At Finadium’s annual Rates & Repo conference, Laura Klimpel, DTCC General Manager of Fixed Income Clearing Corporation (FICC) & Head of SIFMU Business Development, joined other industry leaders to discuss the growing interest and benefits of central clearing of U.S. Treasury (UST) repos during the “Repo Economics & Settlement Venues” panel.
An overview of the panel is below:
Market Benefits
The central clearing of UST repos via FICC’s sponsored service clearing model has seen substantial growth in the past few years, increasing from just one sponsor in 2005 to currently three dozen sponsoring members, as well as a broadening of geographic range from only in the United States, to nearly 40 global jurisdictions. As Klimpel noted in her panel, both public and private markets are reinforced by these high participation rates.
Private goods:
- Increased capacity due to the novation to a central clearing party (CCP), which allows for opportunities for balance sheet netting. Capital constraints, such as supplemental leverage ratio, could potentially impair a dealer or bank from transacting with the client. “The CCP can allow market participants — both the buy and sell side — to increase their capacity to transact,” Klimpel said.
- Credit enhancement due to the benefit of having a double A-rated SIFMU as a post-novation counterparty, allowing the buy side to become comfortable transacting with a broader array of counterparties.
Public goods:
- Regulatory transparency, as all transactions are centrally cleared. Pockets of opacity exist, particularly in the Treasury market, which are of concern to regulators. Central clearing is one way to increase transparency to regulators.
- Uniform risk management due to the consolidation of activity, as the CCP risk manages all transactions across the market in the same way. This risk management protects both firms and the market as a whole in the event of a default and mitigates losses as well as the potential for fire sale risk. Klimpel added, “A CCP is in the unique position to manage the default of a market participant in a uniform and orderly manner.”
Economic Impact of Required UST Repo Clearing
The recent U.S. Securities and Exchange Commission (SEC) proposal, intended to increase cleared activity in UST repo clearing would require a significantly larger portion of tri-party and bilateral repo, where the underlying collateral are U.S. Treasuries, to be submitted to a covered clearing agency. The proposal looks to reinforce risk management and market stability through uniform risk management practices.
Currently, FICC is the only CCP platform in the U.S. that clears UST tri-party repo and cash transactions, and this proposal will expose a wider array of UST repo transactions to the clearing requirement.
The SEC proposal would provide many benefits for market participants, such as balance sheet netting and increased capacity for a wider array of activities. However, the same liquidity and margin requirements that are required by the CCP through FICC’s voluntary sponsored clearing service will apply.
Klimpel addressed the margin and liquidity concerns, saying that FICC uses anti-procyclicality measures — including a 10-year lookback — to avoid major jumps in margin during times of volatility. She also added that the ultimate cost of a CCP will depend on how the new activity interacts with the current activity in central clearing. “We’ve seen market participants take full advantage of novating their buy-side into a CCP, resulting in CCLF obligations reduced due to netting.”
Impact of Central Clearing During March 2020
Looking at the March 2020 crisis, the CCP-sponsored model improved liquidity, muting the day-over-day response. Klimpel explained that while derivatives clearing requires the underlying client to post margin, the FICC-sponsored service offers a wide array of economic arrangements between clients and intermediaries, and many participants don’t contribute margin.
“We had our highest volume during that period — $564 billion on a voluntary basis —demonstrating the capital benefits of being able to reduce balance sheet frictions and capital costs that clearing provides,” causing activity to gravitate to FICC and help improve liquidity during that time.
Mitigating the Cost of Trading Repo
- Partnering: As stated by another panelist, the FICC sponsored clearing model is a great example of how market participants can work together to drive solutions. FICC continues to make the cost of clearing as efficient as possible through optimizing margin and enhancing cross margin across CCPs.
- Advocating: The margin efficiency aspect proposal from the SEC would allow, for the first time, an intermediary that is a broker/dealer in FICC to rehypothecate and post to the CCP. DTCC has been strongly advocating for the regulator to allow this type of rehypothecation, which is currently prohibited under existing law.
- Standardizing: While there is standardization at the CCP level, Klimpel stated, “We need to come together to develop a template for cleared repo trades to help reduce costs.”
- Creativity: DTCC believes in creative solutions instead of a one-size-fits-all approach. “We are looking at multiple access models and solutions to bring everyone into the fold,” Klimpel concluded.