Central clearing of Treasuries should not follow the template laid out by the derivatives market, the market's main clearinghouse has warned, amid increased expectation of meaningful reforms to the world’s most important financial market.
A new paper from Depository Trust & Clearing Corp argues that the broad consensus for Treasuries clearing means that focus should now shift to how such a mandate should be implemented.
But it says copying derivatives reforms that were implemented in response to the 2008 financial crisis would be inappropriate given significant differences between the two markets, particularly the range of different participants trading Treasuries.
"The Treasury market is far more diverse than the derivatives market. One size is not going to fit all in terms of clearing models,” said Laura Klimpel, general manager of the Fixed Income Clearing Corp, the Treasuries clearinghouse the DTCC runs, in an interview with IFR.
“We are fervent believers in open access to clearing. It’s important when thinking about a possible clearing mandate to ensure that participants have the flexibility they need."
Clearinghouses act as middlemen in financial transactions to stop losses cascading through the wider system if one of the counterparties defaults before the trade is completed, usually the business day after a trade is agreed in the case of Treasuries.
Around three-quarters of Treasury trades aren’t centrally cleared, according to Federal Reserve data. But that looks set to change following widespread agreement among regulators, academics and market participants that the US$21trn Treasury market is in need of reform in the wake of several episodes of extreme volatility.
That has sparked a fierce debate about how key market infrastructure should be organised, pitting principal trading firms (which account for a large chunk of Treasuries volumes and mostly don’t clear) against traditional investment banks (which do clear trades).
The FIA Principal Traders Group, a trade body representing PTFs, has said it supports Treasuries clearing while arguing the current set-up is not fit for purpose. It tabled proposals in a July white paper that have the potential to alter Treasury market infrastructure drastically. In particular, it noted limitations with one of FICC’s clearing models and drew parallels to derivatives market reforms where regulators moved to ensure fair access to clearing for clients.
In its latest paper, DTCC said there are significant differences between derivatives and Treasury markets, including the range of participants involved and how trades can be executed. In many cases, DTCC said, participants prefer to bundle clearing and trading relationships together to avoid paying separate clearing fees (which can be problematic for heavily regulated clients such as money-market funds). Prohibiting this model of clearing would shut out an important part of the market, it said.
“There’s a lot of participants, such as money-market funds, that aren’t able to compensate a clearing intermediary other than through a spread. Not all clients are able to post margin or pay fees. They’re not set up operationally to do that,” said Klimpel. “We are definitely open to making changes but we also want to make sure we preserve other clearing models that are working well for other communities."
Klimpel pointed to a couple of areas where additional tweaks to clearing should be implemented to better suit PTFs, particularly around cross-margining and high-frequency trading. PTFs turn over large volumes of trades on razor-thin margins, making them keenly focused on costs.
“Our discourse with the PTF community has been productive. We both support increased clearing of Treasuries,” said Klimpel. “We think there are opportunities for PTFs to find clearing intermediaries that are willing to work with their business models."