SEC Seeks Comment on Treasury Clearing Rule Exemption
Commentary by Steven Lofchie
The SEC solicited public comments on a request for exemptive relief from certain foreign financial institutions and their non-U.S. clients from mandatory U.S. Treasury clearing requirements.
In the notice, the SEC addressed industry uncertainty regarding the extraterritorial reach of mandatory central clearing for U.S. Treasury securities. The SEC explained that non-U.S. firms trading with non-U.S. institutions have not centrally cleared these trades, but if one party is a "direct participant of a U.S. Treasury" clearing agency, the transaction currently falls under the new trade submission requirements (SEA Section 36(a) ("General exemptive authority") and Rule 17ad-22(e)(18)(iv) ("Standards for clearing agencies"). The definition of a U.S. person relies on Exchange Act Rule 3a71-3 ("Cross-border security-based swap dealing activity").
In requesting the relief, the Institute of International Bankers warned that applying these clearing mandates to trades executed entirely outside the United States creates significant legal, operational, and market risks. These risks include the uncertain enforceability of netting rules in foreign jurisdictions, a lack of 24-hour clearing agency operations, and time-zone challenges. The association cautioned that these burdens could drive foreign investors away from U.S. Treasuries, potentially "increas[ing] U.S. ... borrowing costs and impair[ing] ... market liquidity.
The SEC said it is seeking public comment on whether to grant an exemption for transactions occurring entirely outside the United States. The proposed relief would apply when the only connection to the U.S. is that one foreign institution party is a "direct participant of a U.S. Treasury" clearing agency. The SEC said it seeks to determine if this relief will prevent unnecessary frictions in the market while maintaining the benefits of central clearing.
The requested relief was conditioned on the transaction being strictly between a "Non-U.S. Participant" and a "Non-U.S. Client." To qualify, neither party can be a U.S. person, a U.S. branch of a non-U.S. person, or a non-U.S. person whose obligations are guaranteed by a U.S. person. Additionally, the SEC asked commenters to weigh in on whether further conditions should be imposed, such as an "activity limit threshold" that would only exempt these transactions if they do not "surpass a specific portion" of the participant's overall U.S. Treasury market activity.
Comments must be submitted within 30 days following publication in the Federal Register.
Commentary
It is simply remarkable that a new mandate with such extraordinary impact on the financial markets could have been adopted with so little study and on such a fast timetable, with so few of the necessary market technology and operational infrastructure pieces in place.
While the new SEC pushed back the timetable a bit, and addressed some of the burdens (e.g, mixed CUSIP), a lot of uncertainty as to market acceptance remains. The costs of failure seem much greater than the benefits of success. At a minimum, it seems prudent to measure the impact of the mandate on U.S. participants before extending the mandate overseas, particularly given that the level of preparedness outside the United States is lower.
The analogy to the swaps market that was used is flawed for a number of reasons, including: (i) the implementation of the mandate was given much more time in the swaps market; (ii) similar clearing mandates were being imposed globally; and (iii) driving some participants out of the swaps market does not have the same negative consequences as does driving buyers out of the U.S. government securities markets.