(Dec 13): Hedge funds and brokerages are getting new requirements from the Securities and Exchange Commission to centrally clear far more of their US Treasuries trades in a major structural overhaul for the US$26 trillion market.
The SEC will vote Wednesday to require that all transactions involving repurchase agreements use clearing houses, which serve as a backstop by sitting between buyers and sellers. In a partial win for hedge funds, they would be exempt from having to centrally clear their cash Treasuries trades, according to the agency. Still, the new rules could bolster oversight of highly leveraged strategies such as the so-called basis trade — which use the repo market and that US officials say can pose broad dangers.
The new regulation is a signature policy effort for Chair Gary Gensler, who has argued that central clearing reduces risks and that trading by private funds is too opaque. He has also said only a fraction of Treasuries transactions goes through clearinghouses, even as they have become a fixture in other assets.
Although there hasn’t been a major blowup in the Treasuries market since the pandemic-sparked chaos of early 2020, concerns over liquidity persist. Massive Federal Reserve buying of the government debt helped stabilize the market.
For government securities dealers and brokers, the SEC’s new central clearing mandate would apply to Treasuries transactions in both the cash and repurchase markets, according to the SEC. In a repo agreement, one party provides securities as collateral to another in exchange for cash.
The SEC had proposed last year that hedge funds also would have to centrally clear Treasuries trades in the cash market. It’s unclear whether the decision to drop that from the final rule will satisfy critics, who called the original plan unworkable and said it may force companies to exit the market. Hedge funds are already challenging multiple SEC regulations.
Ahead of Wednesday’s meeting, an SEC official told reporters that the agency wasn’t including cash Treasuries transactions by hedge funds in the central-clearing mandate because most of the perceived risks from trading by those firms would be addressed in the repo market.
Gensler has said central clearing for Treasuries is a way to reduce risks of instability for the broader financial system.
The SEC chief has expressed particular concern with the basis trade, which involves using leverage to profit from the price gap between Treasury futures and the underlying cash market. Borrowing in the repurchase market using Treasuries as collateral has soared in recent years to almost US$3 trillion.
Executives at Citigroup Inc and CME Group Inc, among others, have voiced support for the popular trade, which they say provides needed liquidity for government bonds.
Recent spikes
Some in the industry are likely to welcome the new SEC mandate. Recent spikes in repo lending rates caused a stir in the overnight funding market, unsettling some traders.
Some Wall Street strategists have said that they see more benefits to expanding central clearing to just the repo side of Treasuries, whereas the cost of centrally clearing cash Treasuries might outweigh the benefits.
The SEC plans to give clearinghouses until March 31, 2025 to update their procedures and infrastructure to comply with the rule. Market participants would have to start clearing their cash Treasuries trades by Dec 31, 2025, and their repo transactions by June 30, 2026, according to the SEC.
Currently, only one clearing house exists for Treasuries, the Fixed Income Clearing Corp, a subsidiary of the Depository Trust & Clearing Corp. The DTCC has urged the SEC to require more parties to centrally clear their Treasuries transactions.
