At a glance
- The SEC voted four to one in favour of a new central clearing mandate for US Treasury trades
- The new rules aim to shore up the market and prevent failed trades cascading through the market
- But the industry warns the roll-out could prove costly, problematic and could impact market liquidity
A greater number of US Treasury bond trades will now need to be cleared centrally following a historic four to one vote by the Securities and Exchange Commission (SEC) last week. The vote was the final step in the process to implement wider mandatory central clearing of the $26tn US Treasury market, where as much as 80% is thought to be uncleared.
This additional mandate for central clearing aims to boost the resilience of the system and could require as much as $1tn of daily trades to be handled by independent clearing houses.
Under the new mandate, all purchases and sales of US Treasury securities by direct participants who act as interdealer brokers, and all purchases and sales of US Treasury securities between a direct participant and a registered broker-dealer and a government securities dealer or broker, must now submit for central clearing.
These changes are set to come into effect for cash transactions during December 2025 and for repo transactions by June 2026.
The Securities Industry and Financial Markets Association (Sifma), the main trade association for broker-dealers, investment banks and asset managers operating in the US and global capital markets, has expressed reservations about how the rules will be rolled out.
“We are concerned the implementation of a mandate is not conditioned on the achievement of milestones with respect to the further development of the SEC’s rules, the enhancement of access models generally, the co-ordination of global rules to enable market participants to clear, and the significant development of liquidity within the cleared model,” says William Thum, managing director and associate general counsel, Sifma.
Mr Thum warns of an inadvertent reduction in market liquidity, while at the same time making market participants vulnerable to additional credit exposures and risks.
Instead, Sifma argues that the SEC should have adopted a staged approach. Robert Toomey, managing director, associate general counsel and head of Sifma’s capital markets practice, believes its ‘staged approach’ proposals would help avoid introducing unnecessary risks to the market.
Mr Toomey points to previous comments Sifma made back in December 2022. In these, Sifma called for the SEC to first determine if the benefits to any central clearing requirement would outweigh the costs.
This view is echoed in other parts of the market, with some predicting a significant shift in resourcing to cope with the change.
Rules change presents challenges
According to Jo Burnham, who works for OpenGamma, a cash and collateral management platform, the new rules introduce multiple challenges for various market participants.
“Due to the additional costs likely to be incurred, hedge funds traditionally favourable to the bilateral world may need to reallocate significant resources to implement the necessary infrastructure for centrally clearing more US Treasuries,” she says.
Ms Burnham adds that there could be severe challenges for market participants who lack the internal resources to optimise the way that they post collateral.
“There could be even bigger headaches just around the corner. Mandatory clearing often involves the use of collateral to secure trades.
“Therefore, many money market funds are likely to face issues around sourcing eligible collateral, not to mention monitoring collateral requirements to meet clearing house standards,” he says.
Other market participants believe the new rules leave room for uncertainty regarding which — if any — repo trades may still remain outside of the mandatory clearing rules.
Ragu Raymond is director of collateral management business development and client success at Baton Systems, a platform for settlement of assets and wholesale payments.
“The market in 2024 needs more clarity as to what percentage of the US Treasury and repo trading book will be subject to mandatory clearing,” he says.
“If clearing becomes mandatory for certain trades, but not all, there is a risk of creating a bifurcated market structure with different pools of liquidity for trades that are newly cleared, versus those that remain bilateral, introducing previously unencountered costs and hurdles.”
Fabian Vandenreydt, chief product officer at NowCM, a transaction platform for market participants in debt capital markets, believes that central clearing is the way forward but, like the others, sees a potential “liquidity squeeze”.
He also has reservations about the implementation. “When talking to market participants, it is clear that there are operational concerns in terms of the adoption path — big bang versus phased approach — a smooth implementation is critical to avoid market disruption.”
Ultimately, Mr Vandenreydt thinks the sector needs to think hard about the adoption cost versus benefits. “It is important to clearly understand the impact of this initiative on an industry that is already coping with many other regulatory initiatives, such as T+1,” he says.
