US authorities are determined to strengthen the resiliency of the US Treasury market after a series of stress events, most recently at the start of coronavirus pandemic, which resulted in severe market dysfunction and disruption. Regulators are looking at this problem from a variety of perspectives, but a key part of the conversation is whether increased central clearing of Treasury securities and repos would help. Given the pivotal role of the US Treasury market in all parts of the financial system, including derivatives, we think it’s important to consider this carefully and forensically before any specific policy proposals are thrashed out. That’s why we’ve published a new market survey to gather views on the operational, legal and regulatory implications of increased clearing, as well as to determine the impact on derivatives.

As it stands, a relatively small proportion of the overall Treasury securities and repo markets is centrally cleared – the Treasury Market Practices Group, for example, estimates that roughly 13% of US Treasury securities are fully cleared and a further 19% are cleared on one leg of the trade only. While derivatives are very different products with a different risk profile, approximately 75% of over-the-counter interest rate derivatives notional outstanding was cleared as of the end of June 2021, according to the Bank for International Settlements.

In a July 2021 paper on the US Treasury Markets, the Group-of-30 (G-30) Working Group on Treasury Market Liquidity recommended that all Treasury securities trades executed on electronic interdealer trading platforms should be cleared, along with all Treasury repos (including those between dealers and clients). The paper also recommended that regulators and market participants should continue to look into potential clearing of dealer-to-client cash Treasury trades. This is just one paper – another published in November by an interagency working group comprising the US Treasury, the Federal Reserve Board, the Federal Reserve Bank of New York, the Commodity Futures Trading Commission and the Securities and Exchange Commission (SEC) also raised the prospect of greater clearing of US Treasury securities and repos.

Both those papers highlighted a number of possible benefits, including a reduction in counterparty credit risk via margin requirements and the netting of exposures, which could free balance sheet capacity for intermediaries. They also pointed to increased transparency in risk management practices and, with less focus on bilateral counterparty credit risk, the potential for smaller firms to act as liquidity providers.

However, they also identified some potential impacts that need to be considered – for example, higher costs due to clearing fees and margin requirements, which may actually cause some firms to reduce their activity, negatively affecting the supply of liquidity. Increased clearing also means greater concentration of risk in central counterparties.

Both the benefits and costs will affect different products and participants in different ways, so it’s important this issue is considered from varying perspectives. Our Treasury clearing survey attempts to do this by asking questions about the potential benefits and costs in the cash Treasury and repo markets from the viewpoints of dealers, principal trading firms and clients. We ultimately intend to publish the results on an anonymized and aggregated basis, hopefully in time for our Annual General Meeting in Madrid on May 10-12.

Of course, increased central clearing of Treasury securities and repos isn’t the only proposed approach to improving the resiliency of the US Treasury markets. The G-30 paper also recommends US prudential regulators review certain provisions like the leverage ratio to avoid disincentivizing market intermediation without weakening the overall resilience of the financial system. We agree this is something that should be considered – ISDA’s view is that the rules should result in capital levels that are appropriate to the level of risk so banks can efficiently allocate capital and support US Treasury markets.

Other changes to strengthen the Treasury market are already in train, including SEC proposals to extend rules on investor and cybersecurity protection to alternative trading systems that trade Treasury and other government securities.

Our mission is to foster safe and efficient markets, so we support the high-level aims of US regulators to enhance the resilience of the US Treasury market and to increase, diversify and stabilize market-making capacity in this critical sector. We hope the results of our survey will help inform the work of policy-makers as they flesh out their position on clearing.

Click here to access the survey.

More information on the ISDA Annual General Meeting is available here.