SEC Chair Gary Gensler who previously supervised federal debt market management at the U.S. treasury, has advocated a move that requires almost all the treasury trading to move to a counterparty clearing house (CCP) a financial institution that serves as a mediator between investors and that takes care of all types of transactions.
What is the Main Goal of this Move ?
Once achieved, this initiative is meant to decrease the dangerous contagiousness emerging from a sudden collapse of any single financial institution. It is similar to the way authorities dealt with dependent interest-rates after the Lehman Brothers' downfall that caused global money markets great damage.
As the clearinghouse takes on the task of completing transactions, the risk associated with a counterparty's failure to fulfill a deal is substantially mitigated. However, this risk reduction comes at a cost. Investors will contend with increased management costs as the Securities and Exchange Commission's rules tighten under the governance of clearinghouses. Despite the heightened scrutiny on dealers in the event of a counterparty collapse, their increased productivity is anticipated, fueled by clients' unwavering commitment.
According to Gensler and fellow moderators, the initiative is meant to strengthen the resilience in the US Treasuries Market valued at $26 trillion, that has known a perpetuate unsettlement in recent years caused by unexpected freezes in trading.
“It is going to transform the way people interact with the market and the way that the market functions,” emphasized head of market structure at Bank of New York Mellon Corp Nathaniel Wuerffel and former president of domestic markets at the Federal Reserve Bank of New York. “This is by far the biggest of the reform efforts that regulators have been working on over recent years.”
Offshore investment funds have known a partial win in the SEC last month's unveiled rules. They were free from relying on the central clearing for cash trading of treasuries. Their activity has however been noticed in the repo market which can add up to $4 trillion on average per day, and a low percentage of 20% of that actually runs through a CCP.
CCPs will be tasked with setting norms for margins posted by dealers for their trades, a departure from what they traditionally set for their customers. This shift may constrain the basis trade of hedge funds, where leverage is often employed to capitalize on price differentials between Treasuries and futures.
What is Meant by the Basis Trade ? And why are Regulators Worried by it ?
In the present moment, only one CCP is available for treasuries ; the FICC. While there could be chances for new entrants, central clearing is a costly business to establish.
“We see this expansion to broaden participation in central clearing as a natural evolution that FICC is well-positioned to execute on,” a spokesperson for the DTCC said.
The CCP operates on the principle of preventing losses from affecting other firms. Platforms offer a default fund where bank members can deposit securities and cash, acting as a reserve for additional loss protection.
While members must pay for the reserve, the CCP's advantage includes a wider netting of trades between market members every day, which could uplift investors like big banks to take part in more Treasuries trading, which could help to boost liquidity.
The most expected future steps include The FICC's norm changes on issues like margins lining market structure with the SEC's rules. Another key point includes the finalizing of SEC rule in the following months that would require the registration of proprietary trading firms along with other private funds as securities dealers. With that done, more trading would be forced onto a clearinghouse.