Sia Partners Identifies Market Concerns Over SEC Central Clearing Proposal

Steven Lofchie Commentary by Steven Lofchie

Sia Partners, a global management consultancy, identified key market concerns over an SEC proposal that would require U.S. Treasury security transactions and repurchase agreements ("repos") to be centrally cleared. The findings of the independent study were presented in a report issued in early March 2023.

SEC Proposal

As previously covered, the SEC proposed amendments that would require covered clearing agencies that provide central counterparty services for Treasury securities (i.e. the Fixed Income Clearing Corporation ("FICC")) to require its members to centrally clear many of their repo transactions in Treasury securities. The proposal would amend Exchange Act Rule 17Ad-22 ("Standards for clearing agencies") to effectively require that every FICC direct participant centrally clear all secondary transactions in Treasury securities if:

  • the counterparty is a direct participant in the FICC;
  • the direct participant is acting as riskless principal or intermediary between multiple buyers and sellers; and
  • the counterparty is an SEC-registered broker-dealer, a government securities dealer, or certain leveraged accounts or funds.

Findings from Sia Report

In a report submitted to the SEC, Sia highlighted that survey respondents, which included dozens of one-on-one interviews with many of the largest banks and institutional investors globally, cited the need for additional data in order to assess the impact of the proposed mandatory approach on markets. Sia said that firms asked whether:

  • studies reviewing market impact incorporate the economic costs versus benefits of investments that would need to be made by the industry to (i) create a "substantial infrastructure upgrade" and (ii) make legal adjustments to agreements;
  • studies have examined how central clearing for repos and treasuries would impact liquidity in disrupted markets; and
  • alternative solutions have been evaluated, such as (i) expanded netting feature, (ii) decreasing capital requirements on banks in order to increase liquidity or (iii) standardizing margin requirements.

Further, Sia called for a "careful review" of the ability of the FICC to be the sole provider of clearing and questioned whether it has the operational infrastructure to address new threats and risk challenges.

In its report, Sia identified three common concerns among the study participants.

  1. Absence of research or analytical support. Sia reported that participants believed there was a "nearly complete absence" of research or analytical support for the "wide ranging" proposal for mandatory central clearing. Participants asserted that the proposal requires a "compelling set of data" in order to support its "broad" reach across varying types of financial markets.
  2. Policy objectives suggesting that central clearing will reduce risk. Participants expressed doubt that the policy objectives set forth by the SEC and other regulators can be achieved by the proposal; specifically, the claims that central clearing would (i) reduce risk in the financial markets, (ii) increase liquidity and (iii) increase firm participants in the Treasury and repo markets. The study concluded that there is no basis to support these claims and that the proposed amendments may increase concentration risk across markets while not decreasing counterparty risk in a meaningful manner.
  3. Operational, system, and infrastructure challenges. Participants pointed to the "immense" challenges that both individual firms that would be clearing with the FICC, and the FICC itself, would face under the proposal. SIA stated that participants questioned whether the FICC would be able to meet the obligations set forth under the proposal. Participants added that the FICC would need "enormous" investments to accommodate the increase in participants who would require sponsorships and clearing facilitation.

Commentary

The SEC has been lately focused on cybersecurity. Given that focus, the proposal to mandate central clearing of U.S. Treasuries to a single central counterparty seems a tremendous risk. A cyberattack on the FICC would bring a stop not only to the market in U.S. Treasuries (as if that is not enough), but numerous other markets that depend on the movement of Treasuries to move collateral, and money market mutual funds (and no doubt the list of horribles could go on for quite some length). If one is genuinely worried about cybersecurity risk (and it is a cause for genuine concern), wouldn't it be better to tolerate the existence of market structures that, even if not perfect, do not have a single point of failure to much of the U.S. financial system?  

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