CME proposes its UST clearing approach

Key Takeaways

• Anticipating the mid-2026 SEC clearing mandate go live, CME published its approach to “CME Securities Clearing Inc.” – a new CCP for US Treasury (UST) bond clearing.
• The CCP’s two client clearing models will include one where clients settle both trades and margin directly with CME.
• The CCP’s default management resources will include CME’s own capital and a guarantee fund pre-funded from clearing member contributions.
• Time will tell whether CME’s differentiation will overcome FICC’s current monopoly and establish a meaningful share of UST clearing.

Introduction

Following its March declaration of intent, CME in October published its proposed approach to create “CME Securities Clearing Inc.” as a new CCP for UST cash and repo clearing. I clicked “View the plan overview”, revealing a document that we summarize in this blog.

Caveat: The deck is not yet fully detailed; my interpretation may alter after further industry dialogue with CME and the publication by CME of more precise details.

A note on terminology: In this blog, I use different terminology than CME. I use “client” where CME has “user” for an indirect clearing participant. I use “CCP” where CME has “clearinghouse”. Please bear with these differences.

Default management and resources

CME manages all client defaults directly. The clearing member may assist, but is not obliged to.

There is no mention of a settlement guarantee of clients by their clearing member (unlike FICC). As well as IM, CME envisages two additional layers of resources: an amount of CME’s own capital, and a guarantee fund pre-funded by member contributions for both their proprietary and client portfolios.

The overview document does not provide specifics on risk model calculations or stress scenarios for the calculation of IM, CME’s own capital contribution, or guarantee fund contributions.

Clearing models

CME outlines two client clearing models – see the diagrams copied from CME’s plan overview document.

  Supported user access                                                       Independent user access

Our interpretation:

• Cash and repo trades settle direct between the client and CME.
• Daily client margin (calculated gross by client) and twice daily settlement variation or SV¹ (calculated net by account) are auto-debited by CME using a specific cash account which the owner funds based on CME margin statements.
• In the “supported” model, the clearing member owns the auto-debit account and covers all its supported clients.
• In the “independent” model, each client owns the individual auto-debit account, -protecting it from clearing member default. Alternatively, the clearing member may fund the client’s auto-debit account.
• Overall, the supported model settles like the FICC’s sponsored clearing, and the independent model settles like FICC’s netting membership.

Note: 1. SV results from marking repo collateral to market.

Clearing member bank costs

On IM funding, a CME client has no choice but to pay IM. This avoids the possibility in the FICC approach that the clearing member pays IM for the client and/or any associated negotiation to get clients to pay.

On client trade portfolio capital, the direct trade settlement implies that the client cleared trade portfolios incur zero leverage and ccRWA. Also, the lack of a client settlement guarantee avoids any associated ccRWA.

The price of these cost savings is the pre-funded guarantee fund contributions – which are likely to incur funding, leverage, and ccRWA usage. If CMEs use a conventional “cover two” approach for the guarantee fund calculation, each member would fund the worst-case largest two client losses among its clients across stress scenarios. This means a CME member can add unlimited clearing clients that are a lower risk than the largest clients, without adding to guarantee fund contributions. By contrast, each FICC clearing client added incurs more settlement guarantee ccRWA.

CME intends to offer members and clients portfolio margin offsets against its CME cleared derivatives portfolios. Naturally, this would be handled net under a single risk model across cleared swaps, futures, and repo. This ought to improve on the cross-margining partnership effort between CME and FICC. The last time I looked, that partnership involved two separate risk models and intuitively less netting efficiency.

Competitive challenges

Comparing funding and capital costs on like-for-like client portfolios ignores the proverbial elephant in the room – FICC’s 100% current monopoly of UST clearing. A repo clearing at CME will only be margin efficient if, for both the client and its dealer counterparty, the repo would gross up in FICC margin and/or would offset in CME margin. Most likely, shifting a significant market share of UST clearing to CME will result in material market-wide dealer and client margin increases.

It is also inevitable that the adoption of CME Securities Clearing will require banks and buy-side firms to invest in material system and process infrastructure. Further, the need to choose a clearing venue in a multi-CCP environment is a much more quantified and trade-specific decision requiring further investment in sophisticated tools. The key people needed for these initiatives are probably already busy with mandated compliance work for FICC clearing and guaranteed repo trading.

It is also worth noting that if the new CME features are popular, FICC can simply adjust its model to incorporate one or more to bolster its competitive position.

Summary

Time will tell whether CME can overcome the competitive challenges outlined in this blog. If so, its proposed UST CCP is innovative and may reduce the funding and capital costs to banks of providing UST client clearing compared with the current FICC offering.