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How financial services is addressing U.S. Treasury and Repo clearing

Mark Nichols

Principal, Capital Markets Strategy and Business Transformation, Ernst & Young LLP

8 minute read 01 Feb 2024

Central clearing for U.S. Treasury and Repo markets triggers a significant change in U.S. Treasury market structure.

Executive summary

  • The SEC-approved central clearing for U.S. Treasury and Repo markets will materially impact broker-dealers and institutional investors.
  • The rule includes several exemptions and a longer implementation timeline, giving market participants additional time to assess and prepare for implementation.

How EY can help

On December 13, 2023, the Securities and Exchange Commission (SEC) voted 4-1 to approve central clearing for U.S. Treasury and Repo markets, triggering a significant change in U.S. Treasury market structure that will have material impacts to broker-dealers and institutional investors. The rule includes several exemptions highlighted below, and a longer implementation timeline than originally expected, giving market participants additional time to assess the impacts to their business strategy and prepare for implementation.

 

Key rule timelines – staggered compliance 

1. March 18, 2024: rule book updates are due from the covered clearing agencies (i.e., Depository Trust and Clearing Corporation Fixed Income Clearing Corporation (FICC))

 

2. March 31, 2025: implementation of enhanced practices by the covered cleared agencies as outlined in the rule, covering areas including risk management practices, margin practices, customer asset protection, and market access expansion

 

3. December 31, 2025, for Cash: compliance by the direct participants of a U.S. Treasury securities covered clearing agency with the requirement to clear eligible secondary market transactions

 

4. June 30, 2026, for Repo: compliance by the direct participants of a U.S. Treasury securities covered clearing agency with the requirement to clear eligible secondary market transactions (i.e., repo or reverse repo agreements collateralized by U.S. Treasury securities)

 

 Overview of the rule requirements

  • The rule mandates that the following secondary market transaction types will be required to be centrally cleared:

    • U.S. Treasury cash transactions

      • Transactions by direct participants that are acting as interdealer brokers
      • Purchases and sales between clearing members and certain other firm types (e.g., registered broker-dealers, government securities brokers and dealers)
         
    • Repurchase and Reverse repurchase (Repo) transactions 
    • Transactions collateralized by U.S. Treasuries involving direct participants as a counterparty 
    • The requirement to clear repo transactions will impact a broad range of market participants (e.g., hedge funds, asset managers, corporates), given the extent to which repos are facilitated through brokers/dealers that are direct participants at FICC
       
  • Covered Clearing Agencies (CCAs) in the U.S. Treasury market must adopt policies and procedures designed to require their members to submit for clearing the transactions listed above:

    • Clearing agencies will also be required to take steps to facilitate access to clearing for additional market participants (e.g., pension funds, asset managers).
       
  • CCAs will be required to collect margin separately for house and customer transactions. 
  • The rule impacts the Broker-Dealer customer protection rule (Rule 15c3-3) calculations and permits margin required and deposited with a clearing agency to be included as a debit in the customer reserve formula, subject to certain conditions. 
  • Specific exclusions from the rule include:
     
    • Cash transactions between a direct participant and either a hedge fund or leveraged account
    • Inter-affiliate repo activity
    • Instances in which one counterparty is a central bank, a sovereign entity, an international financial institution, and/or a natural person
    • Repos or reverse repos in which one counterparty is a state or local government, or between a direct participant and an affiliated counterparty, as long as the affiliated counterparty submits for clearance and settlement all other repurchase and reverse repurchase agreements to which the affiliate is a party

 

Market participant considerations

Both sell-side and buy-side market participants will need to implement significant changes to their business and operating infrastructure to maintain treasury market access under the centrally cleared model.

 

Key considerations:

Business and clearing model strategy

Firms may need to rethink their market access strategy (e.g., direct participant, sponsored participant, or via correspondent clearing relationships) and the 7services they offer to facilitate market access to their clients. They will need to consider the capital, liquidity, and operational complexities as they determine their strategy and pricing for the services offered.

Margin requirements

The rule may result in increased margin requirements due to an increase in clearing activity and introduces segregation requirements for direct vs. indirect participants. Impacts will differ across the sell-side and buy-side but will result in changes to margin needs, increase guaranteed fund requirements, and increase the potential for intraday margin calls that will need to be supported by firms’ infrastructure and operational processes.

Rule 15c3-3 impacts and amendments

There are various impacts and amendments to the rule, including debits/ credits impacting customer reserve formulas and separate reserve computations, the ability to deduct margin posted to the CCA from the reserve amount, and for some firms the need to increase the frequency and flexibility in their reserve calculation methodology.

Risk Management

SEC believes central clearing will reduce counterparty credit and systematic risks by redirecting activity to FICC’s centralized netting and risk management systems. The rules also introduce the need to set limits for in-scope activity, which will need to be understood by all participants as they determine if a multi-clearing model is required for their activity or if they can manage through a single sponsored provider.

ntersections with other regulations

Within the capital framework, banks may see a reduction in risk-weighted assets due to the lower risk weights assigned to Qualified Central Clearing Parties as well as benefit from the impact balance sheet netting will have on the supplementary leverage ratio, through increased trade volumes could ultimately increase capital for some firms. Additionally, when looking at the overall impact, considerations such as guarantee fund contribution, margin and customer reserve amounts need to be taken into account. Also, the SEC has proposed an expanded definition of a dealer, which if approved will capture large volume buy-side firms into the requirement to clear cash purchases and sales.

Operating Model

Government settlements and middle office functions will have to be reviewed as part of general operating model changes associated with the further move toward clearing. Ensuring that teams have the tools and margin analytics to operate in a cleared environment at a greater scale will be critical to the success of enabling new processes and/or increased volumes of activity.

CCA rulebook clarifications

The industry is awaiting final FICC rule book updates and outstanding industry consensus around key items, with significant impact including repapering, give-ups/ins, international membership, mix trades partially collateralized with Treasuries, and alternative market access models for market participants.

Program Mobilization

Firms have begun assessing impacts across their organizations, starting with understanding the strategic considerations on sponsored, direct or indirect membership and the knock-on impacts across the organization that different approaches and decisions may yield across their businesses.

Recent publications, news articles and industry events

To learn more, read the SEC Final Rule and the associated Fact Sheet here.

Links to other recent publications are also provided below.

Looking to the Horizon - Assessing a Potential Expansion of U.S. Treasury Central Clearing¹

The Depository Trust & Clearing Corporation (DTCC) explores the proposed expansion of central clearing and highlights the associated benefits, challenges, and considerations discovered from FICC’s in-depth survey of U.S. Treasury Market participants in Q2 2023. Key findings from the assessment include:

  • Survey respondents indicated significant gaps in market awareness and understanding of FICC’s access models, risk tools and capabilities.
  • FICC’s various access models and available services are not broadly understood, and a majority of FICC members are unsure which access models they want to use for indirect participant activity.
  • The incremental indirect participant Treasury volume could result in an increase in Value at Risk margin.
  • Some respondents suggested enhancements to FICC’s offerings, including various risk-focused changes (e.g., enhanced cross-margining opportunities, increased transparency of margin calculations).

SEC Ruling on Central Clearing²

BNY Mellon emphasizes the importance of central clearing in the U.S. Treasury market and the various benefits of expanding central clearing, including market stability, improved risk management, and cost reduction. However, the article also highlights that while central clearing may strengthen the market’s safety and liquidity in periods of stress, implementation will be difficult and will restructure how the market operates.

SIFMA Testimony on Examining the SEC’s Agenda³

Kenneth E. Bentsen, President and CEO of SIFMA, testified at a Financial Services Subcommittee on Capital Markets hearing in which he expressed concerns around potential policy changes and the subsequent impacts on capital markets, as well as advocates the need for investor protection and fair markets. 

Bentsen argues that “it is critical that regulators tailor regulatory policies to address legitimate market failures without unnecessarily harming or disrupting markets, especially when our economy faces serious headwinds. However, the high volume and speed of regulatory change proposed by the Securities and Exchange Commission could result in negative consequences for the real economy in terms of output, employment, investment, and prices.”

Thinking About U.S. Treasury Clearing⁴

ISDA discusses the benefits, implications, and challenges of the expected SEC regulations to the market and market participants. The article highlights that while central clearing can reduce counterparty risk and improve transparency, the new regulation could also heighten concentration risk and potentially cause disruptions to the market. ISDA argues that the industry should thoroughly evaluate the costs and benefits of a move to central clearing to understand the full extent of impacts it could have on market participants and infrastructure.

Brendan Maher, Neal Ullman, Jen Andrews, Ray Agoglia and Mark Nichols contributed to this article. 


Summary

On December 13, 2023, the SEC adopted amendments to Rule 17Ad-22 under the Exchange Act to approve central clearing for U.S. Treasury and Repo markets. This ruling produces a significant change in U.S. Treasury market structure, materially impacting broker-dealers and institutional investors. The rule includes several exemptions, and when combined with a longer implementation timeline, gives market participants additional time to assess how their business strategy will be impacted, as well as prepare for implementation.

About this article

Mark Nichols

Principal, Capital Markets Strategy and Business Transformation, Ernst & Young LLP

Capital markets growth and innovation advisor. Delivering digital transformation strategy for global investment banks and institutions. Digital assets leader. Husband. Father. Travel enthusiast.

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Banking and capital markets

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