SEC Proposes Expanded Mandatory Central Clearing of Treasury Trades and Repos
Commentary by Steven Lofchie
The SEC proposed amendments that would require covered clearing agencies that provide central counterparty services for Treasury securities to require its members to centrally clear a significant number of their repo transactions in Treasury securities. There is only one such clearing agency - the Fixed Income Clearing Corporation ("FICC").
The proposal, which would amend SEA Rule 17Ad-22 ("Standards for clearing agencies"), would effectively require that every FICC direct participant centrally clear all transactions in Treasury securities if:
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the counterparty is a direct participant in FICC;
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the direct participant is acting as riskless principal or intermediary between multiple buyers and sellers; and
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the counterparty is an SEC-registered broker-dealer, a government securities dealer, an account held at the foregoing that gets more than 2-1 leverage, or a hedge fund.
The above requirement would not apply where the counterparty is a central bank, sovereign entity, international financial institution or natural person.
The clearing agency would be required to separate calculations for margin where the direct participant was acting for itself and where the direct participant was clearing for others.
In light of the significantly increased margin that a broker-dealer could now be required to keep at the FICC, SEA Rule 15c3-3 ("Customer protection-reserves and custody of securities") would be amended so that the margin the broker-dealer deposited at the FICC with respect to customer trades would serve to reduce the amount the broker-dealer had to deposit in its special reserve account.
The comment period will be 60 days following publication in the Federal Register.
SEC Chair Gary Gensler said "these rules would reduce risk across a vital part of our capital markets, both in normal and stress times." Commissioner Jaime Lizárraga added the proposal "is an important step in enhancing visibility into and lowering risk in the Treasury market."
SEC Commissioner Hester M. Peirce agreed that increased clearing would have benefits for the Treasury market, but she disapproved of the broad expansion of the mandatory clearing requirement. She posed a set of questions addressing deficiencies identified in the proposal. Commissioner Mark T. Uyeda stated that the proposal "takes an important step in seeking an improved regulatory framework for the central clearing of Treasury securities[,]" but encouraged the SEC to strongly consider public comment when drafting the final rule.
Commentary
In mandating central clearing, regulators always insist that transactions in that product have now become safer. The real question is whether the markets - including those products that are not centrally cleared - have become safer.
The problem with central clearing is that central clearing corporations can raise their margin requirements freely during times of stress. The margin they demand during a stress period may be generated by market participants selling off other positions, including treasuries, and thus higher margins on these selected products can damage other products. As mandatory central clearing expands beyond futures and swaps, the scope of products as to which the clearing organization can demand more margin likewise increases, and thus the risk that an increase in such margins will cause a sell off.
A further risk of centralizing clearing is that margin requirements may be set too high, raising the cost of funding positions in Treasury securities. The more those costs rise, the more expensive the national debt becomes to maintain.