Investing in Resilience Amid the US Treasury Clearance Rule
There are three key areas where uncertainties and challenges remain. Firstly, there are different provisions of the SEC clearing rule that require the clearing of certain inter-affiliate transactions.
In the final rule, the SEC responded to market feedback to allow transactions between a member of a Covered Clearing Agency (CCA) and their affiliate to remain outside of the clearing rule, because such transactions are often done for liquidity and collateral management reasons. However, that exemption is conditional. If an affiliate enters into additional outward-facing transactions with clients, those trades must then be centrally cleared. The SEC wanted to avoid firms restructuring their repo activity and moving it to affiliates in order to avoid the clearing rule.
The industry has asked for additional flexibility to allow affiliates to do a small portion of their activity on a non-centrally cleared basis. The view is that firms should not have to devote a large share of their resources to set up clearing a relatively small portion of their activity through affiliates that might be difficult to clear for operational or legal reasons, or because some clients are difficult to bring into central clearing. Some flexibility there could be helpful.
Another aspect of the rule that has garnered attention is its global nature, or ‘extraterritorial’ reach. The Treasury market is a global one, with market participants trading in the market in many different jurisdictions. The mandate requires central clearing of eligible transactions, irrespective of jurisdiction, or the type of firm that is engaging in the eligible activity with few exceptions. This makes sense, because a safe and liquid Treasury market benefits from having a consistent set of rules regardless of where you participate in the market.
There have been calls for greater flexibility in the treatment of transactions involving non-US counterparties. In cross-border and foreign-jurisdiction contexts, clearing certain trades can be more complex, whether because of time-zone differences or because some legal entity structures are more difficult to accommodate. A measured degree of flexibility for transactions involving non-US entities could therefore be beneficial, provided it is applied in a consistent and even-handed manner, without creating opportunities for evasion or an uneven playing field.
The second issue is around the development of a done-away clearing model. In the US Treasury market, the executing dealer would typically also clear the trade, meaning execution and clearing take place together — what is known as a done-with transaction. By contrast, in derivatives and certain other markets, execution and clearing can be separated, allowing a trade to be cleared away from the point of execution.
In market parlance, a done-away transaction is about separating the clearing and execution of a transaction. There may be firms that are well positioned to execute trades, and some that are well positioned to clear trades — those firms may not be the same.
At some point, there may be efficiencies if firms, who are comparatively well positioned to execute, can hand off the clearing of that trade to a firm that has more capital or margin efficiency and is able to clear transactions — that could broaden access within the US Treasury market to central clearing.
We have not seen that done-away clearing model develop yet, but over time we could see dealers face clearing capacity constraints, either because they run out of capital or margin funding capacity to clear their client activity. In that case they may want to turn to a third party that can clear trades with their clients so that they can continue to execute.
As we get closer to the deadlines, we might see some of the done-away clearing models evolve. Done-away clearing is something we can support in our BNY triparty infrastructure for any third-party clearing agent. We are also planning to create a done-away clearing agent service ourselves at BNY, acting as a third-party clearing agent for those using our triparty platform.
The third and final development is the innovation in clearing models that is happening, including as two new Treasury market CCPs launch. The Fixed Income Clearing Corporation (FICC) is the existing US Treasury CCP, and both CME and ICE have been approved as CCPs and are building out models to be able to clear. We are going to see some innovation in the Treasury market in terms of clearing, and market participants will be very interested to see those models and how they compare to the existing clearing models.
