SEC clearing mandate for US Treasury Securities

This article is written by a guest author.

In the September 2023 post Central Clearing of US Treasuries, we outlined the SEC’s US Treasuries (UST) clearing mandate proposal dated September 2022. We noted a survey finding that FICC’s various access models were poorly understood. The rule, finalized by the SEC in December 2023, became effective on 18 March 2024. In this post, we outline the mandate’s timing and scope, and some immediately apparent challenges.

Mandate documents

The Fed register documents, the SEC proposed rule, and the SEC final rule (406 pages) take a lot of effort to read and decipher. We can, however, thank leading law firms for their handy published summaries – for example, Cleary Gottlieb’s proposed rule summary, and a final rule summary give succinct details. As we focus only on certain aspects in this post, we recommend reading the Cleary summaries and browse the Fed register documents for full coverage of the topic.

Mandate timing

The final rule sets the UST clearing mandate to go live on 31 December 2025 for “cash trades”, and on 30 June 2026 for “repos” (repurchase agreements). Before these go-live dates, there are interim deadlines earlier in 2025 for FICC modifications to comply with new rules (which are not covered below).

Chairman Gensler arrived at the SEC in 2020 bringing a more active regulatory approach towards UST. Before that, the Fed was already actively encouraging expanded UST clearing as a response to the 2008 financial crisis (which was in essence a “run on repo”). As a result, the FICC expanded its clearing membership models, adding “CCIT membership” to allow more complete clearing of triparty by including cash lenders (think: money market funds), and adding “sponsored membership” to enable wider buy-side participation. These changes give hope that the final rules adopted will include specific updates to make the newly-added models properly workable and, indirectly, that the 2026 timeline can be met.

Mandate scope vs FICC scope

It is necessary, albeit a bit challenging and tedious, to understand the mandate’s scope and compare this with FICC’s clearing scope. After some digging, here is my summary:

• Which CCPs? The DTCC’s FICC (and specifically GSCC) is the UST CCP. No other CCP clears them.
• Which securities? USTs are literally any security issued by the US Treasury (not Agencies nor MBS, as these are issued by other government departments). UST types are – in descending size order – nominal coupons, bills, TIPS and FRNs.
• Which trade types? “Cash trades” means purchases and sales; “repos” means bilateral (overnight, term, open, or intraday) repo or triparty
• Which counterparties? Loosely defined, these are all direct participant UST cash trades and repos with US financial firms, except cash trades with hedge funds and repos with CCPs and affiliates. More precisely, direct participants are mandated to clear all trades with included securities and trade types with all counterparties except for:
  • Cash trades and repos with firms that are not US financial firms (that is, central banks, sovereign entities, state of local governments, international financial firms, and individuals).
  • Cash trades with hedge funds, private equity funds, and prime brokerage clients. Note: For now, hedge funds only need to worry about repo, as they persuaded the SEC not to proceed with this aspect.
  • Repos with CCPs. Many CCPs trade repos in their funding processes. I imagine the SEC wants to avoid cross-CCP dependencies of, for example, LCH clearing UST repos at FICC.
  • Repos with affiliates of a direct participant. Note: I expect dealers prefer to clear these only when they are risk-, capital- or funding-efficient – which may be a decision per trade.
• FICC gaps. FICC does not yet clear one security type (FRNs, which are less than 2% of UST activity) and two bilateral repo subtypes (open repos, which are material and intraday repos). It is not yet clear to me whether these gaps are considered material enough to warrant being addressed by FICC.

Challenges

At first blush, the following challenges have emerged:

• Mandate adoption operational and infrastructure impact. No doubt this is a big, end-to-end infrastructure change project for FICC, its current members, and any newly joining firms.
• Dealer affiliate handling. Based on financial impacts, banks may need to decide whether an affiliate should become an FICC member and, if so, whether netting, agented, or sponsored membership is more appropriate.
• Pre-trade decisions. Considering the optimal financial impacts will lead dealers and buy-side firms needing to determine pre-trade whether a proposed trade is mandated to clear, whether it should be cleared if optional (for example, an inter-affiliate trade), with which party it is better to do the trade, and how to price in funding and balance sheet impacts.
• Post-trade optimization. Periodically, dealers and clients may want to optimize cleared margin requirements and impact on risk weighted assets (RWA).

Summary

After more discussion and research we intend to publish additional posts on some of these challenges. In the meantime, feel free to reach out with comments, or to suggest other related topics of interest.

This article is written by a guest author.