important structural change for all Treasury market participants, we view it as a logical expansion of the services we provide and consistent with FICC’s mission. We currently process roughly $7 trillion in Treasury activity every day, and our buy-side volumes in the Sponsored Service are up over 70% year-over-year.”
At the firm level, in DTCC’s survey, almost 30% of sell-side institutions planned to facilitate cleared U.S. Treasury activity out of their prime brokerage, agency clearing or futures commission merchant (FCM) businesses. All of those traditionally offer “done-away” execution as part of core client clearing services – that is, executed by a client with one counterparty but cleared by a firm different from the executing counterparty.
Many buy-side firms were “concerned that client clearing services would only be offered by sell-side firms’ repo desk businesses, without done-away capabilities,” stated DTCC Managing Director Laura Klimpel, head of Fixed Income and Financing Solutions. “What we are seeing now from the survey data is an emerging sell-side trend to address this challenge, with firms now looking to also leverage their prime brokerage, agency clearing and FCM businesses to clear clients’ Treasury transactions.”
BNY Mellon head of market structure Nathaniel Wuerffel anticipates a wave of fundamental change for the $27 trillion market, saying, “The character of Treasury-market liquidity and functions will be different, and to some degree it could also change participation in the market.”
For example, “You have to account for the liquidity of the principal amount of the Treasury bond,” Wuerffel said. Because “the liquidity needs of clearing and settling Treasury securities are quite high, the models you build and the types of liquidity facilities you need as a Treasury-market CCP are formidable.”
Clearers’ operational resiliency will be essential because of Treasuries’ “special role” in the financial system, he added.
That may be an argument in favor of having more than one CCP. A single player won’t be considered optimal for the transparency, safety and liquidity that regulators prefer to see, said Thomas Ciulla, managing director of the Capital Markets Solutions practice at Treliant.
For a market participant, “it’s probably easier to deal with just one, but in the unexpected event of another Lehman Brothers, it’s important to have other options to clear through and spread some risk around,” Ciulla remarked.
Tom di Galoma, managing director and co-head of global rates trading at BTIG, told Reuters in March: “I think the volume and amount of issuance is really starting to cause a little bit of a bottleneck, and so the more clearing facilities the Treasury has, the better.”
Treasury liquidity will fall if CCP rules and safety measures are overly burdensome, such as requiring extraordinarily high liquidity commitments and/or margin, or if they implement inefficient access models. But neither can CCPs prioritize Treasury-trading liquidity at the expense of their safety.
BNY’s Nathaniel Wuerffel
“There are tradeoffs that clearers always face,” Wuerffel said, “but they are particularly relevant in the Treasury market.”
Wuerffel, who has previously worked at the Chicago and New York Federal Reserve Banks and represented the latter on the Inter-Agency Working Group on Treasury Market Surveillance, pointed out that BNY provides Treasury-related services including settlement and tri-party repo. BNY is “well-positioned” to assist firms with collateral management, as they will be required to post initial and variation margin at CCPs.
The BNY executive sees CCP access as another area of change. Members of CCPs receive significant privileges, but they must contribute to the clearer’s default fund and adhere to liquidity, capital and other requirements. That limits membership to the largest broker-dealers, and perhaps elite asset managers such as BlackRock and PIMCO.
“The rest of the market is going to have to access the CCPs through one of a variety of models,” Ciulla observed. FICC currently offers options including sponsorships through CCP members or tri-party arrangements.
With netting of gross trading activity bolstering resiliency, reducing overall risk and freeing up market participants’ capital, Wuerffel said, “Even if there are multiple CCPs, we should probably see a reduction in the gross settlement risk in the system.” By contrast, “today’s bilateral trading is the most distributed form of that activity.”
Margin and other CCP requirements are going to increase the cost of trades, widen bid/ask spreads and make leverage more expensive. Wuerffel said that could eat into the profits of market participants, such as hedge funds engaged in so-called basis trades. Costlier cleared Treasury trades could also alter pricing for economically equivalent financial instruments such as futures contracts.