On December 13, 2023, SEC adopted the final rules for enhancing the risk management practices for central clearing in the US treasury market and facilitate additional clearing of US treasury securities transactions. Let us look at the scope, timelines and how it impacts the US treasury market.

1. Current State:

The US Treasury market is worth 26 trillion dollars and is a key pillar of global capital markets. Fixed Income Clearing Corporation (FICC) is the subsidiary of DTCC and is the only central counterparty (also referred to as covered clearing agency) for US treasury market.

However, it is estimated that only a small portion of treasury activity is centrally cleared.

• 80 percent of the treasury cash market is uncleared.
• 70 to 80 percent of treasury repo market collateralized by US treasury is uncleared.

Treasury transactions involving banks, broker-dealers leveraging interdealer broker platforms are predominantly covered for clearing by FICC. However, transactions involving hedge funds, and principal trading firms (PTFs) leveraging interdealer broker platforms largely remain outside the scope of central clearing. The proportion of transactions that are centrally cleared has declined over the past years with a significant rise in the trading activity of PTFs in US treasury securities. Bilateral clearing of a large part of the US treasury market could potentially impact the smooth functioning of the market and potentially causes liquidity risk. To address these concerns, SEC published draft rules for US treasury central clearing on September 14, 2022, and final rules on December 13, 2023.

2. Key highlights of SEC proposals:

SEC final rules broadly cover expanding the scope of central clearing of US treasury securities and enhancements to customer clearing. The benefits of increased central clearing include reduced systemic risk, improved transparency and liquidity, and enhanced regulatory oversight.

Expanding scope of central clearing of US treasury securities: SEC rules require direct participants of covered clearing agencies (CCAs) to submit the following eligible secondary market transactions for central clearing. Rules permit the exclusion of transactions involving certain counterparties like central banks and sovereign entities from central clearing.

• All repo and reverse repo transactions collateralized by US treasury securities to which a direct participant is a counterparty.
• All purchase and sale transactions of US treasury securities by direct participants who are acting as interdealer brokers.
• All purchase and sale transactions of US treasury securities between a direct participant and a registered broker-dealer and a government securities dealer or broker.

Access to CCAs: CCAs are required to offer appropriate clearing access models catering to the needs of diverse market participants.

Separate margin for house and client activity: CCAs need to calculate, collect, and hold margin separately for their direct participants’ proprietary transactions and client transactions.

Broker-dealer customer protection rule amendment: Amendment to rule 15c3-3a permits onward posting of customer margin to CCA by broker-dealer subjected to certain conditions.

3. Implications to broker-dealers:

Majority of large broker-dealers are already direct participants of FICC, and the requirements include offering enhanced customer clearing models to clients, rapid onboarding of clients seeking FICC access including the sponsored membership to meet the anticipated surge in demand from clients, determine eligible transactions for increased central clearing. Key business capabilities impacted include client onboarding, clearing and settlement, margin and collateral management, and compliance.

Broker-dealers, who bilaterally clear all their cash and repo transactions in US treasury securities need to evaluate FICC’s direct and indirect access models and choose the right access model that fits their purpose.

4. Implications to buy-side firms:

Registered funds and hedge funds are important players in the US treasury market. Repo and reverse repo transactions between funds and direct participants of CCAs are eligible for central clearing. A few funds are already indirect participants of FICC and centrally clear their cash and repo transactions in US treasury securities voluntarily.

Firms which bilaterally clear their repo and reverse repo transactions collateralized by US treasury securities need to evaluate the available FICC’s direct and indirect access models. Key considerations for direct membership include capital considerations, firm’s jurisdiction, clearing fund and capped contingent liquidity facility (CCLF) obligations. Key considerations for indirect membership are margin contribution to broker, gross or net margining, sponsored or agent clearing, and clearing capability of done away trades. FICC’s sponsored membership model appears to be the most preferred access model and industry anticipates the surge in requests from buy-side firms seeking FICC’s sponsored membership. Key business capabilities impacted would be account setup with brokers, trade processing, margin and collateral management, and compliance.

5. Timelines:

SEC final rules on US treasury central clearing will go live in multiple phases.

March 31, 2025:

• Separation of house and customer margin
• Broker-dealer customer protection rule amendment
• Access to central clearing

December 31, 2025:

• Central clearing of eligible secondary market cash transactions in US treasury securities

June 30, 2026:

• Central clearing of eligible repo and reverse repo transactions collateralized by US treasury securities.

 6. Summary:

SEC rules to mandate additional central clearing for the US treasury market is considered as one of the significant regulations that has a wide range of impacts in the US treasury market. Covered clearing agencies, banks, broker-dealers, interdealer brokers, registered funds, hedge funds and PTFs need to consider following impacts on the road to implement this important regulatory initiative.

• Account setup and onboarding of clients of clearing members
• Central clearing of additional cash and repo transactions in US treasury securities
• Margin and collateral segregation
• Member and regulatory reporting
• Scalability of systems to handle increased volumes.