Assessing the financial impact of UST repo clearing on banks

June 6, 2024

Key Takeaways

  • Repo clearing mandate means increased costs for banks
  • This may require innovation in repo business models
  • Banks must form estimates of increases ahead of mid-2026

Our recent post on FICC access methods noted that sponsored repo is becoming a material element of US Treasury (UST) clearing.

The mid-2026 go-live for the SEC UST clearing mandate means banks must manage the increased funding and capital costs of FICC repo clearing. Some of these are inevitable but some depend on the business model chosen.

Here we outline those costs and business model choices with the caveat that some details may change as Basel 3.1 and FICC rules are finalized and interpreted in policy by banks.

Funding costs

Members must fund Fixed Income Clearing Corporation (FICC) clearing fund (CF) deposits twice daily based on portfolio net VAR. The cash is used to cover losses when FICC liquidates a defaulting member’s securities during default close out.

Capital costs

Banks publicly disclose their Basel III ratios on a quarterly basis, from which we focus on the following most impactful capital costs:

  • Leverage assets in the supplementary leverage ratio (SLR) denominator from cleared trade portfolios
  • Counterparty credit risk-weighted assets (ccRWA) in the capital ratio denominator from cleared trade portfolios, from FICC’s capped contingency liquidity facility (CCLF) allocations and from FICC-required sponsored member settlement guarantees. FICC may use the CCLF and sponsored member settlement guarantees to buy time until the completion of defaulting member close-out.

Basel 3.1’s mid-2025 go-live can only sharpen the focus on these costs as it increases calculated ccRWA by forcing some banks to use standardized risk weights and exposure calculations more extensively.

Buy-side driven costs

FICC rules mean that netting members fund the above costs not only for their dealer proprietary account but also for their agent member and sponsoring member omnibus accounts whose costs are based on their client buy-side firms’ cleared activity. The buy-side executing firms and sponsored members may negotiate ways to recompense their supporting netting members for those costs in their clearing agreements. However, this is not a requirement of FICC or SEC rules.

FICC netting member costs

In the financial cost trade-off versus uncleared, all the cleared costs above are calculated net across original dealers, which saves material portfolio leverage and ccRWA and holds in check FICC-driven costs. The ccRWA versus FICC is further reduced, given that a 2% qualifying central counterparty (QCCP) risk weight applies compared with 20% or more for uncleared counterparties. Based on these economics, the dealer (D2D) UST repo market adopted FICC repo clearing many years ago, but the increasing volume of dealer sides of dealer-to-client (D2C) repo also benefits from netting across original buy-side counterparties.

Netting member costs are calculated on a netted basis, and these will increase less with the new mandate. Optimizing this cost can use the proven approach of forming matching repo and reverse pairs in a matched book.

FICC client clearing costs

The client side of D2C repo may clear in two ways today:

  1. Via an agent member: The agent member bank is a principal to the cleared trades, so it incurs portfolio leverage and ccRWA. Its FICC-driven funding and ccRWA costs are calculated net across the agent members’ clients.
  2. Via a sponsoring member: The sponsoring member is not a principal to the cleared trades, so incurs no portfolio leverage and ccRWA. Its FICC-driven costs are calculated gross by client.

Before comparing agent member and sponsored member costs, please note that – for a given client portfolio – the sponsored clearing guarantee ccRWA numerically equals the agent clearing portfolio ccRWA facing the client. The two items thus cancel out in the comparison. This leaves us comparing agent member portfolio leverage and net FICC-driven costs against sponsoring member gross FICC-driven costs.

Anecdotally, sponsored clearing has been the main choice of hedge funds and money funds to date, perhaps leverage efficiency has trumped FICC costs in banks’ thinking.

In summary, sponsoring member costs are calculated gross and will increase more into the mandate. Optimizing them may require change or even innovation of the repo trading business model.

Done away UST repo

If a dealer sponsors FICC membership for all its UST repo trading clients, the “done with” approach means costs will be grossed up by each combination of dealer and client – creating higher industry aggregate bank costs.

“Done away” trading is when a client chooses one sponsoring member and gives up trades executed with other dealers to be cleared by their chosen sponsor. Now the costs land on the chosen sponsor for each client netted across original dealers – creating lower industry aggregate bank costs. Done-away trading has been limited to date, while it is common in derivatives clearing.

To flourish, cleared repo done-away may need market-wide automation of give-up (trade messaging and matching infrastructure) across clients, dealers, and FICC. We are aware that cleared post-trade infrastructure is less developed for repo than for derivatives and wonder whether this need may inhibit done-away adoption.

Innovating repo models to manage costs

If current “done with” sponsored repo approaches expand to cover all mandated activity, banks’ repo clearing funding and capital costs will grow materially through the mid-2026 SEC clearing mandate go-live.

Banks must carefully innovate their repo trading business model to manage these costs.

It seems it would be helpful to their decision process if banks formed a solid estimate of these cost increases ahead of time – perhaps complemented by an industry-level impact study from a regulator or trade organization.

Our next post on this topic will look at emerging UST repo trading approaches.

Please contact us with any comments or requests for future blogs.

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