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How the SEC’s US Treasury Clearing Mandate for Cash and Repo Transactions Impacts Market Participants

A guest blog post by Ernst & Young LLP on the recently finalized rules from the U.S. Securities and Exchange Commission regarding its Standards for Covered Clearing Agencies for U.S. Treasury Securities and Application of the Broker-Dealer Customer Protection Rule with Respect to U.S. Treasury Securities.

The following is a guest blog post by Ernst & Young LLP on the recently finalized rules from the U.S. Securities and Exchange Commission regarding its Standards for Covered Clearing Agencies for U.S. Treasury Securities and Application of the Broker-Dealer Customer Protection Rule with Respect to U.S. Treasury Securities. The U.S. Treasury market is a bedrock of the global financial system. SIFMA supports broad policy objectives to enhance its resiliency and capacity through carefully calibrated reforms, including through increasing central clearing. Learn more here.

What are the key requirements of the SEC’s U.S. Treasury (UST) central clearing final rule?

The final UST clearing rule was approved by the Securities and Exchange Commission (SEC) on December 13, 2023, and mandates that secondary trading of in-scope transactions be cleared via a covered clearing agency (CCA). Currently, the Fixed Income Clearing Corporation (FICC), a subsidiary of the Depository Trust and Clearing Corporation, is the only UST CCA.

In-scope transactions that must be cleared by CCAs and compliance dates are as follows:

  1. UST cash purchases and sales have a compliance date of December 31, 2025, for transactions:
    • Entered by direct participants that are interdealer brokers
    • Between clearing members and certain other firm types (e.g., registered broker-dealers, government securities broker-dealers)
  2. UST repo and reverse repo transactions have a compliance date of June 30, 2026, for the direct participants of a UST securities CCA with the requirement to clear eligible secondary market transactions (e.g., repo or reverse repo agreements collateralized by UST securities)

CCAs in the UST market must adopt policies and procedures designed to require their members to submit the transactions listed above for clearing and take steps to facilitate access to clearing for additional market participants (e.g., pension funds, asset managers). CCAs will also be required to collect margin separately for house and customer transactions. Lastly, the rule impacts 15c3-3 reserve calculations and permits margin required and deposited with a clearing agency to be included as a debit in reserve formula calculations, subject to certain conditions.

Key CCA implementation dates are as follows:

  1. CCA rulebook updates are due by March 18, 2024.
  2. CCA implementation of enhanced practices is required by March 31, 2025, and is expected to include risk management practices, margin practices, customer asset protection and market access expansion.

Based on CCA rulebook updates and anticipated enhanced practices, market participants will be met with varying degrees of requirements and actions based on firm type, size, current capabilities and clearing model.

Notable operational impacts that dealers will need to implement by the same March 31, 2025 compliance date related to reserves and margin include:

  1. Updating the 15c3-3 calculation to include the debit calculation component (for those that plan to take the debit)
  2. Updating possession and control calculation to demonstrate effective segregation and possession and control of customer assets
  3. Bifurcating margin flows between house and client activity, inclusive of client account-level granularity

Who is impacted by this new rule?

Market participants across the sell side and buy side will be impacted in different ways; however, the adopted rule will have material impacts to broker-dealers and institutional investors. The approved rule includes several exemptions and a longer implementation timeline than originally expected, giving market participants an opportunity to assess the impact of these changes and evaluate their strategies and implementation paths.

Notable exemptions / exclusions from eligible secondary market transactions include:

  1. Cash transactions between a direct participant and either a hedge fund or leveraged account
  2. Inter-affiliate activity, subject to certain conditions
  3. Instances in which one counterparty is a central bank, a sovereign entity, an international financial institution and/or a natural person
  4. Repos or reverse repos in which one counterparty is a state or local government, or between a direct participant and an affiliated counterparty, as long as the affiliated counterparty submits for clearance and settlement all other repurchase and reverse repurchase agreements to which the affiliate is a party

What are some key considerations for market participants today?

Market participants will need to make material changes to their strategies, business models and operating infrastructure to either offer or maintain UST market access under the clearing mandate.

Key items for market participants to consider include the following:

  1. UST trading and front office strategy. Current and/or aspirational UST clearing access models (direct membership, sponsored, sponsoring, etc.) should be assessed and aligned to the market participant’s business strategy. Identifying the desired UST target state in short order is critical in verifying that required transformation efforts are complete prior to rule compliance dates.
  2. Clearing models and technology. Depending on the existing UST clearing models and supporting infrastructure, firms may require significant internal technology uplift and/or third-party platform implementation to support the desired UST target state.
  3. Operating model and capacity. Government settlements and middle office functions will have to be reviewed as part of general operating model changes. Confirming that operations teams have the tools and capacity to operate in a cleared environment at a greater scale will be critical in determining the proper path forward.
  4. Margin requirements. The rule may yield an increase in margin requirements due to an increase in clearing activity and introduce segregation requirements for direct vs. indirect participants. There are differing impacts to sell- and buy-side firms. The UST clearing mandate will introduce the need for initial margin and increase guaranteed fund requirements. Additionally, further calculation tooling, intraday enhancements and what-if analysis will need to be considered for market participants’ margin infrastructure.
  5. 15c3-3 impacts and amendments. There are various impacts and amendments to the rule, including debits and credits impacting customer and PAB reserve formulas, including the ability to deduct margin passed to the CCAs from the reserve amount.
  6. Risk management updates. Central clearing targets the reduction of counterparty credit risk by redirecting activity to a CCA’s centralized netting and risk management system. The rule also introduces the need to set limits for in-scope activity, which will need to be understood by all participants as they determine if a multi-clearing model is required for their activity or if they can access the system through a single sponsored provider.
  7. Adjacent regulatory impacts. Banks will have to assess the impact to risk-based capital and supplemental leverage ratio-based capital that the broker/bank has to hold to support clearing-related activities. The SEC has also proposed an expanded definition of a dealer that, if approved, will capture a large volume of buy-side firms into the cash and financing elements of this rule.

What CCA rulebook clarifications are needed for implementation?

The industry is awaiting final CCA rulebook updates and outstanding industry consensus around key items with significant impact, including, but not limited to, repapering, give-ups/ins, international membership, mix trades partially collateralized with UST and related items. Rulebook updates from CCAs are due by March 18, 2024.

What can firms initiate now to prepare for the UST central clearing initiative?

For UST market participants, it is critical to manage a key risk arising from the clearing mandate in maintaining market access through brokers, sponsors and/or via CCA direct membership. Market participants should continue to educate themselves on the final rule requirements and anticipated impacts utilizing materials publicly available from the SEC, industry bodies (e.g., SIFMA) and third-party subject-matter advisors. Additionally, participation in industry forums, such as SIFMA, will provide access to leading insights and information on how the market is approaching the rule and a platform for firms to influence industry decisions. To learn more from the SEC, please review the SEC Final Rule and the associated Fact Sheet.

In parallel with rule analysis, impact gathering and business strategy development, market participants should also look to:

  1. Review current UST market access and capabilities supported by internal data and metrics.
  2. Determine the appropriate UST clearing access model to best serve internal needs (e.g., affiliated entities, treasury, funding) and external parties (e.g., clients, brokers, interdealer brokers).
  3. Assess current capabilities for alignment to target state and timely UST clearing mandate compliance.
  4. Develop a high-level roadmap through compliance and initiate required programs that may be high effort or longer duration (e.g., direct membership).

To learn more about how EY teams are addressing the topic, please reach out to Mark Nichols, Neal H. Ullman, Brendan Maher and Ray Agoglia.

The views reflected in this article are the views of the authors and do not necessarily reflect the views of Ernst & Young LLP or other members of the global EY organization.

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Ray Agoglia, Senior Manager – Ernst & Young LLP
Brendan Maher, Managing Director – Ernst & Young LLP
Mark Nichols, Principal – Ernst & Young LLP
Neal H. Ullman, Managing Director – Ernst & Young LLP

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