Lynn Strongin Dodds looks at the different reports assessing the challenges the new SEC clearing and repo mandates will have on industry participants.
Sell-side firms that will provide clearing services under the Securities and Exchange Commission’s (SEC) treasury and repo clearing mandates are concerned about the economics and implementation deadline, according to a new report – US Treasury Markets: Plotting the Sell-Side’s Path to Mandatory Clearing, from Acuiti in partnership with ION.
The SEC legislation, which aims to enhance transparency, stability, and resilience in the $27 tr Treasury market, is considered to be one of the most significant shifts in US capital markets for decades. Under the current timeline, cash Treasury clearing will go live by the end of next year, while the repo clearing is set to take effect on 30 June 2026.
In a December 13, 2023, statement, the SEC Chair Gary Gensler said that “having a significant portion of the Treasury markets uncleared — 70% to 80% of the Treasury funding market and at least 80% of the cash markets — increases system-wide risk”. There are varied risk management and margin practices across different institutions, with trading counterparties exposed to each other’s creditworthiness.
A separate report – US Treasury Central Clearing: Industry Considerations Report – from EY and SIFMA – concurs noting the new legislative blueprint will drive several changes to the overall U.S. Treasury market structure and require the integration of market participants who will now be obliged to centrally clear transactions for the first time.
The Acuiti report, which surveyed or interviewed senior executives at the major future commission merchants (FCMs) and banks, highlighted the key challenges. Top of the list was the significant uncertainty about the viability of current mandate deadlines, with 48% saying the repo deadline was unlikely or impossible while 31% felt the same for the cash cut off.
Respondents also voiced concerns over the nuts and bolts of implementation with over three quarters calling for a staggered approach to repo clearing, either determined by thresholds, as when the Uncleared Margin Rule (UMR) was introduced, or by client type. Some market participants expect that either an extended deadline or phased-in approach will be introduced as the deadline nears.
There also remains widespread doubt that current sell-side models and infrastructure can scale to meet incoming demand. This was especially the case regarding the done-with structure which forms part of the successful sponsored model and bundles clearing and execution services together, that is handled by the dealer that serves as sponsor.
The general consensus was that making this an obligation would limit competition and increase cost as well as complexity. For clients that need multiple clearing relationships, Acuiti said there was a threat that gross margin requirements would balloon from the exposure to several repo counterparties and sponsors which in turn would be difficult to net down.
By contrast, market participants were more positive with the done away models which are used by FCMs allowing clients to execute trades with one counterparty and then clear the transaction through a separate clearing relationship. Many believe they are more scalable for the industry, and central counterparties (CCPs) are in the process of developing their own variations.
Cost overall is a major worry for over 80% of respondents. It is not just about the compliance checklist but also the pressure the new rules will put on the benefits of the FICC sponsored model which until now has been the only clearing house to offer Treasury clearing. Many of the biggest clients typically pay no or minimal haircuts or margin when trading repo under sponsorship. This is because their exposures are netted down in the dealer clearing pools that they are a part of.
As with any regulatory change, technology will be the linchpin. FCMs are planning to increase automation and reduce overheads in what is likely to be a high-volume, low-margin business. It is still early days but almost two-thirds expect to work with third-party vendors for some or all of the required build.
While there will be short term pain, the report notes looking ahead, there will be “an enormous opportunity for those who can create new efficiencies both for clients and themselves. Cross-margining, capital efficiencies and straight through processing (STP) all on offer to those firms that can best understand and adapt to the new paradigm.”
*Related clearing and treasury articles.
