In September 2022, the U.S. Securities and Exchange Commission (SEC) proposed expanding the scope of U.S. Treasury activity that must centrally clear through an SEC-regulated covered clearing agency. The proposal came in the wake of unprecedented Treasury market volatility in 2019 and 2020, and seeks to standardize risk management, reduce settlement risk, centralize default management and increase transparency in the world’s largest and most liquid sovereign debt market.
Related: Making the U.S. Treasury Market Safer for All Participants: How FICC’s Open Access Model Promotes Central Clearing
As the only SEC-regulated covered central counterparty for outright purchases, sales and repo transactions in U.S. Treasury securities, DTCC’s Fixed Income Clearing Corporation (FICC), through its Government Securities Division (GSD), has been working to understand the implications – and to help market participants prepare.
As part of this work, FICC recently surveyed a wide swath of market participants and trade associations from various market segments, including those that currently clear directly through FICC, those that clear indirectly through a sponsor and those that trade bilaterally. We learned that nearly 75% of FICC member respondents submit 50% or less of their indirect participant Treasury activity to FICC – suggesting the remainder clears and settles bilaterally.
Based on this, FICC estimates the SEC proposal could potentially add $500 billion in indirect participant Treasury repo activity, $520 billion of indirect participant Treasury reverse repo activity and $605 billion of indirect participant Treasury cash activity – a total of some $1.63 trillion daily.
Implications for Market Participants
The immediate effect of the expanded clearing proposal is that more firms will need to either become direct FICC members or clear their Treasury activity through a member, which would act as its clearing intermediary.
The survey, however, revealed that respondents do not understand FICC’s various access models and that most members are unsure which model to use for indirect participant activity. Specifically, 52% said they were unsure which model to use for Treasury reverse repo and Treasury repo activity, while 58% said they were unsure which to use for indirect participant Treasury cash activity.
FICC currently offers a variety of different direct and indirect participation options for buy-side and sell-side market participants to allow firms to tailor access to FICC to the manner that best meets their business and regulatory needs. Consistent with its regulatory obligations, FICC has established clear and objective membership requirements for each membership category. Its minimum membership standards are designed to provide fair and open access for firms but are also robust enough to allow FICC to manage the associated material risks.
Membership models include Netting Membership, Centrally Cleared Institutional Tri-Party (CCIT™) Service Membership and sponsored membership. Due to their direct relationships with FICC, both Netting Memberships and CCIT™ Memberships are considered direct participation models under the SEC proposal. Sponsored membership, on the other hand, would be considered an indirect participation model. FICC also offers market participants that are not FICC / GSD members indirect access through an intermediary which participates in either its Prime Broker Clearing or Correspondent Clearing Services.
Changes to Margin Collection and Segregation
The proposal would also mean significant changes to margin collection and account segregation. Currently, FICC generally does not require members’ proprietary, or “house,” activity be segregated from the cleared activity of the members’ customers. However, the SEC proposal, as written, would require FICC to calculate, collect and hold house and customer margin separately, although there would be an option to calculate and collect margin on a gross or net basis, depending on the clearing model the member selects.
FICC also expects the increased indirect participant Treasury volume to correspondingly increase the Value at Risk (VaR) margin, which it conservatively estimates at $26.6 billion across the FICC / GSD membership. This assumes all additional indirect participant activity clears through one of the FICC’s gross margin models, but this could be lower if activity clears through a net margin model.
The survey revealed that respondents do not understand FICC’s various access models and that most members are unsure which model to use for indirect participant activity.
Addressing Other Concerns Raised
The survey also uncovered a variety of concerns by market participants, many of which can be addressed by existing FICC tools and service options. This indicates market participants are unaware of the range of resources FICC offers.
For example, the survey found that only 58% of FICC / GSD netting members use the FICC VaR calculator, an online, interactive, web-based tool to estimate clearing fund requirements. In response, FICC will develop and publicize additional educational tools to help members understand how to use the VaR calculator.
A majority (56%) of respondents also said they were not familiar with USTClearing.com, a microsite the FICC launched in 2022 that serves as a central hub for information, such as FICC’s various Treasury activity services, its direct and indirect participation models, its risk management practices, and governance. FICC will similarly increase industry outreach to raise microsite awareness to encourage greater use.
We are committed to working with members, their clients, the broader market, and public-sector stakeholders to understand the impact of and to prepare for expanded clearing requirements. The survey underscores the need to redouble efforts to engage with the industry to ensure a smooth transition should the SEC implement its proposed changes.