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, 64610-64682 [2022-20288]

Download as PDF 64610 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules SECURITIES AND EXCHANGE COMMISSION 17 CFR Part 240 [Release No. 34–95763; File No. S7–23–22] RIN 3235–AN09 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 Securities and Exchange Commission. ACTION: Proposed rule. AGENCY: The Securities and Exchange Commission (‘‘Commission’’) proposes to amend the standards applicable to covered clearing agencies for U.S. Treasury securities to require that such covered clearing agencies have written policies and procedures reasonably designed to require that every direct participant of the covered clearing agency submit for clearance and settlement all eligible secondary market transactions in U.S. Treasury securities to which it is a counterparty. In addition, the Commission proposes additional amendments to the Covered Clearing Agency Standards, with respect to risk management. These requirements are designed to protect investors, reduce risk, and increase operational efficiency. Finally, the Commission proposes to amend the broker-dealer customer protection rule to permit margin required and on deposit with covered clearing agencies for U.S. Treasury securities to be included as a debit in the reserve formulas for accounts of customers and proprietary accounts of broker-dealers (‘‘PAB’’), subject to certain conditions. DATES: Comments should be received on or before December 27, 2022. ADDRESSES: Comments may be submitted by any of the following methods: SUMMARY: khammond on DSKJM1Z7X2PROD with PROPOSALS2 Electronic Comments • Use the Commission’s internet comment form (https://www.sec.gov/ rules/submitcomments.htm); or • Send an email to rule-comments@ sec.gov. Please include File Number S7– 23–22 on the subject line. Paper Comments • Send paper comments to Secretary, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549–1090. All submissions should refer to File Number S7–23–22. This file number should be included on the subject line VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 if email is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission’s website (https://www.sec.gov/rules/ proposed.shtml). Comments are also available for website viewing and printing in the Commission’s Public Reference Room, 100 F Street NE, Washington, DC 20549, on official business days between the hours of 10 a.m. and 3 p.m. Operating conditions may limit access to the Commission’s Public Reference Room. All comments received will be posted without change. Persons submitting comments are cautioned that we do not redact or edit personal identifying information from comment submissions. You should submit only information that you wish to make available publicly. Studies, memoranda, or other substantive items may be added by the Commission or staff to the comment file during this rulemaking. A notification of the inclusion in the comment file of any such materials will be made available on our website. To ensure direct electronic receipt of such notifications, sign up through the ‘‘Stay Connected’’ option at www.sec.gov to receive notifications by email. FOR FURTHER INFORMATION CONTACT: Elizabeth L. Fitzgerald, Assistant Director, Office of Clearance and Settlement at (202) 551–5710, Division of Trading and Markets; Michael A. Macchiaroli, Associate Director, at (202) 551–5525; Thomas K. McGowan, Associate Director, at (202) 551–5521; Randall W. Roy, Deputy Associate Director, at (202) 551–5522; Raymond Lombardo, Assistant Director, at 202– 551–5755; Sheila Dombal Swartz, Senior Special Counsel, at (202) 551– 5545; or Nina Kostyukovsky, Special Counsel, at (202) 551–8833, Office of Broker-Dealer Finances, Division of Trading and Markets; U.S. Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549–7010. SUPPLEMENTARY INFORMATION: First, the Commission proposes to amend 17 CFR 240.17Ad–22(e)(18) (‘‘Rule 17Ad– 22(e)(18)’’) to require covered clearing agencies that provide central counterparty (‘‘CCP’’) services for U.S. Treasury securities to establish, implement, maintain and enforce written policies and procedures reasonably designed, as applicable, to establish objective, risk-based and publicly disclosed criteria for participation, which require that any direct participant of such a covered clearing agency submit for clearance and settlement all the eligible secondary PO 00000 Frm 00002 Fmt 4701 Sfmt 4702 market transactions in U.S. Treasury securities to which such direct participant is a counterparty. In addition, these policies and procedures must be reasonably designed, as applicable, to identify and monitor the covered clearing agency’s direct participants’ submission of transactions for clearing as required above, including how the covered clearing agency would address a failure to submit transactions. These policies and procedures must also be reasonably designed, as applicable, to ensure that the covered clearing agency has appropriate means to facilitate access to clearance and settlement services of all eligible secondary market transactions in U.S. Treasury securities, including those of indirect participants, which policies and procedures the board of directors of such U.S. Treasury securities CCA must review annually. The Commission would define eligible secondary market transactions as a secondary market transaction in U.S. Treasury securities of a type accepted for clearing by a registered covered clearing agency that is either a repurchase or reverse repurchase agreement collateralized by U.S. Treasury securities, in which one of the counterparties is a direct participant, or certain specified categories of cash purchase or sale transactions. Second, the Commission proposes to amend 17 CFR 240.17Ad–22(e)(6)(i) (‘‘Rule 17Ad– 22(e)(6)(i)’’) to require that a covered clearing agency providing central counterparty services for U.S. Treasury securities establish, implement, maintain and enforce written policies and procedures reasonably designed to, as applicable, calculate, collect, and hold margin for transactions in U.S. Treasury securities submitted on behalf of an indirect participant separately from those submitted on behalf of the direct participant. In connection with these proposed amendments, the Commission is also proposing to include as part of 17 CFR 240.17Ad– 22(a) (‘‘Rule 17Ad–22(a)’’) definitions of ‘‘U.S. Treasury security,’’ ‘‘central bank,’’ ‘‘eligible secondary market transaction,’’ ‘‘international financial institution,’’ and ‘‘sovereign entity.’’ Third, the Commission proposes to amend 17 CFR 240.15c3–3a (‘‘Rule 15c3–3a’’) to permit margin required and on deposit at covered clearing agencies providing central counterparty services for U.S. Treasury securities to be included by broker-dealers as a debit in the customer and PAB reserve formulas, subject to certain conditions. Table of Contents I. Introduction E:\FR\FM\25OCP2.SGM 25OCP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules A. The Commission’s Role in Facilitating the National System of Clearance and Settlement for Securities, Including Treasury Securities B. The Role of Central Counterparty Services C. Existing CCP Services for the U.S. Treasury Market D. Proposal E. Current Regulatory and Industry Discussions Regarding the U.S. Treasury Market II. Background A. Current U.S. Treasury Market Structure and Central Clearing Within That Structure 1. Cash Market 2. U.S. Treasury Repo Market B. Current Regulatory Framework 1. Clearing Agency Regulation Under Section 17A of the Exchange Act 2. The Broker-Dealer Customer Protection Rule III. Proposed Amendments A. U.S. Treasury Securities CCA Membership Requirements 1. Requirement To Clear Eligible Secondary Market Transactions 2. Eligible Secondary Market Transactions a. Repo Transactions b. Purchases and Sales of U.S. Treasury Securities i. IDB Transactions ii. Other Cash Transactions c. Exclusions From the Definition of an Eligible Secondary Market Transaction i. Official Sector Exclusions From the Membership Proposal ii. Natural Person Exclusion 3. How the Membership Proposal Facilitates Prompt and Accurate Clearance and Settlement in the U.S. Treasury Market 4. Policies and Procedures Regarding Direct Participants’ Transactions 5. Request for Comment F. Other Changes to Covered Clearing Agency Standards 1. Netting and Margin Practices for House and Customer Accounts 2. Facilitating Access to U.S. Treasury Securities CCAs 3. Request for Comment G. Proposed Amendments to Rule15c3–3a 1. Proposal 2. Request for Comment H. Compliance Date IV. Economic Analysis A. Broad Economic Considerations B. Baseline 1. U.S. Treasury Securities 2. U.S. Treasury Repurchase Transactions 3. Central Clearing in the U.S. Treasury Securities Market 4. Clearing and Settlement by U.S. Treasury Securities Market Segment a. Dealer-to-Customer Cash U.S. Treasury Securities Market (off-IDBs) i. Bilateral Clearing ii. Central Clearing b. Cash U.S. Treasury Trades Through an IDB i. Central Clearing ii. Bilateral Clearing iii. Hybrid Clearing 5. Margin Practices in U.S. Treasury Secondary Markets VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 6. Disruptions in the U.S. Treasury Securities Market a. COVID–19 Shock of March 2020 b. September 2019 Repo Market Disruptions c. October 2014 Flash Rally 7. Affected Persons a. Covered Clearing Agencies for U.S. Treasury Securities: FICC b. Direct Participants at U.S. Treasury Securities CCAs: FICC Netting Members c. Interdealer Brokers (IDBs) d. Other Market Participants i. FICC Sponsored Members ii. Other Market Participants That Are Not FICC Sponsored Members e. Triparty Agent: Bank of New York Mellon f. Custodian Banks/Fedwire Securities Service (FSS) C. Analysis of Benefits, Costs, and Impact on Efficiency, Competition, and Capital Formation 1. Benefits a. U.S. Treasury Securities CCA Membership Requirements i. Scope of the Membership Proposal ii. Application of the Membership Proposal to Repo Transactions iii. Application of the Membership Proposal to Purchases and Sales of U.S. Treasury Securities iv. Policies and Procedures Regarding Direct Participants’ Transactions b. Other Changes to Covered Clearing Agency Standards i. Netting and Margin Practices for House and Customer Accounts ii. Facilitating Access to U.S. Treasury Securities CCAs c. Proposed Amendments to Rules 15c3–3 and 15c3–3a 2. Costs a. Costs to FICC of the Membership Proposal i. Costs Attendant to an Increase in CCLF ii. Costs of the Membership Proposal in Terms of Increased Margining for Existing FICC Members b. Costs to Non-FICC Members as a Result of the Membership Proposal c. Other Changes to Covered Clearing Agency Standards i. Netting and Margin Practices for House and Customer Accounts ii. Facilitating Access to U.S. Treasury Securities CCAs d. Proposed Amendments to Rules 15c3–3 and 15c3–3a 3. Effect on Efficiency, Competition, and Capital Formation a. Efficiency i. Price Transparency ii. Operational and Balance Sheet Efficiency b. Competition c. Capital Formation D. Reasonable Alternatives 1. Require U.S. Treasury Securities CCAs to Have Policies and Procedures Requiring Only IDB Clearing Members to Submit U.S. Treasury Securities Trades With Non-members for Central Clearing 2. Require U.S. Treasury Securities CCAs to Have Policies and Procedures Requiring the Submission of All PO 00000 Frm 00003 Fmt 4701 Sfmt 4702 64611 Repurchase Agreements With No Change to Requirements for the Submission of Cash Transactions 3. Include All Cash Transactions Within the Scope of the Membership Proposal With Exceptions for Central Banks, Sovereign Entities, International Financial Institutions, and Natural Persons 4. Require U.S. Treasury Securities CCAs To Change CCA Access Provisions and Netting and Margin Practices for House and Customer Accounts and Rule 15c3– 3 E. Request for Comment V. Paperwork Reduction Act A. Proposed Amendment to Rule 17Ad– 22(e)(6) B. Proposed Amendment to Rule 17Ad– 22(e)(18)(iv) C. Request for Comment VI. Small Business Regulatory Enforcement Fairness Act VII. Regulatory Flexibility Act Certification A. Clearing Agencies Statutory Authority I. Introduction A. The Commission’s Role in Facilitating the National System of Clearance and Settlement for Securities, Including Treasury Securities In 1975, Congress added section 17A to the Securities Exchange Act of 1934 (‘‘Exchange Act’’) as part of the Securities Acts Amendments of 1975, which directed the Commission to facilitate the establishment of (i) a national system for the prompt and accurate clearance and settlement of securities transactions (other than exempt securities which typically includes U.S. Treasury securities, except as discussed further below), and (ii) linked or coordinated facilities for clearance and settlement of securities transactions.1 In so doing, Congress made several findings related to the importance of the clearance and settlement of securities transactions and the relationship of clearance and settlement of securities transactions to the protection of investors.2 The Commission carries out its statutory mandate in this regard through its supervision and regulation of registered clearing agencies, which may provide 1 See 15 U.S.C. 78q–1; Report of the Senate Committee on Banking, Housing & Urban Affairs, S. Rep. No. 94–75, at 4 (1975) (stating the Committee’s belief that ‘‘the banking and security industries must move quickly toward the establishment of a fully integrated national system for the prompt and accurate processing and settlement of securities transactions’’). 2 See 15 U.S.C. 78q–1(a)(1)(A) (finding that ‘‘[t]he prompt and accurate clearance and settlement of securities transactions . . . are necessary for the protection of investors and persons facilitating transactions by and acting on behalf of investors’’); see also 15 U.S.C. 78q–1(B), (C), and (D) (setting forth additional findings related to the national system of clearance and settlement). E:\FR\FM\25OCP2.SGM 25OCP2 64612 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules different services to the market including, but not limited to, central counterparty services. In 1986, Congress passed the Government Securities Act, which, among other things, authorized the Commission to regulate clearing agencies engaged in the clearance and settlement of government securities transactions, including those in U.S. Treasury securities, by providing that government securities would not be considered exempt securities for purposes of section 17A of the Exchange Act.3 This inclusion of government securities, including U.S. Treasury securities, within the Commission’s authority for the national system of clearance and settlement underscores the importance of, among other things, the U.S. Treasury market. U.S. Treasury securities play a critical and unique role in the U.S. and global economy, serving as a significant investment instrument and hedging vehicle for investors, a risk-free benchmark for other financial instruments, and an important mechanism for the Federal Reserve’s implementation of monetary policy.4 Consequently, confidence in the U.S. Treasury market, and in its ability to function efficiently, even in times of stress, is critical to the stability of the global financial system.5 khammond on DSKJM1Z7X2PROD with PROPOSALS2 B. The Role of Central Counterparty Services The Commission defines a CCP as a clearing agency that interposes itself 3 Government Securities Act of 1986, section 102(a); 15 U.S.C. 78c(a)(12)(B)(i). 4 See, e.g., Staffs of the U.S. Department of the Treasury, Board of Governors of the Federal Reserve System, Federal Reserve Bank of New York, U.S. Securities and Exchange Commission, and U.S. Commodity Futures Trading Commission, Recent Disruptions and Potential Reforms in the U.S. Treasury Market: A Staff Progress Report, at 1 (Nov. 2021), available at https://home.treasury.gov/ system/files/136/IAWG-Treasury-Report.pdf (‘‘InterAgency Working Group for Treasury Market Surveillance (‘‘IAWG’’) Report’’); Staffs of the U.S. Department of the Treasury, Board of Governors of the Federal Reserve System, Federal Reserve Bank of New York, U.S. Securities and Exchange Commission, and U.S. Commodity Futures Trading Commission, Joint Staff Report: The U.S. Treasury Market on October 15, 2014, at 1, 8 (2015), available at https://home.treasury.gov/system/files/276/jointstaff-report-the-us-treasury-market-on-10-152014.pdf (‘‘Joint Staff Report’’). These reports represent the views of Commission and other Federal regulatory staff. The reports are not a rule, regulation, or statement of the Commission. The Commission has neither approved nor disapproved the content in the reports. These reports, like all staff reports, have no legal force or effect: they do not alter or amend applicable law, and they create no new or additional obligations for any person. 5 Group of Thirty Working Group on Treasury Market Liquidity, U.S. Treasury Markets: Steps Toward Increased Resilience, at 1 (2021), available at https://group30.org/publications/detail/4950 (‘‘G–30 Report’’). VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 between the counterparties to securities transactions, acting functionally as the buyer to every seller and the seller to every buyer.6 The Commission previously has stated that registered clearing agencies that provide CCP services can help increase the safety and efficiency of securities trading, while reducing costs.7 These benefits could be particularly significant in times of market stress, as CCPs would mitigate the potential for a single market participant’s failure to destabilize other market participants or the financial system more broadly, and/or reduce the effects of misinformation and rumors.8 A CCP also addresses concerns about counterparty risk by substituting the creditworthiness and liquidity of the CCP for the creditworthiness and liquidity of the counterparties.9 Further, the Commission has recognized that ‘‘the centralization of clearance and settlement activities at covered clearing agencies allows market participants to reduce costs, increase operational efficiency, and manage risks more effectively.’’ 10 However, the Commission has also recognized that this centralization of activity at clearing agencies makes risk management at such entities a critical function, as reflected in the adoption of additional enhanced Commission requirements, discussed further in section II.B.1 infra.11 Since the enactment of the Securities Acts Amendments of 1975, the Commission has had extensive experience with the risks associated with bilateral clearing and the benefits of centralized clearance and settlement systems for securities. Based on its experience supervising registered clearing agencies, the Commission believes that, over the years, the clearing agencies registered with the Commission that provide CCP services have reduced costs of securities trading, and have been carefully structured, consistent with the Commission’s statutory and regulatory authority, to provide the benefits of clearing, such as 6 17 CFR 240.17Ad–22(a)(2). Clearing Agency Standards Proposing Release, Exchange Act Release No. 71699 (Mar. 12, 2014), 79 FR 29507, 29510 (May 27, 2014) (‘‘CCA Standards Proposing Release’’). 8 See, e.g., Order Granting Temporary Exemptions Under the Securities Exchange Act of 1934 in Connection with Request of Liffe Administration and Management and Lch.Clearnet Ltd. Related to Central Clearing of Credit Default Swaps, and Request for Comments, Exchange Act Release No. 59164 (Dec. 24, 2008), 74 FR 139, 140 (Jan. 2, 2009). 9 Id. 10 CCA Standards Proposing Release, supra note 7, 79 FR at 29587. 11 See, e.g., id. at 29510. 7 Covered PO 00000 Frm 00004 Fmt 4701 Sfmt 4702 multilateral netting 12 and centralized default management, while also managing and reducing counterparty risk. To further the establishment of linked and coordinated facilities for clearance and settlement of securities transactions, the Commission adopted 17 CFR 240.17Ad–22, which sets forth standards for clearing agencies registered with the Commission. These standards address all aspects of a CCP’s operations, including financial risk management, operational risk, default management, governance, and participation requirements. C. Existing CCP Services for the U.S. Treasury Market Currently, only one registered clearing agency, the Fixed Income Clearing Corporation (‘‘FICC’’),13 provides CCP services for U.S. Treasury securities transactions, including cash transactions and repurchase transactions (‘‘repos’’), which are described more fully in section II.A infra.14 As a CCP, FICC novates transactions between two counterparties, effectively becoming the buyer to every seller and the seller to every buyer, and guarantees the settlement of the novated transactions. This means that FICC is exposed to a number of risks arising from such transactions, including counterparty credit risk.15 Because the vast majority of counterparty credit risk is managed bilaterally in the U.S. Treasury market, as discussed more fully in section III.A.3 infra, FICC may face potential contagion risk arising from transactions entered into by one of its participants, even if those transactions are not centrally cleared.16 Currently, most of 12 With multilateral netting, the CCP is able to offset obligations involving the same security across multiple counterparties, thereby reducing the overall amount of securities and funds that need to be delivered. See notes 251 and 252 and accompanying text infra for additional explanation, as well as an example, of multilateral netting. 13 FICC has two divisions. The Government Securities Division generally provides clearing services for U.S. Treasury securities, and the Mortgage-Backed Securities Division, generally provides clearing services for mortgage-backed securities. For purposes of this release, references to FICC will refer to FICC’s Government Securities Division (‘‘GSD’’), unless otherwise indicated. 14 For purposes of this release, an entity providing CCP services in the U.S. Treasury market and therefore serving as a covered clearing agency will be referred to as a ‘‘U.S. Treasury securities CCA.’’ 15 Counterparty credit risk refers to the potential for a market participant’s counterparty to a given transaction to default on the transaction and therefore the market participant will not receive either the cash or securities necessary to settle the transaction. 16 See, e.g., U.S. Department of the Treasury, A Financial System That Creates Economic Opportunities Capital Markets, at 81 (Oct. 2017), available at https://home.treasury.gov/system/files/ E:\FR\FM\25OCP2.SGM 25OCP2 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 FICC’s direct participants are banks and broker-dealers, while other types of entities, such as registered investment companies, investment advisers, and asset owners, rely on FICC’s direct participants to access central clearing indirectly and are not direct participants of FICC. As the only entity providing CCP services in the U.S. Treasury market, if FICC were unable to provide its CCP services for any reason, it could have a broad and severe impact on the overall U.S. economy, as the Financial Stability Oversight Council (‘‘FSOC’’) recognized when it designated FICC as a systemically important financial market utility in 2012.17 Designation of an entity as a systemically important financial market utility brings heightened risk management requirements and additional regulatory supervision, by both its primary regulator and the Board of Governors of the Federal Reserve System.18 The Commission relied, in part, on this heightened supervisory authority under Title VIII of the Dodd-Frank Act to adopt the Covered Clearing Agency Standards. Over the past several years, both the private and public sectors have observed the increased volume of U.S. Treasury secondary market transactions that are not centrally cleared.19 However, because data for these transactions is subject to different and incomplete reporting requirements, it is 136/A-Financial-System-Capital-Markets-FINALFINAL.pdf (‘‘2017 Treasury Report’’) (discussing issues caused by fragmented central clearing with respect to [interdealer brokers] at FICC and describing this contagion risk and stating ‘‘if a large [proprietary trading firm] with unsettled trading volumes were to fail, the failure could introduce risk to the market and market participants’’). 17 Financial Stability Oversight Council, 2012 Annual Report, Appendix A, available at https:// www.treasury.gov/initiatives/fsoc/Documents/ 2012%20Annual%20Report.pdf (‘‘FSOC 2012 Annual Report’’). 18 Id. at 119. The Commission previously has acknowledged that the Clearing Supervision Act reflects Congressional recognition that multilateral clearing or settlement activities ‘‘may reduce risks for clearing participants and the broader financial system,’’ but also may create ‘‘new risks that require multilateral payment, clearing or settlement activities to be well-designed and operated in a safe and sound manner.’’ Exchange Act Release No. 64017 (Mar. 3, 2014), 76 FR 14472, 14474 (Mar. 16, 2011) (‘‘Clearing Agency Standards Proposing Release’’); see also 12 U.S.C. 5462(9), 5463(a)(2). The Commission also recognized that the Clearing Supervision Act is designed, in part, to provide a regulatory framework to help address such risk management issues, ‘‘which is generally consistent with the Exchange Act requirement that clearing agencies be organized in a manner so as to facilitate prompt and accurate clearance and settlement, safeguard securities and funds and protect investors.’’ Id. 19 See, e.g., IAWG Report, supra note 4, at 5–6; 2017 Treasury Report, supra note 15, at 81; Joint Staff Report, supra note 4, at 36–37. VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 difficult to quantify this activity. The best available estimates at this time are those developed by private sector organizations. In particular, the Treasury Market Practice Group 20 estimates that only 13 percent of the overall volume in U.S. dollars of U.S. Treasury cash transactions were centrally cleared as of the first half of 2017, and that an additional 19 percent were what the TMPG refers to as ‘‘hybrid’’ clearing, that is, executed on an interdealer broker platform (as described in section II.A.1 infra) in which one counterparty is a member of a CCA and submits its transaction with the interdealer broker for central clearing, while the other counterparty is not a member of a CCA and bilaterally clears its transaction with the interdealer broker.21 In addition, the G– 30 Report estimated that ‘‘roughly 20 percent of commitments to settle U.S. Treasury security trades are cleared through FICC.’’ 22 Both the TMPG and the Group of 30 also identified the significant risks associated with bilateral clearing.23 For example, the TMPG stated that ‘‘[b]ilateral clearing involves varying risk management practices that are less uniform and less transparent to the broader market and may be less efficient with regard to netting exposures and use of collateral as compared to central clearing. An increase in bilaterally cleared trades likely increases the aggregate liquidity risk in the clearing and settlement process because, unlike a CCP, bilateral arrangements may not have the discipline of establishing a contingent liquidity risk framework or uniform requirements for emergency liquidity.’’ 24 20 The Treasury Market Practices Group (‘‘TMPG’’) is a group of ‘‘market professionals committed to supporting the integrity and efficiency of the Treasury, agency debt, and agency mortgage-backed securities markets.’’ See https:// www.newyorkfed.org/TMPG/. The TMPG is sponsored by the Federal Reserve Bank of New York. Id. 21 TMPG, White Paper on Clearing and Settlement in the Secondary Market for U.S. Treasury Securities, at 12 (July 2019), available at https:// www.newyorkfed.org/medialibrary/Microsites/ tmpg/files/CS_FinalPaper_071119.pdf (‘‘TMPG White Paper’’). These estimates use FR2004 data, which are reports provided to the Federal Reserve Bank of New York regarding primary dealer market activity in U.S. Government securities, covering the first half of 2017 and are based on various assumptions specified in the TMPG White Paper. See also FR2004, Government Securities Dealer Reports, available at https:// www.federalreserve.gov/apps/reportforms/ reportdetail.aspx?sOoYJ+5BzDZq2f74T6b1cw. 22 G–30 Report, supra note 5, at 11. See also IAWG Report, supra note 4, at 5–6; Joint Staff Report, supra note 4, at 36–37. 23 TMPG White Paper, supra note 21, at 3. 24 Id. PO 00000 Frm 00005 Fmt 4701 Sfmt 4702 64613 D. Proposal The Commission believes that a covered clearing agency, including one that provides CCP services,25 is most effective when its participation standards enable the CCA to understand and control the risks presented by its direct participants because such standards are an important tool to limit the potential for member defaults and, as a result, losses to non-defaulting members in the event of a member default, thereby protecting the securities market as a whole.26 For example, when proposing the Covered Clearing Agency Standards in Rule 17Ad–22 in 2014, the Commission explained that ‘‘[a]ppropriate minimum operational, legal, and capital requirements for membership that are maintained and enforced through the supervisory practices of a clearing agency help to ensure all members will be reasonably capable of meeting their various obligations to the clearing agency in stressed market conditions and upon member default.’’ 27 To that end, the Commission’s rules governing the participation requirements of a CCA are designed to achieve that goal. Rule 17Ad–22(e)(18) requires that a CCA establish, implement, maintain and enforce written policies and procedures reasonably designed to, as applicable, establish objective, risk-based and publicly disclosed criteria for participation,28 and 17 CFR 240.17Ad– 22(e)(19) (‘‘Rule 17Ad–22(e)(19)’’) requires a CCA to maintain written policies and procedures reasonably designed to, as applicable, identify, monitor and manage the material risks to it arising from arrangements in which firms that are indirect participants in the CCA rely on the services provided to it by direct participants to access the CCA’s payment, clearing, or settlement facilities.29 As described more fully in section III infra, the increasing volume of noncentrally cleared transactions in U.S. Treasury securities may render U.S. Treasury securities CCAs more susceptible to member defaults from risks outside the transactions cleared by the CCA, and as a result the 25 Hereafter covered clearing agencies are referred to as ‘‘CCAs.’’ 26 Covered Clearing Agency Standards Adopting Release, Exchange Act Release No. 78961 (Sep. 28, 2016), 81 FR 70786, 70839 (Oct. 13, 2016) (‘‘CCA Standards Adopting Release’’); see also CCA Standards Proposing Release, supra note 7, 79 FR at 29552. 27 CCA Standards Proposing Release, supra note 7, 79 FR at 29552; see also CCA Standards Adopting Release, supra note 25, 81 FR at 70839. 28 17 CFR 240.17Ad–22(e)(18). 29 17 CFR 240.17Ad–22(e)(19). E:\FR\FM\25OCP2.SGM 25OCP2 64614 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 Commission is proposing to amend Rule 17Ad–22(e)(18). In particular, and as set forth more fully below, the Commission believes that amending Rule 17Ad– 22(e)(18) to require the CCAs to address their direct participants’ non-centrally cleared transactions, both for repos and certain categories of cash transactions, will help reduce contagion risk to the CCA and bring the benefits of central clearing to more transactions involving U.S. Treasury securities, thereby lowering overall systemic risk in the market. As discussed further in section III.A.3 infra, these benefits include centralized default management, increased multilateral netting, and reduction of settlement fails. The Commission also believes that increasing the volume of transactions submitted for central clearing is consistent with promoting the prompt and accurate clearance and settlement of securities transactions.30 The Commission also proposes to impose additional requirements on how U.S. Treasury securities CCAs calculate, collect, and hold margin posted on behalf of indirect participants (i.e., customers) who rely on the services of a direct participant (i.e., the member of the U.S. Treasury securities CCA) to access the CCA’s services. As set forth in more detail below, the Commission believes that such requirements also will improve the risk management practices at U.S. Treasury securities CCAs and incentivize and facilitate additional central clearing in the U.S. Treasury market, thereby lowering systemic risk. Individually and collectively, these two proposals should further incentivize and facilitate additional central clearing. In addition, the Commission recognizes that the proposal could cause a substantial increase in the margin broker-dealers must post to a U.S. Treasury securities CCA resulting from their customers’ cleared U.S. Treasury securities positions. Currently, brokerdealers are not permitted to include a debit in the customer reserve formula equal to this amount of margin or, more generally, to use customer cash or customer fully paid or excess margin securities to meet a margin requirement. To address this, the Commission 30 See Self-Regulatory Organizations; Fixed Income Clearing Corporation; Order Granting Approval of a Proposed Rule Change Relating to Trade Submission Requirements and Pre-Netting, Exchange Act Release No. 51908 (June 22, 2005), 70 FR 37450 (June 29, 2005) (describing a rule designed to bring additional transactions into FICC’s netting system as ‘‘clearly designed to promote the prompt and accurate clearance and settlement of those transactions and to preserve the safety and soundness of the national clearance and settlement system.’’). VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 proposes an amendment that, subject to certain conditions, would allow the broker-dealer to include a debit in the customer or PAB reserve formula when delivering customer cash or U.S. Treasury securities to meet the margin requirement at an entity providing CCP services in the U.S. Treasury market. E. Current Regulatory and Industry Discussions Regarding the U.S. Treasury Market In normal market conditions, the U.S. Treasury market has functioned extremely well. Even under stress, the market generally has been highly resilient. However, several episodes in the U.S. Treasury market, including the ‘‘flash rally’’ of 2014, the U.S. Treasury repo market stress of September 2019, and the COVID–19 shock of March 2020, have raised questions about the U.S. Treasury market’s continued capacity to absorb shocks and what factors may be limiting the resilience of the U.S. Treasury market under stress.31 Although different in their scope and magnitude, these events all generally involved dramatic increases in market price volatility and/or sharp decreases in available liquidity. A number of recent publications and industry discussions have considered the overall structure and resilience of the U.S. Treasury market, in light of, among other things, the market events noted above.32 The Commission believes that, although this proposal will not, by itself, necessarily prevent future market disruptions, the proposal will support efficiency by reducing counterparty credit risk and improving transparency, as discussed in section III.A.3 infra. Moreover, the Commission believes that enhancing the membership standards applicable to U.S. Treasury securities CCAs should improve the resilience of such CCAs by expanding their ability to manage the risks arising from direct participants who currently engage in non-centrally cleared transactions away from the CCA. In addition, the Commission believes that the risk management standards should facilitate and incentivize additional central clearing, thereby bringing the 31 G–30 Report, supra note 5, at 1; IAWG Report, supra note 4, at 7; Peter Ryan and Robert Toomey, Improving Capacity and Resiliency in US Treasury Markets: Part I (Mar. 24, 2021), available at https:// www.sifma.org/resources/news/improving-capacityand-resiliency-in-us-treasury-markets-part-1/. 32 See generally IAWG Report, supra note 4; G– 30 Report, supra note 5; Nellie Liang & Patrick Parkinson, Enhancing Liquidity of the U.S. Treasury Market Under Stress (Dec. 16, 2020), available at https://www.brookings.edu/wp-content/uploads/ 2020/12/WP72_Liang-Parkinson.pdf (‘‘Liang & Parkinson’’). PO 00000 Frm 00006 Fmt 4701 Sfmt 4702 benefits of additional central clearing to the market for U.S. Treasury securities. The Commission believes that these changes should lower systemic risk in the U.S. Treasury market by increasing the volume of transactions that are subject to central clearing and ensuring that those additional transactions are subject to standardized risk management. The Commission also believes that increased central clearing would provide greater transparency into the market and could, potentially facilitate all-to-all trading.33 The Commission believes that these benefits arising from central clearing should help improve the functioning of the U.S. Treasury market. II. Background A. Current U.S. Treasury Market Structure and Central Clearing Within That Structure U.S. Treasury securities are direct obligations of the U.S. Government issued by the U.S. Department of the Treasury (‘‘Treasury Department’’). Market participants use U.S. Treasury securities as an investment instrument and as a hedging vehicle, among other things. For example, U.S. Treasury securities are often used as collateral in lending arrangements or as margin on other financial transactions. The Treasury Department issues several different types of securities, including U.S. Treasury bills, nominal coupons notes and bonds, Floating Rate Notes, and Treasury Inflation-Protected Securities (‘‘TIPS’’). For each U.S. Treasury security type, the most recently issued (‘‘on-the-run’’) securities are the most liquid in the secondary market.34 Market participants commonly refer to securities issued prior to ‘‘on-the-run’’ securities as ‘‘offthe-run’’ securities. Trading in off-therun U.S. Treasury securities has always been less active than on-the-run trading, and price discovery primarily occurs in on-the-run securities.35 The U.S. Treasury market consists of two components: the primary market 33 See notes 184 through 186 infra. U.S. Treasury securities are the most recently auctioned nominal coupon securities. These securities are referred to as ‘‘on-the-run’’ starting the day after they are auctioned. Nominal coupon securities pay a fixed semi-annual coupon and are currently issued at original maturities of 2, 3, 5, 7, 10, 20, and 30 years. These standard maturities are commonly referred to as ‘‘benchmark’’ securities because the yields for these securities are used as references to price a number of private market transactions. 35 Joint Staff Report, supra note 4, at 35–36. Price discovery also occurs in when-issued trading of U.S. Treasury securities prior to and on the day of the auction (pre- on-the-run trading). See note 38 infra. 34 On-the-run E:\FR\FM\25OCP2.SGM 25OCP2 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 and the secondary market. The primary market is where the Treasury Department auctions securities (i.e., debt) to the public through a competitive bidding process and subsequently issues awarded securities to finance the Federal government.36 These U.S. Treasury securities, which are issued after the auction, are marketable securities and are primarily sold to financial institutions. Financial institutions designated by the Federal Reserve Bank of New York as ‘‘primary dealers’’ are expected to submit competitive bids on a pro-rata basis and participate meaningfully in all U.S. Treasury auctions at reasonably competitive rates or yields.37 U.S. Treasury securities are typically issued a few days after the auction and trade on the secondary market.38 The secondary market is where the subsequent trading of U.S. Treasury securities occurs. The secondary market includes the ‘‘cash market,’’ for outright purchases and sales of securities, and the repo market, where one participant sells a U.S. Treasury security to another participant, along with a commitment to repurchase the security at a specified price on a specified later date.39 This 36 TMPG White Paper, supra note 21, at 6. The Federal Reserve Bank of New York serves as fiscal agent for the U.S. Treasury in conducting auctions of marketable U.S. Treasury debt. See 12 U.S.C. 391. 37 See Federal Reserve Bank of New York, Administration of Relationships with Primary Dealers, available at https://www.newyorkfed.org/ markets/primarydealers.html. Specifically, primary dealers are required to be either (1) a registered broker-dealer or government securities brokerdealer, which is approved as a member of the Financial Industry Regulatory Authority, Inc. and has net regulatory capital of at least $50 million, or (2) a state or federally chartered bank or savings association (or a state or federally licensed branch or agency of a foreign bank) that is subject to bank supervision and maintains at least $1 billion in Tier 1 capital. Id. Thus, for those primary dealers that fall into the former category, they are a subset of the broader set of registered broker-dealers or government securities broker-dealers, which may also participate in the Treasury market, as discussed further in section II.A.1 and 2 infra. 38 The Treasury Department typically announces a new security that it intends to sell several days before the auction at which it is first sold to the public. These securities begin trading after announcement before the auction and through issuance, which occurs a few days after the auction. Such trading is known generally as ‘‘when-issued’’ trading; however, in the timeframe between the announcement and the auction, such trading is known as when-issued and referred to as such by market participants, but after the auction and before issuance, the securities are typically referred to simply as on-the-run, consistent with market practice. Michael Fleming, Or Shachar, and Peter Van Tassel, Treasury Market When-Issued Trading Activity, Liberty Street Economics (Nov. 30, 2020) (‘‘Fleming, Shachar, and Van Tassel’’), available at https://libertystreeteconomics.newyorkfed.org/ 2020/11/treasury-market-when-issued-tradingactivity/. 39 See IAWG Report, supra note 4, at 3. The secondary market also includes the market for U.S. VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 proposal applies to the secondary market for U.S. Treasury securities. 1. Cash Market The cash market has two main components: the interdealer market and the dealer-to-customer market. In the interdealer market, dealers primarily trade with each other and with principal trading firms (‘‘PTFs’’), which trade as principals for their own accounts. The majority of trading in the interdealer market in on-the-run U.S. Treasury securities occurs on electronic platforms operated by interdealer brokers that bring together buyers and sellers anonymously using order books or other trading facilities supported by advanced electronic trading technology (‘‘IDBs’’).40 These IDBs are generally direct participants of a U.S. Treasury securities CCA and stand as counterparties to both sides of each trade on their platforms.41 Typically, an IDB provides a trading facility for multiple buyers and sellers for U.S. Treasury securities to enter orders at specified prices and sizes and have these orders displayed to all users on an anonymous basis. The trading facility automatically matches these orders according to priority and execution rules that are programmed in the trading facility. When a match occurs and a trade is executed, the IDB then books two trades, with the IDB functioning as the principal to each respective counterparty, thereby protecting the anonymity of each party, but taking on credit risk from each counterparty.42 Although the term ‘‘IDB’’ is sometimes used to refer to platforms that may provide voice-based or other trading technology, as referenced below, in this release, consistent with existing commentary on the U.S. Treasury markets, the term IDB does not encompass platforms that provide voicebased or other non-anonymous methods of bringing together buyers and sellers of U.S. Treasury securities and instead refers to electronic platforms providing anonymous methods of bringing together buyers and sellers.43 Treasury futures, which trade electronically on the Chicago Board of Trade, a designated contract market operated by the Chicago Mercantile Exchange (‘‘CME’’) Group, and centrally cleared by CME Clearing. U.S. Treasury futures are generally regulated by the U.S. Commodity Futures Trading Commission and are not the subject of this proposal. 40 Joint Staff Report, supra note 4, at 11, 35–36. 41 IAWG Report, supra note 4, at 21. 42 TMPG White Paper, supra note 21, at 6. 43 The entities referred to as IDBs here are encompassed in the ATSs category in the tables set forth in section IV.B.1 infra because of the way that such IDBs are categorized in TRACE. Specifically, PO 00000 Frm 00007 Fmt 4701 Sfmt 4702 64615 The majority of trades in the interdealer markets are trades in ‘‘onthe-run’’ issues. The majority of interdealer trading for off-the-run U.S. Treasury securities occurs via bilateral transactions through traditional voiceassisted brokers and electronic trading platforms offering various protocols to bring together buyers and sellers, although some interdealer trading in offthe-run U.S. Treasury securities does occur on IDBs that anonymously bring together buyers and sellers.44 Until the mid-2000s, most interdealer trading occurred between primary dealers, who are required to be members of FICC, and was centrally cleared.45 However, in recent years, much of the trading on IDBs, in terms of number of trades and overall volume, has been conducted by PTFs.46 Most IDBs are FICC direct participants, and the trades between an IDB, that is a FICC direct participant, and another FICC direct participant are submitted for central clearing to FICC, which, as noted above, is currently the only U.S. Treasury securities CCA. Various types of market participants are direct participants of FICC, including dealers (both bank-affiliated and independent), banks, and IDBs. FICC’s current rules generally require that FICC direct participants submit for clearing all trades with other FICC direct participants.47 However, FICC’s rules do not require that a trade between a FICC direct participant and a party that is not a FICC direct participant be submitted for clearing. Therefore, for trades on IDBs between a party that is not a FICC direct participant (which, on an IDB, is generally a PTF) and a dealer which is a FICC direct participant—which results in two separate transactions, between the IDB and the dealer, on the one hand, and between the IDB and the PTF, on the other hand—the transaction between the dealer and the IDB would be centrally cleared. But the transaction the ‘‘ATS’’ category in TRACE encompasses these IDBs. By contrast, the non-ATS IDBs category in TRACE encompasses the voice-based or other nonanonymous methods of bringing together buyers and sellers, which are also sometimes referred to as interdealer brokers by market participants. 44 Joint Staff Report, supra note 4, at 35. 45 G–30 Report, supra note 5, at 9; IAWG Report, supra note 4, at 5–6; TMPG White Paper, supra note 21, at 6. See also supra note 37 (setting forth conditions for being a primary dealer). 46 G–30 Report, supra note 5, at 1. 47 FICC Rule 2A section 7(e) (requirement that FICC Netting Members submit to FICC all of its eligible trades with other Netting Members); FICC Rule 18 section 2 (similar requirement with regard to Repo transactions). The Rules for FICC’s GSD are available at https://www.dtcc.com/∼/media/Files/ Downloads/legal/rules/ficc_gov_rules.pdf. Unless otherwise indicated, all references to ‘‘FICC Rule’’ in this release refer to the GSD Rulebook. E:\FR\FM\25OCP2.SGM 25OCP2 64616 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 between a PTF which is not a FICC member and the IDB, on the other side, would not be centrally cleared and instead would be settled bilaterally with the IDB, often through a clearing agent acting on behalf of the non-FICC direct participant.48 A 2015 inter-agency staff publication found that PTFs account for more than half of the trading activity in the futures and electronic IDB markets for U.S. Treasury securities, providing the vast majority of market depth, and questioned whether trades cleared by such firms outside of a CCP are subject to the same level of risk mitigation.49 In 2018, the TMPG determined that ‘‘a majority of trades in the secondary [cash] Treasury market now clear bilaterally, a trend that is contrary to the direction of recent regulatory requirements in other markets (i.e., swaps) that for some products mandate clearing and for others encourage it through higher margin requirements on bilaterally cleared transactions.’’ 50 The trading volume of non-FICC members, at least in the cash U.S. Treasury market, is now estimated to exceed that of FICC members.51 Whether or not a trade is centrally cleared impacts the risk management requirements applicable to the trade. Specifically, trades cleared and settled outside of a CCP may not be subject to the same extent of risk management associated with central clearing, which includes requirements for margin determined by a publicly disclosed method that applies objectively and uniformly to all members of the CCP, loss mutualization, and liquidity risk management.52 Dealer-to-customer trading generally involves ‘‘off-the-run’’ issues more often than the interdealer market and typically is conducted via voice or electronically (i.e., electronic ‘‘request for quote’’ systems referred to section IV infra as non-ATS IDBs).53 Trading in the dealer-to-customer cash market is generally—and has historically been— conducted through bilateral transactions. Customers have not traditionally traded directly with other end users.54 Rather, non-dealers primarily trade with dealers, and dealers use the interdealer market as a 48 See TMPG White Paper, supra note 21, at Figures 5A and 5B (providing graphical description of this type of clearing). 49 Joint Staff Report, supra note 4, at 2, 55. 50 TMPG White Paper, supra note 21, at 2. 51 IAWG Report, supra note 4, at 30; TMPG White Paper, supra note 21, at 12. 52 IAWG Report, supra note 4, at 30; G–30 Report, supra note 5. 53 G–30 Report, supra note 5, at 1; TMPG White Paper, supra note 21, at 1–2. 54 See Exchange Act Release No. 90019 (Sep. 28, 2020), 85 FR 87106, 87108 (Dec. 30, 2020). VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 source of orders and trading interest to help facilitate their trading with customers in the dealer-to-customer market. Generally, trades in the dealerto-customer market are not centrally cleared.55 2. U.S. Treasury Repo Market In a U.S. Treasury repo transaction, one party sells a U.S. Treasury security to another party, along with a commitment to repurchase the security at a specified price on a specified later date. A reverse repo transaction is the same transaction from the buyer’s perspective.56 The effect of such a repo transaction is similar to a cash loan, using the U.S. Treasury securities as collateral. The difference in price between the purchase and repurchase is typically converted to an interest rate, and represents the ‘‘cost’’ of the loan. U.S. Treasury repos can use a particular security as collateral (known in the industry as ‘‘specific collateral’’) or can designate a broad class of securities as collateral (known as ‘‘general collateral’’). Most U.S. Treasury repos are overnight, though the parties can set the term for longer (generally no longer than one year). The U.S. Treasury repo market plays a key role in facilitating the flow of cash and securities in the financial system by allowing market participants to access low cost secured financing, supporting dealer market-making activities, enabling institutional investors with large cash balances to invest cash on a secured basis, and contributing to price discovery and efficient capital allocation.57 The Federal Reserve also engages in U.S. Treasury repos to bring about liquidity in the financial system, implement monetary policy, and promote financial stability. As of March 31, 2022, total repo assets were approximately $6 trillion, while repo liabilities were approximately $5.6 trillion, with over half collateralized by U.S. Treasury securities.58 Of that amount, 38 percent is attributable to the 55 G–30 Report, supra note 5, at 1; IAWG Report, supra note 4, at 3; TMPG White Paper, supra note 21, at 6. 56 For purposes of this release, we generally refer to both repos and reverse repos collectively as ‘‘repos.’’ 57 Viktoria Baklanova, Isaac Kuznits, Trevor Tatum, Primer: Money Market Funds and the Repo Market (Feb. 18, 2021), available at https:// www.sec.gov/files/mmfs-and-the-repo-market021721.pdf (‘‘MMF Primer’’). 58 The Financial Accounts of the United States (Q1 2022), available at https:// www.federalreserve.gov/releases/z1/20220609/ html/l207.htm. The difference between repo assets and repo liabilities in the Financial Accounts is largely attributed to incomplete repo data collections and is calculated as instrument discrepancies. PO 00000 Frm 00008 Fmt 4701 Sfmt 4702 Federal Reserve’s reverse repo programs, 27 percent to securities dealers, 20 percent to what is referred to as ‘‘rest of world’’ and includes, among other entities, foreign hedge funds, and the rest to banks, mortgage real estate investment trusts, and insurance companies.59 Depending on clearing and settlement practices, the U.S. Treasury repo market consists of four main components: (1) non-centrally cleared, settled bilaterally, (2) centrally cleared, settled bilaterally, (3) non-centrally cleared, settled on a triparty platform, and (4) centrally cleared, settled on a triparty platform. For non-centrally cleared bilateral U.S. Treasury repos, the parties agree to the terms and settle the trades between themselves, without involving a CCP or other third-party. As mentioned above, FICC’s rules require its direct participants to submit for central clearing all eligible trades with other direct participants. Therefore, noncentrally cleared bilateral U.S. Treasury repos involve at least one party that is not a FICC direct participant (e.g., a hedge fund); such repos may also involve a repo structure that FICC does not accept for clearing. For centrally cleared bilateral U.S. Treasury repos, the parties are FICC direct participants that submit agreedupon trade details to FICC for central clearing, and those trades are settled delivery versus payment using the members’ clearing banks and/or Fedwire Securities Service.60 Additionally, some institutional participants (e.g., money market funds and hedge funds) that are not FICC direct participants also centrally clear repos through FICC’s sponsored service. In 2005, FICC established this service (the ‘‘Sponsored Service’’), allowing eligible direct participants (Sponsoring Members) to sponsor their clients into a limited form of FICC membership and then to submit certain eligible securities transactions of their clients (Sponsored Members) to FICC for central clearing.61 FICC interacts solely with the Sponsoring Member/direct participant as agent for purposes of the Sponsoring Member’s clients/Sponsored Members’ obligations to and from FICC. Sponsoring Members also guarantee to FICC the payment and performance obligations of their Sponsored 59 See id. note 249 infra. 61 See Self-Regulatory Organizations; Fixed Income Clearing Corporation; Order Approving a Proposed Rule Change Establishing a Sponsored Membership Program, Exchange Act Release No. 51896 (June 21, 2005), 70 FR 36981 (June 27, 2005). 60 See E:\FR\FM\25OCP2.SGM 25OCP2 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 Members.62 Sponsoring Members can be either bank direct participants of FICC which meet certain capital and other requirements or any other FICC direct participant which meets what FICC determines to be the appropriate financial resource requirements; in practice, Sponsoring Members include both banks and broker-dealers.63 Sponsored Members have to be ‘‘qualified institutional buyers’’ as defined by Rule 144A under the Securities Act of 1933, as amended, or otherwise meet the financial standards necessary to be a ‘‘qualified institutional buyer,’’ and currently, Sponsored Members generally consist of hedge funds, money market funds, other asset managers, and smaller banks.64 For non-centrally cleared triparty U.S. Treasury repos, cash lenders (e.g., money market funds) provide financing to cash borrowers (e.g., dealers). The parties agree to the terms of a trade and arrange for a clearing bank to facilitate settlement. Like non-centrally cleared bilateral repos, at least one party to the transaction is not a FICC member. While the clearing bank provides a triparty platform to help facilitate the movement of cash and securities among accounts of counterparties to the transaction, it does not itself become a counterparty to the transactions and does not guarantee either counterparty’s performance of its obligations. Collateral posted to the triparty platform generally cannot be repledged outside the platform, thereby protecting against settlement fails.65 For centrally cleared U.S. Treasury triparty repos, the parties are FICC members that submit agreed-upon trade details to FICC for central clearing through FICC’s General Collateral Finance (‘‘GCF’’) Repo Service. Unlike centrally cleared bilateral repos, these triparty repos are settled on the clearing 62 See Exchange Act Release No. 51896 (June 21, 2005), 70 FR 36981 (June 27, 2005); see also FICC Rule 3A, supra note 47. For general information and statistics regarding the Sponsored Service, see https://www.dtcc.com/clearing-services/ficc-gov/ sponsored-membership, as well as section IV.B.7.d.i infra. The Sponsored Service also allows the submission of cash transactions; however, at this time, the service is generally used only for U.S. Treasury repo transactions. 63 See FICC Rule 3A, section 2(a) and (b), supra note 47; FICC Membership Listing, available at https://www.dtcc.com/-/media/Files/Downloads/ client-center/FICC/Mem-GOV-by-name.xlsx (identifying Sponsoring Members as those with Omnibus accounts). 64 See FICC Rule 3A, section 3(a), supra note 47; FICC Sponsored Membership Listing, available at https://www.dtcc.com/client-center/ficc-govdirectories. 65 See generally Reference Guide to U.S. Repo and Securities Lending Markets (Nov. 9, 2015), available at https://www.financialresearch.gov/workingpapers/files/OFRwp-2015-17_Reference-Guide-toU.S.-Repo-and-Securities-Lending-Markets.pdf. VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 bank’s triparty platform. Like centrally cleared bilateral repos, centrally cleared triparty repos are novated by FICC, and FICC acts as a CCP for these transactions, including by collecting margin pursuant to its margin methodology for such transactions. Until recently, centrally cleared triparty repos were only conducted through the GCF Repo Service, i.e., between two direct members of FICC. However, in September 2021, FICC introduced its Sponsored General Collateral Service (‘‘Sponsored GC Service’’), which enables centrally cleared triparty repos between a sponsored member and its sponsoring member.66 The Sponsored GC Service accepts general collateral in a number of generic CUSIPs, and though U.S. Treasury securities are among the general collateral types acceptable in the Sponsored GC Service, other types of collateral including agency and mortgage backed securities are acceptable for use as collateral as well.67 Each type of eligible collateral for the Sponsored GC Service is assigned its own generic CUSIP number, and security types are not mixed.68 B. Current Regulatory Framework 1. Clearing Agency Regulation Under Section 17A of the Exchange Act As noted above, when Congress added section 17A to the Exchange Act as part of the Securities Acts Amendments of 1975, it directed the Commission to facilitate the establishment of (i) a national system for the prompt and accurate clearance and settlement of securities transactions (other than exempt securities) and (ii) linked or coordinated facilities for clearance and settlement of securities transactions,69 and the Government Securities Act of 1986 specifically included government securities within the scope of section 17A.70 In facilitating the establishment of the national clearance and settlement system, the Commission must have due 66 Exchange Act Release No. 92808 (Aug. 30, 2021), 86 FR 49580 (Sept. 3, 2021). Currently, the Bank of New York Mellon operates the triparty platform that facilitates trades conducted via the GCF Repo Service and Sponsored GC Service. 67 See generally DTCC Sponsored General Collateral Service, available at https:// www.dtcc.com/-/media/Files/Downloads/ClearingServices/FICC/GOV/SponsoredGC-FS-INTL.pdf. 68 Id. 69 See supra note 1. 70 Specifically, the Government Securities Act, among other things, authorized the Commission to regulate clearing agencies engaged in the clearance and settlement of government securities transactions, including those in U.S. Treasury securities, by providing that government securities would no longer be exempt securities for purposes of section 17A of the Exchange Act. Government Securities Act of 1986, section 102(a); 15 U.S.C. 78c(a)(12)(B)(i). PO 00000 Frm 00009 Fmt 4701 Sfmt 4702 64617 regard for the public interest, the protection of investors, the safeguarding of securities and funds, and maintenance of fair competition among brokers and dealers, clearing agencies, and transfer agents.71 The Commission’s ability to achieve these goals is based upon the regulation of clearing agencies registered with the Commission.72 Specifically, section 17A of the Exchange Act provides the Commission with authority to adopt rules as necessary or appropriate in the public interest, for the protection of investors, or otherwise in furtherance of the purposes of the Exchange Act (including for the prompt and accurate clearance and settlement of securities transactions) and prohibits a clearing agency from engaging in any activity in contravention of such rules and regulations.73 The Commission has exercised its broad authority to prescribe requirements for the prompt and accurate clearance and settlement of securities transactions and the safeguarding of securities and funds described above. As noted above, most recently, the Commission has promulgated the Covered Clearing Agency standards, which apply to, among others, any entity providing CCP services, such as FICC.74 These standards require covered clearing agencies, to establish, implement, maintain, and enforce written policies and procedures reasonably designed to, as applicable, meet certain minimum standards regarding, among other things, operations, governance, and risk management. The Commission has previously explained that membership requirements like those set forth in this proposal are an important tool for managing a clearing agency’s risk. For example, when proposing the Covered Clearing Agency Standards, the Commission explained that appropriate minimum membership requirements, including operational, legal, and capital requirements, help ‘‘to ensure all 71 See 15 U.S.C. 78q–1(a)(2)(A). the Exchange Act and the regulations thereunder, any entity providing such central counterparty services is a clearing agency and must register with the Commission or seek an exemption from registration. 15 U.S.C. 78q–1(b)(1); see also 17 CFR 240.17Ad–22(a)(5) (defining covered clearing agency). 73 See 15 U.S.C. 78q–1(d)(1); see also 15 U.S.C. 78q–1(b)(2) (referring to the Commission’s ability to adopt rules with respect to the application of section 17A). As noted above, for purposes of section 17A, the Commission’s authority over securities also includes ‘‘government securities.’’ Government Securities Act of 1986, section 102(a); 15 U.S.C. 78c(a)(12)(B)(i). 74 See supra note 7 and 17 CFR 240.17Ad– 22(a)(5). 72 Under E:\FR\FM\25OCP2.SGM 25OCP2 64618 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules members will be reasonably capable of meeting their various obligations to the clearing agency in stressed market conditions and upon member default.’’ 75 Clearing agency member defaults have long been a concern of the Commission; the Commission has explained that ‘‘[m]ember defaults challenge the safe functioning of a clearing agency by creating credit and liquidity risks, which impede a clearing agency’s ability to settle securities transactions in a timely manner.’’ 76 In particular, among other things, the Covered Clearing Agency Standards impose requirements on a covered clearing agency with respect to both its direct and indirect participants. For example, Rule 17Ad–22(e)(18) requires that covered clearing agencies establish implement, maintain and enforce written policies and procedures reasonably designed to, as applicable, establish objective, risk-based and publicly disclosed criteria for participation.77 Similarly, Rule 17Ad– 22(e)(19) imposes requirements on a covered clearing agency to maintain written policies and procedures reasonably designed to, as applicable, identify, monitor and manage the risks posed to it by indirect participants.78 2. The Broker-Dealer Customer Protection Rule khammond on DSKJM1Z7X2PROD with PROPOSALS2 Rule 15c3–3 is designed ‘‘to give more specific protection to customer funds and securities, in effect forbidding brokers and dealers from using customer assets to finance any part of their businesses unrelated to servicing securities customers; e.g., a firm is virtually precluded from using customer funds to buy securities for its own account.’’ 79 To meet this objective, Rule 15c3–3 requires a broker-dealer that maintains custody of customer securities and cash (a ‘‘carrying brokerdealer’’) to take two primary steps to safeguard these assets, as described below. The steps are designed to protect customers by segregating their securities and cash from the broker-dealer’s proprietary business activities. If the 75 CCA Standards Proposing Release, supra note 7, 79 FR at 29552; see also CCA Standards Adopting Release, supra note 25, 81 FR at 70839 (stating that the use of risk-based criteria helps to protect investors ‘‘by limiting the participants of a covered clearing agency to those for which the covered clearing agency has assessed the likelihood of default.’’). 76 CCA Standards Proposing Release, supra note 7, 79 FR at 29552. 77 17 CFR 240.17Ad–22(e)(18). 78 17 CFR 240.17Ad–22(e)(19). 79 See Exchange Act Release No. 21651 (Jan. 11, 1985), 50 FR 2690, 2690 (Jan. 18, 1985). See also Exchange Act Release No. 9856 (Nov. 10, 1972), 37 FR 25224, 25224 (Nov. 29, 1972). VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 broker-dealer fails financially, the customer securities and cash should be readily available to be returned to the customers. In addition, if the failed broker-dealer is liquidated in a formal proceeding under the Securities Investor Protection Act of 1970 (‘‘SIPA’’), the customer securities and cash should be isolated and readily identifiable as ‘‘customer property’’ and, consequently, available to be distributed to customers ahead of other creditors.80 The first step required by Rule 15c3– 3 is that a carrying broker-dealer must maintain physical possession or control over customers’ fully paid and excess margin securities.81 Control means the broker-dealer must hold these securities in one of several locations specified in Rule 15c3–3 and free of liens or any other interest that could be exercised by a third-party to secure an obligation of the broker-dealer.82 Permissible locations include a clearing corporation 80 See 15 U.S.C. 78aaa et seq. At a high level, in such a liquidation, SIPA would provide for the appointment of a trustee, who is required to return customer name securities to customers of the debtor (15 U.S.C. 78fff–2(c)(2)), distribute the fund of ‘‘customer property’’ ratably to customers (15 U.S.C. 78fff–2(b)), and pay, with money from the SIPC fund, remaining customer net equity claims, to the extent provided by the Act (15 U.S.C. 78fff–2(b) and 3(a)). Customer property is defined as ‘‘cash and securities (except customer name securities delivered to the customer) at any time received, acquired, or held by or for the account of a debtor from or for the securities accounts of a customer, and the proceeds of any such property transferred by the debtor, including property unlawfully converted.’’ 15 U.S.C. 7lll(4). 81 See 17 CFR 240.15c3–3(d). The term ‘‘fully paid securities’’ means all securities carried for the account of a customer in a cash account as defined in Regulation T (12 CFR 220.1 et seq.), as well as securities carried for the account of a customer in a margin account or any special account under Regulation T that have no loan value for margin purposes, and all margin equity securities in such accounts if they are fully paid: provided, however, that the term fully paid securities does not apply to any securities purchased in transactions for which the customer has not made full payment. 17 CFR 240.15c3–3(a)(3). The term ‘‘margin securities’’ means those securities carried for the account of a customer in a margin account as defined in section 4 of Regulation T (12 CFR 220.4), as well as securities carried in any other account (such accounts referred to as ‘‘margin accounts’’) other than the securities referred to in paragraph (a)(3) of Rule 15c3–3. 17 CFR 240.15c3–3(a)(4). The term ‘‘excess margin securities’’ means those securities referred to in paragraph (a)(4) of Rule 15c3–3 carried for the account of a customer having a market value in excess of 140% of the total of the debit balances in the customer’s account or accounts encompassed by paragraph (a)(4) of Rule 15c3–3 which the broker-dealer identifies as not constituting margin securities. 17 CFR 240.15c3– 3(a)(5). 82 See 17 CFR 240.15c3–3(c). Customer securities held by the carrying broker-dealer are not assets of the firm. Rather, the carrying broker-dealer holds them in a custodial capacity, and the possession and control requirement is designed to ensure that the carrying broker-dealer treats them in a manner that allows for their prompt return. PO 00000 Frm 00010 Fmt 4701 Sfmt 4702 and a bank, as defined in section 3(a)(6) of the Exchange Act.83 The second step is that a carrying broker-dealer must maintain a reserve of funds or qualified securities in an account at a bank that is at least equal in value to the net cash owed to customers.84 The account must be titled ‘‘Special Reserve Bank Account for the Exclusive Benefit of Customers’’ (‘‘customer reserve account’’).85 The amount of net cash owed to customers is computed weekly pursuant to a formula set forth in 17 CFR 240.15c3– 3a (‘‘Rule 15c3–3a’’).86 Under the formula, the broker-dealer adds up customer credit items and then subtracts from that amount customer debit items.87 The credit items include credit balances in customer accounts and funds obtained through the use of customer securities.88 The debit items include money owed by customers (e.g., from margin lending), securities borrowed by the broker-dealer to effectuate customer short sales, and required margin posted to certain clearing agencies as a consequence of customer securities transactions.89 If credit items exceed debit items, the net amount must be on deposit in the customer reserve account in the form of 83 Id. 84 17 CFR 240.15c3–3(e). The term ‘‘qualified security’’ is defined in Rule 15c3–3 to mean a security issued by the United States or a security in respect of which the principal and interest are guaranteed by the United States. See 17 CFR 240.15c3–3(a)(6). 85 See 17 CFR 240.15c3–3(e)(1). The purpose of giving the account this title is to alert the bank and creditors of the broker-dealer that this reserve fund is to be used to meet the broker-dealer’s obligations to customers (and not the claims of general creditors) in the event the broker-dealer must be liquidated in a formal proceeding. 86 Some broker-dealers perform a daily computation in order to more dynamically match the deposit requirement with the amount of net cash owed to customers. For example, a brokerdealer that performs a weekly computation generally cannot withdraw excess cash or U.S. Treasury securities from the account until the following week even if the value of the account assets exceeds the net cash owed to customers. Further, the rule permits certain broker-dealers to perform a monthly computation. See 17 CFR 240.15c3–3(e)(3). 87 See id. 88 See 17 CFR 240.15c3–3a, Items 1–9. Brokerdealers are permitted to use customer margin securities to, for example, obtain bank loans to finance the funds used to lend to customers to purchase the securities. The amount of the bank loan is a credit in the formula because this is the amount that the broker-dealer would need to pay the bank to retrieve the securities. Similarly, brokerdealers may use customer margin securities to make stock loans to other broker-dealers in which the lending broker-dealer typically receives cash in return. The amount payable to the other brokerdealer on the stock loan is a credit in the formula because this is the amount the broker-dealer would need to pay the other broker-dealer to retrieve the securities. 89 See 17 CFR 240.15c3–3a, Items 10–14. E:\FR\FM\25OCP2.SGM 25OCP2 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 cash and/or qualified securities.90 A broker-dealer cannot make a withdrawal from the customer reserve account until the next computation and even then only if the computation shows that the reserve requirement has decreased.91 The broker-dealer must make a deposit into the customer reserve account if the computation shows an increase in the reserve requirement. The Rule 15c3–3a formula permits the broker-dealer to offset customer credit items only with customer debit items.92 This means the broker-dealer can use customer cash to facilitate customer transactions such as financing customer margin loans and borrowing securities to make deliveries of securities customers have sold short.93 The broker-dealer margin rules require securities customers to maintain a minimum level of equity in their securities accounts. In addition to protecting the broker-dealer from the consequences of a customer default, this equity serves to over-collateralize the customers’ obligations to the brokerdealer. This buffer protects the customers whose cash was used to facilitate the broker-dealer’s financing of securities purchases. For example, if the broker-dealer fails, the customer debits, because they generally are overcollateralized, should be attractive assets for another broker-dealer to purchase or, if not purchased by another broker-dealer, they should be able to be 90 17 CFR 240.15c3–3(e). Customer cash is a balance sheet item of the carrying broker-dealer (i.e., the amount of cash received from a customer increases the amount of the carrying broker-dealer’s assets and creates a corresponding liability to the customer). The reserve formula is designed to isolate these broker-dealer assets so that an amount equal to the net liabilities to customers is held as a reserve in the form of cash or U.S. Government securities. The requirement to establish this reserve is designed to effectively prevent the carrying broker-dealer from using customer funds for proprietary business activities such as investing in securities. The goal is to put the carrying brokerdealer in a position to be able to readily meet its cash obligations to customers by requiring the firm to make deposits of cash and/or U.S. Government securities into the customer reserve account in the amount of the net cash owed to customers. 91 See 17 CFR 240.15c3–3(e). 92 See 17 CFR 240.15c3–3a. 93 For example, if a broker-dealer holds $100 for customer A, the broker-dealer can use that $100 to finance a security purchase of customer B. The $100 the broker-dealer owes customer A is a credit in the formula and the $100 customer B owes the brokerdealer is a debit in the formula. Therefore, under the Rule 15c3–3a formula there would be no requirement to maintain cash and/or U.S. Government securities in the customer reserve account. However, if the broker-dealer did not use the $100 held in customer A’s account for this purpose, there would be no offsetting debit and, consequently, the broker-dealer would need to have on deposit in the customer reserve account cash and/or U.S. Government securities in an amount at least equal to $100. VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 liquidated to a net positive equity.94 The proceeds of the debits sale or liquidation can be used to repay the customer cash used to finance the customer obligations. This cash plus the funds and/or U.S. Treasury securities held in the customer reserve account should equal or exceed the total amount of customer credit items (i.e., the total amount owed by the broker-dealer to its customers).95 As noted above, debit items in the Rule 15c3–3a formula include margin required and on deposit at certain clearing agencies. In particular, Item 13 of the Rule 15c3–3a formula identifies as a debit item margin required and on deposit with the Options Clearing Corporation for all option contracts written or purchased in accounts of securities customers.96 Similarly, Item 14 of the Rule 15c3–3a formula identifies as a debit item margin related to security futures products written, purchased, or sold in accounts carried for security-based swap customers required and on deposit with a clearing agency registered with the Commission under section 17A of the Exchange Act 97 or a derivatives clearing organization (‘‘DCO’’) registered with the Commodities Futures Trading Commission under section 5b of the Commodity Exchange Act.98 These debit items reflect the fact that customer options and security futures transactions that are cleared generate margin requirements in which the broker-dealer must deliver collateral to the Options Clearing Corporation in the case of options or a clearing agency or DCO in the case of security futures products. Further, 17 CFR 240.15c3–3b (‘‘Rule 15c3–3b’’) sets forth a customer reserve formula for security-based swaps.99 Items 13 and 14 of this formula are identical to Items 13 and 14 of the Rule 15c3–3a formula. The Rule 15c3– 3b formula also permits a debit item for 94 The attractiveness of the over-collateralized debits facilitates the bulk transfer of customer accounts from a failing or failed broker-dealer to another broker-dealer. 95 See Exchange Act Release No. 18417 (Jan. 13, 1982), 47 FR 3512, 3513 (Jan. 25, 1982) (‘‘The alternative approach is founded on the concept that, if the debit items in the Reserve Formula can be liquidated at or near their contract value, these assets along with any cash required to be on deposit under the [customer protection] rule, will be sufficient to satisfy all liabilities to customers (which are represented as credit items in the Reserve Formula).’’). 96 See 17 CFR 240.15c3–3a, Item 13. 97 15 U.S.C. 78q–1. 98 7 U.S.C. 78q–1. 99 See also Exchange Act Release No. 86175 (Jun. 21, 2019), 84 FR 43872, 43938–42 (Aug. 22, 2019) (adopting a reserve computation for security-based swaps that permits a debit for margin delivered to a security-based swap clearing agency). PO 00000 Frm 00011 Fmt 4701 Sfmt 4702 64619 margin related to cleared security-based swaps required and on deposit in a qualified clearing agency account at a clearing agency registered pursuant to section 17A of the Exchange Act. Identifying the collateral delivered to the Options Clearing Corporation, a clearing agency, or a DCO as a debit item permits the broker-dealer to offset credit items, which reduces the amount of cash or qualified securities that must be deposited in the customer reserve account. In addition, under SIPA, ‘‘customer property’’ in a liquidation proceeding of a broker-dealer includes resources provided through the use or realization of customers’ debit cash balances and other customer-related debit items as defined by the Commission by rule.100 Therefore, by defining margin required and on deposit at the Options Clearing Corporation, a clearing agency, or a DCO as a debit item in Rule 15c3–3a, this property is available to the trustee to be used to return cash and securities to the failed broker-dealer’s customers ahead of any other creditors of the broker-dealer. III. Proposed Amendments A. U.S. Treasury Securities CCA Membership Requirements For the reasons set forth below, the Commission believes that direct participants in a U.S. Treasury securities CCA not centrally clearing cash or repo transactions in U.S. Treasury securities creates contagion risk to CCAs clearing and settling in these markets, as well as to the market as a whole, and that this contagion risk can be ameliorated at least in part by increasing the number of such transactions that are centrally cleared. Currently, the only U.S. Treasury securities CCA requires its direct participants to submit for central clearing are their cash and repo transactions in U.S. Treasury securities with other direct participants.101 However, the CCA’s rules do not require its direct participants to submit either cash or repo transactions 102 with 100 See 15 U.S.C. 78lll(4)(B). Rule 2A, section 7(e), supra note 47 (requirement that FICC Netting Members submit to FICC all of their eligible trades with other Netting Members); FICC Rule 18, section 2 (similar requirement with regard to Repo transactions); cf. FICC Rule 3, section 8(e) (providing clearing requirement for FICC IDB Members). 102 With regard to Sponsored GC Repos, as noted above, these transactions can be secured with generic CUSIPs that include U.S. Treasury securities, and with other generic CUSIPs that include other securities, such as agency securities and mortgage backed securities. Because the Membership Proposal is limited to eligible secondary market transactions in U.S. Treasury 101 FICC E:\FR\FM\25OCP2.SGM Continued 25OCP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 64620 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules persons who are not direct participants for central clearing. The Commission now proposes to amend the Covered Clearing Agency Standards to impose additional requirements for any covered clearing agency that provides central counterparty services for transactions in U.S. Treasury securities regarding membership in such CCA. Specifically, the proposal would require that such CCAs establish written policies and procedures reasonably designed to, as applicable, establish objective, risk-based, and publicly disclosed criteria for participation, which require that the direct participants of such covered clearing agency submit for clearance and settlement all eligible secondary market transactions to which they are a counterparty. As described in more detail below, an eligible secondary market transaction in U.S. Treasury securities would be defined to include: • Repurchase agreements and reverse repurchase agreements in which one of the counterparties is a direct participant; • Any purchases and sales entered into by a direct participant if the direct participant (A) brings together multiple buyers and sellers using a trading facility (such as a limit order book) and (B) is a counterparty to both the buyer and seller in two separate transactions; and • Any purchases and sales of U.S. Treasury securities between a direct participant and a counterparty that is a registered broker-dealer, government securities dealer, or government securities broker, a hedge fund, or an account at a registered broker-dealer, government securities dealer, or government securities broker where such account may borrow an amount in excess of one-half of the value of the account or may have gross notional exposure of the transactions in the account that is more than twice the value of the account. However, any transaction (both cash transactions and repos) where the counterparty to the direct participant of the CCA is a central bank, sovereign entity, international financial institution, or a natural person would be excluded from the definition of an eligible secondary market transaction. In addition, the proposal would require that such CCAs establish written policies and procedures reasonably designed to, as applicable, identify and monitor their direct participants’ submission of transactions for clearing, securities, it would not apply to Sponsored GC Repo generic CUSIPs that do not include U.S. Treasury securities. VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 including how the CCA would address a failure to submit transactions. For the reasons set forth below, the Commission believes that taking these incremental steps, which build on the existing rules of the only U.S. Treasury securities CCA, will strengthen risk management at the current and any other future U.S. Treasury securities CCA. Further, the Commission believes that this proposal would bring the benefits of clearance and settlement to a potentially significant portion of the U.S. Treasury securities market. This section first explains what the Membership Proposal is and to whom and what aspects of the U.S. Treasury markets it applies.103 It then describes what constitutes an eligible secondary market transaction and what transactions are excluded from that definition. Finally, it discusses the benefits of the Membership Proposal. 1. Requirement To Clear Eligible Secondary Market Transactions The Membership Proposal would apply to ‘‘direct participants’’ in a U.S. Treasury securities CCA, which would distinguish entities that access a CCA directly (i.e., members of the CCA) from indirect participants who ‘‘rely on the services provided by direct participants to access the covered clearing agency’s payment, clearing or settlement facilities.’’ 104 For purposes of the Covered Clearing Agency Standards, ‘‘participants’’ of a CCA are referred to as ‘‘members’’ or ‘‘direct participants’’ to differentiate these entities from ‘‘direct participants’ customers’’ or ‘‘indirect participants.’’ 105 103 The Commission would add this requirement to the current text of Rule 17Ad–22(e)(18). The Commission is also proposing to adjust the numbering of Rule 17Ad–22(e)(18), 17 CFR 240.17Ad–22(e)(18). But other than adding this proposal as new Rule 17Ad–22(e)(18)(iv), the Commission is not proposing any other substantive changes to the current text of Rule 17Ad–22(e)(18). The other changes to Rule 17Ad–22(e)(18) are entirely stylistic and designed to enhance readability in light of the proposed addition of Rule 17Ad–22(e)(18)(iv). In addition, the Commission proposes to define a U.S. Treasury security as ‘‘any security issued by the U.S. Department of the Treasury.’’ This term is not currently defined in Rule 17Ad–22, and this definition would be codified as Rule 17Ad–22(a)(23). 104 17 CFR 240.17Ad–22(e)(18) and (19). See also CCA Standards Proposing Release, supra note 7, at 29553 (noting that some market participants would not meet a covered clearing agency’s direct participation requirements and proposing risk management requirements for indirect and tiered participants). 105 See, e.g., 17 CFR 240.14Ad–22 (e)(6) (referring to participants) and (e)(2)(vi) (referring to direct participants’ customers). In addition, the Exchange Act defines a participant of a clearing agency as ‘‘any person who uses a clearing agency to clear or settle securities transactions or to transfer, pledge, lend, or hypothecate securities.’’ 15 U.S.C. 78c(a)(24). Indirect participants are expressly PO 00000 Frm 00012 Fmt 4701 Sfmt 4702 Consequently, for purposes of this proposal and consistent with the terminology already used in the Covered Clearing Agency Standards,106 the term ‘‘direct participants’’ would refer to the entities that directly access a U.S. Treasury securities CCA (generally banks and broker-dealers), and the term ‘‘indirect participants’’ would refer to those entities which rely on a direct participant to clear and settle their U.S. Treasury securities transactions with the U.S. Treasury securities CCA (generally their customers or clients).107 Moreover, persons who provide services in connection with clearance and settlement, such as settlement agent, settlement bank, or clearing bank services, and do not submit trades for clearing to a U.S. Treasury securities CCA would not be ‘‘direct participants’’ or ‘‘indirect participants’’ within the meaning of this proposal and the terminology used in the Covered Clearing Agency Standards.108 2. Eligible Secondary Market Transactions As discussed further below, the Commission would also define what constitutes an eligible secondary market transaction in U.S. Treasury securities subject to the Membership Proposal.109 This definition would apply to all types of transactions that are of a type currently accepted for clearing at a U.S. Treasury securities CCA; it would not impose a requirement on a U.S. excluded from the Exchange Act definition of a ‘‘participant’’ of a clearing agency because the Exchange Act provides that a person whose only use of a clearing agency is through another person who is a participant or as a pledgee of securities is not a ‘‘participant’’ of the clearing agency. Id. 106 See 17 CFR 240.17Ad–22(e)(19) (referring to firms that are indirect participants in a covered clearing agency as those that ‘‘rely on the services provided by direct participants to access the covered clearing agency’s payment, clearing, or settlement facilities’’). 107 For example, FICC maintains the Sponsored Service. See supra notes 64 through 66 and accompanying text. Because sponsored members cannot clear or settle government securities transactions without a sponsoring member, the Commission believes that these sponsored members are not ‘‘direct participants.’’ As noted above, such persons are referred to in this release as ‘‘indirect participants’’ or ‘‘customers.’’ 108 The Commission recognizes that some entities may access more limited services of a U.S. Treasury securities CCA without use of its CCP services. For example, FICC provides ‘‘comparison only’’ services for a certain membership type. See FICC Rule 8, supra note 47. Consistent with the definition of a ‘‘participant’’ under the Exchange Act, such entities would not be considered participants of a CCA and therefore would not be subject to this proposed requirement. 109 The Commission proposes to define the scope of an ‘‘eligible secondary market transaction,’’ including transactions that would be excluded from that definition, in Proposed Rule 17Ad–22(a). E:\FR\FM\25OCP2.SGM 25OCP2 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules Treasury securities CCA to offer additional products for clearing. The proposal does not apply to the primary market, i.e., the issuance and sale of a U.S. Treasury security to a primary dealer or other bidder in a U.S. Treasury auction. By statute, the Treasury Department is authorized to borrow money on behalf of the Federal government through the sale and issuance of U.S. Treasury securities to the public.110 The terms and conditions for the sale and issuance for these securities are contained in the applicable Treasury Department auction rules or the securities offering (or auction) announcements.111 The Treasury Department determines when auctions will occur and in what amounts and retains discretion as to the conduct of auctions, including, among other things, whether to award more or less than the amount of securities specified in an auction announcement and reserves the right to modify the terms and conditions of an auction.112 In addition, the Treasury Department gives successful bidders the option of instructing that ‘‘delivery and payment be made through the clearing corporation for securities awarded to the submitter for its own account, but it does not require the use of a clearing corporation for delivery and payment in connection with securities awarded in the auctions.113 In light of the existing regulatory regime for these primary market transactions, as well as the role of such transactions in directly financing the Federal government, the Commission believes that it would be inappropriate for the Membership Proposal to include primary market transactions. As stated above, 114 U.S. Treasury securities start trading after the auction announcement, before the auction and continue trading through issuance and afterwards. The trading that occurs after announcement and prior to issuance is generally referred to as when-issued trading and it covers two distinct periods: before the auction and after the auction. The latter, i.e., when-issued trades that occur the day after the auction are considered on-the-run on some IDBs. All when-issued khammond on DSKJM1Z7X2PROD with PROPOSALS2 110 31 U.S.C. 3101 et seq. Offering Circular, 31 CFR 356. The circular covers all aspects of the sale and issue of U.S. Treasury securities, including bidding, certifications, payment, determination of auction awards, and settlement. 112 See, e.g., Treasury Marketable Securities Offering Announcement Press Releases, available at https://www.treasurydirect.gov/instit/annceresult/ press/press_secannpr.htm; 31 CFR 356.33. 11331 CFR 356.17(d)(2). 114 See note 38 supra. 111 Uniform VerDate Sep<11>2014 22:34 Oct 24, 2022 Jkt 259001 transactions are reported to TRACE.115 In addition, based on its supervisory experience, the Commission understands that FICC already clears when-issued securities. Accordingly, in light of the fact that trading in when issued securities that takes place the day after the auction shares similar characteristics to secondary market transactions and such trading is already reported as a secondary market transaction, the Membership Proposal would apply to when-issued trades that occur the day after the auction and are considered on-the-run on some IDBs, to the extent that such when-issued trades otherwise meet the definition of an eligible secondary market transaction, as discussed further in section III.A.2 infra. However, since when-issued trading that takes place before and including the day of the auction does not share these characteristics and is primarily used as a tool for price discovery leading to the auction, such transactions would not be encompassed by the Membership Proposal. a. Repo Transactions The Commission proposes to include all U.S. Treasury repurchase and reverse repurchase agreements entered into by a direct participant of a U.S. Treasury securities CCA as eligible secondary market transactions subject to the Membership Proposal, subject to the exclusions discussed in section III.A.2.c infra.116 As noted above, the U.S. Treasury repo market plays a key role in facilitating the flow of cash and securities in the financial system by allowing market participants to access financing, supporting dealer marketmaking activities, enabling institutional investors with large cash balances to invest cash on a secured basis, and contributing to price discovery and efficient capital allocation, as well as supporting the calculation of the Secured Overnight Financing Rate (‘‘SOFR’’) by the Federal Reserve Bank of New York.117 Significant gaps persist in the coverage of transaction data in U.S. Treasury repo activity, but the available data indicates that the volume of repo transactions that are bilaterally cleared and settled remains 115 Trades in a security that occurred the day after it was auctioned accounted, on average, for approximately 12% of all trades in U.S. Treasury securities between July 1, 2019, and June 30, 2020, with approximately half of such trades taking place on an IDB. Id. 116 See paragraphs (i) and (iii) of the definition of an ‘‘eligible secondary market transaction’’ in Proposed Rule 17Ad–22(a). 117 MMF Primer, supra note 57; see also Secured Overnight Financing Rate Data, available at https:// www.newyorkfed.org/markets/reference-rates/sofr. PO 00000 Frm 00013 Fmt 4701 Sfmt 4702 64621 substantial.118 For example, recent research with respect to primary dealers indicates that 38 percent of their repo and 60 percent of their reverse repo activity is not centrally cleared, and, overall, that 20 percent of all their repo and 30 percent of their reverse repo activity is centrally cleared through FICC.119 Nevertheless, FICC lacks visibility into its members’ noncentrally cleared repo trades, and the default of one counterparty can have cascading effects on multiple other market participants, including members of FICC, thereby risking contagion to the CCP. In addition, particularly with respect to banks and dealers, an important potential benefit of repo central clearing stems from mitigating the constraints on intermediaries’ balance sheets under the existing accounting and regulatory capital rules.120 Recent research indicates that for primary dealers, use of the centrally cleared bilateral repo market leads to a reduction in balance sheet allocation of approximately 20 percent relative to their total repo exposure.121 The Commission believes that the benefit of this resulting additional balance sheet capacity could be shared by all market participants 118 IAWG Report, supra note 4, at 29 (stating that non-centrally cleared bilateral repo represents a significant portion of the market, roughly equal in size to centrally cleared repo) (citing a 2015 pilot program by the Treasury Department); see also TMPG, Clearing and Settlement Practices for Treasury Secured Financing Transactions Working Group Update (‘‘TMPG Repo White Paper’’), at 1 (Nov. 5, 2021), available at https:// www.newyorkfed.org/medialibrary/Microsites/ tmpg/files/CSP_SFT_Note.pdf; Katy Burne, ‘‘Future Proofing the Treasury Market,’’ BNY Mellon Aerial View, at 7 (Nov. 2021), available at https:// www.bnymellon.com/content/dam/bnymellon/ documents/pdf/aerial-view/future-proofing-the-ustreasury-market.pdf.coredownload.pdf (noting that 63% of repo transactions remain non-centrally cleared according to Office of Financial Research data as of Sept. 10, 2021). 119 Sebastian Infante, et al., Insights from revised Form FR2004 into primary dealer securities financing and MBS activity (Aug. 5, 2022), available at https://www.federalreserve.gov/econres/notes/ feds-notes/insights-from-revised-form-fr2004-intoprimary-dealer-securities-financing-and-mbsactivity-20220805.htm. See section IV.B.2 for a more detailed discussion of this analysis. 120 In effect, accounting rules allow purchases and sales of the same security to be netted but do not allow repos of the same security to be netted, unless the repos are with the same counterparty and the trades have been documented under a master netting agreement. See, e.g., G–30 Report, supra note 5, at 13; Program on International Financial Systems, Mandatory Central Clearing for U.S. Treasuries and U.S. Treasury Repos, at 25–27 (Nov. 2021), available at https://www.pifsinternational. org/wp-content/uploads/2021/11/PIFS-MandatoryCentral-Clearing-for-U.S.-Treasury-Markets11.11.2021.pdf (‘‘PIFS Paper’’). Thus, if a dealer’s repos are all with a U.S. Treasury securities CCA, greater netting is allowed. 121 Infante, et al., supra note 117. E:\FR\FM\25OCP2.SGM 25OCP2 64622 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 through improved market liquidity and smooth market functioning.122 Moreover, it appears that, as with cash markets, risk management practices in the bilateral clearance and settlement of repos are not uniform across market participants and are not transparent.123 Indeed, a recent publication stated that competitive pressures in the bilaterally settled market for repo transactions have exerted downward pressure on haircuts, sometimes to zero.124 The reduction of haircuts, which serve as a counterparty credit risk mitigant in bilateral repos, could result in greater exposure to potential counterparty default risk in non-centrally cleared repos. By contrast, a U.S. Treasury securities CCA is subject to the Commission’s risk management requirements addressing financial, operational, and legal risk management, which include, among other things, margin requirements commensurate with the risks and particular attributes of each relevant product, portfolio, and market.125 Therefore, repos cleared at a U.S. Treasury securities CCA would be subject to transparent risk management standards that are publicly available and applied uniformly and objectively to all participants in the CCA. As discussed in section II.A.2 supra, many market participants have already chosen to centrally clear some of their repo transactions. FICC provides central clearing for its direct participants in both centrally cleared bilateral and triparty repo. In addition, in the Sponsored Program, FICC recently has made several changes to the program with the intent of increasing overall participation in the service and ensuring that market participants can use the service consistent with their applicable regulatory requirements and business strategies. For example, in 2021, FICC expanded the available products to allow Sponsored Members to clear triparty repos through the program,126 in addition to the existing ability to sponsor bilateral repo into central clearing. There are now approximately 30 Sponsoring Members and 1,900 122 See Committee on the Global Financial System, Repo Market Functioning, at 24 (Apr. 2017), available at https://www.bis.org/publ/ cgfs59.pdf. 123 TMPG Repo White Paper, supra note 118, at 1. 124 G–30 Report, supra note 5, at 13. 125 17 CFR 240.17Ad–22(e)(6). 126 See, e.g., supra note 64; Self-Regulatory Organizations; Fixed Income Clearing Corporation; Order Approving a Proposed Rule Change to Expand Sponsoring Member Eligibility in the Government Securities Division Rulebook and Make Other Changes, Exchange Act Release No. 85470 (Mar. 29, 2019), 84 FR 13328 (Apr. 4, 2019). VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 Sponsored Members with access to central clearing, including money market funds, hedge funds, and other asset managers.127 Recent research indicates that, as of the second quarter of 2022, money market funds held had close to $63 billion in centrally cleared U.S. Treasury repos, or 3% of their total Treasury repo volume.128 Most of that centrally cleared repo is through FICC’s Sponsored Program away from the triparty platform.129 In addition, certain private funds participate in the centrally cleared Treasury repo market, through FICC’s Sponsored Program. These firms benefit from improved ability to access the repo market and more advantageous pricing.130 The Commission considered these currently available methods for accessing central clearing for U.S. Treasury repos for both dealers and buyside entities when determining to propose the inclusion of repos as eligible secondary market transactions and believes that this factor further supports its determination. b. Purchases and Sales of U.S. Treasury Securities An estimated 68 percent of the overall dollar value of cash market transactions in U.S. Treasury securities are not centrally cleared, and an estimated 19 percent of the overall dollar value of such transactions are subject to socalled hybrid clearing (as stated above).131 The Commission has identified certain categories of purchases and sales of U.S. Treasury securities that it believes should be part of the definition of an eligible secondary market transaction subject to the Membership Proposal, i.e., for which U.S. Treasury securities CCAs would be obligated to impose membership rules to require clearing of such transactions, for the reasons described below. The Commission believes that including this set of transactions in the eligible secondary market definition and therefore subjecting these transactions 127 See FICC Membership Directories, available at https://www.dtcc.com/client-center/ficc-govdirectories. 128 Viktoria Baklanova et al., Money Market Funds in the Treasury Market (Sept. 1, 2022), available at https://www.sec.gov/files/mmfstreasury-market-090122.pdf (‘‘MMFs in the Treasury Market’’). 129 Id. 130 See, e.g., G–30 Report, supra note 5, at 13 (‘‘Buyside firms benefit because dealers are willing to intermediate cleared repos at narrower spreads, which are reflected in part in higher rates paid to buyside repo investors on cleared repos than on uncleared repos and in part in lower rates charged to repo borrowers (including hedge funds and smaller broker-dealers) on cleared repos.’’). 131 IAWG Report, supra note 4, at 30; see also TMPG White Paper, supra note 21, at 12. PO 00000 Frm 00014 Fmt 4701 Sfmt 4702 to the Membership Proposal represents an incremental first step to address potential risks arising to a U.S. Treasury securities CCA. i. IDB Transactions The Commission proposes to include within the definition of an eligible secondary market transaction any purchase or sale between a direct participant of a U.S. Treasury securities CCA and any counterparty, if the direct participant of the covered clearing agency (A) brings together multiple buyers and sellers using a trading facility (such as a limit order book) and (B) is a counterparty to both the buyer and seller in two separate transactions.132 As a result, this definition will only encompass the transactions of those IDBs in the Treasury market that are direct participants of a U.S. Treasury securities CCA and stand as counterparties to both sides of each trade on their platforms.133 The Commission believes that this aspect of the Membership Proposal generally would result in the benefits described in section III.A.3 infra. Chiefly, the Commission believes that this aspect of the Membership Proposal would specifically address the potential for contagion risk associated with hybrid clearing that a number of commentators have highlighted. As explained above, the configuration of counterparty risk presented by hybrid clearing allows the U.S. Treasury securities CCA to manage the risks arising from the IDB–CCA direct participant transaction, on the one hand, but the U.S. Treasury securities CCA cannot manage the risks arising from the IDB’s offsetting transaction with its non-member counterparty and the potential counterparty credit risk and settlement risk arising to the IDB from that trade.134 Thus, under the current hybrid clearing model, the U.S. Treasury securities CCA is indirectly exposed to the IDB’s non-centrally cleared transaction, but it lacks the ability to risk manage its indirect exposure to this non-centrally cleared leg of the transaction. Specifically, it does not know who the ultimate 132 See paragraph (ii)(A) of the definition of an ‘‘eligible secondary market transaction’’ in Proposed Rule 17Ad–22(a). 133 See notes 40–43 and accompanying text supra. 134 See, e.g., TMPG White Paper, supra note 21, at 22 (noting that in a hybrid clearing arrangement, an IDB’s rights and obligations to the CCP are not offset and the IDB is not in a net zero settlement position with respect to the CCP at settlement date). Thus, the IDB is not able to net all of its positions for clearing at a U.S. Treasury securities CCA, and the IDB’s positions appear to the CCA to be directional, which impacts the amount of margin that the CCA collects for the transaction. E:\FR\FM\25OCP2.SGM 25OCP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules counterparty of the transaction is and cannot collect margin on that transaction. This, in turn, results in margin collection at the CCP which is based upon only one transaction and has been calculated to cover this seemingly directional position, as well as an inability to net these offsetting transactions and provide the benefits of central clearing. In particular, if the IDB’s non-CCP member counterparty fails to settle a transaction that is subject to hybrid clearing, such IDB may not be able to settle the corresponding transaction that has been cleared with the U.S. Treasury securities CCA due to a lack of financial resources at the IDB, which could lead the IDB to default.135 As part of its existing default management procedures, the U.S. Treasury securities CCA could seek to mutualize its losses from the IDB’s default, which could in turn transmit stress to the market as a whole. As noted above, the Commission has previously stated that membership requirements help to guard against defaults of any CCP member, as well as to protect the CCP and the financial system as a whole from the risk that one member’s default could cause others to default, potentially including the CCP itself. Further, contagion stemming from a CCP member default could undermine confidence in the financial system as a whole, even if the health of the CCP is not implicated. This is because the default could cause others to back away from participating in the market. This risk of decreased participation could be particularly problematic if the defaulting participant was an IDB, whose withdrawal from the market could impact other market participants’ ability to access the market for on-therun U.S. Treasury securities, approximately 49.7% of which trade on IDBs.136 Including such transactions as eligible secondary market transactions subject to the Membership Proposal would therefore help protect against this risk by requiring that a U.S. Treasury securities CCA ensure that direct participants who are IDBs centrally clear both sides of their transactions, thereby eliminating the various aspects of potential contagion risk posed by socalled hybrid clearing. 135 See IAWG Report, supra note 4, at 31; Depository Trust and Clearing Corporation, More Clearing, Less Risk: Increasing Centrally Cleared Activity in the U.S. Treasury Cash Market, at 5 (May 2021), available at https://www.dtcc.com/-/media/ Files/PDFs/DTCC-US-Treasury-Whitepaper.pdf (‘‘DTCC May 2021 White Paper’’). 136 TMPG White Paper, supra note 21, at 32; section IV.B.4 (Table 1) infra. VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 ii. Other Cash Transactions The Commission proposes to include certain additional categories of cash transactions of U.S. Treasury securities by the direct participants of a U.S. Treasury securities CCA in the definition of an eligible secondary market transaction subject to the Membership Proposal. First, the Commission is proposing that the definition of an eligible secondary market transaction include those cash purchase and sale transactions in which the counterparty of the direct participant is a registered broker-dealer, government securities broker, or government securities dealer.137 Each of these entities is a type of market intermediary that is engaged in the business of effecting transactions in securities for the account of others (in the case of brokers) or for their own accounts (in the case of dealers).138 As stated in section II.A.1 supra, in 2018, the TMPG determined that a majority of trades in the secondary cash Treasury market now clear bilaterally, 139 and estimated that the trading volume of non-FICC members exceeds that of FICC members.140 As a result, the Commission believes that their collective trading activity likely is responsible for a not insignificant portion of the volume of transactions involving Treasury securities and could present contagion risk to a U.S. Treasury securities CCA.141 In addition, registered broker-dealers, government securities brokers, or dealers that are not direct members of a U.S. Treasury 137 See paragraph (ii)(B) of the definition of an ‘‘eligible secondary market transaction’’ in Proposed Rule 17Ad–22(a). See also 15 U.S.C. 78o(a) and 78o–5(a) (requirement to register) and 78c(4), (5), (43), and (44) (definitions of broker, dealer, government securities dealer, and government securities broker). The Commission acknowledges that the transactions encompassed by paragraph (ii)(B) in the definition of an ‘‘eligible secondary market transaction’’ in Proposed Rule 17Ad–22(a) could also encompass certain transactions that would be encompassed by paragraph (ii)(A) of the same proposed definition, in the event that the direct participant is an IDB transacting with a registered broker-dealer. However, the set of transactions encompassed by paragraph (ii)(B) of the proposed definition is broader than that of paragraph (ii)(A). The Commission believes that this overlap is appropriate because these paragraphs of the proposed definition are designed to accomplish different purposes, which is not impacted by the potential overlap. 138 See generally TMPG, Automated Trading in Treasury Markets (White Paper) (June 2015), available at https://www.newyorkfed.org/TMPG/ medialibrary/microsites/tmpg/files/TPMG-June2015-Automated-Trading-White-Paper.pdf (‘‘TMPG Automated Trading White Paper’’). 139 TMPG White Paper, supra note 21, at 2. 140 IAWG Report, supra note 4, at 30; TMPG White Paper, supra note 21, at 12. 141 See supra note 15 and TMPG Automated Trading White Paper, supra note 138. PO 00000 Frm 00015 Fmt 4701 Sfmt 4702 64623 securities CCA are typically ‘‘introducing firms’’ that establish mechanisms to clear and settle their transactions. For example, currently, many registered brokers and dealers rely on the correspondent clearing service provided by FICC to have a FICC member submit their transactions for clearing at FICC.142 The Commission believes that the benefits that would result from imposing a requirement on U.S. Treasury securities CCAs to require that their direct participants submit for clearing and settlement such transactions in which their counterparties are registered brokerdealers or government securities brokers or government securities dealers would be consistent with the benefits of central clearing set forth in section III.A.3 infra. Moreover, because these entities are already either part of or able to access the national system of clearance and settlement, there should be fewer obstacles to submission of such trades. Second, the Commission proposes to include within the definition of an eligible secondary market transaction any purchase and sale transaction between a direct participant of a U.S. Treasury securities CCA and a hedge fund, that is any private fund (other than a securitized asset fund): (a) with respect to which one or more investment advisers (or related persons of investment advisers) may be paid a performance fee or allocation calculated by taking into account unrealized gains (other than a fee or allocation the calculation of which may take into account unrealized gains solely for the purpose of reducing such fee or allocation to reflect net unrealized losses); (b) that may borrow an amount in excess of one-half of its net asset value (including any committed capital) or may have gross notional exposure in excess of twice its net asset value (including any committed capital); or (c) that may sell securities or other assets short or enter into similar transactions (other than for the purpose of hedging currency exposure or managing duration). This definition of a hedge fund is consistent with the Commission’s definition of a hedge fund in Form PF.143 The Commission’s intent in including transactions with hedge funds in the definition of an eligible market transaction is two-fold. First, hedge funds generally can engage in trading 142 See, e.g., FICC Rule 8 (describing the service), supra note 47; FICC Executing Firm Master List, available at https://www.dtcc.com/client-center/ ficc-gov-directories. 143 17 CFR 279.9 (Form PF Glossary of Terms). E:\FR\FM\25OCP2.SGM 25OCP2 64624 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 strategies that may pose heightened risks of potential financial distress to their counterparties, including those who are direct participants of a U.S. Treasury securities CCA. For example, the Commission observed when proposing Form PF that hedge funds often use financial institutions that may have systemic importance to obtain leverage, and that hedge funds may employ investment strategies that may use leverage, derivatives, complex structured products, and short selling in an effort to generate returns, as well as employ strategies involving high volumes of trading and concentrated investments.144 The Commission recognized that the strategies employed by hedge funds ‘‘can increase the likelihood that the fund will experience stress or fail, and amplify the effects on financial markets.’’ 145 The Commission also stated that significant hedge fund failures, resulting from their investment positions or use of leverage or both, could result in material losses at the financial institutions that lend to them if collateral securing this lending is inadequate, and that these losses could have systemic implications if they require these financial institutions to scale back their lending efforts or other financing activities generally.146 Similarly, the FSOC acknowledged, in light of recent market events, the importance of understanding how hedge fund activities may impact the broader market, including ‘‘how financial strain at hedge funds—particularly those with significant leverage—could create risks to financial stability, and how a reduction in financial intermediation by hedge funds during periods of market stress could exacerbate market impairment.’’ 147 Thus, as a general matter, the Commission believes that if any of a hedge fund’s activities, even 144 Proposing Release, Reporting by Investment Advisers to Private Funds and Certain Commodity Pool Operators and Commodity Trading Advisors on Form PF, Release No. IA–3145 (Jan. 26, 2011), 76 FR 8068, 8073 (Feb. 12, 2011) (‘‘Form PF Proposing Release’’). The Commission adopted the hedge fund definition with some amendments thereafter. Final Rule, Reporting by Investment Advisers to Private Funds and Certain Commodity Pool Operators and Commodity Trading Advisors on Form PF, Release No. IA–3308 (Oct. 31, 2011), 76 FR 71127 (Nov. 16, 2011). 145 Form PF Proposing Release, supra note 144, 76 FR at 8073 (citing President’s Working Group on Financial Markets, Hedge Funds, Leverage, and the Lessons of Long Term Capital Management (Apr. 1999), at 23). 146 Id. (also noting that the simultaneous failure of several similarly positioned hedge funds could create contagion through the financial markets if the failing funds had to liquidate their investment positions at firesale prices). 147 FSOC Statement on Nonbank Financial Intermediation (Feb. 4, 2022), available at https:// home.treasury.gov/news/press-releases/jy0587. VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 those that are not related to the U.S. Treasury market, cause financial stress to a counterparty that is a direct participant of a U.S. Treasury securities CCA, the inclusion of a hedge fund’s U.S. Treasury securities cash transactions with a direct participant in the definition of an eligible secondary market transaction should help ensure that such financial stress would not transmit to the U.S. Treasury securities CCA and through to the U.S. Treasury market. In addition, hedge funds are increasingly large players in the U.S. Treasury market. For example, as of the fourth quarter of 2021, the Commission’s Private Funds Statistics indicated that qualifying hedge funds held aggregate gross notional exposure of $1,760 billion in U.S. Treasury securities.148 However, qualifying hedge funds generally report central clearing of about 15 percent of their overall net asset value.149 There has been a great deal of commentary regarding the role of hedge funds in the U.S. Treasury markets, particularly with respect to the March 2020 market events.150 For example, the FSOC observed that hedge funds were among the three largest types of sellers of Treasury securities, materially contributing to the Treasury market disruption during this period, although not as its sole cause.151 The IAWG staffs stated that, in March 2020, hedge funds were among the largest sellers of Treasury securities as expected price relationships broke down, highly levered positions 148 Private Funds Statistics for Q4 2021, Table 46 (July 22, 2022), available at https://www.sec.gov/ divisions/investment/private-funds-statistics/ private-funds-statistics-2021-q4.pdf. Qualifying hedge funds refers to those hedge funds that have a net asset value (individually or in combination with any feeder funds, parallel funds and/or dependent parallel managed accounts) of at least $500 million as of the last day of any month in the fiscal quarter immediately preceding its most recently completed fiscal quarter. See Form PF (Glossary of Terms). 149 Private Funds Statistics for Q4 2021, Figure 17 (July 22, 2022), available at https://www.sec.gov/ divisions/investment/private-funds-statistics/ private-funds-statistics-2021-q4.pdf. 150 See generally Ayelen Banegas et al., Sizing Hedge Funds’ Treasury Market Activities and Holdings (Oct. 6, 2021), available at https:// www.federalreserve.gov/econres/notes/feds-notes/ sizing-hedge-funds-treasury-market-activities-andholdings-20211006.htm; see also Daniel Barth & R. Jay Kahn, Hedge Funds and the Treasury CashFutures Disconnect (Apr. 1, 2021), available at https://www.financialresearch.gov/working-papers/ 2021/04/01/hedge-funds-and-the-treasury-cashfutures-disconnect/; Hedge Fund Treasury Trading and Funding Fragility: Evidence from the COVID– 19 Crisis, available at https:// www.federalreserve.gov/econres/feds/files/ 2021038pap.pdf. 151 FSOC Feb. 2022, supra note 172; see also IAWG, supra note 4, at 34. PO 00000 Frm 00016 Fmt 4701 Sfmt 4702 magnified losses, and some funds faced margin calls.152 This demonstrates the potential contagion risk that could arise from hedge funds’ activities in the U.S. Treasury market. Similar to the risks posed to a U.S. Treasury securities CCA by non-centrally cleared trades entered into by an IDB, non-centrally cleared transactions entered into between hedge funds and direct participants of the CCA could cause risks to the CCA in the event that the hedge fund is not able to meet its obligations to the direct participant, which could, in turn, create stress to the direct participant and through to the CCA. Therefore, including the direct participant’s purchase and sale transactions with hedge funds within the definition of an eligible secondary market transaction should reduce the potential for financial distress arising from the transactions that could affect the direct participant and the U.S. Treasury securities CCA. This aspect of the proposal would also result in consistent and transparent risk management being applied to such transactions, as discussed further in section III.A.3 infra. The Commission believes that defining a hedge fund in a manner consistent with Form PF is reasonable, because such definition should encompass those funds that use strategies that the Commission has determined merit additional reporting to allow a better picture of the potential systemic risks posed by such activities.153 Including transactions with such funds within the definition of an eligible secondary market transaction should help to limit the potential 152 IAWG, supra note 4, at 34. See also SEC Staff Report on U.S. Credit Markets Interconnectedness and the Effects of the COVID–19 Economic Shock (Oct. 2020), available at https://www.sec.gov/files/ US-Credit-Markets_COVID-19_Report.pdf. 153 Final Rule, Reporting by Investment Advisers to Private Funds and Certain Commodity Pool Operators and Commodity Trading Advisors on Form PF, Release No. IA–3308 (Oct. 31, 2011), 76 FR 71127 (Nov. 16, 2011). The reporting requirements for Form PF vary based on the amount of private fund assets under management for an investment adviser registered with the Commission. For example, if an investment adviser’s private fund assets under management, including with respect to hedge funds, are less than $150 million on the last day of the most recent fiscal year, then the investment adviser is not required to file Form PF. Separately, additional reporting requirements apply to large hedge fund advisers with at least $1.5 billion in hedge fund assets under management. See Form PF, Instructions 1 and 3. However, the Commission believes that including all hedge funds within paragraph (ii)(C) of the definition of an ‘‘eligible secondary market transaction’’ in Proposed Rule 17Ad-22(a) would be consistent with its overall policy goals for central clearing in the U.S. Treasury market and ensuring that hedge fund transactions with direct participants in a U.S. Treasury securities CCA do not adversely impact the direct participant and, potentially, the CCA. E:\FR\FM\25OCP2.SGM 25OCP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules contagion risk that could arise from any financial distress experienced at such a fund that could, in turn, be transmitted to a direct participant of a U.S. Treasury securities CCA (and to the CCA) via any non-centrally cleared transactions. Specifically, using such definition would allow the definition of an eligible secondary market transaction to include transactions between direct participants of a U.S. Treasury securities CCA and a private fund whose characteristics make it more likely that it would have an impact on systemic risk, i.e., its ability to short sell and take on significant leverage. For example, as the Commission recently stated, large investment losses or a margin default involving one large highly levered hedge fund may have systemic risk implications, and large investment losses at multiple hedge funds may indicate market stress that could have systemic effects.154 The Commission believes that using a definition consistent with that of Form PF to identify transactions with a U.S. Treasury securities CCA’s direct participant as part of the definition of an eligible secondary market transaction subject to the Membership Proposal should capture transactions with entities whose default would be most likely to cause potential contagion risk to the Treasury securities CCA. For example, hedge funds’ use of leverage can make them more vulnerable to liquidity shocks, which could, in turn, make them unable to deliver in a transaction with a direct participant of a U.S. Treasury securities CCA. Third, the Commission proposes to include within the definition of an eligible secondary market transaction subject to the Membership Proposal any purchase and sale transaction between a direct participant of a U.S. Treasury securities CCA and an account at a registered broker-dealer, government securities dealer, or government securities broker that either may borrow an amount in excess of one-half of the net value of the account or may have gross notional exposure of the transactions in the account that is more than twice the net value of the account.155 This would apply to accounts that can take on significant leverage, that is, by borrowing an amount that is more than one half of its 154 Proposing Release, Amendments to Form PF To Require Current Reporting and Amend Reporting Requirements for Large Private Equity Advisers and Large Liquidity Fund Advisers, Release No. IA–5950 (Jan. 26, 2022), 87 FR 9106, 9109 (Feb. 17, 2022). 155 See paragraph (ii)(D) of the definition of an ‘‘eligible secondary market transaction’’ in Proposed Rule 17Ad–22(a). VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 net value or take on exposures worth more than twice the account’s net value. The Commission believes that the inclusion of transactions with such accounts within the definition of an eligible secondary market transaction should allow the proposal to encompass transactions between direct participants of a U.S. Treasury securities CCA and a prime brokerage account, which, based on the Commission’s supervisory knowledge, may hold assets of entities, such as, for example, private funds or separately managed accounts, and may use leverage that poses a risk to U.S. Treasury securities CCA and the broader financial system. Covering such accounts would also allow for inclusion of, for example, accounts used by family offices or separately managed accounts that may use strategies more similar to those of a hedge fund. The account provider (i.e., the prime broker) does not have access to, or knowledge of, the account owner’s entire portfolio of assets and is limited to the assets in that particular account. Therefore, the account provider may be unable to make a counterparty whole in the event of a default by the account owner if the account has taken on significant leverage. Typically, the entity providing an account has a lien or some other priority on assets in the account to make a counterparty whole if necessary. By including the account, and not the entity using the account, this aspect of the proposal is targeted to the activity that could bring the most potential risk to a U.S. Treasury securities CCA and the financial system more generally. c. Exclusions From the Definition of an Eligible Secondary Market Transaction The Commission is proposing to exclude transactions between direct participants of a U.S. Treasury securities CCA and certain counterparties from the definition of an eligible secondary market transaction in U.S. Treasury securities. These exclusions would apply to any purchase or sale transaction in U.S. Treasury securities or repurchase or reverse repurchase agreement collateralized by U.S. Treasury securities. First, recognizing the importance of U.S. Treasury securities not only to the financing of the United States government, but also their central role in the formulation and execution of monetary policy and other governmental functions, the Commission is proposing to exclude any transactions in U.S. Treasury securities between a direct participant of a U.S. Treasury securities CCA and a central bank. For similar reasons, the Commission is also proposing to exclude any transactions in U.S. PO 00000 Frm 00017 Fmt 4701 Sfmt 4702 64625 Treasury securities between a direct participant of a U.S. Treasury securities CCA and a sovereign entity or an international financial institution.156 Together, these exclusions are referred to as the ‘‘Official Sector Exclusions.’’ In addition, the Commission is also proposing to exclude transactions in U.S. Treasury securities between a direct participant of a U.S. Treasury securities CCA and a natural person. The Commission does not believe that such transactions should be included in light of the likely low volumes of transactions entered into by natural persons and the low potential for contagion risk arising from such transactions. i. Official Sector Exclusions From the Membership Proposal The Official Sector Exclusions are designed to permit domestic and international policy makers, i.e., central banks, to continue to pursue important policy goals. Because these transactions should present limited to no risk of contagion to a U.S. Treasury securities CCA, the Commission believes that these exclusions are appropriate. For purposes of the Official Sector Exclusion, the Commission proposes to define a central bank as a reserve bank or monetary authority of a central government (including the Board of Governors of the Federal Reserve System or any of the Federal Reserve Banks). The proposed definition would also include the Bank for International Settlements (‘‘BIS’’).157 The BIS is owned by central banks.158 The Commission therefore believes it is appropriate to include the BIS in the definition of central bank for purposes of this proposal. The Commission proposes to define a sovereign entity as a central government (including the U.S. Government), or an agency, department, or ministry of a central government.159 Finally, the Commission proposes to define an international financial institution by specifying the entities, i.e., (1) African Development Bank; (2) African Development Fund; (3) Asian Development Bank; (4) Banco Centroamericano de Integracio´n Econo´mica; (5) Bank for Economic Cooperation and Development in the 156 As discussed more fully below, these exclusions would be codified in paragraph (iii) of the definition of an ‘‘eligible secondary market transaction’’ in Proposed Rule 17Ad–22(a). 157 The Commission proposes to codify this definition in Proposed Rule 17Ad–22(a). 158 See https://www.bis.org/about/index.htm (noting that ‘‘the BIS is owned by 63 central banks, representing countries from around the world that together account for about 95% of world GDP’’). 159 The Commission proposes to codify this definition in Proposed Rule 17Ad–22(a). E:\FR\FM\25OCP2.SGM 25OCP2 64626 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 Middle East and North Africa; (6) Caribbean Development Bank; (7) Corporacio´n Andina de Fomento; (8) Council of Europe Development Bank; (9) European Bank for Reconstruction and Development; (10) European Investment Bank; (11) European Investment Fund; (12) European Stability Mechanism; (13) InterAmerican Development Bank; (14) InterAmerican Investment Corporation; (15) International Bank for Reconstruction and Development; (16) International Development Association; (17) International Finance Corporation; (18) International Monetary Fund; (19) Islamic Development Bank; (20) Multilateral Investment Guarantee Agency; (21) Nordic Investment Bank; (22) North American Development Bank, and providing that the term would also include any other entity that provides financing for national or regional development in which the United States government is a shareholder or contributing member.160 The Commission believes that the proposed exclusion is appropriate to central banks because these entities are created by statute and are part of, or aligned with, a central government.161 Further, the purpose of a central bank is generally to effectuate monetary policy for its respective nation.162 For example, transactions in U.S. Treasury securities are an important tool in the fiscal and monetary policy of the United States, as well as other jurisdictions.163 In particular, cash and repo transactions in U.S. Treasury securities are one of the primary tools used by the Federal Reserve Bank of New York to conduct open market transactions at the direction of the Federal Open Market Committee.164 The System Open Market Account, which is managed by the Federal Reserve Bank of New York’s 160 The Commission proposes to codify this definition in Proposed Rule 17Ad–22(a). Cf. 17 CFR 50.76(b) (CFTC definition of international financial institution for purposes of exemptions from swap clearing requirement). 161 The authorizing statutes generally provide that the government owns all or part of the capital stock or equity interest of the central bank. See, e.g., Capital of the ECB Protocol on the Statute of the European System of Central Banks and of the European Central Bank (‘‘ECB Protocol’’), Article 28.2, available at https://www.ecb.europa.eu/ecb/ legal/pdf/en_statute_2.pdf. 162 See, e.g., ECB Protocol Statute, supra note 106, Article 3.1; Bank of Japan Act, Articles 1 and 2, available at https://www.boj.or.jp/en/about/boj_ law/index.htm/#p01. 163 12 U.S.C. 225a (defining goals of monetary policy); see also https://www.federalreserve.gov/ monetarypolicy/monetary-policy-what-are-its-goalshow-does-it-work.htm. 164 See Federal Reserve Bank; Monetary Policy Implementation, available at https:// www.newyorkfed.org/markets/domestic-marketoperations/monetary-policy-implementation. VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 System Open Market Trading Desk, is ‘‘the largest asset on the Federal Reserve’s balance sheet.’’ 165 In light of the key role of open market operations conducted by the Federal Reserve Bank of New York in the monetary policy of the United States, the Commission believes an exemption from the Membership Proposal is appropriate for the Federal Reserve System.166 In particular, the Commission believes the Federal Reserve System should be free to choose the clearance and settlement mechanisms that are most appropriate to effectuating its policy objectives. Further, the Commission believes that the Official Sector Exclusion should extend to foreign central banks, sovereign entities and international financial institutions for similar reasons and for reasons of international comity. Congress has decided to permit international financial institutions to enjoy a number of privileges and immunities from U.S. law,167 which suggests that in these circumstances, the Commission should not place additional requirements on these institutions’ transactions in U.S. Treasury securities. In addition, in light of ongoing expectations that Federal Reserve Banks and agencies of the Federal government would not be subject to foreign regulatory requirements in their transactions in the sovereign debt of other nations, the Commission believes principles of international comity counsel in favor of exempting foreign 165 Id. 166 Congress similarly exempted transactions in which one counterparty is a member of the Federal Reserve System from the regulation of swaps and security based swaps in Title VII of the Dodd-Frank Act. See 15 U.S.C. 78c(a)(68)(A) (noting that a security-based swap is a swap, as defined in 7 U.S.C. 1a(47), subject to certain other conditions); 7 U.S.C. 1a(47)(B)(ix) (excluding from the definition of swap any transaction in which one counterparty ‘‘is a Federal Reserve bank, the Federal Government, or a Federal agency that is expressly backed by the full faith and credit of the United States’’). 167 See, e.g., the International Organization and Immunities Act (22 U.S.C. 288) and the Foreign Sovereign Immunities Act (28 U.S.C. 1602). The United States has taken appropriate actions to implement international obligations with respect to such immunities and privileges. See, e.g., International Bank for Reconstruction and Development (the ‘‘World Bank’’) and International Monetary Fund (22 U.S.C. 286g and 22 U.S.C. 286h), the European Bank for Reconstruction and Development (22 U.S.C. 290l–6), the Multilateral Investment Guarantee Agency (22 U.S.C. 290k–10), the Africa Development Bank (22 U.S.C. 290–8), the African Development Fund (22 U.S.C. 290g–7), the Asian Development Bank (22 U.S.C. 285g), the Inter-American Development Bank (22 U.S.C. 283g), the Bank for Economic Cooperation and Development in the Middle East and North Africa (22 U.S.C. 290o), and the Inter-American Investment Corporation (22 U.S.C. 283hh). PO 00000 Frm 00018 Fmt 4701 Sfmt 4702 central banks, sovereign entities, and international financial institutions.168 ii. Natural Person Exclusion The Commission is also proposing to exclude from the Membership Proposal otherwise eligible secondary market transactions in U.S. Treasury securities between a direct participant of a U.S. Treasury securities CCA and a natural person. The Commission believes that such an exclusion is appropriate because natural persons generally transact in small volumes and would not present much, if any, contagion risk to a U.S. Treasury securities CCA.169 3. How the Membership Proposal Facilitates Prompt and Accurate Clearance and Settlement in the U.S. Treasury Market The Commission believes that the Membership Proposal would promote the prompt and accurate clearance and settlement of U.S. Treasury securities transactions, providing several benefits to the market for U.S. Treasury securities as a whole. First, the Commission believes that the Membership Proposal would decrease the overall amount of counterparty credit risk in the secondary market for U.S. Treasury securities. Because a U.S. Treasury securities CCA would novate and guarantee each transaction submitted for central clearing, it would become a counterparty to each transaction, as the buyer to every seller and the seller to every buyer. The U.S. Treasury securities CCA would be able to risk manage these transactions centrally, pursuant to risk management procedures that the Commission has reviewed and approved, and would guarantee settlement of the trade in the event of a direct participant default. By contrast, bilaterally cleared cash transactions in U.S. Treasury securities are subject to variable risk management methodologies in which exposures are often less mitigated with less rigorous 168 For similar reasons, the CFTC has similarly determined to exempt swap transactions involving foreign central banks, sovereign entities, and international financial institutions from the statutory requirement that swap transactions be cleared with a Derivatives Clearing Organization. See 17 CFR 50.75, 50.76; Swap Clearing Exemptions, 85 FR 76428, 76429–30, 76432 (Nov. 30, 2020). 169 For example, although it is not a precise indicator of activity by natural persons in the U.S. Treasury markets, the data available on household holdings of U.S. Treasury securities indicates that their activity is not significant to the overall market. See, e.g., The Financial Accounts of the United States, at 119 (Q1 2022) (indicating that less than 3.1% of marketable U.S. Treasury securities are held by the household sector), available at https:// www.federalreserve.gov/releases/z1/20220609/ z1.pdf. E:\FR\FM\25OCP2.SGM 25OCP2 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules practices compared to CCP risk management.170 Indeed, although various SRO margin rules provide for the collection of margin for certain transactions in U.S. Treasury securities, transactions between dealers and institutional customers are subject to a variable ‘‘good-faith’’ margin standard, which the Commission understands— based on its supervisory experience— can often result in fewer financial resources collected to margin exposures than those that would be collected if a CCP margin model, like the one used at FICC, were used.171 The Membership Proposal is designed to ameliorate these risks by requiring Treasury securities CCAs to establish policies and procedures that require their direct participants to submit for clearance and settlement their eligible secondary market transactions, which would include all repo transactions, and specified cash transactions in U.S. Treasury securities, which are most likely to pose contagion risk to a U.S. Treasury securities CCA. In particular, the Membership Proposal is designed to reduce the amount of ‘‘contagion risk’’ to a U.S. Treasury securities CCA arising from what has been described as ‘‘hybrid clearing,’’ as discussed above.172 In a hybrid transaction, the leg of the trade between an IDB, which is a FICC member, and a FICC member counterparty is submitted to FICC for clearance and settlement but the leg between the IDB and a non-FICC member counterparty is not.173 170 TMPG White Paper, supra note 21, at 29. FINRA rules provide for the collection of margin for cash U.S. Treasury transactions, see FINRA Rule 4210(e)(2)(A) (setting forth margin rule for FINRA members for collection of margin on Treasuries and certain other bonds) these rules do not necessarily apply to exempt accounts, see FINRA Rule 4210(e)(2)(F) (permitting FINRA members not to collect margin from exempt accounts and providing for a capital charge for any uncollected mark-to-market loss); FINRA Rule 4210(a)(13) (defining exempt account). Although SRO rules also require a broker-dealer to establish procedures to review limits and types of credit extended to all customers, formulate their own ‘‘house’’ margin requirements, and review the need for instituting higher margin requirements than are required for individual securities or customer accounts, based on the Commission’s supervisory experience, the resulting margin collection is often less than that required pursuant to FICC’s margin model. 172 TMPG White Paper, supra note 21, at 8 n.11 (‘‘IDB platforms act as blind brokers to provide anonymity to their customers. Under the blind broker model, the IDB serves as principal so what might appear to be a single trade between two customers is really two: one between the broker and the buyer and one between the broker and the seller. The buyer and seller are no longer directly exposed to each other, but both are exposed to the blind broker, and the blind broker is exposed to both buyer and seller.’’). 173 TMPG White Paper, supra note 21, at 9. khammond on DSKJM1Z7X2PROD with PROPOSALS2 171 Although VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 Consequently, this FICC-member counterparty would no longer have exposure to the IDB and vice versa. But the IDB must settle the other leg of the trade bilaterally with its non-FICC member counterparty, and the IDB and the non-FICC member counterparty would face counterparty credit risk to each other until the transaction settles. Although this release has discussed ‘‘hybrid clearing,’’ and, more generally, contagion risk, with respect to IDB transactions, the general concept can apply more broadly, in that a FICC member’s transactions that are not submitted for central clearing pose an indirect risk to the CCP as any default on a bilaterally settled transaction could impact the FICC member’s financial resources and ability to meet its obligations to FICC. The Commission believes that requiring U.S. Treasury securities CCAs to impose, as a condition of membership, an obligation on their direct participants to submit all eligible secondary market transactions for central clearing should address the transactions most likely to cause contagion risk. Second, the Commission believes that the Membership Proposal would also help any U.S. Treasury securities CCA to avoid a potential disorderly member default. When cash market transactions are cleared bilaterally, market participants typically enter into bespoke arrangements to govern clearance and settlement with each of their trading counterparties, resulting in multiple interconnected counterparty credit risk exposures. Aside from the inefficiency of multiple sets of bilateral documentation that may differ in key respects, such as the amount of margin required, the default of one counterparty can have cascading effects on multiple other market participants. Defaults in bilaterally settled transactions are likely to be less orderly and subject to variable default management techniques because bilaterally settled transactions are not subject to the default management processes that are required to be in place and publicly disclosed at a CCP.174 Centralized default management is a key feature of central clearing. Because the CCP has novated and guaranteed the transactions, it is uniquely positioned to coordinate the default of a member for trades that it has centrally cleared, and the nondefaulting members can rely on the CCP to complete the transactions of the defaulting member and cover any resulting losses using the defaulting member’s resources and/or its default management tools. Even in a situation 174 See PO 00000 Rule 17Ad–22(e)(13) and (e)(23)(i). Frm 00019 Fmt 4701 Sfmt 4702 64627 where two CCPs have to coordinate the default of a joint member, that coordination should result in more efficiency and market confidence than multiple bilateral settlements. The Commission previously has stated that a CCP’s default management procedures would provide certainty and predictability about the measures available to a covered clearing agency in the event of a default which would, in turn facilitate the orderly handling of member defaults and would enable members to understand their obligations to the covered clearing agency in extreme circumstances.175 By contrast, as the TMPG has observed, independent management of bilateral credit risk by each participant in the clearance and settlement chain likely creates uncertainty about the levels of exposure across market participants and may make runs more likely, and any loss stemming from closing out the position of a defaulting counterparty is a loss to the non-defaulting counterparty and hence a reduction in its capital in many scenarios.176 Moreover, the high quality and credit status of U.S. Treasury securities does not eliminate the potential risk of clearing and settling these securities in the event of a default of a counterparty to a secondary market transaction. For example, if a large participant in a U.S. Treasury trade defaults, it can leave a counterparty with a short position to cover, which may take place as prices of U.S. Treasury securities move rapidly.177 In particular, the Commission notes that the market for U.S. Treasury securities experienced stresses in 1986, 1994, and 2008, with more recent episodes detailed in the recent IAWG Report.178 Having a CCP drawing on its expertise to manage hedging and an orderly liquidation of the portfolio(s) of a party (or parties) in default would constitute an improvement to uncoordinated liquidations. A covered clearing agency, including a U.S. Treasury securities CCA, is required to establish, implement, maintain and enforce written policies and procedures reasonably designed to, as applicable, ensure the CCA has the authority and operational capacity to contain losses and liquidity demands and continue to meet its obligations, which must be 175 CCA Standards Proposing Release, supra note 7, 79 FR at 29545. 176 TMPG White Paper, supra note 21, at 32. 177 TMPG White Paper, supra note 21, at 32 and at 13 n. 17 (noting counterparty risk associated with the Long-Term Capital Management experience in 1998). 178 IAWG Report, supra note 4. E:\FR\FM\25OCP2.SGM 25OCP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 64628 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules tested annually.179 This transparent and established approach to potential defaults stands in contrast to the variable practices that currently prevail in the bilateral market, which are not subject to similar regulation. For these reasons, the Commission believes that a requirement for a U.S. Treasury securities CCA to require that its direct participants submit for clearance and settlement all the transactions encompassed by the definition of an eligible secondary market transaction would help reduce the potential for disorderly defaults, and runs, thereby bolstering the health of the CCP and the market as a whole—consistent with the purpose of robust membership requirements the Commission contemplated in the Covered Clearing Agency Standards, and the Commission’s statutory charge to promote the prompt and accurate clearance and settlement of securities transactions.180 Third, the Commission believes that the Membership Proposal will further the prompt and accurate clearance and settlement of U.S. Treasury securities by increasing the multilateral netting of transactions in these instruments, thereby reducing operational and liquidity risks, among others. Central clearing of transactions nets down gross exposures across participants, which reduces firms’ exposures while positions are open and reduces the magnitude of cash and securities flows required at settlement.181 Consistent with the Commission’s previous statements in this regard, FICC’s failure to receive all eligible trading activity of an active market participant reduces the value of its vital multilateral netting process and causes FICC to be less wellsituated to prevent future market crises.182 Others have also noted that these reductions, particularly in cash and securities flow would reduce liquidity risks associated with those settlements and counterparty credit risks associated with failures to deliver on the contractual settlement date,183 not only for CCP members but for the CCP itself, thereby promoting the safeguarding of U.S. Treasury securities and funds in the custody or control of the CCA and increasing the likelihood of prompt and accurate clearance and settlement of such transactions. In fact, 179 See 17 CFR 240.17Ad–22(e)(13). 15 U.S.C. 78q–1(a)(2)(A). 181 IAWG Report, supra note 4, at 30. For an example of multilateral netting, please see note 252 and accompanying text infra. 182 Exchange Act Release No. 51908, supra note 30. 183 G–30 Report, supra note 5, at 13; see also PIFS Paper, supra note 120, at 28–31. 180 See VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 it has been suggested that additional central clearing, based on assumptions broader than the proposal set forth in this release, may have lowered dealers’ daily settlement obligations in the cash market by 60 percent in the run-up and aftermath of the March 2020 U.S. Treasury market disruption and reduced settlement obligations by 70 percent during the disruption itself.184 The reduction in exposure is not limited to the cash market. For example, it has been estimated that introduction of central clearing for dealer-to-client repos would have reduced dealer exposures from U.S. Treasury repos by over 80% (from $66.5 billion to $12.8 billion) in 2015.185 The benefits of multilateral netting flowing from central clearing can improve market safety by lowering exposure to settlement failures, which would also tend to promote the prompt and accurate clearance and settlement of U.S. Treasury securities transactions.186 Multilateral netting can also reduce the amount of balance sheet required for intermediation and could also enhance dealer capacity to make markets during normal times and stress events because existing bank capital and leverage requirements recognize the riskreducing effects of multilateral netting of trades that CCP clearing accomplishes.187 Fourth, the potential benefits associated with the multilateral netting of transactions at a CCP that the Membership Proposal is designed to bring about could in turn help to unlock further improvements in U.S. Treasury market structure. The increase in clearing and consequent reduction in counterparty credit risk could ‘‘enhance the ability of smaller bank and independent dealers to compete with 184 G–30 Report, supra note 5, at 13 n.21 (citing Michael Fleming & Frank Keane, Staff Report No. 964: Netting Efficiencies of Marketwide Central Clearing, Federal Reserve Bank of New York (Apr. 2021), available at https://www.newyorkfed.org/ medialibrary/media/research/staff_reports/ sr964.pdf). However, this analysis relies upon the assumption that all dealers’ purchases and sales of U.S. Treasury securities transactions would be centrally cleared and, therefore, netted; this proposal, if adopted, would not result in the same scope of central clearing, as it would apply only to eligible secondary market transactions of direct participants in a U.S. Treasury securities CCA. 185 Office of Financial Research, Benefits and Risks of Central Clearing in the Repo Market, 5–6 (Mar. 9, 2017), available at https://www.financial research.gov/briefs/files/OFRBr_2017_04_CCP-forRepos.pdf. 186 Darrel Duffie, Still the World’s Safe Haven, Hutchison Center on Fiscal & Monetary Policy, at 15 (June 2020), available at https:// www.brookings.edu/wp-content/uploads/2020/05/ WP62_Duffie_v2.pdf (‘‘Duffie’’). 187 IAWG Report, supra note 4, at 30; Liang & Parkinson, supra note 32, at 9; Duffie, supra note 186, at 16–17. PO 00000 Frm 00020 Fmt 4701 Sfmt 4702 the incumbent bank dealers.’’ 188 Similarly, decreased counterparty credit risk—and potentially lower costs for intermediation—could result in narrower spreads, thereby enhancing market quality.189 Moreover, increased accessibility of central clearing in U.S. Treasury markets could support movement toward all-to-all trading, even potentially in the repo market, which would further improve market structure and resiliency, although a movement in that direction is not assured.190 This potential movement would stem from the fact that increased central clearing of U.S. Treasury securities transactions would, in turn, result in decreased counterparty risk, making all-to-all trading more attractive, that is, a market participant would be more willing to trade with any counterparty if a CCP were to serve as its ultimate counterparty. Finally, increased central clearing should enhance regulatory visibility in the critically important U.S. Treasury market. Specifically, central clearing increases the transparency of settlement risk to regulators and market participants, and in particular allows a CCP to identify concentrated positions and crowded trades, adjusting margin requirements accordingly, which should help reduce significant risk to the CCP and to the system as a whole.191 In light of the role of U.S. Treasury securities in financing the federal government, it is important that regulators improve their visibility into this market. Increased clearing would provide greater insight into the often opaque repo market, as discussed further in section III.A.2.a supra, as well as to the cash market where TRACE faces certain limitations, as discussed in section IV infra. Increased central clearing would also allow for a more aggregated view of market activity in one place. 188 Liang & Parkinson, supra note 32, at 9. Report, supra note 5, at 13 190 IAWG Report, supra note 4, at 30; Duffie, supra note 186, at 16; G–30 Report, supra note 5, at 13. All-to-all trading would be characterized by the ability for a bid or offer submitted by one market participant to be accepted by any other market participant, with trades executed at the best bid or offer. See, e.g., Liang & Parkinson, supra note 32, at 9. All-to-all trading could improve the quality of trade execution in normal market conditions and broaden and stabilize the supply of market liquidity under stress. See, e.g., G–30 Report, supra note 5, at 10. 191 Duffie, supra note 186, at 15; IAWG Report, supra note 4, at 30 (centralization of transactions at a CCP ‘‘can simplify data collection and improve visibility into market conditions for the authorities and, to some degree, for market participants’’). 189 G–30 E:\FR\FM\25OCP2.SGM 25OCP2 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules 5. Request for Comment khammond on DSKJM1Z7X2PROD with PROPOSALS2 4. Policies and Procedures Regarding Direct Participants’ Transactions The proposal would also require that a U.S. Treasury securities CCA establish written policies and procedures reasonably designed to, as applicable, identify and monitor its direct participants’ required submission of transactions for clearing, including, at a minimum, addressing a direct participant’s failure to submit transactions.192 The Commission believes that such a requirement should help ensure that a U.S. Treasury securities CCA has a framework in place for oversight of participants’ compliance with the policies that would be adopted as part of the Membership Proposal requiring the submission of specified eligible secondary market transactions for clearing. Without such policies and procedures, it would be difficult for the CCA to assess if the direct participants are complying with the Membership Proposal, if adopted. The Commission believes that there are a number of possible methods that a U.S. Treasury securities CCA could establish to assess its direct participants’ compliance with the policies and procedures adopted pursuant to the Membership Proposal. For example, a U.S. Treasury securities CCA could seek attestation from its direct participants as to their submission of the required transactions. The Commission believes that requiring a U.S. Treasury securities CCA to adopt policies and procedures that address a failure of a direct participant to submit transactions that are required to be submitted is consistent with section 17A(b)(3)(G) of the Exchange Act. That section requires that the rules of a registered clearing agency provide that its participants shall be appropriately disciplined for violation of any provision of the rules of the clearing agency by expulsion, suspension, limitation of activities, functions, and operations, fine, censure, or any other fitting sanction. The Commission believes that policies and procedures consistent with this aspect of the proposal should specify how a U.S. Treasury securities CCA would penalize its participants who do not submit the required transactions, whether by a particular fine or other action. Understanding the consequences of not complying with any Membership Proposal, if adopted, should, in turn, help incentivize compliance. The Commission generally requests comments on all aspects of the Membership Proposal. In addition, the Commission requests comments on the following specific issues, with accompanying data and analysis: • Do commenters agree or disagree with any particular aspects of the Membership Proposal, including the definition of an eligible secondary market transaction? If so, which ones and why? If commenters disagree with any provision of the proposed rule, how should such provision be modified and why? • Do commenters agree that transactions entered into by direct participants of a U.S. Treasury securities CCA that are not centrally cleared at the CCA present a contagion risk to the CCA, and thereby present systemic risk? Why or why not? Are there other benefits that expanded central clearing would bring that the Commission has not identified? • Do commenters agree that the Commission should target the Membership Proposal, through the definition of an eligible secondary market transaction, at a subset of transactions entered into by direct participants of a U.S. Treasury securities CCA? Should the Commission instead require that a U.S. Treasury securities CCA adopt policies and procedures reasonably designed to require that its direct participants submit for clearance and settlement all of their transactions in U.S. Treasury securities? • What implications would the increased transaction volume at a U.S. Treasury securities CCA have for participation in the U.S. Treasury market and for the U.S. Treasury market more broadly? For example, would the Membership Proposal help create all-toall trading in the U.S. Treasury securities market? • What impact would the Membership Proposal have on the liquidity risk of a U.S. Treasury securities CCA and how a Treasury securities CCA manages its liquidity risk consistent with Rule 17Ad–22(e)(7) (17 CFR 240.17Ad–22(e)(7))? 193 For example, what would be the potential impact to FICC’s Capped Contingent Liquidity Facility (‘‘CCLF’’) and its participants’ obligations under that requirement? 194 Are there any changes the Commission could adopt to the Membership Proposal that would, in turn, lead to a different impact on FICC’s liquidity exposure and/or CCLF? 193 17 192 See Proposed Rule 17Ad–22(e)(18)(iv)(B). VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 CFR 240.17Ad–22(e)(7). Rule 22A, section 2a, supra note 47. 194 FICC PO 00000 Frm 00021 Fmt 4701 Sfmt 4702 64629 As FICC, or any other U.S. Treasury securities CCA that may enter the market, considers implementing the Membership Proposal, are there actions it can take that may reduce its liquidity risk? • More generally, what impact would the Membership Proposal have on other risks facing a U.S. Treasury securities CCA, including, for example, credit risk and operational risk, and how a U.S. Treasury securities CCA manages its liquidity risk consistent with the applicable Covered Clearing Agency Standards? Are there other changes that a U.S. Treasury securities CCA should make to expand the use of central clearing? • In the event that a U.S. Treasury securities CCA were to offer clearance and settlement services for securities lending transactions in which U.S. Treasury securities are borrowed, should the Commission include such transactions in the definition of an eligible secondary market transaction in Proposed Rule 17Ad–22(a)? Would a failure to include such securities lending transactions in the definition of ‘‘eligible secondary market transactions’’ create opportunities for gaming or evasion of the requirements of Proposed Rule 17Ad–22(e)(18)(iv)(A)? Are there economic or other distinctions that mitigate against including securities lending transactions in the definition of an eligible secondary market transaction? • In light of the fact that the Membership Proposal requires only a U.S. Treasury securities CCA to have written policies and procedures reasonably designed to require its direct members clear their eligible secondary market transactions, is there a risk that market participants will cease their direct participation in U.S. Treasury securities CCAs? • Similarly, are market participants more likely to move some or all of their U.S. Treasury market activities from entities that are direct participants of a U.S. Treasury securities CCA into other affiliated entities? To what extent would a U.S. Treasury securities CCA be exposed to these other transactions? Should the Commission adopt rules to prohibit evasion of a U.S. Treasury securities CCA’s membership requirements through the use of affiliates? • Should either the repurchase, reverse repurchase, or purchase and sale transactions of certain direct participants of a U.S. Treasury securities CCA, e.g., smaller or mid-sized dealers that would otherwise be subject to the Membership Proposal, be excluded from the definition of an eligible secondary E:\FR\FM\25OCP2.SGM 25OCP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 64630 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules market transaction, such that a U.S. Treasury securities CCA would not need to have written policies and procedures requiring that all such direct participants’ transactions in U.S. Treasury securities be cleared? If so, how would the risks described above in this release be mitigated? What criteria should be used to identify any direct participants who are excepted from Proposed Rule 17Ad–22(e)(18)(iv)(A)? Should any such exemption be subject to a gross notional value or other cap? If so, how should that cap be set? Should any exemption from the Membership Proposal be conditioned on the exchange of margin, haircuts and/or other risk management measures? • As an alternative to the Membership Proposal, should the Commission establish volume thresholds for transactions by the direct participants of a Treasury CCA that should be submitted to the Treasury CCA for clearance and settlement? If so, what would be the appropriate volume thresholds? • Do commenters agree that whenissued transactions that take place after the day of the auction and are considered on-the-run by some IDBs are part of the secondary market and would, therefore, be subject to the Membership Proposal, to the extent that such whenissued trades otherwise meet the definition of an eligible secondary market transaction in Proposed Rule 17Ad–22(a)? Do commenters also agree that when-issued securities transactions should not be considered part of the secondary market if they take place before and including the day of the auction? Do commenters have views more generally on whether when-issued transactions, either before, including, or after the day of the auction, are part of the primary or secondary market? • In light of the likely additional balance sheet capacity that flows from clearing repo transactions in U.S. Treasury securities,195 should the definition of an eligible secondary market transaction in Proposed Rule 17Ad–22(a) be limited to repo transactions? Are there any other reasons why the definition of eligible secondary market transactions in Proposed Rule 17Ad–22(a) should be limited to repo transactions? Please explain. • As noted above, both bilateral and triparty repos are currently eligible for central clearing. Should the Commission limit Proposed Rule 17Ad– 22(a) to either bilateral or triparty repo? Why or why not? Are there differences in prevailing haircuts or collateral that 195 See supra note 121 and accompanying text. VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 would make it more desirable to limit Proposed Rule 17Ad–22(a) to bilateral or triparty repo? What other considerations might be relevant to distinguishing between bilateral and triparty repo in the context of Proposed Rule 17Ad–22(a)? • In light of the particular contagion risk posed by hybrid clearing at IDBs, should the definition of eligible secondary market transaction in Proposed Rule 17Ad–22(a) be limited to transactions—repurchase or outright purchase and sale or both—brokered by an IDB? Why or why not? • Is the inclusion of purchase and sale transactions of a registered brokerdealer or government securities broker or government securities dealer in the definition of eligible secondary market transaction in Proposed Rule 17Ad– 22(a) appropriate? Why or why not? Is the participation of the entities set forth in paragraph (ii)(B) of the proposed definition of an ‘‘eligible secondary market transaction’’ in Proposed Rule 17Ad–22(a) in the national system of clearance and settlement likely to increase the potential risk their eligible secondary market transactions in U.S. Treasury securities pose to a U.S. Treasury securities CCA? Are there other reasons that participation in the national system of clearance and settlement should be the basis for being subject to the Membership Proposal? Are there other entities, e.g., banks that also participate in the national system of clearance of and settlement and that should, on the same logic be included as part of paragraph (ii)(B) of the proposed definition of an ‘‘eligible secondary market transaction’’ in Proposed Rule 17Ad–22(a)? Do commenters have any data and/or quantification of the approximate dollar value of transactions that would be encompassed by paragraph (ii)(B) of the definition of an ‘‘eligible secondary market transaction’’ in Proposed Rule 17Ad–22(a)? Are they material enough to warrant inclusion in the Membership Proposal? • Could inclusion of transactions between a direct participant of a U.S. Treasury securities CCA and a registered broker-dealer or government securities broker or dealer in the definition of an eligible secondary market transaction result in pro- or anti-competitive effects in the market for intermediation in the market for U.S. Treasury securities, particularly as some registered brokerdealers have already highlighted that additional central clearing may affect their ability to compete with those firms with larger market share? • Is the inclusion of the secondary market purchase and sale transactions PO 00000 Frm 00022 Fmt 4701 Sfmt 4702 between a direct participant of a U.S. Treasury securities CCA and a hedge fund in the definition of an ‘‘eligible secondary market transaction’’ in Proposed Rule 17Ad–22(a) desirable or appropriate? Why or why not? Do commenters agree that this aspect of the proposal would address the risks posed by hedge funds transacting in the U.S. Treasury market? • Do commenters agree with the definition of a hedge fund in paragraph (ii)(C) of the definition of an ‘‘eligible secondary market transaction’’ in Proposed Rule 17Ad–22(a)? If not, what should that definition be? Would a more limited definition of a hedge fund, e.g., using only one of the subsections (a) through (c) of the proposed definition (and if so, which ones), be easier to administer or better targeted to reach transactions potentially posing risk to the CCA? For example, would a more limited definition that incorporated only subsection (b) of the proposed definition regarding leverage be used in paragraph (ii)(C) of the definition of an ‘‘eligible secondary market transaction’’ in Proposed Rule 17Ad–22(a) be a preferable approach? • Should the definition of a hedge fund be limited so that, to qualify as a hedge fund under the leverage prong of the definition in subsection (b), a fund would have to continue to satisfy that subsection, but also must have actually borrowed or used any leverage during the past 12 months, excluding any borrowings secured by unfunded commitments (i.e., subscription lines of credit); and/or to qualify as a hedge fund under the short selling prong of the definition in subsection (c), the fund must have actually engaged in the short selling activities described in that subsection during the past 12 months? If the Commission were to revise the proposed definition, would excluding actual borrowings secured by unfunded commitments (i.e., subscription lines of credit) appropriately exclude private equity funds, which typically engage in such borrowings? Should any revised definition require actual borrowing or short selling in the last 12 months? Alternatively, should any revised definition require a longer or shorter time period, such as 18 months or nine months, or different time periods for borrowing versus short selling? • Should the definition of a hedge fund be limited to hedge funds managed by an investment adviser registered with the Commission? • Should the inclusion of transactions between hedge funds and direct participants of a U.S. Treasury securities CCA be limited to hedge funds of a certain size or hedge funds managed by E:\FR\FM\25OCP2.SGM 25OCP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules investment advisers of a certain size? If so, what is the appropriate threshold to use? For example, should the Commission limit the definition of a hedge fund to apply only to those with net asset value of at least $500 million? Is a fund of that size more likely to have an impact on particular markets in which it invests or on its particular counterparties? Or should the Commission limit the definition of a hedge fund to those which are managed by an investment adviser with, for example, at least $150 million in private fund assets under management? • Instead of including a definition of a hedge fund in paragraph (ii)(C) of the definition of an ‘‘eligible secondary market transaction’’ in Proposed Rule 17Ad–22(a), should the Commission incorporate by reference the definition of a hedge fund set forth in Form PF? • Do commenters agree that a U.S. Treasury securities CCA should be required to adopt rules requiring that a direct participant of the CCA submit for clearing all transactions between the participant and an account at a registered broker-dealer, government securities dealer, or government securities broker where such account may borrow an in excess of one-half of the net value of the account or may have gross notional exposure of the transactions in the account that is more than twice the net value of the account as described in paragraph (ii)(D) of the definition of an ‘‘eligible secondary market transaction’’ in Proposed Rule 17Ad–22(a)? Why or why not? Do commenters agree that there is an additional benefit from capturing these additional transactions beyond those in paragraph (ii)(D) of the definition of an ‘‘eligible secondary market transaction’’ in Proposed Rule 17Ad–22(a)? • Can the inclusion of particular accounts within the set of counterparties included in the definition of an eligible secondary market transaction in paragraph (ii) of the definition of an ‘‘eligible secondary market transaction’’ in Proposed Rule 17Ad–22(a) be administered by a U.S. Treasury securities CCA and/or its direct participant? Would a direct participant be able to know whether its counterparty is such an account? • Should the particular accounts included within paragraph (ii)(D) of the definition of an ‘‘eligible secondary market transaction’’ in Proposed Rule 17Ad–22(a) also include accounts with banks? Why or why not? • Do commenters agree that particular accounts identified in paragraph (ii)(D) of the definition of an ‘‘eligible secondary market transaction’’ in Proposed Rule 17Ad–22(a) pose (or have VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 the potential to pose) potential contagion risk to a U.S. Treasury securities CCA as described in section III.A.3 supra, such that their purchase and sale transactions of secondary market U.S. Treasury securities should be included in the Membership Proposal? If so, does the definition of a specified account in paragraph (ii)(D) of the definition of an ‘‘eligible secondary market transaction’’ in Proposed Rule 17Ad–22(a) adequately capture the range of specified accounts that could pose (or have the potential to pose) significant system risk? If not, how should the definition of a specified account in paragraph (ii)(D) of the definition of an ‘‘eligible secondary market transaction’’ in Proposed Rule 17Ad–22(a) be adjusted to better capture this risk? For example, should the use of actual leverage in the preceding 12 months be required for such an account? Should different leverage thresholds or gross notional exposures be used? Should there be a size threshold in terms of the size of the account or the entity holding the account? Why or why not? • Instead of identifying a particular set of eligible secondary market cash transactions in Proposed Rule 17Ad– 22(a), should the Commission instead require that a U.S. Treasury securities CCA (i) require its direct participants to submit their U.S. Treasury security repurchase and reverse repurchase transactions, and (ii) in the event that a direct participant has such repurchase or reverse repurchase transactions to submit, require that the direct participant also submit its cash transactions? Would this approach be easier to administer? Would this approach capture the systemic and contagion risks to a U.S. Treasury securities CCA described above? • Should the definition of an ‘‘eligible secondary market transaction’’ in Proposed Rule 17Ad–22(a) include all secondary market purchase and sale transactions by a direct participant of a U.S. Treasury securities CCA in the definition of an eligible secondary market transaction? If so, why? Would doing so materially protect U.S. Treasury CCAs from the potential risks discussed above? Would such a broad requirement have salutary effects on the market for U.S. Treasury as a whole, for example by helping to foster an all-toall market for U.S. Treasury securities or in other ways? • Are there other potential accounts, entities or market participants whose U.S. Treasury security purchase and sale activity as counterparties to direct participants of a U.S. Treasury securities CCA that should be included in the PO 00000 Frm 00023 Fmt 4701 Sfmt 4702 64631 definition of an ‘‘eligible secondary market transaction’’ in Proposed Rule 17Ad–22(a)? For example, should the Commission include purchase and sale activity in which the direct participant’s counterparty is a registered investment company, a money market fund, or other buy-side entity? Has the Commission identified an appropriate set of purchase and sale transactions to include in the definition of an ‘‘eligible secondary market transaction’’ in Proposed Rule 17Ad–22(a)? Why or why not? If the Commission were to include additional purchase and sale activity, should it do so in a staggered or sequenced manner? • Are there particular purchases and sales of U.S. Treasury securities involving a direct participant of a U.S. Treasury securities CCA that the Commission should include or exclude from the definition of an ‘‘eligible secondary market transaction’’ in Proposed Rule 17Ad–22(a)? Should the Commission include or exclude such transactions based on their potential to transmit risk to a U.S. Treasury securities CCA and the financial system as whole? If so, has the Commission identified the purchase and sale transactions most likely to be the source of such risk? If not, what criteria should the Commission use to identify the purchase and sale transactions that should be included or excluded? • Is the Official Sector Exclusion to the definition of an eligible secondary market transaction appropriate? Why or why not? Does this proposed exclusion appropriately take into account transactions made on behalf of a central bank, sovereign entity, or international financial institution, i.e., by an intermediary? • Do commenters agree with the definitions of a central bank, sovereign entity, and international financial institution used in the Official Sector Exclusion? Why or why not? • To the extent that they meet the proposed definition of a ‘‘sovereign entity’’ in Proposed Rule 17Ad–22(a), should sovereign wealth funds or other state-owned investment vehicles be removed from the Official Sector Exclusion? If so, how should these entities be defined for this purpose? Do these entities use leverage or otherwise pose risk to a U.S. Treasury securities CCA that is more similar to the entities that are subject to the Membership Proposal? Why or why not? Are there other factors the Commission should consider in deciding whether to exclude sovereign wealth funds from the Official Sector Exclusion? • Is the Official Sector Exclusion to the Membership Proposal appropriate in E:\FR\FM\25OCP2.SGM 25OCP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 64632 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules light of the fact that foreign governments and central banks are significant participants in the market for U.S. Treasury securities, accounting for a significant portion of sales during the volatility in U.S. Treasury securities during March 2020? • Do central banks, sovereign entities, or international financial institutions, as defined in Proposed Rule 17Ad–22(a), pose risks to their counterparties that could potentially be transmitted back to a U.S. Treasury securities CCA and on to the broader financial system? How could such risk be mitigated? Should the Commission condition the Official Sector Exclusion, as set forth in paragraph (iii) of the definition of an ‘‘eligible secondary market transaction’’ in Proposed Rule 17Ad–22(a), on the exchange of margin, haircuts and/or other risk management measures? • How would a U.S. Treasury securities CCA craft policies and procedures reasonably designed to permit it to identify (and therefore exclude its members’) transactions subject to the Official Sector Exclusion? • Should the Official Sector Exclusion to the Membership Proposal include state or local governments? Why or why not? If so, how should these entities be defined for this purpose? Do these entities use leverage or otherwise pose risk to a U.S. Treasury securities CCA that is more similar to the entities that are subject to the Membership Proposal? Are there other factors the Commission should consider in deciding whether to include state or local governments within the Official Sector Exclusion? • Is the exclusion of transactions with natural persons from the definition of an ‘‘eligible secondary market transaction’’ in Proposed Rule 17Ad–22(a) appropriate? If natural persons are transacting repurchase or reverse repurchase transactions with direct participants of a U.S. Treasury securities CCA, is there any reason to exclude those transactions from the Membership Proposal? What proportion of the specified accounts in paragraph (iii)(C) of the definition of an ‘‘eligible secondary market transaction’’ in Proposed Rule 17Ad–22(a) would be subject to the natural person exclusion contemplated in Proposed Rule 17Ad– 22(a)? Is the exclusion of those accounts appropriate? • Should the exclusion of transactions with natural persons from the definition of an ‘‘eligible secondary market transaction’’ in Proposed Rule 17Ad–22(a) be conditioned on the exchange of margin, haircuts and/or other risk management measures? If so VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 what measures would be appropriate for this exclusion? • Should the natural person exclusion in paragraph (iii) of the definition of an ‘‘eligible secondary market transaction’’ in Proposed Rule 17Ad–22(a) be subject to a volume or size cap, a net worth threshold, or any other limitation? If so, how should such limitation be set? • Should inter-affiliate transactions be excluded from the definition of an eligible secondary market transaction by adding an exclusion to the definition in Proposed Rule 17Ad–22(a) for all such transactions? Why or why not? How should exceptions be identified? Should the Commission condition this potential exclusion from the Membership Proposal for inter-affiliate transactions on the exchange of margin, haircuts and/or other risk management measures? • Should any additional exclusion to the definition of an eligible secondary market transaction in Proposed Rule 17Ad–22(a) be limited to certain transaction volumes or account size thresholds or to particular counterparties? If so, how should these thresholds or counterparty levels be set? Should they be accompanied by a transition period when a previously exempted transaction becomes subject to the clearing requirement? Would a U.S. Treasury securities CCA be able to write policies and procedures that would be effective in accomplishing this task while still promoting central clearing of other U.S. Treasury securities transactions? • Are there any legal, operational or other considerations that could impede an indirect participant’s ability to participate indirectly as proposed under the Membership Proposal? Are there any particular changes to the Membership Proposal that could help facilitate their ability to participate as indirect participants? Should any other indirect participants or transactions be excluded from the Membership Proposal on the basis of any such legal, operational or other considerations? • Are there other changes the Commission can make to the design of the Membership Proposal to improve the resiliency of and liquidity in the U.S. Treasury securities market? • Do commenters agree with Proposed Rule 17Ad–22(e)(18)(iv)(B) that would require a U.S. Treasury securities CCA to have policies and procedures to identify and monitor its direct participants’ submission of transactions for clearing as required in the Membership Proposal, including how the CCA would address a failure to submit transactions? Why or why not? PO 00000 Frm 00024 Fmt 4701 Sfmt 4702 • What types of policies and procedures should a U.S. Treasury securities CCA implement to comply with the requirements of Proposed Rule 17Ad–22(e)(18)(iv)(B), if adopted? What level of detail and transparency would commenters find appropriate regarding such policies and procedures? • Do commenters believe that a U.S. Treasury securities CCA could develop appropriate procedures to comply with the requirements of Proposed Rule 17Ad–22(e)(18)(iv)(B), if adopted? • In the event that there were to be more than one U.S. Treasury securities CCA, should the Commission amend Rule 17Ad–22(e)(20) (17 CFR 240.17Ad–22(e)(20)) to require each such CCA to establish a link with each other Treasury CCA so that the direct participant of either Treasury CCA may satisfy the requirements of Proposed Rule 17Ad–22(e)(18)(iv) without becoming a direct participant of each Treasury CCA? Are there any other steps that the Commission should take? • Will the Membership Proposal have any impact on competition in the provision of CCP services in the U.S. Treasury market? Will the Membership Proposal inappropriately concentrate risk in a single U.S. Treasury securities CCA? B. Other Changes to Covered Clearing Agency Standards As proposed, the Membership Proposal will likely result in a significant increase in the volume of U.S. Treasury securities transactions submitted for central clearing, including transactions of market participants that currently may not submit such transactions for central clearing. For example, as noted above, approximately 68% of the overall dollar volume of cash market activity in the U.S. Treasury market is bilaterally cleared, and dealerto-customer trading appears to comprise significant portion of that market.196 Further, it appears that the customer side of this market is heterogeneous with diverse participants, including pension funds and asset managers who, as noted above, do not participate in central clearing to a great extent, especially for cash market transactions.197 The Commission believes that certain additional changes to its Covered Clearing Agency Standards that would apply only to U.S. Treasury securities CCAs are warranted in light of the Membership Proposal. Such changes, described further below, are designed to improve risk management by and access 196 See note 20 supra. Report, supra note 4, at 3. 197 IAWG E:\FR\FM\25OCP2.SGM 25OCP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules to the US Treasury securities CCA, and will also serve to help manage the risks and facilitate access that would likely result from the Membership Proposal. Thus, as part of ensuring its written policies and procedures are reasonably designed to ensure all of its direct participants clear all eligible secondary market transactions in U.S. Treasury securities, the Commission proposes to require that U.S. Treasury securities CCAs establish, implement, maintain and enforce written policies and procedures reasonably designed to, as applicable, calculate, collect, and hold margin for a direct participant’s proprietary positions separately from the margin calculated and collected from that direct participant in connection with U.S. Treasury securities transactions by an indirect participant (customer) that relies on the services provided by the direct participant to access the U.S. Treasury securities CCA. This proposal would prohibit a U.S. Treasury securities CCA from netting customer and proprietary positions. In addition, the Commission proposes to require that U.S. Treasury securities CCAs establish, implement, maintain and enforce written policies and procedures reasonably designed to, as applicable, ensure that they have appropriate means to facilitate access to clearance and settlement services of all eligible secondary market transactions in U.S. Treasury securities, including those of indirect participants, which policies and procedures the board of directors reviews annually.198 To the extent that changes to the U.S. Treasury securities CCA’s rules or procedures are necessary in light of these proposed amendments to the Covered Clearing Agency Standards, the U.S. Treasury securities CCA, as a selfregulatory organization, would be required file such changes for Commission review and approval, as appropriate, under section 19(b) of the Exchange Act.199 In addition, if a U.S. Treasury securities CCA has been designated as a systemically important financial market utility, changes to programs allowing indirect participants to clear or changes to margin methodologies or practices may need to be filed as advance notices, to the extent that the changes materially impact the nature or level of risk presented by that 198 For example, to the extent that the additional transactions may present different risks on an intraday basis, a U.S. Treasury securities CCA should consider its policies and procedures in light of that risk, especially with respect to policies and procedures designed to meet the requirements of Rules 17Ad–22(e)(6) and (7) (17 CFR 240.17Ad– 22(e)(6) and (7)). 199 See 78 U.S.C. 78s; 17 CFR 240.19b–4. VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 covered clearing agency, which would therefore require consultation with the Federal Reserve Board of Governors as well.200 1. Netting and Margin Practices for House and Customer Accounts The Commission believes that, in conjunction with the Membership Proposal, further proposed changes with respect to risk management requirements could also reduce the potential risk to the U.S. Treasury securities CCA arising from such transactions. As described more fully below, the Commission is proposing amendments to Rule 17Ad–22(e)(6)(i) to require a U.S. Treasury securities CCA to establish, implement, maintain and enforce written policies and procedures reasonably designed to, as applicable, calculate, collect, and hold margin amounts from a direct participant for its proprietary U.S. Treasury securities positions separately and independently from margin calculated and collected from that direct participant in connection with U.S. Treasury securities transactions by an indirect participant that relies on the services provided by the direct participant to access the covered clearing agency’s payment, clearing, or settlement facilities. Such changes should allow a U.S. Treasury securities CCA to better understand the source of potential risk arising from the U.S. Treasury securities transactions it clears and potentially further incentivize central clearing, as discussed further below. Currently, the Commission’s rules do not address how a U.S. Treasury securities CCA should calculate, collect, and hold margin amounts for any U.S. Treasury securities transactions, cash or repo, that a direct participant may submit on behalf of an indirect participant. This means that a U.S. Treasury securities CCA generally may determine a participant’s margin for both proprietary and client positions using the methodology that it determines to be appropriate, while still remaining responsible for complying more generally with the applicable margin requirements under Rule 17Ad– 22(e)(6).201 200 See 12 U.S.C. 8465; 17 CFR 240.19b–4. Rule 17Ad–22(e)(6) requires that a covered clearing agency establish, implement, maintain and enforce written policies and procedures reasonably designed to, as applicable, cover its credit exposure to its participants by establishing a risk-based margin system that, at a minimum and among others: considers, and produces margin levels commensurate with, the risks and particular attributes of each relevant product, portfolio, and market; and calculates margin sufficient to cover its potential future exposure to participants in the interval between the 201 Specifically, PO 00000 Frm 00025 Fmt 4701 Sfmt 4702 64633 For example, in practice, at what is currently the only U.S. Treasury securities CCA, clearing a U.S. Treasury securities transaction between a direct participant and its customer, i.e., a dealer to client trade, would not result in separate collection of margin for the customer transaction. Transactions between direct participants are novated by the U.S. Treasury securities CCA, and, by virtue of multilateral netting, all of a member’s positions are netted into a single payment obligation—either to or from the CCP.202 Under its current client clearing models (except the FICC sponsored member program),203 for a dealer to client trade, although there is no transaction between two direct participants to novate, FICC novates the transaction and becomes a counterparty to the direct participant that has submitted that transaction, but does not have a direct relationship with the direct participant’s client.204 FICC margins the transactions in the direct participant’s (i.e., the dealer’s) account on a net basis, allowing any of the trades for the participant’s own accounts to net against trades by the participant’s customers.205 Under the proposed amendments to Rule 17Ad–22(e)(6)(i), a U.S. Treasury securities CCA would be required to establish, implement, maintain and enforce written policies and procedures reasonably designed to, as applicable, calculate margin amounts for all transactions a direct participant submits to the CCP on behalf of others, separately from the margin that is calculated for transactions that the direct participant submits on its own last margin collection and the close out of positions following a participant default. 17 CFR 240.17Ad– 22(e)(6)(i and iii). 202 See FICC PFMI Disclosure Framework at 10; FICC Rule 11, section 4. 203 In FICC’s sponsored member program, both the Sponsoring Member and the Sponsored Member are members of FICC, and FICC has certain obligations to both entities, including a guaranty of settlement to the Sponsored Member. See generally FICC Rule 3A; Depository Trust & Clearing Corporation, Making the U.S. Treasury Market Safer for All Participants: How FICC’s Open Access Model Promotes Central Clearing, at 6 (Oct. 2021), available at https://www.dtcc.com/-/media/Files/ Downloads/WhitePapers/Making-the-TreasuryMarket-Safer-for-all-Participants.pdf (‘‘DTCC October 2021 White Paper’’). 204 Marta Chaffee and Sam-Schulhofer-Wohl, Is a Treasury Clearing Mandate the Path to Increased Central Clearing, Chicago Fed Insights, at 2 (June 23, 2021), available at https://www.chicagofed.org/ publications/blogs/chicago-fed-insights/2021/ treasury-clearing-mandate (explaining that this conclusion follows from that fact that ‘‘FICC nets members’ trades for their own accounts against trades by the members’ customers, so the dealer’s and customer’s sides of the trade would cancel out in the netting process’’) (‘‘Chicago Fed Insights’’). 205 DTCC October 2021 White Paper, supra note 203, at 5–6. E:\FR\FM\25OCP2.SGM 25OCP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 64634 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules behalf. Such policies and procedures must also provide that margin collateralizing customer positions be collected separately from margin collateralizing a direct participant’s proprietary positions. The Commission believes that the customer positions that would be separated from a direct participant’s proprietary positions generally would arise in the dealer-tocustomer market, in which a dealer transacts directly, as a principal, with its customer, as discussed in section II.A.1 supra. Finally, the CCP would also be required to have policies and procedures reasonably designed to, as applicable, ensure that any margin held for customers or other indirect participants of a member is held in an account separate from those of the direct participant. The proposed amendments to Rule 17Ad–22(e)(6)(i) are designed to ensure that central clearing of U.S. Treasury securities transactions between direct participants and indirect participants of a covered clearing agency clearing U.S. Treasury securities would result in the risk management benefits described above in section III.A.3 supra, as well as to incentivize additional central clearing in the U.S. Treasury market. Specifically, the proposed amendments to Rule 17Ad–22(e)(6)(i) would require that a U.S. Treasury securities CCA calculate, collect, and hold margin for positions in U.S. Treasury securities transactions of a direct participant in a U.S. Treasury securities CCA separately from those of customers or other indirect participants that rely on the direct participant to access the covered clearing agency’s payment, clearing, or settlement facilities. Because the indirect participant’s positions are no longer netted against the direct participant’s positions prior to being submitted for central clearing, the indirect participant’s positions would be subject to the covered clearing agency’s risk management procedures, including collection of margin specific to those transactions.206 This should, in turn, help avoid the risk of a disorderly default in the event of a direct participant default, in that the CCA would be responsible for the central liquidation of the defaulting participant’s trades and would be able to have a more holistic view of the market than would be available for 206 The proposed amendments to Rule 17Ad– 22(e)(6)(i) would not require that a U.S. Treasury securities CCA collect margin from indirect participants, but rather would ensure that U.S. Treasury securities CCAs determine margin for transactions submitted on behalf of indirect participants separately from those of direct participants. VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 competing bilateral efforts to close out transactions with a defaulting entity. Moreover, the proposed amendments to Rule 17Ad–22 (e)(6)(i) should result in dealer-to-customer trades gaining more benefits from central clearing. FICC, in its sponsored membership program, already calculates, collects, and holds margin amounts for its sponsoring members separately and independently from those members they sponsor. FICC’s rules specifically provide for the collection of margin for sponsored member trades on a gross basis, i.e., the total margin amount required for the separate omnibus account for client trades must be equal to the sum of the individual margin amounts that would be due if each customer were margined separately.207 The proposed amendments to Rule 17Ad–22(e)(6)(i), however, would not require that a CCA’s direct participant collect a specified amount of margin from its customers or determine customer margin in a particular manner, such as on a gross basis; the calculation and collection of margin between a CCA direct participant and its customers would be left to other applicable regulations and, to the extent applicable, bilateral negotiation between the member and its customer. In these respects, the proposed amendments to Rule 17Ad–22(e)(6)(i) would require policies and procedures that closely resemble the calculation, collection, and holding of margin for listed options. Currently, the covered clearing agency that clears and settles listed options transactions holds margin for customer trades separately from the proprietary trades of the submitting participant in an omnibus account.208 When considering and adopting the Covered Clearing Agency Standards, the Commission noted that customer segregation can be achieved through such an omnibus account structure, where all collateral belonging to all customers of a particular member is 207 See FICC Rules 1 (definition of Sponsoring Member Omnibus Account) and 3A, section 10, supra note 47; DTCC October 2021 White Paper, supra note 203, at 6. Although not required under the proposed amendments to Rule 17Ad-22(e)(6)(i), calculation of gross margin for each customer, i.e., the sum of the individual margin amounts that would be due if each customer were margined separately, as FICC does for the Sponsored Service, would be permissible under the proposed amendment. 208 See Options Clearing Corp. Rule 601(c)–(d), available at https://www.theocc.com/getmedia/ 9d3854cd-b782-450f-bcf7-33169b0576ce/occ_ rules.pdf (‘‘OCC Rules’’). This approach is also similar to the approach used for futures customers. See 17 CFR 1.22 and Advanced Notice of Proposed Rulemaking, Protection of Cleared Swaps Customers Before and After Commodity Broker Bankruptcies, 75 FR 75162, 75163 (Dec. 2, 2010) (describing the futures model). PO 00000 Frm 00026 Fmt 4701 Sfmt 4702 commingled and held in a single account segregated from that of the member,209 which is consistent with the practice at the clearing agency for listed options and the proposed amendments to Rule 17Ad–22(e)(6)(i). The approach proposed here would also be similar to the requirements applicable to cleared swaps, in that it would require the separation of proprietary and customer funds and securities held at a U.S. Treasury securities CCA.210 However, it would not require any particular method for how customer funds and securities are segregated, which differs from the requirements applicable to derivatives clearing organizations clearing swaps. Such entities are subject to what has been referred to as a legally segregated, operationally commingled (‘‘LSOC’’) approach.211 Under such an approach, customer collateral may be held in one combined account and commingled, but in the event of a customer default, the collateral of non-defaulting customers would not be available to cover any losses attributable to the defaulting customer (i.e., they would be legally separated from the collateral of the defaulting customer).212 In other words, the LSOC model mitigates ‘‘fellow customer risk’’ arising from the default of a customer within the omnibus account. The Commission previously has declined to require such an approach for covered clearing agencies, preferring to allow each covered clearing agency to determine the method that works best for the products it clears and markets it serves.213 When discussing that conclusion, the Commission also noted that this type of segregation does not occur at the CCP level under the current market structure for cash securities and listed options, and that customer positions and funds in the cash securities and listed options markets are protected under SIPA, which is not the case for futures and cleared swaps.214 By contrast to the rules for margin for futures and cleared swaps, the proposed amendments to Rule 17Ad–22(e)(6)(i) would not require that a CCP clearing and settling transactions in U.S. 209 See CCA Standards Proposing Release, supra note 7, 79 FR at 29547; CCA Standards Adopting Release, supra note 25, 81 FR at 70832–33. 210 See 7 U.S.C. 6d(f)(2). 211 17 CFR 22.15. 212 See, e.g., Protection of Cleared Swaps Customer Contracts and Collateral; Conforming Amendments to the Commodity Broker Bankruptcy Provisions, 77 FR 6336, 6339 (Feb. 7, 2012) (describing the LSOC approach and adopting final rules for this approach). 213 See CCA Standards Adopting Release, supra note 25, 81 FR at 70832. 214 Id. at 70833 (citing 15 U.S.C. 78eee et seq.). E:\FR\FM\25OCP2.SGM 25OCP2 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules Treasury securities calculate and collect margin for each customer on a gross basis.215 Instead, the CCP would have the discretion to collect a single netted amount for each clearing member’s customer account as a whole, i.e., netting each customer’s margin against that of other customers within the overall customer account. This is generally how margin is collected for listed options,216 where, as noted above, SIPA acts to protect customer securities and funds at a participant brokerdealer.217 However, in order for a registered broker-dealer to take advantage of the proposed debit in proposed item 15 of 17 CFR 240.15c–3– 3a, if adopted, a U.S. Treasury securities CCA must collect margin on a gross basis, as discussed in section III.C infra. 2. Facilitating Access to U.S. Treasury Securities CCAs The Commission understands that the various models currently available to access central clearing in the U.S. Treasury market may not meet the needs of the many different types of market participants who transact in U.S. Treasury securities with the direct participants of a U.S. Treasury Securities CCA. Although some market participants may choose to become a member of a U.S. Treasury securities CCA, this approach likely would not be viable for a broad range of participants in the U.S. Treasury market for legal, operational and other reasons. Currently, there are several methods available to allow market participants to access CCP services through a FICC member.218 However, based on its supervisory experience, the Commission understands that these models may not meet the regulatory or business needs of all market participants, including indirect participants whose transactions with direct participants would likely be encompassed by rules that FICC would impose, as required by the Membership Proposal if adopted, that its direct participants submit for clearance and settlement all eligible secondary market transactions in U.S. Treasury securities. Consequently, the Commission believes that the access models used at a U.S. khammond on DSKJM1Z7X2PROD with PROPOSALS2 215 See 17 CFR 39.13(g)(8)(A and C) (requiring the collection of initial margin for each customer account equal to the sum of the initial margin accounts that would be required if the individual customer were a direct participant and prohibiting a derivatives clearing organization from netting, or permitting its clearing members to, net positions of different customers against one another). 216 See OCC Rule 810(a)–(c), supra note 208. 217 See supra note 210. 218 See, e.g., FICC Rules 3A, 8, 18, supra note 47 (providing for prime brokerage and correspondent clearing and sponsored membership); see also October 2021 White Paper, supra note 198, at 5–7. VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 Treasury securities CCA will need to be revisited to help ensure that more transactions by indirect participants (particularly in the dealer-to-customer market) could be submitted to comply with the Membership Proposal, if adopted. With regard to methods of access, the Commission understands indirect participants may have significantly different preferences with respect to how they access and obtain clearing services from direct participants of U.S. Treasury securities CCAs. For example, certain market participants may tend to prefer to bundle trading and execution services with a single entity that is a U.S. Treasury securities CCA member for regulatory, operational, and other reasons.219 By contrast, other market participants would prefer to be able to utilize clearing services unbundled from execution services from U.S. Treasury securities CCA members and would prefer that such members operate their clearing services independently from execution services, as appears common in other asset classes.220 In addition, some market participants have expressed concerns with the way FICC’s direct participants conduct their business regarding access for indirect participants, specifically, that FICC direct participants sponsoring indirect members are not willing to submit transactions for such indirect participants to which the direct participant is not a party (i.e., ‘‘done away’’ transactions).221 These concerns, however, are based on the business decisions of FICC’s direct participants rather than the operation of FICC’s Rules; although FICC does not restrict its Sponsoring Members’ ability to be both a trading counterparty and submitting clearing member for an indirect participant, FICC’s Rules allow direct participants in its sponsored membership program to submit ‘‘done away’’ transactions, if they so choose. Accordingly, as currently constituted, FICC’s rules permit but do not require that its direct participants accept such transactions.222 219 DTCC October 2021 White Paper, supra note 203, at 5, 7. 220 Futures Industry Association Principal Traders Group, Clearing a Path to a More Resilient Treasury Market, at 10 (Jul. 2021), available at https://www.fia.org/sites/default/files/2021-07/FIAPTG_Paper_Resilient%20Treasury%20Market_ FINAL.pdf (‘‘FIA PTG Whitepaper’’). 221 Id. at 7–9. 222 See DTCC October White Paper, supra note 203, at 6–7; Exchange Act Release No. 85470 (Mar. 29, 2019), supra note 126 (approving changes to FICC’s Rules to allow Sponsored Members to transact with FICC members that are not their Sponsoring Member). PO 00000 Frm 00027 Fmt 4701 Sfmt 4702 64635 The Commission is proposing Rule 17Ad–22(e)(18)(iv)(C) to require that a U.S. Treasury securities CCA establish, implement, maintain and enforce written policies and procedures reasonably designed to, as applicable, ensure that it has appropriate means to facilitate access to clearance and settlement services of all eligible secondary market transactions in U.S. Treasury securities, including those of indirect participants, which policies and procedures the U.S. Treasury securities CCA’s board of directors reviews annually. Although this new provision would not prescribe specific methods for market participants to obtain indirect access to a U.S. Treasury securities CCA, it is intended to help ensure that all U.S. Treasury security CCAs review their indirect access models and ensure that they facilitate access to clearance and settlement services in a manner suited to the needs and regulatory requirements of market participants throughout the U.S. Treasury securities market, including indirect participants. This new proposed requirement would further expand current Rule 17Ad–22(e)(18), which requires that a covered clearing agency establish, implement, maintain and enforce written policies and procedures reasonably designed to, as applicable, establish objective, risk-based and publicly disclosed criteria for participation, which permit fair and open access by direct and, where relevant indirect participants. Because the Membership Proposal likely would require direct participants to submit additional eligible secondary market transactions for clearing, thereby raising the need for the direct participants to centrally clear transactions with indirect participants that are not currently submitted for clearing, the Commission believes that expanding Rule 17Ad– 22(e)(18) to provide additional requirements regarding a U.S. Treasury securities CCA’s consideration of whether it has ensured appropriate access for indirect participants should help facilitate adoption and implementation of the Membership Proposal, as it will provide additional or reworked models which direct participants can use to submit their transactions executed on behalf of or with indirect participants for central clearing, and lead to better risk management of the risks posed by indirect participants to a U.S. Treasury securities CCA. To facilitate compliance with this proposed requirement, the Commission believes that a U.S. Treasury securities CCA generally should conduct an initial E:\FR\FM\25OCP2.SGM 25OCP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 64636 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules review of its access models and related policies and procedures. As it conducts this review, in view of the critical services it provides, the U.S. Treasury securities CCA generally should seek to provide access in as flexible a means as possible, consistent with its responsibility to provide sound risk management and comply with other provisions of the Exchange Act, the Covered Clearing Agency Standards, and other applicable regulatory requirements. The Commission believes that the U.S. Treasury securities CCA generally should consider a wide variety of appropriate means to facilitate access to clearance and settlement services of all eligible secondary market transactions in U.S. Treasury securities, including those of indirect participants. To ensure that it considers a sufficiently broad set of perspectives, the U.S. Treasury securities CCA generally should consult with a wide-range of stakeholders, including indirect participants, as it seeks to comply with proposed rule 17Ad–22(e)(18)(iv)(B). The Commission believes that a U.S. Treasury securities CCA generally should review any instance in which its policies and procedures treat transactions differently based on the identity of the participant submitting the transaction, the fact that an indirect participant who is a party to the transaction, or the method of execution, or in any other way, and confirm that any variation in the treatment of such transactions is necessary and appropriate to meet the minimum standards regarding, among other things, operations, governance, and risk management identified in the Covered Clearing Agency Standards. The review by a U.S. Treasury securities CCA’s board of directors under proposed Rule 17Ad–22(e)(18)(iv)(B) generally should include consideration whether to establish policies and procedures that enable direct members to submit to the U.S. Treasury securities CCA eligible transactions for clearance and settlement that have been executed by two indirect participants of the U.S. Treasury securities CCA, which could potentially help address some of the concerns potential participants raised about the inability to present ‘‘done away’’ trades for clearance and settlement described above. Finally, a U.S. Treasury securities CCA generally should consider whether to include in its policies and procedures nondiscrimination principles, similar to those the CFTC promulgated to foster the clearance and settlement of swaps,223 to the extent that they are applicable to the clearance and settlement of U.S. Treasury securities. Taken together, initiatives such as these, along with others identified by a U.S. Treasury securities CCA through consultations with relevant stakeholders—including indirect participants—should help ensure that a U.S. Treasury securities CCA is offering appropriate means to facilitate access to its clearance and settlement services for U.S. Treasury securities. To the extent that a U.S. Treasury securities CCA’s initial (or any subsequent) review occasions a change to its rules, such U.S. Treasury securities CCA would need to file such changes for Commission review and approval, as appropriate, under section 19(b) of the Exchange Act and Title VIII of the Dodd-Frank Act.224 Further, as noted above, the Commission is proposing to require annual review by the CCA’s board of directors of the CCA’s written policies and procedures designed to ensure that the CCA has appropriate means to facilitate access to clearance and settlement services of all eligible secondary market transactions in U.S. Treasury securities, including those of indirect participants. The Commission believes that such requirement is important to ensure that such policies regarding access to clearance and settlement services, including for indirect participants, are addressed at the most senior levels of the governance framework of the covered clearing agency, consistent with the importance of such requirements. The review by a U.S. Treasury securities CCA’s board of directors under proposed Rule 17Ad– 22(e)(18)(iv)(B) generally should include consideration whether the U.S. Treasury securities CCA’s written policies and procedures are reasonably designed to ensure appropriate means to facilitate access to clearance and settlement services of all eligible secondary market transactions in U.S. Treasury securities, including those of indirect participants. 3. Request for Comment The Commission generally requests comments on all aspects of new proposed Rules 17Ad–22(e)(6)(i) and 17Ad–22(e)(18)(iv)(C). In addition, the Commission requests comments on the following specific issues, with accompanying data and analysis: • Do commenters agree or disagree with any particular aspects of proposed Rule 17Ad–22(e)(6)(i)? If so, which ones and why? If commenters disagree with any provision of the proposed rule, how 225 See 224 See 223 See 15 U.S.C. 78s(b); 17 CFR 240.19b–4; 12 U.S.C. 5465(e). 17 CFR 39.12(a)(1)(vi). VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 should such provision be modified and why? • Do commenters agree that the transactions in a direct participant’s customer account would generally consist of its transactions in the dealerto-customer market, as a principal to transactions with its customers? Should the Commission further define or distinguish between proprietary and customer positions in the proposed rule text? • As discussed above, the proposed amendments to Rule 17Ad–22(e)(6)(i) do not require a particular approach to the methodology used for calculating customer margin, that is, whether customer margin should be determined on a gross or net basis, by contrast to the gross margin requirement for customer margin for futures and cleared swaps.225 Should the Commission consider further amendments to Rule 17Ad– 22(e)(6) or other Commission rules to include such a requirement? If so, how would such a requirement interact with SIPA 226 and the Bankruptcy Code 227 in the event of a broker-dealer default? • Do commenters believe that additional requirements with respect to the collection of margin at the customer level, i.e., further segregation of customer margin within a customer account (such as an LSOC model) would bring particular costs or benefits to the market? How would any such additional requirement interact with SIPA and the Bankruptcy Code in the event of a broker-dealer default? • More generally, what impact would the proposed amendment to Rule 17Ad– 22(e)(6)(i)(A) have on bankruptcy issues arising under SIPA? Would additional SIPA or bankruptcy issues arise in the event of additional margin requirements similar to those for futures and/or cleared swaps? • Would the proposed amendment to Rule 17Ad–22(e)(6)(i) potentially support (or not support) the expanded use of cross-margining agreements? • Do commenters believe that the proposed amendment to Rule 17Ad– 22(e)(6)(i) would increase (or decrease) the amount of margin required to be collected from direct participants of a U.S. Treasury securities CCA? • Do commenters agree that the requirement to separately calculate, collect, and hold customer margin would further incentivize central clearing in the U.S. Treasury market? • Do commenters agree or disagree with any particular aspects of proposed Rule 17Ad–22(e)(18)(iv)(C)? If so, which PO 00000 Frm 00028 Fmt 4701 Sfmt 4702 17 CFR 39.13(g). 15 U.S.C. 78aaa et seq. 227 See 11 U.S.C. 1 et seq. 226 See E:\FR\FM\25OCP2.SGM 25OCP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules ones and why? If commenters disagree with any provision of the proposed rule, how should such provision be modified and why? • Do commenters agree that proposed Rule 17Ad–22(e)(18)(iv)(C) is sufficient to facilitate access to the clearance and settlement services of a U.S. Treasury securities CCA for both direct and indirect participants? • Do commenters agree that certain market participants may not be able to satisfy a covered clearing agency’s membership criteria? If so, which particular entities, and what are the reasons? • In addition, do commenters agree that particular legal, operational or other considerations may further preclude many market participants from becoming direct members of a U.S. Treasury securities CCA? If so, which entities, and why? For example, are there particular requirements under the Investment Company Act of 1940 or Investment Advisers Act of 1940 that may preclude particular registered funds or their sponsors from participating as direct clearing members? • Among market participants that cannot become direct members of a U.S. Treasury securities CCA, are there particular entities that may be further precluded from participating as indirect participants? If so, which entities, and what might be some of the legal, operational or other considerations that may preclude them from becoming indirect participation? • Are there specific changes to the current indirect participation models that could help facilitate participation by certain market participants? In addition, are there specific changes to particular Commission rules that could facilitate further participation of indirect participants? • Would a separation between trade execution and clearing services at broker-dealers pose issues for any of the market participants in the market for U.S. Treasury securities? • Would a separation between trade execution and clearing services at broker-dealers lead to regulatory arbitrage in view of the fact that the Commission generally does not regulate banks that are not otherwise registered with the Commission? • Should the Commission amend the Covered Clearing Agency standards to require that a U.S. Treasury securities CCA, in turn, require its direct participants to clear transactions executed between indirect participants but submitted to a direct participant for clearing? How effective is such a rule likely to be in view of the restriction in VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 Exchange Act section 17A(b)(3)(E),228 which prohibits any clearing agency from imposing any schedule of prices, or fixing rates or other fees, for services rendered by its participants? C. Proposed Amendments to Rule15c3– 3a 1. Proposal The proposed rules discussed above could cause a substantial increase in the margin broker-dealers must post to a U.S. Treasury securities CCA resulting from their customers’ cleared U.S. Treasury positions. Currently, Rules 15c3–3 and 15c3–3a do not permit broker-dealers to include a debit in the customer reserve formula equal to the amount of margin required and on deposit at a U.S. Treasury securities CCA. This is because no U.S. Treasury securities CCA has implemented rules and practices designed to segregate the margin and limit it to being used solely to cover obligations of the brokerdealer’s customers. Therefore, increases in the amount of margin required to be deposited at a U.S. Treasury securities CCA as a result of the Membership Proposal would result in corresponding increases in the need to use brokerdealers’ cash and securities to meet these requirements. To facilitate implementation of the Membership Proposal, the Commission is proposing to amend Rule 15c3–3a to permit margin required and on deposit at a U.S. Treasury securities CCA to be included as a debit item in the customer reserve formula, subject to the conditions discussed below. This new debit item would offset credit items in the Rule 15c3–3a formula and, thereby, free up resources that could be used to meet the margin requirements of a U.S. Treasury securities CCA. The new debit item would be reported on a newly created Item 15 of the Rule 15c3–3a reserve formula. The proposed amendments also would set forth a number of conditions that would need to be met to include the debit in the reserve formula. As discussed below, these proposed conditions are designed to permit the inclusion of the debit only under conditions that would provide maximum protection to the brokerdealer’s customers. The goal is to facilitate implementation of the Membership Proposal in a way that does not diminish the customer-protection objective of Rules 15c3–3 and 15c3–3a. The proposed conditions would be set forth in a new Note H to the reserve formula similar to how the conditions for including a debit in the reserve 228 15 PO 00000 U.S.C. 78q–1(b)(3)(E). Frm 00029 Fmt 4701 Sfmt 4702 64637 formula with respect to margin required and on deposit at a securities futures clearing agency or DCO are set forth in Note G. The proposed amendments are based, in part, on the conditions in Note G and the requirements in Rules 15c3– 3 and 15c3–3b for including a debit with respect to margin required and on deposit at security-based swap clearing agency. The Note G conditions and requirements of Rules 15c3–3 and 15c3– 3b similarly are designed to permit the debit under circumstances that provide protection to customers. Under the proposed amendments, current Item 15 of the Rule 15c3–3a formula would be renumbered Item 16.229 Proposed Item 15 would identify as a debit in the Rule 15c3–3a formula margin required and on deposit with a clearing agency registered with the Commission under section 17A of the Exchange Act resulting from the following types of transactions in U.S. Treasury securities in customer accounts that have been cleared, settled, and novated by the clearing agency: (1) purchases and sales of U.S. Treasury securities; and (2) U.S. Treasury securities repurchase and reverse repurchase agreements (together ‘‘customer position margin’’). As proposed, this debit item would be limited to customer position margin required and on deposit at a clearing agency that clears, settles, and novates transactions in U.S. Treasury securities. Except for the debits identified in current Items 13 and 14 of the Rule 15c3–3a formula, margin required and on deposit at other types of clearing agencies or for other types of securities transactions would not qualify as a debit item under this proposal. Further, this debit item would be limited to customer position margin required and on deposit at the U.S. Treasury securities CCA as a result of U.S. Treasury positions in customer accounts. Margin required and on deposit at the U.S. Treasury securities CCA as result of the brokerdealer’s proprietary U.S. Treasury positions could not be included in this debit item. This proposed limitation would effectuate a fundamental aspect of Rule 15c3–3: that customer cash and securities not be used by the brokerdealer to finance its proprietary business activities.230 Finally, the debit would be limited to customer position margin required and on deposit at the 229 Current Item 15 is where the broker-dealer reflects the amount, if any, that total credits exceed total debits. 230 As discussed above in section II.B.2., debit items offset credit items thereby reducing the amount of cash or qualified securities that need to be held in the customer reserve account to cover the broker-dealer’s cash liabilities to its customers. E:\FR\FM\25OCP2.SGM 25OCP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 64638 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules U.S. Treasury securities CCA. This would mean that the broker-dealer could not include in this debit item amounts on deposit at the U.S. Treasury securities CCA that exceed the brokerdealer’s margin requirement resulting from its customers’ cleared U.S. Treasury securities positions. This limitation is designed to prevent the broker-dealer from artificially increasing the amount of the debit item by depositing cash and securities at the U.S. Treasury securities CCA that are not needed to meet a margin requirement resulting from its customers’ U.S. Treasury securities positions. As proposed, Item 15 of the Rule 15c3–3a formula would have a Note H that sets forth a number of conditions that would need to be met to include the amount of customer position margin required and on deposit at the U.S. Treasury securities CCA as a debit. Each of the conditions in Note H to Item 15 would need to be met for a broker-dealer to include a debit equal to the amount of customer position margin on deposit at the U.S. Treasury securities CCA. The first condition would be set forth in Note H(a), which would provide that the debit item could be included in the Rule 15c3–3a formula to the extent that the customer position margin is in the form of cash or U.S. Treasury securities and is being used to margin U.S. Treasury securities positions of the customers of the broker-dealer that are cleared, settled, and novated at the U.S. Treasury securities CCA. The objective is to limit the assets underlying the debit item to the safest and most liquid instruments, given that the debit item would offset credit items (cash owed to customers).231 As discussed above, the liquidity of the debit items protects the customers whose cash or securities are used to finance or facilitate customer transactions. Proposed Note H(b) to Item 15 would set forth three conditions that would need to be met to include the amount of customer position margin required and on deposit at the U.S. Treasury securities CCA as a debit item. The first condition set forth in Note H(b)(1) would provide that the customer position margin must consist of cash owed to the customer of the brokerdealer or U.S. Treasury securities held in custody by the broker-dealer for the customer that was delivered by the 231 See, e.g., 17 CFR 240.15c3–3(e) (limiting the assets that can be deposited into the customer reserve account to cash and qualified securities); 17 CFR 240.15c3–3(a)(6) (defining the term ‘‘qualified security’’ to mean a security issued by the United States or a security in respect of which the principal and interest are guaranteed by the United States). VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 broker-dealer to meet to meet a margin requirement resulting from that customer’s U.S. Treasury securities positions cleared, settled, and novated at the U.S. Treasury securities CCA and not for any other customer’s or the broker-dealer’s U.S. Treasury securities positions cleared, settled, and novated at the U.S. Treasury securities CCA.232 In sum, to meet this condition, the broker-dealer would need to: (1) use customer assets exclusively to meet the customer position margin requirement; (2) use a particular customer’s assets exclusively to meet the amount of the customer position margin requirement resulting from that customer’s cleared U.S. Treasury securities positions; and (3) have delivered the customer’s assets to the U.S. Treasury securities CCA. The objective of the first component of this condition—the need to use customer assets exclusively—is to segregate the customer assets being used to meet the customer position margin requirement from the broker-dealer’s proprietary assets. Additional conditions would provide that the U.S. Treasury securities CCA must hold the assets being used to meet the customer position margin requirement in an account of the brokerdealer that is segregated from any other account of the broker-dealer and is identified as being held for the exclusive benefit of the broker-dealer’s customers. The first prong of the condition is designed to ensure that only customer assets are held in the account. The objective of the second component of this condition—the need to use a particular customer’s assets exclusively to meet the amount of the customer position margin requirement resulting from that customer’s cleared U.S. Treasury securities positions—is to avoid the use of one customer’s assets to meet another customer’s margin 232 Cash owed by a broker-dealer to customers is a credit item that is included in Item 1 to the Rule 15c3–1a formula. Thus, cash owed to customers that is used to meet a customer position margin requirement will be accounted for as a credit in Item 1. Further, when a broker-dealer uses customer margin securities to borrow funds or execute a securities loan transaction, the firm must put a credit in the formula. See Items 2 and 3 to Rule 15c3–3a. The credit items are designed to require the broker-dealer to reserve sufficient funds to be able to retrieve securities collateralizing the borrowed funds or that have been loaned. There is not a specific Item in the Rule 15c3–3a formula to include the credit arising from the broker-dealer’s use of customers’ U.S. Treasury securities to meet a customer position margin requirement. Consequently, the Commission is proposing to amend Note B to Item 2 of the Rule 15c3–1a formula to instruct broker-dealers to include as a credit in Item 2 the market value of customers’ U.S. Treasury securities on deposit at a U.S. Treasury securities CCA that meets the definition of a ‘‘qualified clearing agency’’ in Note H. PO 00000 Frm 00030 Fmt 4701 Sfmt 4702 requirement. For example, FICC’s Sponsored Member program allows its members to sponsor a person’s (i.e., a Sponsored Member’s) U.S. Treasury securities transactions for clearance and settlement. FICC interacts solely with the sponsoring member as processing agent for purposes of the day-to-day satisfaction of the Sponsored Member’s obligation to or from FICC, including the Sponsored Member’s cash and securities settlement obligations. However, FICC calculates a separate margin requirement for each Sponsored Member’s trading activity and the sum of each sponsored member’s margin calculation is the aggregate margin requirement that must be met by the sponsoring member. Further, this margin is held in an omnibus account that is separate from the account that holds the Sponsoring Member’s net margin obligation for non-sponsored securities transactions.233 In this scenario, the U.S. Treasury securities CCA’s margin calculations and resulting requirements can be traced to a specific customer’s cleared U.S. Treasury securities positions. Consequently, the broker-dealer would be able to allocate the amount of the U.S. Treasury securities CCA’s daily customer position margin requirement attributable to a specific customer. Under this component of the first condition, the broker-dealer would need to deliver cash or U.S. Treasury securities belonging to that specific customer to meet the amount of the U.S. Treasury securities CCA’s customer position margin requirement resulting from that customer’s cleared U.S. Treasury securities positions. This would mitigate the risk to all the brokerdealer’s customers by limiting when their assets can be used to meet the U.S. Treasury securities CCA’s customer position margin requirement. The objective of the third component of the first condition—that the brokerdealer had delivered the customer’s assets to the U.S. Treasury securities CCA—is to address the potential that a customer may use more than one broker-dealer to engage in U.S. Treasury securities transactions. In this case, two or more broker-dealers may be subject to customer position margin requirements of the U.S. Treasury securities CCA resulting from the customer’s cleared U.S. Treasury securities positions. The intent is to prevent a broker-dealer from including as a debit the amount of customer position margin that another broker-dealer delivered to the U.S. Treasury securities CCA with respect to U.S. Treasury securities positions of a 233 See E:\FR\FM\25OCP2.SGM note 207 supra. 25OCP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules customer of both the broker-dealers. The amount that a given broker-dealer’s debit items can offset its credit items should be limited to the amount customer position margin it delivered to the U.S. Treasury securities CCA. Otherwise, the customers of the brokerdealer would be put at risk for transactions effected by another brokerdealer. Proposed Note H(b)(2) to Item 15 would set forth the second condition for including customer position margin as a debit in the Rule 15c3–3a formula. Under this condition, the customer position margin would need to treated in accordance with rules of the U.S. Treasury securities CCA designed to protect and segregate the customer position margin and the U.S. Treasury securities CCA and broker-dealer would need to be in compliance with those rules (as applicable). Proposed Note H(b)(2)(i) to Item 15 would provide that the customer position margin is treated in accordance with rules requiring the qualified U.S. Treasury securities CCA to calculate a separate margin amount for each customer of the broker-dealer and the broker-dealer to deliver that amount of margin for each customer on a gross basis. As discussed above, a component of the condition in proposed Note H(b)(1) is that the broker-dealer use a particular customer’s assets exclusively to meet the amount of the customer position margin requirement resulting from that customer’s cleared U.S. Treasury securities positions. This condition in proposed Note H(b)(2) is designed to facilitate that condition in proposed Note H(b)(1) by requiring that the U.S. Treasury securities CCA has rules to perform separate customer position margin calculations for each customer of the broker-dealer. This would allow the broker-dealer to allocate the amount of the customer position margin requirement attributable to each of its customers. In addition, the condition would provide that the U.S. Treasury securities CCA has rules requiring the broker-dealer to deliver the amount calculated for each customer on a gross basis. This would mean that the risk of one customer’s positions could not be offset by the risk of another customer’s positions in determining the amount of customer position margin the broker-dealer would need to have on deposit at the U.S. Treasury securities CCA. As a result, the broker-dealer would not be able to deliver assets belonging to one customer to meet the margin requirement of another customer. Proposed Note H(b)(2)(ii) to Item 15 would provide that the customer VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 position margin is treated in accordance with rules requiring that the U.S. Treasury securities CCA be limited to investing it in U.S. Treasury securities with a maturity of one year or less. As discussed above, proposed Note H(a) would provide that the collateral delivered to the U.S. Treasury securities CCA by the broker-dealer to meet the customer position margin requirement must be in the form of cash or U.S. Treasury securities. The objective is to limit the assets underlying the debit item to the safest and most liquid instruments. This objective would be undermined if the U.S. Treasury securities CCA could invest the cash delivered by the broker-dealer or cash obtained by using the U.S Treasury securities delivered by the broker-dealer in assets other than cash and U.S. Treasury securities. Moreover, while the broker-dealer could deliver customer U.S. Treasury securities with a maturity greater than one year, the U.S. Treasury securities CCA’s rule would need to limit it to investing customer position margin in U.S. Treasury securities with a maturity of one year or less. The object is to limit the investments to the safest most liquid instruments. Proposed Note H(b)(2)(iii) to Item 15 would provide that the customer position margin is treated in accordance with rules designed to address the segregation of the broker-dealer’s account at the U.S. Treasury securities CCA that holds the customer position margin and set strict limitations on the U.S. Treasury securities CCA’s ability to use the margin. The required rules are modeled on the requirements for a broker-dealer to include a debit with respect to margin delivered to a security-based swap CCA.234 In particular, the note would provide that the customer position margin is treated in accordance with rules requiring that it must be held in an account of the broker-dealer at the U.S. Treasury securities CCA that is segregated from any other account of the broker-dealer at the U.S. Treasury securities CCA and that is: • Used exclusively to clear, settle, novate, and margin U.S. Treasury securities transactions of the customers of the broker or dealer; • Designated ‘‘Special Clearing Account for the Exclusive Benefit of the Customers of [name of broker-dealer]’’; 234 See 17 CFR 240.15c3–3(p)(1)(iii) (defining the term ‘‘qualified clearing agency account’’); 17 CFR 240.15c3–3b, Item 15 (permitting a broker-dealer to include a debit in the security-based swap reserve formula equal to the margin required and on deposit in a qualified clearing agency account at a clearing agency). See also 84 FR at 43938–42, supra note 99. PO 00000 Frm 00031 Fmt 4701 Sfmt 4702 64639 • Subject to a written notice of the U.S. Treasury securities CCA provided to and retained by the broker-dealer that the cash and U.S. Treasury securities in the account are being held by the U.S. Treasury securities CCA for the exclusive benefit of the customers of the broker-dealer in accordance with the regulations of the Commission and are being kept separate from any other accounts maintained by the brokerdealer or any other clearing member at the U.S. Treasury securities CCA; and • Subject to a written contract between the broker-dealer and the U.S. Treasury securities CCA which provides that the cash and U.S. Treasury securities in the account are not available to cover claims arising from the broker-dealer or any other clearing member defaulting on an obligation to the U.S. Treasury securities CCA or subject to any other right, charge, security interest, lien, or claim of any kind in favor of the U.S. Treasury securities CCA or any person claiming through the U.S. Treasury securities CCA, except a right, charge, security interest, lien, or claim resulting from a cleared U.S. Treasury transaction of a customer of the broker-dealer effected in the account. The objective is to protect the customer position margin that the broker-dealer deposits with the U.S. Treasury securities CCA to margin its customers’ U.S. Treasury security positions by isolating it from any other assets of the broker-dealer at the U.S. Treasury securities CCA and to prevent it from being used to cover any obligation other than an obligation of the broker-dealer’s customer resulting from a U.S. Treasury transaction cleared, settled, and novated in the account. Further, the account designation and written notice requirements are designed to alert creditors of the broker-dealer and U.S. Treasury securities CCA that the assets in this account are not available to satisfy any claims they may have against the broker-dealer or the U.S. Treasury securities CCA. The written contract requirement is designed to limit the U.S. Treasury securities CCA’s rights to use the customer position margin for any purpose other than an obligation of the broker-dealer’s customers. For example, the assets in the account could not be used to cover an obligation of the broker-dealer to the U.S. Treasury securities CCA if the broker-dealer defaults on the obligation. Similarly, the assets in the account could not be used to mutualize the loss across the U.S. Treasury securities CCA’s members if a member defaulted and its clearing funds were insufficient to cover the loss. E:\FR\FM\25OCP2.SGM 25OCP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 64640 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules Proposed Note H(b)(2)(iv) to Item 15 would provide that the customer position margin is treated in accordance with rules designed to address how the U.S. Treasury securities CCA holds the customer position margin. Similar to proposed Note H(b)(2)(iii) to Item 15, the objective would be to isolate the customer position margin and prevent it from being used to satisfy the claims any creditors may have against the U.S. Treasury securities CCA. In particular, the note would provide that the customer position margin is treated in accordance with rules of the U.S. Treasury securities CCA requiring that the U.S. Treasury securities CCA hold the customer position margin itself or at either a U.S. Federal Reserve Bank or a ‘‘bank’’ (as defined in section 3(a)(6) of the Exchange Act (15 U.S.C. 78c(a)(6)) that is insured by the Federal Deposit Insurance Corporation. The objective is to have the U.S. Treasury securities CCA hold the customer position margin at a safe financial institution. In addition, the rules would need to provide that the U.S. Treasury securities CCA’s account at the U.S. Federal Reserve Bank or bank be: • Segregated from any other account of the U.S. Treasury securities CCA or any other person at the U.S. Federal Reserve Bank or bank and used exclusively to hold cash and U.S. Treasury securities to meet current margin requirements of the U.S. Treasury securities CCA resulting from positions in U.S. Treasury securities of the customers of the broker-dealer members of the qualified U.S. Treasury securities CCA; • Subject to a written notice of the U.S. Federal Reserve Bank or bank provided to and retained by the U.S. Treasury securities CCA that the cash and U.S. Treasury securities in the account are being held by the U.S. Federal Reserve Bank or bank pursuant to Rule 15c3–3 and are being kept separate from any other accounts maintained by the U.S. Treasury securities CCA or any other person at the U.S. Federal Reserve Bank or bank; and • Subject to a written contract between the U.S. Treasury securities CCA and the U.S. Federal Reserve Bank or bank which provides that the cash and U.S. Treasury securities in the account are subject to no right, charge, security interest, lien, or claim of any kind in favor of the U.S. Federal Reserve Bank or bank or any person claiming through the U.S. Federal Reserve Bank or bank. These conditions with respect to the account designation, written notice, and written contract would be designed to VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 achieve the same objectives as the analogous conditions discussed above with respect to the broker-dealer’s account at the U.S. Treasury securities CCA.235 Proposed Note H(b)(2)(v) to Item 15 would provide that the customer position margin is treated in accordance with rules of the clearing agency requiring systems, controls, policies, and procedures to return customer position margin to the broker-dealer that is no longer needed to meet a current margin requirement resulting from positions in U.S. Treasury securities of the customers of the broker-dealer no later than the close of the next business day after the day the customer position margin is no longer needed for this purpose. As discussed above, the debit would be limited to customer position margin required and on deposit at the U.S. Treasury securities CCA. This would mean that the broker-dealer could not include in this debit item the amount of customer position margin on deposit at the U.S. Treasury securities CCA that exceeds the broker-dealer’s margin requirement resulting from its customers’ cleared U.S. Treasury securities positions. The objective of this condition is to effectuate the prompt return of customer position margin to the broker-dealer. Proposed Note H(b)(3) to Item 15 would set forth the third condition for including customer position margin as a debit in the Rule 15c3–3a formula. Under this condition, the Commission would need to have approved rules of the U.S. Treasury securities CCA that meet the conditions of proposed Note H and the Commission would had to have published (and not subsequently withdrawn) a notice that brokers-dealers may include a debit in the customer reserve formula when depositing customer position margin to meet a margin requirement of the U.S. Treasury securities CCA resulting from positions in U.S. Treasury securities of the customers of the broker-dealer. The Commission staff would analyze the U.S. Treasury securities CCA’s approved rules and practices regarding the treatment of customer position margin and make a recommendation as to whether they adequately implement the customer protection objectives of the conditions set forth in proposed Note H to Item 15. If satisfied with the staff’s recommendation, the Commission would publish a positive notice. The objective is to permit the debit only after 235 See, e.g., 17 CFR 240.15c3–3a, Note G(b)(2) to Item 14 (setting forth similar requirements when a securities futures clearing agency holds customer margin at a bank). PO 00000 Frm 00032 Fmt 4701 Sfmt 4702 the Commission has approved the U.S. Treasury securities CCA’s rules pursuant to section 19(b) of the Exchange and published the notice.236 Any changes to those rules and practices that would undermine these customer protection objectives could result in the Commission withdrawing the notice, at which point the Commission would no longer permit the debit. Finally, broker-dealers are required to perform a separate reserve computation for their broker-dealer customers and maintain a separate reserve account with respect to that computation.237 The Rule 15c3–3a computation provides that this separate PAB reserve computation must be performed in accordance with the Rule 15c3–3a computation for the broker-dealer’s non-PAB customers, except as provided in Notes to the PAB Computation.238 Therefore, the proposed amendments discussed above adding a new debit in Item 15 would apply to the PAB reserve computation. Further, the Commission is proposing to amend Note 9 Regarding the PAB Reserve Bank Account Computation— which permits a debit in the PAB reserve computation for clearing deposits required to be maintained at registered clearing agencies—to clarify that the conditions set forth in new Note H with respect to including a debit in the non-PAB customer reserve computation would apply to the PAB reserve computation as well. 2. Request for Comment The Commission generally requests comments on all aspects of the proposed amendment to Rule 15c3–3a. In addition, the Commission requests comments on the following specific issues, with accompanying data and analysis: • Do commenters agree or disagree with any particular aspects of the proposed amendment to Rule 15c3–3? If so, which ones and why? If commenters disagree with any provision of the proposed rule amendment, how should such provision be modified and why? • Rule 15c3–3 defines the term ‘‘excess margin securities’’ to mean those securities referred to in paragraph 236 See 15 U.S.C. 78s. 17 CFR 240.15c3–3(a)(16) (defining the term ‘‘PAB account’’ to mean a proprietary securities account of a broker-dealer (which includes a foreign broker-dealer, or a foreign bank acting as a broker-dealer) other than a deliveryversus-payment account or a receipt-versuspayment account); 17 CFR 240.15c3–3(e) (requiring separate reserve accounts and reserve account computations for PAB accounts). 238 See 17 CFR 240.15c3–3a, Notes 1 through 10 Regarding the PAB Reserve Bank Account Computation. 237 See E:\FR\FM\25OCP2.SGM 25OCP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules (a)(4) of Rule 15c3–3 carried for the account of a customer having a market value in excess of 140 percent of the total of the debit balances in the customer’s account or accounts encompassed by paragraph (a)(4) of Rule 15c3–3 which the broker-dealer identifies as not constituting margin securities. With respect to cleared, settled, and novated repurchase and reverse purchase agreements in U.S. Treasury securities, how should this 140 percent test be applied? • In terms of protecting customer position margin held at the U.S. Treasury securities CCA, should the Commission adopt other clearing models? For example, should the Commission adopt an approach similar to how margin for swaps cleared at a U.S. derivatives clearing organization is treated? If so, explain how such a model would work in a liquidation of the broker-dealer under SIPA. • Are there any legal or operational issues that particular participants may face as a result of customer position margin held by a U.S. Treasury securities CCA? Do commenters believe there may be the need for other regulatory relief or guidance by the Commission or other regulators to facilitate the holding of such customer margin? Are there any particular entities that should be exempted from the margin requirements due to particular legal, operational or other issues? • Should the Commission adopt further measures to protect the customer cash and U.S. Treasury securities that are used to meet the customer position margin requirements of the U.S. Treasury securities CCA? For example, should the Commission adopt measures to protect the cash and U.S. Treasury securities in the event of an insolvency of the U.S. Treasury securities CCA? In this regard, should the Commission require that the cash and U.S. Treasury securities be held at a third-party bank in an account that is subject to an agreement between the U.S. Treasury securities CCA, the broker-dealer, and the bank that the assets in the account may only be accessed by the U.S. Treasury securities CCA to cover a loss resulting from a customer of the brokerdealer failing to meet an obligation to the U.S. Treasury securities CCA? Would this approach be workable or practical? Please explain. D. Compliance Date The Commission understands that an existing U.S. Treasury securities CCA likely would need time and resources to develop and adopt policies and procedures to implement the standards set forth in this proposal, if adopted, for VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 its business. In addition, as noted above, any changes to a U.S. Treasury securities CCA’s rules would require that the CCA file proposed rule changes under section 19(b) of the Exchange Act and/or section 806 of the Dodd-Frank Act, as applicable, for the Commission to review and consider such changes for consistency with the applicable standards. More generally, the Commission recognizes that the changes set forth in this proposal, if adopted, including the likely substantial amount of additional transactions to be submitted for central clearing that are not currently submitted in large volumes (such as the dealer-to-customer market) would represent a significant change in current industry practice that may take time for market participants to navigate. The Commission is not proposing a specific compliance date at this time, but instead seeks comment regarding what would be an appropriate timeframe. The Commission generally solicits comment on what an appropriate compliance date would be for each of the proposed rule amendments (Rule 17Ad–22(e)(18), Rule 17Ad–22(e)(6)) if adopted. In addition, the Commission requests comments on the following specific issues, with accompanying data and analysis: • How long would U.S. Treasury securities CCAs and market participants need to implement the proposal if it is adopted substantially as proposed? What data points would U.S. Treasury securities CCAs and market participants use to assess the timing? Are any specific operational or technological issues raised that should be factored into a proposed compliance date? • Would staggering the compliance dates for the different rule amendments proposed help facilitate an orderly implementation of the proposal, if adopted? For example, would it be appropriate for the compliance date for paragraphs (ii)(A) and (B) in the definition of an ‘‘eligible secondary market transaction’’ to be before the compliance date for paragraphs (ii)(C) and (D) of the same definition, and if so, how much before? More generally, if staggering is appropriate, what would be an appropriate schedule of compliance dates? IV. Economic Analysis The Commission is mindful of the economic effects that may result from the proposed amendments, including the benefits, costs, and the effects on efficiency, competition, and capital formation. Exchange Act section 3(f) requires the Commission, when it is PO 00000 Frm 00033 Fmt 4701 Sfmt 4702 64641 engaged in rulemaking pursuant to the Exchange Act and is required to consider or determine whether an action is necessary or appropriate in the public interest, to consider, in addition to the protection of investors, whether the action will promote efficiency, competition, and capital formation.239 In addition, Exchange Act section 23(a)(2) requires the Commission, when making rules pursuant to the Exchange Act, to consider among other matters the impact that any such rule would have on competition and not to adopt any rule that would impose a burden on competition that is not necessary or appropriate in furtherance of the purposes of the Exchange Act.240 This section analyzes the expected economic effects of the proposed rules relative to the current baseline, which consists of the current market and regulatory framework in existence today. In this proposal, the Commission is proposing additional requirements for any U.S. Treasury securities CCA.241 First, the proposal would require that such CCAs establish written policies and procedures reasonably designed to, as applicable, establish objective, riskbased, and publicly disclosed criteria for participation, which require that the direct participants of such CCA submit for clearance and settlement all eligible secondary market transactions to which they are a counterparty (‘‘Membership Proposal’’).242 In addition, the proposal would require that such CCAs establish written policies and procedures reasonably designed to, as applicable, identify and monitor its direct participants’ required submission of transactions for clearing, including, at a minimum, address a failure to submit transactions. The Commission believes that strengthening the membership standards will help reduce contagion risk to U.S. Treasury securities CCAs and bring the benefits of central clearing to more transactions involving U.S. Treasury securities, thereby lowering the risk of disruptions to the U.S. Treasury securities market.243 Second, the Commission is proposing additional requirements on how U.S. Treasury securities CCAs calculate, collect, and hold margin posted on behalf of indirect participants (i.e., customers) who rely on the services of a direct participant (i.e., the member of the U.S. Treasury securities CCA) to 239 See 15 U.S.C. 78c(f). 15 U.S.C. 78w(a)(2). 241 See supra section III.A. 242 See supra section III.A for a description of the Membership Proposal including the definition of ‘‘eligible secondary market transaction.’’ 243 See infra section IV.B.6. 240 See E:\FR\FM\25OCP2.SGM 25OCP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 64642 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules access the CCA’s services.244 As discussed in more detail below, the Commission believes that such requirements also will improve the risk management practices at U.S. Treasury securities CCAs and incentivize and facilitate additional central clearing in the U.S. Treasury securities market. Third, the Commission is proposing requirements that a U.S. Treasury securities CCA establish, implement, maintain and enforce written policies and procedures reasonably designed to, as applicable, ensure that it has appropriate means to facilitate access to clearance and settlement services of all eligible secondary market transactions in U.S. Treasury securities, including those of indirect participants and that the board of directors reviews these policies and procedures annually.245 Although the proposed requirements would not prescribe specific methods for market participants to obtain indirect access to a U.S. Treasury securities CCA, it is intended to help ensure that all U.S. Treasury security CCAs review their indirect access models and ensure that they facilitate access to clearance and settlement services in a manner suited to the needs and regulatory requirements of market participants throughout the U.S. Treasury securities market, including indirect participants. Lastly, the Commission is proposing to amend its rules to permit margin required and on deposit at a U.S. Treasury securities CCA to be included as a debit item in the customer reserve formula, subject to certain conditions.246 As discussed further below, the Commission believes that this proposal, in conjunction with the proposal requiring the separation of house and customer margin, will incentivize and facilitate additional central clearing in the U.S. Treasury securities market. The discussion of the economic effects of the proposed rule begins with a discussion of the risks inherent in the clearance and settlement process and how the use of a CCP can mitigate those risks. This is followed by a baseline of current U.S. Treasury securities market practices. The economic analysis then discusses the likely economic effects of the proposal, as well as its effects on efficiency, competition, and capital formation. The Commission has, where practicable, attempted to quantify the economic effects expected to result from this proposal. In some cases, however, data needed to quantify these economic 244 See supra section III.B.1. supra section III.B.2. 246 See supra section III.C. 245 See VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 effects is not currently available or otherwise publicly available. For example, the reporting of data for bilaterally-cleared repo transactions is currently not a regulatory requirement, so counterparty-specific statistics are not available and any aggregate statistics on this market segment may not be comprehensive.247 Likewise, the reporting of U.S. Treasury securities transactions to FINRA TRACE has been until recently 248 limited to cash transactions in which at least one of the counterparties is a FINRA member, so analyses based on that data will necessarily be incomplete. In many cases, and as noted below, the Commission is unable to quantify these economic effects and solicits comment, including estimates and data from interested parties, that could help inform the estimates of the economic effects of the proposal. A. Broad Economic Considerations Clearance and settlement risk is the risk that a counterparty fails to deliver a security or cash as agreed upon at the time when the security was traded. One method of reducing such risk is to require one or both counterparties to the trade to post collateral.249 The purpose of posting collateral in financial transactions is to alleviate frictions caused by adverse selection and moral hazard.250 The amount of collateral 247 Samuel J. Hempel, R. Jay Kahn, Vy Nguyen, & Sharon Y. Ross, Non-centrally Cleared Bilateral Repo (Aug 24, 2022), available at: https:// www.financialresearch.gov/the-ofr-blog/2022/08/ 24/non-centrally-cleared-bilateral-repo/. 248 Reporting of additional cash transactions to TRACE, by certain U.S. and foreign banks, began on September 1, 2022 but the recent nature of that change precludes the Commission from doing any analysis on that new reporting universe. See generally Federal Reserve System, Agency Information Collection Activities: Announcement of Board Approval Under Delegated Authority and Submission to OMB, 86 FR 59716 (Oct. 28, 2021), available at https://www.govinfo.gov/content/pkg/ FR-2021-10-28/pdf/2021-23432.pdf; see also Supporting Statement for the Treasury Securities and Agency Debt and Mortgage-Backed Securities Reporting Requirements, available at https:// www.federalreserve.gov/reportforms/formsreview/ FR%202956%20OMB%20SS.pdf. 249 An alternative method of reducing counterparty credit risk used in the securities industry is delivery versus payment (‘‘DVP’’). Under DVP, counterparties aim to deliver securities and payment simultaneously, so that the transfer of securities happens if and only if payment has also been made. 250 For example, if the fulfillment of a contract depends on a counterparty exerting unobservable and costly effort, collateral can be used as a commitment device by putting more of the counterparty’s resources at stake in the case of nonfulfillment. See Bengt Holmstrom & Jean Tirole, Financial Intermediation, Loanable Funds, and the Real Sector, 112 Q. J. Econ. 663 (Aug. 1997); Albert J. Menkveld & Guillaume Vuillemey, The Economics of Central Clearing, 13 Ann. Rev. Fin. Econ. 153, 158 (2021). PO 00000 Frm 00034 Fmt 4701 Sfmt 4702 needed to support a set of unsettled trades, however, can depend on whether trades are cleared bilaterally or through a CCP. In particular, in cases where market participants have several outstanding buy and sell orders, central clearing reduces the total collateral required to support a given set of trades due to multilateral netting.251 A simple example illustrates the effect. Suppose there are 3 firms trying to complete three bilateral trades among themselves. Firm A is buying $90 million in U.S. Treasury securities from Firm B, Firm B is buying $80 million in the same U.S. Treasury securities from Firm C, and Firm C is buying $100 million in the same U.S. Treasury securities from Firm A. This would mean that over the settlement cycle, the firms in this example would need to post collateral to cover a total of $270 million in gross obligations to complete these three trades. If these trades were centrally cleared, however, then the net obligations would be substantially smaller. In this example, the collateral required would no longer be that required to support $270 million in outstanding obligations, but instead would reduce to $40 million: $20 million for Firm C, and $10 million each for Firms A and B.252 Central clearing can, in part, replace a trading network made up of a web of bilateral relationships with a simpler hub and spoke model. As each connection is a potential source of failure, a simpler system can imply less risk. Clearance and settlement through a CCP can also make trades less ‘‘informationally sensitive’’ in the sense that the value of the trade does not depend on information about the creditworthiness of the counterparties, thereby reducing adverse selection.253 This occurs when the trade is novated to the CCP, and the CCP becomes the buyer to every seller and the seller to every buyer. This reduces the need for investors to acquire private information 251 Darrell Duffie & Haoxiang Zhu, Does a Central Clearing Counterparty Reduce Counterparty Risk? 1 Rev. Asset Pricing Stud. 74 (2011), available at https://academic.oup.com/raps/article-abstract/1/ 1/74/1528254. The authors note that this benefit scales with the square root of the number of participants when the trading positions are statistically independent and identically distributed. 252 This example is from Duffie, supra note 186. 253 See Gary Gorton & George Pennacchi, Financial Intermediaries and Liquidity Creation, 45 J. Fin. 49 (1990), available at https://www.jstor.org/ stable/2328809. See also Francesca Carapella & David Mills, Information Insensitive Securities: the Benefits of Central Counterparties, Working Paper (2012), available at https://www.newyorkfed.org/ medialibrary/media/research/conference/2012/MP_ Workshop/Carapella_Mills_information_ insensitive_securities.pdf. E:\FR\FM\25OCP2.SGM 25OCP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules about the credit risk of their counterparty. By mitigating adverse selection through the substitution of the CCP’s counterparty credit risk evaluation for a market participant’s own, central clearing through a CCP lowers the cost of trading by market participants and should increase their willingness to trade, thereby improving market liquidity. Reducing the information sensitivity of trades also increases the uniformity of the asset that is traded. In the absence of novation, the U.S. Treasury security is essentially bundled together with counterparty risk. That is, when buying or selling a security, if there is counterparty risk, the pricing depends not only on the security itself but also on the reliability of the counterparty to the trade. It is as if, from an economic perspective, one is ‘‘buying’’ both the security and the characteristics of the counterparty. Besides the reduction in adverse selection, eliminating counterparty risk makes the security a more standard product. Standardization itself increases liquidity.254 Financial networks that incorporate a CCP can further improve the resilience of financial markets. The Bank for International Settlements stated in 2015 that the shift to central clearing had helped to mitigate the risks that emerged in non-centrally cleared markets before and during the 2007– 2009 financial crisis. Further, it had reduced financial institutions’ exposure to counterparty credit risk shocks through netting, margining and collateralization.255 Another potential benefit of central clearing is that it should reduce the magnitude of, or even prevent, fire sales of assets. This mitigation of fire sale risk is achieved when a member defaults and the CCP manages the liquidation of assets. Central management of the liquidation of assets may mitigate suboptimal outcomes in the face of capital or margin constraints. For example, if investors believe that the counterparty will sell in the case of a missed margin call, other investors may join the selloff, leading to further declines in asset prices. If participants can commit to not sell, then a more efficient equilibrium in which there is no fire sale could be achieved. In this way, the CCP acts as a way to select into the more efficient equilibrium by allow 254 See Ben Bernanke, Clearing and Settlement During the Crash, 3 Rev. Fin. Stud. 133 (1990), available at https://www.bu.edu/econ/files/2012/01/ Bernanke-RFS.pdf. 255 Dietrich Domanski, Leonardo Gambacorta, & Cristina Picillo, Central Clearing: Trends and Current Issues, BIS Q. Rev. (Dec. 2015), available at https://www.bis.org/publ/qtrpdf/r_qt1512g.pdf. VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 members to credibly pre-commit to the auction in the case of a missed margin call.256 Finally, broadening central clearing could lead to a wider group of liquidity providers, which likely would increase the reliability of access to funding during periods of market stress.257 The reason is that novation of the trade to a central counterparty reduces one of the major reasons for not choosing a counterparty: the risk that counterparty may fail to deliver on its obligations. It also reduces one of the reasons for failing to provide liquidity, namely concerns over the credit risk of counterparties. Therefore, as a result of increased levels of central clearing and the resulting increased centralization of counterparty credit risk evaluation by a CCP and the CCP’s application of consistent and transparent risk management,258 more counterparties —who would also be potential liquidity providers—would be willing to compete to provide liquidity to buy-side investors and to each other. In addition, several academic studies of the 2008 financial crisis emphasize the role of intermediary balance sheet constraints as a cause of financial crises.259 260 Moreover, losses experienced by market participants can lead to an increase in risk aversion leading those market participants to exit creating a need for new market participants to replace them in order to provide liquidity.261 Therefore, either because of increased 256 John Kuong, Self-fulfilling Fire Sales: Fragility of Collateralized Short-term Debt Markets, 34(6) Review of Financial Studies, 2910–2948 (2021), available at https://academic.oup.com/rfs/article/ 34/6/2910/5918033?login=true. 257 G–30 Report, supra note 5, at 13. 258 See TMPG White Paper, supra note 20, (‘‘[b]ilateral clearing involves varying risk management practices that are less uniform and less transparent to the broader market . . .’’). In addition, FICC has been designated by FSOC as a systemically important financial market utility, which brings heightened risk management requirements and additional regulatory supervision by both its primary regulator and the Board of Governors of the Federal Reserve System. See supra note 17 and associated text. 259 See, e.g., Markus K. Brunnermeier & Yuliy Sannikov, A Macroeconomic Model with a Financial Sector, 104 Am. Econ. Rev. 379 (Feb. 2014), available at https://www.aeaweb.org/ articles?id=10.1257/aer.104.2.379; See also Zhiguo He & Arvind Krishnamurthy, Intermediary Asset Pricing, 103 Am. Eco. Rev. 732 (Apr. 2013), available at https://www.aeaweb.org/ articles?id=10.1257/aer.103.2.732. 260 Balance sheet constraints and the impact of losses on risk aversion both apply to liquidity providers, or rather the ability and willingness of market participants to provide liquidity. This does not apply to the CCP as it does not supply liquidity. 261 See, e.g., John Y. Campbell & John H. Cochrane, By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior, 107 J. Pol. Econ. 205 (Apr. 1999), available at https://www.journals.uchicago.edu/doi/abs/ 10.1086/250059. PO 00000 Frm 00035 Fmt 4701 Sfmt 4702 64643 risk aversion or because some friction implies that the liquidity providers who find themselves warehousing the asset can no longer do so due to trading losses, outside liquidity providers may play an important role in stabilizing the market. In addition, central clearing facilitates anonymized all-to-all trading that would enable the provision of market liquidity by investors.262 263 B. Baseline 1. U.S. Treasury Securities As discussed in section II.A, U.S. Treasury securities are direct obligations of the U.S. Government issued by the U.S. Department of the Treasury. After issuance in the primary market U.S. Treasury securities trade in an active secondary market.264 A number of types of market participants intermediate between end users of U.S. Treasury securities. These end users may hold U.S. Treasury securities as a relatively riskless way of saving, as a way of placing a directional bet on interest rates, or as a means of hedging against deflation. U.S. Treasury securities can also function directly as a medium of exchange in some instances, and, as described in more detail below, as collateral for loans. Market participants refer to the most recently issued U.S. Treasury securities as ‘‘on-the-run,’’ with earlier issues 262 G–30 Report, supra note 5, at 13. See also Duffie, supra note 186, at 4 (‘‘Further, given broad access to a CCP, some Treasury transactions could flow directly from ultimate sellers to ultimate buyers without necessarily impinging on dealer balance sheet space.’’). 263 The market responded to the stress of 2020 through some increase in all-to-all trading. See MarketAxess, FIMSAC Slides, at 6 (Oct. 5, 2020), available at https://www.sec.gov/spotlight/fixedincome-advisory-committee/mcvey-fimsac-slides100120.pdf. Additional central clearing may have enabled a greater increase. 264 There is also an active market for U.S. Treasury securities that trade on a ‘‘when-issued’’ (WI) basis. ‘‘Based on Treasury TRACE transactions data, WI trading volume averaged $80 billion per day between July 1, 2019, and June 30, 2020, accounting for 12 percent of the $651 billion traded daily across all Treasury securities.’’ Fleming, Shachar, and Van Tassel, supra note 38. As discussed in section III.A.2, supra, for purposes of this Proposal only the WI market after the auction but before issuance (WI on-the-run issues) is considered part of the secondary market for U.S. Treasury securities. Most of the WI trading in the Fleming, Shachar, and Van Tassel analysis occurred in on-the-run issues. Id. (‘‘WI trading that occurs up to and including the auction day (account[s] for about one-third of WI trading) and WI trading that occurs after the auction day (account[s] for about two-thirds of WI trading’’). For a discussion of how WI trading functions in the context of central clearing, see Kenneth D. Garbade & Jeffrey F. Ingber, The Treasury Auction Process: Objectives, Structure, and Recent Adaptations, 11 Current Issues in Economics and Finance 1 (2005), available at https://www.newyorkfed.org/medialibrary/ media/research/current_issues/ci11-2.html. E:\FR\FM\25OCP2.SGM 25OCP2 64644 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules referred to as ‘‘off-the-run’’.265 Figure 1 shows the outstanding value of on-therun (Panel A) and off-the-run (Panel B) U.S. Treasury securities. On-the-run U.S. Treasury securities have consistently made up approximately 3% of the total value of all marketable U.S. Treasury securities during the 2012– 2021 period, but, as Figure 3 shows, account for a disproportionate share of Panel A: On-the-nm Treasury Securities trading volume. Thus, an on-the-run security is generally far more liquid than a similar off-the-run security. Figure 1: On-the-run and off-the-run U.S. Treasury securities (trillions) a Panel 8; Off-the-run Treasury Securities f• 20 !- lyearorle$S; 2-lOyears i t-..-:1oyears J 5 1U a Generated from the Federal Reserve Z1 Financial Accounts of the United States Table L.210 Treasury Securities, Series FL313161205.Q. As of June 30, 2022, the total amount outstanding of marketable U.S. Treasury a Generated from the Federal Reserve Z1 Financial Accounts of the United States Table L.210 Treasury Securities, Series FL313161205.Q. khammond on DSKJM1Z7X2PROD with PROPOSALS2 supra note 34. includes $3.5T in bills, $13.6T in notes, $3.8T in bonds, 1.8T in TIPs, and 0.6T in floating rate notes. See U.S. Treasury Bureau of the Fiscal Service, Summary of Treasury Securities Outstanding, available at https://fiscaldata. treasury.gov/datasets/monthly-statement-publicdebt/summary-of-treasury-securities-outstanding. VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 1960 1970 1980 1990 2000 2010 industry reports, 65% of the $955.2 billion in average daily trading volume of U.S. fixed income securities in 2021 was in U.S. Treasury securities.268 As is shown in Figure 3, average weekly trading volume was approximately $3 Trading in the secondary market is reported in Figure 3. According to 266 This 2012 2013 2014 2015 2016 2017 2018 2019 2020 .2021 securities held by the public was $23.3 trillion.266 As shown in Figure 2, the volume of marketable U.S. Treasury securities outstanding has increased by approximately $18 trillion since 2000. The total amount of marketable U.S. .1950 265 See 0 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 267 See U.S. Treasury Bureau of the Fiscal Service, Treasury Debt Position and Activity Report, June 2022, available at https://www.treasurydirect.gov/ govt/reports/pd/pd_debtposactrpt_202206.pdf. 268 Another 29 percent was Agency MBS, 4 percent corporate debt, with the remainder in municipal, non-agency mortgage-backed, Federal agency debt and asset-backed securities. See Securities Industry and Financial Markets PO 00000 Frm 00036 Fmt 4701 Sfmt 4702 Treasury securities issued during 2021 was $20.3 trillion.267 Figure 2: Value of Marketable U.S. Treasury Securities Outstanding Over Time a 2020 trillion in 2021, with notable peaks in March 2020 and early 2021.269 Figure 3: Weekly trading volume in U.S. Treasury securities cash market a Association (‘‘SIFMA’’), US Fixed Income Securities: Issuance, Trading Volume, Outstanding, available at https://www.sifma.org/resources/ research/us-fixed-income-securities-statistics/usfixed-income-securities-statistics-sifma/(as of July 8, 2022) (data sourced from N.Y. Fed, FINRA TRACE, and MSRB). 269 Id. E:\FR\FM\25OCP2.SGM 25OCP2 EP25OC22.000</GPH> EP25OC22.001</GPH> 0.0 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules 64645 ,-~ lllB Bills and FRNs 1 i - Off..the-run 5000 1000 0 IAWG Report, supra note 4, at 14. khammond on DSKJM1Z7X2PROD with PROPOSALS2 2. U.S. Treasury Repurchase Transactions As described in section II.A.2 supra, a U.S. Treasury repurchase transaction generally refers to a transaction in which one market participant sells a U.S. Treasury security to another market participant, along with a commitment to repurchase the security at a specified price on a specified later date. Because one side of the transaction receives cash, and the other side receives securities, to be returned at a later date, the transaction is a close equivalent to a cash loan with securities as collateral. The amount paid for the security serving as collateral may be less than the market price. The difference divided by the market value of the collateral is known as the ‘‘haircut.’’ A positive haircut implies that the loan is overcollateralized: the collateral is worth more than the cash that is loaned. A related term is ‘‘initial margin’’—the ratio of the purchase price to the market value of the collateral. General collateral repurchases are an important variation on the above type of transaction, where one participant lends to another against a class, not a specific issue, of U.S. Treasury securities. U.S. Treasury repo for a specific asset is generally a bilateral arrangement, whereas general collateral repurchases are usually arranged with a third agent, known as a triparty agent. In bilateral repo arrangements, the lender has the title of the specific asset in question, and can sell or re-hypothecate it. In triparty repo, which is discussed below, the lender has a more limited use of collateral. However, it is often rehypothecated within the same triparty system; namely, a lender may use the VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 collateral from the borrower for its own borrowing. As described in section II.A.2 supra, repurchase agreements are generally classified by the term over which they take place, either ‘‘overnight’’ or ‘‘term.’’ In overnight repurchase agreements, the repurchase of the security takes place the day after the initial purchase, meaning that these agreements serve, essentially, as overnight loans collateralized by U.S. Treasury securities. Term repurchase agreements, conversely, take place over a longer horizon.270 U.S. Treasury repo has various economic uses. First, it is a means of secured borrowing and lending, allowing some market participants to, in effect, turn their U.S. Treasury securities into cash positions, and others to temporarily invest cash that is not in use in a way that mitigates exposure to, for example, the counterparty risk of a depository institution. Bilateral repo can allow market participants to effectively price interest rate expectations into bonds, and to arbitrage differences in the market prices of closely related U.S. Treasury securities, because it provides financing for U.S. Treasury security purchases and facilitates short sales. Repos also play a role in monetary policy. The Federal Reserve operates a reverse repurchase facility in which it receives cash from eligible market 270 Overnight repurchase agreements account for 87.5% of daily transaction volume. See Figure 5 and the associated discussion for more details. In addition to term repos agreements with fixed maturity dates, there exist term repurchase agreements with embedded options that lead to an uncertain maturity date. For example, ‘‘callable’’ repos include an option for the lender to call back debt (i.e., resell securities) at their discretion. ‘‘Open’’ repos have no defined term but rather allow either party to close out at the contract at any date after initiation of the agreement. PO 00000 Frm 00037 Fmt 4701 Sfmt 4702 participants in exchange for collateral consisting of U.S. Treasury securities. The interest rate on these repurchase agreements is the overnight reverse repurchase offer rate set by the Federal Reserve to aid implementation of monetary policy by firming up the floor for the effective Federal funds rate.271 The market for repos is dominated by large sophisticated institutions. The institutions that participate in the market for repos are also those for whom access to central clearing may be the least costly economically. Relatedly, although difficult to quantify precisely, the number of participants is one or more orders of magnitude greater in the cash market as compared with the repo market: tens of thousands as opposed to hundreds. As Figure 4 shows, the U.S. Treasury securities repurchase market is large; throughout 2020 and into 2021, daily transaction volume ranged between $1.5 and $2.5 trillion per day. Since April 2021, average daily volume has been considerably higher— approaching $4 trillion per day— coinciding with the growth in the Federal Reserve’s overnight reverse repurchase operations. Figure 4 further splits these categories out into triparty repo and bilateral repo. Despite steadily increasing volumes of centrally cleared repurchase transactions, due in part to the development of services to enable acceptance of more types of repurchase transactions at the covered clearing agency, the Commission understands that the volume of bilateral repurchase transactions that are cleared and settled directly between the two counterparties remains substantial, representing 271 See E:\FR\FM\25OCP2.SGM supra note 164. 25OCP2 EP25OC22.002</GPH> a See 64646 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules approximately half of all bilateral repurchase transactions in 2021.272 Figure 4: Daily U.S. Treasury Repurchase Transaction Volume a 4000 - GCF - DVP 1iparty .3000 · 1000 0 a Figure 4 includes only centrally cleared bilateral repurchase as significant gaps persist in the coverage of transaction data in U.S. Treasury repo for non-centrally cleared bilateral repos. Source: Office of Financial Research Short-term Funding Monitor—Data Sets, U.S. Repo Markets Data Release, refreshed daily, available at https:// www.financialresearch.gov/short-termfunding-monitor/datasets/repo/. See also IAWG Report, supra note 4, at 29. The triparty segment of the U.S. Treasury securities repurchase agreement market is large, with an average of approximately $500 billion of daily trading volume in 2020, and has taken on a substantially larger role since the beginning of 2021, peaking at nearly $3 trillion in transaction volume in the beginning of 2022.273 Of this, overnight repos is the largest segment, making up 87.5% daily transaction volume, as shown in Figure 5. Although different types of securities can be used as collateral in triparty repos, over half (50.9%) of triparty repo collateral since 2015 are U.S. Treasury securities. That number has grown to 65.5 percent since 2021, as shown in Panel B of Figure 5.274 The remainder are agency securities, referring to mortgage-backed securities issued by U.S government agencies and government sponsored enterprises, and various other securities including corporate bonds, non-U.S. sovereign debt, equity, municipal debt, and commercial paper.275 Figure 5: Triparty Repurchase Agreement Trading Volume, Splits a Panel 8: Collateral Type Panel A: Overnight VS, Tenn 3SOO , _ em,<: 31): , _ 1'ml>30 3000 ; lll!il ~illht ~2500 II 2000 lSOO ! 1000 500 500 a https://www.newyorkfed.org/data-andstatistics/data-visualization/tri-party-repo. khammond on DSKJM1Z7X2PROD with PROPOSALS2 3. Central Clearing in the U.S. Treasury Securities Market Currently, FICC is the sole provider of clearance and settlement services for 272 See supra note 150. See also R. Jay Kahn & Luke M. Olson, Who Participates in Cleared Repo? (July 8, 2021), available at https:// www.financialresearch.gov/briefs/files/OFRBr_2101_Repo.pdf. VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 U.S. Treasury securities (see section I, supra). On July 18, 2012, FSOC designated the FICC as a systemically important financial market utility under Title VIII of the U.S. Dodd-Frank Act. FSOC assigned this designation on the basis that a failure or a disruption to FICC could increase the risk of significant liquidity problems spreading among financial institutions or markets and thereby threaten the stability of the financial system in the United States. Direct membership in FICC generally consists of banks and registered dealers, 273 See Mark E. Paddrik, Carlos A. Ramı ´rez, & Matthew J. McCormick, FEDS Notes: The Dynamics of the U.S. Overnight Triparty Repo Market, (Aug. 2, 2021), available at https:// www.federalreserve.gov/econres/notes/feds-notes/ the-dynamics-of-the-us-overnight-triparty-repomarket-20210802.htm. 274 See SIFMA Research, US Repo Fact Sheet, at 11 (Jan. 2021), available at https://www.sifma.org/ wp-content/uploads/2020/04/2021-US-Repo-FactSheet.pdf. 275 Id.; see Paddrik et al., supra note 273. PO 00000 Frm 00038 Fmt 4701 Sfmt 4702 E:\FR\FM\25OCP2.SGM 25OCP2 EP25OC22.003</GPH> EP25OC22.004</GPH> 0 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules and such members must meet specified membership criteria.276 In other markets, not all active participants are direct members of the clearing agency. For this reason, it is likely that under the Membership Proposal, some will access clearing indirectly. At FICC, the indirect clearing models are its Sponsored Program and a prime broker/ correspondent clearing program.277 As of May 3, 2022, FICC has 202 direct members.278 From a direct participant’s perspective, clearing a U.S. Treasury securities transaction at FICC between that participant and its non-participant counterparty (i.e., a dealer-to-client trade) need not result in a separate collection of margin for the customer transaction. Transactions between direct participants are novated by FICC, and, by virtue of multilateral netting, all of a member’s positions are netted into a single payment obligation—either to or from the CCP. In contrast, in a dealerto-client trade, there is no transaction between two direct participants that FICC membership rules would require to be novated to the CCP, and as a result, FICC does not provide any guaranty of settlement or otherwise risk manage this trade.279 In other words, as khammond on DSKJM1Z7X2PROD with PROPOSALS2 276 The Commission believes that not all market participants likely would satisfy a covered clearing agency’s stringent membership criteria. See 17 CFR 17Ad–22(e)(18); FICC Rule 2A, supra note 47. Even among those that do, legal operational or other considerations may preclude many market participants from becoming direct members of a CCP that clears and settles government securities transactions. 277 See, e.g., FICC Rules, 8, 18, 3A (providing for prime brokerage and correspondent clearing, as well as sponsored membership), supra note 47. 278 See FICC Member Directories, available at https://www.dtcc.com/client-center/ficc-govdirectories. (This includes all members who make use of Netting, Repurchase Netting, and/or GCF services.). 279 See Chicago Fed Insights, supra note 204, at 2 (explaining that this conclusion follows from that fact that ‘‘FICC nets members’ trades for their own accounts against trades by the members’ customers, VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 one recent publication explained, ‘‘if a dealer were to buy a security from its own customer and submit this transaction to FICC, there would be no effect on the dealer’s net position at, obligations to, or guarantees from FICC.’’ 280 Indeed, except for its sponsored program, because FICC nets all trades at a dealer before calculating margin, as at present, customer trades with their own dealers generate no margin requirement and are not collateralized at the CCP. The most frequently used FICC model for accessing the clearing agency indirectly is the sponsored clearing model, which is generally used for repo but not for cash transactions. As of October 2021, there were 27 Sponsoring Members and roughly two thousand Sponsored Members from 20 approved jurisdictions, with daily volumes ranging from $225-$280 billion (and peaking in March 2020 at $564 billion).281 Sponsored Members participating in FICC’s Sponsored Service are indirect members of FICC, and upon novation of their U.S. Treasury transactions, FICC becomes obligated to such Sponsored Members.282 FICC requires that its Sponsoring Members provide margin on a gross basis for its Sponsored Member positions.283 In FICC’s correspondent clearing and prime brokerage clearing models, which the Commission understands to be rarely used, the client does not have a legal relationship with FICC.284 FICC only has CCP obligation so the dealer’s and customer’s sides of the trade would cancel out in the netting process.’’). 280 Id. 281 See DTCC May 2021 White Paper, supra note 135, at 6. 282 FICC–GSD Rule 3A sections 3 (membership) and 7 (novation), supra note 47. 283 FICC Rule 3A, section 10(c), supra note 47. See also DTCC October 2021 White Paper, supra note 203, at 5–6. 284 FICC Rule 8, supra note 47. See DTCC October 2021 White Paper, supra note 203, at 5, which PO 00000 Frm 00039 Fmt 4701 Sfmt 4702 64647 to the correspondent clearer or prime broker itself, as applicable, who is a FICC member. In light of this, FICC net margins the activity in the accounts of correspondent clearers and prime brokers. Certain aspects of FICC’s Sponsored Service are worth noting, as they may have an effect on some market participants’ willingness to participate in the service. For example, once a trade is novated, FICC makes delivery of cash or securities to the Sponsoring Member as agent for the Sponsored Member.285 Therefore, market participants may consider the ability of their Sponsoring Member to make delivery to them in situations in which the Sponsoring Member is in default, when determining whether to use the Sponsored Service. In addition, if a Sponsoring Member defaults, FICC continues to guarantee any novated sponsored trades and may determine whether to close out a sponsored trade and/or to permit the Sponsored Member to settle the trade.286 This may lead a potential sponsored member to decline to enter a sponsoring relationship unless it was willing to trade bilaterally with those sponsoring firms. The Commission understands that some Sponsoring Members also may limit which market participant’s trades they are willing to sponsor based on firm type. Sponsored triparty repo is a relatively recent addition.287 Volumes of sponsored repo fluctuate, but they appear to be substantial as Figure 6 shows. Figure 6: Sponsored Repo Daily Trading Volume a reports that $80 billion plus of activity are observed clearing and settling daily through FICC’s correspondent clearing and prime broker clearing models. 285 FICC Rule 3A, sections 8 and 9, supra note 47. Rule 3, section 14(c), supra note 47. 287 See supra note 66 and note 67 and referencing text. 286 FICC E:\FR\FM\25OCP2.SGM 25OCP2 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules : - Repo :li!II Reverse Repo 500 khammond on DSKJM1Z7X2PROD with PROPOSALS2 a Source: FRBNY Repo Operations data, available at https://www.newyorkfed.org/ markets/desk-operations/repo. Operation results in Figure 6 include all repo and reverse repo conducted, including small value exercises. In order for a CCP to perform as the guarantor of trades that have been novated to it, the CCP must have resources available to absorb the costs of clearing member non-performance. FICC is required by Commission rule to have policies and procedures reasonably designed to maintain financial resources at the minimum to enable it to cover a wide range of foreseeable stress scenarios that include, but are not limited to, the default of the participant family that would potentially cause the largest aggregate credit exposure in extreme but plausible market conditions.288 A CCP’s plan to deal with a clearing member default is referred to as its default waterfall. The default waterfall provides an identification of resources that the CCP will use in attempting to recoup losses from clearing member defaults. The FICC waterfall comprises the defaulting clearing member’s contribution (i.e., margin, as well as any other resources the member has on deposit such as excess margin, the proceeds from liquidating the member’s portfolio, and any amounts available from crossguaranty agreements), the corporate contribution to the clearing fund, followed by non-defaulting clearing members’ margin.289 In addition, with respect to liquidity risk, the Commission’s rules require FICC to have policies and procedures reasonably designed to meet a ‘‘cover-1’’ standard and hold qualifying liquid 288 17 CFT 240.17Ad–22(e)(4)(iii). Rule 4, sections 6 and 7, supra note 47. 289 FICC VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 resources sufficient to complete its settlement obligations in the event of the default of the largest member and its affiliates.290 For example, if a clearing member has a net long position in a security that has not yet settled, the CCP must have the cash available to complete the purchase. The securities can be subsequently liquidated and any losses that may result would be covered by the resources in the default waterfall. The first liquidity source that FICC would use in the event of a member default is the cash portion of the clearing fund.291 Second, FICC can pledge securities in the clearing fund as a source of cash, including securities that would have otherwise been delivered to the defaulting member.292 Should additional liquid resources be required FICC could make use of the Capped Contingent Liquidity Facility (‘‘CCLF’’).293 The CCLF is a rules-based arrangement in which FICC members are obligated to participate as a condition of their membership. Should FICC declare a CCLF event, each member would be obligated to enter into repurchase agreements with FICC up to 290 Specifically, the Commission’s rules require FICC to have policies and procedures reasonably designed to maintain sufficient liquid resources at the minimum in all relevant currencies to effect same-day and, where appropriate, intraday and multiday settlement of payment obligations with a high degree of confidence under a wide range of foreseeable stress scenarios that includes, but is not limited to, the default of the participant family that would generate the largest aggregate payment obligation for the covered clearing agency in extreme but plausible market conditions, and to hold qualifying liquid resources sufficient to meet that requirement. See 17 CFR 240.17Ad–22(e)(7)(i) and (ii). 291 FICC Rule 4, sections 5 and 6, supra note 47. 292 Id. 293 FICC Rule 22A, section 2a, supra note 47. PO 00000 Frm 00040 Fmt 4701 Sfmt 4702 a member-specific limit.294 The CCLF is not prefunded, and it is separate from FICC’s margin requirements. Each FICC member is required, by FICC’s rules, to attest that its CCLF requirement has been incorporated into its liquidity planning and related operational plans at least annually and in the event of any changes to such Member’s CCLF requirement.295 Thus, the members are obligated to have such resources lined up, which can be costly.296 The CCLF provides a mechanism for FICC to enter into repurchase transactions based on the clearing activity of the defaulted participant. Specifically, in the event that FICC declares a CCLF event, FICC’s members would be required to hold and fund their deliveries to the defaulting member, up to a predetermined capped dollar amount, by entering into repurchase transactions with FICC until FICC completes the associated closeout.297 The aggregate size of the 294 These repurchase agreements may continue for up to 30 days. See FICC Rule 22A, section 2a(a)(L), supra note 47. 295 FICC Rule 22A, section 2a(d), supra note 47. 296 See Independent Dealer & Trader Association, White Paper on the Repo Market Affecting U.S. Treasury and Agency MBS, at 8 (Dec. 6, 2019), available at https://static1.squarespace.com/static/ 5ad0d0abda02bc52f0ad4922/t/ 5dea7fb6af08dd44e68f48cc/1575649207172/ IDTA+-+White+Paper+%2812.6.19%29-c2.pdf (‘‘In light of the fact that a significant component of a firm’s CCLF obligation is based on its overnight liquidity exposures at FICC, middle-market dealers immediately took to reducing their reliance on overnight liquidity. Some middle-market dealers reduced the size of their portfolio and extended liquidity terms in place of overnight funding, adding to both financing and opportunity costs. Others have incorporated liquidity plans for which commitment and administration fees materially added to the cost of doing business.’’). 297 See generally FICC Rule 22A, section 2a(b), supra note 47. For details on the process, see the Order Approving a Proposed Rule Change to E:\FR\FM\25OCP2.SGM 25OCP2 EP25OC22.005</GPH> 64648 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules CCLF is the historical cover-1 liquidity requirement (i.e., the largest liquidity need generated by an Affiliated Family during the preceding six-month period) plus a liquidity buffer (i.e., the greater of 20 percent of the historical cover-1 liquidity requirement or $15 billion).298 The first $15 billion of the total amount of the CCLF is shared, on a scaled basis, across all members. Any remaining amount is allocated to members who present liquidity needs greater than $15 billion, using a liquidity tier structure based on frequency of liquidity created across liquidity tiers in $5 billion increments.299 The size of the CCLF and each member’s share is reset every 6 64649 months or as appropriate.300 Figure 7 provides data on the aggregate amount of the CCLF from 2018 quarter 4 through 2021 quarter 2. The aggregate size of the CCLF was over $80 billion in 2021 quarter 2. Figure 7: Aggregate CCLF ($MM) at Quarter End a FICC-GSD CCLF at Quarter End 120,000 110,000 100,000 ~ ~ 90,000 V). 80,000 70,000 60,000 2018Q4 2019Q12019Q2 2019Q3 2019Q4 2020Q12020Q2 2020Q3 2020Q4 2021Q12021Q2 a See CPMI–IOSCO Quantitative Disclosures—FICC, Disclosure Reference 7.1.6, available at https://www.dtcc.com/ legal/policy-and-compliance. 4. Clearing and Settlement by U.S. Treasury Securities Market Segment khammond on DSKJM1Z7X2PROD with PROPOSALS2 Data on the extent of central clearing in the U.S. Treasury securities market appears to be lacking. As discussed previously, the Commission believes that approximately half of bilateral repo trades are centrally cleared. The percentage of centrally cleared triparty repo appears to be lower than this, as sponsored triparty clearing is relatively new. For further details of central Implement the Capped Contingency Liquidity Facility in the Government Securities Division Rulebook, Exchange Act Release No. 82090 (Nov. 15, 2017), 82 FR 52457 (Nov. 21, 2017). 298 FICC Rule 1 (definitions of Aggregate Total Amount and Liquidity Buffer) and 22A, section 2, supra note 47. 299 FICC Rule 22A, section 2a(iii), (iv), and (v), supra note 47. See also Exchange Act Release No. 82090, supra note 297, 82 FR at 55429–30. VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 clearing in repo, see section II.A.2, supra. The state of cash clearing in the U.S. Treasury securities market is discussed in section II.A.1 supra. Estimates from the first half of 2017 further suggest that only 13 percent of the cash transactions in the U.S. Treasury securities market are centrally cleared. These estimates suggest that another 19 percent of transactions in this market are subject to so-called hybrid clearing in which one leg of a transaction facilitated by an IDB platform is centrally cleared and the other leg of the transaction is cleared bilaterally.301 Below, we discuss the dealer-tocustomer market and the ‘‘inter-dealer’’ market (on IDBs) separately. Tables 1 and 2 show the volumes in these markets for on-the-run and off-the-run securities. Until the mid-2000s, most inter-dealer trading occurred between primary dealers who were FICC members and it was centrally cleared.302 Today, PTFs actively buy and sell large volumes of U.S. Treasury securities on an intraday basis using high-speed and other algorithmic trading strategies.303 PTFs are not generally FICC members and, as such, their trades are often not centrally cleared. Moreover, PTFs compose a 300 FICC Rule 22A, section 2a(b)(ii), (iii), (iv), and (v), supra note 47. 301 See IAWG Report, supra note 4, at 30; see also TMPG White Paper, supra note 21, at 12. The figures are estimated using FR 2004 data covering the first half of 2017 and are based on various assumptions: (a) primary dealers account for all dealer activity, (b) 5% of dealers’ trading not through an IDB is with another dealer, (c) the shares of dealer and non-dealer activity in the IDB market for coupon securities equal the weighted averages of the shares reported in the Oct. 15 report (that is, 41.5% and 58.5%, respectively), (d) only dealers trade bills, FRNs, and TIPS in the IDB market, and e) the likelihood of dealer and non-dealers trading with one another in the IDB market solely reflects their shares of overall volume. 302 See G–30 Report at 9, supra note 5; IAWG Report, supra note 4, at 5–6; TMPG White Paper, supra note 21, at 6. 303 See Joint Staff Report, supra note 4, at 32, 35– 36, 39. PO 00000 Frm 00041 Fmt 4701 Sfmt 4702 E:\FR\FM\25OCP2.SGM 25OCP2 EP25OC22.006</GPH> Quarter End 64650 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules substantial portion of trading volume, averaging about 20% of overall U.S. Treasury cash market volume and accounting for around 50–60% of IDB volume in outright purchases and sales of U.S. Treasury securities.304 Primary dealers, who are FICC members and who transact the 40–50% of IDB volume not accounted for by PTFs, are required by Federal Reserve Bank of New York policy to centrally clear their U.S. Treasury securities primary market cash activity.305 As Tables 1 and 2 below show, during the 6-month period ending in September 2021 trading volume of onthe-run U.S. Treasury securities was approximately two and half times that of off-the-run U.S. Treasury securities. Over half (56.9%) of on-the-run U.S. Treasury security trading volume and approximately one quarter (28.5%) of off-the-run U.S. Treasury security trading volume occurred on ATSs (which are also IDBs) and non-ATS IDBs.306 Of the on-the-run U.S. Treasury security trading volume that occurred on ATS IDBs and non-ATS IDBs, 41.5% were dealer trades, 44.6% were PTF trades and the remainder were customer trades. For off-the-run trading in U.S. Treasury securities, the comparable figures are 72.2% dealer trades, 9.1% PTF trades, and the remainder are customer trades. In contrast to trades that take place on an ATS or a non-ATS IDB, 56.9% of on-the-run U.S. Treasury security transactions and 75.9% of offthe-run U.S. Treasury security transactions are traded bilaterally. The majority of these (86.0% of on-the-run and 89.9% of off-the-run) are dealer-tocustomer trades. TABLE 1—ON-THE-RUN U.S. TREASURY SECURITIES TRADING VOLUME On-the-Run U.S. Treasury Securities Trading Volume Number of venues Average weekly volume ($M) Volume share (%) ATSs ............................................................................................................................................ Customer trades ................................................................................................................... Dealer trades ........................................................................................................................ PTF trades ............................................................................................................................ Non-ATS Interdealer Brokers ...................................................................................................... Customer trades ................................................................................................................... Dealer trades ........................................................................................................................ PTF trades ............................................................................................................................ Bilateral dealer-to-dealer trades .................................................................................................. Bilateral dealer-to-customer trades ............................................................................................. Bilateral dealer-to-PTF trades ..................................................................................................... 18 11 18 11 24 19 23 9 352 333 97 812,480 52,754 344,781 414,945 118,067 77,334 40,252 481 92,051 604,823 7,250 49.7 3.2 21.1 25.4 7.2 4.7 2.5 a 0.0 5.6 37.0 0.4 Total ............................................................................................................................... ........................ 1,634,671 100.0 This table reports trading volume and volume share for ATSs,b Non-ATS interdealer brokers, bilateral dealer-to-dealer transactions, bilateral dealer-to-customer, and bilateral dealer-to-PTF transactions for on-the-run U.S. Treasury Securities. On-the-run U.S. Treasury Securities are the most recently issued nominal coupon securities. Nominal coupon securities pay a fixed semi-annual coupon and are currently issued at original maturities of 2, 3, 5, 7, 10, 20, and 30 years. Treasury Bills and Floating Rate Notes are excluded. Volume is the average weekly dollar volume in par value (in millions of dollars) over the 6-month period, from April 1, 2021, to September 30, 2021.c Number of Venues is the number of different trading venues in each category and the number of distinct MPIDs for bilateral transactions.d Market Share (%) is the measure of the dollar volume as a percent of total dollar volume.e The volumes of ATSs and non-ATS interdealer brokers are broken out by Customer trades, Dealer trades, and PTF trades within each group.f Data is based on the regulatory version of TRACE for U.S. Treasury Securities from Apr. 1, 2021, to Sept. 30, 2021. Bilateral trades are a catchall classification that may include trades conducted via bilateral negotiation, as well as trades conducted electronically via platforms not registered with FINRA as an ATS. a The percentage to the nearest non-zero is 0.02%. analysis is necessarily limited to transactions reported to TRACE, which may not be all transactions in U.S. Treasury securities. Transactions that take place on non-FINRA member ATSs or between two non-FINRA members are not reported to TRACE. Entities in the ATS TRACE category encompass the IDBs described in the preamble of this release. By contrast, the non-ATS IDB category in TRACE encompasses the voice-based or other non-anonymous methods of bringing together buyers and sellers. See supra note 43 and referencing text. c FINRA reports volume as par volume, where par volume is the volume measured by the face value of the bond, in dollars. See relevant weekly volume files, available at https://www.finra.org/filing-reporting/trace/data/trace-treasury-aggregates. d Dealers are counted using the number of distinct MPIDs. e Total dollar volume (in par value) is calculated as the sum of dollar volume for ATSs, non-ATS interdealer brokers, bilateral dealer-to-dealer transactions, and bilateral dealer-to-customer transactions. f We identify ATS trades and non-ATS interdealer broker trades using MPID. The regulatory version of TRACE for U.S. Treasury securities includes an identifier for customer and interdealer trades. Furthermore, we use MPID for non-FINRA member subscriber counterparties in the regulatory version of TRACE for U.S. Treasury securities to identify PTF trades on ATSs. b This khammond on DSKJM1Z7X2PROD with PROPOSALS2 TABLE 2—OFF-THE-RUN U.S. TREASURY SECURITIES TRADING VOLUME Off-the-Run U.S. Treasury Securities Trading Volume Number of venues ATSs ............................................................................................................................................ 304 See James Collin Harkrader & Michael Puglia, FEDS Notes: Principal Trading Firm Activity in Treasury Cash Markets (Aug. 2020) (‘‘Harkrader and Puglia FEDS Note’’), available at https:// VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 www.federalreserve.gov/econres/notes/feds-notes/ principal-trading-firm-activity-in-treasury-cashmarkets-20200804.htm. 305 See supra note 37. PO 00000 Frm 00042 Fmt 4701 Sfmt 4702 17 Volume 110,945 Volume share (%) 17.3 306 The term ‘‘IDB’’ typically refers only to IDBs that are also ATSs. See supra note 43 and associated text. E:\FR\FM\25OCP2.SGM 25OCP2 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules 64651 TABLE 2—OFF-THE-RUN U.S. TREASURY SECURITIES TRADING VOLUME—Continued Off-the-Run U.S. Treasury Securities Trading Volume Number of venues Volume Volume share (%) Customer trades ................................................................................................................... Dealer trades ........................................................................................................................ PTF trades ............................................................................................................................ Non-ATS Interdealer Brokers ...................................................................................................... Customer trades ................................................................................................................... Dealer trades ........................................................................................................................ PTF trades ............................................................................................................................ Bilateral dealer-to-dealer trades .................................................................................................. Bilateral dealer-to-customer trades ............................................................................................. Bilateral dealer-to-PTF trades ..................................................................................................... 10 17 11 22 18 21 12 509 333 114 13,304 83,668 13,973 43,604 15,092 28,451 61 47,912 437,665 1,415 2.1 13.0 2.2 6.8 2.4 4.4 a 0.0 7.5 68.2 0.2 Total ............................................................................................................................... ........................ 641,540 100.0 This table reports trading volume and volume share for ATSs,b non-ATS interdealer brokers, bilateral dealer-to-dealer transactions, bilateral dealer-to-customer, and bilateral dealer-to-PTF transactions for off-the-run U.S. Treasury Securities. Off-the-run or ‘‘seasoned’’ U.S. Treasury Securities include TIPS, STRIPS, and nominal coupon securities issues that preceded the current on-the-run nominal coupon securities. Number of Venues is the number of different trading venues in each category and the number of distinct MPIDs for bilateral transactions. Volume is the average weekly dollar volume in par value (in millions of dollars) over the 6-month period, from April 1, 2021, to September 30, 2021. Market Share (%) is the measure of the dollar volume as a percent of the total dollar volume. The volumes of ATSs and nonATS interdealer brokers are broken out by Customer trades, Dealer trades, and PTF trades within each group.c Data is based on the regulatory version of TRACE for U.S. Treasury Securities from Apr. 1, 2021, to Sept. 30, 2021. Bilateral trades are a catchall classification that may include trades conducted via bilateral negotiation, as well as trades conducted electronically via platforms not registered with FINRA as an ATS. a The percentage to the nearest non-zero is 0.01%. analysis based on TRACE is necessarily limited to transactions reported to TRACE, which may not be all transactions in government securities. Transactions that take place on non-FINRA member ATSs or between two non-FINRA members are not reported to TRACE. The analysis based on TRACE is necessarily limited to transactions reported to TRACE, which may not be all transactions in government securities. Transactions that take place on non-FINRA member ATSs or between two non-FINRA members are not reported to TRACE. Entities in the ATS TRACE category encompass the IDBs described in the preamble of this release. By contrast, the non-ATS IDB category in TRACE encompasses the voice-based or other non-anonymous methods of bringing together buyers and sellers. See supra note 4344 and referencing text. c We identify ATS trades and non-ATS interdealer broker trades using MPID in the regulatory version of TRACE for U.S. Treasury securities. The regulatory version of TRACE for U.S. Treasury securities includes an identifier for customer and interdealer trades. Furthermore, we use MPID for non-FINRA member subscriber counterparties in the regulatory version of TRACE for U.S. Treasury Securities to identify PTF trades on ATSs. b The a. Dealer-to-Customer Cash U.S. Treasury Securities Market (Off-IDBs) khammond on DSKJM1Z7X2PROD with PROPOSALS2 i. Bilateral Clearing In cash U.S. Treasury security transactions that are bilaterally cleared, the process generally begins with participants initiating the trade by an electronic or voice trading platform, and both parties booking the details of the trade in their internal systems and confirming the details of the trade with one another. Once the details are confirmed, each party then sends messages to its clearing or settlement agents to initiate the clearing process. Different types of institutions use different clearing and settlement agents, with buy-side firms typically using custodial banks, dealers using clearing banks, and hedge funds and PTFs using prime brokers. With regard to the posting of margin, the Commission understands that most bilaterally cleared trades go unmargined.307 307 TMPG White Paper, supra note 21, at 3 (‘‘Margining has not been a common practice for regularly settling bilaterally cleared transactions . . .’’). VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 Bilaterally cleared trades make up 87% of total trading in the secondary U.S. Treasury securities market, making them the most prevalent trade type in the market.308 These trades include at least one party that is not a member of the CCP. The bilateral clearing process comes with risks. After the trade is executed, the principals to the trade face counterparty credit risk, in the event that either party fails to deliver on its obligations.309 ii. Central Clearing There is essentially no central clearing of dealer-to-client trades of U.S. Treasury Securities.310 Should a trade be centrally cleared, the CCP receives a notice of the executed trade from both parties, and after comparison (i.e., matching of the trade details), the CCP guarantees and novates the contract, where novation refers to the process by 308 TMPG White Paper, supra note 21, at 12. This figure is estimated from 2017H1 data and includes approximately 19% hybrid clearing. See supra section III.A.2.b (IDB Transactions) and infra section IV.b.4.b (iii) for discussions of hybrid clearing. 309 TMPG White Paper, supra note 21, at 13. 310 See G–30 Report, supra note 5, at 1. PO 00000 Frm 00043 Fmt 4701 Sfmt 4702 which the CCP becomes the counterparty to both the buyer and seller in the original trade. Once the trading day ends and all trades have been reported to the CCP (i.e., end of T+0), the CCP determines its net obligations to each CCP participant for each security and communicates the resulting settlement obligations to the counterparties. The participants then have the obligation to settle their portion of the trade on T+1. Once this information is communicated, the participants send instructions to their settlement agents. In contrast to the bilateral case, central clearing reduces the credit risk that both parties are exposed to throughout the trade. While at execution both CCP members hold the usual counterparty credit risk to one another, this risk is transformed, generally within minutes of trade execution, when the trade details are sent to the CCP and the CCP guarantees and novates the trade. Instead, both parties to the trade now hold centrally cleared credit risk, and the CCP has counterparty risk to both members. E:\FR\FM\25OCP2.SGM 25OCP2 64652 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules b. Cash U.S. Treasury Trades Through an IDB 311 Trades through IDBs can go through three different clearing processes, as IDBs act as the principals for the buying and selling entities transacting on the IDB who may or may not be CCP members. When the purchaser and the seller are CCP members, each leg of the trade is centrally cleared. When neither of the parties to the trade is a CCP member, conversely, each leg of the trade is cleared bilaterally. Finally, when one party to the trade is a CCP member and the other is not, the CCP member’s trade is centrally cleared, while the other leg of the trade is cleared bilaterally. For clarity, we outline each of these cases separately. khammond on DSKJM1Z7X2PROD with PROPOSALS2 i. Central Clearing In the case where both the buyer and seller are CCP members, the process is largely the same as the process outlined in section IV.B.4.a.ii. Since all three parties, buyer, seller, and IDB are CCP members, there are just two centrally cleared trades submitted simultaneously, one between the seller and the IDB, and the other between the IDB and the buyer. Both trades are submitted to the CCP, which novates the trades, resulting in 4 separate trades. At the end of T+0, the CCP nets out the IDB’s position, and sends the buyer and seller their net obligations on T+1. The credit risk in this trade is largely the same as in the centrally cleared case without an IDB, though there is now additional counterparty credit risk on T+0 coming from the IDB’s involvement in the trade. However, this additional counterparty risk is not present for very long, for two reasons. First, once the trade is submitted for clearing, counterparty risk shifts from bilateral to centrally cleared (that is, from the IDB to the CCP). Second, while the IDB holds centrally cleared credit risk, the position is netted out at the end of T+0. ii. Bilateral Clearing The case where the non-CCP member buyer and seller use an IDB is similar to the bilateral clearing case detailed in section IV.B.4.a(i) supra.312 At execution, the trade is placed either by voice or on the IDB’s electronic platform. On T+1, the IDB settles both legs of the trade. To settle its trade with the IDB, the seller instructs its settlement agent to send securities against payment to the IDB. This settlement agent then transfers the 311 See generally TMPG White Paper, supra note 21. 312 See also TMPG White Paper, supra note 21, at 23. VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 securities from the seller to the securities account of the buyer’s settlement agent. The buyer’s settlement agent then credits the securities to the IDB’s securities account. To settle its trade with the buyer, the IDB instructs the buyer’s settlement agent to transfer securities to the buyer’s account, by transferring the securities from the IDB’s securities account to the settlement agent’s omnibus account. Finally, the clearing agent credits the securities to the buyer’s securities account, which is maintained by the clearing agent. Additionally, because the IDB is principal to both parties, it can clear and settle trades on a net basis with respect to each party. This netting occurs throughout the day on T+0 and the net position is settled on T+1. Credit risk in this scenario is different than in the centrally cleared case discussed in the previous section. Because the IDB stands as principal between the buyer and the seller but does not submit the trades for central clearing, the IDB, buyer, and seller all hold counterparty credit risk for net unsettled positions throughout T+0 and overnight on the net exposures to each party. In addition, unlike the centrally cleared case where the CCP collects margin from its counterparties, the Commission understands that IDBs generally do not collect margin to collateralize this risk.313 Further, the IDB is now involved in settlement, making it subject to the counterparty credit risk described in section IV.B.4.a(i), supra. In particular, the settlement agent for the buyer faces credit extension risk from the IDB, as they deliver cash to the seller’s settlement agent prior to the security being transferred. Once the securities are transferred, this risk is extinguished. Finally, since the trade is not centrally cleared and the IDB stands as principal between the two parties, the IDB has a legal obligation to deliver securities to the buyer, even if the seller fails to deliver or defaults. In practice, an IDB might fail to deliver securities if the seller fails, generating what is known as a matched fail, where there is an expectation that the fail will be cured shortly (to the extent that it is not caused by a creditworthiness or liquidity event on the seller’s part). If the seller is impaired or goes into bankruptcy, the IDB will likely source securities for delivery to the buyer, rather than carry an open fail to deliver, due to both its obligation to deliver securities as well as reputational concerns. For the same reasons the IDB will likely source cash if the buyer is 313 See PO 00000 TMPG White Paper, supra note 21, at 3. Frm 00044 Fmt 4701 Sfmt 4702 impaired or goes into default. Given these obligations, the IDB actively monitors participants and their positions across its various platforms. Nevertheless, unlike a CCP, an IDB does not mutualize risk across all of the participants on its platform. As a result, compared to a CCP that collects margin and mutualizes losses among its members, if a counterparty to a bilaterally cleared trade defaults to the IDB, all else equal there is a greater risk that the IDB would then default to the other counterparty. iii. Hybrid Clearing In IDB trades where one counterparty to the trade is a FICC member and the other is a non-FICC member, then a hybrid clearing model is used in which one side of the trade is cleared through FICC, and the other is cleared and settled bilaterally. In these cases, the leg of the trade between the FICC member and the IDB will follow the central clearing example outlined in section IV.B.4.b.i infra, as FICC members are generally dealers. Similarly, the leg of the trade between the IDB and the nonFICC member will be bilaterally cleared as described in section IV.B.4.b.ii supra, as the non-FICC entities trading on IDBs are generally PTFs and other unregistered market participants. 5. Margin Practices in U.S. Treasury Secondary Markets As described above, posting of margin is one way to manage the risk of settlement in cash trades. Indeed, for trades that are centrally cleared, the CCP collects margin on an intraday basis, typically twice per day.314 Varying bespoke arrangements appear to characterize current margining practices in the bilateral, non-centrally cleared cash market.315 Indeed, a recent publication stated that competitive pressures in the bilaterally settled market for repo transactions has exerted downward pressure on haircuts, sometimes to zero.316 The reduction of haircuts, which serve as the primary counterparty credit risk mitigant in bilateral repos, could result in greater exposure to potential counterparty default risk in non-centrally cleared repos. Such arrangements (in both cash 314 TMPG White Paper, supra note 21, at 3. at 3. Non-centrally cleared cash trades are negotiated and settled bilaterally, and the Commission has little direct insight into the arrangements market participants use to manage their counterparty exposure. The TMPG observes in the White Paper that non-centrally cleared trades are ‘‘. . . not margined in a uniform or transparent manner, thereby creating uncertainty about counterparties’ exposure to credit and market risk.’’ Id. 316 G–30 Report, supra note 5, at 13. 315 Id. E:\FR\FM\25OCP2.SGM 25OCP2 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 and repo) may not take into account the value of margin in protecting against systemic events, because they are designed to be optimal for the counterparties rather than the larger financial market. For centrally cleared cash U.S. Treasury transactions, however, FICC rules dictate that margin must be posted based on the net positions of all members with the clearing agency. Positions in securities with longer maturities—for example, 20+ year U.S. Treasury bonds—require more margin to be posted because they are more sensitive to interest rate changes. Required margin is also larger for short positions, and rises with volatility in the U.S. Treasury securities market.317 For example, during the first quarter of 2020, a period which includes the U.S. Treasury securities market disruption of March 2020, total initial margin required was 9.4% higher than the previous quarter and the average total variation margin paid was 72% higher.318 FICC Rules set forth the various components of a member’s margin requirements.319 The largest component is a Value-at-Risk (VaR) charge, which is calculated both intraday and end-of-day and reflects potential price volatility of unsettled positions. FICC typically calculates VaR using ten years of historical data; for securities without the requisite amount of data, FICC instead employs a haircut approach, where the required margin is some percentage of the traded security’s value. Other components of FICC’s margin requirements include a liquidity adjustment charge, which is levied against members who have large, concentrated positions in particular securities that FICC determines to be difficult to liquidate, and special charges that can be levied in response to changes in aggregate market conditions (such as increases in marketwide volatility). In the market for bilaterally cleared repo, margin typically comes in the form of overcollateralization. That is, if a lender is providing $100 of cash, the borrower will provide more than $100 of securities as collateral. This extra 317 See FICC Rule 4, section 1b, supra note 47. FICC’s margin requirements are discussed in more detail below. A key component of the margin requirement is a Value-at-Risk charge, where the calculated margin requirement is based in part on the historical volatility of the traded security. Securities that are more sensitive to interest rates should have higher VaR, all else equal. 318 See CPMI IOSCO Quantitative Disclosure Results for 2020Q1 and 2019Q4, items 6.1.1 and 6.6.1, available at https://www.dtcc.com/legal/ policy-and-compliance. 319 FICC Rule 4, section 1b, supra note 47. VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 collateral—which is essentially a form of initial margin—protects the lender by making it more costly for the borrower to default, while also protecting the lender against the risk that short-term volatility erodes the value of the posted collateral. The difference between the cash provided and the value of the collateral is known colloquially as a ‘‘haircut.’’ Triparty repo also features overcollateralization, where the haircut is again negotiated bilaterally between the two counterparties.320 Data from the Federal Reserve Bank of New York show that a 2% haircut is the norm in the Triparty/GCF repo market, though there are occasionally some deviations from the norm.321 Money market funds also generally require margin of 2%, which is generally the case for other investment companies as well.322 Outside of money market funds and other investment companies, due to the lack of reporting requirements for bilateral repo, the Commission lacks good insight into margin practices of participants in the market for bilaterally cleared repo. Anecdotally, the Commission understands that—as with the cash market—some participants may not be required to post any margin.323 While overcollateralization protects the lender, the bilaterally cleared repo market generally does not feature the same level of protection for the borrower. Indeed, one of the main benefits of the bilateral market to lenders is that it allows them to reuse the collateral. As a result, borrowers are exposed to settlement risk and must manage that risk as they see fit. In the triparty repo market, posted collateral remains in the custody of the clearing bank and cannot be reused by the lender except as collateral in another triparty repurchase agreement, reducing settlement risk for the borrower. 320 Although triparty repo transactions are settled through a clearing bank, the terms of the transactions are bilaterally negotiated. Although haircuts vary by collateral type, the variance of haircuts is small for U.S. Treasury repo compared to other collateral types. See Paddrik, et al., supra note 273. 321 For data on the median, 10th, and 90th percentiles of overcollateralization in Triparty repo, see https://www.newyorkfed.org/data-andstatistics/data-visualization/tri-party-repo. The median level of overcollateralization has been 2% for the entire period from May 2010 through June 2022. The 10th and 90th percentiles are also typically 2%, although the 10th percentile has occasionally fallen to as low as zero—notably, in the summer of 2010 and again briefly in September 2012—while the 90th percentile has occasionally spiked to as high as 5%—specifically in January 2017 and again in April of the same year. 322 See MMF Primer, supra note 57. 323 See G–30 Report, supra note 5, at 13 (noting that minimum margin requirements ‘‘. . . would stop competitive pressures from driving haircuts down (sometimes to zero), which reportedly has been the case in recent years.’’). PO 00000 Frm 00045 Fmt 4701 Sfmt 4702 64653 Unlike bilaterally cleared and triparty repo, centrally cleared repo generally does not feature overcollateralization. Instead, the counterparties post cash margin to the CCP twice per day, as they do with trades in the cash market. Borrowers may be required to post more margin than lenders, similar to how in the bilaterally cleared market borrowers post margin through overcollateralization while lenders do not. 6. Disruptions in the U.S. Treasury Securities Market There have been significant disruptions in the U.S. Treasury securities market in recent years. Although different in their scope and magnitude, these events all generally involved dramatic increases in market price volatility and/or sharp decreases in available liquidity.324 U.S. Treasury securities are generally not information sensitive in that their payoff is fixed in nominal terms. Moreover, there is little evidence that information on inflation risk or expectations could have driven the volatility observed in these episodes, raising the possibility that the volatility originated in a buy-sell imbalance, as opposed to fundamental factors. While a market failure could be the origin of price volatility, the forward-looking nature of markets can compound liquidity-driven price movements. The fear of being unable to exit a position can lead to a ‘‘rush to the exits,’’ leading to yet greater price swings. Because U.S. Treasury securities are standardized, they generally benefit from a deep, ready market for transactions. Investors count on the ability to move between cash and U.S. Treasury securities seamlessly.325 This makes events that reduce liquidity in these markets especially striking and destabilizing to the overall market. a. COVID–19 Shock of March 2020 The market for U.S. Treasury securities experienced significant disruptions in March 2020, characterized by a spike in volume, whose origins may have been multiple but included high levels of selling by foreign banks and by hedge funds.326 For example, hedge funds, one of the principal sellers of U.S Treasury futures, hedge their short futures position by 324 See IAWG Report, supra note 4, for further discussion of these and other disruptions. 325 U.S. Treasury securities are often used as substitutes for cash. There is anecdotal evidence that during March 2020, some market participants refused U.S. Treasury securities collateral in favor of cash. 326 See U.S. Credit Markets Interconnectedness and the Effects of the COVID–19 Economic Shock (Oct. 2020) at 3. E:\FR\FM\25OCP2.SGM 25OCP2 64654 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 establishing a long position in the cash market, creating a ‘‘cash-futures basis trade.’’ The cash position of this trade is often highly levered, using the repo market for financing. In March, as the U.S. Treasury securities market came under stress and as repo rates increased in some segments of the repo market, the economics of the cash-futures basis trade worsened and various funds found it necessary to unwind at least a portion of their positions. This unwinding of positions resulted in more outright sales of U.S. Treasury securities in the cash market, adding further stress through a feedback loop.327 During this period, bid-ask spreads increased by a factor of 5, and market depth on inter-dealer brokers decreased by a factor of 10. The price of 30-year U.S. Treasury securities fell by 10% in one two-day period. Arbitrage relations appeared to break down throughout the market.328 This may, as discussed above, have led to the winding down of the cash-futures basis trade, for example, adding to further stress.329 There also appeared to be large-scale selling from foreign investors, including official institutions, to address their domestic currency and liquidity needs.330 Duffie and Liang and Parkinson, among others, have tied these patterns to underlying U.S. Treasury securities market structure, in which intermediation capacity may be reduced relative to the size of the market and ultimate buyers and sellers may have difficulty locating each other. These authors discuss ways in which central clearing could have reduced these problems, mitigating the large price swings due to illiquidity in the market just when it was most needed.331 One view of central clearing is that it may facilitate all-to-all trading, thus helping ultimate buyers and sellers find each other.332 More buyers and sellers of U.S. Treasury securities could potentially act as additional sources of liquidity in a market with central clearing. 327 Id. at 4. In addition, a similar dynamic was observed in the risk parity trades, where hedge funds lever up (through the repo markets) lower volatility fixed-income positions (e.g., government bonds) to create a risk-equalized portfolio across asset classes. See id. 328 Duffie, supra note 186. 329 See supra note 150. 330 See Colin R. Weiss, Foreign Demand for U.S. Treasury Securities during the Pandemic (Feds Notes, Jan. 28, 2022), available at https:// www.federalreserve.gov/econres/notes/feds-notes/ foreign-demand-for-us-treasury-securities-duringthe-pandemic-20220128.htm. 331 Duffie, supra note 186; Liang & Parkinson, supra note 32. 332 See Duffie supra note 186. VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 b. September 2019 Repo Market Disruptions The repo market experienced a substantial disruption starting September 16, 2019 when overnight repo rates began to rise, and on September 17, 2019 when the rise in repo rates accelerated dramatically. During the episode, the Secured Overnight Financing Rate (SOFR)—a measure of the average cost of overnight repo borrowing—spiked by 300 basis points to over 5% in the course of 2 days. There was also a wide dispersion around this average; some trades occurred at rates as high as 9%. On top of this, the spread between the 1st and 99th percentile rates increased substantially from its average earlier in 2019 of approximately 25 basis points to approximately 675 basis points during the disruption. The disruption spilled over into the other markets, with the Effective Federal Funds Rate (EFFR) rising above the Federal Reserve target by 5 basis points. The disruption occurred amidst two events: first, a large withdrawal of reserves from the banking system to service corporate tax payments due September 16; and second, the settlement of U.S. Treasury securities auctions. Altogether, the tax payments led approximately $120 billion to flow away from bank reserves, bringing them down to their lowest level in 5 years.333 Moreover, the auction settlement raised the number of U.S. Treasury securities outstanding, which was accompanied by an increased demand for cash to fund purchases of these securities. The need for cash reserves played a role in what appears to be an unwillingness of banks to lend to one another at very high rates. Less tangibly, market expectations could have played a role; it is possible that the spike in rates could have been interpreted as a signal for a future need of cash reserves, leading banks to conserve cash regardless of what appeared to be strong economic incentives to do otherwise. While the need for the banking system to replace reserves with cash may be part of the explanation, in a welloperating market high rates for overnight borrowing collateralized by U.S. Treasury securities would have attracted other market participants. Ultimately, as in March 2020, the Federal Reserve injected reserves into the system—the economic equivalent of lending to banks. The overnight repo 333 See Sriya Anbil et al., What Happened in Money Markets in September 2019? (Feb. 27, 2020), available at https://www.federalreserve.gov/ econres/notes/feds-notes/what-happened-in-moneymarkets-in-september-2019-20200227.htm. PO 00000 Frm 00046 Fmt 4701 Sfmt 4702 operations totaled $75 billion on September 17, 2019. Besides directly providing cash, this perhaps signaled the Fed’s willingness and ability to lend as needed to restore rates to levels that would be dictated in the absence of market frictions. In such a setting, a potential benefit of enhanced clearing for U.S. Treasury repo and cash is its ability to reduce those market frictions directly, without official sector intervention. c. October 2014 Flash Rally In March 2020 U.S. Treasury securities’ prices fell, whereas in September 2019 the rate for lending increased. Both events were associated in an increase in the cost of borrowing. The events of October 15, 2014, were different in form: in this instance, yields on U.S. Treasury bonds fell quickly and dramatically, leading to large increases in prices, without any clear explanation. The intraday range for the 10-year bond was 37 basis points, one of the largest on record, and far outside the typical historical distribution.334 October 15, 2014, featured the release of somewhat weaker-than-expected U.S. retail sales data at 8:30 a.m. ET. While the data appeared to prompt the initial decline in interest rates, the reaction was far larger than would have been expected given the modest surprise in the data. Suggestive of some connection is that the dollar amount of standing quotes in the central limit order books on cash and futures trading platforms—a measure of the quantity of liquidity that is commonly referred to as ‘‘market depth’’—fell dramatically in the hour before the event window. A sudden rise in price does not at first appear as potentially disruptive as a decline. However, it appears that levered market participants had taken short positions in anticipation of an increase in yields. Any further increase in price would have forced these participants to cover their positions. Indeed, hedge funds became net buyers of U.S. Treasury securities on the morning of October 15, 2014. The decline in liquidity may have led to a further concern of an inability to exit positions. In particular, although the share of trading volume attributed to PTFs on October 15 does not stand out as unusual relative to the prior period,335 PTFs significantly reduced the dollar amounts of standing quotes in central limit order books,336 leading to greater pressure on the system. This withdrawal of liquidity appears to have 334 See generally Joint Staff Report, supra note 4. Joint Staff Report, supra note 4, at 21. 336 See IAWG Report, supra note 4, at 18. 335 See E:\FR\FM\25OCP2.SGM 25OCP2 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules been motivated by an attempt to manage risk. Lastly, though broker-dealers increased their trading volume, they provided less liquidity to the order books by widening their spreads and in some cases withdrawing for brief periods from the offer side of the book.337 This disruption showed that market liquidity provision had become more short-term in nature, some liquidity providers were backed by less capital, and liquidity was more vulnerable to shocks as a result of the change in the composition of liquidity providers. In addition, electronic trading permitted rapid increases in orders that removed liquidity. These vulnerabilities are similar to ones observed during the March 2020 events.338 As in the previously described episodes, the price swings illustrate the apparent difficulty for outside capital at accessing the market. Improved market functioning could have allowed economic incentives to help stabilize the system: end-users of U.S. Treasury securities could have reacted to the unusually high prices by selling. However, such participants would have needed access to pricing and to the ability to trade. 7. Affected Persons a. Covered Clearing Agencies for U.S. Treasury Securities: FICC Although the Membership Proposal would apply to all U.S. Treasury securities CCAs, FICC’s Government Securities Division, as noted previously, is the sole provider of clearance and settlement services for U.S. Treasury securities. FICC is a wholly owned subsidiary of The Depository Trust & Clearing Corporation (DTCC); DTCC is a private corporation whose common shares are owned by fee-paying participants in DTCC’s clearing agency subsidiaries, including FICC.339 In 2021 and 2020, FICC’s total clearing revenue was approximately $310 and $297.3 million, respectively, and its net income was approximately $13.4 and 18.1 million, respectively.340 The G–30 Report estimated that ‘‘roughly 20 percent of commitments to settle U.S. Treasury security trades are khammond on DSKJM1Z7X2PROD with PROPOSALS2 337 See id. id. 339 See generally Notice of No Objection to Advance Notices, Exchange Act Rel. No. 74142 (Jan. 27, 2015), 80 FR 5188 (Jan. 30, 2015) (not objecting to a proposal that DTCC’s new common share ownership formula will be based solely on fees paid to its subsidiary clearing agencies). 340 FICC, Financial Statements as of and for the Years Ended Dec. 31, 2021 and 2020, available at https://www.dtcc.com/-/media/Files/Downloads/ legal/financials/2021/FICC-Annual-FinancialStatements-2021-and-2020.pdf 338 See VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 cleared through FICC.’’ 341 Although various analyses have noted the increased volume of secondary market U.S. Treasury transactions that are not centrally cleared,342 the dollar value of transactions FICC clears remains substantial. In 2021, FICC’s GSD processed $1.419 quadrillion in U.S. Government securities.343 In March 2020, clearing dollar volume in U.S. Treasury securities at FICC rose ‘‘to over $6 trillion daily, an almost 43 percent increase over the usual daily average of $4.2 trillion cleared [at that time].’’ 344 There are differences between the degree of central clearing in the cash and the repo markets. Based on 2017 data, the TMPG estimated that 13 percent of cash U.S. Treasury securities transactions are centrally cleared; 68 percent are bilaterally cleared; and 19 percent involve hybrid clearing, in which only one leg of a transaction on an IDB platform is centrally cleared.345 A Federal Reserve staff analysis of primary dealer repo and reverse repo transactions during the first half of 2022 found ‘‘that approximately 20 percent of all repo and 30 percent of reverse repo is centrally cleared via FICC.’’ 346 Measured by dollar volume, repos, according to DTCC, are the largest component of the government fixedincome market.347 In mid-July 2021, according to Finadium and based on 341 G–30 Report, supra note 5, at 11. e.g., IAWG Report, supra note 4, at 5–6 (citing TMPG White Paper); 2017 Treasury Report, supra note 16, at 81; Joint Staff Report, supra note 4, at 36–37. 343 Performance Dashboard, DTCC 2021 Annual Report, at 56, available at https://www.dtcc.com/∼/ media/files/downloads/about/annual-reports/ DTCC-2021-Annual-Report. FICC’s GSD also process U.S. Government securities that are not U.S. Treasury securities but the dollar amount processed of such securities is believed to be nominal by comparison to that of U.S. Treasury securities. 344 DTCC May 2021 White Paper, supra note 135, at 3. 345 See IAWG Report, supra note 4, at 30; see also TMPG White Paper, supra note 21, at 12. 346 Sebastian Infante, et al., supra note 119 (‘‘Form FR2004 data only cover activities of primary dealers. Therefore, any estimate based on that data is likely to underestimate the total size of the repo market. Discussions with market participants suggest that the nonprimary dealer’s market share is smaller than that attributed to the primary dealers, but growing.’’). The authors also show that all cleared bilateral repo and reverse repo have U.S. Treasury securities and TIPS as collateral (the authors’ Figure 4); Viktoria Baklanova, Adam Copeland, and Rebecca McCaughrin, Reference Guide to U.S. Repo and Securities Lending Markets, N.Y. Fed. Staff Report No. 740, at 11 (rev. Dec. 2015) available at: https://www.newyorkfed.org/ medialibrary/media/research/staff_reports/ sr740.pdf. 347 DTCC, A Guide to Clearance and Settlement, Chapter 8: Settling Debt Instruments, available at: https://www.dtcc.com/clearance-settlement-guide/ #/chapterEight. 342 See, PO 00000 Frm 00047 Fmt 4701 Sfmt 4702 64655 DTCC data, FICC processed $1.15 trillion in repo, or roughly 25 percent of the $4.4 trillion U.S. repo market at that time.348 For all of 2021, DTCC reported that FICC processed $251 trillion through its GCF Repo Service.349 b. Direct Participants at U.S. Treasury Securities CCAs: FICC Netting Members If adopted, the Membership Proposal would directly affect market participants that are direct participants in a U.S. Treasury securities CCA, which currently means only direct participants at FICC’s GSD. FICC direct participants are also referred to as FICC Netting Members. As previously discussed, FICC Netting Members are the only FICC members eligible to become a counterparty to FICC to a U.S. Treasury securities transaction, including repo and reverse repo trades. As of May 3, 2022, FICC’s GSD had 202 Netting Members of which 187 were participants in FICC’s repo netting service.350 FICC Netting Members generally consist of bank-affiliated dealers and registered broker-dealers. These dealers include all 25 financial institutions currently designated by the Federal Reserve Bank of New York (N.Y. Fed) as ‘‘primary dealers.’’ 351 In 2021, the average daily trading dollar value in U.S. Treasury securities by primary dealers was $624.1 billion.352 The relative significance of dealer trading in the cash market for U.S. Treasury securities can is shown in Figure 8. BILLING CODE 8011–01–P 348 Finadium, Building Out Industry Data for New Industry Leads, at 9 (2021), available at: https:// finadium.com/wp-content/pdfs/finadium-dtccbuilding-out-repo-data.pdf. 349 DTCC 2021 Annual Report, supra note 343, at 56. 350 FICC GSD Member Directory, available at: https://www.dtcc.com/-/media/Files/Downloads/ client-center/FICC/Mem-GOV-by-name.xlsx. 104 Netting Members participated in FICC’s GCF service. 351 Primary dealers are counterparties to the N.Y. Fed in its implementation of monetary policy and expected to participate meaningfully in all U.S. Treasury securities auctions for new issuances of U.S. Treasury securities. https://home.treasury.gov/ policy-issues/financing-the-government/quarterlyrefunding/primary-dealers. A current list of primary dealers is available at: https://www.newyorkfed.org/ markets/primarydealers. 352 SIFMA, 2022 Capital Markets Fact Book, at 56 (July 2022) available at https://www.sifma.org/wpcontent/uploads/2022/07/CM-Fact-Book-2022SIFMA.pdf (SIMFA’s term primary dealers refers to N.Y. Fed prime brokers). Id. The dollar value of trading in U.S. Treasury securities by primary dealers has a combined average annual growth rate of 1.9 percent for the ten year period ending in 2021. E:\FR\FM\25OCP2.SGM 25OCP2 64656 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules Figure 8 Share of U.S. Treasury Securities Cash Market Activity for All Securities By Participant Type Source: FINRA TRACE. This figure plots shares of trading volume by participant type for the entire U.S. Treasury securities cash market from April 1, 2019 to December 31, 2019. Figure from Harkrader and Puglia FEDS Note, supra note 305. Note: "Buy-side share is assumed to capture institutions such as hedge funds and investment firms but may also include other financial institutions such as banks." 353 SIFMA Research, US Repo Markets: A Chart Book, at 6, 7, and 8 (Feb. 2022), available at SIFMA-Research-US-Repo-Markets-Chart-Book2022.pdf. Because these are figures for primary dealer repo and reverse repo, they need not be equal. In the aggregate, however, repo must equal reverse repo. 354 The Financial Accounts of the United States, L.207, line 1 (Federal Funds and Security VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 Although a large portion of this activity is cleared by FICC, a large portion is also not centrally cleared. For 2021, DTCC reported that ‘‘FICC matches, nets, settles and risk manages repo transactions valued at more than $3T daily.’’ 355 During the first half of 2022, Federal Reserve staff estimated that a ‘‘large fraction of primary dealers’ repo (38 percent) and reverse repo (60 percent) activity is in the uncleared bilateral segment.’’ 356 See Figure 9. Although these statistics include all collateral types, for the subset of the repo market that includes a primary dealer on one side, the Commission has Repurchase Agreements) available at https:// www.federalreserve.gov/releases/z1/20220310/ html/l207.htm. 355 DTCC 2021 Annual Report, supra note 343, at 32. 356 2022 Fed Note, supra note 346. PO 00000 Frm 00048 Fmt 4701 Sfmt 4702 more detailed data. As Figures 10 and 11 show, the vast majority of uncleared bilateral and tri-party primary dealer repo and reverse repo collateral consists of U.S. Treasury securities (including TIPS). The largest remaining components of repo (approximately 40 percent) and reverse repo activity (approximately 8 percent) are not centrally cleared but settle on the triparty platform. This is labeled ‘‘TriParty (excluding GCF)’’ in Figure 9, and the degree to which Treasury collateral is used in these transactions is displayed in Figure 11. The final and by far the smallest component of repo and reverse repo activity (amounting to about 2% of activity) is triparty repo using FICC’s Sponsored GC service.357 Figure 9 Repo Clearing 2021–2022 357 Id. E:\FR\FM\25OCP2.SGM 25OCP2 EP25OC22.007</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 As previously discussed, the total notional transactions in the repo market is larger than that of the cash U.S. Treasury securities market. In 2021, aggregate daily primary dealer outstanding total repo positions were $4.3 trillion consisting of $2.5 trillion in repo (75% of which is collateralized by U.S. Treasury securities) and $1.8 trillion in reverse repo (89% of which is collateralized by U.S. Treasury securities).353 As of December 31, 2021, the repo market as a whole was valued at approximately $5.8 trillion.354 64657 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules Repo. Reverse Repo 1t1111ons 3_0 Weekly GCF 1lillk>ns 3.0 Weekly Figure 10 Uncleared Bilateral Repo and Reverse Repo Collateral 2022 Undeared Bilateral Repo Uncleared Bilateral Reverse Repo Trillions Weekly Clllpooile 5ecurllies 1\-illions 1.4 1.2 1.2 1.0 1.0 0.8 o.a 0.6 O.G 0.4 0.4 0.2 0.2 0.0 Jan. Feb. Mar. Apr. May Jun. 1.4 0.0 Jan. July 2022 Feb. Mar. Apr. May Jun. July 2022 Source: Board of Governors of the Federal Reserve System, Government Securities Dealers Reports (FR 2004) VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 PO 00000 Frm 00049 Fmt 4701 Sfmt 4702 E:\FR\FM\25OCP2.SGM 25OCP2 EP25OC22.008</GPH> EP25OC22.009</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 Figure 11 Tri-party Repo and Reverse Repo Collateral 2022 64658 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules Tri-Party Repo Tri-Party Reverse Repo Trillions 1.4 llilllons 0.30 Weekly 1.2 025 1.0 0.20 o.a 0.15 0.6 0.10 0.4 0.05 0.2 0.0 Jan. Feb. Mar. Apr. 2022 May July Jun. 0.00 Jan. Feb. Mar. Apr. May Jun. July 2022 BILLING CODE 8011–01–C c. Interdealer Brokers (IDBs) Interdealer brokers 358 and the trading platforms they operate play a significant role in the markets for U.S. Treasury securities. As previously discussed, an IDB will generally provide a trading facility for multiple buyers and sellers for U.S. Treasury securities to enter orders at specified prices and sizes and have these orders displayed anonymously to all users. When a trade is executed, the IDB then books two trades, with the IDB functioning as the principal to each respective counterparty, thereby protecting the anonymity of each party, but taking on credit risk from each of them. Although there is no legal requirement for an IDB to be a FICC direct participant/Netting Member, the Commission believes most IDBs are FICC Netting Members.359 In any event, under FICC’s existing rules, if an IDB’s customer in a U.S. Treasury security transaction is not a FICC member, the IDB’s transaction with that customer need not be centrally cleared and may be bilaterally cleared. As discussed above in section II.A.1, each transaction at an IDB is split into two pieces: a leg between the buyer and the IDB and a leg between the IDB and the seller. If the buyer or seller is a dealer, the respective leg is centrally cleared. Transaction legs involving PTFs are generally cleared and settled bilaterally. TMPG estimates that ‘‘roughly threequarters of IDB trades clear bilaterally.’’ 360 To help visualize the significance of the role played by IDBs in the centrally cleared market, and given existing data limitations, Table 3, adapted from a table prepared by the TMPG in 2019, presents five clearing and settlement case types that cover the vast majority of secondary market cash trades. The table uses Federal Reserve data collected from primary dealers in the first half of 2017 to estimate the daily volume (dollar and share percentage) attributable to each clearing and settlement case type. TABLE 3—ESTIMATED SECONDARY CASH MARKET PRIMARY DEALER DAILY TRADING DOLLAR (BILLIONS) AND PERCENTAGE VOLUME BY CLEARING AND SETTLEMENT TYPE $ Volume billions Clearing and settlement type $289 15 52 73 103 $531 IDB share 95% 5% ........................ ........................ ........................ $304 (57.2%) ........................ ........................ 22.9% 31.9% 45.3% $228 (42.8%) Overall percentage (%) 54.3 2.9 9.8 13.6 19.4 100 Source: TMPG White Paper on Clearing and Settlement in the Secondary Market for U.S. Treasury Securities (2019), adapted from a table at p. 12. Table 3 Notes: Figures are estimated using the Federal Reserves’ Form FR2004 data for the first half of 2017 and are based on the following assumptions: (a) primary dealers account for all dealer activity, (b) 5% of dealers’ trading not through an IDB is with another dealer, (c) the shares of dealer and non-dealer activity in the IDB market for coupon securities equal the weighted averages of the shares reported in the October 15 report (that is, 41.5% and 58.5%, respectively), (d) only dealers trade bills, FRNs, and TIPS in the IDB market, and (e) the likelihood of dealer and non-dealers trading with one another in the IDB market solely reflects their shares of overall volume. The table presents estimates because precise information is not available on the size of the market or on how activity breaks down by the method of clearing and settlement. 358 As noted previously, IDB is not used to encompass platforms that provide voice-based or other non-anonymous methods of bringing together buyers and sellers of U.S. Treasury securities. IDB instead refers to electronic platforms providing VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 anonymous methods of bringing together buyers and sellers. 359 See generally TMPG White Paper, supra note 21. The TMPG White Paper assumes throughout that IDBs are CCP direct members (e.g., ‘‘More PO 00000 Frm 00050 Fmt 4701 Sfmt 4702 specifically, the IDB platforms themselves and a number of platform participants continue to clear and settle through the CCP.’’ TMPG White Paper at 2.) 360 TMPG White Paper, supra note 21, at 2. E:\FR\FM\25OCP2.SGM 25OCP2 EP25OC22.010</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 Bilateral clearing, no IDB .................................................................................................................. Central clearing, no IDB .................................................................................................................... Central clearing, with IDB ................................................................................................................. Bilateral clearing, with IDB ................................................................................................................ Bilateral/central clearing, with IDB .................................................................................................... Totals ......................................................................................................................................... Non-IDB share Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules d. Other Market Participants i. FICC Sponsored Members khammond on DSKJM1Z7X2PROD with PROPOSALS2 As discussed previously, some institutional participants that are not FICC Netting Members/FICC direct participants are able to centrally clear repos through FICC’s Sponsored Service.361 The Sponsored Service allows eligible direct participants (Sponsoring Members) to (i) sponsor their clients into a limited form of FICC membership (Sponsored Members) and then (ii) submit certain eligible client securities transactions for central clearing. If adopted, the Membership Proposal could affect Sponsored Members. FICC interacts solely with the Sponsoring Member/direct participant as agent. Sponsoring Members guarantee to FICC the payment and performance obligations of its Sponsored Members.362 Following FICC’s expansion in 2021 of its Sponsored Service to allow Sponsored Members to clear triparty repos through the program,363 there are now approximately 30 Sponsoring Members and approximately 1,900 Sponsored Members 364 with access to central clearing. During the 12 month period ending on August 9, 2022, the total dollar value of Sponsored Members’ daily repo and reverse repo activity ranged from a high of $415.8 billion on December 31, 2021 to a low of $230.2 billion on October 21, 2021.365 Among the various types of financial firms that are Sponsored Members are 361 FICC’s Sponsored Member program also allows the submission of cash transactions; however, as previously noted, the service is generally used only for U.S. Treasury repo transactions at this time. 362 See FICC’s GSD Rule 3A, supra note 47. Sponsored Members have to be Securities Act Rule 144A ‘‘qualified institutional buyers,’’ or otherwise meet the financial standards necessary to be a ‘‘qualified institutional buyer.’’ See id., Rule 3A, section 3(a). 363 See Self-Regulatory Organizations; Fixed Income Clearing Corporation; Order Approving a Proposed Rule Change to Expand Sponsoring Member Eligibility in the Government Securities Division Rulebook and Make Other Changes, Exchange Act Release No. 85470 (Mar. 29, 2019), supra note 126. 364 See FICC Membership Directories (‘‘FICC Membership’’), available at https://www.dtcc.com/ client-center/ficc-gov-directories. As of Dec. 31, 2021, DTCC reported that FICC had 30 sponsoring members and over 1,800 sponsored members. DTCC 2021 Annual Report, supra note 343, at 19. 365 This information was available from DTCC on the 1 year version of the FICC Sponsored Activity chart as of Aug. 12, 2022, available at: https:// www.dtcc.com/charts/membership. VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 (i) over 1,400 funds, including a number of hedge funds, many money market funds, other mutual funds, and a smaller number of ETFs; 366 (ii) banks, including a small number of national, regional Federal Home Loan Banks, and international banks; and (iii) other asset managers including a few insurance companies.367 ii. Other Market Participants That Are Not FICC Sponsored Members In addition to Sponsored Members, various types of direct and indirect market participants hold significant amounts of U.S. Treasury securities and repo, and potentially purchase and sell U.S. Treasury securities in the secondary cash and repo markets. To the extent that these persons engage in secondary market transactions, we expect their trading may be affected by increased central clearing resulting from the adoption of the Proposal. The most prominent examples are: 1. Hedge Funds, Family Offices, and Separately Managed Accounts Hedge funds are active participants in the secondary market for U.S. Treasury securities and their trading activities have been shown to be a cause of price movements in the U.S. Treasury securities market.368 Hedge funds can use U.S. Treasury securities, for example, in order to borrow cash to take leveraged positions in other markets, or to execute complex trading strategies. As of December 31, 2021 approximately 25 percent of qualifying hedge funds reporting on Form PF 369 reported U.S. 366 For various persons, direct participation in FICC may not be an alternative to the Sponsored Membership program. For example, ‘‘[a] subset of market participants, such as certain money market funds, face legal obstacles to joining FICC because they are prohibited from mutualizing losses from other clearing members in the way that FICC rules currently require.’’ Chicago Fed Insights, supra note 204. 367 FICC Membership, supra note 364. 368 Ron Alquist & Ram Yamarthy, Hedge Funds and Treasury Market Price Impact: Evidence from Direct Exposures, OFR Working Paper 22–05 (Aug. 23, 2022) (‘‘find[ing] economically significant and consistent evidence that changes in aggregate hedge fund [Treasury] exposures are related to Treasury yield changes [and] . . . that particular strategy groups and lower-levered hedge funds display a larger estimated price impact on Treasuries.’’), available at https://www.financialresearch.gov/ working-papers/files/OFRwp-22-05-hedge-fundsand-treasury-market-price-impact.pdf. 369 For an explanation of qualifying hedge funds, see supra note 148. Although the Proposal would cover any hedge fund, smaller funds holdings are not reflected in these statistics because of Form PF’s PO 00000 Frm 00051 Fmt 4701 Sfmt 4702 64659 Treasury securities holdings totaling $1.76 trillion in notional exposure in the cash market and $2.25 trillion in notional exposure to repos.370 For Large Hedge Fund Advisers (LHFA) 371 reporting on Form PF for the same period, monthly turnover in U.S. Treasury securities was $3.4 trillion. Family offices are entities established by families to manage family wealth.372 Family offices tend to exhibit behavior and have objectives that are similar to those of hedge funds including the use of leverage, aggressive investment strategies, and holding illiquid assets. A recent survey of family offices undertaken by RBC 373 found that of 385 participating family offices around the world, almost half (46%) are based in North America. Average family office AUM for North American families was $1 billion. Similarly, Separately Managed Accounts (SMAs) are also portfolios of assets managed by an investment adviser, usually targeted towards wealthy individual investors. Because of the end investor’s risk tolerance, SMAs can also pursue aggressive, leveraged strategies. minimum $150 million reporting threshold. An adviser must file Form PF if (1) it is registered (or required to register) with the Commission as an investment adviser, including if it also is registered (or required to register) with CFTC as a commodity pool operator or commodity trading adviser, (2) it manages one or more private funds, and (3) the adviser and its related persons, collectively had at least $150 million in private fund assets under management as of the last day of its most recently completed fiscal year. See Form PF General Instruction No. 1, available at https://www.sec.gov/ files/formpf.pdf. 370 Division of Investment Management Analytics Office, Private Funds Statistics Fourth Calendar Quarter 2021, Table 46 at 39 (July 22, 2022), available at https://www.sec.gov/divisions/ investment/private-funds-statistics/private-fundsstatistics-2021-q4.pdf. 371 Large hedge fund advisers reporting on Form PF ‘‘have at least $1.5 billion in hedge fund assets under management.’’ See Id. at 61. 372 ‘‘Historically, most family offices have not been registered as investment advisers under the Advisers Act because of the ‘private adviser exemption’ provided under the Advisers Act to firms that advice fewer than fifteen clients and meet certain other conditions.’’ SEC Staff, Family Office: A Small Entity Compliance Guide, available at https://www.sec.gov/rules/final/2011/ia-3220secg.htm. 373 Campden Wealth and The Royal Bank of Canada, The North America Family Office Report (2021), available at: https://www.rbcwealth management.com/_assets/documents/cmp/thenorth-america-family-office-report-2021-finalua.pdf. E:\FR\FM\25OCP2.SGM 25OCP2 64660 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules 2. Registered Investment Companies (RICs) Including Money Market Funds, Other Mutual Funds, and ETFs RICs, mainly money market funds, mutual funds, and ETFs, are large holders of U.S. Treasury securities.374 At the end of the first quarter of 2022, money market funds held $1.8 trillion of U.S. Treasury securities ($1.2 trillion in T-Bills and $603.9 billion in other U.S. Treasury securities).375 Mutual funds held an additional $1.5 trillion of other U.S. Treasury securities ($34.1 billion of T-Bills and $1.5 trillion of other U.S. Treasury securities) while exchangetraded funds held an additional $334.1 billion in U.S. Treasury securities.376 The degree to which these entities would be affected depends on the extent to which their trading is likely to take place in the secondary market.377 RICs are also active participants in the repo market with money market funds being active cash investors. According to data filed with the Commission, money market funds investments in U.S. Treasury repo, both bilateral and triparty, amounted to approximately $2.3 trillion in June 2022. Moreover, as shown in Figure 12, money market fund U.S. Treasury repo volume has grown from approximately $200 billion monthly in 2011 with the vast majority of the most recent year’s growth attributed to investments in the Federal Reserve’s repo facility.378 Figure 12: Money Market Fund Monthly Repo Volume (01/2011–06/2022) 2500 mi Investments in Federal Reserve's reverse repo facility 2000 !:!I Treasury repos with other counterparties V, c:: 0 § 1500 a::i ~ ~ g 1000 500 0 Jan-11 Jan-13 .Jan-15 Jan-17 Jan-19 Jan-21 For RICs, holdings of U.S. Treasury securities play an important role in managing liquidity risk stemming from potential redemptions. Given their highly liquid nature, U.S. Treasury securities can be used to raise cash to meet redemptions. For example, a survey conducted by an industry group showed that in the first quarter of 2020 RICs had net sales of $128 billion in Treasury and agency bonds, mainly to meet redemption requests at the onset of the Covid-19 pandemic.379 In addition to reliance on Treasury securities as sources of liquidity, RICs use Treasury securities as collateral for borrowing in the repo market as another source of liquidity. Also, RICs accept Treasury securities as collateral in their securities lending programs established to an additional source of income for the fund shareholders. 374 Investment companies are the third largest holder of U.S. Treasury securities holding just under $3.6 trillion. MMFs in the Treasury Market, supra note 128, at 3 (citing to Financial Accounts of the United States as of Mar. 2022). The other large (over 5 percent) holders are: ‘‘other’’ holders (including hedge funds) 30 percent, the Federal Reserve (23 percent), pension funds (14 percent), and U.S. banks and state and local governments (each holding 6 percent). See id. at 2 (figure 5). 375 Federal Reserve Statistical Release, Z.1 Financial Accounts of the U.S, Flow of Funds, Balance Sheets, and Integrated Macroeconomic Accounts, at 119 (L210 Treasury Securities—lines 42–49) (‘‘Financial Accounts of the U.S.’’), available at: https://www.federalreserve.gov/releases/z1/ 20220609/z1.pdf. 376 Id. at 119 (L210 Treasury Securities—lines 45– 47 and 49). 377 For example, an analysis of money market fund portfolios’ turnover of U.S. Treasury securities by the Commission staff indicates only limited secondary market trading activity. Recently published estimates based on monthly filings of Form N–MFP suggest that, on average, money market funds hold around 70 percent of U.S. Treasury securities to the next month with around 6 percent of U.S. Treasury securities holdings disposed of before maturity. The remaining approximately 23 percent of holdings mature during the month. MMFs in the Treasury Market, supra note 128, at 3. These estimates suggest that the proposal’s effect on money market fund cash market transactions in U.S. Treasury securities will be very limited relative the proposal’s effects on money market funds’ repo activities which could be more significant. 378 Id. at 4. The Commission understands the credit rating agencies consider concentration of counterparty credit risk as one factor in determining their rating of money market funds which may drive money market funds to seek diversification of counterparties for the repo transactions. 379 See Shelly Antoniewicz & Sean Collins, Setting the Record Straight on Bond Mutual Funds’ Sales of Treasuries, Investment Company Institute Viewpoints (Feb. 24, 2022), available at https:// www.ici.org/viewpoints/22-view-bondfund-survey-2. VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 PO 00000 Frm 00052 Fmt 4701 Sfmt 4702 E:\FR\FM\25OCP2.SGM 25OCP2 EP25OC22.011</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 Source: SEC Form N-MFP Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules 3. Principal Trading Firms (PTFs) The role and importance of PTFs providing liquidity in the U.S. Treasury securities market have been the subject of a number of analyses and reports in recent years.380 For example, using FINRA’s Regulatory TRACE data in connection with a recent rulemaking proposal, we identified 174 market participants who were active in the U.S. Treasury securities market in July 2021 and that were not members of FINRA.381 We ‘‘found that these participants accounted for approximately 19 percent of the aggregate U.S. Treasury security trading volume [], with PTFs representing the highest volumes of trading among these participants.’’ 382 We explained that in our analysis khammond on DSKJM1Z7X2PROD with PROPOSALS2 PTFs had by far the highest volumes among identified non-FINRA member participants in the U.S. Treasury market, and the largest PTFs had trading volumes that were roughly comparable to the volumes of the largest dealers. A Federal Reserve staff analysis found that PTFs were particularly active in the interdealer segment of the U.S. Treasury market in 2019, accounting for 61 percent of the volume on [electronic] interdealer broker platforms . . . .383 380 See, e.g., G–30 Report, supra note 5, at 1; Joint Staff Report, supra note 4, at 3–4, 36, 55 (‘‘PTFs now account for more than half of the trading activity in the futures and electronically brokered interdealer cash markets.’’); Harkrader and Puglia FEDS Note, supra note 304; Doug Brain, et al., FEDS Notes, ‘‘Unlocking the Treasury Market Through TRACE’’ (Sept. 28, 2018), available at https:// www.federalreserve.gov/econres/notes/feds-notes/ unlocking-the-treasury-market-through-trace20180928.htm. See also Ryan and Toomey Blog Part III, supra note 31 (While in the interdealer cash market, U.S. Treasury securities are often cleared and settled through FICC, ‘‘dealer trades with principal trading firms (‘‘PTFs’’)—a very large share of this market—are generally cleared bilaterally because most PTFs are not members of the FICC.’’). See also IAWG Report, supra note 4, at 21 (‘‘on February 25, 2021, a large shift in investor sentiment triggered very high trading volumes [] that temporarily overwhelmed the intermediation capacity of the Treasury market. . . . . Some market participants observed that the stresses on February 25, 2021, were exacerbated by lack of elasticity in liquidity supply resulting from activity limits that IDB platforms impose on some firms, especially PTFs that do not participate in central clearing.’’). 381 Further Definition of ‘‘As a Part of a Regular Business’’ in the Definition of Dealer and Government Securities Dealer, Exchange Act Rel. No. 94524 (Mar. 28, 2022), 87 FR 23054, 23072, and 23080 (Apr. 18, 2022) (‘‘Because regulatory TRACE data pertaining to Treasury securities reported by certain ATSs contains the identity of non-FINRA member trading parties, we are able to analyze PTFs’ importance in the U.S. Treasury market during July 2021 and summarize the number and type of market participants by monthly trading volume . . . .’’). ‘‘Although FINRA membership is not synonymous with dealer registration status, the Commission believes that many of the market participants who are not FINRA members are also likely not registered as government securities dealers.’’ Id. at 23072 n. 167. 382 Id. at 23072. 383 Id. at 23080. Harkrader and Puglia FEDS Note, supra note 304. See also FEDS Notes, Unlocking the VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 Based on this Federal Reserve study and assuming that all PTFs are not FICC members and that PTF trading on IDB electronic platforms during the final three quarters 2019 was a reasonable proxy for the average daily current volume of such trading today by PTFs, the Membership Proposal would subject as much as approximately $116.51 billion per day in PTF trades on electronic/automated IDBs to central clearing.384 4. State and Local Governments State and local governments are significant holders of U.S. Treasury securities. As of March 2022, state and local governments held approximately $1.5 trillion in U.S. Treasury securities 385 as part of their budgetary and short-term investment duties. 5. Private Pensions Funds and Insurance Companies. Insurance companies and pension funds also have significant positions in U.S. Treasury securities. As of March 2022, private pension funds and insurance companies are large holders of U.S. Treasury securities, holding $5.6 trillion and $374.8 billion respectively.386 e. Triparty Agent: Bank of New York Mellon 387 Although triparty repo transactions are bilaterally negotiated, they are settled through BNY Mellon, which currently plays a central role in the triparty repo market as the sole triparty agent.388 Besides providing collateral valuation, margining, and management services, BNY Mellon also provides back-office support to both parties by settling transactions on its books and confirming that the terms of the repo are met. Additionally, the clearing bank acts as custodian for the securities held as Treasury Market Through TRACE (Sept. 28, 2018). Harkrader and Puglia used FINRA TRACE data on the trading volume shares of different participant types on IDB platforms for nominal coupon securities from April 1, 2019 to December 31, 2019. They identified $191 billion of average daily dollar volume on electronic/automated IDB platforms during the period. They also noted data limitations, which they estimated amounted to ‘‘a very small fraction of total activity.’’ Id. 384 Harkrader and Puglia FEDS Note, supra note 304, at table 1 (61% of $191 billion = $116.51 billion). 385 Financial Accounts of the U.S., supra note 375 (Line 19). 386 Id. (Lines 29, 32, and 35). 387 Paddrik, et al., supra note 273 (‘‘The Federal Reserve Board, through the Federal Reserve Bank of New York (FRBNY), supervises triparty custodian banks and, on a mandatory basis pursuant to its supervisory authority, collects transaction-level data at the daily frequency.’’). 388 J.P. Morgan Chase previously served as a custodian in the triparty space but largely exited the market in 2019. Id. at 2–3. PO 00000 Frm 00053 Fmt 4701 Sfmt 4702 64661 collateral and allocates collateral to trades at the close of the business day. As discussed previously, FICC recently introduced the Sponsored GC Service that extends FICC’s GCF repo service to allow for the clearing of triparty repo.389 An expansion of central clearing under the Membership Proposal could affect BNY Mellon’s triparty business. It is, however, unclear whether increased central clearing would increase or decrease the amount of repo traded that makes use of triparty agent’s services previously described. f. Custodian Banks/Fedwire Securities Service (FSS) Currently, custodian banks handle much of the trading activity for longonly buy-side clients in the U.S. Treasury securities cash and repo markets. When an asset buyer and seller engage bilaterally as principals in a collateralized securities transaction, a repo for example, a custodian bank will often provide various services to support the transaction. Custodian services include transaction settlement verification, verifying the amount of the relevant credit exposure, calculating required initial and variation margin, and making margin calls. In a tri-party repo transaction that isn’t centrally cleared, a custodian perform a clearing function by settling the transaction on its own books without a corresponding transfer of securities on the books of a central securities depository.390 FSS, operated by the Federal Reserve Bank system, provides issuance, maintenance, transfer and settlement services for all marketable U.S. Treasury securities to its 3,800 participants.391 For example, FSS offers the ability to transfer securities and funds to settle secondary-market trades, to facilitate the pledging of collateral used to secure 389 See supra note 66 and accompanying discussion. 390 The Clearing House, The Custody Services of Banks (July 2016) available at: https:// www.davispolk.com/sites/default/files/20160728_ tch_white_paper_the_custody_services_of_ banks.pdf 391 See Fedwire Securities Service brochure (‘‘FSS brochure’’), available at: https:// www.frbservices.org/binaries/content/assets/ crsocms/financial-services/securities/securitiesproduct-sheet.pdf. The Federal Reserve Banks offer highly competitive transaction, per-issue and monthly maintenance prices. Account maintenance fees are waived for accounts holding only U.S. Treasury securities and for certain accounts used to pledge securities to the U.S. Treasury and Federal Reserve Banks. Service fees are available at FRBservices.org. Fees for services are set by the Federal Reserve Banks. A 2022 fee schedule is available at: https://www.frbservices.org/resources/ fees/securities-2022 E:\FR\FM\25OCP2.SGM 25OCP2 64662 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules obligations, and to facilitate repo transactions.392 C. Analysis of Benefits, Costs, and Impact on Efficiency, Competition, and Capital Formation 1. Benefits khammond on DSKJM1Z7X2PROD with PROPOSALS2 The proposed amendments would likely yield benefits associated with increased levels of central clearing in the secondary market for U.S. Treasury securities. The Commission previously has stated that registered clearing agencies that provide CCP services both reduce trading costs and help increase the safety and efficiency of securities trading.393 These benefits could be particularly significant in times of market stress, as CCPs would mitigate the potential for a single market participant’s failure to destabilize other market participants, destabilize the financial system more broadly, and/or reduce the effects of misinformation and rumors.394 A CCP also would address concerns about counterparty risk by substituting the creditworthiness and liquidity of the CCP for the creditworthiness and liquidity of counterparties.395 Further, the Commission has recognized that ‘‘the centralization of clearance and settlement activities at covered clearing agencies allows market participants to reduce costs, increase operational efficiency, and manage risks more effectively.’’ 396 However, the Commission has also recognized that this centralization of activity at clearing agencies makes risk management at such entities a critical function.397 Bilateral clearing arrangements do not allow for multilateral netting of obligations, which reduce end-of-day settlement obligations.398 Larger gross settlement obligations, which increase with leverage, increase operational risks and subsequently the possibility of settlement fails. Central clearing of transactions nets down gross exposures across participants, which reduces firms’ exposures while positions are open, and reduces the magnitude of cash and securities flows required at settlement.399 These reductions, particularly in cash and securities flow ‘‘would reduce liquidity risks associated with those settlements and counterparty 392 FSS brochure, supra note 391. supra note 7. 394 See supra note 8. 395 Id. 396 See supra note 10. 397 Id. 398 See section IV.A.1, supra for a discussion of central clearing and the mitigation of clearance and settlement risks. 399 See IAWG Report, supra note 4, at 30. 393 See VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 credit risks associated with failures to deliver on the contractual settlement date,’’ not only for CCP members but for the CCP itself.400 It has been suggested that wider central clearing could have lowered dealers’ daily settlement obligations in the cash market by up to 60 percent in the run-up to and aftermath of the March 2020 U.S. Treasury securities market disruption and reduced settlement obligations by up to 70 percent during the disruption itself.401 The reduction in exposure is not limited to the cash market; it has been estimated that the introduction of central clearing for dealer-to-client repos would have reduced dealer exposures from U.S. Treasury repos by over 80% (from $66.5 billion to $12.8 billion) in 2015.402 The benefits of multilateral netting flowing from central clearing can improve market safety by lowering exposure to settlement failures.403 Multilateral netting can also reduce the regulatory capital required to support a given level of intermediation activity 404 and could also enhance capacity to make markets during normal times and stress events because existing bank capital and leverage requirements recognize the risk-reducing effects of multilateral netting of trades that CCP clearing accomplishes.405 By reducing the level or margin required to support a given total level of trading activity, central clearing may reduce total risk to the system. Financial crises are sometimes precipitated by margin calls following a period of increased volatility. If a market participant holds offsetting positions, then margin calls that might occur could be avoided. 400 See G–30 Report, supra note 5, at 13, supra note 5; see also PIFS Paper, supra note 120, at 28– 31. 401 Id. See also Michael Fleming & Frank Keane, Netting Efficiencies of Marketwide Central Clearing (Staff Report No. Staff Report No. 964), FEDERAL RESERVE BANK OF NEW YORK (Apr. 2021), available at https://www.newyorkfed.org/ medialibrary/media/research/staff_reports/ sr964.pdf. 402 PIFS Paper, supra note 120, at 29 (citing OFFICE OF FINANCIAL RESEARCH, Benefits and Risks of Central Clearing in the Repo Market, 5–6 (Mar. 9, 2017), available at https:// www.financialresearch.gov/briefs/files/OFRBr_ 2017_04_CCP-for-Repos.pdf). 403 Duffie, supra note 186, at 15. 404 See section IV.A.2, supra for an example of how multilateral netting can reduce margin required to support a given level of trading activity. 405 See IAWG Report, supra note 4, at 30; Liang & Parkinson, supra note 32, at 9; Duffie, supra note 186, at 16–17. It is important to note that this netting may offset any potentially higher liquidity charges faced by major participants from clearing at the CCP. See Duffie, supra note 186, at 17 (‘‘To the contrary, the netting of most purchases against sales at a CCP would lower the overall liquidity requirements of dealers, assuming that dealers continue to intermediate the market effectively.’’). PO 00000 Frm 00054 Fmt 4701 Sfmt 4702 Because financial markets are forwardlooking, reducing the anticipation of margin calls on other market participants can avoid costly ‘‘bankrun’’ type dynamics.406 Some benefits associated with capital reductions are particularly relevant for overnight and term repo. In the case of financing activity in U.S. Treasury securities market—U.S. Treasury repo— the entire notional value of the position has to be recorded on a dealer’s balance sheet as soon as the start leg of the repo settles, and unless the dealer faces off against the exact same legal counterparty with respect to an offsetting financing trade of the same tenor, the dealer will not be able to net such balance sheet impact against any other position. The grossing up of the dealer’s balance sheet in this manner can have implications with respect to the amount of capital the dealer is required to reserve against such activity. When transactions are cleared through a CCP, dealers can offset their centrally cleared repo positions of the same tenor, and thereby free up their capital to increase funding capacity to the market.407 According to research that Finadium conducted among repo dealers, netting can compress High Quality Liquid Asset (HQLA) bilateral trading books by 60% to 80%.408 Cash and repo trades cleared and settled outside of a CCP may not be subject to the same level of uniform and transparent risk management associated with central clearing.409 By contrast, FICC is subject to the Commission’s risk management requirements addressing financial, operational, and legal risk management, which include, among other things, margin requirements commensurate with the risks and particular attributes of each relevant product, portfolio, and market.410 As the Commission believes that this proposal will incentivize and facilitate additional central clearing in the U.S. Treasury 406 See Menkveld and Vuillemey, 2021, Annual Review of Financial Economics. 407 The positive impact on dealer’s ability to increase funding capacity will be offset, in part, by the direct and indirect costs of central clearing. See id. and section C.2 infra. 408 Finadium LLC, Netting Rules for Repo, Securities Lending and Prime Brokerage (Sept. 2014). Assets are considered to be HQLA if they can be easily and immediately converted into cash at little or no loss of value. The test of whether liquid assets are of ‘‘high quality’’ is that, by way of sale or repo, their liquidity-generating capacity is assumed to remain intact even in period of severe idiosyncratic and market stress. See https:// www.bis.org/basel_framework/chapter/LCR/ 30.htm?tldate=20191231&inforce=20191215. 409 See TMPG Repo White Paper, supra note 118, at 1. See also section IV.B.5, supra. 410 G–30 Report, supra note 5, at 13; 17 CFR 240.17Ad–22(e)(6). E:\FR\FM\25OCP2.SGM 25OCP2 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 securities market, risk management should improve. To offset the risks it faces as a central counterparty, the CCP requires its members to post margin, and the CCP actively monitors the positions its members hold. Moreover, in the event that the posted margin is not enough to cover losses from default, the CCP has a loss-sharing procedure that mutualizes loss among its members. By lowering counterparty risk, central clearing also allows for the ‘‘unbundling’’ of counterparty risk from other characteristics of the asset that is being traded. This unbundling makes the financial market for Treasury securities more competitive.411 The Commission also believes that this proposal would help avoid a potential disorderly default by a member of any U.S. Treasury securities CCA. Defaults in bilaterally settled transactions are likely to be disorganized and subject to variable default management techniques, often subject to bilaterally negotiated contracts with little uniformity. Independent management of bilateral credit risk creates uncertainty about the levels of exposure across market participants and may make runs more likely; any loss stemming from closing out the position of a defaulting counterparty is a loss to the nondefaulting counterparty and hence a reduction in its capital in many scenarios.412 Increased use of central clearing should enhance regulatory visibility in the critically important U.S. Treasury securities market. Specifically, central clearing increases the transparency of settlement risk to regulators and market participants, and in particular allows the CCP to identify concentrated positions and crowded trades, adjusting margin requirements accordingly, which should help avoid significant risk to the CCP and to the system as a whole.413 As discussed further below, the Commission is unable to quantify certain economic benefits and solicits comment, including estimates and data from interested parties, that could help inform the estimates of the economic effects of the proposal. 411 ‘‘One of the conditions for a perfectly competitive market is that [market participants] are happy to [buy or sell] from any of the many [sellers or buyers] of the [asset]. No [buyer or seller] of the [asset] has any particular advantage . . .’’ David M. Kreps, ‘‘A Course in Microeconomic Theory’’ Princeton University Press (1990), at 264 (describing the conditions of a perfectly competitive market.) When the transaction is novated to the CCP, market participants substitute the default risk of the CCP for that of the original counterparty. 412 See TMPG White Paper, supra note 21, at 32. 413 Duffie, supra note 186, at 15; DTCC October 2021 White Paper, supra note 203, at 1; IAWG Report, supra note 4. VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 a. U.S. Treasury Securities CCA Membership Requirements The Commission is proposing to amend Rule 17Ad–22(e)(18) to require any covered clearing agency that provides central counterparty services for transactions in U.S. Treasury securities to establish written policies and procedures reasonably designed to, as applicable, require that direct participants of a covered clearing agency submit all eligible secondary market U.S. Treasury securities transactions in which they enter for clearing at a covered clearing agency.414 As previously explained in section III.A.2 supra, an eligible secondary market transaction in U.S. Treasury securities would be defined to include: (1) repurchase agreements and reverse repurchase agreements in which one of the counterparties is a direct participant; (2) any purchases and sales entered into by a direct participant that is an interdealer broker, meaning if the direct participant of the covered clearing agency brings together multiple buyers and sellers using a trading facility (such as a limit order book) and is a counterparty to both the buyer and seller in two separate transactions; (3) any purchases and sales of U.S. Treasury securities between a direct participant and a counterparty that is either a registered broker-dealer, government securities dealer, or government securities broker; a hedge fund; 415 or an account at a registered broker-dealer, government securities dealer, or government securities broker where such account may borrow an amount in excess of one-half of the net value of the account or may have gross notional exposure of the transactions in the account that is more than twice the net value of the account.416 However, any transaction (both cash transactions 414 See supra section III.A. the purpose of the proposed rule, a hedge fund is defined as any private fund (other than a securitized asset fund): (a) with respect to which one or more investment advisers (or related persons of investment advisers) may be paid a performance fee or allocation calculated by taking into account unrealized gains (other than a fee or allocation the calculation of which may take into account unrealized gains solely for the purpose of reducing such fee or allocation to reflect net unrealized losses); (b) that may borrow an amount in excess of one-half of its net asset value (including any committed capital) or may have gross notional exposure in excess of twice its net asset value (including any committed capital); or (c) that may sell securities or other assets short or enter into similar transactions (other than for the purpose of hedging currency exposure or managing duration). This definition of a hedge fund is consistent with the Commission’s definition of a hedge fund in Form PF. See section III.A.2.b (Other Cash Transactions), supra. 416 See section III.A.2.b (Other Cash Transactions), supra. 415 For PO 00000 Frm 00055 Fmt 4701 Sfmt 4702 64663 and repos) where the counterparty to the direct participant of the CCA is a central bank, sovereign entity, international financial institution, or a natural person would be excluded from the definition of an eligible secondary market transaction. The proposed amendment to Rule 17Ad–22(e)(18) would increase the fraction of secondary market U.S. Treasury securities transactions required to be submitted for clearing at a covered clearing agency. The Commission believes that this would result in achieving the benefits associated with an increased level of central clearing discussed in section IV.C.1 supra. i. Scope of the Membership Proposal A significant share of both cash and repo transactions in U.S. Treasury securities, including those of direct participants in a covered clearing agency, are not currently centrally cleared.417 The Commission believes that covered clearing agency members not centrally clearing cash or repo transactions in U.S. Treasury securities creates contagion risk to CCAs clearing and settling such transactions, as well as to the market as a whole and that this contagion risk can be ameliorated by centrally clearing such transactions. Currently, FICC, the only U.S. Treasury securities CCA, requires its direct participants to submit for central clearing their cash and repo transactions in U.S. Treasury securities with other members.418 However, FICC’s rules do not require its direct participants, such as IDBs, to submit either cash or repo transactions 419 with persons who are not FICC members for central clearing. The expanded scope of the Membership Proposal would reduce instances of ‘‘hybrid’’ clearing, where FICC lacks visibility on the bilaterally cleared component of a trade. As previously mentioned in section II.A.1 supra, trades cleared and settled outside of a CCP may not be subject to the same level of risk management associated with central clearing, which includes requirements for margin determined by a publicly disclosed method that applies objectively and uniformly to all members of the CCP, loss mutualization, and liquidity risk management.420 The Membership Proposal would not only result in the consistent and transparent application of risk management 417 See DTCC May 2021 White Paper, supra note 135, at 5; IAWG Report, supra note 4, at 6. 418 See note 101 supra. 419 With regard to Sponsored GC Repos, see note 102. 420 IAWG Report, supra note 4, at 30; G–30 Report, supra note 5. E:\FR\FM\25OCP2.SGM 25OCP2 64664 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules requirements to trades that are now bilaterally cleared but would also increase the CCA’s awareness of those trades, which it now lacks.421 ii. Application of the Membership Proposal to Repo Transactions The Commission proposes to require that all direct participants of a U.S. Treasury securities CCA submit for clearing all eligible secondary market transactions that are repurchase agreements or reverse repurchase agreements. As discussed in section IV.B.5, supra risk management practices in the bilateral clearance and settlement of repos are not uniform across market participants and are less transparent than analogous practices under central clearing.422 The benefits of central clearing— including the benefits of netting— increase with the fraction of total volume of similar transactions submitting for clearing at a CCP. Significant gaps persist in the current coverage of transaction data in U.S. Treasury repo.423 Nonetheless, the Commission understands that, among bilaterally settled repo, approximately half was centrally cleared as of 2021.424 Centrally cleared triparty repo is a relatively new service, and the proportion may be smaller. Thus, despite the volume of centrally cleared repo transactions as seen in Figure 10 above, and the development of services to encompass more types of repo transactions at FICC, the Commission understands the volume of repo not currently centrally cleared to be substantial. The requirement that all U.S. Treasury CCA members submit all eligible repurchase agreements for central clearing should increase the fraction of total volume of such transactions submitted for central clearing realizing the benefits described above in section IV.C.1 supra. In addition, because repo participants are 421 See supra note 258. Repo White Paper, supra note 123, at 422 TMPG 1. 423 IAWG Report, supra note 4, at 29. (‘‘Non-centrally cleared bilateral repo represents a significant portion of the Treasury market, roughly equal in size to centrally cleared repo.’’) (citing a 2015 pilot program by the U.S. Treasury Department); see also TMPG Repo White Paper, supra note 118, at 1; Katy Burne, ‘‘Future Proofing the Treasury Market,’’ BNY Mellon Aerial View, supra note 118, at 7 (noting that 63% of repo transactions remain non-centrally cleared according to Office of Financial Research data as of Sept. 10, 2021). khammond on DSKJM1Z7X2PROD with PROPOSALS2 424 Id. VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 generally large, sophisticated market players, the requirement for repo transactions will cover a set of market participants that already have built most of the necessary processes and infrastructure to comply with the rule. iii. Application of the Membership Proposal to Purchases and Sales of U.S. Treasury Securities As discussed above, 68 percent of cash market transactions in U.S. Treasury securities are not centrally cleared, and another 19 percent of such transactions are subject to so-called hybrid clearing.425 The Commission has identified certain categories of purchases and sales of U.S. Treasury securities that it believes should be part of the Membership Proposal, i.e., for which U.S. Treasury securities CCAs would be obligated to impose membership rules to require clearing of such transactions. The benefits of including these categories are described below. As with repurchase transactions, the general benefits of central clearing discussed in section IV.A, supra become greater as the fraction of total transaction volume that is centrally cleared increases. In other words, there are positive externalities associated with broader central clearing. However, unlike in the repo market, the Commission is not proposing that all cash market transactions completed with a FICC member be centrally cleared.426 The Commission understands the set of participants in U.S. Treasury securities cash markets to be far broader and more heterogeneous than in the repo markets. The cash market has many participants that trade in relatively small amounts, whereas the market for repo is dominated by larger, more sophisticated institutions. Although difficult to quantify precisely, the number of participants is one or more orders of magnitude greater in the cash market as compared with the repo market. Because the benefits increase with the number and size of transactions, whereas the costs have a large fixed component, extending the clearing mandate to institutions that are market participants in repo markets and a subset of the institutions that are 425 See supra note 21. G–30 report recommends an approach to clearing all of repo, and some cash trades. See generally G–30 Report, supra note 5. 426 The PO 00000 Frm 00056 Fmt 4701 Sfmt 4702 participants in cash markets may capture a large fraction of market activity while also capturing the most active market participants who may already have some ability to connect with the clearing agency and experience with central clearing. a. IDB Transactions The Commission proposes that all purchases and sales of U.S. Treasury securities entered into by a direct participant of a U.S. Treasury securities CCA and any counterparty, if the direct participant of the CCA brings together multiple buyers and sellers using a trading facility (such as a limit order book) and serves as a counterparty to both the purchaser and seller in two separate transactions executed on its platform, be subject to the Membership Proposal. This requirement would encompass the transactions of those entities serving as IDBs in the U.S. Treasury securities market, in that it would cover entities that are standing in the middle of transactions between two counterparties that execute a trade on the IDB’s platform.427 If adopted, the proposal will result in more central clearing of IDB trades. FICC Member IDBs do not take directional positions on the securities that trade on the IDB’s platform. Consequently, a requirement that FICC member IDBs clear all of their trades will give FICC better insight into the risk position of its clearing members though the elimination of the hybrid clearing transactions mentioned above. In contrast to other FICC members, FICC members that are also IDBs will be required to clear all of their cash trades (and repo, as described above). As described in the TMPG White Paper and in the recent G–30 report,428 IDBs act as central nodes in the system, in effect serving as clearing agencies without the regulatory structure of clearing agency. Furthermore, the netting benefits to IDBs, as described in section IV.c.1 supra are likely to be particularly high, because each transaction on an IDB is matched by a transaction on the other side. IDBs are sophisticated institutions that have experience managing the central clearing of trades as they already centrally clear all trades with other FICC members. 427 See supra section II.A.1 for further discussion of IDBs and their role in the cash market for U.S. Treasury securities. 428 See generally G–30 Report, supra note 5. E:\FR\FM\25OCP2.SGM 25OCP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules The configuration of counterparty risk presented by hybrid clearing allows FICC to manage the risks arising from the IDB–FICC member trade, but FICC cannot manage the risks arising from the IDB’s offsetting trade with its non-FICC member counterparty and the potential counterparty credit risk and settlement risk arising to the IDB from that trade.429 Thus, the IDB is not able to net all of its positions for clearing at FICC, and the IDB’s positions appear to FICC to be directional, which impacts the amount of margin that FICC collects for the visible leg of the ‘‘hybrid’’ transaction. This lack of visibility can increase risk during stress events, when margin requirements usually increase. Thus, FICC is indirectly exposed to the IDB’s non-centrally cleared leg of the hybrid clearing transaction, but it lacks the information to understand and manage its indirect exposure to this transaction. As a result, in the event that the nonFICC counterparty were to default to the IDB, causing stress to the IDB, that stress to the IDB could be transmitted to the CCP and potentially to the system as a whole.430 In particular, if the IDB’s nonFICC counterparty fails to settle a transaction that is subject to hybrid clearing, such an IDB may not be able to settle the corresponding transaction that has been cleared with FICC, which could lead the IDB to default. As part of its existing default management procedures, FICC could seek to mutualize its losses from the IDB’s default, which could in turn transmit stress to the market as a whole. The Commission has previously stated that membership requirements help to guard against defaults of any CCP member, as well to protect the CCP and the financial system as a whole from the risk that one member’s default could cause others to default, potentially including the CCP itself.431 Further, contagion stemming from a CCP member default could be problematic for the system as a whole, even if the health of the CCP is not implicated. This is so because the default could cause others to back away from participating in the market. This risk of decreased market participation could be particularly acute if the defaulting participant were an IDB, whose withdrawal from the market could jeopardize other market 429 See, e.g., TMPG White Paper, supra note 21, at 22 (noting that in a hybrid clearing arrangement, an ‘‘IDB’s rights and obligations towards the CCP are not offset and therefore the IDB is not in a net zero settlement position with respect to the CCP at settlement date.’’). 430 See DTCC May 2021 White Paper, supra note 135, at 5. 431 See supra note 7. VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 participants’ ability to access the market for on-the-run U.S. Treasury securities.432 And because IDBs facilitate a significant proportion of trading in on-the-run U.S. Treasury securities, that is, they form central nodes, such a withdrawal could have significant consequences for the market as a whole.433 The Membership Proposal would therefore help mitigate this risk by mandating that a U.S. Treasury securities CCA ensure its IDB members clear both sides of their transactions, thereby eliminating the various facets of potential contagion risk posed by so-called hybrid clearing. b. Other Cash Transactions The Commission has identified additional categories of cash transactions of U.S. Treasury securities to include in the membership requirements for a U.S Treasury securities CCA that it believes will provide the benefits of increased central clearing of U.S. Treasury securities transactions described above. First, the Commission is proposing that the definition of an eligible secondary market transaction includes those cash purchase and sale transactions in which the counterparty of the direct participant is a registered broker-dealer, government securities broker, or dealer.434 These entities, by definition, are engaged in the business of effecting transactions in securities for the account of others (for brokers) or for their own accounts (for dealers). Thus, these entities already are participating in securities markets and have identified mechanisms to clear and settle their transactions.435 More generally, many registered brokers and dealers are familiar with transacting through introducing brokers who pass their transactions to clearing brokers for clearing and settlement. Second, the Commission proposes that transactions between a direct participant and hedge funds be included in the Membership Proposal. This aspect of the proposal would employ a definition of a hedge fund consistent with that in Form PF.436 The proposed requirement seeks to reach funds that are leveraged and that 432 TMPG White Paper, supra note 21, at 32. id. 434 15 U.S.C. 78o(a) and 78o–5(a) (requirement to register) and 78c(4), (5), (43), and (44) (definitions). 435 See supra note 218 and referencing text describing several methods available to allow market participants to access CCP services through a FICC member. 436 See supra section III.A.2.b (Other Cash Transactions) for a discussion of the definition of hedge fund in the proposed rule and its consistency with that in Form PF Glossary of Terms. See also note 143. 433 See PO 00000 Frm 00057 Fmt 4701 Sfmt 4702 64665 may use trading strategies that involve derivatives, complex structured products, short selling, high turnover, and/or concentrated investments, which may, in turn, present more potential risk to a U.S. Treasury securities CCA through a form of the contagion risk discussed above. When discussing a proposal using a similar standard to define a hedge fund, the Commission recognized that strategies employed by hedge funds, in particular high levels of leverage ‘‘can increase the likelihood that the fund will experience stress or fail, and amplify the effects on financial markets.’’ 437 The Commission also stated that ‘‘significant hedge fund failures (whether caused by their investment positions or use of leverage or both) could result in material losses at the financial institutions that lend to them if collateral securing this lending is inadequate. These losses could have systemic implications if they require these financial institutions to scale back their lending efforts or other financing activities generally. The simultaneous failure of several similarly positioned hedge funds could create contagion through the financial markets if the failing funds liquidate their investment positions in parallel at fire-sale prices, thereby depressing the mark-to-market valuations of securities that may be widely held by other financial institutions and investors.’’ 438 Through the central clearing of transactions effected by funds and other leveraged accounts, the Commission expects to mitigate the risks attendant to a simultaneous failure of hedge funds or other similar market participants, thus reducing contagion. Third, the Commission proposes to include within the definition of an eligible secondary market transaction subject to the Membership Proposal any purchase and sale transaction between a direct participant of a U.S. Treasury securities CCA and an account at a registered broker-dealer, government securities dealer, or government securities broker that either may borrow an amount in excess of one-half of the net value of the account or may have gross notional exposure of the transactions in the account that is more than twice the net value of the account.439 As discussed above, the Commission believes that the inclusion of transactions with such accounts should allow the proposal to encompass transactions between direct participants of a U.S. Treasury securities CCA and a 437 See supra note 145. at 21. 439 See supra section III.A.2.b (Other Cash Transactions). 438 Id. E:\FR\FM\25OCP2.SGM 25OCP2 64666 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules prime brokerage account, which, based on the Commission’s supervisory knowledge, may hold assets of private funds and separately managed accounts and that may use leverage that poses a risk to U.S. Treasury securities CCA and the broader financial system similar to that of hedge funds as described above. Covering such accounts would also allow for inclusion of, for example, accounts used by family offices or separately managed accounts that may use strategies more similar to those of a hedge fund. c. Exclusions From the Membership Proposal khammond on DSKJM1Z7X2PROD with PROPOSALS2 The Commission is proposing to exclude certain otherwise eligible secondary market transactions in U.S. Treasury securities from the Membership Proposal. Recognizing the importance of U.S. Treasury securities not only to the financing of the United States government, but also their central role in the formulation and execution of monetary policy and other governmental functions, the Commission is proposing to exclude from the Membership Proposal any otherwise eligible secondary market transaction in U.S. Treasury securities between a direct participant of a U.S. Treasury securities CCA and a central bank.440 For similar reasons, the Commission is also proposing to exclude from the Membership Proposal otherwise eligible secondary market transactions in U.S. Treasury securities between a direct participant of a U.S. Treasury securities CCA and a sovereign entity or an international financial institution.441 Although the Commission believes that the benefits of central clearing are generally increasing in the fraction of total volume that is centrally cleared, it also believes that the Federal Reserve System should be free to choose the clearance and settlement mechanisms that are most appropriate to effectuating its policy objectives.442 Further, the Commission believes that the exclusion should extend to foreign central banks, sovereign entities and international financial institutions for reasons of 440 See supra section III.A.2.c.i for a discussion of the proposed definition of a central bank for the purposes of the rule. 441 See supra section III.A.2.c.i for a discussion of the proposed definition of sovereign entity and international financial institution. See also supra note 160. 442 See supra section III.A.2.c.i for a discussion of the activities of Federal Reserve Bank of New York’s open market operations conducted at the direction of the Federal Open Market Committee. See also section IV.B.2, supra. VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 international comity.443 In light of ongoing expectations that Federal Reserve Banks and agencies of the Federal government would not be subject to foreign regulatory requirements in their transactions in the sovereign debt of other nations, the Commission believes principles of international comity counsel in favor of exempting foreign central banks, sovereign authorities, and international institutions. The Commission also proposes to exclude transactions between U.S. Treasury CCA members and natural persons from the Membership Proposal. The Commission believes that natural persons generally transact in small volumes and would not present much, if any, contagion risk to a U.S. Treasury securities CCA and therefore, the benefits discussed above are unlikely to be important for these transactions. iv. Policies and Procedures Regarding Direct Participants’ Transactions The Commission is proposing Rule 17Ad–22(e)(18)(iv)(B) that would require that a U.S. Treasury securities CCA establish written policies and procedures to identify and monitor its direct participants’ required submission of transactions for clearing, including, at a minimum, addressing a direct participant’s failure to submit transactions. The Commission believes that such a requirement should help ensure that a U.S. Treasury securities CCA adopts policies and procedures directed at understanding whether and how its participants comply with the policies that will be adopted as part of the Membership Proposal requiring the submission of specified eligible secondary market transactions for clearing. Without such policies and procedures, it would be difficult for the CCA to assess if the direct participants are complying with the Membership Proposal. b. Other Changes to Covered Clearing Agency Standards The Commission believes that certain additional changes to its Covered Clearing Agency Standards that would apply only to U.S. Treasury securities CCAs are warranted to facilitate additional clearing. Such changes should help ensure that the U.S. Treasury securities CCA can continue to manage the risks arising from more transactions from additional indirect participants and to facilitate the increased use of central clearing and the accompanying benefits. These changes, by making central clearing more efficient for market participants, also create incentives for greater use of central clearing. i. Netting and Margin Practices for House and Customer Accounts The Commission is proposing amendments to Rule 17Ad–22(e)(6)(i) to require a U.S. Treasury securities CCA to establish, implement, maintain and enforce written policies and procedures reasonably designed to, as applicable, calculate, collect, and hold margin amounts from a direct participant for its proprietary U.S. Treasury securities positions, separately and independently from margin calculated and collected from that direct participant in connection with U.S. Treasury securities transactions by an indirect participant that relies on the services provided by the direct participant to access the covered clearing agency’s payment, clearing, or settlement facilities. Such changes should allow a U.S. Treasury securities CCA to better understand the source of potential risk arising from the U.S. Treasury securities transactions it clears and potentially further incentivize central clearing. In practice, at FICC, clearing a U.S. Treasury securities transaction between a direct participant and its customer, i.e., a dealer to client trade, would not result in separate collection of margin for the customer transaction. Except for transactions submitted under the FICC sponsored member program,444 FICC margins the transactions in the direct participant’s (i.e., the dealer’s) account on a net basis, allowing any of the trades for the participant’s own accounts to net against trades by the participant’s customers.445 Under the proposed amendments to Rule 17Ad–22(e)(6)(i), a U.S. Treasury securities CCA would be required to establish, implement, maintain and enforce written policies and procedures reasonably designed to, as applicable, calculate margin amounts for all transactions that a direct participant submits to the CCP on behalf of others, separately from the margin that is calculated for transactions that the direct participant submits on its own behalf. Such policies and procedures must also provide that margin collateralizing customer positions be collected separately from margin collateralizing a direct participant’s proprietary positions. Finally, the CCP would also be required to have policies and procedures reasonably designed to, 444 See 443 See id. for a discussion of the Commission’s belief in the principles of international comity. PO 00000 Frm 00058 Fmt 4701 Sfmt 4702 supra note 203. October 2021 White Paper, supra note 203, at 5–6. 445 DTCC E:\FR\FM\25OCP2.SGM 25OCP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules as applicable, ensure that any margin held for customers or other indirect participants of a member is held in an account separate from those of the direct participant. Because the proposed amendments to Rule 17Ad–22(e)(6)(i) would require separating positions in U.S. Treasury securities transactions of a direct participant in a U.S. Treasury securities CCA from those of customers or other indirect participants, the indirect participants’ positions, including those submitted outside of the sponsored member program, will no longer be netted against the direct participant’s positions. The indirect participants’ positions will be subject to the covered clearing agency’s risk management procedures, including collection of margin specific to those transactions. These changes should allow a U.S. Treasury securities CCA to better understand the source of potential risk arising from the U.S. Treasury securities transactions it clears. In addition, these changes should help avoid the risk of a disorderly default in the event of a direct participant default, in that FICC would be responsible for the central liquidation of the defaulting participant’s trades without directly impacting the trades of the participant’s customers or the margin posted for those trades. Moreover, the proposed amendments to Rule 17Ad–22(e)(6)(i) should result in dealer-to-customer trades gaining more benefits from central clearing. Because margin for a direct participant’s (i.e., a dealer’s) trades would be calculated, collected, and held separately and independently from those of an indirect participant, such as a customer, the direct participant’s trades with the indirect participant can be netted against the direct participant’s position vis-a`-vis other dealers, which is not currently the case.446 Holding margin amounts from a direct participant of a U.S Treasury securities CCA separately and independently from those of an indirect participant may reduce incentives for indirect participants to trade excessively in times of high volatility.447 Such incentives exist because the customers of a broker-dealer do not always bear the full cost of settlement risk for their trades. Broker-dealers incur costs in managing settlement risk with CCPs. Broker-dealers can recover the average cost of risk management from their customers. However, if a particular trade has above-average settlement risk, such as when market prices are unusually volatile, it is difficult for broker-dealers to pass along these higher costs to their customers because fees typically depend on factors other than those such as market volatility that impact settlement risk. Holding margin of indirect participants separately from direct participants should reduce any such incentives to trade more than they otherwise would if they bore the full cost of settlement risk for their trades. ii. Facilitating Access to U.S. Treasury Securities CCAs The various access models currently available to access central clearing in the U.S. Treasury securities market may not meet the needs of the many different types of market participants who transact in U.S. Treasury securities with the direct members of a U.S. Treasury Securities CCA. The proposed additional provision to Rule 17Ad– 22(e)(18)(iv)(C) requires a U.S. Treasury securities CCA to establish, implement, maintain, and enforce certain written policies and procedures regarding access to clearance and settlement services, which, while not prescribing specific methods of access, is intended to ensure that all U.S. Treasury security CCAs have appropriate means to facilitate access to clearance and settlement services in a manner suited to the needs of market participants, including indirect participants. Some market participants have commented on the current practice of tying clearing services to trading under the sponsored clearing model.448 Under this model, the decision to clear the trades of an indirect participant appears to be contingent on that indirect participant trading with the direct participant sponsoring the indirect member.449 If the indirect participant is a competitor of the sponsoring direct participant and the direct participant has discretion on which trades to clear, the indirect participant may have difficulty accessing clearing. The proposed rule would require the U.S. Treasury securities CCA to ensure appropriate means to facilitate access; for some current indirect participants this may imply direct membership (with a potential change in membership criteria); 450 alternatively, requiring something similar to a ‘‘done-away’’ 448 See FIA–PTG Whitepaper, supra note 220. id. at 7. 450 Accessing clearing through another party may lower costs, but market participants have commented that there may still be residual exposure should that counterparty default after the CCA has performed on its obligations. 449 See 446 Chicago Fed Insights, supra note 204, at 3. Sam Schulhofer-Wohl, Externalities in securities clearing and settlement: Should securities CCPs clear trades for everyone? (Fed. Res. Bank Chi. Working Paper No. 2021–02, 2021). 447 See VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 PO 00000 Frm 00059 Fmt 4701 Sfmt 4702 64667 clearing model may be another means of facilitating clearing. Other considerations relate to the services available through the sponsored clearing model. For example, buy-side participants, currently engage in both triparty and bilateral repo, across multiple tenors, and on either side (lending or borrowing) of the transaction. At present, it appears that FICC direct members may be able to decline to submit a trade for central clearing at their discretion.451 Thus some indirect participants who are unable to enter into a similar transaction using a different FICC direct member who is willing to submit the trade for central clearing would not be able to access central clearing under the current practice. The proposed rule would require FICC to create new policies and procedures to facilitate access to clearing for these participants. In addition, the proposal would require the CCA’s written policies and procedures be annually reviewed by the CCA’s board of directors to ensure that the CCA has appropriate means to facilitate access to clearance and settlement services of all eligible secondary market transactions in U.S. Treasury securities, including those of indirect participants. This review should help ensure that such policies regarding access to clearance and settlement services, including for indirect participants, are addressed at the most senior levels of the governance framework. The annual review ensures that such policies and procedures be reviewed periodically and potentially updated to address any changes in market conditions. c. Proposed Amendments to Rules 15c3–3 and 15c3–3a The proposed rules discussed above could cause a substantial increase in the margin broker-dealers must post to a U.S. Treasury securities CCA resulting from their customers’ cleared U.S. Treasury securities positions. Currently, Rules 15c3–3 and 15c3–3a do not permit broker-dealers to include a debit in the customer reserve formula equal to the amount of margin required and on deposit at a U.S. Treasury securities CCA. This is because no U.S. Treasury securities CCA has implemented rules and practices designed to segregate customer margin and limit it to being used solely to cover obligations of the broker-dealer’s customers. Therefore, increases in the amount of margin required to be deposited at a U.S. Treasury securities CCA as a result of the Membership Proposal would result 451 See E:\FR\FM\25OCP2.SGM supra section IV.B.3. 25OCP2 64668 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules in corresponding increases in the need to use broker-dealers’ cash and securities to meet these requirements. The proposed amendment to Rule 15c3–3a would permit, under certain conditions, margin required and on deposit at a U.S. Treasury securities CCA to be included as a debit item in the customer reserve formula. This new debit item would offset credit items in the Rule 15c3–3a formula and, thereby, free up resources that could be used to meet the margin requirements of a U.S. Treasury securities CCA. The proposed amendment would allow a customer’s broker to use customer funds to meet margin requirements at the CCP generated by the customer’s trades, lowering the cost of providing clearing services. As discussed further below, we expect these changes to allow more efficient use of margin for cleared trades relative to the baseline. This change, alone, could create incentives for greater use of central clearing, and thus could promote the benefits described in previous sections. 2. Costs The Commission has, where practicable, attempted to quantify the economic effects it expects may result from this proposal. In some cases, however, data needed to quantify these economic effects are not currently available or depends on the particular changes made to the U.S. Treasury securities CCA policies and procedures. As noted below, the Commission is unable to quantify certain economic effects and solicits comment, including estimates and data from interested parties, which could help inform the estimates of the economic effects of the proposal. khammond on DSKJM1Z7X2PROD with PROPOSALS2 a. Costs to FICC of the Membership Proposal The Commission believes that the direct costs of this proposal to the U.S. Treasury securities CCA, which are mostly in the form of new policies and procedures, are likely to be modest. This is because all but one of these proposals require the CCA to make certain changes to its policies and procedures. The other proposal amends Rule 15c3–3a to permit margin required and on deposit at a U.S. Treasury securities CCA to be included as a debit item in the customer reserve formula for broker-dealers, subject to the conditions discussed above. Proposed Rule 17Ad–22(e)(18)(iv) would require a U.S. Treasury securities CCA to establish, implement, maintain, and enforce written policies and VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 procedures, as discussed above.452 Because policies and procedures regarding the clearing of all eligible secondary market transactions entered into by a direct participant in a U.S. Treasury securities CCA are not currently required under existing Rule 17Ad–22, the Commission believes that the proposed Rule 17Ad–22(e)(18)(iv) may require a covered clearing agency to make substantial changes to its policies and procedures. The proposed rule amendment contains similar provisions to existing FICC rules, but would also impose additional requirements that do not appear in existing Rule 17Ad–22.453 As a result, the Commission believes that a U.S. Treasury securities CCA would incur burdens of reviewing and updating existing policies and procedures in order to comply with the provisions of proposed Rule 17Ad–22(e)(18)(iv) and, in some cases, may need to create new policies and procedures. The Commission preliminarily estimates that U.S. Treasury securities CCAs would incur an aggregate onetime cost of approximately $207,000 to create new policies and procedures.454 455 The proposed rule would also require ongoing monitoring and compliance activities with respect to the written policies and procedures 452 See supra section III.A.4 for a discussion of the requirement that a U.S. Treasury securities CCA establish written policies and procedures reasonably designed to, as applicable, identify and monitor its direct participants’ required submission of transactions for clearing, including, at a minimum, addressing a direct participant’s failure to submit transactions. See supra section III.B.2 for a discussion of the requirement that U.S. Treasury securities CCA establish, implement, maintain and enforce written policies and procedures reasonably designed to, as applicable, ensure that it has appropriate means to facilitate access to clearance and settlement services of all eligible secondary market transactions in U.S. Treasury securities, including those of indirect participants, which policies and procedures the U.S. Treasury securities CCA’s board of directors reviews annually. 453 See supra note 34 and accompanying text (discussing current FICC rules). 454 To monetize the internal costs, the Commission staff used data from SIFMA publications, modified by Commission staff to account for an 1800 hour work-year and multiplied by 5.35 (professionals) or 2.93 (office) to account for bonuses, firm size, employee benefits and overhead. See SIFMA, Management and Professional Earnings in the Security Industry—2013 (Oct. 7, 2013); SIFMA, Office Salaries in the Securities Industry— 2013 (Oct. 7, 2013). These figures have been adjusted for inflation using data published by the Bureau of Labor Statistics. 455 This figure was calculated as follows: Assistant General Counsel for 40 hours (at $518 per hour) + Compliance Attorney for 80 hours (at $406 per hour) + Computer Operations Manager for 20 hours (at $490 per hour) + Senior Risk Management Specialist for 40 hours (at $397 per hour) + Business Risk Analyst for 80 hours (at $305 per hour) = $103,280 × 2 respondent clearing agencies = $206,560. See infra section V.A. PO 00000 Frm 00060 Fmt 4701 Sfmt 4702 created in response to the proposed rule. The Commission preliminarily estimates that the ongoing activities required by proposed Rule 17Ad– 22(e)(18)(iv) would impose an aggregate ongoing cost on covered clearing agencies of approximately $61,000 per year.456 i. Costs Attendant to an Increase in CCLF This proposal will likely result in a significant increase in the volume of U.S. Treasury securities transactions submitted to clearing. As pointed out by the G–30 report, FICC differs qualitatively from other CCPs in that counterparty credit risks are relatively small but liquidity risks in the event of member defaults could be extraordinarily large.457 This is because net long positions generate liquidity obligations for FICC because, in the event of a member default, FICC would have to deliver cash in order to complete settlement of such positions with non-defaulting parties. Increased clearing volume of cash and repo transactions as a result of the proposed rule could increase FICC’s credit and liquidity exposure to its largest members including those members acting as sponsors of non-members. FICC is obligated by Commission rule to maintain liquidity resources to enable it to complete settlement in the event of a clearing member default of a Member.458 These resources include the CCLF in which Members will be required to hold and fund their deliveries to an insolvent clearing member up to a predetermined cap by entering into repo transactions with FICC until it completes the associated close-out. This facility allows clearing members to effectively manage their potential financing requirements with predetermined caps.459 As reported in the CPMI–IOSCO disclosure by FICC for Q2 of 2021, the combined liquidity commitment by clearing members to the FICC’s Capped Contingent Liquidity Facility (CCLF) was $82.5 billion for all repos and cash trades of U.S. Treasury and Agency securities. Since the inception of the CCLF in 2018, the CCLF has ranged in 456 This figure was calculated as follows: Compliance Attorney for 25 hours (at $518 per hour) + Business Risk Analyst for 40 hours (at $305 per hour + Senior Risk Management Specialist for 20 hours (at $397 per hour) = $30,290 × 2 respondent clearing agencies = $60,580. See infra section V.A. 457 G–30 Report, supra note 5, at 14. 458 See supra section IV.B.3. 459 FICC Disclosure Framework 2021 at 88, available at https://www.dtcc.com/-/media/Files/ Downloads/legal/policy-and-compliance/FICC_ Disclosure_Framework.pdf. E:\FR\FM\25OCP2.SGM 25OCP2 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules size from $82.5B to $108B.460 Commitments by bank-affiliated dealers to the CCLF count against regulatory liquidity requirements, including the Liquidity Coverage Ratio (LCR).461 The Commission understands that dealers affiliated with banks may satisfy their CCLF obligations using a guarantee from that affiliated bank but dealers not affiliated with banks may incur costs to obtain commitments to meet CCLF liquidity requirements. ii. Costs of the Membership Proposal in Terms of Increased Margining for Existing FICC Members As discussed above, the Commission recognizes that the proposal could cause an increase in the margin clearing members must post to a U.S. Treasury securities CCA resulting from the additional transactions that will be submitted for clearing as a result of the proposal. Although various SRO margin rules provide for the collection of margin for certain transactions in U.S. Treasury securities, the Commission understands that transactions between dealers and institutional customers are subject to a variable ‘‘good-faith’’ margin standard, which the Commission understands—based on its supervisory experience—can often result in fewer financial resources collected for margin exposures than those that would be collected if a CCP margin model, like the one used at FICC, were used.462 Mitigating the potential for higher margin requirements for transactions submitted for clearing at a U.S. Treasury securities CCA is the benefit of netting that results from additional centrally cleared transactions.463 As described in section IV.C.1 supra, this mitigant is likely to be especially significant in the case of IDB members. Also, substantially mitigating the costs for clearing members is the ability to rehypothecate customer margin, as described in section IV.C.2.d infra. b. Costs to Non-FICC Members as a Result of the Membership Proposal The Membership Proposal would require that all repo transactions with a direct participant be centrally cleared and that certain cash transactions with khammond on DSKJM1Z7X2PROD with PROPOSALS2 460 See supra section IV.B.3. is calculated as the ratio of High-Quality Liquid Assets (HQLA) divided by estimated total net cash outflow during a 30-day stress period. Because commitments by bank-affiliated dealers to the CCLF would increase the denominator of the ratio, a bank-affiliated dealer would have to increase HQLA to reach a required level of LCR. 462 See supra note 106. 463 See supra section IV.C.1 for a discussion of the benefits of multilateral netting expected to result from higher volumes of centrally cleared transactions. 461 LCR VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 64669 a direct participant to be centrally cleared. These costs will depend on the policies and procedures developed by the CCA, as discussed in sections IV.C.2.a infra and IV.C.2.d supra. As stated above, the Commission believes that these proposed amendments will increase central clearing in the U.S Treasury securities market. Transactions that are not currently submitted for central clearing but would be under the current proposed amendments would be subject to certain transaction, position, and other fees as determined by the U.S. Treasury securities CCA.464 Market participants who enter into eligible secondary market transactions with members of U.S. Treasury securities CCAs who do not have access to clearing may incur costs related to establishing the required relationships with a clearing member in order to submit the eligible transactions for clearing. These market participants may also incur additional costs related to the submission and management of collateral. It is possible that such market participants may seek alternative counterparties that are not U.S. Treasury securities CCA members in order to avoid incurring these costs. As discussed in the baseline, the majority of repo and cash transactions in the dealer-to-customer segment are not centrally cleared. This differentiates the U.S. Treasury securities market from the markets for swaps and for futures. There is currently some clearing of customer repo; the majority of this clearing is ‘‘done-with’’—the clearing broker and the counterparty are one and the same. However, in the swaps and futures markets, and in the equities market, clearing is ‘‘done-away’’— meaning that the clearing broker may be other than the trading counterparty. Market participants have identified costs with the done-with model. Market participants in the secondary market for U.S Treasury securities that would be required to be centrally cleared could incur direct costs for arranging legal agreements with every potential counterparty. Depending on the customer there may be a large number of such arrangements. There are indirect costs arising when a trading counterparty is a competitor. In this case, clearing risks leakage of information. Moreover, the pricing and offering of clearing services may be determined by forces other than the costs and benefits of the clearing relationship itself, such as the degree of competition between the counterparties. Other economic arrangements facilitating customer clearing are possible and may develop, as in other markets.465 One such arrangement is direct CCA membership. However, for smaller entities, CCA membership may not be economically viable, and for some entities, legal requirements may prevent outright membership. Another possibility is seeking out counterparties other than CCA members. The ‘‘done away’’ structure of clearing has worked effectively in other markets, and, if it were to develop, would significantly mitigate these costs. Some participants may not currently post collateral for cash clearing and may be now required to do so, depending on the form the clearing relationship takes. There may be costs associated with the transfer of collateral. An institutional investor self-managing its account would instruct its custodian to post collateral with the CCA on the execution date, and post a transaction in its internal accounting system showing the movement of collateral. The day after trade execution, the investor would oversee the return of collateral from FICC, with an attendant mark of a transaction on the investor’s internal accounting system. Similar steps would occur for an institutional investor trading through an investment adviser, though in this case the adviser might instruct the custodian and mark the transaction, depending on whether the adviser has custody. The institutional investor might also pay a wire fee associated with the transfer of collateral. Besides the costs of developing new contracts with counterparties to support central clearing, there will also be a cost to non-CCA members associated with margin, to the extent that more margin is required than in a bilateral agreement and to the extent that the margin was not simply included in the price quoted for the trade. This cost of margining is analogous to that borne by CCA members and is discussed further above. As a result of the proposed rule, a potential cost to money market fund participants that would face FICC as a counterparty is that the funds’ credit ratings could be affected if FICC becomes a substantially large counterparty of these participants, which could be interpreted by credit models and ratings methodologies as a heightened concentration risk factor. As concentration risk in a CCP is typically not viewed in the same way as concentration risk with a bilateral trading party, credit rating agencies may quickly adapt their methods to 464 The fee structure for FICC is described in its rulebook. See FICC Rules, supra note 47, at 307. 465 See FIA–PTG Whitepaper, supra note 220 (for a description of different client clearing models). PO 00000 Frm 00061 Fmt 4701 Sfmt 4702 E:\FR\FM\25OCP2.SGM 25OCP2 64670 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules distinguish the CCA from a conventional counterparty. The Commission also recognizes the risks associated with increased centralization of clearance and settlement activities. In particular, the Commission has previously noted that ‘‘[w]hile providing benefits to market participants, the concentration of these activities at a covered clearing agency implicitly exposes market participants to the risks faced by covered clearing agencies themselves, making risk management at covered clearing agencies a key element of systemic risk mitigation.’’ 466 As discussed previously, currently only FICC provides CCP services for U.S. Treasury securities transactions, including outright cash transactions and repos.467 Were FICC unable to provide its CCP services for any reason then this could have a broad and severe impact on the overall U.S. economy. The FSOC recognized this when it designated FICC as a systemically important financial market utility in 2012,468 which subjects it to heightened risk management requirements and additional regulatory supervision, by both its primary regulator and the Federal Reserve Board of Governors.469 c. Other Changes to Covered Clearing Agency Standards i. Netting and Margin Practices for House and Customer Accounts The proposed amendments to Rule 17Ad–22(e)(6)(i) require a U.S. Treasury securities CCA to establish, implement, maintain and enforce written policies and procedures reasonably designed to, as applicable, calculate, collect, and hold margin amounts from a direct participant for its proprietary U.S. Treasury securities positions, separately and independently from margin calculated and collected from that direct participant in connection with U.S. supra note 11. supra section I.C. 468 See note 17 supra. 469 Id. at 119. As the Commission has previously stated, ‘‘Congress recognized in the Clearing Supervision Act that the operation of multilateral payment, clearing or settlement activities may reduce risks for clearing participants and the broader financial system, while at the same time creating new risks that require multilateral payment, clearing or settlement activities to be well-designed and operated in a safe and sound manner. The Clearing Supervision Act is designed, in part, to provide a regulatory framework to help deal with such risk management issues, which is generally consistent with the Exchange Act requirement that clearing agencies be organized in a manner so as to facilitate prompt and accurate clearance and settlement, safeguard securities and funds and protect investors.’’ Clearing Agency Standards Proposing Release, supra note 7, 76 FR at 14474; see also 12 U.S.C. 5462(9), 5463(a)(2). Treasury securities transactions by an indirect participant that relies on the services provided by the direct participant to access the covered clearing agency’s payment, clearing, or settlement facilities.470 The proposed rule amendment contains similar provisions to existing FICC rules, specifically with respect to its Sponsored Member program, but would also impose additional requirements that do not appear in existing Rule 17Ad–22. As a result, the Commission believes that a U.S. Treasury securities CCA would incur burdens of reviewing and updating existing policies and procedures in order to comply with the proposed amendments to Rule 17Ad– 22(e)(6) and, in some cases, may need to create new policies and procedures.471 The Commission preliminarily estimates that U.S. Treasury securities CCAs would incur an aggregate onetime cost of approximately $106,850 to create new policies and procedures.472 The proposed rule would also require ongoing monitoring and compliance activities with respect to the written policies and procedures created in response to the proposed rule. The Commission preliminarily estimates that the ongoing activities required by proposed amendments to Rule 17Ad– 22(e)(6) would impose an aggregate ongoing cost on covered clearing agencies of approximately $60,580 per year.473 ii. Facilitating Access to U.S. Treasury Securities CCAs The proposed Rule 17Ad– 22(e)(18)(iv)(C) would require a U.S. Treasury securities CCA to establish, implement, maintain, and enforce written policies and procedures reasonably designed to, as applicable, ensure that it has appropriate means to facilitate access to clearance and settlement services of all eligible secondary market transactions in U.S. Treasury securities, including those of 466 See khammond on DSKJM1Z7X2PROD with PROPOSALS2 467 See VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 470 See supra section III.B.1. supra note 62 and accompanying text (discussing existing FICC rules for sponsored member program). 472 This figure was calculated as follows: Assistant General Counsel for 20 hours (at $518 per hour) + Compliance Attorney for 40 hours (at $406 per hour) + Computer Operations Manager for 12 hours (at $490 per hour) + Senior Programmer for 20 hours (at $368 per hour) + Senior Risk Management Specialist for 25 hours (at $397 per hour) + Senior Business Analyst for 12 hours (at $305 per hour) = $53,425 × 2 respondent clearing agencies = $106,850. See infra section V.B. 473 This figure was calculated as follows: Compliance Attorney for 25 hours (at $406 per hour) + Business Risk Analyst for 40 hours (at $305 per hour) + Senior Risk Management Specialist for 20 hours (at $397 per hour) = $30,290 × 2 respondent clearing agencies = $60,580. See infra section V.B. 471 See PO 00000 Frm 00062 Fmt 4701 Sfmt 4702 indirect participants, which policies and procedures the U.S. Treasury securities CCA’s board of directors reviews annually. The proposed rule would require a U.S. Treasury securities CCA to establish, implement, maintain, and enforce written policies and procedures. The Commission believes that a respondent U.S. Treasury securities CCA would incur burdens of reviewing and updating existing policies and procedures and would need to create new policies and procedures in order to comply with the provisions of proposed Rule 17Ad–22(e)(18)(iv)(C). These costs are included in the costs of creating new policies and procedures associated with Rule 17Ad–22(e) discussed above.474 d. Proposed Amendments to Rules 15c3–3 and 15c3–3a The proposed amendment to Rule 15c3–3a would permit, under certain conditions, margin required and on deposit at a U.S. Treasury securities CCA to be included as a debit item in the customer reserve formula. This new debit item would offset credit items in the Rule 15c3–3a formula and, thereby, free up resources that could be used to meet the margin requirements of a U.S. Treasury securities CCA. The proposed amendment would allow a customer’s broker to use customer funds to meet margin requirements at the CCP generated by the customer’s trades, lowering the cost of providing clearing services. Broker-dealers may incur costs from updating procedures and systems to be able to use customer funds to meet customer margin requirements. However, the proposed rule does not require that the broker-dealer does so. 3. Effect on Efficiency, Competition, and Capital Formation a. Efficiency i. Price Transparency As mentioned in section II.A.1 supra, the majority of trading in on-the-run U.S. Treasury securities in the interdealer market occurs on electronic platforms operated by IDBs that bring together buyers and sellers anonymously using order books or other trading facilities supported by advanced electronic trading technology. These platforms are usually run independently in the sense that there is no centralized market for price discovery or even a ‘‘single virtual market with multiple points of entry’’.475 As a result, pre474 See supra section IV.C.2. O’Hara and Mao Ye, ‘‘Is Market Fragmentation Harming Market Quality,’’ 100 J. Fin. Econ. 459 (2011), available at https://doi.org/ 10.1016/j.jfineco.2011.02.006. 475 Mauren E:\FR\FM\25OCP2.SGM 25OCP2 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 trade transparency is suboptimal: quotations and prices coming from and going to an IDB may be distributed unevenly to market participants who have a relationship with that IDB. Efficiency, which measures the degree to which prices can quickly respond to relevant information, is impaired because of this market fragmentation; some areas of the market may not reflect information passed on by prices in other sectors. Central clearing can promote price discovery in several ways: first, the clearing agency itself becomes a source of data; 476 and second, the accessibility of central clearing could promote all-to-all trading as previously mentioned in section III.A.3 supra, which would reduce the obstacles to information flow that come from fragmentation.477 ii. Operational and Balance Sheet Efficiency Greater use of central clearing could also increase the operational efficiency of trading U.S. Treasury securities. Central clearing replaces a complex web of bilateral clearing relationships with a single relationship to the CCP. In that sense, the complex network of relationships that a market participant may have for bilaterally clearing U.S. Treasury securities would shrink, with attendant reductions in paperwork, administrative costs, and operational risk. Central clearing also enhances balance sheet efficiency, allowing firms to put capital to more productive uses. The proposed amendment to Rule 15c3– 3a would permit, under certain conditions, margin required and on deposit at a U.S. Treasury securities CCA to be included as a debit item in the customer reserve formula. This new debit item would offset credit items in the Rule 15c3–3a formula and, thereby, free up resources that could be used to meet the margin requirements of a U.S. Treasury securities CCA. The proposed amendment would allow a customer’s broker to use customer funds to meet margin requirements at the CCP generated by the customer’s trades, lowering the cost of providing clearing services. Though these lower costs may or may not be fully passed on to end clients, in a competitive environment the Commission expects that at least some of these savings will pass-through to customers. b. Competition With respect to the market for execution of U.S. Treasury securities by 476 FIA–PTG 477 See Whitepaper, supra note 220. supra note 190. VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 broker-dealers, increased central clearing can enhance the ability of smaller participants to compete with incumbent dealers.478 Similarly, decreased counterparty credit risk—and potentially lower costs for intermediation—could result in narrower spreads, thereby enhancing market quality.479 While estimating this quantitatively is difficult, research has demonstrated lower costs associated with central clearing in other settings.480 Moreover, increased accessibility of central clearing in U.S. Treasury securities markets could support all-to-all trading, which would further improve competitive pricing, market structure and resiliency.481 The U.S. Treasury securities intermediation business is also capitalintensive, due to strict regulatory requirements around capital and the sheer size of the U.S. Treasury securities markets. These requirements represent a barrier to entry to new participants. The proposed amendments to Rule 15c3–3a, which would permit margin required and on deposit at a U.S. Treasury securities CCA to be included as a debit item in the customer reserve formula, in addition to the natural capital efficiencies of margin offsetting provided by clearing, would provide some capital relief for smaller brokerdealers. This may enable them to better compete in this market or enter the market altogether. With respect to the market for U.S. Treasury securities clearing services, currently there is a single provider of central clearing. The proposed amendments would likely engender indirect costs associated with increased levels of central clearing in the secondary market for U.S. Treasury securities. Generally, the economic characteristics of a financial market infrastructure (‘‘FMI’’), including clearing agencies, include specialization, economies of scale, barriers to entry, and a limited number of competitors.482 483 The Commission 478 See G–30 Report, supra note 5, at 13. id. 480 See Y.C. Loon and Z.K. Zhong, The Impact of Central Clearing on Counterparty Risk, Liquidity, and Trading: Evidence from the Credit Default Swap Market, 112(1) JOURNAL OF FINANCIAL ECONOMICS 91–115 (Apr. 2014). 481 See IAWG Report, supra note 4, at 30; Duffie, supra note 186, at 16; G–30 Report, supra note 5, at 13. 482 See Committee on Payment and Settlement Systems and Technical Committee of the International Organization of Securities Commissions (‘‘CPSS–IOSCO’’), Principles for Financial Market Infrastructures (Apr. 16, 2012), available at https://www.bis.org/publ/cpss101a.pdf (‘‘PFMI Report’’). 483 See generally Nadia Linciano, Giovanni Siciliano & Gianfranco Trovatore, The Clearing and 479 See PO 00000 Frm 00063 Fmt 4701 Sfmt 4702 64671 noted in its proposal of rules applicable to covered clearing agencies that such characteristics, coupled with the particulars of an FMI’s legal mandate could result in market power, leading to lower levels of service, higher prices, and under-investment in risk management systems.484 Market power may also affect the allocation of benefits and costs flowing from these proposed rules, namely the extent to which these benefits and costs are passed through by FICC to participants.485 The centralization of clearing activities for a particular class of transaction in a single clearing agency may also result in a reduction in its incentives to innovate and to invest in the development of appropriate risk management practices on an ongoing basis. Finally, the scope of the rule does not preclude members of FICC from strategically renouncing membership if they assess that the benefits of maintaining their ability to trade without centrally clearing their trades exceed their costs of surrendering their membership with the CCA. If this scenario materializes for a number of FICC members, then there will be costs to the overall market. Those costs could be the product of a smaller number of clearing members competing in the market for clearing services. Costs could also manifest themselves as increased risk from non-centrally cleared transactions and a reduction in the margin, operational and capital efficiencies related to central clearing. Further, if the number of clearing members falls, then the exposure of FICC to its largest clearing member could increase resulting in additional increases in the required size of the CCLF. c. Capital Formation The proposed rule may encourage private-sector capital formation. U.S. Treasury securities form a benchmark Settlement Industry: Structure Competition and Regulatory Issues (Italian Secs. & Exch. Comm’n Research Paper 58, May 2005), available at https:// www.ssrn.com/abstract=777508 (concluding in part that the core services offered by the clearance and settlement industry tend toward natural monopolies because the industry can be characterized as a network industry, where consumers buy systems rather than single goods, consumption externalities exist, costs lock-in consumers once they choose a system, and production improves with economies of scale). 484 See CCA Standards Proposing Release, supra note 7. 485 For a discussion of cost pass-through, including when there lacks competition, see for example, UK Competition and Markets Authority, Cost pass-through: theory, measurement and policy implications (June 17, 2014), available at https:// www.gov.uk/government/publications/cost-passthrough-theory-measurement-and-policyimplications. E:\FR\FM\25OCP2.SGM 25OCP2 64672 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules securities broker, government securities dealer, hedge fund, or account at a registered broker-dealer, government securities dealer, or government securities broker where such account may borrow an amount in excess of onehalf of its net assets or may have gross notional exposure in excess of twice its net assets.489 As discussed in section IV.C.1.a supra, the benefits arising from cash clearing for IDB members are particularly high. Hybrid clearing creates unique issues for FICC because FICC is able to manage the risks arising from the IDB–FICC member trade, but it lacks any knowledge of the IDB’s offsetting trade with its other counterparty and the potential exposure arising to the IDB from that trade, leaving the IDB, from FICC’s D. Reasonable Alternatives perspective, as apparently having a 1. Require U.S. Treasury Securities directional exposure despite the nonCCAs to Have Policies and Procedures centrally cleared trade that would leave Requiring Only IDB Clearing Members the IDB flat.490 This lack of knowledge to Submit U.S. Treasury Securities could prevent FICC from ‘‘accurately Trades With Non-Members for Central identifying, measuring and managing its Clearing direct and indirect counterparty risk One alternative would be to narrow exposure and can affect its decisionthe scope of the Membership Proposal making,’’ 491 which in turn potentially as it pertains to cash transactions in the increases the likelihood that a default of secondary market for U.S. Treasury an IDB member could in turn harm the securities. The narrower definition of CCP or the system as a whole. As noted eligible secondary market transaction above, the Commission has previously contemplated in this alternative would stated that membership requirements include (1) a repurchase or reverse help to guard against defaults of any repurchase agreement collateralized by CCP member, as well to protect the CCP U.S. Treasury securities, in which one and the financial system as a whole of the counterparties is a direct from the risk that one member’s default participant; or (2) a purchase or sale could cause others to default, between a direct participant and any potentially including the CCP itself. counterparty, if the direct participant of Further, contagion stemming from a the covered clearing agency (A) brings CCP member default could be together multiple buyers and sellers problematic for the system as a whole, using a trading facility (such as a limit even if the health of the CCP is not order book) and (B) is a counterparty to implicated. The default could cause both the buyer and seller in two others to back away from participating separate transactions.488 This alternative in the market, particularly if the differs from the proposal above by defaulting participant was an IDB, omitting from the definition of eligible whose withdrawal from the market transactions those cash transactions could jeopardize other market between a direct participant and a participants’ ability to access the market registered broker-dealer, government for U.S. Treasury securities.492 This alternative would, with a more 486 Standard textbook treatments of finance use limited scope, move a large portion of the U.S. Treasury rate of return as a benchmark in computing the cost of capital for private companies. secondary market transactions in U.S. Treasury securities that are not The link between interest rates of government debt and corporate debt is a long-standing feature of the currently centrally cleared into central khammond on DSKJM1Z7X2PROD with PROPOSALS2 for fixed income and even equity rates of return, and the proposed rule could lower the cost of capital for privatesector issuers.486 If the yield required by investors to hold U.S. Treasury securities reflects, in part, the risks associated with the buying and selling of U.S. Treasury securities, and increased central clearing of these transactions lowers those risks, then the proposed rule may put downward pressure on required yields. Research has shown that investors value both the safety and liquidity of U.S. Treasury securities. Because prices in the primary market both reflect and are driven by prices in the secondary market, liquidity could be one of the factors translating into lower rates of borrowing costs for US taxpayers.487 financial landscape. See, e.g., Benjamin Friedman, Implications of Government Deficits for Interest Rates, Equity Returns, and Corporate Financing, Fin. Corp. Cap. Form. (1986). See also Philippon, The Bond Market’s Q, Q.J. Econ. (Aug. 2009) (noting a link between the level of interest rates and investment). 487 See Arvind Krishnamurthy & Annette VissingJorgensen, The Aggregate Demand for Treasury Debt, 120 J. Pol. Econ. (Apr. 2012). 488 Such direct participants are referred to in this section and the alternatives below as ‘‘IDBs’’. See supra section III.A.2.b (IDB Transactions). VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 clearing.493 The degree of central clearing would still allow for a partial picture of concentrated positions to the clearing agency. That said, there would be a limited benefit in terms of operational and balance sheet efficiency, and the benefits other than those specifically related to the IDB would be greatly reduced. Specifically, the reduced scope of this alternative would not capture types of participants that are usually leveraged such as hedge funds. As discussed above, funds that are leveraged present potential risk to a U.S. Treasury securities CCA.494 As a result of not including transactions with hedge funds and levered accounts, the Commission believes that benefits of the rule with respect to financial stability, margin offsetting and visibility of risk would be curtailed. This alternative could also include within the definition of eligible secondary market transactions a purchase or sale between a direct participant and a registered brokerdealer, government securities broker, or government securities dealer. Including these transactions within the scope of eligible transactions would increase the benefits discussed above associated with an increased proportion of transactions being centrally cleared.495 However, as discussed above, the costs associated with including these transactions within the scope of eligible transactions may be less than those transactions not included by this alternative.496 2. Require U.S. Treasury Securities CCAs To Have Policies and Procedures Requiring the Submission of All Repurchase Agreements With No Change to Requirements for the Submission of Cash Transactions The Commission could exclude the cash U.S. Treasury securities market from the proposed rule and instead only require covered clearing agencies have policies and procedures reasonably designed to require that direct participants of the covered clearing agency submit for central clearing all transactions in U.S. Treasury repo transactions into which it enters. 493 See 489 See supra section III.A.2.b for a discussion of cash transactions included in the definition of eligible transactions. 490 See TMPG White Paper, supra note 20 at 22 (noting that in a hybrid clearing arrangement, an ‘‘IDB’s rights and obligations vis-a-vis the CCP are not offset and therefore the IDB is not in a net zero settlement position with respect to the CCP at settlement date.’’). 491 See TMPG White Paper, supra note 21, at 27. 492 See TMPG White Paper, supra note 21, at 32. PO 00000 Frm 00064 Fmt 4701 Sfmt 4702 494 See id. supra section IV.C.1.III(b). See also note 145. 495 See supra section IV.A for a discussion of the benefits associated with increased central clearing. 496 See supra section IV.C.1.a.III(b) for a discussion of the familiarity of many registered brokers with methods of central clearing of U.S. Treasury securities transactions. See also section IV.C.2.b for a discussion of the costs to non-FICC members, including the entities included within this alternative, of the Membership proposal. E:\FR\FM\25OCP2.SGM 25OCP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules The Commission understands that there is a likely benefit of additional balance sheet capacity that flow from clearing repo transactions in U.S. Treasury securities that might not occur with the clearing of cash transactions. Multilateral netting can reduce the amount of balance sheet required for intermediation of repo and could enhance dealer capacity to make markets during normal times and stress events, because existing bank capital and leverage requirements recognize the risk-reducing effects of multilateral netting of trades that CCP clearing accomplishes.497 The upfront costs of adjusting to the rule would be lower under this alternative than under the current proposal, as a result of a smaller sample of participants and activities in scope and also the current level of interconnectedness among those participants. As previously mentioned, the number of participants in the U.S. Treasury repo market is significantly smaller than the number of participants in the cash market and is composed of sophisticated investors who have already incurred the costs of building the ability to novate transactions to the CCP. Infrastructure for Sponsored Clearing already exists, so that processing changes should be less than in other more comprehensive alternatives and costs would be concentrated on the implementation of similar agreements at a larger scale. Nevertheless, excluding the cash U.S. Treasury securities market from the rule proposal would omit the largest sector of the U.S. Treasury market, both in terms of activity and number of participants. This alternative would yield smaller benefits in the areas of financial stability, risk visibility, margin offset efficiencies, and capital requirement reductions. The Commission believes that, given the scale-intensive nature of clearing, there are economies of scale that can only be realized when a larger number of financial market participants clear their U.S. Treasury securities cash trades. Moreover, certain leveraged and opportunistic market participants that are net contributors of risk to the U.S. Treasury security market, such as hedge funds and leveraged accounts in brokerdealers, would be exempt from the clearing requirement under this alternative. 497 See IAWG Report at 30, supra note 4; Liang & Parkinson, supra note 32, at 9; Duffie, supra note 186, at 16–17. VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 3. Include All Cash Transactions Within the Scope of the Membership Proposal With Exceptions for Central Banks, Sovereign Entities, International Financial Institutions, and Natural Persons The Commission could require covered clearing agencies to have policies and procedures reasonably designed to require that direct participants of the covered clearing agency submit for central clearing all cash and repo transactions in U.S. Treasury securities into which they enter, except for natural persons, central banks, sovereign entities and international finance institutions. This policy option would include cash transactions between direct participants of a U.S. Treasury securities CCA and any counterparty (including those included in the Membership Proposal) except for those that fall within one of the aforementioned exceptions. This alternative would capture more of the potential benefits and positive externalities that result from increased central clearing, more closely resembling the assumptions and estimated benefits of Fleming and Keane’s calculations 498 on clearing benefits. By virtue of requiring all repo and most cash transactions to be centrally cleared, the alternative goes the furthest in solving the underlying collective action problem whereby some participants may find it optimal to not participate in central clearing, reducing the benefits that may accrue to the market as a whole. As discussed above, the benefits of clearing are scale-dependent, so that a more comprehensive clearing directive would result in larger positive externalities (e.g., lower contagion risk, less financial network complexity) and larger economies of scale (e.g., larger margin offsets) for the U.S. Treasury securities market. Another benefit of this alternative would be an enhanced ability of FICC (and, by extension, regulatory agencies) to observe the dynamics and manage the risks in the U.S. Treasury securities markets. Nevertheless, there are compelling reasons for the exclusions that the proposal makes for a specific sample of marker participants. Buy-side participants in the U.S. Treasury securities markets that do not take on any leverage, or take less than one-half their assets in leverage, such as the 498 Michael Fleming & Frank Keane, Staff Report No. 964: Netting Efficiencies of Marketwide Central Clearing, Federal Reserve Bank of New York (Apr. 2021), available at https://www.newyorkfed.org/ medialibrary/media/research/staff_reports/ sr964.pdf. PO 00000 Frm 00065 Fmt 4701 Sfmt 4702 64673 majority of bond mutual funds, typically have lower daily turnover. As a result of their lower turnover and subsequent lower volume, they typically do not have the existing infrastructure to readily connect to the CCP, making their up-front costs significantly higher than for other participants. This implies that the costs of including these participants in the Membership Proposal are likely higher than those of participants included in the proposal and the benefits smaller. 4. Require U.S. Treasury Securities CCAs To Change CCA Access Provisions and Netting and Margin Practices for House and Customer Accounts and Rule 15c3–3 The Commission could, as an alternative to the selected policy choice, only amend Rules 15c3–3, 17Ad– 22(e)(6)(i), and 17Ad–22(e)(18)(iv)(C). This alternative would not include implementing changes related to the Membership Proposal, as set forth in Proposed Rule 17Ad–22(e)(18)(iv)(A) and (B). This alternative would require a U.S. Treasury securities CCA to establish, implement, maintain and enforce certain written policies and procedures that would be reasonably designed to, as applicable, calculate, collect, and hold margin amounts from a direct participant for its proprietary U.S. Treasury securities positions separately and independently from margin that would be held for an indirect participant. Specifically, the requirement to separately and independently hold an indirect participant’s margin would apply to margin calculated by and collected from a direct participant in connection with its U.S. Treasury securities transactions with an indirect participant that relies on the direct participant’s services to access the covered clearing agency’s payment, clearing, or settlement facilities. The alternative would also include changes to 17Ad–22(e)(18)(iv)(C), directing FICC to, as more fully described above, have policies and procedures, to be annually reviewed by its board of directors, to have appropriate means to facilitate access to clearing all eligible secondary market transactions in U.S. Treasury securities. This alternative would also include changes to Rule 15c3–3a, to permit margin required and on deposit at a U.S. Treasury securities CCA to be included as a debit item in the customer reserve formula, subject to the conditions discussed below. This new debit item would offset credit items in the Rule 15c3–3a formula and, thereby, free up E:\FR\FM\25OCP2.SGM 25OCP2 64674 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 resources that could be used to meet the margin requirements of a U.S. Treasury securities CCA. The new debit item would be reported on a newly created Item 15 of the Rule 15c3–3a reserve formula. As discussed in section IV.C.2.b, supra, the proposed amendments to Rule 17Ad–22(e)(6)(i) should produce benefits for dealer-to-customer trades. Because margin for a direct participant’s (i.e., a dealer’s) trades that have been novated to the CCP would be calculated, collected, and held separately and independently from those of an indirect participant, such as a customer, the direct participant’s trades with the indirect participant that have been novated to the CCP would be able to be netted against the direct participant’s position with other dealers. Such netting is not currently available. In summary, the Commission expects changes in the customer reserve formula and expanded margin offset possibilities to allow more efficient use of margin for cleared trades relative to current market practice. Nonetheless, the Commission believes that this alternative is not preferable to the proposal. Although this alternative may result in additional central clearing of U.S Treasury security trades by reducing some of the impediments to central clearing, the benefits are likely to be less in the absence of the membership proposal. As previously explained, the benefits of clearing are proportional to the number of participants submitting their trades to the CCP: the higher the number of participants, the greater the benefits of central clearing. Absent a coordinated effort that induces participants to incur short-term, private costs in order to obtain a larger, longer-term collective benefit, which the Membership Proposal provides, the Commission believes that the number of participants that will voluntarily make the necessary changes to clear their transactions would be lower under this alternative. E. Request for Comment The Commission requests comment on all aspects of this initial economic analysis, including the potential benefits and costs, including all effects on efficiency, competition, and capital formation; and reasonable alternatives to the proposal. We request and encourage any interested person to submit comments regarding the proposal, our analysis of the potential effects of the proposal, and other matters that may have an effect on the proposal. We request that commenters identify sources of data and information as well as provide data and information VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 to assist us in analyzing the economic consequences of the proposal. We also are interested in comments on the qualitative benefits and costs the Commission has identified and any benefits and costs the Commission may have overlooked. In addition to our general request for comments on the economic analysis associated with the proposal, the Commission requests specific comment on certain aspects of the proposal: Baseline • The Commission seeks input and supporting data on the size of the U.S. Treasury securities market as a whole and additional data on the proportion of cash and repo U.S. Treasury transactions that U.S. Treasury securities CCA members clear and settle with the CCP and those that they clear and settle bilaterally. In particular, what proportion of dealer to client and dealer-to-dealer transactions are cleared? • The Commission seeks data on U.S. Treasury securities transactions executed by banks and other institutions that are not members of FINRA and therefore do not have a regulatory requirement to report their executed trades to TRACE. • Does the current menu of clearing offerings, including Sponsored Clearing, provide enough options for individuals and institutions who want to participate in the U.S. Treasury Securities market? • What role does the market for ‘‘when-issued’’ U.S. Treasury securities that trade prior to and on the day of the auction currently play in risk mitigation and hedging strategies of primary dealers? What role does this market play in price discovery? • Should the Commission include in the scope of eligible secondary market transactions when-issued transactions in U.S. Treasury securities that take place prior to and on the day of the auction for those securities? What are the potential benefits and costs of including in the scope of eligible secondary market transaction preauction and auction day when-issued transactions along with post-auction when-issued transactions? Is there a greater contagion risk from fails-todeliver if the proposal’s scope of eligible secondary market transactions does not include ‘‘when-issued’’ U.S. Treasury securities transactions that take place prior to and on the day of the auction? Economic Effects, Including Impact of Efficiency, Competition, and Capital Formation • Are there any additional costs and benefits associated with the proposed PO 00000 Frm 00066 Fmt 4701 Sfmt 4702 amendments that should be included in the analysis? What additional materials and data should be included for estimating these costs and benefits? • Does the economic analysis capture the relative risks posed by various types of market participants to the functioning of U.S. Treasury market? • Will U.S. Treasury securities CCAs face additional costs to managing the risk of higher volumes and increased heterogeneity of entities that will result from the Membership proposal? • Who requests sponsored membership? Is it the asset owner or the investment manager? If the asset owner, how does the adviser support sponsored membership with multiple sponsoring members? If the investment manager sets this up, how does the asset owner change investment managers and is more lead time required to set up a new account with a new investment manager? Who pays for all this and what does it cost? • What are the operational costs to asset owners and to advisers to centrally clear cash U.S. Treasury securities? Will there be benefits to asset owners or to advisers? Will operational risk for asset owners or adviser increase or decrease and why? • What are the operational costs to asset owners and to advisers to centrally clear repos? Will there be benefits to asset owners or to advisers? Will operational risk for asset owners or adviser increase or decrease and why? • What would be the potential impact to FICC’s CCLF and its participants’ obligations under that requirement? What costs may participants incur as a result of changes to their obligations under that requirement? Would these costs vary depending on whether or not the entity was affiliated with a bank? Would they vary based on the size of the entity? • Market participants in the secondary market for U.S Treasury securities that would be required to be centrally cleared could incur direct costs for arranging legal agreements with every potential counterparty. Depending on the customer there may be a large number of such arrangements. How much does it cost to arrange such legal agreements and how many such agreements might a market participant need to arrange? • Given the potential effects on competition of the proposal if adopted, should FICC be required to review its fee structure as part of its review required by Rule 17Ad–22(e)(18)(iv)? Within what time frame should this review take place? • Are there any additional impacts on dealer competition that should be E:\FR\FM\25OCP2.SGM 25OCP2 64675 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules included in the analysis? The Commission seeks information and data on dealer concentration over time. In particular, have there been any changes in dealer concentration in recent years? Reasonable Alternatives • The Commission seeks input on the costs, benefits and feasibility of the alternatives to the proposed rule described above. Are there any additional benefits or costs that should be included in the analysis of the reasonable alternatives considered? V. Paperwork Reduction Act A. Proposed Changes to Covered Clearing Agency Standards The proposed amendments to Rule 17Ad–22(e) contain ‘‘collection of information’’ requirements within the meaning of the PRA.499 The Commission is submitting the proposed collection of information to the Office of Management and Budget (‘‘OMB’’) for review in accordance with the PRA. For the proposed amendments to Rule 17Ad–22(e), the title of the existing information collection is ‘‘Clearing Agency Standards for Operation and Governance’’ (OMB Control No. 3235– 0695), and that collection would be revised by the changes in this proposal, if adopted. An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a currently valid OMB control number. Respondents under this rule are Treasury securities CCAs, of which there is currently one. The Commission anticipates that one additional entity A. Proposed Amendment to Rule 17Ad– 22(e)(6) The purpose of this collection of information is to enable a covered clearing agency for Treasury securities to better understand and manage the risks presented by transactions that a direct participant may submit on behalf of its customer, i.e., an indirect participant which relies upon the direct participant to access the covered clearing agency. The collection is mandatory. To the extent that the Commission receives confidential information pursuant to this collection of information, such information would be kept confidential subject to the provisions of applicable law.500 The proposed amendments to Rule 17Ad–22(e)(6) would require a Treasury securities CCA to establish, implement, maintain, and enforce written policies and procedures. The proposed rule amendment contains similar provisions to existing FICC rules, specifically with respect to its Sponsored Member program, but would also impose additional requirements that do not appear in existing Rule 17Ad–22. As a result, the Commission preliminarily believes that a respondent Treasury securities CCA would incur burdens of reviewing and updating existing policies and procedures in order to comply with the proposed amendments Name of information collection Type of burden 17Ad–22 .............................. Recordkeeping ................... B. Proposed Amendment to Rule 17Ad– 22(e)(18)(iv) The purpose of the collection of information under proposed Rule 499 See 44 U.S.C. 3501 et seq. e.g., 5 U.S.C. 552. Exemption 4 of the Freedom of Information Act provides an exemption for trade secrets and commercial or financial information obtained from a person and privileged or confidential. See 5 U.S.C. 552(b)(4). Exemption 8 of the Freedom of Information Act provides an exemption for matters that are contained in or related to examination, operating, or condition reports prepared by, on behalf of, or for the use of an agency responsible for the regulation or supervision of financial institutions. See 5 U.S.C. 552(b)(8). 500 See, khammond on DSKJM1Z7X2PROD with PROPOSALS2 may seek to register as a clearing agency to provide CCP services for Treasury securities in the next three years, and so for purposes of this proposal the Commission has assumed two respondents. VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 Initial burden per entity (hours) Number of respondents 2 to Rule 17Ad–22(e)(6) and, in some cases, may need to create new policies and procedures.501 The Commission preliminarily believes that the estimated PRA burdens for the proposed amendments to Rule 17Ad–22(e)(6) may require a respondent clearing agency to make substantial changes to its policies and procedures. Based on the similar policies and procedures requirements and the corresponding burden estimates previously made by the Commission for several rules in the Covered Clearing Agency Standards where the Commission anticipated similar burdens,502 the Commission preliminarily estimates that respondent Treasury securities CCAs would incur an aggregate one-time burden of approximately 258 hours to review existing policies and procedures and create new policies and procedures.503 Proposed Rule 17Ad–22(e)(6) would impose ongoing burdens on a respondent Treasury securities CCA. The proposed rule would require ongoing monitoring and compliance activities with respect to the written policies and procedures created in response to the proposed rule. Based on the similar reporting requirements and the corresponding burden estimates previously made by the Commission for several rules in the Covered Clearing Agency Standards where the Commission anticipated similar burdens,504 the Commission preliminarily estimates that the ongoing activities required by proposed Rule 17Ad–22(e)(6) would impose an aggregate annual burden on respondent clearing agencies of 182 hours.505 Aggregate initial burden (hours) 129 258 Ongoing burden per entity (hours) Aggregate ongoing burden (hours) 91 182 17Ad–22(e)(18)(iv) is to enable a U.S. Treasury securities CCA to ensure that its direct participants submit for clearance and settlement, as a requirement of membership in the CCA, all eligible secondary market transactions in U.S. Treasury securities to the U.S. Treasury securities CCA to 501 See supra note 126 and accompanying text (discussing existing FICC rules for sponsored member program). 502 See CCA Standards Adopting Release, supra note 26, 81 FR at 70895–97 (discussing Rules 17Ad–22(e)(13), (15), and (18)). Although the proposed rule amendment is with respect to Rule 17Ad–22(e)(6), the Commission believes that these Rules present the best overall comparison to the current proposed rule amendment, in light of the nature of the changes needed to implement the proposal here and what was proposed in the Covered Clearing Agency Standards. 503 This figure was calculated as follows: (Assistant General Counsel for 20 hours) + (Compliance Attorney for 40 hours) + (Computer Operations Manager for 12 hours) + (Senior Programmer for 20 hours) + (Senior Risk Management Specialist for 25 hours) + (Senior Business Analyst for 12 hours) = 129 hours × 2 respondent clearing agencies = 258 hours. 504 See CCA Standards Adopting Release, supra note 26, 81 FR at 70893 and 70895–96 (discussing Rules 17Ad–22(e)(6) and (13)). 505 This figure was calculated as follows: (Compliance Attorney for 25 hours + Business Risk Analyst for 40 hours + Senior Risk Management Specialist for 20 hours) = 80 hours × 2 respondent clearing agencies = 160 hours. PO 00000 Frm 00067 Fmt 4701 Sfmt 4702 E:\FR\FM\25OCP2.SGM 25OCP2 64676 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules which the direct participants are a counterparty. This should, in turn, help ensure that the risk presented by the eligible secondary market transactions of that direct participant that are not centrally cleared would not be transmitted to the U.S. Treasury securities CCA, and to enable the CCA to identify and manage the risks posed by those transactions that are currently not submitted for central clearing. In addition, the purpose of this proposal is to ensure that the U.S. Treasury securities CCA adopts policies and procedures to identify and monitor its direct participants’ submission of transactions for clearance and settlement, including how the CCA would address a failure to submit transactions that are required to be submitted. Finally, the purpose of the proposal is to ensure that the CCA has appropriate means to facilitate access to clearance and settlement services of all eligible secondary market transactions in U.S. Treasury securities, including those of indirect participants, which policies and procedures the board of directors of such covered clearing agency reviews annually. This additional collection is mandatory. To the extent that the Commission receives confidential Name of information collection Type of burden 17Ad–22(e) ......................... Recordkeeping ................... C. Request for Comment Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits comments to: 1. Evaluate whether the proposed collections of information are necessary for the proper performance of the Commission’s functions, including whether the information shall have practical utility; 2. Evaluate the accuracy of the Commission’s estimates of the burdens khammond on DSKJM1Z7X2PROD with PROPOSALS2 information pursuant to this collection of information, such information would be kept confidential subject to the provisions of applicable law.506 Proposed Rule 17Ad–22(e)(18)(iv) would require a U.S. Treasury securities CCA to establish, implement, maintain, and enforce written policies and procedures, as discussed above. Because such policies and procedures are not currently required under existing Rule 17Ad–22, the Commission preliminarily believes that the estimated PRA burdens for proposed Rule 17Ad–22(e)(18)(iv) would be significant and may require a respondent clearing agency to make substantial changes to its policies and procedures. The proposed rule amendment contains similar provisions to existing rules, but would also impose additional requirements that do not appear in existing Rule 17Ad–22.507 As a result, the Commission preliminarily believes that a respondent U.S. Treasury securities CCA would incur burdens of reviewing and updating existing policies and procedures in order to comply with the provisions of proposed Rule 17Ad–22(e)(18)(iv) and, in some cases, may need to create new policies and procedures. Based on the similar policies and procedures requirements and the corresponding burden estimates 506 See, e.g., 5 U.S.C. 552 et seq. Exemption 4 of the Freedom of Information Act provides an exemption for trade secrets and commercial or financial information obtained from a person and privileged or confidential. See 5 U.S.C. 552(b)(4). Exemption 8 of the Freedom of Information Act provides an exemption for matters that are contained in or related to examination, operating, or condition reports prepared by, on behalf of, or for the use of an agency responsible for the regulation or supervision of financial institutions. See 5 U.S.C. 552(b)(8). 507 See supra note 34 and accompanying text (discussing current FICC rules). VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 Initial burden per entity (hours) Number of respondents 2 previously made by the Commission for several rules in the Covered Clearing Agency Standards where the Commission anticipated similar burdens,508 the Commission preliminarily estimates that respondent Treasury securities CCAs would incur an aggregate one-time burden of approximately 520 hours to review existing policies and procedures and create new policies and procedures.509 Proposed Rule 17Ad–22(e)(18)(iv) would impose ongoing burdens on a respondent Treasury securities CCA. The proposed rule would require ongoing monitoring and compliance activities with respect to the written policies and procedures created in response to the proposed rule. Based on the similar reporting requirements and the corresponding burden estimates previously made by the Commission for several rules in the Covered Clearing Agency Standards where the Commission anticipated similar burdens,510 the Commission preliminarily estimates that the ongoing activities required by proposed Rule 17Ad–22(e)(18)(iv) would impose an aggregate ongoing burden on respondent clearing agencies of 170 hours.511 Aggregate initial burden (hours) 260 520 Ongoing burden per entity (hours) Aggregate ongoing burden (hours) 80 170 of the proposed collections of information; 3. Determine whether there are ways to enhance the quality, utility, and clarity of the information to be collected; 4. Evaluate whether there are ways to minimize the burden of collection of information on those who are to respond, including through the use of automated collection techniques or other forms of information technology; and 5. Evaluate whether the proposed rules and rule amendments would have any effects on any other collection of information not previously identified in this section. Persons submitting comments on the collection of information requirements should direct them to the Office of Management and Budget, Attention: Desk Officer for the Securities and 508 See CCA Standards Adopting Release, supra note 26, 81 FR at 70895–97 (discussing Rules 17Ad–22(e)(13), (15), and (18)). The Commission believes that these Rules present the best comparison to the current proposed rule amendment, in light of the nature of the changes proposed. Although the proposed rule amendment is with respect to Rule 17Ad–22(e)(18), the Commission believes that considering additional rules in the Covered Clearing Agency Standards is reasonable in light of the nature of the proposed requirement and the changes necessary to establish and implement that requirement, as compared to the current Commission rules and U.S. Treasury securities CCA rules. 509 This figure was calculated as follows: Assistant General Counsel for 40 hours + Compliance Attorney for 80 hours + Computer Operations Manager for 20 hours + Senior Risk Management Specialist for 40 hours + Business Risk Analyst for 80 hours = 260 hours × 2 respondent clearing agencies = 520 hours. 510 See supra note 502 above (discussing relevant aspects of the Covered Clearing Agency Standards). 511 This figure was calculated as follows: Compliance Attorney for 25 hours + Business Risk Analyst for 40 hours + Senior Risk Management Specialist for 20 hours = 85 hours × 2 respondent clearing agencies = 170 hours. PO 00000 Frm 00068 Fmt 4701 Sfmt 4702 E:\FR\FM\25OCP2.SGM 25OCP2 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules Exchange Commission, Office of Information and Regulatory Affairs, Washington, DC 20503, and should also send a copy of their comments to Secretary, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549–1090, with reference to File Number S7–23–22. Requests for materials submitted to OMB by the Commission with regard to this collection of information should be in writing, with reference to File Number S7–23–22 and be submitted to the Securities and Exchange Commission, Office of FOIA/PA Services, 100 F Street NE, Washington, DC 20549–2736. As OMB is required to make a decision concerning the collection of information between 30 and 60 days after publication, a comment to OMB is best assured of having its full effect if OMB receives it within 30 days of publication. B. Broker-Dealers The proposed rule amendment to Rule 15c3–3a does not require a new collection of information on the part of any entities subject to these rules. Accordingly, the requirements imposed by the PRA are not applicable to this rule amendment. khammond on DSKJM1Z7X2PROD with PROPOSALS2 VI. Small Business Regulatory Enforcement Fairness Act Under the Small Business Regulatory Enforcement Fairness Act of 1996,512 a rule is ‘‘major’’ if it has resulted, or is likely to result in: an annual effect on the economy of $100 million or more; a major increase in costs or prices for consumers or individual industries; or significant adverse effects on competition, investment, or innovation. The Commission requests comment on whether the proposed rules and rule amendments would be a ‘‘major’’ rule for purposes of the Small Business Regulatory Enforcement Fairness Act. In addition, the Commission solicits comment and empirical data on: the potential effect on the U.S. economy on annual basis; any potential increase in costs or prices for consumer or individual industries; and any potential effect on competition, investment, or innovation. VII. Regulatory Flexibility Act Certification The Regulatory Flexibility Act (‘‘RFA’’) requires the Commission, in promulgating rules, to consider the impact of those rules on small entities.513 Section 603(a) of the 512 Pubic Law 104–121, Title II, 110 Stat. 857 (1996). 513 See 5 U.S.C. 601 et seq. VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 Administrative Procedure Act,514 as amended by the RFA, generally requires the Commission to undertake a regulatory flexibility analysis of all proposed rules to determine the impact of such rulemaking on ‘‘small entities.’’ 515 Section 605(b) of the RFA states that this requirement shall not apply to any proposed rule which, if adopted, would not have a significant economic impact on a substantial number of small entities.516 A. Clearing Agencies The proposed amendments to Rule 17Ad–22 would apply to covered clearing agencies, which would include registered clearing agencies that provide the services of a central counterparty or central securities depository.517 For the purposes of Commission rulemaking and as applicable to the proposed amendments to Rule 17Ad–22, a small entity includes, when used with reference to a clearing agency, a clearing agency that (i) compared, cleared, and settled less than $500 million in securities transactions during the preceding fiscal year, (ii) had less than $200 million of funds and securities in its custody or control at all times during the preceding fiscal year (or at any time that it has been in business, if shorter), and (iii) is not affiliated with any person (other than a natural person) that is not a small business or small organization.518 Based on the Commission’s existing information about the clearing agencies currently registered with the Commission, the Commission preliminarily believes that such entities exceed the thresholds defining ‘‘small entities’’ set out above. While other clearing agencies may emerge and seek to register as clearing agencies, the Commission preliminarily does not believe that any such entities would be ‘‘small entities’’ as defined in Exchange Act Rule 0–10.519 In any case, clearing agencies can only become subject to the new requirements under proposed Rule 17Ad–22(e) should they meet the definition of a covered clearing agency, 514 5 U.S.C. 603(a). 601(b) of the RFA permits agencies to formulate their own definitions of ‘‘small entities.’’ See 5 U.S.C. 601(b). The Commission has adopted definitions for the term ‘‘small entity’’ for the purposes of rulemaking in accordance with the RFA. These definitions, as relevant to this proposed rulemaking, are set forth in Rule 0–10, 17 CFR 240.0–10. 516 See 5 U.S.C. 605(b). 517 17 CFR 240.17AD–22(a)(5). 518 See 17 CFR 240.0–10(d). 519 See 17 CFR 240.0–10(d). The Commission based this determination on its review of public sources of financial information about registered clearing agencies and lifecycle event service providers for OTC derivatives. 515 Section PO 00000 Frm 00069 Fmt 4701 Sfmt 4702 64677 as described above. Accordingly, the Commission preliminarily believes that any such registered clearing agencies will exceed the thresholds for ‘‘small entities’’ set forth in Exchange Act Rule 0–10. B. Broker-Dealers For purposes of Commission rulemaking in connection with the RFA, a small entity includes a broker-dealer that: (1) had total capital (net worth plus subordinated liabilities) of less than $500,000 on the date in the prior fiscal year as of which its audited financial statements were prepared pursuant to Rule 17a–5(d) under the Exchange Act, or, if not required to file such statements, a broker-dealer with total capital (net worth plus subordinated liabilities) of less than $500,000 on the last day of the preceding fiscal year (or in the time that it has been in business, if shorter); and (2) is not affiliated with any person (other than a natural person) that is not a small business or small organization.520 Under the standards adopted by the Small Business Administration, small entities in the finance and insurance industry include the following: (1) for entities in credit intermediation and related activities, firms with $175 million or less in assets; (2) for non-depository credit intermediation and certain other activities, firms with $7 million or less in annual receipts; (3) for entities in financial investments and related activities, firms with $7 million or less in annual receipts; (4) for insurance carriers and entities in related activities, firms with $7 million or less in annual receipts; and (5) for funds, trusts, and other financial vehicles, firms with $7 million or less in annual receipts. The proposed rule amendment to Rule 15c3–3a would permit margin required and on deposit at a covered clearing agency providing central counterparty services for Treasury securities to be included by brokerdealers as a debit in the customer or PAB reserve formula. Only carrying broker-dealers will be impacted by the proposed rule amendment. This is because only carrying broker-dealers are required to maintain a customer or PAB reserve account and may collect customer margin. Based on FOCUS Report data, the Commission estimates that as of December 31, 2021, there were approximately 744 broker-dealers that were ‘‘small’’ for the purposes of Rule 0–10. Of these, the Commission estimates that there are less than ten broker-dealers that are carrying broker520 See E:\FR\FM\25OCP2.SGM 17 CFR 240.0–10(c). 25OCP2 64678 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules dealers (i.e., can carry customer or PAB margin accounts and extend credit). However, based on December 31, 2021, FOCUS Report data, none of these small carrying broker-dealers carried debit balances. This means that any ‘‘small’’ carrying firms are not extending margin credit to their customers, and therefore, the proposed rule amendment likely would not apply to them. Therefore, while the Commission believes that some small broker-dealers could be affected by the proposed amendment, the amendment will not have a significant impact on a substantial number of small broker-dealers. C. Certification For the reasons described above, the Commission certifies that the proposed amendments to Rules 17Ad–22 and 15c3–3a would not have a significant economic impact on a substantial number of small entities for purposes of the RFA. The Commission requests comment regarding this certification. The Commission requests that commenters describe the nature of any impact on small entities, including clearing agencies and broker-dealers, and provide empirical data to support the extent of the impact. Statutory Authority The Commission is proposing amendments to Rule 17Ad–22 under the Commission’s rulemaking authority set forth in section 17A of the Exchange Act, 15 U.S.C. 78q–1. Pursuant to the Exchange Act, 15 U.S.C. 78a et seq., and particularly, sections 15 and 23(a) (15 U.S.C. 78o and 78w(a)), thereof, the Commission is proposing to amend § 240.15c3–3a under the Exchange Act. List of Subjects in 17 CFR Part 240 Reporting and recordkeeping requirements, Securities. Text of Amendments In accordance with the foregoing, title 17, chapter II of the Code of Federal Regulations is proposed to be amended as follows: PART 240—GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 1934 1. The authority citation for part 240 continues to read, in part, as follows: ■ Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z–2, 77z–3, 77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78c–3, 78c–5, 78d, 78e, 78f, 78g, 78i, 78j, 78j–1, 78k, 78k–1, 78l, 78m, 78n, 78n–1, 78o, 78o–4, 78o–10, 78p, 78q, 78q–1, 78s, 78u–5, 78w, 78x, 78dd, 78ll, 78mm, 80a–20, 80a–23, 80a–29, 80a–37, 80b– 3, 80b–4, 80b–11, and 7201 et seq., and 8302; 7 U.S.C. 2(c)(2)(E); 12 U.S.C. 5221(e)(3); 18 U.S.C. 1350; Pub. L. 111–203, 939A, 124 Stat. 1376 (2010); and Pub. L. 112–106, sec. 503 and 602, 126 Stat. 326 (2012), unless otherwise noted. * * * * * * * 2. Revise § 240.15c3–3a to read as follows: ■ § 240.15c3–3a Exhibit A–Formula for determination of customer and PAB account reserve requirements of brokers and dealers under § 240.15c3–3. § 240.15c3–3a Exhibit A–Formula for determination of customer and PAB account reserve requirements of brokers and dealers under § 240.15c3–3. khammond on DSKJM1Z7X2PROD with PROPOSALS2 Free credit balances and other credit balances in customers’ security accounts. (See Note A) ...................... Monies borrowed collateralized by securities carried for the accounts of customers (See Note B) .................. Monies payable against customers’ securities loaned (See Note C) ................................................................. Customers’ securities failed to receive (See Note D) ......................................................................................... Credit balances in firm accounts which are attributable to principal sales to customers ................................... Market value of stock dividends, stock splits and similar distributions receivable outstanding over 30 calendar days ........................................................................................................................................................... 7. Market value of short security count differences over 30 calendar days old ..................................................... 8. Market value of short securities and credits (not to be offset by longs or by debits) in all suspense accounts over 30 calendar days ......................................................................................................................................... 9. Market value of securities which are in transfer in excess of 40 calendar days and have not been confirmed to be in transfer by the transfer agent or the issuer during the 40 days ............................................................ 10. Debit balances in customers’ cash and margin accounts excluding unsecured accounts and accounts doubtful of collection. (See Note E) ..................................................................................................................... 11. Securities borrowed to effectuate short sales by customers and securities borrowed to make delivery on customers’ securities failed to deliver .................................................................................................................. 12. Failed to deliver of customers’ securities not older than 30 calendar days ..................................................... 13. Margin required and on deposit with the Options Clearing Corporation for all option contracts written or purchased in customer accounts. (See Note F) .................................................................................................. 14. Margin required and on deposit with a clearing agency registered with the Commission under section 17A of the Act (15 U.S.C. 78q–1) or a derivatives clearing organization registered with the Commodity Futures Trading Commission under section 5b of the Commodity Exchange Act (7 U.S.C. 7a–1) related to the following types of positions written, purchased or sold in customer accounts: (1) security futures products and (2) futures contracts (and options thereon) carried in a securities account pursuant to an SRO portfolio margining rule (See Note G) ...................................................................................................................................... 15. Margin required and on deposit with a clearing agency registered with the Commission under section 17A of the Act (15 U.S.C. 78q–1) resulting from the following types of transactions in U.S. Treasury securities in customer accounts that have been cleared, settled, and novated by the clearing agency: (1) purchases and sales of U.S. Treasury securities; and (2) U.S. Treasury securities repurchase and reverse repurchase agreements (See Note H) .................................................................................................................................... Total credits ...................................................................................................................................................... Total debits ....................................................................................................................................................... 16. Excess of total credits (sum of items 1–9) over total debits (sum of items 10–15) required to be on deposit in the ‘‘Reserve Bank Account’’ (§ 240.15c3–3(e)). If the computation is made monthly as permitted by this section, the deposit must be not less than 105 percent of the excess of total credits over total debits. ........... 19:08 Oct 24, 2022 Jkt 259001 PO 00000 Frm 00070 Fmt 4701 Sfmt 4702 * * 1. 2. 3. 4. 5. 6. VerDate Sep<11>2014 * Section 240.17Ad–22 is also issued under 12 U.S.C. 5461 et seq. E:\FR\FM\25OCP2.SGM 25OCP2 Credits Debits XXX XXX XXX XXX XXX ........................ ........................ ........................ ........................ ........................ XXX XXX ........................ ........................ XXX ........................ XXX ........................ ........................ XXX ........................ ........................ XXX XXX ........................ XXX ........................ XXX ........................ XXX ........................ ........................ ........................ ........................ ........................ XXX Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 Notes Regarding the Customer Reserve Bank Account Computation Note A. Item 1 must include all outstanding drafts payable to customers which have been applied against free credit balances or other credit balances and must also include checks drawn in excess of bank balances per the records of the broker or dealer. Note B. Item 2 must include the amount of options-related or security futures productrelated Letters of Credit obtained by a member of a registered clearing agency or a derivatives clearing organization which are collateralized by customers’ securities, to the extent of the member’s margin requirement at the registered clearing agency or derivatives clearing organization. Item 2 must also include the amount of Letters of Credit which are collateralized by customers’ securities and related to other futures contracts (and options thereon) carried in a securities account pursuant to an SRO portfolio margining rule. Item 2 must include the market value of customers’ U.S. Treasury securities on deposit at a ‘‘qualified clearing agency’’ as defined in Note H below. Note C. Item 3 must include in addition to monies payable against customers’ securities loaned the amount by which the market value of securities loaned exceeds the collateral value received from the lending of such securities. Note D. Item 4 must include in addition to customers’ securities failed to receive the amount by which the market value of securities failed to receive and outstanding more than thirty (30) calendar days exceeds their contract value. Note E. (1) Debit balances in margin accounts must be reduced by the amount by which a specific security (other than an exempted security) which is collateral for margin accounts exceeds in aggregate value 15 percent of the aggregate value of all securities which collateralize all margin accounts receivable; provided, however, the required reduction must not be in excess of the amounts of the debit balance required to be excluded because of this concentration rule. A specified security is deemed to be collateral for a margin account only to the extent it represents in value not more than 140 percent of the customer debit balance in a margin account. (2) Debit balances in special omnibus accounts, maintained in compliance with the requirements of Section 7(f) of Regulation T (12 CFR 220.7(f)) or similar accounts carried on behalf of another broker or dealer, must be reduced by any deficits in such accounts (or if a credit, such credit must be increased) less any calls for margin, mark to the market, or other required deposits which are outstanding five business days or less. (3) Debit balances in customers’ cash and margin accounts included in the formula under Item 10 must be reduced by an amount equal to 1 percent of their aggregate value. (4) Debit balances in cash and margin accounts of household members and other persons related to principals of a broker or dealer and debit balances in cash and margin accounts of affiliated persons of a broker or dealer must be excluded from the Reserve VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 Formula, unless the broker or dealer can demonstrate that such debit balances are directly related to credit items in the formula. (5) Debit balances in margin accounts (other than omnibus accounts) must be reduced by the amount by which any single customer’s debit balance exceeds 25 percent (to the extent such amount is greater than $50,000) of the broker-dealer’s tentative net capital (i.e., net capital prior to securities haircuts) unless the broker or dealer can demonstrate that the debit balance is directly related to credit items in the Reserve Formula. Related accounts (e.g., the separate accounts of an individual, accounts under common control or subject to cross guarantees) will be deemed to be a single customer’s accounts for purposes of this provision. If the registered national securities exchange or the registered national securities association having responsibility for examining the broker or dealer (‘‘designated examining authority’’) is satisfied, after taking into account the circumstances of the concentrated account including the quality, diversity, and marketability of the collateral securing the debit balances or margin accounts subject to this provision, that the concentration of debit balances is appropriate, then such designated examining authority may grant a partial or plenary exception from this provision. The debit balance may be included in the reserve formula computation for five business days from the day the request is made. (6) Debit balances in joint accounts, custodian accounts, participation in hedge funds or limited partnerships or similar type accounts or arrangements that include both assets of a person or persons who would be excluded from the definition of customer (‘‘noncustomer’’) and assets of a person or persons who would be included in the definition of customer must be included in the Reserve Formula in the following manner: if the percentage ownership of the non-customer is less than 5 percent then the entire debit balance shall be included in the formula; if such percentage ownership is between 5 percent and 50 percent then the portion of the debit balance attributable to the non-customer must be excluded from the formula unless the broker or dealer can demonstrate that the debit balance is directly related to credit items in the formula; or if such percentage ownership is greater than 50 percent, then the entire debit balance must be excluded from the formula unless the broker or dealer can demonstrate that the debit balance is directly related to credit items in the formula. Note F. Item 13 must include the amount of margin required and on deposit with the Options Clearing Corporation to the extent such margin is represented by cash, proprietary qualified securities and letters of credit collateralized by customers’ securities. Note G. (a) Item 14 must include the amount of margin required and on deposit with a clearing agency registered with the Commission under section 17A of the Act (15 U.S.C. 78q–1) or a derivatives clearing organization registered with the Commodity Futures Trading Commission under section 5b of the Commodity Exchange Act (7 U.S.C. 7a–1) for customer accounts to the extent that PO 00000 Frm 00071 Fmt 4701 Sfmt 4702 64679 the margin is represented by cash, proprietary qualified securities, and letters of credit collateralized by customers’ securities. (b) Item 14 will apply only if the broker or dealer has the margin related to security futures products, or futures (and options thereon) carried in a securities account pursuant to an approved SRO portfolio margining program on deposit with: (1) A registered clearing agency or derivatives clearing organization that: (i) Maintains security deposits from clearing members in connection with regulated options or futures transactions and assessment power over member firms that equal a combined total of at least $2 billion, at least $500 million of which must be in the form of security deposits. For the purposes of this Note G, the term ‘‘security deposits’’ refers to a general fund, other than margin deposits or their equivalent, that consists of cash or securities held by a registered clearing agency or derivative clearing organization; or (ii) Maintains at least $3 billion in margin deposits; or (iii) Does not meet the requirements of paragraphs (b)(1)(i) through (b)(1)(iii) of this Note G, if the Commission has determined, upon a written request for exemption by or for the benefit of the broker or dealer, that the broker or dealer may utilize such a registered clearing agency or derivatives clearing organization. The Commission may, in its sole discretion, grant such an exemption subject to such conditions as are appropriate under the circumstances, if the Commission determines that such conditional or unconditional exemption is necessary or appropriate in the public interest, and is consistent with the protection of investors; and (2) A registered clearing agency or derivatives clearing organization that, if it holds funds or securities deposited as margin for security futures products or futures in a portfolio margin account in a bank, as defined in section 3(a)(6) of the Act (15 U.S.C. 78c(a)(6)), obtains and preserves written notification from the bank at which it holds such funds and securities or at which such funds and securities are held on its behalf. The written notification will state that all funds and/or securities deposited with the bank as margin (including customer security futures products and futures in a portfolio margin account), or held by the bank and pledged to such registered clearing agency or derivatives clearing agency as margin, are being held by the bank for the exclusive benefit of clearing members of the registered clearing agency or derivatives clearing organization (subject to the interest of such registered clearing agency or derivatives clearing organization therein), and are being kept separate from any other accounts maintained by the registered clearing agency or derivatives clearing organization with the bank. The written notification also will provide that such funds and/or securities will at no time be used directly or indirectly as security for a loan to the registered clearing agency or derivatives clearing organization by the bank, and will be subject to no right, charge, security interest, lien, or claim of any kind in favor of the bank or any E:\FR\FM\25OCP2.SGM 25OCP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 64680 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules person claiming through the bank. This provision, however, will not prohibit a registered clearing agency or derivatives clearing organization from pledging customer funds or securities as collateral to a bank for any purpose that the rules of the Commission or the registered clearing agency or derivatives clearing organization otherwise permit; and (3) A registered clearing agency or derivatives clearing organization establishes, documents, and maintains: (i) Safeguards in the handling, transfer, and delivery of cash and securities; (ii) Fidelity bond coverage for its employees and agents who handle customer funds or securities. In the case of agents of a registered clearing agency or derivatives clearing organization, the agent may provide the fidelity bond coverage; and (iii) Provisions for periodic examination by independent public accountants; and (iv) A derivatives clearing organization that, if it is not otherwise registered with the Commission, has provided the Commission with a written undertaking, in a form acceptable to the Commission, executed by a duly authorized person at the derivatives clearing organization, to the effect that, with respect to the clearance and settlement of the customer security futures products and futures in a portfolio margin account of the broker or dealer, the derivatives clearing organization will permit the Commission to examine the books and records of the derivatives clearing organization for compliance with the requirements set forth in § 240.15c3–3a, Note G (b)(1) through (3). (c) Item 14 will apply only if a broker or dealer determines, at least annually, that the registered clearing agency or derivatives clearing organization with which the broker or dealer has on deposit margin related to securities future products or futures in a portfolio margin account meets the conditions of this Note G. Note H. (a) Item 15 must include the amount of margin required and on deposit with a clearing agency registered with the Commission under section 17A of the Act (15 U.S.C. 78q–1) that clears, settles, and novates transactions in U.S. Treasury securities (‘‘qualified clearing agency’’) to the extent that the margin is in the form of cash or U.S. Treasury securities and is being used to margin U.S. Treasury securities positions of the customers of the broker or dealer that are cleared, settled, and novated by the qualified clearing agency. (b) Item 15 will apply only if the cash and U.S. Treasury securities required and on deposit at the qualified clearing agency: (1) Are, in the case of cash, owed by the broker or dealer to the customer of the broker or dealer or, in the case of U.S. Treasury securities, held in custody by the broker or dealer for the customer of the broker or dealer and were delivered by the broker or dealer to the qualified clearing agency to meet a margin requirement resulting from that customer’s U.S. Treasury securities positions cleared, settled, and novated at the qualified clearing agency and not for any other customer’s or the broker’s or dealer’s U.S. Treasury securities positions cleared, settled, and novated at the qualified clearing agency; VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 (2) Are treated in accordance with rules of the qualified clearing agency that impose the following requirements and the qualified clearing agency and broker or dealer are in compliance with the requirements of the rules (as applicable); (i) Rules requiring the qualified clearing agency to calculate a separate margin amount for each customer of the broker or dealer and the broker or dealer to deliver that amount of margin for each customer on a gross basis; (ii) Rules limiting the qualified clearing agency from investing cash delivered by the broker or dealer to margin U.S. Treasury security transactions of the customers of the broker or dealer or cash realized through using U.S. Treasury securities delivered by the broker or dealer for that purpose in any asset other than U.S. Treasury securities with a maturity of one year or less; (iii) Rules requiring that the cash and U.S. Treasury securities used to margin the U.S. Treasury securities positions of the customers of the broker or dealer be held in an account of the broker or dealer at the qualified clearing agency that is segregated from any other account of the broker or dealer at the qualified clearing agency and that is: (A) Used exclusively to clear, settle, novate, and margin U.S. Treasury securities transactions of the customers of the broker or dealer; (B) Designated ‘‘Special Clearing Account for the Exclusive Benefit of the Customers of [name of broker or dealer]’’; (C) Subject to a written notice of the qualified clearing agency provided to and retained by the broker or dealer that the cash and U.S. Treasury securities in the account are being held by the qualified clearing agency for the exclusive benefit of the customers of the broker or dealer in accordance with the regulations of the Commission and are being kept separate from any other accounts maintained by the broker or dealer or any other clearing member at the qualified clearing agency; and (D) Subject to a written contract between the broker or dealer and the qualified clearing agency which provides that the cash and U.S. Treasury securities in the account are not available to cover claims arising from the broker or dealer or any other clearing member defaulting on an obligation to the qualified clearing agency or subject to any other right, charge, security interest, lien, or claim of any kind in favor of the qualified clearing agency or any person claiming through the qualified clearing agency, except a right, charge, security interest, lien, or claim resulting from a cleared U.S. Treasury securities transaction of a customer of the broker or dealer effected in the account; (iv) Rules requiring the qualified clearing agency to hold the customer cash and U.S. Treasury securities used to margin the U.S. Treasury securities positions of the customers of the broker or dealer itself or in an account of the clearing agency at a U.S. Federal Reserve Bank or a ‘‘bank,’’ as that term is defined in section 3(a)(6) of the Act (15 U.S.C. 78c(a)(6)), that is insured by the Federal Deposit Insurance Corporation, and that the account at the U.S. Federal Reserve Bank or bank must be: PO 00000 Frm 00072 Fmt 4701 Sfmt 4702 (A) Segregated from any other account of the qualified clearing agency or any other person at the U.S. Federal Reserve Bank or bank and used exclusively to hold cash and U.S. Treasury securities to meet current margin requirements of the qualified clearing agency resulting from positions in U.S. Treasury securities of the customers of the broker or dealer members of the qualified clearing agency; (B) Subject to a written notice of the U.S. Federal Reserve Bank or bank provided to and retained by the qualified clearing agency that the cash and U.S. Treasury securities in the account are being held by the U.S. Federal Reserve Bank or bank pursuant to § 240.15c3–3 and are being kept separate from any other accounts maintained by the qualified clearing agency or any other person at the U.S. Federal Reserve Bank or bank; and (C) Subject to a written contract between the qualified clearing agency and the U.S. Federal Reserve Bank or bank which provides that the cash and U.S. Treasury securities in the account are subject to no right, charge, security interest, lien, or claim of any kind in favor of the U.S. Federal Reserve Bank or bank or any person claiming through the U.S. Federal Reserve Bank or bank; and (v) Rules requiring systems, controls, policies, and procedures to return cash and U.S. Treasury securities to the broker or dealer that are no longer needed to meet a current margin requirement resulting from positions in U.S. Treasury securities of the customers of the broker or dealer no later than the close of the next business day after the day the cash and U.S. Treasury securities are no longer needed for this purpose; and (3) The Commission has approved rules of the qualified clearing agency that meet the conditions of this Note H and has published (and not subsequently withdrawn) a notice that brokers or dealers may include a debit in the customer reserve formula when depositing customer cash or U.S. Treasury securities to meet a margin requirement of the qualified clearing agency resulting from positions in U.S. Treasury securities of the customers of the broker or dealer. Notes Regarding the PAB Reserve Bank Account Computation Note 1. Broker-dealers should use the formula in Exhibit A for the purposes of computing the PAB reserve requirement, except that references to ‘‘accounts,’’ ‘‘customer accounts, or ‘‘customers’’ will be treated as references to PAB accounts. Note 2. Any credit (including a credit applied to reduce a debit) that is included in the computation required by § 240.15c3–3 with respect to customer accounts (the ‘‘customer reserve computation’’) may not be included as a credit in the computation required by § 240.15c3–3 with respect to PAB accounts (the ‘‘PAB reserve computation’’). Note 3. Note E(1) to § 240.15c3–3a does not apply to the PAB reserve computation. Note 4. Note E(3) to § 240.15c3–3a which reduces debit balances by 1 percent does not apply to the PAB reserve computation. Note 5. Interest receivable, floor brokerage, and commissions receivable of another broker or dealer from the broker or dealer E:\FR\FM\25OCP2.SGM 25OCP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules (excluding clearing deposits) that are otherwise allowable assets under § 240.15c3– 1 need not be included in the PAB reserve computation, provided the amounts have been clearly identified as payables on the books of the broker or dealer. Commissions receivable and other receivables of another broker or dealer from the broker or dealer that are otherwise non-allowable assets under § 240.15c3–1 and clearing deposits of another broker or dealer may be included as ‘‘credit balances’’ for purposes of the PAB reserve computation, provided the commissions receivable and other receivables are subject to immediate cash payment to the other broker or dealer and the clearing deposit is subject to payment within 30 days. Note 6. Credits included in the PAB reserve computation that result from the use of securities held for a PAB account (‘‘PAB securities’’) that are pledged to meet intraday margin calls in a cross-margin account established between the Options Clearing Corporation and any regulated derivatives clearing organization may be reduced to the extent that the excess margin held by the other clearing corporation in the crossmargin relationship is used the following business day to replace the PAB securities that were previously pledged. In addition, balances resulting from a portfolio margin account that are segregated pursuant to Commodity Futures Trading Commission regulations need not be included in the PAB Reserve Bank Account computation. Note 7. Deposits received prior to a transaction pending settlement which are $5 million or greater for any single transaction or $10 million in aggregate may be excluded as credits from the PAB reserve computation if such balances are placed and maintained in a separate PAB Reserve Bank Account by 12 p.m. Eastern Time on the following business day. Thereafter, the money representing any such deposits may be withdrawn to complete the related transactions without performing a new PAB reserve computation. Note 8. A credit balance resulting from a PAB reserve computation may be reduced by the amount that items representing such credits are swept into money market funds or mutual funds of an investment company registered under the Investment Company Act of 1940 on or prior to 10 a.m. Eastern Time on the deposit date provided that the credits swept into any such fund are not subject to any right, charge, security interest, lien, or claim of any kind in favor of the investment company or the broker or dealer. Any credits that have been swept into money market funds or mutual funds must be maintained in the name of a particular broker or for the benefit of another broker. Note 9. Clearing deposits required to be maintained at registered clearing agencies may be included as debits in the PAB reserve computation to the extent the percentage of the deposit, which is based upon the clearing agency’s aggregate deposit requirements (e.g., dollar trading volume), that relates to the proprietary business of other brokers and dealers can be identified. However, Note H to Item 15 of § 240.15c3–3a applies with respect to margin delivered to a U.S. Treasury securities clearing agency. VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 Note 10. A broker or dealer that clears PAB accounts through an affiliate or third party clearing broker must include these PAB account balances and the omnibus PAB account balance in its PAB reserve computation. 3. Amend § 240.17Ad-22 by: a. In paragraph (a): i. Removing the second-level paragraph designations, and ■ ii. Inserting in alphabetical order definitions for ‘‘Central bank’’, ‘‘Eligible secondary market transaction’’, ‘‘International financial institution’’, ‘‘Sovereign entity’’, and ‘‘U.S. Treasury security’’. ■ b. Revising paragraphs (e)(6)(i) and (e)(18). The revisions and additions read as follows: ■ ■ ■ § 240.17Ad-22 agencies. Standards for clearing (a) * * * Central bank means a reserve bank or monetary authority of a central government (including the Board of Governors of the Federal Reserve System or any of the Federal Reserve Banks) and the Bank for International Settlements. * * * * * Eligible secondary market transaction refers to a secondary market transaction in U.S. Treasury securities of a type accepted for clearing by a registered covered clearing agency that is: (i) A repurchase or reverse repurchase agreement collateralized by U.S. Treasury securities, in which one of the counterparties is a direct participant; or (ii) A purchase or sale, between a direct participant and (A) Any counterparty, if the direct participant of the covered clearing agency brings together multiple buyers and sellers using a trading facility (such as a limit order book) and is a counterparty to both the buyer and seller in two separate transactions; (B) Registered broker-dealer, government securities broker, or government securities dealer; (C) A hedge fund, that is, any private fund (other than a securitized asset fund): (1) With respect to which one or more investment advisers (or related persons of investment advisers) may be paid a performance fee or allocation calculated by taking into account unrealized gains (other than a fee or allocation the calculation of which may take into account unrealized gains solely for the purpose of reducing such fee or allocation to reflect net unrealized losses); (2) That may borrow an amount in excess of one-half of its net asset value PO 00000 Frm 00073 Fmt 4701 Sfmt 4702 64681 (including any committed capital) or may have gross notional exposure in excess of twice its net asset value (including any committed capital); or (3) That may sell securities or other assets short or enter into similar transactions (other than for the purpose of hedging currency exposure or managing duration); or (D) An account at a registered brokerdealer, government securities dealer, or government securities broker where such account may borrow an amount in excess of one-half of the net value of the account or may have gross notional exposure of the transactions in the account that is more than twice the net value of the account; except that (iii) any purchase or sale transaction in U.S. Treasury securities or repurchase or reverse repurchase agreement collateralized by U.S. Treasury securities in which one counterparty is a central bank, a sovereign entity, an international financial institution, or a natural person shall be excluded from the definition set forth in this section of an eligible secondary market transaction. * * * * * International financial institution means the African Development Bank; African Development Fund; Asian Development Bank; Banco Centroamericano de Integracio´n Econo´mica; Bank for Economic Cooperation and Development in the Middle East and North Africa; Caribbean Development Bank; Corporacio´n Andina de Fomento; Council of Europe Development Bank; European Bank for Reconstruction and Development; European Investment Bank; European Investment Fund; European Stability Mechanism; InterAmerican Development Bank; InterAmerican Investment Corporation; International Bank for Reconstruction and Development; International Development Association; International Finance Corporation; International Monetary Fund; Islamic Development Bank; Multilateral Investment Guarantee Agency; Nordic Investment Bank; North American Development Bank; and any other entity that provides financing for national or regional development in which the U.S. Government is a shareholder or contributing member. * * * * * Sovereign entity means a central government (including the U.S. Government), or an agency, department, or ministry of a central government. * * * * * E:\FR\FM\25OCP2.SGM 25OCP2 64682 Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 U.S. Treasury security means any security issued by the U.S. Department of the Treasury. * * * * * (e) * * * (6) * * * (i) Considers, and produces margin levels commensurate with, the risks and particular attributes of each relevant product, portfolio, and market, and, if the covered clearing agency provides central counterparty services for U.S. Treasury securities, calculates, collects, and holds margin amounts from a direct participant for its proprietary positions in Treasury securities separately and independently from margin calculated and collected from that direct participant in connection with U.S. Treasury securities transactions by an indirect participant that relies on the services provided by the direct participant to access the covered clearing agency’s payment, clearing, or settlement facilities; * * * * * VerDate Sep<11>2014 19:08 Oct 24, 2022 Jkt 259001 (18) Establish objective, risk-based, and publicly disclosed criteria for participation, which (i) Permit fair and open access by direct and, where relevant, indirect participants and other financial market utilities, (ii) Require participants to have sufficient financial resources and robust operational capacity to meet obligations arising from participation in the clearing agency, (iii) Monitor compliance with such participation requirements on an ongoing basis, and (iv) When the covered clearing agency provides central counterparty services for transactions in U.S. Treasury securities, (A) Require that any direct participant of such covered clearing agency submit for clearance and settlement all of the eligible secondary market transactions to which such direct participant is a counterparty; PO 00000 Frm 00074 Fmt 4701 Sfmt 9990 (B) Identify and monitor its direct participants’ submission of transactions for clearing as required in paragraph (e)(18)(iv)(A) of this section, including how the covered clearing agency would address a failure to submit transactions in accordance with paragraph (e)(18)(iv)(A) of this section; and (C) Ensure that it has appropriate means to facilitate access to clearance and settlement services of all eligible secondary market transactions in U.S. Treasury securities, including those of indirect participants, which policies and procedures board of directors of such covered clearing agency reviews annually. * * * * * By the Commission. Dated: September 14, 2022. Vanessa A. Countryman, Secretary. [FR Doc. 2022–20288 Filed 10–24–22; 8:45 am] BILLING CODE 8011–01–P E:\FR\FM\25OCP2.SGM 25OCP2

Agencies

[Federal Register Volume 87, Number 205 (Tuesday, October 25, 2022)]
[Proposed Rules]
[Pages 64610-64682]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2022-20288]



[[Page 64609]]

Vol. 87

Tuesday,

No. 205

October 25, 2022

Part III





Securities and Exchange Commission





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17 CFR Part 240





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; Proposed Rule

Federal Register / Vol. 87 , No. 205 / Tuesday, October 25, 2022 / 
Proposed Rules

[[Page 64610]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-95763; File No. S7-23-22]
RIN 3235-AN09


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

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: The Securities and Exchange Commission (``Commission'') 
proposes to amend the standards applicable to covered clearing agencies 
for U.S. Treasury securities to require that such covered clearing 
agencies have written policies and procedures reasonably designed to 
require that every direct participant of the covered clearing agency 
submit for clearance and settlement all eligible secondary market 
transactions in U.S. Treasury securities to which it is a counterparty. 
In addition, the Commission proposes additional amendments to the 
Covered Clearing Agency Standards, with respect to risk management. 
These requirements are designed to protect investors, reduce risk, and 
increase operational efficiency. Finally, the Commission proposes to 
amend the broker-dealer customer protection rule to permit margin 
required and on deposit with covered clearing agencies for U.S. 
Treasury securities to be included as a debit in the reserve formulas 
for accounts of customers and proprietary accounts of broker-dealers 
(``PAB''), subject to certain conditions.

DATES: Comments should be received on or before December 27, 2022.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's internet comment form (https://www.sec.gov/rules/submitcomments.htm); or
     Send an email to [email protected]. Please include 
File Number S7-23-22 on the subject line.

Paper Comments

     Send paper comments to Secretary, Securities and Exchange 
Commission, 100 F Street NE, Washington, DC 20549-1090.

All submissions should refer to File Number S7-23-22. This file number 
should be included on the subject line if email is used. To help the 
Commission process and review your comments more efficiently, please 
use only one method. The Commission will post all comments on the 
Commission's website (https://www.sec.gov/rules/proposed.shtml). 
Comments are also available for website viewing and printing in the 
Commission's Public Reference Room, 100 F Street NE, Washington, DC 
20549, on official business days between the hours of 10 a.m. and 3 
p.m. Operating conditions may limit access to the Commission's Public 
Reference Room. All comments received will be posted without change. 
Persons submitting comments are cautioned that we do not redact or edit 
personal identifying information from comment submissions. You should 
submit only information that you wish to make available publicly.
    Studies, memoranda, or other substantive items may be added by the 
Commission or staff to the comment file during this rulemaking. A 
notification of the inclusion in the comment file of any such materials 
will be made available on our website. To ensure direct electronic 
receipt of such notifications, sign up through the ``Stay Connected'' 
option at www.sec.gov to receive notifications by email.

FOR FURTHER INFORMATION CONTACT: Elizabeth L. Fitzgerald, Assistant 
Director, Office of Clearance and Settlement at (202) 551-5710, 
Division of Trading and Markets; Michael A. Macchiaroli, Associate 
Director, at (202) 551-5525; Thomas K. McGowan, Associate Director, at 
(202) 551-5521; Randall W. Roy, Deputy Associate Director, at (202) 
551-5522; Raymond Lombardo, Assistant Director, at 202-551-5755; Sheila 
Dombal Swartz, Senior Special Counsel, at (202) 551-5545; or Nina 
Kostyukovsky, Special Counsel, at (202) 551-8833, Office of Broker-
Dealer Finances, Division of Trading and Markets; U.S. Securities and 
Exchange Commission, 100 F Street NE, Washington, DC 20549-7010.

SUPPLEMENTARY INFORMATION: First, the Commission proposes to amend 17 
CFR 240.17Ad-22(e)(18) (``Rule 17Ad-22(e)(18)'') to require covered 
clearing agencies that provide central counterparty (``CCP'') services 
for U.S. Treasury securities to establish, implement, maintain and 
enforce written policies and procedures reasonably designed, as 
applicable, to establish objective, risk-based and publicly disclosed 
criteria for participation, which require that any direct participant 
of such a covered clearing agency submit for clearance and settlement 
all the eligible secondary market transactions in U.S. Treasury 
securities to which such direct participant is a counterparty. In 
addition, these policies and procedures must be reasonably designed, as 
applicable, to identify and monitor the covered clearing agency's 
direct participants' submission of transactions for clearing as 
required above, including how the covered clearing agency would address 
a failure to submit transactions. These policies and procedures must 
also be reasonably designed, as applicable, to ensure that the covered 
clearing agency has appropriate means to facilitate access to clearance 
and settlement services of all eligible secondary market transactions 
in U.S. Treasury securities, including those of indirect participants, 
which policies and procedures the board of directors of such U.S. 
Treasury securities CCA must review annually. The Commission would 
define eligible secondary market transactions as a secondary market 
transaction in U.S. Treasury securities of a type accepted for clearing 
by a registered covered clearing agency that is either a repurchase or 
reverse repurchase agreement collateralized by U.S. Treasury 
securities, in which one of the counterparties is a direct participant, 
or certain specified categories of cash purchase or sale transactions. 
Second, the Commission proposes to amend 17 CFR 240.17Ad-22(e)(6)(i) 
(``Rule 17Ad-22(e)(6)(i)'') to require that a covered clearing agency 
providing central counterparty services for U.S. Treasury securities 
establish, implement, maintain and enforce written policies and 
procedures reasonably designed to, as applicable, calculate, collect, 
and hold margin for transactions in U.S. Treasury securities submitted 
on behalf of an indirect participant separately from those submitted on 
behalf of the direct participant. In connection with these proposed 
amendments, the Commission is also proposing to include as part of 17 
CFR 240.17Ad-22(a) (``Rule 17Ad-22(a)'') definitions of ``U.S. Treasury 
security,'' ``central bank,'' ``eligible secondary market 
transaction,'' ``international financial institution,'' and ``sovereign 
entity.'' Third, the Commission proposes to amend 17 CFR 240.15c3-3a 
(``Rule 15c3-3a'') to permit margin required and on deposit at covered 
clearing agencies providing central counterparty services for U.S. 
Treasury securities to be included by broker-dealers as a debit in the 
customer and PAB reserve formulas, subject to certain conditions.

Table of Contents

I. Introduction

[[Page 64611]]

    A. The Commission's Role in Facilitating the National System of 
Clearance and Settlement for Securities, Including Treasury 
Securities
    B. The Role of Central Counterparty Services
    C. Existing CCP Services for the U.S. Treasury Market
    D. Proposal
    E. Current Regulatory and Industry Discussions Regarding the 
U.S. Treasury Market
II. Background
    A. Current U.S. Treasury Market Structure and Central Clearing 
Within That Structure
    1. Cash Market
    2. U.S. Treasury Repo Market
    B. Current Regulatory Framework
    1. Clearing Agency Regulation Under Section 17A of the Exchange 
Act
    2. The Broker-Dealer Customer Protection Rule
III. Proposed Amendments
    A. U.S. Treasury Securities CCA Membership Requirements
    1. Requirement To Clear Eligible Secondary Market Transactions
    2. Eligible Secondary Market Transactions
    a. Repo Transactions
    b. Purchases and Sales of U.S. Treasury Securities
    i. IDB Transactions
    ii. Other Cash Transactions
    c. Exclusions From the Definition of an Eligible Secondary 
Market Transaction
    i. Official Sector Exclusions From the Membership Proposal
    ii. Natural Person Exclusion
    3. How the Membership Proposal Facilitates Prompt and Accurate 
Clearance and Settlement in the U.S. Treasury Market
    4. Policies and Procedures Regarding Direct Participants' 
Transactions
    5. Request for Comment
    F. Other Changes to Covered Clearing Agency Standards
    1. Netting and Margin Practices for House and Customer Accounts
    2. Facilitating Access to U.S. Treasury Securities CCAs
    3. Request for Comment
    G. Proposed Amendments to Rule15c3-3a
    1. Proposal
    2. Request for Comment
    H. Compliance Date
IV. Economic Analysis
    A. Broad Economic Considerations
    B. Baseline
    1. U.S. Treasury Securities
    2. U.S. Treasury Repurchase Transactions
    3. Central Clearing in the U.S. Treasury Securities Market
    4. Clearing and Settlement by U.S. Treasury Securities Market 
Segment
    a. Dealer-to-Customer Cash U.S. Treasury Securities Market (off-
IDBs)
    i. Bilateral Clearing
    ii. Central Clearing
    b. Cash U.S. Treasury Trades Through an IDB
    i. Central Clearing
    ii. Bilateral Clearing
    iii. Hybrid Clearing
    5. Margin Practices in U.S. Treasury Secondary Markets
    6. Disruptions in the U.S. Treasury Securities Market
    a. COVID-19 Shock of March 2020
    b. September 2019 Repo Market Disruptions
    c. October 2014 Flash Rally
    7. Affected Persons
    a. Covered Clearing Agencies for U.S. Treasury Securities: FICC
    b. Direct Participants at U.S. Treasury Securities CCAs: FICC 
Netting Members
    c. Interdealer Brokers (IDBs)
    d. Other Market Participants
    i. FICC Sponsored Members
    ii. Other Market Participants That Are Not FICC Sponsored 
Members
    e. Triparty Agent: Bank of New York Mellon
    f. Custodian Banks/Fedwire Securities Service (FSS)
    C. Analysis of Benefits, Costs, and Impact on Efficiency, 
Competition, and Capital Formation
    1. Benefits
    a. U.S. Treasury Securities CCA Membership Requirements
    i. Scope of the Membership Proposal
    ii. Application of the Membership Proposal to Repo Transactions
    iii. Application of the Membership Proposal to Purchases and 
Sales of U.S. Treasury Securities
    iv. Policies and Procedures Regarding Direct Participants' 
Transactions
    b. Other Changes to Covered Clearing Agency Standards
    i. Netting and Margin Practices for House and Customer Accounts
    ii. Facilitating Access to U.S. Treasury Securities CCAs
    c. Proposed Amendments to Rules 15c3-3 and 15c3-3a
    2. Costs
    a. Costs to FICC of the Membership Proposal
    i. Costs Attendant to an Increase in CCLF
    ii. Costs of the Membership Proposal in Terms of Increased 
Margining for Existing FICC Members
    b. Costs to Non-FICC Members as a Result of the Membership 
Proposal
    c. Other Changes to Covered Clearing Agency Standards
    i. Netting and Margin Practices for House and Customer Accounts
    ii. Facilitating Access to U.S. Treasury Securities CCAs
    d. Proposed Amendments to Rules 15c3-3 and 15c3-3a
    3. Effect on Efficiency, Competition, and Capital Formation
    a. Efficiency
    i. Price Transparency
    ii. Operational and Balance Sheet Efficiency
    b. Competition
    c. Capital Formation
    D. Reasonable Alternatives
    1. Require U.S. Treasury Securities CCAs to Have Policies and 
Procedures Requiring Only IDB Clearing Members to Submit U.S. 
Treasury Securities Trades With Non-members for Central Clearing
    2. Require U.S. Treasury Securities CCAs to Have Policies and 
Procedures Requiring the Submission of All Repurchase Agreements 
With No Change to Requirements for the Submission of Cash 
Transactions
    3. Include All Cash Transactions Within the Scope of the 
Membership Proposal With Exceptions for Central Banks, Sovereign 
Entities, International Financial Institutions, and Natural Persons
    4. Require U.S. Treasury Securities CCAs To Change CCA Access 
Provisions and Netting and Margin Practices for House and Customer 
Accounts and Rule 15c3-3
    E. Request for Comment
V. Paperwork Reduction Act
    A. Proposed Amendment to Rule 17Ad-22(e)(6)
    B. Proposed Amendment to Rule 17Ad-22(e)(18)(iv)
    C. Request for Comment
VI. Small Business Regulatory Enforcement Fairness Act
VII. Regulatory Flexibility Act Certification
    A. Clearing Agencies
Statutory Authority

I. Introduction

A. The Commission's Role in Facilitating the National System of 
Clearance and Settlement for Securities, Including Treasury Securities

    In 1975, Congress added section 17A to the Securities Exchange Act 
of 1934 (``Exchange Act'') as part of the Securities Acts Amendments of 
1975, which directed the Commission to facilitate the establishment of 
(i) a national system for the prompt and accurate clearance and 
settlement of securities transactions (other than exempt securities 
which typically includes U.S. Treasury securities, except as discussed 
further below), and (ii) linked or coordinated facilities for clearance 
and settlement of securities transactions.\1\ In so doing, Congress 
made several findings related to the importance of the clearance and 
settlement of securities transactions and the relationship of clearance 
and settlement of securities transactions to the protection of 
investors.\2\ The Commission carries out its statutory mandate in this 
regard through its supervision and regulation of registered clearing 
agencies, which may provide

[[Page 64612]]

different services to the market including, but not limited to, central 
counterparty services.
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    \1\ See 15 U.S.C. 78q-1; Report of the Senate Committee on 
Banking, Housing & Urban Affairs, S. Rep. No. 94-75, at 4 (1975) 
(stating the Committee's belief that ``the banking and security 
industries must move quickly toward the establishment of a fully 
integrated national system for the prompt and accurate processing 
and settlement of securities transactions'').
    \2\ See 15 U.S.C. 78q-1(a)(1)(A) (finding that ``[t]he prompt 
and accurate clearance and settlement of securities transactions . . 
. are necessary for the protection of investors and persons 
facilitating transactions by and acting on behalf of investors''); 
see also 15 U.S.C. 78q-1(B), (C), and (D) (setting forth additional 
findings related to the national system of clearance and 
settlement).
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    In 1986, Congress passed the Government Securities Act, which, 
among other things, authorized the Commission to regulate clearing 
agencies engaged in the clearance and settlement of government 
securities transactions, including those in U.S. Treasury securities, 
by providing that government securities would not be considered exempt 
securities for purposes of section 17A of the Exchange Act.\3\ This 
inclusion of government securities, including U.S. Treasury securities, 
within the Commission's authority for the national system of clearance 
and settlement underscores the importance of, among other things, the 
U.S. Treasury market.
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    \3\ Government Securities Act of 1986, section 102(a); 15 U.S.C. 
78c(a)(12)(B)(i).
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    U.S. Treasury securities play a critical and unique role in the 
U.S. and global economy, serving as a significant investment instrument 
and hedging vehicle for investors, a risk-free benchmark for other 
financial instruments, and an important mechanism for the Federal 
Reserve's implementation of monetary policy.\4\ Consequently, 
confidence in the U.S. Treasury market, and in its ability to function 
efficiently, even in times of stress, is critical to the stability of 
the global financial system.\5\
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    \4\ See, e.g., Staffs of the U.S. Department of the Treasury, 
Board of Governors of the Federal Reserve System, Federal Reserve 
Bank of New York, U.S. Securities and Exchange Commission, and U.S. 
Commodity Futures Trading Commission, Recent Disruptions and 
Potential Reforms in the U.S. Treasury Market: A Staff Progress 
Report, at 1 (Nov. 2021), available at https://home.treasury.gov/system/files/136/IAWG-Treasury-Report.pdf (``Inter-Agency Working 
Group for Treasury Market Surveillance (``IAWG'') Report''); Staffs 
of the U.S. Department of the Treasury, Board of Governors of the 
Federal Reserve System, Federal Reserve Bank of New York, U.S. 
Securities and Exchange Commission, and U.S. Commodity Futures 
Trading Commission, Joint Staff Report: The U.S. Treasury Market on 
October 15, 2014, at 1, 8 (2015), available at https://home.treasury.gov/system/files/276/joint-staff-report-the-us-treasury-market-on-10-15-2014.pdf (``Joint Staff Report''). These 
reports represent the views of Commission and other Federal 
regulatory staff. The reports are not a rule, regulation, or 
statement of the Commission. The Commission has neither approved nor 
disapproved the content in the reports. These reports, like all 
staff reports, have no legal force or effect: they do not alter or 
amend applicable law, and they create no new or additional 
obligations for any person.
    \5\ Group of Thirty Working Group on Treasury Market Liquidity, 
U.S. Treasury Markets: Steps Toward Increased Resilience, at 1 
(2021), available at https://group30.org/publications/detail/4950 
(``G-30 Report'').
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B. The Role of Central Counterparty Services

    The Commission defines a CCP as a clearing agency that interposes 
itself between the counterparties to securities transactions, acting 
functionally as the buyer to every seller and the seller to every 
buyer.\6\ The Commission previously has stated that registered clearing 
agencies that provide CCP services can help increase the safety and 
efficiency of securities trading, while reducing costs.\7\ These 
benefits could be particularly significant in times of market stress, 
as CCPs would mitigate the potential for a single market participant's 
failure to destabilize other market participants or the financial 
system more broadly, and/or reduce the effects of misinformation and 
rumors.\8\ A CCP also addresses concerns about counterparty risk by 
substituting the creditworthiness and liquidity of the CCP for the 
creditworthiness and liquidity of the counterparties.\9\ Further, the 
Commission has recognized that ``the centralization of clearance and 
settlement activities at covered clearing agencies allows market 
participants to reduce costs, increase operational efficiency, and 
manage risks more effectively.'' \10\ However, the Commission has also 
recognized that this centralization of activity at clearing agencies 
makes risk management at such entities a critical function, as 
reflected in the adoption of additional enhanced Commission 
requirements, discussed further in section II.B.1 infra.\11\
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    \6\ 17 CFR 240.17Ad-22(a)(2).
    \7\ Covered Clearing Agency Standards Proposing Release, 
Exchange Act Release No. 71699 (Mar. 12, 2014), 79 FR 29507, 29510 
(May 27, 2014) (``CCA Standards Proposing Release'').
    \8\ See, e.g., Order Granting Temporary Exemptions Under the 
Securities Exchange Act of 1934 in Connection with Request of Liffe 
Administration and Management and Lch.Clearnet Ltd. Related to 
Central Clearing of Credit Default Swaps, and Request for Comments, 
Exchange Act Release No. 59164 (Dec. 24, 2008), 74 FR 139, 140 (Jan. 
2, 2009).
    \9\ Id.
    \10\ CCA Standards Proposing Release, supra note 7, 79 FR at 
29587.
    \11\ See, e.g., id. at 29510.
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    Since the enactment of the Securities Acts Amendments of 1975, the 
Commission has had extensive experience with the risks associated with 
bilateral clearing and the benefits of centralized clearance and 
settlement systems for securities. Based on its experience supervising 
registered clearing agencies, the Commission believes that, over the 
years, the clearing agencies registered with the Commission that 
provide CCP services have reduced costs of securities trading, and have 
been carefully structured, consistent with the Commission's statutory 
and regulatory authority, to provide the benefits of clearing, such as 
multilateral netting \12\ and centralized default management, while 
also managing and reducing counterparty risk. To further the 
establishment of linked and coordinated facilities for clearance and 
settlement of securities transactions, the Commission adopted 17 CFR 
240.17Ad-22, which sets forth standards for clearing agencies 
registered with the Commission. These standards address all aspects of 
a CCP's operations, including financial risk management, operational 
risk, default management, governance, and participation requirements.
---------------------------------------------------------------------------

    \12\ With multilateral netting, the CCP is able to offset 
obligations involving the same security across multiple 
counterparties, thereby reducing the overall amount of securities 
and funds that need to be delivered. See notes 251 and 252 and 
accompanying text infra for additional explanation, as well as an 
example, of multilateral netting.
---------------------------------------------------------------------------

C. Existing CCP Services for the U.S. Treasury Market

    Currently, only one registered clearing agency, the Fixed Income 
Clearing Corporation (``FICC''),\13\ provides CCP services for U.S. 
Treasury securities transactions, including cash transactions and 
repurchase transactions (``repos''), which are described more fully in 
section II.A infra.\14\ As a CCP, FICC novates transactions between two 
counterparties, effectively becoming the buyer to every seller and the 
seller to every buyer, and guarantees the settlement of the novated 
transactions. This means that FICC is exposed to a number of risks 
arising from such transactions, including counterparty credit risk.\15\ 
Because the vast majority of counterparty credit risk is managed 
bilaterally in the U.S. Treasury market, as discussed more fully in 
section III.A.3 infra, FICC may face potential contagion risk arising 
from transactions entered into by one of its participants, even if 
those transactions are not centrally cleared.\16\ Currently, most of

[[Page 64613]]

FICC's direct participants are banks and broker-dealers, while other 
types of entities, such as registered investment companies, investment 
advisers, and asset owners, rely on FICC's direct participants to 
access central clearing indirectly and are not direct participants of 
FICC.
---------------------------------------------------------------------------

    \13\ FICC has two divisions. The Government Securities Division 
generally provides clearing services for U.S. Treasury securities, 
and the Mortgage-Backed Securities Division, generally provides 
clearing services for mortgage-backed securities. For purposes of 
this release, references to FICC will refer to FICC's Government 
Securities Division (``GSD''), unless otherwise indicated.
    \14\ For purposes of this release, an entity providing CCP 
services in the U.S. Treasury market and therefore serving as a 
covered clearing agency will be referred to as a ``U.S. Treasury 
securities CCA.''
    \15\ Counterparty credit risk refers to the potential for a 
market participant's counterparty to a given transaction to default 
on the transaction and therefore the market participant will not 
receive either the cash or securities necessary to settle the 
transaction.
    \16\ See, e.g., U.S. Department of the Treasury, A Financial 
System That Creates Economic Opportunities Capital Markets, at 81 
(Oct. 2017), available at https://home.treasury.gov/system/files/136/A-Financial-System-Capital-Markets-FINAL-FINAL.pdf (``2017 
Treasury Report'') (discussing issues caused by fragmented central 
clearing with respect to [interdealer brokers] at FICC and 
describing this contagion risk and stating ``if a large [proprietary 
trading firm] with unsettled trading volumes were to fail, the 
failure could introduce risk to the market and market 
participants'').
---------------------------------------------------------------------------

    As the only entity providing CCP services in the U.S. Treasury 
market, if FICC were unable to provide its CCP services for any reason, 
it could have a broad and severe impact on the overall U.S. economy, as 
the Financial Stability Oversight Council (``FSOC'') recognized when it 
designated FICC as a systemically important financial market utility in 
2012.\17\ Designation of an entity as a systemically important 
financial market utility brings heightened risk management requirements 
and additional regulatory supervision, by both its primary regulator 
and the Board of Governors of the Federal Reserve System.\18\ The 
Commission relied, in part, on this heightened supervisory authority 
under Title VIII of the Dodd-Frank Act to adopt the Covered Clearing 
Agency Standards.
---------------------------------------------------------------------------

    \17\ Financial Stability Oversight Council, 2012 Annual Report, 
Appendix A, available at https://www.treasury.gov/initiatives/fsoc/Documents/2012%20Annual%20Report.pdf (``FSOC 2012 Annual Report'').
    \18\ Id. at 119. The Commission previously has acknowledged that 
the Clearing Supervision Act reflects Congressional recognition that 
multilateral clearing or settlement activities ``may reduce risks 
for clearing participants and the broader financial system,'' but 
also may create ``new risks that require multilateral payment, 
clearing or settlement activities to be well-designed and operated 
in a safe and sound manner.'' Exchange Act Release No. 64017 (Mar. 
3, 2014), 76 FR 14472, 14474 (Mar. 16, 2011) (``Clearing Agency 
Standards Proposing Release''); see also 12 U.S.C. 5462(9), 
5463(a)(2). The Commission also recognized that the Clearing 
Supervision Act is designed, in part, to provide a regulatory 
framework to help address such risk management issues, ``which is 
generally consistent with the Exchange Act requirement that clearing 
agencies be organized in a manner so as to facilitate prompt and 
accurate clearance and settlement, safeguard securities and funds 
and protect investors.'' Id.
---------------------------------------------------------------------------

    Over the past several years, both the private and public sectors 
have observed the increased volume of U.S. Treasury secondary market 
transactions that are not centrally cleared.\19\ However, because data 
for these transactions is subject to different and incomplete reporting 
requirements, it is difficult to quantify this activity. The best 
available estimates at this time are those developed by private sector 
organizations. In particular, the Treasury Market Practice Group \20\ 
estimates that only 13 percent of the overall volume in U.S. dollars of 
U.S. Treasury cash transactions were centrally cleared as of the first 
half of 2017, and that an additional 19 percent were what the TMPG 
refers to as ``hybrid'' clearing, that is, executed on an interdealer 
broker platform (as described in section II.A.1 infra) in which one 
counterparty is a member of a CCA and submits its transaction with the 
interdealer broker for central clearing, while the other counterparty 
is not a member of a CCA and bilaterally clears its transaction with 
the interdealer broker.\21\ In addition, the G-30 Report estimated that 
``roughly 20 percent of commitments to settle U.S. Treasury security 
trades are cleared through FICC.'' \22\
---------------------------------------------------------------------------

    \19\ See, e.g., IAWG Report, supra note 4, at 5-6; 2017 Treasury 
Report, supra note 15, at 81; Joint Staff Report, supra note 4, at 
36-37.
    \20\ The Treasury Market Practices Group (``TMPG'') is a group 
of ``market professionals committed to supporting the integrity and 
efficiency of the Treasury, agency debt, and agency mortgage-backed 
securities markets.'' See https://www.newyorkfed.org/TMPG/. The TMPG is sponsored by the Federal Reserve Bank of New 
York. Id.
    \21\ TMPG, White Paper on Clearing and Settlement in the 
Secondary Market for U.S. Treasury Securities, at 12 (July 2019), 
available at https://www.newyorkfed.org/medialibrary/Microsites/tmpg/files/CS_FinalPaper_071119.pdf (``TMPG White Paper''). These 
estimates use FR2004 data, which are reports provided to the Federal 
Reserve Bank of New York regarding primary dealer market activity in 
U.S. Government securities, covering the first half of 2017 and are 
based on various assumptions specified in the TMPG White Paper. See 
also FR2004, Government Securities Dealer Reports, available at 
https://www.federalreserve.gov/apps/reportforms/reportdetail.aspx?sOoYJ+5BzDZq2f74T6b1cw.
    \22\ G-30 Report, supra note 5, at 11. See also IAWG Report, 
supra note 4, at 5-6; Joint Staff Report, supra note 4, at 36-37.
---------------------------------------------------------------------------

    Both the TMPG and the Group of 30 also identified the significant 
risks associated with bilateral clearing.\23\ For example, the TMPG 
stated that ``[b]ilateral clearing involves varying risk management 
practices that are less uniform and less transparent to the broader 
market and may be less efficient with regard to netting exposures and 
use of collateral as compared to central clearing. An increase in 
bilaterally cleared trades likely increases the aggregate liquidity 
risk in the clearing and settlement process because, unlike a CCP, 
bilateral arrangements may not have the discipline of establishing a 
contingent liquidity risk framework or uniform requirements for 
emergency liquidity.'' \24\
---------------------------------------------------------------------------

    \23\ TMPG White Paper, supra note 21, at 3.
    \24\ Id.
---------------------------------------------------------------------------

D. Proposal

    The Commission believes that a covered clearing agency, including 
one that provides CCP services,\25\ is most effective when its 
participation standards enable the CCA to understand and control the 
risks presented by its direct participants because such standards are 
an important tool to limit the potential for member defaults and, as a 
result, losses to non-defaulting members in the event of a member 
default, thereby protecting the securities market as a whole.\26\ For 
example, when proposing the Covered Clearing Agency Standards in Rule 
17Ad-22 in 2014, the Commission explained that ``[a]ppropriate minimum 
operational, legal, and capital requirements for membership that are 
maintained and enforced through the supervisory practices of a clearing 
agency help to ensure all members will be reasonably capable of meeting 
their various obligations to the clearing agency in stressed market 
conditions and upon member default.'' \27\ To that end, the 
Commission's rules governing the participation requirements of a CCA 
are designed to achieve that goal. Rule 17Ad-22(e)(18) requires that a 
CCA establish, implement, maintain and enforce written policies and 
procedures reasonably designed to, as applicable, establish objective, 
risk-based and publicly disclosed criteria for participation,\28\ and 
17 CFR 240.17Ad-22(e)(19) (``Rule 17Ad-22(e)(19)'') requires a CCA to 
maintain written policies and procedures reasonably designed to, as 
applicable, identify, monitor and manage the material risks to it 
arising from arrangements in which firms that are indirect participants 
in the CCA rely on the services provided to it by direct participants 
to access the CCA's payment, clearing, or settlement facilities.\29\
---------------------------------------------------------------------------

    \25\ Hereafter covered clearing agencies are referred to as 
``CCAs.''
    \26\ Covered Clearing Agency Standards Adopting Release, 
Exchange Act Release No. 78961 (Sep. 28, 2016), 81 FR 70786, 70839 
(Oct. 13, 2016) (``CCA Standards Adopting Release''); see also CCA 
Standards Proposing Release, supra note 7, 79 FR at 29552.
    \27\ CCA Standards Proposing Release, supra note 7, 79 FR at 
29552; see also CCA Standards Adopting Release, supra note 25, 81 FR 
at 70839.
    \28\ 17 CFR 240.17Ad-22(e)(18).
    \29\ 17 CFR 240.17Ad-22(e)(19).
---------------------------------------------------------------------------

    As described more fully in section III infra, the increasing volume 
of non-centrally cleared transactions in U.S. Treasury securities may 
render U.S. Treasury securities CCAs more susceptible to member 
defaults from risks outside the transactions cleared by the CCA, and as 
a result the

[[Page 64614]]

Commission is proposing to amend Rule 17Ad-22(e)(18). In particular, 
and as set forth more fully below, the Commission believes that 
amending Rule 17Ad-22(e)(18) to require the CCAs to address their 
direct participants' non-centrally cleared transactions, both for repos 
and certain categories of cash transactions, will help reduce contagion 
risk to the CCA and bring the benefits of central clearing to more 
transactions involving U.S. Treasury securities, thereby lowering 
overall systemic risk in the market. As discussed further in section 
III.A.3 infra, these benefits include centralized default management, 
increased multilateral netting, and reduction of settlement fails. The 
Commission also believes that increasing the volume of transactions 
submitted for central clearing is consistent with promoting the prompt 
and accurate clearance and settlement of securities transactions.\30\
---------------------------------------------------------------------------

    \30\ See Self-Regulatory Organizations; Fixed Income Clearing 
Corporation; Order Granting Approval of a Proposed Rule Change 
Relating to Trade Submission Requirements and Pre-Netting, Exchange 
Act Release No. 51908 (June 22, 2005), 70 FR 37450 (June 29, 2005) 
(describing a rule designed to bring additional transactions into 
FICC's netting system as ``clearly designed to promote the prompt 
and accurate clearance and settlement of those transactions and to 
preserve the safety and soundness of the national clearance and 
settlement system.'').
---------------------------------------------------------------------------

    The Commission also proposes to impose additional requirements on 
how U.S. Treasury securities CCAs calculate, collect, and hold margin 
posted on behalf of indirect participants (i.e., customers) who rely on 
the services of a direct participant (i.e., the member of the U.S. 
Treasury securities CCA) to access the CCA's services. As set forth in 
more detail below, the Commission believes that such requirements also 
will improve the risk management practices at U.S. Treasury securities 
CCAs and incentivize and facilitate additional central clearing in the 
U.S. Treasury market, thereby lowering systemic risk. Individually and 
collectively, these two proposals should further incentivize and 
facilitate additional central clearing.
    In addition, the Commission recognizes that the proposal could 
cause a substantial increase in the margin broker-dealers must post to 
a U.S. Treasury securities CCA resulting from their customers' cleared 
U.S. Treasury securities positions. Currently, broker-dealers are not 
permitted to include a debit in the customer reserve formula equal to 
this amount of margin or, more generally, to use customer cash or 
customer fully paid or excess margin securities to meet a margin 
requirement. To address this, the Commission proposes an amendment 
that, subject to certain conditions, would allow the broker-dealer to 
include a debit in the customer or PAB reserve formula when delivering 
customer cash or U.S. Treasury securities to meet the margin 
requirement at an entity providing CCP services in the U.S. Treasury 
market.

E. Current Regulatory and Industry Discussions Regarding the U.S. 
Treasury Market

    In normal market conditions, the U.S. Treasury market has 
functioned extremely well. Even under stress, the market generally has 
been highly resilient. However, several episodes in the U.S. Treasury 
market, including the ``flash rally'' of 2014, the U.S. Treasury repo 
market stress of September 2019, and the COVID-19 shock of March 2020, 
have raised questions about the U.S. Treasury market's continued 
capacity to absorb shocks and what factors may be limiting the 
resilience of the U.S. Treasury market under stress.\31\ Although 
different in their scope and magnitude, these events all generally 
involved dramatic increases in market price volatility and/or sharp 
decreases in available liquidity.
---------------------------------------------------------------------------

    \31\ G-30 Report, supra note 5, at 1; IAWG Report, supra note 4, 
at 7; Peter Ryan and Robert Toomey, Improving Capacity and 
Resiliency in US Treasury Markets: Part I (Mar. 24, 2021), available 
at https://www.sifma.org/resources/news/improving-capacity-and-resiliency-in-us-treasury-markets-part-1/.
---------------------------------------------------------------------------

    A number of recent publications and industry discussions have 
considered the overall structure and resilience of the U.S. Treasury 
market, in light of, among other things, the market events noted 
above.\32\ The Commission believes that, although this proposal will 
not, by itself, necessarily prevent future market disruptions, the 
proposal will support efficiency by reducing counterparty credit risk 
and improving transparency, as discussed in section III.A.3 infra. 
Moreover, the Commission believes that enhancing the membership 
standards applicable to U.S. Treasury securities CCAs should improve 
the resilience of such CCAs by expanding their ability to manage the 
risks arising from direct participants who currently engage in non-
centrally cleared transactions away from the CCA. In addition, the 
Commission believes that the risk management standards should 
facilitate and incentivize additional central clearing, thereby 
bringing the benefits of additional central clearing to the market for 
U.S. Treasury securities.
---------------------------------------------------------------------------

    \32\ See generally IAWG Report, supra note 4; G-30 Report, supra 
note 5; Nellie Liang & Patrick Parkinson, Enhancing Liquidity of the 
U.S. Treasury Market Under Stress (Dec. 16, 2020), available at 
https://www.brookings.edu/wp-content/uploads/2020/12/WP72_Liang-Parkinson.pdf (``Liang & Parkinson'').
---------------------------------------------------------------------------

    The Commission believes that these changes should lower systemic 
risk in the U.S. Treasury market by increasing the volume of 
transactions that are subject to central clearing and ensuring that 
those additional transactions are subject to standardized risk 
management. The Commission also believes that increased central 
clearing would provide greater transparency into the market and could, 
potentially facilitate all-to-all trading.\33\ The Commission believes 
that these benefits arising from central clearing should help improve 
the functioning of the U.S. Treasury market.
---------------------------------------------------------------------------

    \33\ See notes 184 through 186 infra.
---------------------------------------------------------------------------

II. Background

A. Current U.S. Treasury Market Structure and Central Clearing Within 
That Structure

    U.S. Treasury securities are direct obligations of the U.S. 
Government issued by the U.S. Department of the Treasury (``Treasury 
Department''). Market participants use U.S. Treasury securities as an 
investment instrument and as a hedging vehicle, among other things. For 
example, U.S. Treasury securities are often used as collateral in 
lending arrangements or as margin on other financial transactions. The 
Treasury Department issues several different types of securities, 
including U.S. Treasury bills, nominal coupons notes and bonds, 
Floating Rate Notes, and Treasury Inflation-Protected Securities 
(``TIPS''). For each U.S. Treasury security type, the most recently 
issued (``on-the-run'') securities are the most liquid in the secondary 
market.\34\ Market participants commonly refer to securities issued 
prior to ``on-the-run'' securities as ``off-the-run'' securities. 
Trading in off-the-run U.S. Treasury securities has always been less 
active than on-the-run trading, and price discovery primarily occurs in 
on-the-run securities.\35\
---------------------------------------------------------------------------

    \34\ On-the-run U.S. Treasury securities are the most recently 
auctioned nominal coupon securities. These securities are referred 
to as ``on-the-run'' starting the day after they are auctioned. 
Nominal coupon securities pay a fixed semi-annual coupon and are 
currently issued at original maturities of 2, 3, 5, 7, 10, 20, and 
30 years. These standard maturities are commonly referred to as 
``benchmark'' securities because the yields for these securities are 
used as references to price a number of private market transactions.
    \35\ Joint Staff Report, supra note 4, at 35-36. Price discovery 
also occurs in when-issued trading of U.S. Treasury securities prior 
to and on the day of the auction (pre- on-the-run trading). See note 
38 infra.
---------------------------------------------------------------------------

    The U.S. Treasury market consists of two components: the primary 
market

[[Page 64615]]

and the secondary market. The primary market is where the Treasury 
Department auctions securities (i.e., debt) to the public through a 
competitive bidding process and subsequently issues awarded securities 
to finance the Federal government.\36\ These U.S. Treasury securities, 
which are issued after the auction, are marketable securities and are 
primarily sold to financial institutions. Financial institutions 
designated by the Federal Reserve Bank of New York as ``primary 
dealers'' are expected to submit competitive bids on a pro-rata basis 
and participate meaningfully in all U.S. Treasury auctions at 
reasonably competitive rates or yields.\37\ U.S. Treasury securities 
are typically issued a few days after the auction and trade on the 
secondary market.\38\ The secondary market is where the subsequent 
trading of U.S. Treasury securities occurs. The secondary market 
includes the ``cash market,'' for outright purchases and sales of 
securities, and the repo market, where one participant sells a U.S. 
Treasury security to another participant, along with a commitment to 
repurchase the security at a specified price on a specified later 
date.\39\ This proposal applies to the secondary market for U.S. 
Treasury securities.
---------------------------------------------------------------------------

    \36\ TMPG White Paper, supra note 21, at 6. The Federal Reserve 
Bank of New York serves as fiscal agent for the U.S. Treasury in 
conducting auctions of marketable U.S. Treasury debt. See 12 U.S.C. 
391.
    \37\ See Federal Reserve Bank of New York, Administration of 
Relationships with Primary Dealers, available at https://www.newyorkfed.org/markets/primarydealers.html. Specifically, 
primary dealers are required to be either (1) a registered broker-
dealer or government securities broker-dealer, which is approved as 
a member of the Financial Industry Regulatory Authority, Inc. and 
has net regulatory capital of at least $50 million, or (2) a state 
or federally chartered bank or savings association (or a state or 
federally licensed branch or agency of a foreign bank) that is 
subject to bank supervision and maintains at least $1 billion in 
Tier 1 capital. Id. Thus, for those primary dealers that fall into 
the former category, they are a subset of the broader set of 
registered broker-dealers or government securities broker-dealers, 
which may also participate in the Treasury market, as discussed 
further in section II.A.1 and 2 infra.
    \38\ The Treasury Department typically announces a new security 
that it intends to sell several days before the auction at which it 
is first sold to the public. These securities begin trading after 
announcement before the auction and through issuance, which occurs a 
few days after the auction. Such trading is known generally as 
``when-issued'' trading; however, in the timeframe between the 
announcement and the auction, such trading is known as when-issued 
and referred to as such by market participants, but after the 
auction and before issuance, the securities are typically referred 
to simply as on-the-run, consistent with market practice. Michael 
Fleming, Or Shachar, and Peter Van Tassel, Treasury Market When-
Issued Trading Activity, Liberty Street Economics (Nov. 30, 2020) 
(``Fleming, Shachar, and Van Tassel''), available at https://libertystreeteconomics.newyorkfed.org/2020/11/treasury-market-when-issued-trading-activity/.
    \39\ See IAWG Report, supra note 4, at 3. The secondary market 
also includes the market for U.S. Treasury futures, which trade 
electronically on the Chicago Board of Trade, a designated contract 
market operated by the Chicago Mercantile Exchange (``CME'') Group, 
and centrally cleared by CME Clearing. U.S. Treasury futures are 
generally regulated by the U.S. Commodity Futures Trading Commission 
and are not the subject of this proposal.
---------------------------------------------------------------------------

1. Cash Market
    The cash market has two main components: the interdealer market and 
the dealer-to-customer market. In the interdealer market, dealers 
primarily trade with each other and with principal trading firms 
(``PTFs''), which trade as principals for their own accounts. The 
majority of trading in the interdealer market in on-the-run U.S. 
Treasury securities occurs on electronic platforms operated by 
interdealer brokers that bring together buyers and sellers anonymously 
using order books or other trading facilities supported by advanced 
electronic trading technology (``IDBs'').\40\ These IDBs are generally 
direct participants of a U.S. Treasury securities CCA and stand as 
counterparties to both sides of each trade on their platforms.\41\
---------------------------------------------------------------------------

    \40\ Joint Staff Report, supra note 4, at 11, 35-36.
    \41\ IAWG Report, supra note 4, at 21.
---------------------------------------------------------------------------

    Typically, an IDB provides a trading facility for multiple buyers 
and sellers for U.S. Treasury securities to enter orders at specified 
prices and sizes and have these orders displayed to all users on an 
anonymous basis. The trading facility automatically matches these 
orders according to priority and execution rules that are programmed in 
the trading facility. When a match occurs and a trade is executed, the 
IDB then books two trades, with the IDB functioning as the principal to 
each respective counterparty, thereby protecting the anonymity of each 
party, but taking on credit risk from each counterparty.\42\
---------------------------------------------------------------------------

    \42\ TMPG White Paper, supra note 21, at 6.
---------------------------------------------------------------------------

    Although the term ``IDB'' is sometimes used to refer to platforms 
that may provide voice-based or other trading technology, as referenced 
below, in this release, consistent with existing commentary on the U.S. 
Treasury markets, the term IDB does not encompass platforms that 
provide voice-based or other non-anonymous methods of bringing together 
buyers and sellers of U.S. Treasury securities and instead refers to 
electronic platforms providing anonymous methods of bringing together 
buyers and sellers.\43\
---------------------------------------------------------------------------

    \43\ The entities referred to as IDBs here are encompassed in 
the ATSs category in the tables set forth in section IV.B.1 infra 
because of the way that such IDBs are categorized in TRACE. 
Specifically, the ``ATS'' category in TRACE encompasses these IDBs. 
By contrast, the non-ATS IDBs category in TRACE encompasses the 
voice-based or other non-anonymous methods of bringing together 
buyers and sellers, which are also sometimes referred to as 
interdealer brokers by market participants.
---------------------------------------------------------------------------

    The majority of trades in the interdealer markets are trades in 
``on-the-run'' issues. The majority of interdealer trading for off-the-
run U.S. Treasury securities occurs via bilateral transactions through 
traditional voice-assisted brokers and electronic trading platforms 
offering various protocols to bring together buyers and sellers, 
although some interdealer trading in off-the-run U.S. Treasury 
securities does occur on IDBs that anonymously bring together buyers 
and sellers.\44\
---------------------------------------------------------------------------

    \44\ Joint Staff Report, supra note 4, at 35.
---------------------------------------------------------------------------

    Until the mid-2000s, most interdealer trading occurred between 
primary dealers, who are required to be members of FICC, and was 
centrally cleared.\45\ However, in recent years, much of the trading on 
IDBs, in terms of number of trades and overall volume, has been 
conducted by PTFs.\46\
---------------------------------------------------------------------------

    \45\ G-30 Report, supra note 5, at 9; IAWG Report, supra note 4, 
at 5-6; TMPG White Paper, supra note 21, at 6. See also supra note 
37 (setting forth conditions for being a primary dealer).
    \46\ G-30 Report, supra note 5, at 1.
---------------------------------------------------------------------------

    Most IDBs are FICC direct participants, and the trades between an 
IDB, that is a FICC direct participant, and another FICC direct 
participant are submitted for central clearing to FICC, which, as noted 
above, is currently the only U.S. Treasury securities CCA. Various 
types of market participants are direct participants of FICC, including 
dealers (both bank-affiliated and independent), banks, and IDBs. FICC's 
current rules generally require that FICC direct participants submit 
for clearing all trades with other FICC direct participants.\47\ 
However, FICC's rules do not require that a trade between a FICC direct 
participant and a party that is not a FICC direct participant be 
submitted for clearing. Therefore, for trades on IDBs between a party 
that is not a FICC direct participant (which, on an IDB, is generally a 
PTF) and a dealer which is a FICC direct participant--which results in 
two separate transactions, between the IDB and the dealer, on the one 
hand, and between the IDB and the PTF, on the other hand--the 
transaction between the dealer and the IDB would be centrally cleared. 
But the transaction

[[Page 64616]]

between a PTF which is not a FICC member and the IDB, on the other 
side, would not be centrally cleared and instead would be settled 
bilaterally with the IDB, often through a clearing agent acting on 
behalf of the non-FICC direct participant.\48\
---------------------------------------------------------------------------

    \47\ FICC Rule 2A section 7(e) (requirement that FICC Netting 
Members submit to FICC all of its eligible trades with other Netting 
Members); FICC Rule 18 section 2 (similar requirement with regard to 
Repo transactions). The Rules for FICC's GSD are available at 
https://www.dtcc.com/~/media/Files/Downloads/legal/rules/
ficc_gov_rules.pdf. Unless otherwise indicated, all references to 
``FICC Rule'' in this release refer to the GSD Rulebook.
    \48\ See TMPG White Paper, supra note 21, at Figures 5A and 5B 
(providing graphical description of this type of clearing).
---------------------------------------------------------------------------

    A 2015 inter-agency staff publication found that PTFs account for 
more than half of the trading activity in the futures and electronic 
IDB markets for U.S. Treasury securities, providing the vast majority 
of market depth, and questioned whether trades cleared by such firms 
outside of a CCP are subject to the same level of risk mitigation.\49\ 
In 2018, the TMPG determined that ``a majority of trades in the 
secondary [cash] Treasury market now clear bilaterally, a trend that is 
contrary to the direction of recent regulatory requirements in other 
markets (i.e., swaps) that for some products mandate clearing and for 
others encourage it through higher margin requirements on bilaterally 
cleared transactions.'' \50\ The trading volume of non-FICC members, at 
least in the cash U.S. Treasury market, is now estimated to exceed that 
of FICC members.\51\ Whether or not a trade is centrally cleared 
impacts the risk management requirements applicable to the trade. 
Specifically, trades cleared and settled outside of a CCP may not be 
subject to the same extent of risk management associated with central 
clearing, which includes requirements for margin determined by a 
publicly disclosed method that applies objectively and uniformly to all 
members of the CCP, loss mutualization, and liquidity risk 
management.\52\
---------------------------------------------------------------------------

    \49\ Joint Staff Report, supra note 4, at 2, 55.
    \50\ TMPG White Paper, supra note 21, at 2.
    \51\ IAWG Report, supra note 4, at 30; TMPG White Paper, supra 
note 21, at 12.
    \52\ IAWG Report, supra note 4, at 30; G-30 Report, supra note 
5.
---------------------------------------------------------------------------

    Dealer-to-customer trading generally involves ``off-the-run'' 
issues more often than the interdealer market and typically is 
conducted via voice or electronically (i.e., electronic ``request for 
quote'' systems referred to section IV infra as non-ATS IDBs).\53\ 
Trading in the dealer-to-customer cash market is generally--and has 
historically been--conducted through bilateral transactions. Customers 
have not traditionally traded directly with other end users.\54\ 
Rather, non-dealers primarily trade with dealers, and dealers use the 
interdealer market as a source of orders and trading interest to help 
facilitate their trading with customers in the dealer-to-customer 
market. Generally, trades in the dealer-to-customer market are not 
centrally cleared.\55\
---------------------------------------------------------------------------

    \53\ G-30 Report, supra note 5, at 1; TMPG White Paper, supra 
note 21, at 1-2.
    \54\ See Exchange Act Release No. 90019 (Sep. 28, 2020), 85 FR 
87106, 87108 (Dec. 30, 2020).
    \55\ G-30 Report, supra note 5, at 1; IAWG Report, supra note 4, 
at 3; TMPG White Paper, supra note 21, at 6.
---------------------------------------------------------------------------

2. U.S. Treasury Repo Market
    In a U.S. Treasury repo transaction, one party sells a U.S. 
Treasury security to another party, along with a commitment to 
repurchase the security at a specified price on a specified later date. 
A reverse repo transaction is the same transaction from the buyer's 
perspective.\56\ The effect of such a repo transaction is similar to a 
cash loan, using the U.S. Treasury securities as collateral. The 
difference in price between the purchase and repurchase is typically 
converted to an interest rate, and represents the ``cost'' of the loan. 
U.S. Treasury repos can use a particular security as collateral (known 
in the industry as ``specific collateral'') or can designate a broad 
class of securities as collateral (known as ``general collateral''). 
Most U.S. Treasury repos are overnight, though the parties can set the 
term for longer (generally no longer than one year).
---------------------------------------------------------------------------

    \56\ For purposes of this release, we generally refer to both 
repos and reverse repos collectively as ``repos.''
---------------------------------------------------------------------------

    The U.S. Treasury repo market plays a key role in facilitating the 
flow of cash and securities in the financial system by allowing market 
participants to access low cost secured financing, supporting dealer 
market-making activities, enabling institutional investors with large 
cash balances to invest cash on a secured basis, and contributing to 
price discovery and efficient capital allocation.\57\ The Federal 
Reserve also engages in U.S. Treasury repos to bring about liquidity in 
the financial system, implement monetary policy, and promote financial 
stability. As of March 31, 2022, total repo assets were approximately 
$6 trillion, while repo liabilities were approximately $5.6 trillion, 
with over half collateralized by U.S. Treasury securities.\58\ Of that 
amount, 38 percent is attributable to the Federal Reserve's reverse 
repo programs, 27 percent to securities dealers, 20 percent to what is 
referred to as ``rest of world'' and includes, among other entities, 
foreign hedge funds, and the rest to banks, mortgage real estate 
investment trusts, and insurance companies.\59\
---------------------------------------------------------------------------

    \57\ Viktoria Baklanova, Isaac Kuznits, Trevor Tatum, Primer: 
Money Market Funds and the Repo Market (Feb. 18, 2021), available at 
https://www.sec.gov/files/mmfs-and-the-repo-market-021721.pdf (``MMF 
Primer'').
    \58\ The Financial Accounts of the United States (Q1 2022), 
available at https://www.federalreserve.gov/releases/z1/20220609/html/l207.htm. The difference between repo assets and repo 
liabilities in the Financial Accounts is largely attributed to 
incomplete repo data collections and is calculated as instrument 
discrepancies.
    \59\ See id.
---------------------------------------------------------------------------

    Depending on clearing and settlement practices, the U.S. Treasury 
repo market consists of four main components: (1) non-centrally 
cleared, settled bilaterally, (2) centrally cleared, settled 
bilaterally, (3) non-centrally cleared, settled on a triparty platform, 
and (4) centrally cleared, settled on a triparty platform.
    For non-centrally cleared bilateral U.S. Treasury repos, the 
parties agree to the terms and settle the trades between themselves, 
without involving a CCP or other third-party. As mentioned above, 
FICC's rules require its direct participants to submit for central 
clearing all eligible trades with other direct participants. Therefore, 
non-centrally cleared bilateral U.S. Treasury repos involve at least 
one party that is not a FICC direct participant (e.g., a hedge fund); 
such repos may also involve a repo structure that FICC does not accept 
for clearing.
    For centrally cleared bilateral U.S. Treasury repos, the parties 
are FICC direct participants that submit agreed-upon trade details to 
FICC for central clearing, and those trades are settled delivery versus 
payment using the members' clearing banks and/or Fedwire Securities 
Service.\60\ Additionally, some institutional participants (e.g., money 
market funds and hedge funds) that are not FICC direct participants 
also centrally clear repos through FICC's sponsored service. In 2005, 
FICC established this service (the ``Sponsored Service''), allowing 
eligible direct participants (Sponsoring Members) to sponsor their 
clients into a limited form of FICC membership and then to submit 
certain eligible securities transactions of their clients (Sponsored 
Members) to FICC for central clearing.\61\ FICC interacts solely with 
the Sponsoring Member/direct participant as agent for purposes of the 
Sponsoring Member's clients/Sponsored Members' obligations to and from 
FICC. Sponsoring Members also guarantee to FICC the payment and 
performance obligations of their Sponsored

[[Page 64617]]

Members.\62\ Sponsoring Members can be either bank direct participants 
of FICC which meet certain capital and other requirements or any other 
FICC direct participant which meets what FICC determines to be the 
appropriate financial resource requirements; in practice, Sponsoring 
Members include both banks and broker-dealers.\63\ Sponsored Members 
have to be ``qualified institutional buyers'' as defined by Rule 144A 
under the Securities Act of 1933, as amended, or otherwise meet the 
financial standards necessary to be a ``qualified institutional 
buyer,'' and currently, Sponsored Members generally consist of hedge 
funds, money market funds, other asset managers, and smaller banks.\64\
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    \60\ See note 249 infra.
    \61\ See Self-Regulatory Organizations; Fixed Income Clearing 
Corporation; Order Approving a Proposed Rule Change Establishing a 
Sponsored Membership Program, Exchange Act Release No. 51896 (June 
21, 2005), 70 FR 36981 (June 27, 2005).
    \62\ See Exchange Act Release No. 51896 (June 21, 2005), 70 FR 
36981 (June 27, 2005); see also FICC Rule 3A, supra note 47. For 
general information and statistics regarding the Sponsored Service, 
see https://www.dtcc.com/clearing-services/ficc-gov/sponsored-membership, as well as section IV.B.7.d.i infra. The Sponsored 
Service also allows the submission of cash transactions; however, at 
this time, the service is generally used only for U.S. Treasury repo 
transactions.
    \63\ See FICC Rule 3A, section 2(a) and (b), supra note 47; FICC 
Membership Listing, available at https://www.dtcc.com/-/media/Files/Downloads/client-center/FICC/Mem-GOV-by-name.xlsx (identifying 
Sponsoring Members as those with Omnibus accounts).
    \64\ See FICC Rule 3A, section 3(a), supra note 47; FICC 
Sponsored Membership Listing, available at https://www.dtcc.com/client-center/ficc-gov-directories.
---------------------------------------------------------------------------

    For non-centrally cleared triparty U.S. Treasury repos, cash 
lenders (e.g., money market funds) provide financing to cash borrowers 
(e.g., dealers). The parties agree to the terms of a trade and arrange 
for a clearing bank to facilitate settlement. Like non-centrally 
cleared bilateral repos, at least one party to the transaction is not a 
FICC member. While the clearing bank provides a triparty platform to 
help facilitate the movement of cash and securities among accounts of 
counterparties to the transaction, it does not itself become a 
counterparty to the transactions and does not guarantee either 
counterparty's performance of its obligations. Collateral posted to the 
triparty platform generally cannot be repledged outside the platform, 
thereby protecting against settlement fails.\65\
---------------------------------------------------------------------------

    \65\ See generally Reference Guide to U.S. Repo and Securities 
Lending Markets (Nov. 9, 2015), available at https://www.financialresearch.gov/working-papers/files/OFRwp-2015-17_Reference-Guide-to-U.S.-Repo-and-Securities-Lending-Markets.pdf.
---------------------------------------------------------------------------

    For centrally cleared U.S. Treasury triparty repos, the parties are 
FICC members that submit agreed-upon trade details to FICC for central 
clearing through FICC's General Collateral Finance (``GCF'') Repo 
Service. Unlike centrally cleared bilateral repos, these triparty repos 
are settled on the clearing bank's triparty platform. Like centrally 
cleared bilateral repos, centrally cleared triparty repos are novated 
by FICC, and FICC acts as a CCP for these transactions, including by 
collecting margin pursuant to its margin methodology for such 
transactions. Until recently, centrally cleared triparty repos were 
only conducted through the GCF Repo Service, i.e., between two direct 
members of FICC. However, in September 2021, FICC introduced its 
Sponsored General Collateral Service (``Sponsored GC Service''), which 
enables centrally cleared triparty repos between a sponsored member and 
its sponsoring member.\66\ The Sponsored GC Service accepts general 
collateral in a number of generic CUSIPs, and though U.S. Treasury 
securities are among the general collateral types acceptable in the 
Sponsored GC Service, other types of collateral including agency and 
mortgage backed securities are acceptable for use as collateral as 
well.\67\ Each type of eligible collateral for the Sponsored GC Service 
is assigned its own generic CUSIP number, and security types are not 
mixed.\68\
---------------------------------------------------------------------------

    \66\ Exchange Act Release No. 92808 (Aug. 30, 2021), 86 FR 49580 
(Sept. 3, 2021). Currently, the Bank of New York Mellon operates the 
triparty platform that facilitates trades conducted via the GCF Repo 
Service and Sponsored GC Service.
    \67\ See generally DTCC Sponsored General Collateral Service, 
available at https://www.dtcc.com/-/media/Files/Downloads/Clearing-Services/FICC/GOV/SponsoredGC-FS-INTL.pdf.
    \68\ Id.
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B. Current Regulatory Framework

1. Clearing Agency Regulation Under Section 17A of the Exchange Act
    As noted above, when Congress added section 17A to the Exchange Act 
as part of the Securities Acts Amendments of 1975, it directed the 
Commission to facilitate the establishment of (i) a national system for 
the prompt and accurate clearance and settlement of securities 
transactions (other than exempt securities) and (ii) linked or 
coordinated facilities for clearance and settlement of securities 
transactions,\69\ and the Government Securities Act of 1986 
specifically included government securities within the scope of section 
17A.\70\ In facilitating the establishment of the national clearance 
and settlement system, the Commission must have due regard for the 
public interest, the protection of investors, the safeguarding of 
securities and funds, and maintenance of fair competition among brokers 
and dealers, clearing agencies, and transfer agents.\71\ The 
Commission's ability to achieve these goals is based upon the 
regulation of clearing agencies registered with the Commission.\72\ 
Specifically, section 17A of the Exchange Act provides the Commission 
with authority to adopt rules as necessary or appropriate in the public 
interest, for the protection of investors, or otherwise in furtherance 
of the purposes of the Exchange Act (including for the prompt and 
accurate clearance and settlement of securities transactions) and 
prohibits a clearing agency from engaging in any activity in 
contravention of such rules and regulations.\73\
---------------------------------------------------------------------------

    \69\ See supra note 1.
    \70\ Specifically, the Government Securities Act, among other 
things, authorized the Commission to regulate clearing agencies 
engaged in the clearance and settlement of government securities 
transactions, including those in U.S. Treasury securities, by 
providing that government securities would no longer be exempt 
securities for purposes of section 17A of the Exchange Act. 
Government Securities Act of 1986, section 102(a); 15 U.S.C. 
78c(a)(12)(B)(i).
    \71\ See 15 U.S.C. 78q-1(a)(2)(A).
    \72\ Under the Exchange Act and the regulations thereunder, any 
entity providing such central counterparty services is a clearing 
agency and must register with the Commission or seek an exemption 
from registration. 15 U.S.C. 78q-1(b)(1); see also 17 CFR 240.17Ad-
22(a)(5) (defining covered clearing agency).
    \73\ See 15 U.S.C. 78q-1(d)(1); see also 15 U.S.C. 78q-1(b)(2) 
(referring to the Commission's ability to adopt rules with respect 
to the application of section 17A). As noted above, for purposes of 
section 17A, the Commission's authority over securities also 
includes ``government securities.'' Government Securities Act of 
1986, section 102(a); 15 U.S.C. 78c(a)(12)(B)(i).
---------------------------------------------------------------------------

    The Commission has exercised its broad authority to prescribe 
requirements for the prompt and accurate clearance and settlement of 
securities transactions and the safeguarding of securities and funds 
described above. As noted above, most recently, the Commission has 
promulgated the Covered Clearing Agency standards, which apply to, 
among others, any entity providing CCP services, such as FICC.\74\ 
These standards require covered clearing agencies, to establish, 
implement, maintain, and enforce written policies and procedures 
reasonably designed to, as applicable, meet certain minimum standards 
regarding, among other things, operations, governance, and risk 
management.
---------------------------------------------------------------------------

    \74\ See supra note 7 and 17 CFR 240.17Ad-22(a)(5).
---------------------------------------------------------------------------

    The Commission has previously explained that membership 
requirements like those set forth in this proposal are an important 
tool for managing a clearing agency's risk. For example, when proposing 
the Covered Clearing Agency Standards, the Commission explained that 
appropriate minimum membership requirements, including operational, 
legal, and capital requirements, help ``to ensure all

[[Page 64618]]

members will be reasonably capable of meeting their various obligations 
to the clearing agency in stressed market conditions and upon member 
default.'' \75\ Clearing agency member defaults have long been a 
concern of the Commission; the Commission has explained that ``[m]ember 
defaults challenge the safe functioning of a clearing agency by 
creating credit and liquidity risks, which impede a clearing agency's 
ability to settle securities transactions in a timely manner.'' \76\
---------------------------------------------------------------------------

    \75\ CCA Standards Proposing Release, supra note 7, 79 FR at 
29552; see also CCA Standards Adopting Release, supra note 25, 81 FR 
at 70839 (stating that the use of risk-based criteria helps to 
protect investors ``by limiting the participants of a covered 
clearing agency to those for which the covered clearing agency has 
assessed the likelihood of default.'').
    \76\ CCA Standards Proposing Release, supra note 7, 79 FR at 
29552.
---------------------------------------------------------------------------

    In particular, among other things, the Covered Clearing Agency 
Standards impose requirements on a covered clearing agency with respect 
to both its direct and indirect participants. For example, Rule 17Ad-
22(e)(18) requires that covered clearing agencies establish implement, 
maintain and enforce written policies and procedures reasonably 
designed to, as applicable, establish objective, risk-based and 
publicly disclosed criteria for participation.\77\ Similarly, Rule 
17Ad-22(e)(19) imposes requirements on a covered clearing agency to 
maintain written policies and procedures reasonably designed to, as 
applicable, identify, monitor and manage the risks posed to it by 
indirect participants.\78\
---------------------------------------------------------------------------

    \77\ 17 CFR 240.17Ad-22(e)(18).
    \78\ 17 CFR 240.17Ad-22(e)(19).
---------------------------------------------------------------------------

2. The Broker-Dealer Customer Protection Rule
    Rule 15c3-3 is designed ``to give more specific protection to 
customer funds and securities, in effect forbidding brokers and dealers 
from using customer assets to finance any part of their businesses 
unrelated to servicing securities customers; e.g., a firm is virtually 
precluded from using customer funds to buy securities for its own 
account.'' \79\ To meet this objective, Rule 15c3-3 requires a broker-
dealer that maintains custody of customer securities and cash (a 
``carrying broker-dealer'') to take two primary steps to safeguard 
these assets, as described below. The steps are designed to protect 
customers by segregating their securities and cash from the broker-
dealer's proprietary business activities. If the broker-dealer fails 
financially, the customer securities and cash should be readily 
available to be returned to the customers. In addition, if the failed 
broker-dealer is liquidated in a formal proceeding under the Securities 
Investor Protection Act of 1970 (``SIPA''), the customer securities and 
cash should be isolated and readily identifiable as ``customer 
property'' and, consequently, available to be distributed to customers 
ahead of other creditors.\80\
---------------------------------------------------------------------------

    \79\ See Exchange Act Release No. 21651 (Jan. 11, 1985), 50 FR 
2690, 2690 (Jan. 18, 1985). See also Exchange Act Release No. 9856 
(Nov. 10, 1972), 37 FR 25224, 25224 (Nov. 29, 1972).
    \80\ See 15 U.S.C. 78aaa et seq. At a high level, in such a 
liquidation, SIPA would provide for the appointment of a trustee, 
who is required to return customer name securities to customers of 
the debtor (15 U.S.C. 78fff-2(c)(2)), distribute the fund of 
``customer property'' ratably to customers (15 U.S.C. 78fff-2(b)), 
and pay, with money from the SIPC fund, remaining customer net 
equity claims, to the extent provided by the Act (15 U.S.C. 78fff-
2(b) and 3(a)). Customer property is defined as ``cash and 
securities (except customer name securities delivered to the 
customer) at any time received, acquired, or held by or for the 
account of a debtor from or for the securities accounts of a 
customer, and the proceeds of any such property transferred by the 
debtor, including property unlawfully converted.'' 15 U.S.C. 
7lll(4).
---------------------------------------------------------------------------

    The first step required by Rule 15c3-3 is that a carrying broker-
dealer must maintain physical possession or control over customers' 
fully paid and excess margin securities.\81\ Control means the broker-
dealer must hold these securities in one of several locations specified 
in Rule 15c3-3 and free of liens or any other interest that could be 
exercised by a third-party to secure an obligation of the broker-
dealer.\82\ Permissible locations include a clearing corporation and a 
bank, as defined in section 3(a)(6) of the Exchange Act.\83\
---------------------------------------------------------------------------

    \81\ See 17 CFR 240.15c3-3(d). The term ``fully paid 
securities'' means all securities carried for the account of a 
customer in a cash account as defined in Regulation T (12 CFR 220.1 
et seq.), as well as securities carried for the account of a 
customer in a margin account or any special account under Regulation 
T that have no loan value for margin purposes, and all margin equity 
securities in such accounts if they are fully paid: provided, 
however, that the term fully paid securities does not apply to any 
securities purchased in transactions for which the customer has not 
made full payment. 17 CFR 240.15c3-3(a)(3). The term ``margin 
securities'' means those securities carried for the account of a 
customer in a margin account as defined in section 4 of Regulation T 
(12 CFR 220.4), as well as securities carried in any other account 
(such accounts referred to as ``margin accounts'') other than the 
securities referred to in paragraph (a)(3) of Rule 15c3-3. 17 CFR 
240.15c3-3(a)(4). The term ``excess margin securities'' means those 
securities referred to in paragraph (a)(4) of Rule 15c3-3 carried 
for the account of a customer having a market value in excess of 
140% of the total of the debit balances in the customer's account or 
accounts encompassed by paragraph (a)(4) of Rule 15c3-3 which the 
broker-dealer identifies as not constituting margin securities. 17 
CFR 240.15c3-3(a)(5).
    \82\ See 17 CFR 240.15c3-3(c). Customer securities held by the 
carrying broker-dealer are not assets of the firm. Rather, the 
carrying broker-dealer holds them in a custodial capacity, and the 
possession and control requirement is designed to ensure that the 
carrying broker-dealer treats them in a manner that allows for their 
prompt return.
    \83\ Id.
---------------------------------------------------------------------------

    The second step is that a carrying broker-dealer must maintain a 
reserve of funds or qualified securities in an account at a bank that 
is at least equal in value to the net cash owed to customers.\84\ The 
account must be titled ``Special Reserve Bank Account for the Exclusive 
Benefit of Customers'' (``customer reserve account'').\85\ The amount 
of net cash owed to customers is computed weekly pursuant to a formula 
set forth in 17 CFR 240.15c3-3a (``Rule 15c3-3a'').\86\ Under the 
formula, the broker-dealer adds up customer credit items and then 
subtracts from that amount customer debit items.\87\ The credit items 
include credit balances in customer accounts and funds obtained through 
the use of customer securities.\88\ The debit items include money owed 
by customers (e.g., from margin lending), securities borrowed by the 
broker-dealer to effectuate customer short sales, and required margin 
posted to certain clearing agencies as a consequence of customer 
securities transactions.\89\ If credit items exceed debit items, the 
net amount must be on deposit in the customer reserve account in the 
form of

[[Page 64619]]

cash and/or qualified securities.\90\ A broker-dealer cannot make a 
withdrawal from the customer reserve account until the next computation 
and even then only if the computation shows that the reserve 
requirement has decreased.\91\ The broker-dealer must make a deposit 
into the customer reserve account if the computation shows an increase 
in the reserve requirement.
---------------------------------------------------------------------------

    \84\ 17 CFR 240.15c3-3(e). The term ``qualified security'' is 
defined in Rule 15c3-3 to mean a security issued by the United 
States or a security in respect of which the principal and interest 
are guaranteed by the United States. See 17 CFR 240.15c3-3(a)(6).
    \85\ See 17 CFR 240.15c3-3(e)(1). The purpose of giving the 
account this title is to alert the bank and creditors of the broker-
dealer that this reserve fund is to be used to meet the broker-
dealer's obligations to customers (and not the claims of general 
creditors) in the event the broker-dealer must be liquidated in a 
formal proceeding.
    \86\ Some broker-dealers perform a daily computation in order to 
more dynamically match the deposit requirement with the amount of 
net cash owed to customers. For example, a broker-dealer that 
performs a weekly computation generally cannot withdraw excess cash 
or U.S. Treasury securities from the account until the following 
week even if the value of the account assets exceeds the net cash 
owed to customers. Further, the rule permits certain broker-dealers 
to perform a monthly computation. See 17 CFR 240.15c3-3(e)(3).
    \87\ See id.
    \88\ See 17 CFR 240.15c3-3a, Items 1-9. Broker-dealers are 
permitted to use customer margin securities to, for example, obtain 
bank loans to finance the funds used to lend to customers to 
purchase the securities. The amount of the bank loan is a credit in 
the formula because this is the amount that the broker-dealer would 
need to pay the bank to retrieve the securities. Similarly, broker-
dealers may use customer margin securities to make stock loans to 
other broker-dealers in which the lending broker-dealer typically 
receives cash in return. The amount payable to the other broker-
dealer on the stock loan is a credit in the formula because this is 
the amount the broker-dealer would need to pay the other broker-
dealer to retrieve the securities.
    \89\ See 17 CFR 240.15c3-3a, Items 10-14.
    \90\ 17 CFR 240.15c3-3(e). Customer cash is a balance sheet item 
of the carrying broker-dealer (i.e., the amount of cash received 
from a customer increases the amount of the carrying broker-dealer's 
assets and creates a corresponding liability to the customer). The 
reserve formula is designed to isolate these broker-dealer assets so 
that an amount equal to the net liabilities to customers is held as 
a reserve in the form of cash or U.S. Government securities. The 
requirement to establish this reserve is designed to effectively 
prevent the carrying broker-dealer from using customer funds for 
proprietary business activities such as investing in securities. The 
goal is to put the carrying broker-dealer in a position to be able 
to readily meet its cash obligations to customers by requiring the 
firm to make deposits of cash and/or U.S. Government securities into 
the customer reserve account in the amount of the net cash owed to 
customers.
    \91\ See 17 CFR 240.15c3-3(e).
---------------------------------------------------------------------------

    The Rule 15c3-3a formula permits the broker-dealer to offset 
customer credit items only with customer debit items.\92\ This means 
the broker-dealer can use customer cash to facilitate customer 
transactions such as financing customer margin loans and borrowing 
securities to make deliveries of securities customers have sold 
short.\93\ The broker-dealer margin rules require securities customers 
to maintain a minimum level of equity in their securities accounts. In 
addition to protecting the broker-dealer from the consequences of a 
customer default, this equity serves to over-collateralize the 
customers' obligations to the broker-dealer. This buffer protects the 
customers whose cash was used to facilitate the broker-dealer's 
financing of securities purchases. For example, if the broker-dealer 
fails, the customer debits, because they generally are over-
collateralized, should be attractive assets for another broker-dealer 
to purchase or, if not purchased by another broker-dealer, they should 
be able to be liquidated to a net positive equity.\94\ The proceeds of 
the debits sale or liquidation can be used to repay the customer cash 
used to finance the customer obligations. This cash plus the funds and/
or U.S. Treasury securities held in the customer reserve account should 
equal or exceed the total amount of customer credit items (i.e., the 
total amount owed by the broker-dealer to its customers).\95\
---------------------------------------------------------------------------

    \92\ See 17 CFR 240.15c3-3a.
    \93\ For example, if a broker-dealer holds $100 for customer A, 
the broker-dealer can use that $100 to finance a security purchase 
of customer B. The $100 the broker-dealer owes customer A is a 
credit in the formula and the $100 customer B owes the broker-dealer 
is a debit in the formula. Therefore, under the Rule 15c3-3a formula 
there would be no requirement to maintain cash and/or U.S. 
Government securities in the customer reserve account. However, if 
the broker-dealer did not use the $100 held in customer A's account 
for this purpose, there would be no offsetting debit and, 
consequently, the broker-dealer would need to have on deposit in the 
customer reserve account cash and/or U.S. Government securities in 
an amount at least equal to $100.
    \94\ The attractiveness of the over-collateralized debits 
facilitates the bulk transfer of customer accounts from a failing or 
failed broker-dealer to another broker-dealer.
    \95\ See Exchange Act Release No. 18417 (Jan. 13, 1982), 47 FR 
3512, 3513 (Jan. 25, 1982) (``The alternative approach is founded on 
the concept that, if the debit items in the Reserve Formula can be 
liquidated at or near their contract value, these assets along with 
any cash required to be on deposit under the [customer protection] 
rule, will be sufficient to satisfy all liabilities to customers 
(which are represented as credit items in the Reserve Formula).'').
---------------------------------------------------------------------------

    As noted above, debit items in the Rule 15c3-3a formula include 
margin required and on deposit at certain clearing agencies. In 
particular, Item 13 of the Rule 15c3-3a formula identifies as a debit 
item margin required and on deposit with the Options Clearing 
Corporation for all option contracts written or purchased in accounts 
of securities customers.\96\ Similarly, Item 14 of the Rule 15c3-3a 
formula identifies as a debit item margin related to security futures 
products written, purchased, or sold in accounts carried for security-
based swap customers required and on deposit with a clearing agency 
registered with the Commission under section 17A of the Exchange Act 
\97\ or a derivatives clearing organization (``DCO'') registered with 
the Commodities Futures Trading Commission under section 5b of the 
Commodity Exchange Act.\98\ These debit items reflect the fact that 
customer options and security futures transactions that are cleared 
generate margin requirements in which the broker-dealer must deliver 
collateral to the Options Clearing Corporation in the case of options 
or a clearing agency or DCO in the case of security futures products. 
Further, 17 CFR 240.15c3-3b (``Rule 15c3-3b'') sets forth a customer 
reserve formula for security-based swaps.\99\ Items 13 and 14 of this 
formula are identical to Items 13 and 14 of the Rule 15c3-3a formula. 
The Rule 15c3-3b formula also permits a debit item for margin related 
to cleared security-based swaps required and on deposit in a qualified 
clearing agency account at a clearing agency registered pursuant to 
section 17A of the Exchange Act.
---------------------------------------------------------------------------

    \96\ See 17 CFR 240.15c3-3a, Item 13.
    \97\ 15 U.S.C. 78q-1.
    \98\ 7 U.S.C. 78q-1.
    \99\ See also Exchange Act Release No. 86175 (Jun. 21, 2019), 84 
FR 43872, 43938-42 (Aug. 22, 2019) (adopting a reserve computation 
for security-based swaps that permits a debit for margin delivered 
to a security-based swap clearing agency).
---------------------------------------------------------------------------

    Identifying the collateral delivered to the Options Clearing 
Corporation, a clearing agency, or a DCO as a debit item permits the 
broker-dealer to offset credit items, which reduces the amount of cash 
or qualified securities that must be deposited in the customer reserve 
account. In addition, under SIPA, ``customer property'' in a 
liquidation proceeding of a broker-dealer includes resources provided 
through the use or realization of customers' debit cash balances and 
other customer-related debit items as defined by the Commission by 
rule.\100\ Therefore, by defining margin required and on deposit at the 
Options Clearing Corporation, a clearing agency, or a DCO as a debit 
item in Rule 15c3-3a, this property is available to the trustee to be 
used to return cash and securities to the failed broker-dealer's 
customers ahead of any other creditors of the broker-dealer.
---------------------------------------------------------------------------

    \100\ See 15 U.S.C. 78lll(4)(B).
---------------------------------------------------------------------------

III. Proposed Amendments

A. U.S. Treasury Securities CCA Membership Requirements

    For the reasons set forth below, the Commission believes that 
direct participants in a U.S. Treasury securities CCA not centrally 
clearing cash or repo transactions in U.S. Treasury securities creates 
contagion risk to CCAs clearing and settling in these markets, as well 
as to the market as a whole, and that this contagion risk can be 
ameliorated at least in part by increasing the number of such 
transactions that are centrally cleared. Currently, the only U.S. 
Treasury securities CCA requires its direct participants to submit for 
central clearing are their cash and repo transactions in U.S. Treasury 
securities with other direct participants.\101\ However, the CCA's 
rules do not require its direct participants to submit either cash or 
repo transactions \102\ with

[[Page 64620]]

persons who are not direct participants for central clearing. The 
Commission now proposes to amend the Covered Clearing Agency Standards 
to impose additional requirements for any covered clearing agency that 
provides central counterparty services for transactions in U.S. 
Treasury securities regarding membership in such CCA.
---------------------------------------------------------------------------

    \101\ FICC Rule 2A, section 7(e), supra note 47 (requirement 
that FICC Netting Members submit to FICC all of their eligible 
trades with other Netting Members); FICC Rule 18, section 2 (similar 
requirement with regard to Repo transactions); cf. FICC Rule 3, 
section 8(e) (providing clearing requirement for FICC IDB Members).
    \102\ With regard to Sponsored GC Repos, as noted above, these 
transactions can be secured with generic CUSIPs that include U.S. 
Treasury securities, and with other generic CUSIPs that include 
other securities, such as agency securities and mortgage backed 
securities. Because the Membership Proposal is limited to eligible 
secondary market transactions in U.S. Treasury securities, it would 
not apply to Sponsored GC Repo generic CUSIPs that do not include 
U.S. Treasury securities.
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    Specifically, the proposal would require that such CCAs establish 
written policies and procedures reasonably designed to, as applicable, 
establish objective, risk-based, and publicly disclosed criteria for 
participation, which require that the direct participants of such 
covered clearing agency submit for clearance and settlement all 
eligible secondary market transactions to which they are a 
counterparty. As described in more detail below, an eligible secondary 
market transaction in U.S. Treasury securities would be defined to 
include:
     Repurchase agreements and reverse repurchase agreements in 
which one of the counterparties is a direct participant;
     Any purchases and sales entered into by a direct 
participant if the direct participant (A) brings together multiple 
buyers and sellers using a trading facility (such as a limit order 
book) and (B) is a counterparty to both the buyer and seller in two 
separate transactions; and
     Any purchases and sales of U.S. Treasury securities 
between a direct participant and a counterparty that is a registered 
broker-dealer, government securities dealer, or government securities 
broker, a hedge fund, or an account at a registered broker-dealer, 
government securities dealer, or government securities broker where 
such account may borrow an amount in excess of one-half of the value of 
the account or may have gross notional exposure of the transactions in 
the account that is more than twice the value of the account.
    However, any transaction (both cash transactions and repos) where 
the counterparty to the direct participant of the CCA is a central 
bank, sovereign entity, international financial institution, or a 
natural person would be excluded from the definition of an eligible 
secondary market transaction. In addition, the proposal would require 
that such CCAs establish written policies and procedures reasonably 
designed to, as applicable, identify and monitor their direct 
participants' submission of transactions for clearing, including how 
the CCA would address a failure to submit transactions.
    For the reasons set forth below, the Commission believes that 
taking these incremental steps, which build on the existing rules of 
the only U.S. Treasury securities CCA, will strengthen risk management 
at the current and any other future U.S. Treasury securities CCA. 
Further, the Commission believes that this proposal would bring the 
benefits of clearance and settlement to a potentially significant 
portion of the U.S. Treasury securities market.
    This section first explains what the Membership Proposal is and to 
whom and what aspects of the U.S. Treasury markets it applies.\103\ It 
then describes what constitutes an eligible secondary market 
transaction and what transactions are excluded from that definition. 
Finally, it discusses the benefits of the Membership Proposal.
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    \103\ The Commission would add this requirement to the current 
text of Rule 17Ad-22(e)(18). The Commission is also proposing to 
adjust the numbering of Rule 17Ad-22(e)(18), 17 CFR 240.17Ad-
22(e)(18). But other than adding this proposal as new Rule 17Ad-
22(e)(18)(iv), the Commission is not proposing any other substantive 
changes to the current text of Rule 17Ad-22(e)(18). The other 
changes to Rule 17Ad-22(e)(18) are entirely stylistic and designed 
to enhance readability in light of the proposed addition of Rule 
17Ad-22(e)(18)(iv). In addition, the Commission proposes to define a 
U.S. Treasury security as ``any security issued by the U.S. 
Department of the Treasury.'' This term is not currently defined in 
Rule 17Ad-22, and this definition would be codified as Rule 17Ad-
22(a)(23).
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1. Requirement To Clear Eligible Secondary Market Transactions
    The Membership Proposal would apply to ``direct participants'' in a 
U.S. Treasury securities CCA, which would distinguish entities that 
access a CCA directly (i.e., members of the CCA) from indirect 
participants who ``rely on the services provided by direct participants 
to access the covered clearing agency's payment, clearing or settlement 
facilities.'' \104\ For purposes of the Covered Clearing Agency 
Standards, ``participants'' of a CCA are referred to as ``members'' or 
``direct participants'' to differentiate these entities from ``direct 
participants' customers'' or ``indirect participants.'' \105\ 
Consequently, for purposes of this proposal and consistent with the 
terminology already used in the Covered Clearing Agency Standards,\106\ 
the term ``direct participants'' would refer to the entities that 
directly access a U.S. Treasury securities CCA (generally banks and 
broker-dealers), and the term ``indirect participants'' would refer to 
those entities which rely on a direct participant to clear and settle 
their U.S. Treasury securities transactions with the U.S. Treasury 
securities CCA (generally their customers or clients).\107\
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    \104\ 17 CFR 240.17Ad-22(e)(18) and (19). See also CCA Standards 
Proposing Release, supra note 7, at 29553 (noting that some market 
participants would not meet a covered clearing agency's direct 
participation requirements and proposing risk management 
requirements for indirect and tiered participants).
    \105\ See, e.g., 17 CFR 240.14Ad-22 (e)(6) (referring to 
participants) and (e)(2)(vi) (referring to direct participants' 
customers). In addition, the Exchange Act defines a participant of a 
clearing agency as ``any person who uses a clearing agency to clear 
or settle securities transactions or to transfer, pledge, lend, or 
hypothecate securities.'' 15 U.S.C. 78c(a)(24). Indirect 
participants are expressly excluded from the Exchange Act definition 
of a ``participant'' of a clearing agency because the Exchange Act 
provides that a person whose only use of a clearing agency is 
through another person who is a participant or as a pledgee of 
securities is not a ``participant'' of the clearing agency. Id.
    \106\ See 17 CFR 240.17Ad-22(e)(19) (referring to firms that are 
indirect participants in a covered clearing agency as those that 
``rely on the services provided by direct participants to access the 
covered clearing agency's payment, clearing, or settlement 
facilities'').
    \107\ For example, FICC maintains the Sponsored Service. See 
supra notes 64 through 66 and accompanying text. Because sponsored 
members cannot clear or settle government securities transactions 
without a sponsoring member, the Commission believes that these 
sponsored members are not ``direct participants.'' As noted above, 
such persons are referred to in this release as ``indirect 
participants'' or ``customers.''
---------------------------------------------------------------------------

    Moreover, persons who provide services in connection with clearance 
and settlement, such as settlement agent, settlement bank, or clearing 
bank services, and do not submit trades for clearing to a U.S. Treasury 
securities CCA would not be ``direct participants'' or ``indirect 
participants'' within the meaning of this proposal and the terminology 
used in the Covered Clearing Agency Standards.\108\
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    \108\ The Commission recognizes that some entities may access 
more limited services of a U.S. Treasury securities CCA without use 
of its CCP services. For example, FICC provides ``comparison only'' 
services for a certain membership type. See FICC Rule 8, supra note 
47. Consistent with the definition of a ``participant'' under the 
Exchange Act, such entities would not be considered participants of 
a CCA and therefore would not be subject to this proposed 
requirement.
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2. Eligible Secondary Market Transactions
    As discussed further below, the Commission would also define what 
constitutes an eligible secondary market transaction in U.S. Treasury 
securities subject to the Membership Proposal.\109\ This definition 
would apply to all types of transactions that are of a type currently 
accepted for clearing at a U.S. Treasury securities CCA; it would not 
impose a requirement on a U.S.

[[Page 64621]]

Treasury securities CCA to offer additional products for clearing.
---------------------------------------------------------------------------

    \109\ The Commission proposes to define the scope of an 
``eligible secondary market transaction,'' including transactions 
that would be excluded from that definition, in Proposed Rule 17Ad-
22(a).
---------------------------------------------------------------------------

    The proposal does not apply to the primary market, i.e., the 
issuance and sale of a U.S. Treasury security to a primary dealer or 
other bidder in a U.S. Treasury auction. By statute, the Treasury 
Department is authorized to borrow money on behalf of the Federal 
government through the sale and issuance of U.S. Treasury securities to 
the public.\110\ The terms and conditions for the sale and issuance for 
these securities are contained in the applicable Treasury Department 
auction rules or the securities offering (or auction) 
announcements.\111\ The Treasury Department determines when auctions 
will occur and in what amounts and retains discretion as to the conduct 
of auctions, including, among other things, whether to award more or 
less than the amount of securities specified in an auction announcement 
and reserves the right to modify the terms and conditions of an 
auction.\112\ In addition, the Treasury Department gives successful 
bidders the option of instructing that ``delivery and payment be made 
through the clearing corporation for securities awarded to the 
submitter for its own account, but it does not require the use of a 
clearing corporation for delivery and payment in connection with 
securities awarded in the auctions.\113\ In light of the existing 
regulatory regime for these primary market transactions, as well as the 
role of such transactions in directly financing the Federal government, 
the Commission believes that it would be inappropriate for the 
Membership Proposal to include primary market transactions.
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    \110\ 31 U.S.C. 3101 et seq.
    \111\ Uniform Offering Circular, 31 CFR 356. The circular covers 
all aspects of the sale and issue of U.S. Treasury securities, 
including bidding, certifications, payment, determination of auction 
awards, and settlement.
    \112\ See, e.g., Treasury Marketable Securities Offering 
Announcement Press Releases, available at https://www.treasurydirect.gov/instit/annceresult/press/press_secannpr.htm; 
31 CFR 356.33.
    \113\31 CFR 356.17(d)(2).
---------------------------------------------------------------------------

    As stated above,\114\ U.S. Treasury securities start trading after 
the auction announcement, before the auction and continue trading 
through issuance and afterwards. The trading that occurs after 
announcement and prior to issuance is generally referred to as when-
issued trading and it covers two distinct periods: before the auction 
and after the auction. The latter, i.e., when-issued trades that occur 
the day after the auction are considered on-the-run on some IDBs. All 
when-issued transactions are reported to TRACE.\115\ In addition, based 
on its supervisory experience, the Commission understands that FICC 
already clears when-issued securities. Accordingly, in light of the 
fact that trading in when issued securities that takes place the day 
after the auction shares similar characteristics to secondary market 
transactions and such trading is already reported as a secondary market 
transaction, the Membership Proposal would apply to when-issued trades 
that occur the day after the auction and are considered on-the-run on 
some IDBs, to the extent that such when-issued trades otherwise meet 
the definition of an eligible secondary market transaction, as 
discussed further in section III.A.2 infra. However, since when-issued 
trading that takes place before and including the day of the auction 
does not share these characteristics and is primarily used as a tool 
for price discovery leading to the auction, such transactions would not 
be encompassed by the Membership Proposal.
---------------------------------------------------------------------------

    \114\ See note 38 supra.
    \115\ Trades in a security that occurred the day after it was 
auctioned accounted, on average, for approximately 12% of all trades 
in U.S. Treasury securities between July 1, 2019, and June 30, 2020, 
with approximately half of such trades taking place on an IDB. Id.
---------------------------------------------------------------------------

a. Repo Transactions
    The Commission proposes to include all U.S. Treasury repurchase and 
reverse repurchase agreements entered into by a direct participant of a 
U.S. Treasury securities CCA as eligible secondary market transactions 
subject to the Membership Proposal, subject to the exclusions discussed 
in section III.A.2.c infra.\116\ As noted above, the U.S. Treasury repo 
market plays a key role in facilitating the flow of cash and securities 
in the financial system by allowing market participants to access 
financing, supporting dealer market-making activities, enabling 
institutional investors with large cash balances to invest cash on a 
secured basis, and contributing to price discovery and efficient 
capital allocation, as well as supporting the calculation of the 
Secured Overnight Financing Rate (``SOFR'') by the Federal Reserve Bank 
of New York.\117\ Significant gaps persist in the coverage of 
transaction data in U.S. Treasury repo activity, but the available data 
indicates that the volume of repo transactions that are bilaterally 
cleared and settled remains substantial.\118\ For example, recent 
research with respect to primary dealers indicates that 38 percent of 
their repo and 60 percent of their reverse repo activity is not 
centrally cleared, and, overall, that 20 percent of all their repo and 
30 percent of their reverse repo activity is centrally cleared through 
FICC.\119\ Nevertheless, FICC lacks visibility into its members' non-
centrally cleared repo trades, and the default of one counterparty can 
have cascading effects on multiple other market participants, including 
members of FICC, thereby risking contagion to the CCP.
---------------------------------------------------------------------------

    \116\ See paragraphs (i) and (iii) of the definition of an 
``eligible secondary market transaction'' in Proposed Rule 17Ad-
22(a).
    \117\ MMF Primer, supra note 57; see also Secured Overnight 
Financing Rate Data, available at https://www.newyorkfed.org/markets/reference-rates/sofr.
    \118\ IAWG Report, supra note 4, at 29 (stating that non-
centrally cleared bilateral repo represents a significant portion of 
the market, roughly equal in size to centrally cleared repo) (citing 
a 2015 pilot program by the Treasury Department); see also TMPG, 
Clearing and Settlement Practices for Treasury Secured Financing 
Transactions Working Group Update (``TMPG Repo White Paper''), at 1 
(Nov. 5, 2021), available at https://www.newyorkfed.org/medialibrary/Microsites/tmpg/files/CSP_SFT_Note.pdf; Katy Burne, 
``Future Proofing the Treasury Market,'' BNY Mellon Aerial View, at 
7 (Nov. 2021), available at https://www.bnymellon.com/content/dam/bnymellon/documents/pdf/aerial-view/future-proofing-the-us-treasury-market.pdf.coredownload.pdf (noting that 63% of repo transactions 
remain non-centrally cleared according to Office of Financial 
Research data as of Sept. 10, 2021).
    \119\ Sebastian Infante, et al., Insights from revised Form 
FR2004 into primary dealer securities financing and MBS activity 
(Aug. 5, 2022), available at https://www.federalreserve.gov/econres/notes/feds-notes/insights-from-revised-form-fr2004-into-primary-dealer-securities-financing-and-mbs-activity-20220805.htm. See 
section IV.B.2 for a more detailed discussion of this analysis.
---------------------------------------------------------------------------

    In addition, particularly with respect to banks and dealers, an 
important potential benefit of repo central clearing stems from 
mitigating the constraints on intermediaries' balance sheets under the 
existing accounting and regulatory capital rules.\120\ Recent research 
indicates that for primary dealers, use of the centrally cleared 
bilateral repo market leads to a reduction in balance sheet allocation 
of approximately 20 percent relative to their total repo exposure.\121\ 
The Commission believes that the benefit of this resulting additional 
balance sheet capacity could be shared by all market participants

[[Page 64622]]

through improved market liquidity and smooth market functioning.\122\
---------------------------------------------------------------------------

    \120\ In effect, accounting rules allow purchases and sales of 
the same security to be netted but do not allow repos of the same 
security to be netted, unless the repos are with the same 
counterparty and the trades have been documented under a master 
netting agreement. See, e.g., G-30 Report, supra note 5, at 13; 
Program on International Financial Systems, Mandatory Central 
Clearing for U.S. Treasuries and U.S. Treasury Repos, at 25-27 (Nov. 
2021), available at https://www.pifsinternational.org/wp-content/uploads/2021/11/PIFS-Mandatory-Central-Clearing-for-U.S.-Treasury-Markets-11.11.2021.pdf (``PIFS Paper''). Thus, if a dealer's repos 
are all with a U.S. Treasury securities CCA, greater netting is 
allowed.
    \121\ Infante, et al., supra note 117.
    \122\ See Committee on the Global Financial System, Repo Market 
Functioning, at 24 (Apr. 2017), available at https://www.bis.org/publ/cgfs59.pdf.
---------------------------------------------------------------------------

    Moreover, it appears that, as with cash markets, risk management 
practices in the bilateral clearance and settlement of repos are not 
uniform across market participants and are not transparent.\123\ 
Indeed, a recent publication stated that competitive pressures in the 
bilaterally settled market for repo transactions have exerted downward 
pressure on haircuts, sometimes to zero.\124\ The reduction of 
haircuts, which serve as a counterparty credit risk mitigant in 
bilateral repos, could result in greater exposure to potential 
counterparty default risk in non-centrally cleared repos.
---------------------------------------------------------------------------

    \123\ TMPG Repo White Paper, supra note 118, at 1.
    \124\ G-30 Report, supra note 5, at 13.
---------------------------------------------------------------------------

    By contrast, a U.S. Treasury securities CCA is subject to the 
Commission's risk management requirements addressing financial, 
operational, and legal risk management, which include, among other 
things, margin requirements commensurate with the risks and particular 
attributes of each relevant product, portfolio, and market.\125\ 
Therefore, repos cleared at a U.S. Treasury securities CCA would be 
subject to transparent risk management standards that are publicly 
available and applied uniformly and objectively to all participants in 
the CCA.
---------------------------------------------------------------------------

    \125\ 17 CFR 240.17Ad-22(e)(6).
---------------------------------------------------------------------------

    As discussed in section II.A.2 supra, many market participants have 
already chosen to centrally clear some of their repo transactions. FICC 
provides central clearing for its direct participants in both centrally 
cleared bilateral and triparty repo. In addition, in the Sponsored 
Program, FICC recently has made several changes to the program with the 
intent of increasing overall participation in the service and ensuring 
that market participants can use the service consistent with their 
applicable regulatory requirements and business strategies. For 
example, in 2021, FICC expanded the available products to allow 
Sponsored Members to clear triparty repos through the program,\126\ in 
addition to the existing ability to sponsor bilateral repo into central 
clearing. There are now approximately 30 Sponsoring Members and 1,900 
Sponsored Members with access to central clearing, including money 
market funds, hedge funds, and other asset managers.\127\
---------------------------------------------------------------------------

    \126\ See, e.g., supra note 64; Self-Regulatory Organizations; 
Fixed Income Clearing Corporation; Order Approving a Proposed Rule 
Change to Expand Sponsoring Member Eligibility in the Government 
Securities Division Rulebook and Make Other Changes, Exchange Act 
Release No. 85470 (Mar. 29, 2019), 84 FR 13328 (Apr. 4, 2019).
    \127\ See FICC Membership Directories, available at https://www.dtcc.com/client-center/ficc-gov-directories.
---------------------------------------------------------------------------

    Recent research indicates that, as of the second quarter of 2022, 
money market funds held had close to $63 billion in centrally cleared 
U.S. Treasury repos, or 3% of their total Treasury repo volume.\128\ 
Most of that centrally cleared repo is through FICC's Sponsored Program 
away from the triparty platform.\129\ In addition, certain private 
funds participate in the centrally cleared Treasury repo market, 
through FICC's Sponsored Program. These firms benefit from improved 
ability to access the repo market and more advantageous pricing.\130\ 
The Commission considered these currently available methods for 
accessing central clearing for U.S. Treasury repos for both dealers and 
buy-side entities when determining to propose the inclusion of repos as 
eligible secondary market transactions and believes that this factor 
further supports its determination.
---------------------------------------------------------------------------

    \128\ Viktoria Baklanova et al., Money Market Funds in the 
Treasury Market (Sept. 1, 2022), available at https://www.sec.gov/files/mmfs-treasury-market-090122.pdf (``MMFs in the Treasury 
Market'').
    \129\ Id.
    \130\ See, e.g., G-30 Report, supra note 5, at 13 (``Buyside 
firms benefit because dealers are willing to intermediate cleared 
repos at narrower spreads, which are reflected in part in higher 
rates paid to buyside repo investors on cleared repos than on 
uncleared repos and in part in lower rates charged to repo borrowers 
(including hedge funds and smaller broker-dealers) on cleared 
repos.'').
---------------------------------------------------------------------------

b. Purchases and Sales of U.S. Treasury Securities
    An estimated 68 percent of the overall dollar value of cash market 
transactions in U.S. Treasury securities are not centrally cleared, and 
an estimated 19 percent of the overall dollar value of such 
transactions are subject to so-called hybrid clearing (as stated 
above).\131\ The Commission has identified certain categories of 
purchases and sales of U.S. Treasury securities that it believes should 
be part of the definition of an eligible secondary market transaction 
subject to the Membership Proposal, i.e., for which U.S. Treasury 
securities CCAs would be obligated to impose membership rules to 
require clearing of such transactions, for the reasons described below. 
The Commission believes that including this set of transactions in the 
eligible secondary market definition and therefore subjecting these 
transactions to the Membership Proposal represents an incremental first 
step to address potential risks arising to a U.S. Treasury securities 
CCA.
---------------------------------------------------------------------------

    \131\ IAWG Report, supra note 4, at 30; see also TMPG White 
Paper, supra note 21, at 12.
---------------------------------------------------------------------------

i. IDB Transactions
    The Commission proposes to include within the definition of an 
eligible secondary market transaction any purchase or sale between a 
direct participant of a U.S. Treasury securities CCA and any 
counterparty, if the direct participant of the covered clearing agency 
(A) brings together multiple buyers and sellers using a trading 
facility (such as a limit order book) and (B) is a counterparty to both 
the buyer and seller in two separate transactions.\132\ As a result, 
this definition will only encompass the transactions of those IDBs in 
the Treasury market that are direct participants of a U.S. Treasury 
securities CCA and stand as counterparties to both sides of each trade 
on their platforms.\133\
---------------------------------------------------------------------------

    \132\ See paragraph (ii)(A) of the definition of an ``eligible 
secondary market transaction'' in Proposed Rule 17Ad-22(a).
    \133\ See notes 40-43 and accompanying text supra.
---------------------------------------------------------------------------

    The Commission believes that this aspect of the Membership Proposal 
generally would result in the benefits described in section III.A.3 
infra. Chiefly, the Commission believes that this aspect of the 
Membership Proposal would specifically address the potential for 
contagion risk associated with hybrid clearing that a number of 
commentators have highlighted. As explained above, the configuration of 
counterparty risk presented by hybrid clearing allows the U.S. Treasury 
securities CCA to manage the risks arising from the IDB-CCA direct 
participant transaction, on the one hand, but the U.S. Treasury 
securities CCA cannot manage the risks arising from the IDB's 
offsetting transaction with its non-member counterparty and the 
potential counterparty credit risk and settlement risk arising to the 
IDB from that trade.\134\ Thus, under the current hybrid clearing 
model, the U.S. Treasury securities CCA is indirectly exposed to the 
IDB's non-centrally cleared transaction, but it lacks the ability to 
risk manage its indirect exposure to this non-centrally cleared leg of 
the transaction. Specifically, it does not know who the ultimate

[[Page 64623]]

counterparty of the transaction is and cannot collect margin on that 
transaction. This, in turn, results in margin collection at the CCP 
which is based upon only one transaction and has been calculated to 
cover this seemingly directional position, as well as an inability to 
net these offsetting transactions and provide the benefits of central 
clearing. In particular, if the IDB's non-CCP member counterparty fails 
to settle a transaction that is subject to hybrid clearing, such IDB 
may not be able to settle the corresponding transaction that has been 
cleared with the U.S. Treasury securities CCA due to a lack of 
financial resources at the IDB, which could lead the IDB to 
default.\135\ As part of its existing default management procedures, 
the U.S. Treasury securities CCA could seek to mutualize its losses 
from the IDB's default, which could in turn transmit stress to the 
market as a whole.
---------------------------------------------------------------------------

    \134\ See, e.g., TMPG White Paper, supra note 21, at 22 (noting 
that in a hybrid clearing arrangement, an IDB's rights and 
obligations to the CCP are not offset and the IDB is not in a net 
zero settlement position with respect to the CCP at settlement 
date). Thus, the IDB is not able to net all of its positions for 
clearing at a U.S. Treasury securities CCA, and the IDB's positions 
appear to the CCA to be directional, which impacts the amount of 
margin that the CCA collects for the transaction.
    \135\ See IAWG Report, supra note 4, at 31; Depository Trust and 
Clearing Corporation, More Clearing, Less Risk: Increasing Centrally 
Cleared Activity in the U.S. Treasury Cash Market, at 5 (May 2021), 
available at https://www.dtcc.com/-/media/Files/PDFs/DTCC-US-Treasury-Whitepaper.pdf (``DTCC May 2021 White Paper'').
---------------------------------------------------------------------------

    As noted above, the Commission has previously stated that 
membership requirements help to guard against defaults of any CCP 
member, as well as to protect the CCP and the financial system as a 
whole from the risk that one member's default could cause others to 
default, potentially including the CCP itself. Further, contagion 
stemming from a CCP member default could undermine confidence in the 
financial system as a whole, even if the health of the CCP is not 
implicated. This is because the default could cause others to back away 
from participating in the market. This risk of decreased participation 
could be particularly problematic if the defaulting participant was an 
IDB, whose withdrawal from the market could impact other market 
participants' ability to access the market for on-the-run U.S. Treasury 
securities, approximately 49.7% of which trade on IDBs.\136\ Including 
such transactions as eligible secondary market transactions subject to 
the Membership Proposal would therefore help protect against this risk 
by requiring that a U.S. Treasury securities CCA ensure that direct 
participants who are IDBs centrally clear both sides of their 
transactions, thereby eliminating the various aspects of potential 
contagion risk posed by so-called hybrid clearing.
---------------------------------------------------------------------------

    \136\ TMPG White Paper, supra note 21, at 32; section IV.B.4 
(Table 1) infra.
---------------------------------------------------------------------------

ii. Other Cash Transactions
    The Commission proposes to include certain additional categories of 
cash transactions of U.S. Treasury securities by the direct 
participants of a U.S. Treasury securities CCA in the definition of an 
eligible secondary market transaction subject to the Membership 
Proposal.
    First, the Commission is proposing that the definition of an 
eligible secondary market transaction include those cash purchase and 
sale transactions in which the counterparty of the direct participant 
is a registered broker-dealer, government securities broker, or 
government securities dealer.\137\ Each of these entities is a type of 
market intermediary that is engaged in the business of effecting 
transactions in securities for the account of others (in the case of 
brokers) or for their own accounts (in the case of dealers).\138\ As 
stated in section II.A.1 supra, in 2018, the TMPG determined that a 
majority of trades in the secondary cash Treasury market now clear 
bilaterally,\139\ and estimated that the trading volume of non-FICC 
members exceeds that of FICC members.\140\ As a result, the Commission 
believes that their collective trading activity likely is responsible 
for a not insignificant portion of the volume of transactions involving 
Treasury securities and could present contagion risk to a U.S. Treasury 
securities CCA.\141\ In addition, registered broker-dealers, government 
securities brokers, or dealers that are not direct members of a U.S. 
Treasury securities CCA are typically ``introducing firms'' that 
establish mechanisms to clear and settle their transactions. For 
example, currently, many registered brokers and dealers rely on the 
correspondent clearing service provided by FICC to have a FICC member 
submit their transactions for clearing at FICC.\142\
---------------------------------------------------------------------------

    \137\ See paragraph (ii)(B) of the definition of an ``eligible 
secondary market transaction'' in Proposed Rule 17Ad-22(a). See also 
15 U.S.C. 78o(a) and 78o-5(a) (requirement to register) and 78c(4), 
(5), (43), and (44) (definitions of broker, dealer, government 
securities dealer, and government securities broker). The Commission 
acknowledges that the transactions encompassed by paragraph (ii)(B) 
in the definition of an ``eligible secondary market transaction'' in 
Proposed Rule 17Ad-22(a) could also encompass certain transactions 
that would be encompassed by paragraph (ii)(A) of the same proposed 
definition, in the event that the direct participant is an IDB 
transacting with a registered broker-dealer. However, the set of 
transactions encompassed by paragraph (ii)(B) of the proposed 
definition is broader than that of paragraph (ii)(A). The Commission 
believes that this overlap is appropriate because these paragraphs 
of the proposed definition are designed to accomplish different 
purposes, which is not impacted by the potential overlap.
    \138\ See generally TMPG, Automated Trading in Treasury Markets 
(White Paper) (June 2015), available at https://www.newyorkfed.org/TMPG/medialibrary/microsites/tmpg/files/TPMG-June-2015-Automated-Trading-White-Paper.pdf (``TMPG Automated Trading White Paper'').
    \139\ TMPG White Paper, supra note 21, at 2.
    \140\ IAWG Report, supra note 4, at 30; TMPG White Paper, supra 
note 21, at 12.
    \141\ See supra note 15 and TMPG Automated Trading White Paper, 
supra note 138.
    \142\ See, e.g., FICC Rule 8 (describing the service), supra 
note 47; FICC Executing Firm Master List, available at https://www.dtcc.com/client-center/ficc-gov-directories.
---------------------------------------------------------------------------

    The Commission believes that the benefits that would result from 
imposing a requirement on U.S. Treasury securities CCAs to require that 
their direct participants submit for clearing and settlement such 
transactions in which their counterparties are registered broker-
dealers or government securities brokers or government securities 
dealers would be consistent with the benefits of central clearing set 
forth in section III.A.3 infra. Moreover, because these entities are 
already either part of or able to access the national system of 
clearance and settlement, there should be fewer obstacles to submission 
of such trades.
    Second, the Commission proposes to include within the definition of 
an eligible secondary market transaction any purchase and sale 
transaction between a direct participant of a U.S. Treasury securities 
CCA and a hedge fund, that is any private fund (other than a 
securitized asset fund): (a) with respect to which one or more 
investment advisers (or related persons of investment advisers) may be 
paid a performance fee or allocation calculated by taking into account 
unrealized gains (other than a fee or allocation the calculation of 
which may take into account unrealized gains solely for the purpose of 
reducing such fee or allocation to reflect net unrealized losses); (b) 
that may borrow an amount in excess of one-half of its net asset value 
(including any committed capital) or may have gross notional exposure 
in excess of twice its net asset value (including any committed 
capital); or (c) that may sell securities or other assets short or 
enter into similar transactions (other than for the purpose of hedging 
currency exposure or managing duration). This definition of a hedge 
fund is consistent with the Commission's definition of a hedge fund in 
Form PF.\143\
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    \143\ 17 CFR 279.9 (Form PF Glossary of Terms).
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    The Commission's intent in including transactions with hedge funds 
in the definition of an eligible market transaction is two-fold. First, 
hedge funds generally can engage in trading

[[Page 64624]]

strategies that may pose heightened risks of potential financial 
distress to their counterparties, including those who are direct 
participants of a U.S. Treasury securities CCA. For example, the 
Commission observed when proposing Form PF that hedge funds often use 
financial institutions that may have systemic importance to obtain 
leverage, and that hedge funds may employ investment strategies that 
may use leverage, derivatives, complex structured products, and short 
selling in an effort to generate returns, as well as employ strategies 
involving high volumes of trading and concentrated investments.\144\ 
The Commission recognized that the strategies employed by hedge funds 
``can increase the likelihood that the fund will experience stress or 
fail, and amplify the effects on financial markets.'' \145\ The 
Commission also stated that significant hedge fund failures, resulting 
from their investment positions or use of leverage or both, could 
result in material losses at the financial institutions that lend to 
them if collateral securing this lending is inadequate, and that these 
losses could have systemic implications if they require these financial 
institutions to scale back their lending efforts or other financing 
activities generally.\146\
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    \144\ Proposing Release, Reporting by Investment Advisers to 
Private Funds and Certain Commodity Pool Operators and Commodity 
Trading Advisors on Form PF, Release No. IA-3145 (Jan. 26, 2011), 76 
FR 8068, 8073 (Feb. 12, 2011) (``Form PF Proposing Release''). The 
Commission adopted the hedge fund definition with some amendments 
thereafter. Final Rule, Reporting by Investment Advisers to Private 
Funds and Certain Commodity Pool Operators and Commodity Trading 
Advisors on Form PF, Release No. IA-3308 (Oct. 31, 2011), 76 FR 
71127 (Nov. 16, 2011).
    \145\ Form PF Proposing Release, supra note 144, 76 FR at 8073 
(citing President's Working Group on Financial Markets, Hedge Funds, 
Leverage, and the Lessons of Long Term Capital Management (Apr. 
1999), at 23).
    \146\ Id. (also noting that the simultaneous failure of several 
similarly positioned hedge funds could create contagion through the 
financial markets if the failing funds had to liquidate their 
investment positions at firesale prices).
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    Similarly, the FSOC acknowledged, in light of recent market events, 
the importance of understanding how hedge fund activities may impact 
the broader market, including ``how financial strain at hedge funds--
particularly those with significant leverage--could create risks to 
financial stability, and how a reduction in financial intermediation by 
hedge funds during periods of market stress could exacerbate market 
impairment.'' \147\ Thus, as a general matter, the Commission believes 
that if any of a hedge fund's activities, even those that are not 
related to the U.S. Treasury market, cause financial stress to a 
counterparty that is a direct participant of a U.S. Treasury securities 
CCA, the inclusion of a hedge fund's U.S. Treasury securities cash 
transactions with a direct participant in the definition of an eligible 
secondary market transaction should help ensure that such financial 
stress would not transmit to the U.S. Treasury securities CCA and 
through to the U.S. Treasury market.
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    \147\ FSOC Statement on Nonbank Financial Intermediation (Feb. 
4, 2022), available at https://home.treasury.gov/news/press-releases/jy0587.
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    In addition, hedge funds are increasingly large players in the U.S. 
Treasury market. For example, as of the fourth quarter of 2021, the 
Commission's Private Funds Statistics indicated that qualifying hedge 
funds held aggregate gross notional exposure of $1,760 billion in U.S. 
Treasury securities.\148\ However, qualifying hedge funds generally 
report central clearing of about 15 percent of their overall net asset 
value.\149\ There has been a great deal of commentary regarding the 
role of hedge funds in the U.S. Treasury markets, particularly with 
respect to the March 2020 market events.\150\ For example, the FSOC 
observed that hedge funds were among the three largest types of sellers 
of Treasury securities, materially contributing to the Treasury market 
disruption during this period, although not as its sole cause.\151\ The 
IAWG staffs stated that, in March 2020, hedge funds were among the 
largest sellers of Treasury securities as expected price relationships 
broke down, highly levered positions magnified losses, and some funds 
faced margin calls.\152\
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    \148\ Private Funds Statistics for Q4 2021, Table 46 (July 22, 
2022), available at https://www.sec.gov/divisions/investment/private-funds-statistics/private-funds-statistics-2021-q4.pdf. 
Qualifying hedge funds refers to those hedge funds that have a net 
asset value (individually or in combination with any feeder funds, 
parallel funds and/or dependent parallel managed accounts) of at 
least $500 million as of the last day of any month in the fiscal 
quarter immediately preceding its most recently completed fiscal 
quarter. See Form PF (Glossary of Terms).
    \149\ Private Funds Statistics for Q4 2021, Figure 17 (July 22, 
2022), available at https://www.sec.gov/divisions/investment/private-funds-statistics/private-funds-statistics-2021-q4.pdf.
    \150\ See generally Ayelen Banegas et al., Sizing Hedge Funds' 
Treasury Market Activities and Holdings (Oct. 6, 2021), available at 
https://www.federalreserve.gov/econres/notes/feds-notes/sizing-hedge-funds-treasury-market-activities-and-holdings-20211006.htm; 
see also Daniel Barth & R. Jay Kahn, Hedge Funds and the Treasury 
Cash-Futures Disconnect (Apr. 1, 2021), available at https://www.financialresearch.gov/working-papers/2021/04/01/hedge-funds-and-the-treasury-cash-futures-disconnect/; Hedge Fund Treasury Trading 
and Funding Fragility: Evidence from the COVID-19 Crisis, available 
at https://www.federalreserve.gov/econres/feds/files/2021038pap.pdf.
    \151\ FSOC Feb. 2022, supra note 172; see also IAWG, supra note 
4, at 34.
    \152\ IAWG, supra note 4, at 34. See also SEC Staff Report on 
U.S. Credit Markets Interconnectedness and the Effects of the COVID-
19 Economic Shock (Oct. 2020), available at https://www.sec.gov/files/US-Credit-Markets_COVID-19_Report.pdf.
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    This demonstrates the potential contagion risk that could arise 
from hedge funds' activities in the U.S. Treasury market. Similar to 
the risks posed to a U.S. Treasury securities CCA by non-centrally 
cleared trades entered into by an IDB, non-centrally cleared 
transactions entered into between hedge funds and direct participants 
of the CCA could cause risks to the CCA in the event that the hedge 
fund is not able to meet its obligations to the direct participant, 
which could, in turn, create stress to the direct participant and 
through to the CCA. Therefore, including the direct participant's 
purchase and sale transactions with hedge funds within the definition 
of an eligible secondary market transaction should reduce the potential 
for financial distress arising from the transactions that could affect 
the direct participant and the U.S. Treasury securities CCA. This 
aspect of the proposal would also result in consistent and transparent 
risk management being applied to such transactions, as discussed 
further in section III.A.3 infra.
    The Commission believes that defining a hedge fund in a manner 
consistent with Form PF is reasonable, because such definition should 
encompass those funds that use strategies that the Commission has 
determined merit additional reporting to allow a better picture of the 
potential systemic risks posed by such activities.\153\ Including 
transactions with such funds within the definition of an eligible 
secondary market transaction should help to limit the potential

[[Page 64625]]

contagion risk that could arise from any financial distress experienced 
at such a fund that could, in turn, be transmitted to a direct 
participant of a U.S. Treasury securities CCA (and to the CCA) via any 
non-centrally cleared transactions. Specifically, using such definition 
would allow the definition of an eligible secondary market transaction 
to include transactions between direct participants of a U.S. Treasury 
securities CCA and a private fund whose characteristics make it more 
likely that it would have an impact on systemic risk, i.e., its ability 
to short sell and take on significant leverage. For example, as the 
Commission recently stated, large investment losses or a margin default 
involving one large highly levered hedge fund may have systemic risk 
implications, and large investment losses at multiple hedge funds may 
indicate market stress that could have systemic effects.\154\ The 
Commission believes that using a definition consistent with that of 
Form PF to identify transactions with a U.S. Treasury securities CCA's 
direct participant as part of the definition of an eligible secondary 
market transaction subject to the Membership Proposal should capture 
transactions with entities whose default would be most likely to cause 
potential contagion risk to the Treasury securities CCA. For example, 
hedge funds' use of leverage can make them more vulnerable to liquidity 
shocks, which could, in turn, make them unable to deliver in a 
transaction with a direct participant of a U.S. Treasury securities 
CCA.
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    \153\ Final Rule, Reporting by Investment Advisers to Private 
Funds and Certain Commodity Pool Operators and Commodity Trading 
Advisors on Form PF, Release No. IA-3308 (Oct. 31, 2011), 76 FR 
71127 (Nov. 16, 2011). The reporting requirements for Form PF vary 
based on the amount of private fund assets under management for an 
investment adviser registered with the Commission. For example, if 
an investment adviser's private fund assets under management, 
including with respect to hedge funds, are less than $150 million on 
the last day of the most recent fiscal year, then the investment 
adviser is not required to file Form PF. Separately, additional 
reporting requirements apply to large hedge fund advisers with at 
least $1.5 billion in hedge fund assets under management. See Form 
PF, Instructions 1 and 3. However, the Commission believes that 
including all hedge funds within paragraph (ii)(C) of the definition 
of an ``eligible secondary market transaction'' in Proposed Rule 
17Ad-22(a) would be consistent with its overall policy goals for 
central clearing in the U.S. Treasury market and ensuring that hedge 
fund transactions with direct participants in a U.S. Treasury 
securities CCA do not adversely impact the direct participant and, 
potentially, the CCA.
    \154\ Proposing Release, Amendments to Form PF To Require 
Current Reporting and Amend Reporting Requirements for Large Private 
Equity Advisers and Large Liquidity Fund Advisers, Release No. IA-
5950 (Jan. 26, 2022), 87 FR 9106, 9109 (Feb. 17, 2022).
---------------------------------------------------------------------------

    Third, the Commission proposes to include within the definition of 
an eligible secondary market transaction subject to the Membership 
Proposal any purchase and sale transaction between a direct participant 
of a U.S. Treasury securities CCA and an account at a registered 
broker-dealer, government securities dealer, or government securities 
broker that either may borrow an amount in excess of one-half of the 
net value of the account or may have gross notional exposure of the 
transactions in the account that is more than twice the net value of 
the account.\155\ This would apply to accounts that can take on 
significant leverage, that is, by borrowing an amount that is more than 
one half of its net value or take on exposures worth more than twice 
the account's net value.
---------------------------------------------------------------------------

    \155\ See paragraph (ii)(D) of the definition of an ``eligible 
secondary market transaction'' in Proposed Rule 17Ad-22(a).
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    The Commission believes that the inclusion of transactions with 
such accounts within the definition of an eligible secondary market 
transaction should allow the proposal to encompass transactions between 
direct participants of a U.S. Treasury securities CCA and a prime 
brokerage account, which, based on the Commission's supervisory 
knowledge, may hold assets of entities, such as, for example, private 
funds or separately managed accounts, and may use leverage that poses a 
risk to U.S. Treasury securities CCA and the broader financial system. 
Covering such accounts would also allow for inclusion of, for example, 
accounts used by family offices or separately managed accounts that may 
use strategies more similar to those of a hedge fund. The account 
provider (i.e., the prime broker) does not have access to, or knowledge 
of, the account owner's entire portfolio of assets and is limited to 
the assets in that particular account. Therefore, the account provider 
may be unable to make a counterparty whole in the event of a default by 
the account owner if the account has taken on significant leverage. 
Typically, the entity providing an account has a lien or some other 
priority on assets in the account to make a counterparty whole if 
necessary. By including the account, and not the entity using the 
account, this aspect of the proposal is targeted to the activity that 
could bring the most potential risk to a U.S. Treasury securities CCA 
and the financial system more generally.
c. Exclusions From the Definition of an Eligible Secondary Market 
Transaction
    The Commission is proposing to exclude transactions between direct 
participants of a U.S. Treasury securities CCA and certain 
counterparties from the definition of an eligible secondary market 
transaction in U.S. Treasury securities. These exclusions would apply 
to any purchase or sale transaction in U.S. Treasury securities or 
repurchase or reverse repurchase agreement collateralized by U.S. 
Treasury securities. First, recognizing the importance of U.S. Treasury 
securities not only to the financing of the United States government, 
but also their central role in the formulation and execution of 
monetary policy and other governmental functions, the Commission is 
proposing to exclude any transactions in U.S. Treasury securities 
between a direct participant of a U.S. Treasury securities CCA and a 
central bank. For similar reasons, the Commission is also proposing to 
exclude any transactions in U.S. Treasury securities between a direct 
participant of a U.S. Treasury securities CCA and a sovereign entity or 
an international financial institution.\156\ Together, these exclusions 
are referred to as the ``Official Sector Exclusions.''
---------------------------------------------------------------------------

    \156\ As discussed more fully below, these exclusions would be 
codified in paragraph (iii) of the definition of an ``eligible 
secondary market transaction'' in Proposed Rule 17Ad-22(a).
---------------------------------------------------------------------------

    In addition, the Commission is also proposing to exclude 
transactions in U.S. Treasury securities between a direct participant 
of a U.S. Treasury securities CCA and a natural person. The Commission 
does not believe that such transactions should be included in light of 
the likely low volumes of transactions entered into by natural persons 
and the low potential for contagion risk arising from such 
transactions.
i. Official Sector Exclusions From the Membership Proposal
    The Official Sector Exclusions are designed to permit domestic and 
international policy makers, i.e., central banks, to continue to pursue 
important policy goals. Because these transactions should present 
limited to no risk of contagion to a U.S. Treasury securities CCA, the 
Commission believes that these exclusions are appropriate.
    For purposes of the Official Sector Exclusion, the Commission 
proposes to define a central bank as a reserve bank or monetary 
authority of a central government (including the Board of Governors of 
the Federal Reserve System or any of the Federal Reserve Banks). The 
proposed definition would also include the Bank for International 
Settlements (``BIS'').\157\ The BIS is owned by central banks.\158\ The 
Commission therefore believes it is appropriate to include the BIS in 
the definition of central bank for purposes of this proposal. The 
Commission proposes to define a sovereign entity as a central 
government (including the U.S. Government), or an agency, department, 
or ministry of a central government.\159\ Finally, the Commission 
proposes to define an international financial institution by specifying 
the entities, i.e., (1) African Development Bank; (2) African 
Development Fund; (3) Asian Development Bank; (4) Banco Centroamericano 
de Integraci[oacute]n Econ[oacute]mica; (5) Bank for Economic 
Cooperation and Development in the

[[Page 64626]]

Middle East and North Africa; (6) Caribbean Development Bank; (7) 
Corporaci[oacute]n Andina de Fomento; (8) Council of Europe Development 
Bank; (9) European Bank for Reconstruction and Development; (10) 
European Investment Bank; (11) European Investment Fund; (12) European 
Stability Mechanism; (13) Inter-American Development Bank; (14) Inter-
American Investment Corporation; (15) International Bank for 
Reconstruction and Development; (16) International Development 
Association; (17) International Finance Corporation; (18) International 
Monetary Fund; (19) Islamic Development Bank; (20) Multilateral 
Investment Guarantee Agency; (21) Nordic Investment Bank; (22) North 
American Development Bank, and providing that the term would also 
include any other entity that provides financing for national or 
regional development in which the United States government is a 
shareholder or contributing member.\160\
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    \157\ The Commission proposes to codify this definition in 
Proposed Rule 17Ad-22(a).
    \158\ See https://www.bis.org/about/index.htm (noting that ``the 
BIS is owned by 63 central banks, representing countries from around 
the world that together account for about 95% of world GDP'').
    \159\ The Commission proposes to codify this definition in 
Proposed Rule 17Ad-22(a).
    \160\ The Commission proposes to codify this definition in 
Proposed Rule 17Ad-22(a). Cf. 17 CFR 50.76(b) (CFTC definition of 
international financial institution for purposes of exemptions from 
swap clearing requirement).
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    The Commission believes that the proposed exclusion is appropriate 
to central banks because these entities are created by statute and are 
part of, or aligned with, a central government.\161\ Further, the 
purpose of a central bank is generally to effectuate monetary policy 
for its respective nation.\162\ For example, transactions in U.S. 
Treasury securities are an important tool in the fiscal and monetary 
policy of the United States, as well as other jurisdictions.\163\ In 
particular, cash and repo transactions in U.S. Treasury securities are 
one of the primary tools used by the Federal Reserve Bank of New York 
to conduct open market transactions at the direction of the Federal 
Open Market Committee.\164\ The System Open Market Account, which is 
managed by the Federal Reserve Bank of New York's System Open Market 
Trading Desk, is ``the largest asset on the Federal Reserve's balance 
sheet.'' \165\ In light of the key role of open market operations 
conducted by the Federal Reserve Bank of New York in the monetary 
policy of the United States, the Commission believes an exemption from 
the Membership Proposal is appropriate for the Federal Reserve 
System.\166\ In particular, the Commission believes the Federal Reserve 
System should be free to choose the clearance and settlement mechanisms 
that are most appropriate to effectuating its policy objectives.
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    \161\ The authorizing statutes generally provide that the 
government owns all or part of the capital stock or equity interest 
of the central bank. See, e.g., Capital of the ECB Protocol on the 
Statute of the European System of Central Banks and of the European 
Central Bank (``ECB Protocol''), Article 28.2, available at https://www.ecb.europa.eu/ecb/legal/pdf/en_statute_2.pdf.
    \162\ See, e.g., ECB Protocol Statute, supra note 106, Article 
3.1; Bank of Japan Act, Articles 1 and 2, available at https://www.boj.or.jp/en/about/boj_law/index.htm/#p01.
    \163\ 12 U.S.C. 225a (defining goals of monetary policy); see 
also https://www.federalreserve.gov/monetarypolicy/monetary-policy-what-are-its-goals-how-does-it-work.htm.
    \164\ See Federal Reserve Bank; Monetary Policy Implementation, 
available at https://www.newyorkfed.org/markets/domestic-market-operations/monetary-policy-implementation.
    \165\ Id.
    \166\ Congress similarly exempted transactions in which one 
counterparty is a member of the Federal Reserve System from the 
regulation of swaps and security based swaps in Title VII of the 
Dodd-Frank Act. See 15 U.S.C. 78c(a)(68)(A) (noting that a security-
based swap is a swap, as defined in 7 U.S.C. 1a(47), subject to 
certain other conditions); 7 U.S.C. 1a(47)(B)(ix) (excluding from 
the definition of swap any transaction in which one counterparty 
``is a Federal Reserve bank, the Federal Government, or a Federal 
agency that is expressly backed by the full faith and credit of the 
United States'').
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    Further, the Commission believes that the Official Sector Exclusion 
should extend to foreign central banks, sovereign entities and 
international financial institutions for similar reasons and for 
reasons of international comity. Congress has decided to permit 
international financial institutions to enjoy a number of privileges 
and immunities from U.S. law,\167\ which suggests that in these 
circumstances, the Commission should not place additional requirements 
on these institutions' transactions in U.S. Treasury securities. In 
addition, in light of ongoing expectations that Federal Reserve Banks 
and agencies of the Federal government would not be subject to foreign 
regulatory requirements in their transactions in the sovereign debt of 
other nations, the Commission believes principles of international 
comity counsel in favor of exempting foreign central banks, sovereign 
entities, and international financial institutions.\168\
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    \167\ See, e.g., the International Organization and Immunities 
Act (22 U.S.C. 288) and the Foreign Sovereign Immunities Act (28 
U.S.C. 1602). The United States has taken appropriate actions to 
implement international obligations with respect to such immunities 
and privileges. See, e.g., International Bank for Reconstruction and 
Development (the ``World Bank'') and International Monetary Fund (22 
U.S.C. 286g and 22 U.S.C. 286h), the European Bank for 
Reconstruction and Development (22 U.S.C. 290l-6), the Multilateral 
Investment Guarantee Agency (22 U.S.C. 290k-10), the Africa 
Development Bank (22 U.S.C. 290-8), the African Development Fund (22 
U.S.C. 290g-7), the Asian Development Bank (22 U.S.C. 285g), the 
Inter-American Development Bank (22 U.S.C. 283g), the Bank for 
Economic Cooperation and Development in the Middle East and North 
Africa (22 U.S.C. 290o), and the Inter-American Investment 
Corporation (22 U.S.C. 283hh).
    \168\ For similar reasons, the CFTC has similarly determined to 
exempt swap transactions involving foreign central banks, sovereign 
entities, and international financial institutions from the 
statutory requirement that swap transactions be cleared with a 
Derivatives Clearing Organization. See 17 CFR 50.75, 50.76; Swap 
Clearing Exemptions, 85 FR 76428, 76429-30, 76432 (Nov. 30, 2020).
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ii. Natural Person Exclusion
    The Commission is also proposing to exclude from the Membership 
Proposal otherwise eligible secondary market transactions in U.S. 
Treasury securities between a direct participant of a U.S. Treasury 
securities CCA and a natural person. The Commission believes that such 
an exclusion is appropriate because natural persons generally transact 
in small volumes and would not present much, if any, contagion risk to 
a U.S. Treasury securities CCA.\169\
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    \169\ For example, although it is not a precise indicator of 
activity by natural persons in the U.S. Treasury markets, the data 
available on household holdings of U.S. Treasury securities 
indicates that their activity is not significant to the overall 
market. See, e.g., The Financial Accounts of the United States, at 
119 (Q1 2022) (indicating that less than 3.1% of marketable U.S. 
Treasury securities are held by the household sector), available at 
https://www.federalreserve.gov/releases/z1/20220609/z1.pdf.
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3. How the Membership Proposal Facilitates Prompt and Accurate 
Clearance and Settlement in the U.S. Treasury Market
    The Commission believes that the Membership Proposal would promote 
the prompt and accurate clearance and settlement of U.S. Treasury 
securities transactions, providing several benefits to the market for 
U.S. Treasury securities as a whole.
    First, the Commission believes that the Membership Proposal would 
decrease the overall amount of counterparty credit risk in the 
secondary market for U.S. Treasury securities. Because a U.S. Treasury 
securities CCA would novate and guarantee each transaction submitted 
for central clearing, it would become a counterparty to each 
transaction, as the buyer to every seller and the seller to every 
buyer. The U.S. Treasury securities CCA would be able to risk manage 
these transactions centrally, pursuant to risk management procedures 
that the Commission has reviewed and approved, and would guarantee 
settlement of the trade in the event of a direct participant default.
    By contrast, bilaterally cleared cash transactions in U.S. Treasury 
securities are subject to variable risk management methodologies in 
which exposures are often less mitigated with less rigorous

[[Page 64627]]

practices compared to CCP risk management.\170\ Indeed, although 
various SRO margin rules provide for the collection of margin for 
certain transactions in U.S. Treasury securities, transactions between 
dealers and institutional customers are subject to a variable ``good-
faith'' margin standard, which the Commission understands--based on its 
supervisory experience--can often result in fewer financial resources 
collected to margin exposures than those that would be collected if a 
CCP margin model, like the one used at FICC, were used.\171\ The 
Membership Proposal is designed to ameliorate these risks by requiring 
Treasury securities CCAs to establish policies and procedures that 
require their direct participants to submit for clearance and 
settlement their eligible secondary market transactions, which would 
include all repo transactions, and specified cash transactions in U.S. 
Treasury securities, which are most likely to pose contagion risk to a 
U.S. Treasury securities CCA.
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    \170\ TMPG White Paper, supra note 21, at 29.
    \171\ Although FINRA rules provide for the collection of margin 
for cash U.S. Treasury transactions, see FINRA Rule 4210(e)(2)(A) 
(setting forth margin rule for FINRA members for collection of 
margin on Treasuries and certain other bonds) these rules do not 
necessarily apply to exempt accounts, see FINRA Rule 4210(e)(2)(F) 
(permitting FINRA members not to collect margin from exempt accounts 
and providing for a capital charge for any uncollected mark-to-
market loss); FINRA Rule 4210(a)(13) (defining exempt account). 
Although SRO rules also require a broker-dealer to establish 
procedures to review limits and types of credit extended to all 
customers, formulate their own ``house'' margin requirements, and 
review the need for instituting higher margin requirements than are 
required for individual securities or customer accounts, based on 
the Commission's supervisory experience, the resulting margin 
collection is often less than that required pursuant to FICC's 
margin model.
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    In particular, the Membership Proposal is designed to reduce the 
amount of ``contagion risk'' to a U.S. Treasury securities CCA arising 
from what has been described as ``hybrid clearing,'' as discussed 
above.\172\ In a hybrid transaction, the leg of the trade between an 
IDB, which is a FICC member, and a FICC member counterparty is 
submitted to FICC for clearance and settlement but the leg between the 
IDB and a non-FICC member counterparty is not.\173\ Consequently, this 
FICC-member counterparty would no longer have exposure to the IDB and 
vice versa. But the IDB must settle the other leg of the trade 
bilaterally with its non-FICC member counterparty, and the IDB and the 
non-FICC member counterparty would face counterparty credit risk to 
each other until the transaction settles. Although this release has 
discussed ``hybrid clearing,'' and, more generally, contagion risk, 
with respect to IDB transactions, the general concept can apply more 
broadly, in that a FICC member's transactions that are not submitted 
for central clearing pose an indirect risk to the CCP as any default on 
a bilaterally settled transaction could impact the FICC member's 
financial resources and ability to meet its obligations to FICC. The 
Commission believes that requiring U.S. Treasury securities CCAs to 
impose, as a condition of membership, an obligation on their direct 
participants to submit all eligible secondary market transactions for 
central clearing should address the transactions most likely to cause 
contagion risk.
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    \172\ TMPG White Paper, supra note 21, at 8 n.11 (``IDB 
platforms act as blind brokers to provide anonymity to their 
customers. Under the blind broker model, the IDB serves as principal 
so what might appear to be a single trade between two customers is 
really two: one between the broker and the buyer and one between the 
broker and the seller. The buyer and seller are no longer directly 
exposed to each other, but both are exposed to the blind broker, and 
the blind broker is exposed to both buyer and seller.'').
    \173\ TMPG White Paper, supra note 21, at 9.
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    Second, the Commission believes that the Membership Proposal would 
also help any U.S. Treasury securities CCA to avoid a potential 
disorderly member default. When cash market transactions are cleared 
bilaterally, market participants typically enter into bespoke 
arrangements to govern clearance and settlement with each of their 
trading counterparties, resulting in multiple interconnected 
counterparty credit risk exposures. Aside from the inefficiency of 
multiple sets of bilateral documentation that may differ in key 
respects, such as the amount of margin required, the default of one 
counterparty can have cascading effects on multiple other market 
participants. Defaults in bilaterally settled transactions are likely 
to be less orderly and subject to variable default management 
techniques because bilaterally settled transactions are not subject to 
the default management processes that are required to be in place and 
publicly disclosed at a CCP.\174\ Centralized default management is a 
key feature of central clearing. Because the CCP has novated and 
guaranteed the transactions, it is uniquely positioned to coordinate 
the default of a member for trades that it has centrally cleared, and 
the non-defaulting members can rely on the CCP to complete the 
transactions of the defaulting member and cover any resulting losses 
using the defaulting member's resources and/or its default management 
tools. Even in a situation where two CCPs have to coordinate the 
default of a joint member, that coordination should result in more 
efficiency and market confidence than multiple bilateral settlements.
---------------------------------------------------------------------------

    \174\ See Rule 17Ad-22(e)(13) and (e)(23)(i).
---------------------------------------------------------------------------

    The Commission previously has stated that a CCP's default 
management procedures would provide certainty and predictability about 
the measures available to a covered clearing agency in the event of a 
default which would, in turn facilitate the orderly handling of member 
defaults and would enable members to understand their obligations to 
the covered clearing agency in extreme circumstances.\175\ By contrast, 
as the TMPG has observed, independent management of bilateral credit 
risk by each participant in the clearance and settlement chain likely 
creates uncertainty about the levels of exposure across market 
participants and may make runs more likely, and any loss stemming from 
closing out the position of a defaulting counterparty is a loss to the 
non-defaulting counterparty and hence a reduction in its capital in 
many scenarios.\176\ Moreover, the high quality and credit status of 
U.S. Treasury securities does not eliminate the potential risk of 
clearing and settling these securities in the event of a default of a 
counterparty to a secondary market transaction. For example, if a large 
participant in a U.S. Treasury trade defaults, it can leave a 
counterparty with a short position to cover, which may take place as 
prices of U.S. Treasury securities move rapidly.\177\ In particular, 
the Commission notes that the market for U.S. Treasury securities 
experienced stresses in 1986, 1994, and 2008, with more recent episodes 
detailed in the recent IAWG Report.\178\
---------------------------------------------------------------------------

    \175\ CCA Standards Proposing Release, supra note 7, 79 FR at 
29545.
    \176\ TMPG White Paper, supra note 21, at 32.
    \177\ TMPG White Paper, supra note 21, at 32 and at 13 n. 17 
(noting counterparty risk associated with the Long-Term Capital 
Management experience in 1998).
    \178\ IAWG Report, supra note 4.
---------------------------------------------------------------------------

    Having a CCP drawing on its expertise to manage hedging and an 
orderly liquidation of the portfolio(s) of a party (or parties) in 
default would constitute an improvement to uncoordinated liquidations. 
A covered clearing agency, including a U.S. Treasury securities CCA, is 
required to establish, implement, maintain and enforce written policies 
and procedures reasonably designed to, as applicable, ensure the CCA 
has the authority and operational capacity to contain losses and 
liquidity demands and continue to meet its obligations, which must be

[[Page 64628]]

tested annually.\179\ This transparent and established approach to 
potential defaults stands in contrast to the variable practices that 
currently prevail in the bilateral market, which are not subject to 
similar regulation. For these reasons, the Commission believes that a 
requirement for a U.S. Treasury securities CCA to require that its 
direct participants submit for clearance and settlement all the 
transactions encompassed by the definition of an eligible secondary 
market transaction would help reduce the potential for disorderly 
defaults, and runs, thereby bolstering the health of the CCP and the 
market as a whole--consistent with the purpose of robust membership 
requirements the Commission contemplated in the Covered Clearing Agency 
Standards, and the Commission's statutory charge to promote the prompt 
and accurate clearance and settlement of securities transactions.\180\
---------------------------------------------------------------------------

    \179\ See 17 CFR 240.17Ad-22(e)(13).
    \180\ See 15 U.S.C. 78q-1(a)(2)(A).
---------------------------------------------------------------------------

    Third, the Commission believes that the Membership Proposal will 
further the prompt and accurate clearance and settlement of U.S. 
Treasury securities by increasing the multilateral netting of 
transactions in these instruments, thereby reducing operational and 
liquidity risks, among others. Central clearing of transactions nets 
down gross exposures across participants, which reduces firms' 
exposures while positions are open and reduces the magnitude of cash 
and securities flows required at settlement.\181\ Consistent with the 
Commission's previous statements in this regard, FICC's failure to 
receive all eligible trading activity of an active market participant 
reduces the value of its vital multilateral netting process and causes 
FICC to be less well-situated to prevent future market crises.\182\ 
Others have also noted that these reductions, particularly in cash and 
securities flow would reduce liquidity risks associated with those 
settlements and counterparty credit risks associated with failures to 
deliver on the contractual settlement date,\183\ not only for CCP 
members but for the CCP itself, thereby promoting the safeguarding of 
U.S. Treasury securities and funds in the custody or control of the CCA 
and increasing the likelihood of prompt and accurate clearance and 
settlement of such transactions. In fact, it has been suggested that 
additional central clearing, based on assumptions broader than the 
proposal set forth in this release, may have lowered dealers' daily 
settlement obligations in the cash market by 60 percent in the run-up 
and aftermath of the March 2020 U.S. Treasury market disruption and 
reduced settlement obligations by 70 percent during the disruption 
itself.\184\ The reduction in exposure is not limited to the cash 
market. For example, it has been estimated that introduction of central 
clearing for dealer-to-client repos would have reduced dealer exposures 
from U.S. Treasury repos by over 80% (from $66.5 billion to $12.8 
billion) in 2015.\185\
---------------------------------------------------------------------------

    \181\ IAWG Report, supra note 4, at 30. For an example of 
multilateral netting, please see note 252 and accompanying text 
infra.
    \182\ Exchange Act Release No. 51908, supra note 30.
    \183\ G-30 Report, supra note 5, at 13; see also PIFS Paper, 
supra note 120, at 28-31.
    \184\ G-30 Report, supra note 5, at 13 n.21 (citing Michael 
Fleming & Frank Keane, Staff Report No. 964: Netting Efficiencies of 
Marketwide Central Clearing, Federal Reserve Bank of New York (Apr. 
2021), available at https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr964.pdf). However, this analysis relies 
upon the assumption that all dealers' purchases and sales of U.S. 
Treasury securities transactions would be centrally cleared and, 
therefore, netted; this proposal, if adopted, would not result in 
the same scope of central clearing, as it would apply only to 
eligible secondary market transactions of direct participants in a 
U.S. Treasury securities CCA.
    \185\ Office of Financial Research, Benefits and Risks of 
Central Clearing in the Repo Market, 5-6 (Mar. 9, 2017), available 
at https://www.financialresearch.gov/briefs/files/OFRBr_2017_04_CCP-for-Repos.pdf.
---------------------------------------------------------------------------

    The benefits of multilateral netting flowing from central clearing 
can improve market safety by lowering exposure to settlement failures, 
which would also tend to promote the prompt and accurate clearance and 
settlement of U.S. Treasury securities transactions.\186\ Multilateral 
netting can also reduce the amount of balance sheet required for 
intermediation and could also enhance dealer capacity to make markets 
during normal times and stress events because existing bank capital and 
leverage requirements recognize the risk-reducing effects of 
multilateral netting of trades that CCP clearing accomplishes.\187\
---------------------------------------------------------------------------

    \186\ Darrel Duffie, Still the World's Safe Haven, Hutchison 
Center on Fiscal & Monetary Policy, at 15 (June 2020), available at 
https://www.brookings.edu/wp-content/uploads/2020/05/WP62_Duffie_v2.pdf (``Duffie'').
    \187\ IAWG Report, supra note 4, at 30; Liang & Parkinson, supra 
note 32, at 9; Duffie, supra note 186, at 16-17.
---------------------------------------------------------------------------

    Fourth, the potential benefits associated with the multilateral 
netting of transactions at a CCP that the Membership Proposal is 
designed to bring about could in turn help to unlock further 
improvements in U.S. Treasury market structure. The increase in 
clearing and consequent reduction in counterparty credit risk could 
``enhance the ability of smaller bank and independent dealers to 
compete with the incumbent bank dealers.'' \188\ Similarly, decreased 
counterparty credit risk--and potentially lower costs for 
intermediation--could result in narrower spreads, thereby enhancing 
market quality.\189\ Moreover, increased accessibility of central 
clearing in U.S. Treasury markets could support movement toward all-to-
all trading, even potentially in the repo market, which would further 
improve market structure and resiliency, although a movement in that 
direction is not assured.\190\ This potential movement would stem from 
the fact that increased central clearing of U.S. Treasury securities 
transactions would, in turn, result in decreased counterparty risk, 
making all-to-all trading more attractive, that is, a market 
participant would be more willing to trade with any counterparty if a 
CCP were to serve as its ultimate counterparty.
---------------------------------------------------------------------------

    \188\ Liang & Parkinson, supra note 32, at 9.
    \189\ G-30 Report, supra note 5, at 13
    \190\ IAWG Report, supra note 4, at 30; Duffie, supra note 186, 
at 16; G-30 Report, supra note 5, at 13. All-to-all trading would be 
characterized by the ability for a bid or offer submitted by one 
market participant to be accepted by any other market participant, 
with trades executed at the best bid or offer. See, e.g., Liang & 
Parkinson, supra note 32, at 9. All-to-all trading could improve the 
quality of trade execution in normal market conditions and broaden 
and stabilize the supply of market liquidity under stress. See, 
e.g., G-30 Report, supra note 5, at 10.
---------------------------------------------------------------------------

    Finally, increased central clearing should enhance regulatory 
visibility in the critically important U.S. Treasury market. 
Specifically, central clearing increases the transparency of settlement 
risk to regulators and market participants, and in particular allows a 
CCP to identify concentrated positions and crowded trades, adjusting 
margin requirements accordingly, which should help reduce significant 
risk to the CCP and to the system as a whole.\191\ In light of the role 
of U.S. Treasury securities in financing the federal government, it is 
important that regulators improve their visibility into this market. 
Increased clearing would provide greater insight into the often opaque 
repo market, as discussed further in section III.A.2.a supra, as well 
as to the cash market where TRACE faces certain limitations, as 
discussed in section IV infra. Increased central clearing would also 
allow for a more aggregated view of market activity in one place.
---------------------------------------------------------------------------

    \191\ Duffie, supra note 186, at 15; IAWG Report, supra note 4, 
at 30 (centralization of transactions at a CCP ``can simplify data 
collection and improve visibility into market conditions for the 
authorities and, to some degree, for market participants'').

---------------------------------------------------------------------------

[[Page 64629]]

4. Policies and Procedures Regarding Direct Participants' Transactions
    The proposal would also require that a U.S. Treasury securities CCA 
establish written policies and procedures reasonably designed to, as 
applicable, identify and monitor its direct participants' required 
submission of transactions for clearing, including, at a minimum, 
addressing a direct participant's failure to submit transactions.\192\ 
The Commission believes that such a requirement should help ensure that 
a U.S. Treasury securities CCA has a framework in place for oversight 
of participants' compliance with the policies that would be adopted as 
part of the Membership Proposal requiring the submission of specified 
eligible secondary market transactions for clearing. Without such 
policies and procedures, it would be difficult for the CCA to assess if 
the direct participants are complying with the Membership Proposal, if 
adopted.
---------------------------------------------------------------------------

    \192\ See Proposed Rule 17Ad-22(e)(18)(iv)(B).
---------------------------------------------------------------------------

    The Commission believes that there are a number of possible methods 
that a U.S. Treasury securities CCA could establish to assess its 
direct participants' compliance with the policies and procedures 
adopted pursuant to the Membership Proposal. For example, a U.S. 
Treasury securities CCA could seek attestation from its direct 
participants as to their submission of the required transactions.
    The Commission believes that requiring a U.S. Treasury securities 
CCA to adopt policies and procedures that address a failure of a direct 
participant to submit transactions that are required to be submitted is 
consistent with section 17A(b)(3)(G) of the Exchange Act. That section 
requires that the rules of a registered clearing agency provide that 
its participants shall be appropriately disciplined for violation of 
any provision of the rules of the clearing agency by expulsion, 
suspension, limitation of activities, functions, and operations, fine, 
censure, or any other fitting sanction. The Commission believes that 
policies and procedures consistent with this aspect of the proposal 
should specify how a U.S. Treasury securities CCA would penalize its 
participants who do not submit the required transactions, whether by a 
particular fine or other action. Understanding the consequences of not 
complying with any Membership Proposal, if adopted, should, in turn, 
help incentivize compliance.
5. Request for Comment
    The Commission generally requests comments on all aspects of the 
Membership Proposal. In addition, the Commission requests comments on 
the following specific issues, with accompanying data and analysis:
     Do commenters agree or disagree with any particular 
aspects of the Membership Proposal, including the definition of an 
eligible secondary market transaction? If so, which ones and why? If 
commenters disagree with any provision of the proposed rule, how should 
such provision be modified and why?
     Do commenters agree that transactions entered into by 
direct participants of a U.S. Treasury securities CCA that are not 
centrally cleared at the CCA present a contagion risk to the CCA, and 
thereby present systemic risk? Why or why not? Are there other benefits 
that expanded central clearing would bring that the Commission has not 
identified?
     Do commenters agree that the Commission should target the 
Membership Proposal, through the definition of an eligible secondary 
market transaction, at a subset of transactions entered into by direct 
participants of a U.S. Treasury securities CCA? Should the Commission 
instead require that a U.S. Treasury securities CCA adopt policies and 
procedures reasonably designed to require that its direct participants 
submit for clearance and settlement all of their transactions in U.S. 
Treasury securities?
     What implications would the increased transaction volume 
at a U.S. Treasury securities CCA have for participation in the U.S. 
Treasury market and for the U.S. Treasury market more broadly? For 
example, would the Membership Proposal help create all-to-all trading 
in the U.S. Treasury securities market?
     What impact would the Membership Proposal have on the 
liquidity risk of a U.S. Treasury securities CCA and how a Treasury 
securities CCA manages its liquidity risk consistent with Rule 17Ad-
22(e)(7) (17 CFR 240.17Ad-22(e)(7))? \193\ For example, what would be 
the potential impact to FICC's Capped Contingent Liquidity Facility 
(``CCLF'') and its participants' obligations under that requirement? 
\194\ Are there any changes the Commission could adopt to the 
Membership Proposal that would, in turn, lead to a different impact on 
FICC's liquidity exposure and/or CCLF? As FICC, or any other U.S. 
Treasury securities CCA that may enter the market, considers 
implementing the Membership Proposal, are there actions it can take 
that may reduce its liquidity risk?
---------------------------------------------------------------------------

    \193\ 17 CFR 240.17Ad-22(e)(7).
    \194\ FICC Rule 22A, section 2a, supra note 47.
---------------------------------------------------------------------------

     More generally, what impact would the Membership Proposal 
have on other risks facing a U.S. Treasury securities CCA, including, 
for example, credit risk and operational risk, and how a U.S. Treasury 
securities CCA manages its liquidity risk consistent with the 
applicable Covered Clearing Agency Standards? Are there other changes 
that a U.S. Treasury securities CCA should make to expand the use of 
central clearing?
     In the event that a U.S. Treasury securities CCA were to 
offer clearance and settlement services for securities lending 
transactions in which U.S. Treasury securities are borrowed, should the 
Commission include such transactions in the definition of an eligible 
secondary market transaction in Proposed Rule 17Ad-22(a)? Would a 
failure to include such securities lending transactions in the 
definition of ``eligible secondary market transactions'' create 
opportunities for gaming or evasion of the requirements of Proposed 
Rule 17Ad-22(e)(18)(iv)(A)? Are there economic or other distinctions 
that mitigate against including securities lending transactions in the 
definition of an eligible secondary market transaction?
     In light of the fact that the Membership Proposal requires 
only a U.S. Treasury securities CCA to have written policies and 
procedures reasonably designed to require its direct members clear 
their eligible secondary market transactions, is there a risk that 
market participants will cease their direct participation in U.S. 
Treasury securities CCAs?
     Similarly, are market participants more likely to move 
some or all of their U.S. Treasury market activities from entities that 
are direct participants of a U.S. Treasury securities CCA into other 
affiliated entities? To what extent would a U.S. Treasury securities 
CCA be exposed to these other transactions? Should the Commission adopt 
rules to prohibit evasion of a U.S. Treasury securities CCA's 
membership requirements through the use of affiliates?
     Should either the repurchase, reverse repurchase, or 
purchase and sale transactions of certain direct participants of a U.S. 
Treasury securities CCA, e.g., smaller or mid-sized dealers that would 
otherwise be subject to the Membership Proposal, be excluded from the 
definition of an eligible secondary

[[Page 64630]]

market transaction, such that a U.S. Treasury securities CCA would not 
need to have written policies and procedures requiring that all such 
direct participants' transactions in U.S. Treasury securities be 
cleared? If so, how would the risks described above in this release be 
mitigated? What criteria should be used to identify any direct 
participants who are excepted from Proposed Rule 17Ad-22(e)(18)(iv)(A)? 
Should any such exemption be subject to a gross notional value or other 
cap? If so, how should that cap be set? Should any exemption from the 
Membership Proposal be conditioned on the exchange of margin, haircuts 
and/or other risk management measures?
     As an alternative to the Membership Proposal, should the 
Commission establish volume thresholds for transactions by the direct 
participants of a Treasury CCA that should be submitted to the Treasury 
CCA for clearance and settlement? If so, what would be the appropriate 
volume thresholds?
     Do commenters agree that when-issued transactions that 
take place after the day of the auction and are considered on-the-run 
by some IDBs are part of the secondary market and would, therefore, be 
subject to the Membership Proposal, to the extent that such when-issued 
trades otherwise meet the definition of an eligible secondary market 
transaction in Proposed Rule 17Ad-22(a)? Do commenters also agree that 
when-issued securities transactions should not be considered part of 
the secondary market if they take place before and including the day of 
the auction? Do commenters have views more generally on whether when-
issued transactions, either before, including, or after the day of the 
auction, are part of the primary or secondary market?
     In light of the likely additional balance sheet capacity 
that flows from clearing repo transactions in U.S. Treasury 
securities,\195\ should the definition of an eligible secondary market 
transaction in Proposed Rule 17Ad-22(a) be limited to repo 
transactions? Are there any other reasons why the definition of 
eligible secondary market transactions in Proposed Rule 17Ad-22(a) 
should be limited to repo transactions? Please explain.
---------------------------------------------------------------------------

    \195\ See supra note 121 and accompanying text.
---------------------------------------------------------------------------

     As noted above, both bilateral and triparty repos are 
currently eligible for central clearing. Should the Commission limit 
Proposed Rule 17Ad-22(a) to either bilateral or triparty repo? Why or 
why not? Are there differences in prevailing haircuts or collateral 
that would make it more desirable to limit Proposed Rule 17Ad-22(a) to 
bilateral or triparty repo? What other considerations might be relevant 
to distinguishing between bilateral and triparty repo in the context of 
Proposed Rule 17Ad-22(a)?
     In light of the particular contagion risk posed by hybrid 
clearing at IDBs, should the definition of eligible secondary market 
transaction in Proposed Rule 17Ad-22(a) be limited to transactions--
repurchase or outright purchase and sale or both--brokered by an IDB? 
Why or why not?
     Is the inclusion of purchase and sale transactions of a 
registered broker-dealer or government securities broker or government 
securities dealer in the definition of eligible secondary market 
transaction in Proposed Rule 17Ad-22(a) appropriate? Why or why not? Is 
the participation of the entities set forth in paragraph (ii)(B) of the 
proposed definition of an ``eligible secondary market transaction'' in 
Proposed Rule 17Ad-22(a) in the national system of clearance and 
settlement likely to increase the potential risk their eligible 
secondary market transactions in U.S. Treasury securities pose to a 
U.S. Treasury securities CCA? Are there other reasons that 
participation in the national system of clearance and settlement should 
be the basis for being subject to the Membership Proposal? Are there 
other entities, e.g., banks that also participate in the national 
system of clearance of and settlement and that should, on the same 
logic be included as part of paragraph (ii)(B) of the proposed 
definition of an ``eligible secondary market transaction'' in Proposed 
Rule 17Ad-22(a)? Do commenters have any data and/or quantification of 
the approximate dollar value of transactions that would be encompassed 
by paragraph (ii)(B) of the definition of an ``eligible secondary 
market transaction'' in Proposed Rule 17Ad-22(a)? Are they material 
enough to warrant inclusion in the Membership Proposal?
     Could inclusion of transactions between a direct 
participant of a U.S. Treasury securities CCA and a registered broker-
dealer or government securities broker or dealer in the definition of 
an eligible secondary market transaction result in pro- or anti-
competitive effects in the market for intermediation in the market for 
U.S. Treasury securities, particularly as some registered broker-
dealers have already highlighted that additional central clearing may 
affect their ability to compete with those firms with larger market 
share?
     Is the inclusion of the secondary market purchase and sale 
transactions between a direct participant of a U.S. Treasury securities 
CCA and a hedge fund in the definition of an ``eligible secondary 
market transaction'' in Proposed Rule 17Ad-22(a) desirable or 
appropriate? Why or why not? Do commenters agree that this aspect of 
the proposal would address the risks posed by hedge funds transacting 
in the U.S. Treasury market?
     Do commenters agree with the definition of a hedge fund in 
paragraph (ii)(C) of the definition of an ``eligible secondary market 
transaction'' in Proposed Rule 17Ad-22(a)? If not, what should that 
definition be? Would a more limited definition of a hedge fund, e.g., 
using only one of the subsections (a) through (c) of the proposed 
definition (and if so, which ones), be easier to administer or better 
targeted to reach transactions potentially posing risk to the CCA? For 
example, would a more limited definition that incorporated only 
subsection (b) of the proposed definition regarding leverage be used in 
paragraph (ii)(C) of the definition of an ``eligible secondary market 
transaction'' in Proposed Rule 17Ad-22(a) be a preferable approach?
     Should the definition of a hedge fund be limited so that, 
to qualify as a hedge fund under the leverage prong of the definition 
in subsection (b), a fund would have to continue to satisfy that 
subsection, but also must have actually borrowed or used any leverage 
during the past 12 months, excluding any borrowings secured by unfunded 
commitments (i.e., subscription lines of credit); and/or to qualify as 
a hedge fund under the short selling prong of the definition in 
subsection (c), the fund must have actually engaged in the short 
selling activities described in that subsection during the past 12 
months? If the Commission were to revise the proposed definition, would 
excluding actual borrowings secured by unfunded commitments (i.e., 
subscription lines of credit) appropriately exclude private equity 
funds, which typically engage in such borrowings? Should any revised 
definition require actual borrowing or short selling in the last 12 
months? Alternatively, should any revised definition require a longer 
or shorter time period, such as 18 months or nine months, or different 
time periods for borrowing versus short selling?
     Should the definition of a hedge fund be limited to hedge 
funds managed by an investment adviser registered with the Commission?
     Should the inclusion of transactions between hedge funds 
and direct participants of a U.S. Treasury securities CCA be limited to 
hedge funds of a certain size or hedge funds managed by

[[Page 64631]]

investment advisers of a certain size? If so, what is the appropriate 
threshold to use? For example, should the Commission limit the 
definition of a hedge fund to apply only to those with net asset value 
of at least $500 million? Is a fund of that size more likely to have an 
impact on particular markets in which it invests or on its particular 
counterparties? Or should the Commission limit the definition of a 
hedge fund to those which are managed by an investment adviser with, 
for example, at least $150 million in private fund assets under 
management?
     Instead of including a definition of a hedge fund in 
paragraph (ii)(C) of the definition of an ``eligible secondary market 
transaction'' in Proposed Rule 17Ad-22(a), should the Commission 
incorporate by reference the definition of a hedge fund set forth in 
Form PF?
     Do commenters agree that a U.S. Treasury securities CCA 
should be required to adopt rules requiring that a direct participant 
of the CCA submit for clearing all transactions between the participant 
and an account at a registered broker-dealer, government securities 
dealer, or government securities broker where such account may borrow 
an in excess of one-half of the net value of the account or may have 
gross notional exposure of the transactions in the account that is more 
than twice the net value of the account as described in paragraph 
(ii)(D) of the definition of an ``eligible secondary market 
transaction'' in Proposed Rule 17Ad-22(a)? Why or why not? Do 
commenters agree that there is an additional benefit from capturing 
these additional transactions beyond those in paragraph (ii)(D) of the 
definition of an ``eligible secondary market transaction'' in Proposed 
Rule 17Ad-22(a)?
     Can the inclusion of particular accounts within the set of 
counterparties included in the definition of an eligible secondary 
market transaction in paragraph (ii) of the definition of an ``eligible 
secondary market transaction'' in Proposed Rule 17Ad-22(a) be 
administered by a U.S. Treasury securities CCA and/or its direct 
participant? Would a direct participant be able to know whether its 
counterparty is such an account?
     Should the particular accounts included within paragraph 
(ii)(D) of the definition of an ``eligible secondary market 
transaction'' in Proposed Rule 17Ad-22(a) also include accounts with 
banks? Why or why not?
     Do commenters agree that particular accounts identified in 
paragraph (ii)(D) of the definition of an ``eligible secondary market 
transaction'' in Proposed Rule 17Ad-22(a) pose (or have the potential 
to pose) potential contagion risk to a U.S. Treasury securities CCA as 
described in section III.A.3 supra, such that their purchase and sale 
transactions of secondary market U.S. Treasury securities should be 
included in the Membership Proposal? If so, does the definition of a 
specified account in paragraph (ii)(D) of the definition of an 
``eligible secondary market transaction'' in Proposed Rule 17Ad-22(a) 
adequately capture the range of specified accounts that could pose (or 
have the potential to pose) significant system risk? If not, how should 
the definition of a specified account in paragraph (ii)(D) of the 
definition of an ``eligible secondary market transaction'' in Proposed 
Rule 17Ad-22(a) be adjusted to better capture this risk? For example, 
should the use of actual leverage in the preceding 12 months be 
required for such an account? Should different leverage thresholds or 
gross notional exposures be used? Should there be a size threshold in 
terms of the size of the account or the entity holding the account? Why 
or why not?
     Instead of identifying a particular set of eligible 
secondary market cash transactions in Proposed Rule 17Ad-22(a), should 
the Commission instead require that a U.S. Treasury securities CCA (i) 
require its direct participants to submit their U.S. Treasury security 
repurchase and reverse repurchase transactions, and (ii) in the event 
that a direct participant has such repurchase or reverse repurchase 
transactions to submit, require that the direct participant also submit 
its cash transactions? Would this approach be easier to administer? 
Would this approach capture the systemic and contagion risks to a U.S. 
Treasury securities CCA described above?
     Should the definition of an ``eligible secondary market 
transaction'' in Proposed Rule 17Ad-22(a) include all secondary market 
purchase and sale transactions by a direct participant of a U.S. 
Treasury securities CCA in the definition of an eligible secondary 
market transaction? If so, why? Would doing so materially protect U.S. 
Treasury CCAs from the potential risks discussed above? Would such a 
broad requirement have salutary effects on the market for U.S. Treasury 
as a whole, for example by helping to foster an all-to-all market for 
U.S. Treasury securities or in other ways?
     Are there other potential accounts, entities or market 
participants whose U.S. Treasury security purchase and sale activity as 
counterparties to direct participants of a U.S. Treasury securities CCA 
that should be included in the definition of an ``eligible secondary 
market transaction'' in Proposed Rule 17Ad-22(a)? For example, should 
the Commission include purchase and sale activity in which the direct 
participant's counterparty is a registered investment company, a money 
market fund, or other buy-side entity? Has the Commission identified an 
appropriate set of purchase and sale transactions to include in the 
definition of an ``eligible secondary market transaction'' in Proposed 
Rule 17Ad-22(a)? Why or why not? If the Commission were to include 
additional purchase and sale activity, should it do so in a staggered 
or sequenced manner?
     Are there particular purchases and sales of U.S. Treasury 
securities involving a direct participant of a U.S. Treasury securities 
CCA that the Commission should include or exclude from the definition 
of an ``eligible secondary market transaction'' in Proposed Rule 17Ad-
22(a)? Should the Commission include or exclude such transactions based 
on their potential to transmit risk to a U.S. Treasury securities CCA 
and the financial system as whole? If so, has the Commission identified 
the purchase and sale transactions most likely to be the source of such 
risk? If not, what criteria should the Commission use to identify the 
purchase and sale transactions that should be included or excluded?
     Is the Official Sector Exclusion to the definition of an 
eligible secondary market transaction appropriate? Why or why not? Does 
this proposed exclusion appropriately take into account transactions 
made on behalf of a central bank, sovereign entity, or international 
financial institution, i.e., by an intermediary?
     Do commenters agree with the definitions of a central 
bank, sovereign entity, and international financial institution used in 
the Official Sector Exclusion? Why or why not?
     To the extent that they meet the proposed definition of a 
``sovereign entity'' in Proposed Rule 17Ad-22(a), should sovereign 
wealth funds or other state-owned investment vehicles be removed from 
the Official Sector Exclusion? If so, how should these entities be 
defined for this purpose? Do these entities use leverage or otherwise 
pose risk to a U.S. Treasury securities CCA that is more similar to the 
entities that are subject to the Membership Proposal? Why or why not? 
Are there other factors the Commission should consider in deciding 
whether to exclude sovereign wealth funds from the Official Sector 
Exclusion?
     Is the Official Sector Exclusion to the Membership 
Proposal appropriate in

[[Page 64632]]

light of the fact that foreign governments and central banks are 
significant participants in the market for U.S. Treasury securities, 
accounting for a significant portion of sales during the volatility in 
U.S. Treasury securities during March 2020?
     Do central banks, sovereign entities, or international 
financial institutions, as defined in Proposed Rule 17Ad-22(a), pose 
risks to their counterparties that could potentially be transmitted 
back to a U.S. Treasury securities CCA and on to the broader financial 
system? How could such risk be mitigated? Should the Commission 
condition the Official Sector Exclusion, as set forth in paragraph 
(iii) of the definition of an ``eligible secondary market transaction'' 
in Proposed Rule 17Ad-22(a), on the exchange of margin, haircuts and/or 
other risk management measures?
     How would a U.S. Treasury securities CCA craft policies 
and procedures reasonably designed to permit it to identify (and 
therefore exclude its members') transactions subject to the Official 
Sector Exclusion?
     Should the Official Sector Exclusion to the Membership 
Proposal include state or local governments? Why or why not? If so, how 
should these entities be defined for this purpose? Do these entities 
use leverage or otherwise pose risk to a U.S. Treasury securities CCA 
that is more similar to the entities that are subject to the Membership 
Proposal? Are there other factors the Commission should consider in 
deciding whether to include state or local governments within the 
Official Sector Exclusion?
     Is the exclusion of transactions with natural persons from 
the definition of an ``eligible secondary market transaction'' in 
Proposed Rule 17Ad-22(a) appropriate? If natural persons are 
transacting repurchase or reverse repurchase transactions with direct 
participants of a U.S. Treasury securities CCA, is there any reason to 
exclude those transactions from the Membership Proposal? What 
proportion of the specified accounts in paragraph (iii)(C) of the 
definition of an ``eligible secondary market transaction'' in Proposed 
Rule 17Ad-22(a) would be subject to the natural person exclusion 
contemplated in Proposed Rule 17Ad-22(a)? Is the exclusion of those 
accounts appropriate?
     Should the exclusion of transactions with natural persons 
from the definition of an ``eligible secondary market transaction'' in 
Proposed Rule 17Ad-22(a) be conditioned on the exchange of margin, 
haircuts and/or other risk management measures? If so what measures 
would be appropriate for this exclusion?
     Should the natural person exclusion in paragraph (iii) of 
the definition of an ``eligible secondary market transaction'' in 
Proposed Rule 17Ad-22(a) be subject to a volume or size cap, a net 
worth threshold, or any other limitation? If so, how should such 
limitation be set?
     Should inter-affiliate transactions be excluded from the 
definition of an eligible secondary market transaction by adding an 
exclusion to the definition in Proposed Rule 17Ad-22(a) for all such 
transactions? Why or why not? How should exceptions be identified? 
Should the Commission condition this potential exclusion from the 
Membership Proposal for inter-affiliate transactions on the exchange of 
margin, haircuts and/or other risk management measures?
     Should any additional exclusion to the definition of an 
eligible secondary market transaction in Proposed Rule 17Ad-22(a) be 
limited to certain transaction volumes or account size thresholds or to 
particular counterparties? If so, how should these thresholds or 
counterparty levels be set? Should they be accompanied by a transition 
period when a previously exempted transaction becomes subject to the 
clearing requirement? Would a U.S. Treasury securities CCA be able to 
write policies and procedures that would be effective in accomplishing 
this task while still promoting central clearing of other U.S. Treasury 
securities transactions?
     Are there any legal, operational or other considerations 
that could impede an indirect participant's ability to participate 
indirectly as proposed under the Membership Proposal? Are there any 
particular changes to the Membership Proposal that could help 
facilitate their ability to participate as indirect participants? 
Should any other indirect participants or transactions be excluded from 
the Membership Proposal on the basis of any such legal, operational or 
other considerations?
     Are there other changes the Commission can make to the 
design of the Membership Proposal to improve the resiliency of and 
liquidity in the U.S. Treasury securities market?
     Do commenters agree with Proposed Rule 17Ad-
22(e)(18)(iv)(B) that would require a U.S. Treasury securities CCA to 
have policies and procedures to identify and monitor its direct 
participants' submission of transactions for clearing as required in 
the Membership Proposal, including how the CCA would address a failure 
to submit transactions? Why or why not?
     What types of policies and procedures should a U.S. 
Treasury securities CCA implement to comply with the requirements of 
Proposed Rule 17Ad-22(e)(18)(iv)(B), if adopted? What level of detail 
and transparency would commenters find appropriate regarding such 
policies and procedures?
     Do commenters believe that a U.S. Treasury securities CCA 
could develop appropriate procedures to comply with the requirements of 
Proposed Rule 17Ad-22(e)(18)(iv)(B), if adopted?
     In the event that there were to be more than one U.S. 
Treasury securities CCA, should the Commission amend Rule 17Ad-
22(e)(20) (17 CFR 240.17Ad-22(e)(20)) to require each such CCA to 
establish a link with each other Treasury CCA so that the direct 
participant of either Treasury CCA may satisfy the requirements of 
Proposed Rule 17Ad-22(e)(18)(iv) without becoming a direct participant 
of each Treasury CCA? Are there any other steps that the Commission 
should take?
     Will the Membership Proposal have any impact on 
competition in the provision of CCP services in the U.S. Treasury 
market? Will the Membership Proposal inappropriately concentrate risk 
in a single U.S. Treasury securities CCA?

B. Other Changes to Covered Clearing Agency Standards

    As proposed, the Membership Proposal will likely result in a 
significant increase in the volume of U.S. Treasury securities 
transactions submitted for central clearing, including transactions of 
market participants that currently may not submit such transactions for 
central clearing. For example, as noted above, approximately 68% of the 
overall dollar volume of cash market activity in the U.S. Treasury 
market is bilaterally cleared, and dealer-to-customer trading appears 
to comprise significant portion of that market.\196\ Further, it 
appears that the customer side of this market is heterogeneous with 
diverse participants, including pension funds and asset managers who, 
as noted above, do not participate in central clearing to a great 
extent, especially for cash market transactions.\197\
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    \196\ See note 20 supra.
    \197\ IAWG Report, supra note 4, at 3.
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    The Commission believes that certain additional changes to its 
Covered Clearing Agency Standards that would apply only to U.S. 
Treasury securities CCAs are warranted in light of the Membership 
Proposal. Such changes, described further below, are designed to 
improve risk management by and access

[[Page 64633]]

to the US Treasury securities CCA, and will also serve to help manage 
the risks and facilitate access that would likely result from the 
Membership Proposal. Thus, as part of ensuring its written policies and 
procedures are reasonably designed to ensure all of its direct 
participants clear all eligible secondary market transactions in U.S. 
Treasury securities, the Commission proposes to require that U.S. 
Treasury securities CCAs establish, implement, maintain and enforce 
written policies and procedures reasonably designed to, as applicable, 
calculate, collect, and hold margin for a direct participant's 
proprietary positions separately from the margin calculated and 
collected from that direct participant in connection with U.S. Treasury 
securities transactions by an indirect participant (customer) that 
relies on the services provided by the direct participant to access the 
U.S. Treasury securities CCA. This proposal would prohibit a U.S. 
Treasury securities CCA from netting customer and proprietary 
positions. In addition, the Commission proposes to require that U.S. 
Treasury securities CCAs establish, implement, maintain and enforce 
written policies and procedures reasonably designed to, as applicable, 
ensure that they have appropriate means to facilitate access to 
clearance and settlement services of all eligible secondary market 
transactions in U.S. Treasury securities, including those of indirect 
participants, which policies and procedures the board of directors 
reviews annually.\198\
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    \198\ For example, to the extent that the additional 
transactions may present different risks on an intraday basis, a 
U.S. Treasury securities CCA should consider its policies and 
procedures in light of that risk, especially with respect to 
policies and procedures designed to meet the requirements of Rules 
17Ad-22(e)(6) and (7) (17 CFR 240.17Ad-22(e)(6) and (7)).
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    To the extent that changes to the U.S. Treasury securities CCA's 
rules or procedures are necessary in light of these proposed amendments 
to the Covered Clearing Agency Standards, the U.S. Treasury securities 
CCA, as a self-regulatory organization, would be required file such 
changes for Commission review and approval, as appropriate, under 
section 19(b) of the Exchange Act.\199\ In addition, if a U.S. Treasury 
securities CCA has been designated as a systemically important 
financial market utility, changes to programs allowing indirect 
participants to clear or changes to margin methodologies or practices 
may need to be filed as advance notices, to the extent that the changes 
materially impact the nature or level of risk presented by that covered 
clearing agency, which would therefore require consultation with the 
Federal Reserve Board of Governors as well.\200\
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    \199\ See 78 U.S.C. 78s; 17 CFR 240.19b-4.
    \200\ See 12 U.S.C. 8465; 17 CFR 240.19b-4.
---------------------------------------------------------------------------

1. Netting and Margin Practices for House and Customer Accounts
    The Commission believes that, in conjunction with the Membership 
Proposal, further proposed changes with respect to risk management 
requirements could also reduce the potential risk to the U.S. Treasury 
securities CCA arising from such transactions. As described more fully 
below, the Commission is proposing amendments to Rule 17Ad-22(e)(6)(i) 
to require a U.S. Treasury securities CCA to establish, implement, 
maintain and enforce written policies and procedures reasonably 
designed to, as applicable, calculate, collect, and hold margin amounts 
from a direct participant for its proprietary U.S. Treasury securities 
positions separately and independently from margin calculated and 
collected from that direct participant in connection with U.S. Treasury 
securities transactions by an indirect participant that relies on the 
services provided by the direct participant to access the covered 
clearing agency's payment, clearing, or settlement facilities. Such 
changes should allow a U.S. Treasury securities CCA to better 
understand the source of potential risk arising from the U.S. Treasury 
securities transactions it clears and potentially further incentivize 
central clearing, as discussed further below.
    Currently, the Commission's rules do not address how a U.S. 
Treasury securities CCA should calculate, collect, and hold margin 
amounts for any U.S. Treasury securities transactions, cash or repo, 
that a direct participant may submit on behalf of an indirect 
participant. This means that a U.S. Treasury securities CCA generally 
may determine a participant's margin for both proprietary and client 
positions using the methodology that it determines to be appropriate, 
while still remaining responsible for complying more generally with the 
applicable margin requirements under Rule 17Ad-22(e)(6).\201\
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    \201\ Specifically, Rule 17Ad-22(e)(6) requires that a covered 
clearing agency establish, implement, maintain and enforce written 
policies and procedures reasonably designed to, as applicable, cover 
its credit exposure to its participants by establishing a risk-based 
margin system that, at a minimum and among others: considers, and 
produces margin levels commensurate with, the risks and particular 
attributes of each relevant product, portfolio, and market; and 
calculates margin sufficient to cover its potential future exposure 
to participants in the interval between the last margin collection 
and the close out of positions following a participant default. 17 
CFR 240.17Ad-22(e)(6)(i and iii).
---------------------------------------------------------------------------

    For example, in practice, at what is currently the only U.S. 
Treasury securities CCA, clearing a U.S. Treasury securities 
transaction between a direct participant and its customer, i.e., a 
dealer to client trade, would not result in separate collection of 
margin for the customer transaction. Transactions between direct 
participants are novated by the U.S. Treasury securities CCA, and, by 
virtue of multilateral netting, all of a member's positions are netted 
into a single payment obligation--either to or from the CCP.\202\ Under 
its current client clearing models (except the FICC sponsored member 
program),\203\ for a dealer to client trade, although there is no 
transaction between two direct participants to novate, FICC novates the 
transaction and becomes a counterparty to the direct participant that 
has submitted that transaction, but does not have a direct relationship 
with the direct participant's client.\204\ FICC margins the 
transactions in the direct participant's (i.e., the dealer's) account 
on a net basis, allowing any of the trades for the participant's own 
accounts to net against trades by the participant's customers.\205\
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    \202\ See FICC PFMI Disclosure Framework at 10; FICC Rule 11, 
section 4.
    \203\ In FICC's sponsored member program, both the Sponsoring 
Member and the Sponsored Member are members of FICC, and FICC has 
certain obligations to both entities, including a guaranty of 
settlement to the Sponsored Member. See generally FICC Rule 3A; 
Depository Trust & Clearing Corporation, Making the U.S. Treasury 
Market Safer for All Participants: How FICC's Open Access Model 
Promotes Central Clearing, at 6 (Oct. 2021), available at https://www.dtcc.com/-/media/Files/Downloads/WhitePapers/Making-the-Treasury-Market-Safer-for-all-Participants.pdf (``DTCC October 2021 
White Paper'').
    \204\ Marta Chaffee and Sam-Schulhofer-Wohl, Is a Treasury 
Clearing Mandate the Path to Increased Central Clearing, Chicago Fed 
Insights, at 2 (June 23, 2021), available at https://www.chicagofed.org/publications/blogs/chicago-fed-insights/2021/treasury-clearing-mandate (explaining that this conclusion follows 
from that fact that ``FICC nets members' trades for their own 
accounts against trades by the members' customers, so the dealer's 
and customer's sides of the trade would cancel out in the netting 
process'') (``Chicago Fed Insights'').
    \205\ DTCC October 2021 White Paper, supra note 203, at 5-6.
---------------------------------------------------------------------------

    Under the proposed amendments to Rule 17Ad-22(e)(6)(i), a U.S. 
Treasury securities CCA would be required to establish, implement, 
maintain and enforce written policies and procedures reasonably 
designed to, as applicable, calculate margin amounts for all 
transactions a direct participant submits to the CCP on behalf of 
others, separately from the margin that is calculated for transactions 
that the direct participant submits on its own

[[Page 64634]]

behalf. Such policies and procedures must also provide that margin 
collateralizing customer positions be collected separately from margin 
collateralizing a direct participant's proprietary positions. The 
Commission believes that the customer positions that would be separated 
from a direct participant's proprietary positions generally would arise 
in the dealer-to-customer market, in which a dealer transacts directly, 
as a principal, with its customer, as discussed in section II.A.1 
supra. Finally, the CCP would also be required to have policies and 
procedures reasonably designed to, as applicable, ensure that any 
margin held for customers or other indirect participants of a member is 
held in an account separate from those of the direct participant.
    The proposed amendments to Rule 17Ad-22(e)(6)(i) are designed to 
ensure that central clearing of U.S. Treasury securities transactions 
between direct participants and indirect participants of a covered 
clearing agency clearing U.S. Treasury securities would result in the 
risk management benefits described above in section III.A.3 supra, as 
well as to incentivize additional central clearing in the U.S. Treasury 
market. Specifically, the proposed amendments to Rule 17Ad-22(e)(6)(i) 
would require that a U.S. Treasury securities CCA calculate, collect, 
and hold margin for positions in U.S. Treasury securities transactions 
of a direct participant in a U.S. Treasury securities CCA separately 
from those of customers or other indirect participants that rely on the 
direct participant to access the covered clearing agency's payment, 
clearing, or settlement facilities. Because the indirect participant's 
positions are no longer netted against the direct participant's 
positions prior to being submitted for central clearing, the indirect 
participant's positions would be subject to the covered clearing 
agency's risk management procedures, including collection of margin 
specific to those transactions.\206\ This should, in turn, help avoid 
the risk of a disorderly default in the event of a direct participant 
default, in that the CCA would be responsible for the central 
liquidation of the defaulting participant's trades and would be able to 
have a more holistic view of the market than would be available for 
competing bilateral efforts to close out transactions with a defaulting 
entity. Moreover, the proposed amendments to Rule 17Ad-22 (e)(6)(i) 
should result in dealer-to-customer trades gaining more benefits from 
central clearing.
---------------------------------------------------------------------------

    \206\ The proposed amendments to Rule 17Ad-22(e)(6)(i) would not 
require that a U.S. Treasury securities CCA collect margin from 
indirect participants, but rather would ensure that U.S. Treasury 
securities CCAs determine margin for transactions submitted on 
behalf of indirect participants separately from those of direct 
participants.
---------------------------------------------------------------------------

    FICC, in its sponsored membership program, already calculates, 
collects, and holds margin amounts for its sponsoring members 
separately and independently from those members they sponsor. FICC's 
rules specifically provide for the collection of margin for sponsored 
member trades on a gross basis, i.e., the total margin amount required 
for the separate omnibus account for client trades must be equal to the 
sum of the individual margin amounts that would be due if each customer 
were margined separately.\207\ The proposed amendments to Rule 17Ad-
22(e)(6)(i), however, would not require that a CCA's direct participant 
collect a specified amount of margin from its customers or determine 
customer margin in a particular manner, such as on a gross basis; the 
calculation and collection of margin between a CCA direct participant 
and its customers would be left to other applicable regulations and, to 
the extent applicable, bilateral negotiation between the member and its 
customer.
---------------------------------------------------------------------------

    \207\ See FICC Rules 1 (definition of Sponsoring Member Omnibus 
Account) and 3A, section 10, supra note 47; DTCC October 2021 White 
Paper, supra note 203, at 6. Although not required under the 
proposed amendments to Rule 17Ad-22(e)(6)(i), calculation of gross 
margin for each customer, i.e., the sum of the individual margin 
amounts that would be due if each customer were margined separately, 
as FICC does for the Sponsored Service, would be permissible under 
the proposed amendment.
---------------------------------------------------------------------------

    In these respects, the proposed amendments to Rule 17Ad-22(e)(6)(i) 
would require policies and procedures that closely resemble the 
calculation, collection, and holding of margin for listed options. 
Currently, the covered clearing agency that clears and settles listed 
options transactions holds margin for customer trades separately from 
the proprietary trades of the submitting participant in an omnibus 
account.\208\ When considering and adopting the Covered Clearing Agency 
Standards, the Commission noted that customer segregation can be 
achieved through such an omnibus account structure, where all 
collateral belonging to all customers of a particular member is 
commingled and held in a single account segregated from that of the 
member,\209\ which is consistent with the practice at the clearing 
agency for listed options and the proposed amendments to Rule 17Ad-
22(e)(6)(i).
---------------------------------------------------------------------------

    \208\ See Options Clearing Corp. Rule 601(c)-(d), available at 
https://www.theocc.com/getmedia/9d3854cd-b782-450f-bcf7-33169b0576ce/occ_rules.pdf (``OCC Rules''). This approach is also 
similar to the approach used for futures customers. See 17 CFR 1.22 
and Advanced Notice of Proposed Rulemaking, Protection of Cleared 
Swaps Customers Before and After Commodity Broker Bankruptcies, 75 
FR 75162, 75163 (Dec. 2, 2010) (describing the futures model).
    \209\ See CCA Standards Proposing Release, supra note 7, 79 FR 
at 29547; CCA Standards Adopting Release, supra note 25, 81 FR at 
70832-33.
---------------------------------------------------------------------------

    The approach proposed here would also be similar to the 
requirements applicable to cleared swaps, in that it would require the 
separation of proprietary and customer funds and securities held at a 
U.S. Treasury securities CCA.\210\ However, it would not require any 
particular method for how customer funds and securities are segregated, 
which differs from the requirements applicable to derivatives clearing 
organizations clearing swaps. Such entities are subject to what has 
been referred to as a legally segregated, operationally commingled 
(``LSOC'') approach.\211\ Under such an approach, customer collateral 
may be held in one combined account and commingled, but in the event of 
a customer default, the collateral of non-defaulting customers would 
not be available to cover any losses attributable to the defaulting 
customer (i.e., they would be legally separated from the collateral of 
the defaulting customer).\212\ In other words, the LSOC model mitigates 
``fellow customer risk'' arising from the default of a customer within 
the omnibus account. The Commission previously has declined to require 
such an approach for covered clearing agencies, preferring to allow 
each covered clearing agency to determine the method that works best 
for the products it clears and markets it serves.\213\ When discussing 
that conclusion, the Commission also noted that this type of 
segregation does not occur at the CCP level under the current market 
structure for cash securities and listed options, and that customer 
positions and funds in the cash securities and listed options markets 
are protected under SIPA, which is not the case for futures and cleared 
swaps.\214\
---------------------------------------------------------------------------

    \210\ See 7 U.S.C. 6d(f)(2).
    \211\ 17 CFR 22.15.
    \212\ See, e.g., Protection of Cleared Swaps Customer Contracts 
and Collateral; Conforming Amendments to the Commodity Broker 
Bankruptcy Provisions, 77 FR 6336, 6339 (Feb. 7, 2012) (describing 
the LSOC approach and adopting final rules for this approach).
    \213\ See CCA Standards Adopting Release, supra note 25, 81 FR 
at 70832.
    \214\ Id. at 70833 (citing 15 U.S.C. 78eee et seq.).
---------------------------------------------------------------------------

    By contrast to the rules for margin for futures and cleared swaps, 
the proposed amendments to Rule 17Ad-22(e)(6)(i) would not require that 
a CCP clearing and settling transactions in U.S.

[[Page 64635]]

Treasury securities calculate and collect margin for each customer on a 
gross basis.\215\ Instead, the CCP would have the discretion to collect 
a single netted amount for each clearing member's customer account as a 
whole, i.e., netting each customer's margin against that of other 
customers within the overall customer account. This is generally how 
margin is collected for listed options,\216\ where, as noted above, 
SIPA acts to protect customer securities and funds at a participant 
broker-dealer.\217\ However, in order for a registered broker-dealer to 
take advantage of the proposed debit in proposed item 15 of 17 CFR 
240.15c-3-3a, if adopted, a U.S. Treasury securities CCA must collect 
margin on a gross basis, as discussed in section III.C infra.
---------------------------------------------------------------------------

    \215\ See 17 CFR 39.13(g)(8)(A and C) (requiring the collection 
of initial margin for each customer account equal to the sum of the 
initial margin accounts that would be required if the individual 
customer were a direct participant and prohibiting a derivatives 
clearing organization from netting, or permitting its clearing 
members to, net positions of different customers against one 
another).
    \216\ See OCC Rule 810(a)-(c), supra note 208.
    \217\ See supra note 210.
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2. Facilitating Access to U.S. Treasury Securities CCAs
    The Commission understands that the various models currently 
available to access central clearing in the U.S. Treasury market may 
not meet the needs of the many different types of market participants 
who transact in U.S. Treasury securities with the direct participants 
of a U.S. Treasury Securities CCA. Although some market participants 
may choose to become a member of a U.S. Treasury securities CCA, this 
approach likely would not be viable for a broad range of participants 
in the U.S. Treasury market for legal, operational and other reasons. 
Currently, there are several methods available to allow market 
participants to access CCP services through a FICC member.\218\ 
However, based on its supervisory experience, the Commission 
understands that these models may not meet the regulatory or business 
needs of all market participants, including indirect participants whose 
transactions with direct participants would likely be encompassed by 
rules that FICC would impose, as required by the Membership Proposal if 
adopted, that its direct participants submit for clearance and 
settlement all eligible secondary market transactions in U.S. Treasury 
securities. Consequently, the Commission believes that the access 
models used at a U.S. Treasury securities CCA will need to be revisited 
to help ensure that more transactions by indirect participants 
(particularly in the dealer-to-customer market) could be submitted to 
comply with the Membership Proposal, if adopted.
---------------------------------------------------------------------------

    \218\ See, e.g., FICC Rules 3A, 8, 18, supra note 47 (providing 
for prime brokerage and correspondent clearing and sponsored 
membership); see also October 2021 White Paper, supra note 198, at 
5-7.
---------------------------------------------------------------------------

    With regard to methods of access, the Commission understands 
indirect participants may have significantly different preferences with 
respect to how they access and obtain clearing services from direct 
participants of U.S. Treasury securities CCAs. For example, certain 
market participants may tend to prefer to bundle trading and execution 
services with a single entity that is a U.S. Treasury securities CCA 
member for regulatory, operational, and other reasons.\219\ By 
contrast, other market participants would prefer to be able to utilize 
clearing services unbundled from execution services from U.S. Treasury 
securities CCA members and would prefer that such members operate their 
clearing services independently from execution services, as appears 
common in other asset classes.\220\ In addition, some market 
participants have expressed concerns with the way FICC's direct 
participants conduct their business regarding access for indirect 
participants, specifically, that FICC direct participants sponsoring 
indirect members are not willing to submit transactions for such 
indirect participants to which the direct participant is not a party 
(i.e., ``done away'' transactions).\221\ These concerns, however, are 
based on the business decisions of FICC's direct participants rather 
than the operation of FICC's Rules; although FICC does not restrict its 
Sponsoring Members' ability to be both a trading counterparty and 
submitting clearing member for an indirect participant, FICC's Rules 
allow direct participants in its sponsored membership program to submit 
``done away'' transactions, if they so choose. Accordingly, as 
currently constituted, FICC's rules permit but do not require that its 
direct participants accept such transactions.\222\
---------------------------------------------------------------------------

    \219\ DTCC October 2021 White Paper, supra note 203, at 5, 7.
    \220\ Futures Industry Association Principal Traders Group, 
Clearing a Path to a More Resilient Treasury Market, at 10 (Jul. 
2021), available at https://www.fia.org/sites/default/files/2021-07/FIA-PTG_Paper_Resilient%20Treasury%20Market_FINAL.pdf (``FIA PTG 
Whitepaper'').
    \221\ Id. at 7-9.
    \222\ See DTCC October White Paper, supra note 203, at 6-7; 
Exchange Act Release No. 85470 (Mar. 29, 2019), supra note 126 
(approving changes to FICC's Rules to allow Sponsored Members to 
transact with FICC members that are not their Sponsoring Member).
---------------------------------------------------------------------------

    The Commission is proposing Rule 17Ad-22(e)(18)(iv)(C) to require 
that a U.S. Treasury securities CCA establish, implement, maintain and 
enforce written policies and procedures reasonably designed to, as 
applicable, ensure that it has appropriate means to facilitate access 
to clearance and settlement services of all eligible secondary market 
transactions in U.S. Treasury securities, including those of indirect 
participants, which policies and procedures the U.S. Treasury 
securities CCA's board of directors reviews annually. Although this new 
provision would not prescribe specific methods for market participants 
to obtain indirect access to a U.S. Treasury securities CCA, it is 
intended to help ensure that all U.S. Treasury security CCAs review 
their indirect access models and ensure that they facilitate access to 
clearance and settlement services in a manner suited to the needs and 
regulatory requirements of market participants throughout the U.S. 
Treasury securities market, including indirect participants.
    This new proposed requirement would further expand current Rule 
17Ad-22(e)(18), which requires that a covered clearing agency 
establish, implement, maintain and enforce written policies and 
procedures reasonably designed to, as applicable, establish objective, 
risk-based and publicly disclosed criteria for participation, which 
permit fair and open access by direct and, where relevant indirect 
participants. Because the Membership Proposal likely would require 
direct participants to submit additional eligible secondary market 
transactions for clearing, thereby raising the need for the direct 
participants to centrally clear transactions with indirect participants 
that are not currently submitted for clearing, the Commission believes 
that expanding Rule 17Ad-22(e)(18) to provide additional requirements 
regarding a U.S. Treasury securities CCA's consideration of whether it 
has ensured appropriate access for indirect participants should help 
facilitate adoption and implementation of the Membership Proposal, as 
it will provide additional or reworked models which direct participants 
can use to submit their transactions executed on behalf of or with 
indirect participants for central clearing, and lead to better risk 
management of the risks posed by indirect participants to a U.S. 
Treasury securities CCA.
    To facilitate compliance with this proposed requirement, the 
Commission believes that a U.S. Treasury securities CCA generally 
should conduct an initial

[[Page 64636]]

review of its access models and related policies and procedures. As it 
conducts this review, in view of the critical services it provides, the 
U.S. Treasury securities CCA generally should seek to provide access in 
as flexible a means as possible, consistent with its responsibility to 
provide sound risk management and comply with other provisions of the 
Exchange Act, the Covered Clearing Agency Standards, and other 
applicable regulatory requirements. The Commission believes that the 
U.S. Treasury securities CCA generally should consider a wide variety 
of appropriate means to facilitate access to clearance and settlement 
services of all eligible secondary market transactions in U.S. Treasury 
securities, including those of indirect participants. To ensure that it 
considers a sufficiently broad set of perspectives, the U.S. Treasury 
securities CCA generally should consult with a wide-range of 
stakeholders, including indirect participants, as it seeks to comply 
with proposed rule 17Ad-22(e)(18)(iv)(B).
    The Commission believes that a U.S. Treasury securities CCA 
generally should review any instance in which its policies and 
procedures treat transactions differently based on the identity of the 
participant submitting the transaction, the fact that an indirect 
participant who is a party to the transaction, or the method of 
execution, or in any other way, and confirm that any variation in the 
treatment of such transactions is necessary and appropriate to meet the 
minimum standards regarding, among other things, operations, 
governance, and risk management identified in the Covered Clearing 
Agency Standards. The review by a U.S. Treasury securities CCA's board 
of directors under proposed Rule 17Ad-22(e)(18)(iv)(B) generally should 
include consideration whether to establish policies and procedures that 
enable direct members to submit to the U.S. Treasury securities CCA 
eligible transactions for clearance and settlement that have been 
executed by two indirect participants of the U.S. Treasury securities 
CCA, which could potentially help address some of the concerns 
potential participants raised about the inability to present ``done 
away'' trades for clearance and settlement described above. Finally, a 
U.S. Treasury securities CCA generally should consider whether to 
include in its policies and procedures non-discrimination principles, 
similar to those the CFTC promulgated to foster the clearance and 
settlement of swaps,\223\ to the extent that they are applicable to the 
clearance and settlement of U.S. Treasury securities. Taken together, 
initiatives such as these, along with others identified by a U.S. 
Treasury securities CCA through consultations with relevant 
stakeholders--including indirect participants--should help ensure that 
a U.S. Treasury securities CCA is offering appropriate means to 
facilitate access to its clearance and settlement services for U.S. 
Treasury securities. To the extent that a U.S. Treasury securities 
CCA's initial (or any subsequent) review occasions a change to its 
rules, such U.S. Treasury securities CCA would need to file such 
changes for Commission review and approval, as appropriate, under 
section 19(b) of the Exchange Act and Title VIII of the Dodd-Frank 
Act.\224\
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    \223\ See 17 CFR 39.12(a)(1)(vi).
    \224\ See 15 U.S.C. 78s(b); 17 CFR 240.19b-4; 12 U.S.C. 5465(e).
---------------------------------------------------------------------------

    Further, as noted above, the Commission is proposing to require 
annual review by the CCA's board of directors of the CCA's written 
policies and procedures designed to ensure that the CCA has appropriate 
means to facilitate access to clearance and settlement services of all 
eligible secondary market transactions in U.S. Treasury securities, 
including those of indirect participants. The Commission believes that 
such requirement is important to ensure that such policies regarding 
access to clearance and settlement services, including for indirect 
participants, are addressed at the most senior levels of the governance 
framework of the covered clearing agency, consistent with the 
importance of such requirements. The review by a U.S. Treasury 
securities CCA's board of directors under proposed Rule 17Ad-
22(e)(18)(iv)(B) generally should include consideration whether the 
U.S. Treasury securities CCA's written policies and procedures are 
reasonably designed to ensure appropriate means to facilitate access to 
clearance and settlement services of all eligible secondary market 
transactions in U.S. Treasury securities, including those of indirect 
participants.
3. Request for Comment
    The Commission generally requests comments on all aspects of new 
proposed Rules 17Ad-22(e)(6)(i) and 17Ad-22(e)(18)(iv)(C). In addition, 
the Commission requests comments on the following specific issues, with 
accompanying data and analysis:
     Do commenters agree or disagree with any particular 
aspects of proposed Rule 17Ad-22(e)(6)(i)? If so, which ones and why? 
If commenters disagree with any provision of the proposed rule, how 
should such provision be modified and why?
     Do commenters agree that the transactions in a direct 
participant's customer account would generally consist of its 
transactions in the dealer-to-customer market, as a principal to 
transactions with its customers? Should the Commission further define 
or distinguish between proprietary and customer positions in the 
proposed rule text?
     As discussed above, the proposed amendments to Rule 17Ad-
22(e)(6)(i) do not require a particular approach to the methodology 
used for calculating customer margin, that is, whether customer margin 
should be determined on a gross or net basis, by contrast to the gross 
margin requirement for customer margin for futures and cleared 
swaps.\225\ Should the Commission consider further amendments to Rule 
17Ad-22(e)(6) or other Commission rules to include such a requirement? 
If so, how would such a requirement interact with SIPA \226\ and the 
Bankruptcy Code \227\ in the event of a broker-dealer default?
---------------------------------------------------------------------------

    \225\ See 17 CFR 39.13(g).
    \226\ See 15 U.S.C. 78aaa et seq.
    \227\ See 11 U.S.C. 1 et seq.
---------------------------------------------------------------------------

     Do commenters believe that additional requirements with 
respect to the collection of margin at the customer level, i.e., 
further segregation of customer margin within a customer account (such 
as an LSOC model) would bring particular costs or benefits to the 
market? How would any such additional requirement interact with SIPA 
and the Bankruptcy Code in the event of a broker-dealer default?
     More generally, what impact would the proposed amendment 
to Rule 17Ad-22(e)(6)(i)(A) have on bankruptcy issues arising under 
SIPA? Would additional SIPA or bankruptcy issues arise in the event of 
additional margin requirements similar to those for futures and/or 
cleared swaps?
     Would the proposed amendment to Rule 17Ad-22(e)(6)(i) 
potentially support (or not support) the expanded use of cross-
margining agreements?
     Do commenters believe that the proposed amendment to Rule 
17Ad-22(e)(6)(i) would increase (or decrease) the amount of margin 
required to be collected from direct participants of a U.S. Treasury 
securities CCA?
     Do commenters agree that the requirement to separately 
calculate, collect, and hold customer margin would further incentivize 
central clearing in the U.S. Treasury market?
     Do commenters agree or disagree with any particular 
aspects of proposed Rule 17Ad-22(e)(18)(iv)(C)? If so, which

[[Page 64637]]

ones and why? If commenters disagree with any provision of the proposed 
rule, how should such provision be modified and why?
     Do commenters agree that proposed Rule 17Ad-
22(e)(18)(iv)(C) is sufficient to facilitate access to the clearance 
and settlement services of a U.S. Treasury securities CCA for both 
direct and indirect participants?
     Do commenters agree that certain market participants may 
not be able to satisfy a covered clearing agency's membership criteria? 
If so, which particular entities, and what are the reasons?
     In addition, do commenters agree that particular legal, 
operational or other considerations may further preclude many market 
participants from becoming direct members of a U.S. Treasury securities 
CCA? If so, which entities, and why? For example, are there particular 
requirements under the Investment Company Act of 1940 or Investment 
Advisers Act of 1940 that may preclude particular registered funds or 
their sponsors from participating as direct clearing members?
     Among market participants that cannot become direct 
members of a U.S. Treasury securities CCA, are there particular 
entities that may be further precluded from participating as indirect 
participants? If so, which entities, and what might be some of the 
legal, operational or other considerations that may preclude them from 
becoming indirect participation?
     Are there specific changes to the current indirect 
participation models that could help facilitate participation by 
certain market participants? In addition, are there specific changes to 
particular Commission rules that could facilitate further participation 
of indirect participants?
     Would a separation between trade execution and clearing 
services at broker-dealers pose issues for any of the market 
participants in the market for U.S. Treasury securities?
     Would a separation between trade execution and clearing 
services at broker-dealers lead to regulatory arbitrage in view of the 
fact that the Commission generally does not regulate banks that are not 
otherwise registered with the Commission?
     Should the Commission amend the Covered Clearing Agency 
standards to require that a U.S. Treasury securities CCA, in turn, 
require its direct participants to clear transactions executed between 
indirect participants but submitted to a direct participant for 
clearing? How effective is such a rule likely to be in view of the 
restriction in Exchange Act section 17A(b)(3)(E),\228\ which prohibits 
any clearing agency from imposing any schedule of prices, or fixing 
rates or other fees, for services rendered by its participants?
---------------------------------------------------------------------------

    \228\ 15 U.S.C. 78q-1(b)(3)(E).
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C. Proposed Amendments to Rule15c3-3a

1. Proposal
    The proposed rules discussed above could cause a substantial 
increase in the margin broker-dealers must post to a U.S. Treasury 
securities CCA resulting from their customers' cleared U.S. Treasury 
positions. Currently, Rules 15c3-3 and 15c3-3a do not permit broker-
dealers to include a debit in the customer reserve formula equal to the 
amount of margin required and on deposit at a U.S. Treasury securities 
CCA. This is because no U.S. Treasury securities CCA has implemented 
rules and practices designed to segregate the margin and limit it to 
being used solely to cover obligations of the broker-dealer's 
customers. Therefore, increases in the amount of margin required to be 
deposited at a U.S. Treasury securities CCA as a result of the 
Membership Proposal would result in corresponding increases in the need 
to use broker-dealers' cash and securities to meet these requirements.
    To facilitate implementation of the Membership Proposal, the 
Commission is proposing to amend Rule 15c3-3a to permit margin required 
and on deposit at a U.S. Treasury securities CCA to be included as a 
debit item in the customer reserve formula, subject to the conditions 
discussed below. This new debit item would offset credit items in the 
Rule 15c3-3a formula and, thereby, free up resources that could be used 
to meet the margin requirements of a U.S. Treasury securities CCA. The 
new debit item would be reported on a newly created Item 15 of the Rule 
15c3-3a reserve formula. The proposed amendments also would set forth a 
number of conditions that would need to be met to include the debit in 
the reserve formula. As discussed below, these proposed conditions are 
designed to permit the inclusion of the debit only under conditions 
that would provide maximum protection to the broker-dealer's customers. 
The goal is to facilitate implementation of the Membership Proposal in 
a way that does not diminish the customer-protection objective of Rules 
15c3-3 and 15c3-3a.
    The proposed conditions would be set forth in a new Note H to the 
reserve formula similar to how the conditions for including a debit in 
the reserve formula with respect to margin required and on deposit at a 
securities futures clearing agency or DCO are set forth in Note G. The 
proposed amendments are based, in part, on the conditions in Note G and 
the requirements in Rules 15c3-3 and 15c3-3b for including a debit with 
respect to margin required and on deposit at security-based swap 
clearing agency. The Note G conditions and requirements of Rules 15c3-3 
and 15c3-3b similarly are designed to permit the debit under 
circumstances that provide protection to customers.
    Under the proposed amendments, current Item 15 of the Rule 15c3-3a 
formula would be renumbered Item 16.\229\ Proposed Item 15 would 
identify as a debit in the Rule 15c3-3a formula margin required and on 
deposit with a clearing agency registered with the Commission under 
section 17A of the Exchange Act resulting from the following types of 
transactions in U.S. Treasury securities in customer accounts that have 
been cleared, settled, and novated by the clearing agency: (1) 
purchases and sales of U.S. Treasury securities; and (2) U.S. Treasury 
securities repurchase and reverse repurchase agreements (together 
``customer position margin''). As proposed, this debit item would be 
limited to customer position margin required and on deposit at a 
clearing agency that clears, settles, and novates transactions in U.S. 
Treasury securities. Except for the debits identified in current Items 
13 and 14 of the Rule 15c3-3a formula, margin required and on deposit 
at other types of clearing agencies or for other types of securities 
transactions would not qualify as a debit item under this proposal. 
Further, this debit item would be limited to customer position margin 
required and on deposit at the U.S. Treasury securities CCA as a result 
of U.S. Treasury positions in customer accounts. Margin required and on 
deposit at the U.S. Treasury securities CCA as result of the broker-
dealer's proprietary U.S. Treasury positions could not be included in 
this debit item. This proposed limitation would effectuate a 
fundamental aspect of Rule 15c3-3: that customer cash and securities 
not be used by the broker-dealer to finance its proprietary business 
activities.\230\ Finally, the debit would be limited to customer 
position margin required and on deposit at the

[[Page 64638]]

U.S. Treasury securities CCA. This would mean that the broker-dealer 
could not include in this debit item amounts on deposit at the U.S. 
Treasury securities CCA that exceed the broker-dealer's margin 
requirement resulting from its customers' cleared U.S. Treasury 
securities positions. This limitation is designed to prevent the 
broker-dealer from artificially increasing the amount of the debit item 
by depositing cash and securities at the U.S. Treasury securities CCA 
that are not needed to meet a margin requirement resulting from its 
customers' U.S. Treasury securities positions.
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    \229\ Current Item 15 is where the broker-dealer reflects the 
amount, if any, that total credits exceed total debits.
    \230\ As discussed above in section II.B.2., debit items offset 
credit items thereby reducing the amount of cash or qualified 
securities that need to be held in the customer reserve account to 
cover the broker-dealer's cash liabilities to its customers.
---------------------------------------------------------------------------

    As proposed, Item 15 of the Rule 15c3-3a formula would have a Note 
H that sets forth a number of conditions that would need to be met to 
include the amount of customer position margin required and on deposit 
at the U.S. Treasury securities CCA as a debit. Each of the conditions 
in Note H to Item 15 would need to be met for a broker-dealer to 
include a debit equal to the amount of customer position margin on 
deposit at the U.S. Treasury securities CCA.
    The first condition would be set forth in Note H(a), which would 
provide that the debit item could be included in the Rule 15c3-3a 
formula to the extent that the customer position margin is in the form 
of cash or U.S. Treasury securities and is being used to margin U.S. 
Treasury securities positions of the customers of the broker-dealer 
that are cleared, settled, and novated at the U.S. Treasury securities 
CCA. The objective is to limit the assets underlying the debit item to 
the safest and most liquid instruments, given that the debit item would 
offset credit items (cash owed to customers).\231\ As discussed above, 
the liquidity of the debit items protects the customers whose cash or 
securities are used to finance or facilitate customer transactions.
---------------------------------------------------------------------------

    \231\ See, e.g., 17 CFR 240.15c3-3(e) (limiting the assets that 
can be deposited into the customer reserve account to cash and 
qualified securities); 17 CFR 240.15c3-3(a)(6) (defining the term 
``qualified security'' to mean a security issued by the United 
States or a security in respect of which the principal and interest 
are guaranteed by the United States).
---------------------------------------------------------------------------

    Proposed Note H(b) to Item 15 would set forth three conditions that 
would need to be met to include the amount of customer position margin 
required and on deposit at the U.S. Treasury securities CCA as a debit 
item. The first condition set forth in Note H(b)(1) would provide that 
the customer position margin must consist of cash owed to the customer 
of the broker-dealer or U.S. Treasury securities held in custody by the 
broker-dealer for the customer that was delivered by the broker-dealer 
to meet to meet a margin requirement resulting from that customer's 
U.S. Treasury securities positions cleared, settled, and novated at the 
U.S. Treasury securities CCA and not for any other customer's or the 
broker-dealer's U.S. Treasury securities positions cleared, settled, 
and novated at the U.S. Treasury securities CCA.\232\ In sum, to meet 
this condition, the broker-dealer would need to: (1) use customer 
assets exclusively to meet the customer position margin requirement; 
(2) use a particular customer's assets exclusively to meet the amount 
of the customer position margin requirement resulting from that 
customer's cleared U.S. Treasury securities positions; and (3) have 
delivered the customer's assets to the U.S. Treasury securities CCA. 
The objective of the first component of this condition--the need to use 
customer assets exclusively--is to segregate the customer assets being 
used to meet the customer position margin requirement from the broker-
dealer's proprietary assets. Additional conditions would provide that 
the U.S. Treasury securities CCA must hold the assets being used to 
meet the customer position margin requirement in an account of the 
broker-dealer that is segregated from any other account of the broker-
dealer and is identified as being held for the exclusive benefit of the 
broker-dealer's customers. The first prong of the condition is designed 
to ensure that only customer assets are held in the account.
---------------------------------------------------------------------------

    \232\ Cash owed by a broker-dealer to customers is a credit item 
that is included in Item 1 to the Rule 15c3-1a formula. Thus, cash 
owed to customers that is used to meet a customer position margin 
requirement will be accounted for as a credit in Item 1. Further, 
when a broker-dealer uses customer margin securities to borrow funds 
or execute a securities loan transaction, the firm must put a credit 
in the formula. See Items 2 and 3 to Rule 15c3-3a. The credit items 
are designed to require the broker-dealer to reserve sufficient 
funds to be able to retrieve securities collateralizing the borrowed 
funds or that have been loaned. There is not a specific Item in the 
Rule 15c3-3a formula to include the credit arising from the broker-
dealer's use of customers' U.S. Treasury securities to meet a 
customer position margin requirement. Consequently, the Commission 
is proposing to amend Note B to Item 2 of the Rule 15c3-1a formula 
to instruct broker-dealers to include as a credit in Item 2 the 
market value of customers' U.S. Treasury securities on deposit at a 
U.S. Treasury securities CCA that meets the definition of a 
``qualified clearing agency'' in Note H.
---------------------------------------------------------------------------

    The objective of the second component of this condition--the need 
to use a particular customer's assets exclusively to meet the amount of 
the customer position margin requirement resulting from that customer's 
cleared U.S. Treasury securities positions--is to avoid the use of one 
customer's assets to meet another customer's margin requirement. For 
example, FICC's Sponsored Member program allows its members to sponsor 
a person's (i.e., a Sponsored Member's) U.S. Treasury securities 
transactions for clearance and settlement. FICC interacts solely with 
the sponsoring member as processing agent for purposes of the day-to-
day satisfaction of the Sponsored Member's obligation to or from FICC, 
including the Sponsored Member's cash and securities settlement 
obligations. However, FICC calculates a separate margin requirement for 
each Sponsored Member's trading activity and the sum of each sponsored 
member's margin calculation is the aggregate margin requirement that 
must be met by the sponsoring member. Further, this margin is held in 
an omnibus account that is separate from the account that holds the 
Sponsoring Member's net margin obligation for non-sponsored securities 
transactions.\233\ In this scenario, the U.S. Treasury securities CCA's 
margin calculations and resulting requirements can be traced to a 
specific customer's cleared U.S. Treasury securities positions. 
Consequently, the broker-dealer would be able to allocate the amount of 
the U.S. Treasury securities CCA's daily customer position margin 
requirement attributable to a specific customer. Under this component 
of the first condition, the broker-dealer would need to deliver cash or 
U.S. Treasury securities belonging to that specific customer to meet 
the amount of the U.S. Treasury securities CCA's customer position 
margin requirement resulting from that customer's cleared U.S. Treasury 
securities positions. This would mitigate the risk to all the broker-
dealer's customers by limiting when their assets can be used to meet 
the U.S. Treasury securities CCA's customer position margin 
requirement.
---------------------------------------------------------------------------

    \233\ See note 207 supra.
---------------------------------------------------------------------------

    The objective of the third component of the first condition--that 
the broker-dealer had delivered the customer's assets to the U.S. 
Treasury securities CCA--is to address the potential that a customer 
may use more than one broker-dealer to engage in U.S. Treasury 
securities transactions. In this case, two or more broker-dealers may 
be subject to customer position margin requirements of the U.S. 
Treasury securities CCA resulting from the customer's cleared U.S. 
Treasury securities positions. The intent is to prevent a broker-dealer 
from including as a debit the amount of customer position margin that 
another broker-dealer delivered to the U.S. Treasury securities CCA 
with respect to U.S. Treasury securities positions of a

[[Page 64639]]

customer of both the broker-dealers. The amount that a given broker-
dealer's debit items can offset its credit items should be limited to 
the amount customer position margin it delivered to the U.S. Treasury 
securities CCA. Otherwise, the customers of the broker-dealer would be 
put at risk for transactions effected by another broker-dealer.
    Proposed Note H(b)(2) to Item 15 would set forth the second 
condition for including customer position margin as a debit in the Rule 
15c3-3a formula. Under this condition, the customer position margin 
would need to treated in accordance with rules of the U.S. Treasury 
securities CCA designed to protect and segregate the customer position 
margin and the U.S. Treasury securities CCA and broker-dealer would 
need to be in compliance with those rules (as applicable).
    Proposed Note H(b)(2)(i) to Item 15 would provide that the customer 
position margin is treated in accordance with rules requiring the 
qualified U.S. Treasury securities CCA to calculate a separate margin 
amount for each customer of the broker-dealer and the broker-dealer to 
deliver that amount of margin for each customer on a gross basis. As 
discussed above, a component of the condition in proposed Note H(b)(1) 
is that the broker-dealer use a particular customer's assets 
exclusively to meet the amount of the customer position margin 
requirement resulting from that customer's cleared U.S. Treasury 
securities positions. This condition in proposed Note H(b)(2) is 
designed to facilitate that condition in proposed Note H(b)(1) by 
requiring that the U.S. Treasury securities CCA has rules to perform 
separate customer position margin calculations for each customer of the 
broker-dealer. This would allow the broker-dealer to allocate the 
amount of the customer position margin requirement attributable to each 
of its customers. In addition, the condition would provide that the 
U.S. Treasury securities CCA has rules requiring the broker-dealer to 
deliver the amount calculated for each customer on a gross basis. This 
would mean that the risk of one customer's positions could not be 
offset by the risk of another customer's positions in determining the 
amount of customer position margin the broker-dealer would need to have 
on deposit at the U.S. Treasury securities CCA. As a result, the 
broker-dealer would not be able to deliver assets belonging to one 
customer to meet the margin requirement of another customer.
    Proposed Note H(b)(2)(ii) to Item 15 would provide that the 
customer position margin is treated in accordance with rules requiring 
that the U.S. Treasury securities CCA be limited to investing it in 
U.S. Treasury securities with a maturity of one year or less. As 
discussed above, proposed Note H(a) would provide that the collateral 
delivered to the U.S. Treasury securities CCA by the broker-dealer to 
meet the customer position margin requirement must be in the form of 
cash or U.S. Treasury securities. The objective is to limit the assets 
underlying the debit item to the safest and most liquid instruments. 
This objective would be undermined if the U.S. Treasury securities CCA 
could invest the cash delivered by the broker-dealer or cash obtained 
by using the U.S Treasury securities delivered by the broker-dealer in 
assets other than cash and U.S. Treasury securities. Moreover, while 
the broker-dealer could deliver customer U.S. Treasury securities with 
a maturity greater than one year, the U.S. Treasury securities CCA's 
rule would need to limit it to investing customer position margin in 
U.S. Treasury securities with a maturity of one year or less. The 
object is to limit the investments to the safest most liquid 
instruments.
    Proposed Note H(b)(2)(iii) to Item 15 would provide that the 
customer position margin is treated in accordance with rules designed 
to address the segregation of the broker-dealer's account at the U.S. 
Treasury securities CCA that holds the customer position margin and set 
strict limitations on the U.S. Treasury securities CCA's ability to use 
the margin. The required rules are modeled on the requirements for a 
broker-dealer to include a debit with respect to margin delivered to a 
security-based swap CCA.\234\ In particular, the note would provide 
that the customer position margin is treated in accordance with rules 
requiring that it must be held in an account of the broker-dealer at 
the U.S. Treasury securities CCA that is segregated from any other 
account of the broker-dealer at the U.S. Treasury securities CCA and 
that is:
---------------------------------------------------------------------------

    \234\ See 17 CFR 240.15c3-3(p)(1)(iii) (defining the term 
``qualified clearing agency account''); 17 CFR 240.15c3-3b, Item 15 
(permitting a broker-dealer to include a debit in the security-based 
swap reserve formula equal to the margin required and on deposit in 
a qualified clearing agency account at a clearing agency). See also 
84 FR at 43938-42, supra note 99.
---------------------------------------------------------------------------

     Used exclusively to clear, settle, novate, and margin U.S. 
Treasury securities transactions of the customers of the broker or 
dealer;
     Designated ``Special Clearing Account for the Exclusive 
Benefit of the Customers of [name of broker-dealer]'';
     Subject to a written notice of the U.S. Treasury 
securities CCA provided to and retained by the broker-dealer that the 
cash and U.S. Treasury securities in the account are being held by the 
U.S. Treasury securities CCA for the exclusive benefit of the customers 
of the broker-dealer in accordance with the regulations of the 
Commission and are being kept separate from any other accounts 
maintained by the broker-dealer or any other clearing member at the 
U.S. Treasury securities CCA; and
     Subject to a written contract between the broker-dealer 
and the U.S. Treasury securities CCA which provides that the cash and 
U.S. Treasury securities in the account are not available to cover 
claims arising from the broker-dealer or any other clearing member 
defaulting on an obligation to the U.S. Treasury securities CCA or 
subject to any other right, charge, security interest, lien, or claim 
of any kind in favor of the U.S. Treasury securities CCA or any person 
claiming through the U.S. Treasury securities CCA, except a right, 
charge, security interest, lien, or claim resulting from a cleared U.S. 
Treasury transaction of a customer of the broker-dealer effected in the 
account.
    The objective is to protect the customer position margin that the 
broker-dealer deposits with the U.S. Treasury securities CCA to margin 
its customers' U.S. Treasury security positions by isolating it from 
any other assets of the broker-dealer at the U.S. Treasury securities 
CCA and to prevent it from being used to cover any obligation other 
than an obligation of the broker-dealer's customer resulting from a 
U.S. Treasury transaction cleared, settled, and novated in the account. 
Further, the account designation and written notice requirements are 
designed to alert creditors of the broker-dealer and U.S. Treasury 
securities CCA that the assets in this account are not available to 
satisfy any claims they may have against the broker-dealer or the U.S. 
Treasury securities CCA. The written contract requirement is designed 
to limit the U.S. Treasury securities CCA's rights to use the customer 
position margin for any purpose other than an obligation of the broker-
dealer's customers. For example, the assets in the account could not be 
used to cover an obligation of the broker-dealer to the U.S. Treasury 
securities CCA if the broker-dealer defaults on the obligation. 
Similarly, the assets in the account could not be used to mutualize the 
loss across the U.S. Treasury securities CCA's members if a member 
defaulted and its clearing funds were insufficient to cover the loss.

[[Page 64640]]

    Proposed Note H(b)(2)(iv) to Item 15 would provide that the 
customer position margin is treated in accordance with rules designed 
to address how the U.S. Treasury securities CCA holds the customer 
position margin. Similar to proposed Note H(b)(2)(iii) to Item 15, the 
objective would be to isolate the customer position margin and prevent 
it from being used to satisfy the claims any creditors may have against 
the U.S. Treasury securities CCA. In particular, the note would provide 
that the customer position margin is treated in accordance with rules 
of the U.S. Treasury securities CCA requiring that the U.S. Treasury 
securities CCA hold the customer position margin itself or at either a 
U.S. Federal Reserve Bank or a ``bank'' (as defined in section 3(a)(6) 
of the Exchange Act (15 U.S.C. 78c(a)(6)) that is insured by the 
Federal Deposit Insurance Corporation. The objective is to have the 
U.S. Treasury securities CCA hold the customer position margin at a 
safe financial institution. In addition, the rules would need to 
provide that the U.S. Treasury securities CCA's account at the U.S. 
Federal Reserve Bank or bank be:
     Segregated from any other account of the U.S. Treasury 
securities CCA or any other person at the U.S. Federal Reserve Bank or 
bank and used exclusively to hold cash and U.S. Treasury securities to 
meet current margin requirements of the U.S. Treasury securities CCA 
resulting from positions in U.S. Treasury securities of the customers 
of the broker-dealer members of the qualified U.S. Treasury securities 
CCA;
     Subject to a written notice of the U.S. Federal Reserve 
Bank or bank provided to and retained by the U.S. Treasury securities 
CCA that the cash and U.S. Treasury securities in the account are being 
held by the U.S. Federal Reserve Bank or bank pursuant to Rule 15c3-3 
and are being kept separate from any other accounts maintained by the 
U.S. Treasury securities CCA or any other person at the U.S. Federal 
Reserve Bank or bank; and
     Subject to a written contract between the U.S. Treasury 
securities CCA and the U.S. Federal Reserve Bank or bank which provides 
that the cash and U.S. Treasury securities in the account are subject 
to no right, charge, security interest, lien, or claim of any kind in 
favor of the U.S. Federal Reserve Bank or bank or any person claiming 
through the U.S. Federal Reserve Bank or bank.
    These conditions with respect to the account designation, written 
notice, and written contract would be designed to achieve the same 
objectives as the analogous conditions discussed above with respect to 
the broker-dealer's account at the U.S. Treasury securities CCA.\235\
---------------------------------------------------------------------------

    \235\ See, e.g., 17 CFR 240.15c3-3a, Note G(b)(2) to Item 14 
(setting forth similar requirements when a securities futures 
clearing agency holds customer margin at a bank).
---------------------------------------------------------------------------

    Proposed Note H(b)(2)(v) to Item 15 would provide that the customer 
position margin is treated in accordance with rules of the clearing 
agency requiring systems, controls, policies, and procedures to return 
customer position margin to the broker-dealer that is no longer needed 
to meet a current margin requirement resulting from positions in U.S. 
Treasury securities of the customers of the broker-dealer no later than 
the close of the next business day after the day the customer position 
margin is no longer needed for this purpose. As discussed above, the 
debit would be limited to customer position margin required and on 
deposit at the U.S. Treasury securities CCA. This would mean that the 
broker-dealer could not include in this debit item the amount of 
customer position margin on deposit at the U.S. Treasury securities CCA 
that exceeds the broker-dealer's margin requirement resulting from its 
customers' cleared U.S. Treasury securities positions. The objective of 
this condition is to effectuate the prompt return of customer position 
margin to the broker-dealer.
    Proposed Note H(b)(3) to Item 15 would set forth the third 
condition for including customer position margin as a debit in the Rule 
15c3-3a formula. Under this condition, the Commission would need to 
have approved rules of the U.S. Treasury securities CCA that meet the 
conditions of proposed Note H and the Commission would had to have 
published (and not subsequently withdrawn) a notice that brokers-
dealers may include a debit in the customer reserve formula when 
depositing customer position margin to meet a margin requirement of the 
U.S. Treasury securities CCA resulting from positions in U.S. Treasury 
securities of the customers of the broker-dealer. The Commission staff 
would analyze the U.S. Treasury securities CCA's approved rules and 
practices regarding the treatment of customer position margin and make 
a recommendation as to whether they adequately implement the customer 
protection objectives of the conditions set forth in proposed Note H to 
Item 15. If satisfied with the staff's recommendation, the Commission 
would publish a positive notice. The objective is to permit the debit 
only after the Commission has approved the U.S. Treasury securities 
CCA's rules pursuant to section 19(b) of the Exchange and published the 
notice.\236\ Any changes to those rules and practices that would 
undermine these customer protection objectives could result in the 
Commission withdrawing the notice, at which point the Commission would 
no longer permit the debit.
---------------------------------------------------------------------------

    \236\ See 15 U.S.C. 78s.
---------------------------------------------------------------------------

    Finally, broker-dealers are required to perform a separate reserve 
computation for their broker-dealer customers and maintain a separate 
reserve account with respect to that computation.\237\ The Rule 15c3-3a 
computation provides that this separate PAB reserve computation must be 
performed in accordance with the Rule 15c3-3a computation for the 
broker-dealer's non-PAB customers, except as provided in Notes to the 
PAB Computation.\238\ Therefore, the proposed amendments discussed 
above adding a new debit in Item 15 would apply to the PAB reserve 
computation. Further, the Commission is proposing to amend Note 9 
Regarding the PAB Reserve Bank Account Computation--which permits a 
debit in the PAB reserve computation for clearing deposits required to 
be maintained at registered clearing agencies--to clarify that the 
conditions set forth in new Note H with respect to including a debit in 
the non-PAB customer reserve computation would apply to the PAB reserve 
computation as well.
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    \237\ See 17 CFR 240.15c3-3(a)(16) (defining the term ``PAB 
account'' to mean a proprietary securities account of a broker-
dealer (which includes a foreign broker-dealer, or a foreign bank 
acting as a broker-dealer) other than a delivery-versus-payment 
account or a receipt-versus-payment account); 17 CFR 240.15c3-3(e) 
(requiring separate reserve accounts and reserve account 
computations for PAB accounts).
    \238\ See 17 CFR 240.15c3-3a, Notes 1 through 10 Regarding the 
PAB Reserve Bank Account Computation.
---------------------------------------------------------------------------

2. Request for Comment
    The Commission generally requests comments on all aspects of the 
proposed amendment to Rule 15c3-3a. In addition, the Commission 
requests comments on the following specific issues, with accompanying 
data and analysis:
     Do commenters agree or disagree with any particular 
aspects of the proposed amendment to Rule 15c3-3? If so, which ones and 
why? If commenters disagree with any provision of the proposed rule 
amendment, how should such provision be modified and why?
     Rule 15c3-3 defines the term ``excess margin securities'' 
to mean those securities referred to in paragraph

[[Page 64641]]

(a)(4) of Rule 15c3-3 carried for the account of a customer having a 
market value in excess of 140 percent of the total of the debit 
balances in the customer's account or accounts encompassed by paragraph 
(a)(4) of Rule 15c3-3 which the broker-dealer identifies as not 
constituting margin securities. With respect to cleared, settled, and 
novated repurchase and reverse purchase agreements in U.S. Treasury 
securities, how should this 140 percent test be applied?
     In terms of protecting customer position margin held at 
the U.S. Treasury securities CCA, should the Commission adopt other 
clearing models? For example, should the Commission adopt an approach 
similar to how margin for swaps cleared at a U.S. derivatives clearing 
organization is treated? If so, explain how such a model would work in 
a liquidation of the broker-dealer under SIPA.
     Are there any legal or operational issues that particular 
participants may face as a result of customer position margin held by a 
U.S. Treasury securities CCA? Do commenters believe there may be the 
need for other regulatory relief or guidance by the Commission or other 
regulators to facilitate the holding of such customer margin? Are there 
any particular entities that should be exempted from the margin 
requirements due to particular legal, operational or other issues?
     Should the Commission adopt further measures to protect 
the customer cash and U.S. Treasury securities that are used to meet 
the customer position margin requirements of the U.S. Treasury 
securities CCA? For example, should the Commission adopt measures to 
protect the cash and U.S. Treasury securities in the event of an 
insolvency of the U.S. Treasury securities CCA? In this regard, should 
the Commission require that the cash and U.S. Treasury securities be 
held at a third-party bank in an account that is subject to an 
agreement between the U.S. Treasury securities CCA, the broker-dealer, 
and the bank that the assets in the account may only be accessed by the 
U.S. Treasury securities CCA to cover a loss resulting from a customer 
of the broker-dealer failing to meet an obligation to the U.S. Treasury 
securities CCA? Would this approach be workable or practical? Please 
explain.

D. Compliance Date

    The Commission understands that an existing U.S. Treasury 
securities CCA likely would need time and resources to develop and 
adopt policies and procedures to implement the standards set forth in 
this proposal, if adopted, for its business. In addition, as noted 
above, any changes to a U.S. Treasury securities CCA's rules would 
require that the CCA file proposed rule changes under section 19(b) of 
the Exchange Act and/or section 806 of the Dodd-Frank Act, as 
applicable, for the Commission to review and consider such changes for 
consistency with the applicable standards. More generally, the 
Commission recognizes that the changes set forth in this proposal, if 
adopted, including the likely substantial amount of additional 
transactions to be submitted for central clearing that are not 
currently submitted in large volumes (such as the dealer-to-customer 
market) would represent a significant change in current industry 
practice that may take time for market participants to navigate.
    The Commission is not proposing a specific compliance date at this 
time, but instead seeks comment regarding what would be an appropriate 
timeframe.
    The Commission generally solicits comment on what an appropriate 
compliance date would be for each of the proposed rule amendments (Rule 
17Ad-22(e)(18), Rule 17Ad-22(e)(6)) if adopted. In addition, the 
Commission requests comments on the following specific issues, with 
accompanying data and analysis:
     How long would U.S. Treasury securities CCAs and market 
participants need to implement the proposal if it is adopted 
substantially as proposed? What data points would U.S. Treasury 
securities CCAs and market participants use to assess the timing? Are 
any specific operational or technological issues raised that should be 
factored into a proposed compliance date?
     Would staggering the compliance dates for the different 
rule amendments proposed help facilitate an orderly implementation of 
the proposal, if adopted? For example, would it be appropriate for the 
compliance date for paragraphs (ii)(A) and (B) in the definition of an 
``eligible secondary market transaction'' to be before the compliance 
date for paragraphs (ii)(C) and (D) of the same definition, and if so, 
how much before? More generally, if staggering is appropriate, what 
would be an appropriate schedule of compliance dates?

IV. Economic Analysis

    The Commission is mindful of the economic effects that may result 
from the proposed amendments, including the benefits, costs, and the 
effects on efficiency, competition, and capital formation. Exchange Act 
section 3(f) requires the Commission, when it is engaged in rulemaking 
pursuant to the Exchange Act and is required to consider or determine 
whether an action is necessary or appropriate in the public interest, 
to consider, in addition to the protection of investors, whether the 
action will promote efficiency, competition, and capital 
formation.\239\ In addition, Exchange Act section 23(a)(2) requires the 
Commission, when making rules pursuant to the Exchange Act, to consider 
among other matters the impact that any such rule would have on 
competition and not to adopt any rule that would impose a burden on 
competition that is not necessary or appropriate in furtherance of the 
purposes of the Exchange Act.\240\ This section analyzes the expected 
economic effects of the proposed rules relative to the current 
baseline, which consists of the current market and regulatory framework 
in existence today.
---------------------------------------------------------------------------

    \239\ See 15 U.S.C. 78c(f).
    \240\ See 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------

    In this proposal, the Commission is proposing additional 
requirements for any U.S. Treasury securities CCA.\241\ First, the 
proposal would require that such CCAs establish written policies and 
procedures reasonably designed to, as applicable, establish objective, 
risk-based, and publicly disclosed criteria for participation, which 
require that the direct participants of such CCA submit for clearance 
and settlement all eligible secondary market transactions to which they 
are a counterparty (``Membership Proposal'').\242\ In addition, the 
proposal would require that such CCAs establish written policies and 
procedures reasonably designed to, as applicable, identify and monitor 
its direct participants' required submission of transactions for 
clearing, including, at a minimum, address a failure to submit 
transactions. The Commission believes that strengthening the membership 
standards will help reduce contagion risk to U.S. Treasury securities 
CCAs and bring the benefits of central clearing to more transactions 
involving U.S. Treasury securities, thereby lowering the risk of 
disruptions to the U.S. Treasury securities market.\243\
---------------------------------------------------------------------------

    \241\ See supra section III.A.
    \242\ See supra section III.A for a description of the 
Membership Proposal including the definition of ``eligible secondary 
market transaction.''
    \243\ See infra section IV.B.6.
---------------------------------------------------------------------------

    Second, the Commission is proposing additional requirements on how 
U.S. Treasury securities CCAs calculate, collect, and hold margin 
posted on behalf of indirect participants (i.e., customers) who rely on 
the services of a direct participant (i.e., the member of the U.S. 
Treasury securities CCA) to

[[Page 64642]]

access the CCA's services.\244\ As discussed in more detail below, the 
Commission believes that such requirements also will improve the risk 
management practices at U.S. Treasury securities CCAs and incentivize 
and facilitate additional central clearing in the U.S. Treasury 
securities market.
---------------------------------------------------------------------------

    \244\ See supra section III.B.1.
---------------------------------------------------------------------------

    Third, the Commission is proposing requirements that a U.S. 
Treasury securities CCA establish, implement, maintain and enforce 
written policies and procedures reasonably designed to, as applicable, 
ensure that it has appropriate means to facilitate access to clearance 
and settlement services of all eligible secondary market transactions 
in U.S. Treasury securities, including those of indirect participants 
and that the board of directors reviews these policies and procedures 
annually.\245\ Although the proposed requirements would not prescribe 
specific methods for market participants to obtain indirect access to a 
U.S. Treasury securities CCA, it is intended to help ensure that all 
U.S. Treasury security CCAs review their indirect access models and 
ensure that they facilitate access to clearance and settlement services 
in a manner suited to the needs and regulatory requirements of market 
participants throughout the U.S. Treasury securities market, including 
indirect participants.
---------------------------------------------------------------------------

    \245\ See supra section III.B.2.
---------------------------------------------------------------------------

    Lastly, the Commission is proposing to amend its rules to permit 
margin required and on deposit at a U.S. Treasury securities CCA to be 
included as a debit item in the customer reserve formula, subject to 
certain conditions.\246\ As discussed further below, the Commission 
believes that this proposal, in conjunction with the proposal requiring 
the separation of house and customer margin, will incentivize and 
facilitate additional central clearing in the U.S. Treasury securities 
market.
---------------------------------------------------------------------------

    \246\ See supra section III.C.
---------------------------------------------------------------------------

    The discussion of the economic effects of the proposed rule begins 
with a discussion of the risks inherent in the clearance and settlement 
process and how the use of a CCP can mitigate those risks. This is 
followed by a baseline of current U.S. Treasury securities market 
practices. The economic analysis then discusses the likely economic 
effects of the proposal, as well as its effects on efficiency, 
competition, and capital formation. The Commission has, where 
practicable, attempted to quantify the economic effects expected to 
result from this proposal. In some cases, however, data needed to 
quantify these economic effects is not currently available or otherwise 
publicly available. For example, the reporting of data for bilaterally-
cleared repo transactions is currently not a regulatory requirement, so 
counterparty-specific statistics are not available and any aggregate 
statistics on this market segment may not be comprehensive.\247\ 
Likewise, the reporting of U.S. Treasury securities transactions to 
FINRA TRACE has been until recently \248\ limited to cash transactions 
in which at least one of the counterparties is a FINRA member, so 
analyses based on that data will necessarily be incomplete.
---------------------------------------------------------------------------

    \247\ Samuel J. Hempel, R. Jay Kahn, Vy Nguyen, & Sharon Y. 
Ross, Non-centrally Cleared Bilateral Repo (Aug 24, 2022), available 
at: https://www.financialresearch.gov/the-ofr-blog/2022/08/24/non-centrally-cleared-bilateral-repo/.
    \248\ Reporting of additional cash transactions to TRACE, by 
certain U.S. and foreign banks, began on September 1, 2022 but the 
recent nature of that change precludes the Commission from doing any 
analysis on that new reporting universe. See generally Federal 
Reserve System, Agency Information Collection Activities: 
Announcement of Board Approval Under Delegated Authority and 
Submission to OMB, 86 FR 59716 (Oct. 28, 2021), available at https://www.govinfo.gov/content/pkg/FR-2021-10-28/pdf/2021-23432.pdf; see 
also Supporting Statement for the Treasury Securities and Agency 
Debt and Mortgage-Backed Securities Reporting Requirements, 
available at https://www.federalreserve.gov/reportforms/formsreview/FR%202956%20OMB%20SS.pdf.
---------------------------------------------------------------------------

    In many cases, and as noted below, the Commission is unable to 
quantify these economic effects and solicits comment, including 
estimates and data from interested parties, that could help inform the 
estimates of the economic effects of the proposal.

A. Broad Economic Considerations

    Clearance and settlement risk is the risk that a counterparty fails 
to deliver a security or cash as agreed upon at the time when the 
security was traded. One method of reducing such risk is to require one 
or both counterparties to the trade to post collateral.\249\ The 
purpose of posting collateral in financial transactions is to alleviate 
frictions caused by adverse selection and moral hazard.\250\ The amount 
of collateral needed to support a set of unsettled trades, however, can 
depend on whether trades are cleared bilaterally or through a CCP. In 
particular, in cases where market participants have several outstanding 
buy and sell orders, central clearing reduces the total collateral 
required to support a given set of trades due to multilateral 
netting.\251\ A simple example illustrates the effect. Suppose there 
are 3 firms trying to complete three bilateral trades among themselves. 
Firm A is buying $90 million in U.S. Treasury securities from Firm B, 
Firm B is buying $80 million in the same U.S. Treasury securities from 
Firm C, and Firm C is buying $100 million in the same U.S. Treasury 
securities from Firm A. This would mean that over the settlement cycle, 
the firms in this example would need to post collateral to cover a 
total of $270 million in gross obligations to complete these three 
trades. If these trades were centrally cleared, however, then the net 
obligations would be substantially smaller. In this example, the 
collateral required would no longer be that required to support $270 
million in outstanding obligations, but instead would reduce to $40 
million: $20 million for Firm C, and $10 million each for Firms A and 
B.\252\ Central clearing can, in part, replace a trading network made 
up of a web of bilateral relationships with a simpler hub and spoke 
model. As each connection is a potential source of failure, a simpler 
system can imply less risk.
---------------------------------------------------------------------------

    \249\ An alternative method of reducing counterparty credit risk 
used in the securities industry is delivery versus payment 
(``DVP''). Under DVP, counterparties aim to deliver securities and 
payment simultaneously, so that the transfer of securities happens 
if and only if payment has also been made.
    \250\ For example, if the fulfillment of a contract depends on a 
counterparty exerting unobservable and costly effort, collateral can 
be used as a commitment device by putting more of the counterparty's 
resources at stake in the case of nonfulfillment. See Bengt 
Holmstrom & Jean Tirole, Financial Intermediation, Loanable Funds, 
and the Real Sector, 112 Q. J. Econ. 663 (Aug. 1997); Albert J. 
Menkveld & Guillaume Vuillemey, The Economics of Central Clearing, 
13 Ann. Rev. Fin. Econ. 153, 158 (2021).
    \251\ Darrell Duffie & Haoxiang Zhu, Does a Central Clearing 
Counterparty Reduce Counterparty Risk? 1 Rev. Asset Pricing Stud. 74 
(2011), available at https://academic.oup.com/raps/article-abstract/1/1/74/1528254. The authors note that this benefit scales with the 
square root of the number of participants when the trading positions 
are statistically independent and identically distributed.
    \252\ This example is from Duffie, supra note 186.
---------------------------------------------------------------------------

    Clearance and settlement through a CCP can also make trades less 
``informationally sensitive'' in the sense that the value of the trade 
does not depend on information about the creditworthiness of the 
counterparties, thereby reducing adverse selection.\253\ This occurs 
when the trade is novated to the CCP, and the CCP becomes the buyer to 
every seller and the seller to every buyer. This reduces the need for 
investors to acquire private information

[[Page 64643]]

about the credit risk of their counterparty. By mitigating adverse 
selection through the substitution of the CCP's counterparty credit 
risk evaluation for a market participant's own, central clearing 
through a CCP lowers the cost of trading by market participants and 
should increase their willingness to trade, thereby improving market 
liquidity. Reducing the information sensitivity of trades also 
increases the uniformity of the asset that is traded. In the absence of 
novation, the U.S. Treasury security is essentially bundled together 
with counterparty risk. That is, when buying or selling a security, if 
there is counterparty risk, the pricing depends not only on the 
security itself but also on the reliability of the counterparty to the 
trade. It is as if, from an economic perspective, one is ``buying'' 
both the security and the characteristics of the counterparty. Besides 
the reduction in adverse selection, eliminating counterparty risk makes 
the security a more standard product. Standardization itself increases 
liquidity.\254\
---------------------------------------------------------------------------

    \253\ See Gary Gorton & George Pennacchi, Financial 
Intermediaries and Liquidity Creation, 45 J. Fin. 49 (1990), 
available at https://www.jstor.org/stable/2328809. See also 
Francesca Carapella & David Mills, Information Insensitive 
Securities: the Benefits of Central Counterparties, Working Paper 
(2012), available at https://www.newyorkfed.org/medialibrary/media/research/conference/2012/MP_Workshop/Carapella_Mills_information_insensitive_securities.pdf.
    \254\ See Ben Bernanke, Clearing and Settlement During the 
Crash, 3 Rev. Fin. Stud. 133 (1990), available at https://www.bu.edu/econ/files/2012/01/Bernanke-RFS.pdf.
---------------------------------------------------------------------------

    Financial networks that incorporate a CCP can further improve the 
resilience of financial markets. The Bank for International Settlements 
stated in 2015 that the shift to central clearing had helped to 
mitigate the risks that emerged in non-centrally cleared markets before 
and during the 2007-2009 financial crisis. Further, it had reduced 
financial institutions' exposure to counterparty credit risk shocks 
through netting, margining and collateralization.\255\
---------------------------------------------------------------------------

    \255\ Dietrich Domanski, Leonardo Gambacorta, & Cristina 
Picillo, Central Clearing: Trends and Current Issues, BIS Q. Rev. 
(Dec. 2015), available at https://www.bis.org/publ/qtrpdf/r_qt1512g.pdf.
---------------------------------------------------------------------------

    Another potential benefit of central clearing is that it should 
reduce the magnitude of, or even prevent, fire sales of assets. This 
mitigation of fire sale risk is achieved when a member defaults and the 
CCP manages the liquidation of assets. Central management of the 
liquidation of assets may mitigate suboptimal outcomes in the face of 
capital or margin constraints. For example, if investors believe that 
the counterparty will sell in the case of a missed margin call, other 
investors may join the selloff, leading to further declines in asset 
prices. If participants can commit to not sell, then a more efficient 
equilibrium in which there is no fire sale could be achieved. In this 
way, the CCP acts as a way to select into the more efficient 
equilibrium by allow members to credibly pre-commit to the auction in 
the case of a missed margin call.\256\
---------------------------------------------------------------------------

    \256\ John Kuong, Self-fulfilling Fire Sales: Fragility of 
Collateralized Short-term Debt Markets, 34(6) Review of Financial 
Studies, 2910-2948 (2021), available at https://academic.oup.com/rfs/article/34/6/2910/5918033?login=true.
---------------------------------------------------------------------------

    Finally, broadening central clearing could lead to a wider group of 
liquidity providers, which likely would increase the reliability of 
access to funding during periods of market stress.\257\ The reason is 
that novation of the trade to a central counterparty reduces one of the 
major reasons for not choosing a counterparty: the risk that 
counterparty may fail to deliver on its obligations. It also reduces 
one of the reasons for failing to provide liquidity, namely concerns 
over the credit risk of counterparties. Therefore, as a result of 
increased levels of central clearing and the resulting increased 
centralization of counterparty credit risk evaluation by a CCP and the 
CCP's application of consistent and transparent risk management,\258\ 
more counterparties --who would also be potential liquidity providers--
would be willing to compete to provide liquidity to buy-side investors 
and to each other. In addition, several academic studies of the 2008 
financial crisis emphasize the role of intermediary balance sheet 
constraints as a cause of financial crises.259 260 Moreover, 
losses experienced by market participants can lead to an increase in 
risk aversion leading those market participants to exit creating a need 
for new market participants to replace them in order to provide 
liquidity.\261\ Therefore, either because of increased risk aversion or 
because some friction implies that the liquidity providers who find 
themselves warehousing the asset can no longer do so due to trading 
losses, outside liquidity providers may play an important role in 
stabilizing the market. In addition, central clearing facilitates 
anonymized all-to-all trading that would enable the provision of market 
liquidity by investors.\262 263\
---------------------------------------------------------------------------

    \257\ G-30 Report, supra note 5, at 13.
    \258\ See TMPG White Paper, supra note 20, (``[b]ilateral 
clearing involves varying risk management practices that are less 
uniform and less transparent to the broader market . . .''). In 
addition, FICC has been designated by FSOC as a systemically 
important financial market utility, which brings heightened risk 
management requirements and additional regulatory supervision by 
both its primary regulator and the Board of Governors of the Federal 
Reserve System. See supra note 17 and associated text.
    \259\ See, e.g., Markus K. Brunnermeier & Yuliy Sannikov, A 
Macroeconomic Model with a Financial Sector, 104 Am. Econ. Rev. 379 
(Feb. 2014), available at https://www.aeaweb.org/articles?id=10.1257/aer.104.2.379; See also Zhiguo He & Arvind 
Krishnamurthy, Intermediary Asset Pricing, 103 Am. Eco. Rev. 732 
(Apr. 2013), available at https://www.aeaweb.org/articles?id=10.1257/aer.103.2.732.
    \260\ Balance sheet constraints and the impact of losses on risk 
aversion both apply to liquidity providers, or rather the ability 
and willingness of market participants to provide liquidity. This 
does not apply to the CCP as it does not supply liquidity.
    \261\ See, e.g., John Y. Campbell & John H. Cochrane, By Force 
of Habit: A Consumption-Based Explanation of Aggregate Stock Market 
Behavior, 107 J. Pol. Econ. 205 (Apr. 1999), available at https://www.journals.uchicago.edu/doi/abs/10.1086/250059.
    \262\ G-30 Report, supra note 5, at 13. See also Duffie, supra 
note 186, at 4 (``Further, given broad access to a CCP, some 
Treasury transactions could flow directly from ultimate sellers to 
ultimate buyers without necessarily impinging on dealer balance 
sheet space.'').
    \263\ The market responded to the stress of 2020 through some 
increase in all-to-all trading. See MarketAxess, FIMSAC Slides, at 6 
(Oct. 5, 2020), available at https://www.sec.gov/spotlight/fixed-income-advisory-committee/mcvey-fimsac-slides-100120.pdf. Additional 
central clearing may have enabled a greater increase.
---------------------------------------------------------------------------

B. Baseline

1. U.S. Treasury Securities
    As discussed in section II.A, U.S. Treasury securities are direct 
obligations of the U.S. Government issued by the U.S. Department of the 
Treasury. After issuance in the primary market U.S. Treasury securities 
trade in an active secondary market.\264\ A number of types of market 
participants intermediate between end users of U.S. Treasury 
securities. These end users may hold U.S. Treasury securities as a 
relatively riskless way of saving, as a way of placing a directional 
bet on interest rates, or as a means of hedging against deflation. U.S. 
Treasury securities can also function directly as a medium of exchange 
in some instances, and, as described in more detail below, as 
collateral for loans.
---------------------------------------------------------------------------

    \264\ There is also an active market for U.S. Treasury 
securities that trade on a ``when-issued'' (WI) basis. ``Based on 
Treasury TRACE transactions data, WI trading volume averaged $80 
billion per day between July 1, 2019, and June 30, 2020, accounting 
for 12 percent of the $651 billion traded daily across all Treasury 
securities.'' Fleming, Shachar, and Van Tassel, supra note 38. As 
discussed in section III.A.2, supra, for purposes of this Proposal 
only the WI market after the auction but before issuance (WI on-the-
run issues) is considered part of the secondary market for U.S. 
Treasury securities. Most of the WI trading in the Fleming, Shachar, 
and Van Tassel analysis occurred in on-the-run issues. Id. (``WI 
trading that occurs up to and including the auction day (account[s] 
for about one-third of WI trading) and WI trading that occurs after 
the auction day (account[s] for about two-thirds of WI trading''). 
For a discussion of how WI trading functions in the context of 
central clearing, see Kenneth D. Garbade & Jeffrey F. Ingber, The 
Treasury Auction Process: Objectives, Structure, and Recent 
Adaptations, 11 Current Issues in Economics and Finance 1 (2005), 
available at https://www.newyorkfed.org/medialibrary/media/research/current_issues/ci11-2.html.
---------------------------------------------------------------------------

    Market participants refer to the most recently issued U.S. Treasury 
securities as ``on-the-run,'' with earlier issues

[[Page 64644]]

referred to as ``off-the-run''.\265\ Figure 1 shows the outstanding 
value of on-the-run (Panel A) and off-the-run (Panel B) U.S. Treasury 
securities. On-the-run U.S. Treasury securities have consistently made 
up approximately 3% of the total value of all marketable U.S. Treasury 
securities during the 2012-2021 period, but, as Figure 3 shows, account 
for a disproportionate share of trading volume. Thus, an on-the-run 
security is generally far more liquid than a similar off-the-run 
security.
---------------------------------------------------------------------------

    \265\ See supra note 34.

Figure 1: On-the-run and off-the-run U.S. Treasury securities 
(trillions) \a\
[GRAPHIC] [TIFF OMITTED] TP25OC22.000

    \a\ Generated from the Federal Reserve Z1 Financial Accounts of 
the United States Table L.210 Treasury Securities, Series 
FL313161205.Q.

    As of June 30, 2022, the total amount outstanding of marketable 
U.S. Treasury securities held by the public was $23.3 trillion.\266\ As 
shown in Figure 2, the volume of marketable U.S. Treasury securities 
outstanding has increased by approximately $18 trillion since 2000. The 
total amount of marketable U.S. Treasury securities issued during 2021 
was $20.3 trillion.\267\
---------------------------------------------------------------------------

    \266\ This includes $3.5T in bills, $13.6T in notes, $3.8T in 
bonds, 1.8T in TIPs, and 0.6T in floating rate notes. See U.S. 
Treasury Bureau of the Fiscal Service, Summary of Treasury 
Securities Outstanding, available at https://fiscaldata.treasury.gov/datasets/monthly-statement-public-debt/summary-of-treasury-securities-outstanding.
    \267\ See U.S. Treasury Bureau of the Fiscal Service, Treasury 
Debt Position and Activity Report, June 2022, available at https://www.treasurydirect.gov/govt/reports/pd/pd_debtposactrpt_202206.pdf.

Figure 2: Value of Marketable U.S. Treasury Securities Outstanding Over 
Time \a\
[GRAPHIC] [TIFF OMITTED] TP25OC22.001

    \a\ Generated from the Federal Reserve Z1 Financial Accounts of 
the United States Table L.210 Treasury Securities, Series 
FL313161205.Q.

    Trading in the secondary market is reported in Figure 3. According 
to industry reports, 65% of the $955.2 billion in average daily trading 
volume of U.S. fixed income securities in 2021 was in U.S. Treasury 
securities.\268\ As is shown in Figure 3, average weekly trading volume 
was approximately $3 trillion in 2021, with notable peaks in March 2020 
and early 2021.\269\
---------------------------------------------------------------------------

    \268\ Another 29 percent was Agency MBS, 4 percent corporate 
debt, with the remainder in municipal, non-agency mortgage-backed, 
Federal agency debt and asset-backed securities. See Securities 
Industry and Financial Markets Association (``SIFMA''), US Fixed 
Income Securities: Issuance, Trading Volume, Outstanding, available 
at https://www.sifma.org/resources/research/us-fixed-income-securities-statistics/us-fixed-income-securities-statistics-sifma/
(as of July 8, 2022) (data sourced from N.Y. Fed, FINRA TRACE, and 
MSRB).
    \269\ Id.

Figure 3: Weekly trading volume in U.S. Treasury securities cash market 
\a\

[[Page 64645]]

[GRAPHIC] [TIFF OMITTED] TP25OC22.002

    \a\ See IAWG Report, supra note 4, at 14.
2. U.S. Treasury Repurchase Transactions
    As described in section II.A.2 supra, a U.S. Treasury repurchase 
transaction generally refers to a transaction in which one market 
participant sells a U.S. Treasury security to another market 
participant, along with a commitment to repurchase the security at a 
specified price on a specified later date. Because one side of the 
transaction receives cash, and the other side receives securities, to 
be returned at a later date, the transaction is a close equivalent to a 
cash loan with securities as collateral. The amount paid for the 
security serving as collateral may be less than the market price. The 
difference divided by the market value of the collateral is known as 
the ``haircut.'' A positive haircut implies that the loan is over-
collateralized: the collateral is worth more than the cash that is 
loaned. A related term is ``initial margin''--the ratio of the purchase 
price to the market value of the collateral.
    General collateral repurchases are an important variation on the 
above type of transaction, where one participant lends to another 
against a class, not a specific issue, of U.S. Treasury securities. 
U.S. Treasury repo for a specific asset is generally a bilateral 
arrangement, whereas general collateral repurchases are usually 
arranged with a third agent, known as a triparty agent. In bilateral 
repo arrangements, the lender has the title of the specific asset in 
question, and can sell or re-hypothecate it. In triparty repo, which is 
discussed below, the lender has a more limited use of collateral. 
However, it is often re-hypothecated within the same triparty system; 
namely, a lender may use the collateral from the borrower for its own 
borrowing.
    As described in section II.A.2 supra, repurchase agreements are 
generally classified by the term over which they take place, either 
``overnight'' or ``term.'' In overnight repurchase agreements, the 
repurchase of the security takes place the day after the initial 
purchase, meaning that these agreements serve, essentially, as 
overnight loans collateralized by U.S. Treasury securities. Term 
repurchase agreements, conversely, take place over a longer 
horizon.\270\
---------------------------------------------------------------------------

    \270\ Overnight repurchase agreements account for 87.5% of daily 
transaction volume. See Figure 5 and the associated discussion for 
more details. In addition to term repos agreements with fixed 
maturity dates, there exist term repurchase agreements with embedded 
options that lead to an uncertain maturity date. For example, 
``callable'' repos include an option for the lender to call back 
debt (i.e., resell securities) at their discretion. ``Open'' repos 
have no defined term but rather allow either party to close out at 
the contract at any date after initiation of the agreement.
---------------------------------------------------------------------------

    U.S. Treasury repo has various economic uses. First, it is a means 
of secured borrowing and lending, allowing some market participants to, 
in effect, turn their U.S. Treasury securities into cash positions, and 
others to temporarily invest cash that is not in use in a way that 
mitigates exposure to, for example, the counterparty risk of a 
depository institution. Bilateral repo can allow market participants to 
effectively price interest rate expectations into bonds, and to 
arbitrage differences in the market prices of closely related U.S. 
Treasury securities, because it provides financing for U.S. Treasury 
security purchases and facilitates short sales.
    Repos also play a role in monetary policy. The Federal Reserve 
operates a reverse repurchase facility in which it receives cash from 
eligible market participants in exchange for collateral consisting of 
U.S. Treasury securities. The interest rate on these repurchase 
agreements is the overnight reverse repurchase offer rate set by the 
Federal Reserve to aid implementation of monetary policy by firming up 
the floor for the effective Federal funds rate.\271\
---------------------------------------------------------------------------

    \271\ See supra note 164.
---------------------------------------------------------------------------

    The market for repos is dominated by large sophisticated 
institutions. The institutions that participate in the market for repos 
are also those for whom access to central clearing may be the least 
costly economically. Relatedly, although difficult to quantify 
precisely, the number of participants is one or more orders of 
magnitude greater in the cash market as compared with the repo market: 
tens of thousands as opposed to hundreds. As Figure 4 shows, the U.S. 
Treasury securities repurchase market is large; throughout 2020 and 
into 2021, daily transaction volume ranged between $1.5 and $2.5 
trillion per day. Since April 2021, average daily volume has been 
considerably higher--approaching $4 trillion per day--coinciding with 
the growth in the Federal Reserve's overnight reverse repurchase 
operations. Figure 4 further splits these categories out into triparty 
repo and bilateral repo. Despite steadily increasing volumes of 
centrally cleared repurchase transactions, due in part to the 
development of services to enable acceptance of more types of 
repurchase transactions at the covered clearing agency, the Commission 
understands that the volume of bilateral repurchase transactions that 
are cleared and settled directly between the two counterparties remains 
substantial, representing

[[Page 64646]]

approximately half of all bilateral repurchase transactions in 
2021.\272\
---------------------------------------------------------------------------

    \272\ See supra note 150. See also R. Jay Kahn & Luke M. Olson, 
Who Participates in Cleared Repo? (July 8, 2021), available at 
https://www.financialresearch.gov/briefs/files/OFRBr_21-01_Repo.pdf.

Figure 4: Daily U.S. Treasury Repurchase Transaction Volume \a\
[GRAPHIC] [TIFF OMITTED] TP25OC22.003

    \a\ Figure 4 includes only centrally cleared bilateral 
repurchase as significant gaps persist in the coverage of 
transaction data in U.S. Treasury repo for non-centrally cleared 
bilateral repos. Source: Office of Financial Research Short-term 
Funding Monitor--Data Sets, U.S. Repo Markets Data Release, 
refreshed daily, available at https://www.financialresearch.gov/short-term-funding-monitor/datasets/repo/. See also IAWG Report, 
supra note 4, at 29.

    The triparty segment of the U.S. Treasury securities repurchase 
agreement market is large, with an average of approximately $500 
billion of daily trading volume in 2020, and has taken on a 
substantially larger role since the beginning of 2021, peaking at 
nearly $3 trillion in transaction volume in the beginning of 2022.\273\ 
Of this, overnight repos is the largest segment, making up 87.5% daily 
transaction volume, as shown in Figure 5. Although different types of 
securities can be used as collateral in triparty repos, over half 
(50.9%) of triparty repo collateral since 2015 are U.S. Treasury 
securities. That number has grown to 65.5 percent since 2021, as shown 
in Panel B of Figure 5.\274\ The remainder are agency securities, 
referring to mortgage-backed securities issued by U.S government 
agencies and government sponsored enterprises, and various other 
securities including corporate bonds, non-U.S. sovereign debt, equity, 
municipal debt, and commercial paper.\275\
---------------------------------------------------------------------------

    \273\ See Mark E. Paddrik, Carlos A. Ram[iacute]rez, & Matthew 
J. McCormick, FEDS Notes: The Dynamics of the U.S. Overnight 
Triparty Repo Market, (Aug. 2, 2021), available at https://www.federalreserve.gov/econres/notes/feds-notes/the-dynamics-of-the-us-overnight-triparty-repo-market-20210802.htm.
    \274\ See SIFMA Research, US Repo Fact Sheet, at 11 (Jan. 2021), 
available at https://www.sifma.org/wp-content/uploads/2020/04/2021-US-Repo-Fact-Sheet.pdf.
    \275\ Id.; see Paddrik et al., supra note 273.

Figure 5: Triparty Repurchase Agreement Trading Volume, Splits \a\
[GRAPHIC] [TIFF OMITTED] TP25OC22.004

    \a\ https://www.newyorkfed.org/data-and-statistics/data-visualization/tri-party-repo.
3. Central Clearing in the U.S. Treasury Securities Market
    Currently, FICC is the sole provider of clearance and settlement 
services for U.S. Treasury securities (see section I, supra). On July 
18, 2012, FSOC designated the FICC as a systemically important 
financial market utility under Title VIII of the U.S. Dodd-Frank Act. 
FSOC assigned this designation on the basis that a failure or a 
disruption to FICC could increase the risk of significant liquidity 
problems spreading among financial institutions or markets and thereby 
threaten the stability of the financial system in the United States.
    Direct membership in FICC generally consists of banks and 
registered dealers,

[[Page 64647]]

and such members must meet specified membership criteria.\276\ In other 
markets, not all active participants are direct members of the clearing 
agency. For this reason, it is likely that under the Membership 
Proposal, some will access clearing indirectly. At FICC, the indirect 
clearing models are its Sponsored Program and a prime broker/
correspondent clearing program.\277\ As of May 3, 2022, FICC has 202 
direct members.\278\
---------------------------------------------------------------------------

    \276\ The Commission believes that not all market participants 
likely would satisfy a covered clearing agency's stringent 
membership criteria. See 17 CFR 17Ad-22(e)(18); FICC Rule 2A, supra 
note 47. Even among those that do, legal operational or other 
considerations may preclude many market participants from becoming 
direct members of a CCP that clears and settles government 
securities transactions.
    \277\ See, e.g., FICC Rules, 8, 18, 3A (providing for prime 
brokerage and correspondent clearing, as well as sponsored 
membership), supra note 47.
    \278\ See FICC Member Directories, available at https://www.dtcc.com/client-center/ficc-gov-directories. (This includes all 
members who make use of Netting, Repurchase Netting, and/or GCF 
services.).
---------------------------------------------------------------------------

    From a direct participant's perspective, clearing a U.S. Treasury 
securities transaction at FICC between that participant and its non-
participant counterparty (i.e., a dealer-to-client trade) need not 
result in a separate collection of margin for the customer transaction. 
Transactions between direct participants are novated by FICC, and, by 
virtue of multilateral netting, all of a member's positions are netted 
into a single payment obligation--either to or from the CCP. In 
contrast, in a dealer-to-client trade, there is no transaction between 
two direct participants that FICC membership rules would require to be 
novated to the CCP, and as a result, FICC does not provide any guaranty 
of settlement or otherwise risk manage this trade.\279\ In other words, 
as one recent publication explained, ``if a dealer were to buy a 
security from its own customer and submit this transaction to FICC, 
there would be no effect on the dealer's net position at, obligations 
to, or guarantees from FICC.'' \280\ Indeed, except for its sponsored 
program, because FICC nets all trades at a dealer before calculating 
margin, as at present, customer trades with their own dealers generate 
no margin requirement and are not collateralized at the CCP.
---------------------------------------------------------------------------

    \279\ See Chicago Fed Insights, supra note 204, at 2 (explaining 
that this conclusion follows from that fact that ``FICC nets 
members' trades for their own accounts against trades by the 
members' customers, so the dealer's and customer's sides of the 
trade would cancel out in the netting process.'').
    \280\ Id.
---------------------------------------------------------------------------

    The most frequently used FICC model for accessing the clearing 
agency indirectly is the sponsored clearing model, which is generally 
used for repo but not for cash transactions. As of October 2021, there 
were 27 Sponsoring Members and roughly two thousand Sponsored Members 
from 20 approved jurisdictions, with daily volumes ranging from $225-
$280 billion (and peaking in March 2020 at $564 billion).\281\
---------------------------------------------------------------------------

    \281\ See DTCC May 2021 White Paper, supra note 135, at 6.
---------------------------------------------------------------------------

    Sponsored Members participating in FICC's Sponsored Service are 
indirect members of FICC, and upon novation of their U.S. Treasury 
transactions, FICC becomes obligated to such Sponsored Members.\282\ 
FICC requires that its Sponsoring Members provide margin on a gross 
basis for its Sponsored Member positions.\283\ In FICC's correspondent 
clearing and prime brokerage clearing models, which the Commission 
understands to be rarely used, the client does not have a legal 
relationship with FICC.\284\ FICC only has CCP obligation to the 
correspondent clearer or prime broker itself, as applicable, who is a 
FICC member. In light of this, FICC net margins the activity in the 
accounts of correspondent clearers and prime brokers.
---------------------------------------------------------------------------

    \282\ FICC-GSD Rule 3A sections 3 (membership) and 7 (novation), 
supra note 47.
    \283\ FICC Rule 3A, section 10(c), supra note 47. See also DTCC 
October 2021 White Paper, supra note 203, at 5-6.
    \284\ FICC Rule 8, supra note 47. See DTCC October 2021 White 
Paper, supra note 203, at 5, which reports that $80 billion plus of 
activity are observed clearing and settling daily through FICC's 
correspondent clearing and prime broker clearing models.
---------------------------------------------------------------------------

    Certain aspects of FICC's Sponsored Service are worth noting, as 
they may have an effect on some market participants' willingness to 
participate in the service. For example, once a trade is novated, FICC 
makes delivery of cash or securities to the Sponsoring Member as agent 
for the Sponsored Member.\285\ Therefore, market participants may 
consider the ability of their Sponsoring Member to make delivery to 
them in situations in which the Sponsoring Member is in default, when 
determining whether to use the Sponsored Service. In addition, if a 
Sponsoring Member defaults, FICC continues to guarantee any novated 
sponsored trades and may determine whether to close out a sponsored 
trade and/or to permit the Sponsored Member to settle the trade.\286\ 
This may lead a potential sponsored member to decline to enter a 
sponsoring relationship unless it was willing to trade bilaterally with 
those sponsoring firms. The Commission understands that some Sponsoring 
Members also may limit which market participant's trades they are 
willing to sponsor based on firm type. Sponsored triparty repo is a 
relatively recent addition.\287\ Volumes of sponsored repo fluctuate, 
but they appear to be substantial as Figure 6 shows.
---------------------------------------------------------------------------

    \285\ FICC Rule 3A, sections 8 and 9, supra note 47.
    \286\ FICC Rule 3, section 14(c), supra note 47.
    \287\ See supra note 66 and note 67 and referencing text.

Figure 6: Sponsored Repo Daily Trading Volume \a\

[[Page 64648]]

[GRAPHIC] [TIFF OMITTED] TP25OC22.005

    \a\ Source: FRBNY Repo Operations data, available at https://www.newyorkfed.org/markets/desk-operations/repo. Operation results 
in Figure 6 include all repo and reverse repo conducted, including 
small value exercises.

    In order for a CCP to perform as the guarantor of trades that have 
been novated to it, the CCP must have resources available to absorb the 
costs of clearing member non-performance. FICC is required by 
Commission rule to have policies and procedures reasonably designed to 
maintain financial resources at the minimum to enable it to cover a 
wide range of foreseeable stress scenarios that include, but are not 
limited to, the default of the participant family that would 
potentially cause the largest aggregate credit exposure in extreme but 
plausible market conditions.\288\ A CCP's plan to deal with a clearing 
member default is referred to as its default waterfall. The default 
waterfall provides an identification of resources that the CCP will use 
in attempting to recoup losses from clearing member defaults. The FICC 
waterfall comprises the defaulting clearing member's contribution 
(i.e., margin, as well as any other resources the member has on deposit 
such as excess margin, the proceeds from liquidating the member's 
portfolio, and any amounts available from cross-guaranty agreements), 
the corporate contribution to the clearing fund, followed by non-
defaulting clearing members' margin.\289\
---------------------------------------------------------------------------

    \288\ 17 CFT 240.17Ad-22(e)(4)(iii).
    \289\ FICC Rule 4, sections 6 and 7, supra note 47.
---------------------------------------------------------------------------

    In addition, with respect to liquidity risk, the Commission's rules 
require FICC to have policies and procedures reasonably designed to 
meet a ``cover-1'' standard and hold qualifying liquid resources 
sufficient to complete its settlement obligations in the event of the 
default of the largest member and its affiliates.\290\ For example, if 
a clearing member has a net long position in a security that has not 
yet settled, the CCP must have the cash available to complete the 
purchase. The securities can be subsequently liquidated and any losses 
that may result would be covered by the resources in the default 
waterfall. The first liquidity source that FICC would use in the event 
of a member default is the cash portion of the clearing fund.\291\ 
Second, FICC can pledge securities in the clearing fund as a source of 
cash, including securities that would have otherwise been delivered to 
the defaulting member.\292\ Should additional liquid resources be 
required FICC could make use of the Capped Contingent Liquidity 
Facility (``CCLF'').\293\
---------------------------------------------------------------------------

    \290\ Specifically, the Commission's rules require FICC to have 
policies and procedures reasonably designed to maintain sufficient 
liquid resources at the minimum in all relevant currencies to effect 
same-day and, where appropriate, intraday and multiday settlement of 
payment obligations with a high degree of confidence under a wide 
range of foreseeable stress scenarios that includes, but is not 
limited to, the default of the participant family that would 
generate the largest aggregate payment obligation for the covered 
clearing agency in extreme but plausible market conditions, and to 
hold qualifying liquid resources sufficient to meet that 
requirement. See 17 CFR 240.17Ad-22(e)(7)(i) and (ii).
    \291\ FICC Rule 4, sections 5 and 6, supra note 47.
    \292\ Id.
    \293\ FICC Rule 22A, section 2a, supra note 47.
---------------------------------------------------------------------------

    The CCLF is a rules-based arrangement in which FICC members are 
obligated to participate as a condition of their membership. Should 
FICC declare a CCLF event, each member would be obligated to enter into 
repurchase agreements with FICC up to a member-specific limit.\294\ The 
CCLF is not prefunded, and it is separate from FICC's margin 
requirements. Each FICC member is required, by FICC's rules, to attest 
that its CCLF requirement has been incorporated into its liquidity 
planning and related operational plans at least annually and in the 
event of any changes to such Member's CCLF requirement.\295\ Thus, the 
members are obligated to have such resources lined up, which can be 
costly.\296\
---------------------------------------------------------------------------

    \294\ These repurchase agreements may continue for up to 30 
days. See FICC Rule 22A, section 2a(a)(L), supra note 47.
    \295\ FICC Rule 22A, section 2a(d), supra note 47.
    \296\ See Independent Dealer & Trader Association, White Paper 
on the Repo Market Affecting U.S. Treasury and Agency MBS, at 8 
(Dec. 6, 2019), available at https://static1.squarespace.com/static/5ad0d0abda02bc52f0ad4922/t/5dea7fb6af08dd44e68f48cc/1575649207172/IDTA+-+White+Paper+%2812.6.19%29-c2.pdf (``In light of the fact that 
a significant component of a firm's CCLF obligation is based on its 
overnight liquidity exposures at FICC, middle-market dealers 
immediately took to reducing their reliance on overnight liquidity. 
Some middle-market dealers reduced the size of their portfolio and 
extended liquidity terms in place of overnight funding, adding to 
both financing and opportunity costs. Others have incorporated 
liquidity plans for which commitment and administration fees 
materially added to the cost of doing business.'').
---------------------------------------------------------------------------

    The CCLF provides a mechanism for FICC to enter into repurchase 
transactions based on the clearing activity of the defaulted 
participant. Specifically, in the event that FICC declares a CCLF 
event, FICC's members would be required to hold and fund their 
deliveries to the defaulting member, up to a predetermined capped 
dollar amount, by entering into repurchase transactions with FICC until 
FICC completes the associated closeout.\297\ The aggregate size of the

[[Page 64649]]

CCLF is the historical cover-1 liquidity requirement (i.e., the largest 
liquidity need generated by an Affiliated Family during the preceding 
six-month period) plus a liquidity buffer (i.e., the greater of 20 
percent of the historical cover-1 liquidity requirement or $15 
billion).\298\
---------------------------------------------------------------------------

    \297\ See generally FICC Rule 22A, section 2a(b), supra note 47. 
For details on the process, see the Order Approving a Proposed Rule 
Change to Implement the Capped Contingency Liquidity Facility in the 
Government Securities Division Rulebook, Exchange Act Release No. 
82090 (Nov. 15, 2017), 82 FR 52457 (Nov. 21, 2017).
    \298\ FICC Rule 1 (definitions of Aggregate Total Amount and 
Liquidity Buffer) and 22A, section 2, supra note 47.
---------------------------------------------------------------------------

    The first $15 billion of the total amount of the CCLF is shared, on 
a scaled basis, across all members. Any remaining amount is allocated 
to members who present liquidity needs greater than $15 billion, using 
a liquidity tier structure based on frequency of liquidity created 
across liquidity tiers in $5 billion increments.\299\ The size of the 
CCLF and each member's share is reset every 6 months or as 
appropriate.\300\ Figure 7 provides data on the aggregate amount of the 
CCLF from 2018 quarter 4 through 2021 quarter 2. The aggregate size of 
the CCLF was over $80 billion in 2021 quarter 2.
---------------------------------------------------------------------------

    \299\ FICC Rule 22A, section 2a(iii), (iv), and (v), supra note 
47. See also Exchange Act Release No. 82090, supra note 297, 82 FR 
at 55429-30.
    \300\ FICC Rule 22A, section 2a(b)(ii), (iii), (iv), and (v), 
supra note 47.

Figure 7: Aggregate CCLF ($MM) at Quarter End \a\
[GRAPHIC] [TIFF OMITTED] TP25OC22.006

    \a\ See CPMI-IOSCO Quantitative Disclosures--FICC, Disclosure 
Reference 7.1.6, available at https://www.dtcc.com/legal/policy-and-compliance.
4. Clearing and Settlement by U.S. Treasury Securities Market Segment
    Data on the extent of central clearing in the U.S. Treasury 
securities market appears to be lacking. As discussed previously, the 
Commission believes that approximately half of bilateral repo trades 
are centrally cleared. The percentage of centrally cleared triparty 
repo appears to be lower than this, as sponsored triparty clearing is 
relatively new. For further details of central clearing in repo, see 
section II.A.2, supra.
    The state of cash clearing in the U.S. Treasury securities market 
is discussed in section II.A.1 supra. Estimates from the first half of 
2017 further suggest that only 13 percent of the cash transactions in 
the U.S. Treasury securities market are centrally cleared. These 
estimates suggest that another 19 percent of transactions in this 
market are subject to so-called hybrid clearing in which one leg of a 
transaction facilitated by an IDB platform is centrally cleared and the 
other leg of the transaction is cleared bilaterally.\301\
---------------------------------------------------------------------------

    \301\ See IAWG Report, supra note 4, at 30; see also TMPG White 
Paper, supra note 21, at 12. The figures are estimated using FR 2004 
data covering the first half of 2017 and are based on various 
assumptions: (a) primary dealers account for all dealer activity, 
(b) 5% of dealers' trading not through an IDB is with another 
dealer, (c) the shares of dealer and non-dealer activity in the IDB 
market for coupon securities equal the weighted averages of the 
shares reported in the Oct. 15 report (that is, 41.5% and 58.5%, 
respectively), (d) only dealers trade bills, FRNs, and TIPS in the 
IDB market, and e) the likelihood of dealer and non-dealers trading 
with one another in the IDB market solely reflects their shares of 
overall volume.
---------------------------------------------------------------------------

    Below, we discuss the dealer-to-customer market and the ``inter-
dealer'' market (on IDBs) separately. Tables 1 and 2 show the volumes 
in these markets for on-the-run and off-the-run securities.
    Until the mid-2000s, most inter-dealer trading occurred between 
primary dealers who were FICC members and it was centrally 
cleared.\302\ Today, PTFs actively buy and sell large volumes of U.S. 
Treasury securities on an intraday basis using high-speed and other 
algorithmic trading strategies.\303\ PTFs are not generally FICC 
members and, as such, their trades are often not centrally cleared. 
Moreover, PTFs compose a

[[Page 64650]]

substantial portion of trading volume, averaging about 20% of overall 
U.S. Treasury cash market volume and accounting for around 50-60% of 
IDB volume in outright purchases and sales of U.S. Treasury 
securities.\304\ Primary dealers, who are FICC members and who transact 
the 40-50% of IDB volume not accounted for by PTFs, are required by 
Federal Reserve Bank of New York policy to centrally clear their U.S. 
Treasury securities primary market cash activity.\305\
---------------------------------------------------------------------------

    \302\ See G-30 Report at 9, supra note 5; IAWG Report, supra 
note 4, at 5-6; TMPG White Paper, supra note 21, at 6.
    \303\ See Joint Staff Report, supra note 4, at 32, 35-36, 39.
    \304\ See James Collin Harkrader & Michael Puglia, FEDS Notes: 
Principal Trading Firm Activity in Treasury Cash Markets (Aug. 2020) 
(``Harkrader and Puglia FEDS Note''), available at https://www.federalreserve.gov/econres/notes/feds-notes/principal-trading-firm-activity-in-treasury-cash-markets-20200804.htm.
    \305\ See supra note 37.
---------------------------------------------------------------------------

    As Tables 1 and 2 below show, during the 6-month period ending in 
September 2021 trading volume of on-the-run U.S. Treasury securities 
was approximately two and half times that of off-the-run U.S. Treasury 
securities. Over half (56.9%) of on-the-run U.S. Treasury security 
trading volume and approximately one quarter (28.5%) of off-the-run 
U.S. Treasury security trading volume occurred on ATSs (which are also 
IDBs) and non-ATS IDBs.\306\ Of the on-the-run U.S. Treasury security 
trading volume that occurred on ATS IDBs and non-ATS IDBs, 41.5% were 
dealer trades, 44.6% were PTF trades and the remainder were customer 
trades. For off-the-run trading in U.S. Treasury securities, the 
comparable figures are 72.2% dealer trades, 9.1% PTF trades, and the 
remainder are customer trades. In contrast to trades that take place on 
an ATS or a non-ATS IDB, 56.9% of on-the-run U.S. Treasury security 
transactions and 75.9% of off-the-run U.S. Treasury security 
transactions are traded bilaterally. The majority of these (86.0% of 
on-the-run and 89.9% of off-the-run) are dealer-to-customer trades.
---------------------------------------------------------------------------

    \306\ The term ``IDB'' typically refers only to IDBs that are 
also ATSs. See supra note 43 and associated text.

                           Table 1--On-the-Run U.S. Treasury Securities Trading Volume
----------------------------------------------------------------------------------------------------------------
                               On-the-Run U.S. Treasury Securities Trading Volume
-----------------------------------------------------------------------------------------------------------------
                                                                                      Average
                                                                     Number of    weekly  volume   Volume share
                                                                      venues            ($M)            (%)
----------------------------------------------------------------------------------------------------------------
ATSs............................................................              18         812,480            49.7
    Customer trades.............................................              11          52,754             3.2
    Dealer trades...............................................              18         344,781            21.1
    PTF trades..................................................              11         414,945            25.4
Non-ATS Interdealer Brokers.....................................              24         118,067             7.2
    Customer trades.............................................              19          77,334             4.7
    Dealer trades...............................................              23          40,252             2.5
    PTF trades..................................................               9             481         \a\ 0.0
Bilateral dealer-to-dealer trades...............................             352          92,051             5.6
Bilateral dealer-to-customer trades.............................             333         604,823            37.0
Bilateral dealer-to-PTF trades..................................              97           7,250             0.4
                                                                 -----------------------------------------------
        Total...................................................  ..............       1,634,671           100.0
----------------------------------------------------------------------------------------------------------------
This table reports trading volume and volume share for ATSs,\b\ Non-ATS interdealer brokers, bilateral dealer-to-
 dealer transactions, bilateral dealer-to-customer, and bilateral dealer-to-PTF transactions for on-the-run U.S.
 Treasury Securities. On-the-run U.S. Treasury Securities are the most recently issued nominal coupon
 securities. Nominal coupon securities pay a fixed semi-annual coupon and are currently issued at original
 maturities of 2, 3, 5, 7, 10, 20, and 30 years. Treasury Bills and Floating Rate Notes are excluded. Volume is
 the average weekly dollar volume in par value (in millions of dollars) over the 6-month period, from April 1,
 2021, to September 30, 2021.\c\ Number of Venues is the number of different trading venues in each category and
 the number of distinct MPIDs for bilateral transactions.\d\ Market Share (%) is the measure of the dollar
 volume as a percent of total dollar volume.\e\ The volumes of ATSs and non-ATS interdealer brokers are broken
 out by Customer trades, Dealer trades, and PTF trades within each group.\f\ Data is based on the regulatory
 version of TRACE for U.S. Treasury Securities from Apr. 1, 2021, to Sept. 30, 2021. Bilateral trades are a
 catchall classification that may include trades conducted via bilateral negotiation, as well as trades
 conducted electronically via platforms not registered with FINRA as an ATS.
----------------------------------------------------------------------------------------------------------------
\a\ The percentage to the nearest non-zero is 0.02%.
\b\ This analysis is necessarily limited to transactions reported to TRACE, which may not be all transactions in
  U.S. Treasury securities. Transactions that take place on non-FINRA member ATSs or between two non-FINRA
  members are not reported to TRACE. Entities in the ATS TRACE category encompass the IDBs described in the
  preamble of this release. By contrast, the non-ATS IDB category in TRACE encompasses the voice-based or other
  non-anonymous methods of bringing together buyers and sellers. See supra note 43 and referencing text.
\c\ FINRA reports volume as par volume, where par volume is the volume measured by the face value of the bond,
  in dollars. See relevant weekly volume files, available at https://www.finra.org/filing-reporting/trace/data/trace-treasury-aggregates.
\d\ Dealers are counted using the number of distinct MPIDs.
\e\ Total dollar volume (in par value) is calculated as the sum of dollar volume for ATSs, non-ATS interdealer
  brokers, bilateral dealer-to-dealer transactions, and bilateral dealer-to-customer transactions.
\f\ We identify ATS trades and non-ATS interdealer broker trades using MPID. The regulatory version of TRACE for
  U.S. Treasury securities includes an identifier for customer and interdealer trades. Furthermore, we use MPID
  for non-FINRA member subscriber counterparties in the regulatory version of TRACE for U.S. Treasury securities
  to identify PTF trades on ATSs.


                          Table 2--Off-the-Run U.S. Treasury Securities Trading Volume
----------------------------------------------------------------------------------------------------------------
                               Off-the-Run U.S. Treasury Securities Trading Volume
-----------------------------------------------------------------------------------------------------------------
                                                                     Number of                     Volume share
                                                                      venues          Volume            (%)
----------------------------------------------------------------------------------------------------------------
ATSs............................................................              17         110,945            17.3

[[Page 64651]]

 
    Customer trades.............................................              10          13,304             2.1
    Dealer trades...............................................              17          83,668            13.0
    PTF trades..................................................              11          13,973             2.2
Non-ATS Interdealer Brokers.....................................              22          43,604             6.8
    Customer trades.............................................              18          15,092             2.4
    Dealer trades...............................................              21          28,451             4.4
    PTF trades..................................................              12              61         \a\ 0.0
Bilateral dealer-to-dealer trades...............................             509          47,912             7.5
Bilateral dealer-to-customer trades.............................             333         437,665            68.2
Bilateral dealer-to-PTF trades..................................             114           1,415             0.2
                                                                 -----------------------------------------------
        Total...................................................  ..............         641,540           100.0
----------------------------------------------------------------------------------------------------------------
This table reports trading volume and volume share for ATSs,\b\ non-ATS interdealer brokers, bilateral dealer-to-
 dealer transactions, bilateral dealer-to-customer, and bilateral dealer-to-PTF transactions for off-the-run
 U.S. Treasury Securities. Off-the-run or ``seasoned'' U.S. Treasury Securities include TIPS, STRIPS, and
 nominal coupon securities issues that preceded the current on-the-run nominal coupon securities. Number of
 Venues is the number of different trading venues in each category and the number of distinct MPIDs for
 bilateral transactions. Volume is the average weekly dollar volume in par value (in millions of dollars) over
 the 6-month period, from April 1, 2021, to September 30, 2021. Market Share (%) is the measure of the dollar
 volume as a percent of the total dollar volume. The volumes of ATSs and nonATS interdealer brokers are broken
 out by Customer trades, Dealer trades, and PTF trades within each group.\c\ Data is based on the regulatory
 version of TRACE for U.S. Treasury Securities from Apr. 1, 2021, to Sept. 30, 2021. Bilateral trades are a
 catchall classification that may include trades conducted via bilateral negotiation, as well as trades
 conducted electronically via platforms not registered with FINRA as an ATS.
----------------------------------------------------------------------------------------------------------------
\a\ The percentage to the nearest non-zero is 0.01%.
\b\ The analysis based on TRACE is necessarily limited to transactions reported to TRACE, which may not be all
  transactions in government securities. Transactions that take place on non-FINRA member ATSs or between two
  non-FINRA members are not reported to TRACE. The analysis based on TRACE is necessarily limited to
  transactions reported to TRACE, which may not be all transactions in government securities. Transactions that
  take place on non-FINRA member ATSs or between two non-FINRA members are not reported to TRACE. Entities in
  the ATS TRACE category encompass the IDBs described in the preamble of this release. By contrast, the non-ATS
  IDB category in TRACE encompasses the voice-based or other non-anonymous methods of bringing together buyers
  and sellers. See supra note 4344 and referencing text.
\c\ We identify ATS trades and non-ATS interdealer broker trades using MPID in the regulatory version of TRACE
  for U.S. Treasury securities. The regulatory version of TRACE for U.S. Treasury securities includes an
  identifier for customer and interdealer trades. Furthermore, we use MPID for non-FINRA member subscriber
  counterparties in the regulatory version of TRACE for U.S. Treasury Securities to identify PTF trades on ATSs.

a. Dealer-to-Customer Cash U.S. Treasury Securities Market (Off-IDBs)
i. Bilateral Clearing
    In cash U.S. Treasury security transactions that are bilaterally 
cleared, the process generally begins with participants initiating the 
trade by an electronic or voice trading platform, and both parties 
booking the details of the trade in their internal systems and 
confirming the details of the trade with one another. Once the details 
are confirmed, each party then sends messages to its clearing or 
settlement agents to initiate the clearing process. Different types of 
institutions use different clearing and settlement agents, with buy-
side firms typically using custodial banks, dealers using clearing 
banks, and hedge funds and PTFs using prime brokers. With regard to the 
posting of margin, the Commission understands that most bilaterally 
cleared trades go unmargined.\307\
---------------------------------------------------------------------------

    \307\ TMPG White Paper, supra note 21, at 3 (``Margining has not 
been a common practice for regularly settling bilaterally cleared 
transactions . . .'').
---------------------------------------------------------------------------

    Bilaterally cleared trades make up 87% of total trading in the 
secondary U.S. Treasury securities market, making them the most 
prevalent trade type in the market.\308\ These trades include at least 
one party that is not a member of the CCP. The bilateral clearing 
process comes with risks. After the trade is executed, the principals 
to the trade face counterparty credit risk, in the event that either 
party fails to deliver on its obligations.\309\
---------------------------------------------------------------------------

    \308\ TMPG White Paper, supra note 21, at 12. This figure is 
estimated from 2017H1 data and includes approximately 19% hybrid 
clearing. See supra section III.A.2.b (IDB Transactions) and infra 
section IV.b.4.b (iii) for discussions of hybrid clearing.
    \309\ TMPG White Paper, supra note 21, at 13.
---------------------------------------------------------------------------

ii. Central Clearing
    There is essentially no central clearing of dealer-to-client trades 
of U.S. Treasury Securities.\310\ Should a trade be centrally cleared, 
the CCP receives a notice of the executed trade from both parties, and 
after comparison (i.e., matching of the trade details), the CCP 
guarantees and novates the contract, where novation refers to the 
process by which the CCP becomes the counterparty to both the buyer and 
seller in the original trade. Once the trading day ends and all trades 
have been reported to the CCP (i.e., end of T+0), the CCP determines 
its net obligations to each CCP participant for each security and 
communicates the resulting settlement obligations to the 
counterparties. The participants then have the obligation to settle 
their portion of the trade on T+1. Once this information is 
communicated, the participants send instructions to their settlement 
agents. In contrast to the bilateral case, central clearing reduces the 
credit risk that both parties are exposed to throughout the trade. 
While at execution both CCP members hold the usual counterparty credit 
risk to one another, this risk is transformed, generally within minutes 
of trade execution, when the trade details are sent to the CCP and the 
CCP guarantees and novates the trade. Instead, both parties to the 
trade now hold centrally cleared credit risk, and the CCP has 
counterparty risk to both members.
---------------------------------------------------------------------------

    \310\ See G-30 Report, supra note 5, at 1.

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[[Page 64652]]

b. Cash U.S. Treasury Trades Through an IDB \311\
---------------------------------------------------------------------------

    \311\ See generally TMPG White Paper, supra note 21.
---------------------------------------------------------------------------

    Trades through IDBs can go through three different clearing 
processes, as IDBs act as the principals for the buying and selling 
entities transacting on the IDB who may or may not be CCP members. When 
the purchaser and the seller are CCP members, each leg of the trade is 
centrally cleared. When neither of the parties to the trade is a CCP 
member, conversely, each leg of the trade is cleared bilaterally. 
Finally, when one party to the trade is a CCP member and the other is 
not, the CCP member's trade is centrally cleared, while the other leg 
of the trade is cleared bilaterally. For clarity, we outline each of 
these cases separately.
i. Central Clearing
    In the case where both the buyer and seller are CCP members, the 
process is largely the same as the process outlined in section 
IV.B.4.a.ii. Since all three parties, buyer, seller, and IDB are CCP 
members, there are just two centrally cleared trades submitted 
simultaneously, one between the seller and the IDB, and the other 
between the IDB and the buyer. Both trades are submitted to the CCP, 
which novates the trades, resulting in 4 separate trades. At the end of 
T+0, the CCP nets out the IDB's position, and sends the buyer and 
seller their net obligations on T+1.
    The credit risk in this trade is largely the same as in the 
centrally cleared case without an IDB, though there is now additional 
counterparty credit risk on T+0 coming from the IDB's involvement in 
the trade. However, this additional counterparty risk is not present 
for very long, for two reasons. First, once the trade is submitted for 
clearing, counterparty risk shifts from bilateral to centrally cleared 
(that is, from the IDB to the CCP). Second, while the IDB holds 
centrally cleared credit risk, the position is netted out at the end of 
T+0.
ii. Bilateral Clearing
    The case where the non-CCP member buyer and seller use an IDB is 
similar to the bilateral clearing case detailed in section IV.B.4.a(i) 
supra.\312\ At execution, the trade is placed either by voice or on the 
IDB's electronic platform. On T+1, the IDB settles both legs of the 
trade. To settle its trade with the IDB, the seller instructs its 
settlement agent to send securities against payment to the IDB. This 
settlement agent then transfers the securities from the seller to the 
securities account of the buyer's settlement agent. The buyer's 
settlement agent then credits the securities to the IDB's securities 
account. To settle its trade with the buyer, the IDB instructs the 
buyer's settlement agent to transfer securities to the buyer's account, 
by transferring the securities from the IDB's securities account to the 
settlement agent's omnibus account. Finally, the clearing agent credits 
the securities to the buyer's securities account, which is maintained 
by the clearing agent. Additionally, because the IDB is principal to 
both parties, it can clear and settle trades on a net basis with 
respect to each party. This netting occurs throughout the day on T+0 
and the net position is settled on T+1.
---------------------------------------------------------------------------

    \312\ See also TMPG White Paper, supra note 21, at 23.
---------------------------------------------------------------------------

    Credit risk in this scenario is different than in the centrally 
cleared case discussed in the previous section. Because the IDB stands 
as principal between the buyer and the seller but does not submit the 
trades for central clearing, the IDB, buyer, and seller all hold 
counterparty credit risk for net unsettled positions throughout T+0 and 
overnight on the net exposures to each party. In addition, unlike the 
centrally cleared case where the CCP collects margin from its 
counterparties, the Commission understands that IDBs generally do not 
collect margin to collateralize this risk.\313\ Further, the IDB is now 
involved in settlement, making it subject to the counterparty credit 
risk described in section IV.B.4.a(i), supra. In particular, the 
settlement agent for the buyer faces credit extension risk from the 
IDB, as they deliver cash to the seller's settlement agent prior to the 
security being transferred. Once the securities are transferred, this 
risk is extinguished.
---------------------------------------------------------------------------

    \313\ See TMPG White Paper, supra note 21, at 3.
---------------------------------------------------------------------------

    Finally, since the trade is not centrally cleared and the IDB 
stands as principal between the two parties, the IDB has a legal 
obligation to deliver securities to the buyer, even if the seller fails 
to deliver or defaults. In practice, an IDB might fail to deliver 
securities if the seller fails, generating what is known as a matched 
fail, where there is an expectation that the fail will be cured shortly 
(to the extent that it is not caused by a creditworthiness or liquidity 
event on the seller's part). If the seller is impaired or goes into 
bankruptcy, the IDB will likely source securities for delivery to the 
buyer, rather than carry an open fail to deliver, due to both its 
obligation to deliver securities as well as reputational concerns. For 
the same reasons the IDB will likely source cash if the buyer is 
impaired or goes into default. Given these obligations, the IDB 
actively monitors participants and their positions across its various 
platforms. Nevertheless, unlike a CCP, an IDB does not mutualize risk 
across all of the participants on its platform. As a result, compared 
to a CCP that collects margin and mutualizes losses among its members, 
if a counterparty to a bilaterally cleared trade defaults to the IDB, 
all else equal there is a greater risk that the IDB would then default 
to the other counterparty.
iii. Hybrid Clearing
    In IDB trades where one counterparty to the trade is a FICC member 
and the other is a non-FICC member, then a hybrid clearing model is 
used in which one side of the trade is cleared through FICC, and the 
other is cleared and settled bilaterally. In these cases, the leg of 
the trade between the FICC member and the IDB will follow the central 
clearing example outlined in section IV.B.4.b.i infra, as FICC members 
are generally dealers. Similarly, the leg of the trade between the IDB 
and the non-FICC member will be bilaterally cleared as described in 
section IV.B.4.b.ii supra, as the non-FICC entities trading on IDBs are 
generally PTFs and other unregistered market participants.
5. Margin Practices in U.S. Treasury Secondary Markets
    As described above, posting of margin is one way to manage the risk 
of settlement in cash trades. Indeed, for trades that are centrally 
cleared, the CCP collects margin on an intraday basis, typically twice 
per day.\314\ Varying bespoke arrangements appear to characterize 
current margining practices in the bilateral, non-centrally cleared 
cash market.\315\ Indeed, a recent publication stated that competitive 
pressures in the bilaterally settled market for repo transactions has 
exerted downward pressure on haircuts, sometimes to zero.\316\ The 
reduction of haircuts, which serve as the primary counterparty credit 
risk mitigant in bilateral repos, could result in greater exposure to 
potential counterparty default risk in non-centrally cleared repos. 
Such arrangements (in both cash

[[Page 64653]]

and repo) may not take into account the value of margin in protecting 
against systemic events, because they are designed to be optimal for 
the counterparties rather than the larger financial market.
---------------------------------------------------------------------------

    \314\ TMPG White Paper, supra note 21, at 3.
    \315\ Id. at 3. Non-centrally cleared cash trades are negotiated 
and settled bilaterally, and the Commission has little direct 
insight into the arrangements market participants use to manage 
their counterparty exposure. The TMPG observes in the White Paper 
that non-centrally cleared trades are ``. . . not margined in a 
uniform or transparent manner, thereby creating uncertainty about 
counterparties' exposure to credit and market risk.'' Id.
    \316\ G-30 Report, supra note 5, at 13.
---------------------------------------------------------------------------

    For centrally cleared cash U.S. Treasury transactions, however, 
FICC rules dictate that margin must be posted based on the net 
positions of all members with the clearing agency. Positions in 
securities with longer maturities--for example, 20+ year U.S. Treasury 
bonds--require more margin to be posted because they are more sensitive 
to interest rate changes. Required margin is also larger for short 
positions, and rises with volatility in the U.S. Treasury securities 
market.\317\ For example, during the first quarter of 2020, a period 
which includes the U.S. Treasury securities market disruption of March 
2020, total initial margin required was 9.4% higher than the previous 
quarter and the average total variation margin paid was 72% 
higher.\318\
---------------------------------------------------------------------------

    \317\ See FICC Rule 4, section 1b, supra note 47. FICC's margin 
requirements are discussed in more detail below. A key component of 
the margin requirement is a Value-at-Risk charge, where the 
calculated margin requirement is based in part on the historical 
volatility of the traded security. Securities that are more 
sensitive to interest rates should have higher VaR, all else equal.
    \318\ See CPMI IOSCO Quantitative Disclosure Results for 2020Q1 
and 2019Q4, items 6.1.1 and 6.6.1, available at https://www.dtcc.com/legal/policy-and-compliance.
---------------------------------------------------------------------------

    FICC Rules set forth the various components of a member's margin 
requirements.\319\ The largest component is a Value-at-Risk (VaR) 
charge, which is calculated both intraday and end-of-day and reflects 
potential price volatility of unsettled positions. FICC typically 
calculates VaR using ten years of historical data; for securities 
without the requisite amount of data, FICC instead employs a haircut 
approach, where the required margin is some percentage of the traded 
security's value. Other components of FICC's margin requirements 
include a liquidity adjustment charge, which is levied against members 
who have large, concentrated positions in particular securities that 
FICC determines to be difficult to liquidate, and special charges that 
can be levied in response to changes in aggregate market conditions 
(such as increases in market-wide volatility).
---------------------------------------------------------------------------

    \319\ FICC Rule 4, section 1b, supra note 47.
---------------------------------------------------------------------------

    In the market for bilaterally cleared repo, margin typically comes 
in the form of overcollateralization. That is, if a lender is providing 
$100 of cash, the borrower will provide more than $100 of securities as 
collateral. This extra collateral--which is essentially a form of 
initial margin--protects the lender by making it more costly for the 
borrower to default, while also protecting the lender against the risk 
that short-term volatility erodes the value of the posted collateral. 
The difference between the cash provided and the value of the 
collateral is known colloquially as a ``haircut.'' Triparty repo also 
features overcollateralization, where the haircut is again negotiated 
bilaterally between the two counterparties.\320\ Data from the Federal 
Reserve Bank of New York show that a 2% haircut is the norm in the 
Triparty/GCF repo market, though there are occasionally some deviations 
from the norm.\321\ Money market funds also generally require margin of 
2%, which is generally the case for other investment companies as 
well.\322\ Outside of money market funds and other investment 
companies, due to the lack of reporting requirements for bilateral 
repo, the Commission lacks good insight into margin practices of 
participants in the market for bilaterally cleared repo. Anecdotally, 
the Commission understands that--as with the cash market--some 
participants may not be required to post any margin.\323\
---------------------------------------------------------------------------

    \320\ Although triparty repo transactions are settled through a 
clearing bank, the terms of the transactions are bilaterally 
negotiated. Although haircuts vary by collateral type, the variance 
of haircuts is small for U.S. Treasury repo compared to other 
collateral types. See Paddrik, et al., supra note 273.
    \321\ For data on the median, 10th, and 90th percentiles of 
overcollateralization in Triparty repo, see https://www.newyorkfed.org/data-and-statistics/data-visualization/tri-party-repo. The median level of overcollateralization has been 2% for the 
entire period from May 2010 through June 2022. The 10th and 90th 
percentiles are also typically 2%, although the 10th percentile has 
occasionally fallen to as low as zero--notably, in the summer of 
2010 and again briefly in September 2012--while the 90th percentile 
has occasionally spiked to as high as 5%--specifically in January 
2017 and again in April of the same year.
    \322\ See MMF Primer, supra note 57.
    \323\ See G-30 Report, supra note 5, at 13 (noting that minimum 
margin requirements ``. . . would stop competitive pressures from 
driving haircuts down (sometimes to zero), which reportedly has been 
the case in recent years.'').
---------------------------------------------------------------------------

    While overcollateralization protects the lender, the bilaterally 
cleared repo market generally does not feature the same level of 
protection for the borrower. Indeed, one of the main benefits of the 
bilateral market to lenders is that it allows them to reuse the 
collateral. As a result, borrowers are exposed to settlement risk and 
must manage that risk as they see fit. In the triparty repo market, 
posted collateral remains in the custody of the clearing bank and 
cannot be reused by the lender except as collateral in another triparty 
repurchase agreement, reducing settlement risk for the borrower.
    Unlike bilaterally cleared and triparty repo, centrally cleared 
repo generally does not feature overcollateralization. Instead, the 
counterparties post cash margin to the CCP twice per day, as they do 
with trades in the cash market. Borrowers may be required to post more 
margin than lenders, similar to how in the bilaterally cleared market 
borrowers post margin through overcollateralization while lenders do 
not.
6. Disruptions in the U.S. Treasury Securities Market
    There have been significant disruptions in the U.S. Treasury 
securities market in recent years. Although different in their scope 
and magnitude, these events all generally involved dramatic increases 
in market price volatility and/or sharp decreases in available 
liquidity.\324\ U.S. Treasury securities are generally not information 
sensitive in that their payoff is fixed in nominal terms. Moreover, 
there is little evidence that information on inflation risk or 
expectations could have driven the volatility observed in these 
episodes, raising the possibility that the volatility originated in a 
buy-sell imbalance, as opposed to fundamental factors. While a market 
failure could be the origin of price volatility, the forward-looking 
nature of markets can compound liquidity-driven price movements. The 
fear of being unable to exit a position can lead to a ``rush to the 
exits,'' leading to yet greater price swings. Because U.S. Treasury 
securities are standardized, they generally benefit from a deep, ready 
market for transactions. Investors count on the ability to move between 
cash and U.S. Treasury securities seamlessly.\325\ This makes events 
that reduce liquidity in these markets especially striking and 
destabilizing to the overall market.
---------------------------------------------------------------------------

    \324\ See IAWG Report, supra note 4, for further discussion of 
these and other disruptions.
    \325\ U.S. Treasury securities are often used as substitutes for 
cash. There is anecdotal evidence that during March 2020, some 
market participants refused U.S. Treasury securities collateral in 
favor of cash.
---------------------------------------------------------------------------

a. COVID-19 Shock of March 2020
    The market for U.S. Treasury securities experienced significant 
disruptions in March 2020, characterized by a spike in volume, whose 
origins may have been multiple but included high levels of selling by 
foreign banks and by hedge funds.\326\ For example, hedge funds, one of 
the principal sellers of U.S Treasury futures, hedge their short 
futures position by

[[Page 64654]]

establishing a long position in the cash market, creating a ``cash-
futures basis trade.'' The cash position of this trade is often highly 
levered, using the repo market for financing. In March, as the U.S. 
Treasury securities market came under stress and as repo rates 
increased in some segments of the repo market, the economics of the 
cash-futures basis trade worsened and various funds found it necessary 
to unwind at least a portion of their positions. This unwinding of 
positions resulted in more outright sales of U.S. Treasury securities 
in the cash market, adding further stress through a feedback loop.\327\
---------------------------------------------------------------------------

    \326\ See U.S. Credit Markets Interconnectedness and the Effects 
of the COVID-19 Economic Shock (Oct. 2020) at 3.
    \327\ Id. at 4. In addition, a similar dynamic was observed in 
the risk parity trades, where hedge funds lever up (through the repo 
markets) lower volatility fixed-income positions (e.g., government 
bonds) to create a risk-equalized portfolio across asset classes. 
See id.
---------------------------------------------------------------------------

    During this period, bid-ask spreads increased by a factor of 5, and 
market depth on inter-dealer brokers decreased by a factor of 10. The 
price of 30-year U.S. Treasury securities fell by 10% in one two-day 
period. Arbitrage relations appeared to break down throughout the 
market.\328\ This may, as discussed above, have led to the winding down 
of the cash-futures basis trade, for example, adding to further 
stress.\329\ There also appeared to be large-scale selling from foreign 
investors, including official institutions, to address their domestic 
currency and liquidity needs.\330\
---------------------------------------------------------------------------

    \328\ Duffie, supra note 186.
    \329\ See supra note 150.
    \330\ See Colin R. Weiss, Foreign Demand for U.S. Treasury 
Securities during the Pandemic (Feds Notes, Jan. 28, 2022), 
available at https://www.federalreserve.gov/econres/notes/feds-notes/foreign-demand-for-us-treasury-securities-during-the-pandemic-20220128.htm.
---------------------------------------------------------------------------

    Duffie and Liang and Parkinson, among others, have tied these 
patterns to underlying U.S. Treasury securities market structure, in 
which intermediation capacity may be reduced relative to the size of 
the market and ultimate buyers and sellers may have difficulty locating 
each other. These authors discuss ways in which central clearing could 
have reduced these problems, mitigating the large price swings due to 
illiquidity in the market just when it was most needed.\331\ One view 
of central clearing is that it may facilitate all-to-all trading, thus 
helping ultimate buyers and sellers find each other.\332\ More buyers 
and sellers of U.S. Treasury securities could potentially act as 
additional sources of liquidity in a market with central clearing.
---------------------------------------------------------------------------

    \331\ Duffie, supra note 186; Liang & Parkinson, supra note 32.
    \332\ See Duffie supra note 186.
---------------------------------------------------------------------------

b. September 2019 Repo Market Disruptions
    The repo market experienced a substantial disruption starting 
September 16, 2019 when overnight repo rates began to rise, and on 
September 17, 2019 when the rise in repo rates accelerated 
dramatically. During the episode, the Secured Overnight Financing Rate 
(SOFR)--a measure of the average cost of overnight repo borrowing--
spiked by 300 basis points to over 5% in the course of 2 days. There 
was also a wide dispersion around this average; some trades occurred at 
rates as high as 9%. On top of this, the spread between the 1st and 
99th percentile rates increased substantially from its average earlier 
in 2019 of approximately 25 basis points to approximately 675 basis 
points during the disruption. The disruption spilled over into the 
other markets, with the Effective Federal Funds Rate (EFFR) rising 
above the Federal Reserve target by 5 basis points.
    The disruption occurred amidst two events: first, a large 
withdrawal of reserves from the banking system to service corporate tax 
payments due September 16; and second, the settlement of U.S. Treasury 
securities auctions. Altogether, the tax payments led approximately 
$120 billion to flow away from bank reserves, bringing them down to 
their lowest level in 5 years.\333\ Moreover, the auction settlement 
raised the number of U.S. Treasury securities outstanding, which was 
accompanied by an increased demand for cash to fund purchases of these 
securities. The need for cash reserves played a role in what appears to 
be an unwillingness of banks to lend to one another at very high rates. 
Less tangibly, market expectations could have played a role; it is 
possible that the spike in rates could have been interpreted as a 
signal for a future need of cash reserves, leading banks to conserve 
cash regardless of what appeared to be strong economic incentives to do 
otherwise.
---------------------------------------------------------------------------

    \333\ See Sriya Anbil et al., What Happened in Money Markets in 
September 2019? (Feb. 27, 2020), available at https://www.federalreserve.gov/econres/notes/feds-notes/what-happened-in-money-markets-in-september-2019-20200227.htm.
---------------------------------------------------------------------------

    While the need for the banking system to replace reserves with cash 
may be part of the explanation, in a well-operating market high rates 
for overnight borrowing collateralized by U.S. Treasury securities 
would have attracted other market participants. Ultimately, as in March 
2020, the Federal Reserve injected reserves into the system--the 
economic equivalent of lending to banks. The overnight repo operations 
totaled $75 billion on September 17, 2019. Besides directly providing 
cash, this perhaps signaled the Fed's willingness and ability to lend 
as needed to restore rates to levels that would be dictated in the 
absence of market frictions. In such a setting, a potential benefit of 
enhanced clearing for U.S. Treasury repo and cash is its ability to 
reduce those market frictions directly, without official sector 
intervention.
c. October 2014 Flash Rally
    In March 2020 U.S. Treasury securities' prices fell, whereas in 
September 2019 the rate for lending increased. Both events were 
associated in an increase in the cost of borrowing. The events of 
October 15, 2014, were different in form: in this instance, yields on 
U.S. Treasury bonds fell quickly and dramatically, leading to large 
increases in prices, without any clear explanation. The intraday range 
for the 10-year bond was 37 basis points, one of the largest on record, 
and far outside the typical historical distribution.\334\ October 15, 
2014, featured the release of somewhat weaker-than-expected U.S. retail 
sales data at 8:30 a.m. ET. While the data appeared to prompt the 
initial decline in interest rates, the reaction was far larger than 
would have been expected given the modest surprise in the data. 
Suggestive of some connection is that the dollar amount of standing 
quotes in the central limit order books on cash and futures trading 
platforms--a measure of the quantity of liquidity that is commonly 
referred to as ``market depth''--fell dramatically in the hour before 
the event window.
---------------------------------------------------------------------------

    \334\ See generally Joint Staff Report, supra note 4.
---------------------------------------------------------------------------

    A sudden rise in price does not at first appear as potentially 
disruptive as a decline. However, it appears that levered market 
participants had taken short positions in anticipation of an increase 
in yields. Any further increase in price would have forced these 
participants to cover their positions. Indeed, hedge funds became net 
buyers of U.S. Treasury securities on the morning of October 15, 2014. 
The decline in liquidity may have led to a further concern of an 
inability to exit positions. In particular, although the share of 
trading volume attributed to PTFs on October 15 does not stand out as 
unusual relative to the prior period,\335\ PTFs significantly reduced 
the dollar amounts of standing quotes in central limit order 
books,\336\ leading to greater pressure on the system. This withdrawal 
of liquidity appears to have

[[Page 64655]]

been motivated by an attempt to manage risk. Lastly, though broker-
dealers increased their trading volume, they provided less liquidity to 
the order books by widening their spreads and in some cases withdrawing 
for brief periods from the offer side of the book.\337\
---------------------------------------------------------------------------

    \335\ See Joint Staff Report, supra note 4, at 21.
    \336\ See IAWG Report, supra note 4, at 18.
    \337\ See id.
---------------------------------------------------------------------------

    This disruption showed that market liquidity provision had become 
more short-term in nature, some liquidity providers were backed by less 
capital, and liquidity was more vulnerable to shocks as a result of the 
change in the composition of liquidity providers. In addition, 
electronic trading permitted rapid increases in orders that removed 
liquidity. These vulnerabilities are similar to ones observed during 
the March 2020 events.\338\ As in the previously described episodes, 
the price swings illustrate the apparent difficulty for outside capital 
at accessing the market. Improved market functioning could have allowed 
economic incentives to help stabilize the system: end-users of U.S. 
Treasury securities could have reacted to the unusually high prices by 
selling. However, such participants would have needed access to pricing 
and to the ability to trade.
---------------------------------------------------------------------------

    \338\ See id.
---------------------------------------------------------------------------

7. Affected Persons
a. Covered Clearing Agencies for U.S. Treasury Securities: FICC
    Although the Membership Proposal would apply to all U.S. Treasury 
securities CCAs, FICC's Government Securities Division, as noted 
previously, is the sole provider of clearance and settlement services 
for U.S. Treasury securities. FICC is a wholly owned subsidiary of The 
Depository Trust & Clearing Corporation (DTCC); DTCC is a private 
corporation whose common shares are owned by fee-paying participants in 
DTCC's clearing agency subsidiaries, including FICC.\339\ In 2021 and 
2020, FICC's total clearing revenue was approximately $310 and $297.3 
million, respectively, and its net income was approximately $13.4 and 
18.1 million, respectively.\340\
---------------------------------------------------------------------------

    \339\ See generally Notice of No Objection to Advance Notices, 
Exchange Act Rel. No. 74142 (Jan. 27, 2015), 80 FR 5188 (Jan. 30, 
2015) (not objecting to a proposal that DTCC's new common share 
ownership formula will be based solely on fees paid to its 
subsidiary clearing agencies).
    \340\ FICC, Financial Statements as of and for the Years Ended 
Dec. 31, 2021 and 2020, available at https://www.dtcc.com/-/media/Files/Downloads/legal/financials/2021/FICC-Annual-Financial-Statements-2021-and-2020.pdf
---------------------------------------------------------------------------

    The G-30 Report estimated that ``roughly 20 percent of commitments 
to settle U.S. Treasury security trades are cleared through FICC.'' 
\341\ Although various analyses have noted the increased volume of 
secondary market U.S. Treasury transactions that are not centrally 
cleared,\342\ the dollar value of transactions FICC clears remains 
substantial. In 2021, FICC's GSD processed $1.419 quadrillion in U.S. 
Government securities.\343\ In March 2020, clearing dollar volume in 
U.S. Treasury securities at FICC rose ``to over $6 trillion daily, an 
almost 43 percent increase over the usual daily average of $4.2 
trillion cleared [at that time].'' \344\
---------------------------------------------------------------------------

    \341\ G-30 Report, supra note 5, at 11.
    \342\ See, e.g., IAWG Report, supra note 4, at 5-6 (citing TMPG 
White Paper); 2017 Treasury Report, supra note 16, at 81; Joint 
Staff Report, supra note 4, at 36-37.
    \343\ Performance Dashboard, DTCC 2021 Annual Report, at 56, 
available at https://www.dtcc.com/~/media/files/downloads/about/
annual-reports/DTCC-2021-Annual-Report. FICC's GSD also process U.S. 
Government securities that are not U.S. Treasury securities but the 
dollar amount processed of such securities is believed to be nominal 
by comparison to that of U.S. Treasury securities.
    \344\ DTCC May 2021 White Paper, supra note 135, at 3.
---------------------------------------------------------------------------

    There are differences between the degree of central clearing in the 
cash and the repo markets. Based on 2017 data, the TMPG estimated that 
13 percent of cash U.S. Treasury securities transactions are centrally 
cleared; 68 percent are bilaterally cleared; and 19 percent involve 
hybrid clearing, in which only one leg of a transaction on an IDB 
platform is centrally cleared.\345\ A Federal Reserve staff analysis of 
primary dealer repo and reverse repo transactions during the first half 
of 2022 found ``that approximately 20 percent of all repo and 30 
percent of reverse repo is centrally cleared via FICC.'' \346\ Measured 
by dollar volume, repos, according to DTCC, are the largest component 
of the government fixed-income market.\347\ In mid-July 2021, according 
to Finadium and based on DTCC data, FICC processed $1.15 trillion in 
repo, or roughly 25 percent of the $4.4 trillion U.S. repo market at 
that time.\348\ For all of 2021, DTCC reported that FICC processed $251 
trillion through its GCF Repo Service.\349\
---------------------------------------------------------------------------

    \345\ See IAWG Report, supra note 4, at 30; see also TMPG White 
Paper, supra note 21, at 12.
    \346\ Sebastian Infante, et al., supra note 119 (``Form FR2004 
data only cover activities of primary dealers. Therefore, any 
estimate based on that data is likely to underestimate the total 
size of the repo market. Discussions with market participants 
suggest that the nonprimary dealer's market share is smaller than 
that attributed to the primary dealers, but growing.''). The authors 
also show that all cleared bilateral repo and reverse repo have U.S. 
Treasury securities and TIPS as collateral (the authors' Figure 4); 
Viktoria Baklanova, Adam Copeland, and Rebecca McCaughrin, Reference 
Guide to U.S. Repo and Securities Lending Markets, N.Y. Fed. Staff 
Report No. 740, at 11 (rev. Dec. 2015) available at: https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr740.pdf.
    \347\ DTCC, A Guide to Clearance and Settlement, Chapter 8: 
Settling Debt Instruments, available at: https://www.dtcc.com/clearance-settlement-guide/#/chapterEight.
    \348\ Finadium, Building Out Industry Data for New Industry 
Leads, at 9 (2021), available at: https://finadium.com/wp-content/pdfs/finadium-dtcc-building-out-repo-data.pdf.
    \349\ DTCC 2021 Annual Report, supra note 343, at 56.
---------------------------------------------------------------------------

b. Direct Participants at U.S. Treasury Securities CCAs: FICC Netting 
Members
    If adopted, the Membership Proposal would directly affect market 
participants that are direct participants in a U.S. Treasury securities 
CCA, which currently means only direct participants at FICC's GSD. FICC 
direct participants are also referred to as FICC Netting Members. As 
previously discussed, FICC Netting Members are the only FICC members 
eligible to become a counterparty to FICC to a U.S. Treasury securities 
transaction, including repo and reverse repo trades. As of May 3, 2022, 
FICC's GSD had 202 Netting Members of which 187 were participants in 
FICC's repo netting service.\350\ FICC Netting Members generally 
consist of bank-affiliated dealers and registered broker-dealers. These 
dealers include all 25 financial institutions currently designated by 
the Federal Reserve Bank of New York (N.Y. Fed) as ``primary dealers.'' 
\351\ In 2021, the average daily trading dollar value in U.S. Treasury 
securities by primary dealers was $624.1 billion.\352\ The relative 
significance of dealer trading in the cash market for U.S. Treasury 
securities can is shown in Figure 8.
---------------------------------------------------------------------------

    \350\ FICC GSD Member Directory, available at: https://www.dtcc.com/-/media/Files/Downloads/client-center/FICC/Mem-GOV-by-name.xlsx. 104 Netting Members participated in FICC's GCF service.
    \351\ Primary dealers are counterparties to the N.Y. Fed in its 
implementation of monetary policy and expected to participate 
meaningfully in all U.S. Treasury securities auctions for new 
issuances of U.S. Treasury securities. https://home.treasury.gov/policy-issues/financing-the-government/quarterly-refunding/primary-dealers. A current list of primary dealers is available at: https://www.newyorkfed.org/markets/primarydealers.
    \352\ SIFMA, 2022 Capital Markets Fact Book, at 56 (July 2022) 
available at https://www.sifma.org/wp-content/uploads/2022/07/CM-Fact-Book-2022-SIFMA.pdf (SIMFA's term primary dealers refers to 
N.Y. Fed prime brokers). Id. The dollar value of trading in U.S. 
Treasury securities by primary dealers has a combined average annual 
growth rate of 1.9 percent for the ten year period ending in 2021.
---------------------------------------------------------------------------

BILLING CODE 8011-01-P

[[Page 64656]]

[GRAPHIC] [TIFF OMITTED] TP25OC22.007

    As previously discussed, the total notional transactions in the 
repo market is larger than that of the cash U.S. Treasury securities 
market. In 2021, aggregate daily primary dealer outstanding total repo 
positions were $4.3 trillion consisting of $2.5 trillion in repo (75% 
of which is collateralized by U.S. Treasury securities) and $1.8 
trillion in reverse repo (89% of which is collateralized by U.S. 
Treasury securities).\353\ As of December 31, 2021, the repo market as 
a whole was valued at approximately $5.8 trillion.\354\ Although a 
large portion of this activity is cleared by FICC, a large portion is 
also not centrally cleared. For 2021, DTCC reported that ``FICC 
matches, nets, settles and risk manages repo transactions valued at 
more than $3T daily.'' \355\ During the first half of 2022, Federal 
Reserve staff estimated that a ``large fraction of primary dealers' 
repo (38 percent) and reverse repo (60 percent) activity is in the 
uncleared bilateral segment.'' \356\ See Figure 9. Although these 
statistics include all collateral types, for the subset of the repo 
market that includes a primary dealer on one side, the Commission has 
more detailed data. As Figures 10 and 11 show, the vast majority of 
uncleared bilateral and tri-party primary dealer repo and reverse repo 
collateral consists of U.S. Treasury securities (including TIPS). The 
largest remaining components of repo (approximately 40 percent) and 
reverse repo activity (approximately 8 percent) are not centrally 
cleared but settle on the triparty platform. This is labeled ``Tri-
Party (excluding GCF)'' in Figure 9, and the degree to which Treasury 
collateral is used in these transactions is displayed in Figure 11. The 
final and by far the smallest component of repo and reverse repo 
activity (amounting to about 2% of activity) is triparty repo using 
FICC's Sponsored GC service.\357\
---------------------------------------------------------------------------

    \353\ SIFMA Research, US Repo Markets: A Chart Book, at 6, 7, 
and 8 (Feb. 2022), available at SIFMA-Research-US-Repo-Markets-
Chart-Book-2022.pdf. Because these are figures for primary dealer 
repo and reverse repo, they need not be equal. In the aggregate, 
however, repo must equal reverse repo.
    \354\ The Financial Accounts of the United States, L.207, line 1 
(Federal Funds and Security Repurchase Agreements) available at 
https://www.federalreserve.gov/releases/z1/20220310/html/l207.htm.
    \355\ DTCC 2021 Annual Report, supra note 343, at 32.
    \356\ 2022 Fed Note, supra note 346.
    \357\ Id.

Figure 9 Repo Clearing 2021-2022

[[Page 64657]]

[GRAPHIC] [TIFF OMITTED] TP25OC22.008

Figure 10 Uncleared Bilateral Repo and Reverse Repo Collateral 2022
[GRAPHIC] [TIFF OMITTED] TP25OC22.009

Figure 11 Tri-party Repo and Reverse Repo Collateral 2022

[[Page 64658]]

[GRAPHIC] [TIFF OMITTED] TP25OC22.010

BILLING CODE 8011-01-C
c. Interdealer Brokers (IDBs)
    Interdealer brokers \358\ and the trading platforms they operate 
play a significant role in the markets for U.S. Treasury securities. As 
previously discussed, an IDB will generally provide a trading facility 
for multiple buyers and sellers for U.S. Treasury securities to enter 
orders at specified prices and sizes and have these orders displayed 
anonymously to all users. When a trade is executed, the IDB then books 
two trades, with the IDB functioning as the principal to each 
respective counterparty, thereby protecting the anonymity of each 
party, but taking on credit risk from each of them. Although there is 
no legal requirement for an IDB to be a FICC direct participant/Netting 
Member, the Commission believes most IDBs are FICC Netting 
Members.\359\ In any event, under FICC's existing rules, if an IDB's 
customer in a U.S. Treasury security transaction is not a FICC member, 
the IDB's transaction with that customer need not be centrally cleared 
and may be bilaterally cleared. As discussed above in section II.A.1, 
each transaction at an IDB is split into two pieces: a leg between the 
buyer and the IDB and a leg between the IDB and the seller. If the 
buyer or seller is a dealer, the respective leg is centrally cleared. 
Transaction legs involving PTFs are generally cleared and settled 
bilaterally.
---------------------------------------------------------------------------

    \358\ As noted previously, IDB is not used to encompass 
platforms that provide voice-based or other non-anonymous methods of 
bringing together buyers and sellers of U.S. Treasury securities. 
IDB instead refers to electronic platforms providing anonymous 
methods of bringing together buyers and sellers.
    \359\ See generally TMPG White Paper, supra note 21. The TMPG 
White Paper assumes throughout that IDBs are CCP direct members 
(e.g., ``More specifically, the IDB platforms themselves and a 
number of platform participants continue to clear and settle through 
the CCP.'' TMPG White Paper at 2.)
---------------------------------------------------------------------------

    TMPG estimates that ``roughly three-quarters of IDB trades clear 
bilaterally.'' \360\ To help visualize the significance of the role 
played by IDBs in the centrally cleared market, and given existing data 
limitations, Table 3, adapted from a table prepared by the TMPG in 
2019, presents five clearing and settlement case types that cover the 
vast majority of secondary market cash trades. The table uses Federal 
Reserve data collected from primary dealers in the first half of 2017 
to estimate the daily volume (dollar and share percentage) attributable 
to each clearing and settlement case type.
---------------------------------------------------------------------------

    \360\ TMPG White Paper, supra note 21, at 2.

Table 3--Estimated Secondary Cash Market Primary Dealer Daily Trading Dollar (Billions) and Percentage Volume by
                                          Clearing and Settlement Type
----------------------------------------------------------------------------------------------------------------
                                                     $ Volume                                         Overall
          Clearing and settlement type               billions      Non-IDB share     IDB share    percentage (%)
----------------------------------------------------------------------------------------------------------------
Bilateral clearing, no IDB......................            $289             95%  ..............            54.3
Central clearing, no IDB........................              15              5%  ..............             2.9
Central clearing, with IDB......................              52  ..............           22.9%             9.8
Bilateral clearing, with IDB....................              73  ..............           31.9%            13.6
Bilateral/central clearing, with IDB............             103  ..............           45.3%            19.4
    Totals......................................            $531    $304 (57.2%)    $228 (42.8%)             100
----------------------------------------------------------------------------------------------------------------
Source: TMPG White Paper on Clearing and Settlement in the Secondary Market for U.S. Treasury Securities (2019),
  adapted from a table at p. 12.
Table 3 Notes: Figures are estimated using the Federal Reserves' Form FR2004 data for the first half of 2017 and
  are based on the following assumptions: (a) primary dealers account for all dealer activity, (b) 5% of
  dealers' trading not through an IDB is with another dealer, (c) the shares of dealer and non-dealer activity
  in the IDB market for coupon securities equal the weighted averages of the shares reported in the October 15
  report (that is, 41.5% and 58.5%, respectively), (d) only dealers trade bills, FRNs, and TIPS in the IDB
  market, and (e) the likelihood of dealer and non-dealers trading with one another in the IDB market solely
  reflects their shares of overall volume. The table presents estimates because precise information is not
  available on the size of the market or on how activity breaks down by the method of clearing and settlement.


[[Page 64659]]

d. Other Market Participants
i. FICC Sponsored Members
    As discussed previously, some institutional participants that are 
not FICC Netting Members/FICC direct participants are able to centrally 
clear repos through FICC's Sponsored Service.\361\ The Sponsored 
Service allows eligible direct participants (Sponsoring Members) to (i) 
sponsor their clients into a limited form of FICC membership (Sponsored 
Members) and then (ii) submit certain eligible client securities 
transactions for central clearing. If adopted, the Membership Proposal 
could affect Sponsored Members. FICC interacts solely with the 
Sponsoring Member/direct participant as agent. Sponsoring Members 
guarantee to FICC the payment and performance obligations of its 
Sponsored Members.\362\ Following FICC's expansion in 2021 of its 
Sponsored Service to allow Sponsored Members to clear triparty repos 
through the program,\363\ there are now approximately 30 Sponsoring 
Members and approximately 1,900 Sponsored Members \364\ with access to 
central clearing. During the 12 month period ending on August 9, 2022, 
the total dollar value of Sponsored Members' daily repo and reverse 
repo activity ranged from a high of $415.8 billion on December 31, 2021 
to a low of $230.2 billion on October 21, 2021.\365\
---------------------------------------------------------------------------

    \361\ FICC's Sponsored Member program also allows the submission 
of cash transactions; however, as previously noted, the service is 
generally used only for U.S. Treasury repo transactions at this 
time.
    \362\ See FICC's GSD Rule 3A, supra note 47. Sponsored Members 
have to be Securities Act Rule 144A ``qualified institutional 
buyers,'' or otherwise meet the financial standards necessary to be 
a ``qualified institutional buyer.'' See id., Rule 3A, section 3(a).
    \363\ See Self-Regulatory Organizations; Fixed Income Clearing 
Corporation; Order Approving a Proposed Rule Change to Expand 
Sponsoring Member Eligibility in the Government Securities Division 
Rulebook and Make Other Changes, Exchange Act Release No. 85470 
(Mar. 29, 2019), supra note 126.
    \364\ See FICC Membership Directories (``FICC Membership''), 
available at https://www.dtcc.com/client-center/ficc-gov-directories. As of Dec. 31, 2021, DTCC reported that FICC had 30 
sponsoring members and over 1,800 sponsored members. DTCC 2021 
Annual Report, supra note 343, at 19.
    \365\ This information was available from DTCC on the 1 year 
version of the FICC Sponsored Activity chart as of Aug. 12, 2022, 
available at: https://www.dtcc.com/charts/membership.
---------------------------------------------------------------------------

    Among the various types of financial firms that are Sponsored 
Members are (i) over 1,400 funds, including a number of hedge funds, 
many money market funds, other mutual funds, and a smaller number of 
ETFs; \366\ (ii) banks, including a small number of national, regional 
Federal Home Loan Banks, and international banks; and (iii) other asset 
managers including a few insurance companies.\367\
---------------------------------------------------------------------------

    \366\ For various persons, direct participation in FICC may not 
be an alternative to the Sponsored Membership program. For example, 
``[a] subset of market participants, such as certain money market 
funds, face legal obstacles to joining FICC because they are 
prohibited from mutualizing losses from other clearing members in 
the way that FICC rules currently require.'' Chicago Fed Insights, 
supra note 204.
    \367\ FICC Membership, supra note 364.
---------------------------------------------------------------------------

ii. Other Market Participants That Are Not FICC Sponsored Members
    In addition to Sponsored Members, various types of direct and 
indirect market participants hold significant amounts of U.S. Treasury 
securities and repo, and potentially purchase and sell U.S. Treasury 
securities in the secondary cash and repo markets. To the extent that 
these persons engage in secondary market transactions, we expect their 
trading may be affected by increased central clearing resulting from 
the adoption of the Proposal. The most prominent examples are:
1. Hedge Funds, Family Offices, and Separately Managed Accounts
    Hedge funds are active participants in the secondary market for 
U.S. Treasury securities and their trading activities have been shown 
to be a cause of price movements in the U.S. Treasury securities 
market.\368\ Hedge funds can use U.S. Treasury securities, for example, 
in order to borrow cash to take leveraged positions in other markets, 
or to execute complex trading strategies. As of December 31, 2021 
approximately 25 percent of qualifying hedge funds reporting on Form PF 
\369\ reported U.S. Treasury securities holdings totaling $1.76 
trillion in notional exposure in the cash market and $2.25 trillion in 
notional exposure to repos.\370\ For Large Hedge Fund Advisers (LHFA) 
\371\ reporting on Form PF for the same period, monthly turnover in 
U.S. Treasury securities was $3.4 trillion.
---------------------------------------------------------------------------

    \368\ Ron Alquist & Ram Yamarthy, Hedge Funds and Treasury 
Market Price Impact: Evidence from Direct Exposures, OFR Working 
Paper 22-05 (Aug. 23, 2022) (``find[ing] economically significant 
and consistent evidence that changes in aggregate hedge fund 
[Treasury] exposures are related to Treasury yield changes [and] . . 
. that particular strategy groups and lower-levered hedge funds 
display a larger estimated price impact on Treasuries.''), available 
at https://www.financialresearch.gov/working-papers/files/OFRwp-22-05-hedge-funds-and-treasury-market-price-impact.pdf.
    \369\ For an explanation of qualifying hedge funds, see supra 
note 148. Although the Proposal would cover any hedge fund, smaller 
funds holdings are not reflected in these statistics because of Form 
PF's minimum $150 million reporting threshold. An adviser must file 
Form PF if (1) it is registered (or required to register) with the 
Commission as an investment adviser, including if it also is 
registered (or required to register) with CFTC as a commodity pool 
operator or commodity trading adviser, (2) it manages one or more 
private funds, and (3) the adviser and its related persons, 
collectively had at least $150 million in private fund assets under 
management as of the last day of its most recently completed fiscal 
year. See Form PF General Instruction No. 1, available at https://www.sec.gov/files/formpf.pdf.
    \370\ Division of Investment Management Analytics Office, 
Private Funds Statistics Fourth Calendar Quarter 2021, Table 46 at 
39 (July 22, 2022), available at https://www.sec.gov/divisions/investment/private-funds-statistics/private-funds-statistics-2021-q4.pdf.
    \371\ Large hedge fund advisers reporting on Form PF ``have at 
least $1.5 billion in hedge fund assets under management.'' See Id. 
at 61.
---------------------------------------------------------------------------

    Family offices are entities established by families to manage 
family wealth.\372\ Family offices tend to exhibit behavior and have 
objectives that are similar to those of hedge funds including the use 
of leverage, aggressive investment strategies, and holding illiquid 
assets. A recent survey of family offices undertaken by RBC \373\ found 
that of 385 participating family offices around the world, almost half 
(46%) are based in North America. Average family office AUM for North 
American families was $1 billion.
---------------------------------------------------------------------------

    \372\ ``Historically, most family offices have not been 
registered as investment advisers under the Advisers Act because of 
the `private adviser exemption' provided under the Advisers Act to 
firms that advice fewer than fifteen clients and meet certain other 
conditions.'' SEC Staff, Family Office: A Small Entity Compliance 
Guide, available at https://www.sec.gov/rules/final/2011/ia-3220-secg.htm.
    \373\ Campden Wealth and The Royal Bank of Canada, The North 
America Family Office Report (2021), available at: https://www.rbcwealthmanagement.com/_assets/documents/cmp/the-north-america-family-office-report-2021-final-ua.pdf.
---------------------------------------------------------------------------

    Similarly, Separately Managed Accounts (SMAs) are also portfolios 
of assets managed by an investment adviser, usually targeted towards 
wealthy individual investors. Because of the end investor's risk 
tolerance, SMAs can also pursue aggressive, leveraged strategies.

[[Page 64660]]

2. Registered Investment Companies (RICs) Including Money Market Funds, 
Other Mutual Funds, and ETFs
    RICs, mainly money market funds, mutual funds, and ETFs, are large 
holders of U.S. Treasury securities.\374\ At the end of the first 
quarter of 2022, money market funds held $1.8 trillion of U.S. Treasury 
securities ($1.2 trillion in T-Bills and $603.9 billion in other U.S. 
Treasury securities).\375\ Mutual funds held an additional $1.5 
trillion of other U.S. Treasury securities ($34.1 billion of T-Bills 
and $1.5 trillion of other U.S. Treasury securities) while exchange-
traded funds held an additional $334.1 billion in U.S. Treasury 
securities.\376\ The degree to which these entities would be affected 
depends on the extent to which their trading is likely to take place in 
the secondary market.\377\
    RICs are also active participants in the repo market with money 
market funds being active cash investors. According to data filed with 
the Commission, money market funds investments in U.S. Treasury repo, 
both bilateral and triparty, amounted to approximately $2.3 trillion in 
June 2022. Moreover, as shown in Figure 12, money market fund U.S. 
Treasury repo volume has grown from approximately $200 billion monthly 
in 2011 with the vast majority of the most recent year's growth 
attributed to investments in the Federal Reserve's repo facility.\378\
---------------------------------------------------------------------------

    \374\ Investment companies are the third largest holder of U.S. 
Treasury securities holding just under $3.6 trillion. MMFs in the 
Treasury Market, supra note 128, at 3 (citing to Financial Accounts 
of the United States as of Mar. 2022). The other large (over 5 
percent) holders are: ``other'' holders (including hedge funds) 30 
percent, the Federal Reserve (23 percent), pension funds (14 
percent), and U.S. banks and state and local governments (each 
holding 6 percent). See id. at 2 (figure 5).
    \375\ Federal Reserve Statistical Release, Z.1 Financial 
Accounts of the U.S, Flow of Funds, Balance Sheets, and Integrated 
Macroeconomic Accounts, at 119 (L210 Treasury Securities--lines 42-
49) (``Financial Accounts of the U.S.''), available at: https://www.federalreserve.gov/releases/z1/20220609/z1.pdf.
    \376\ Id. at 119 (L210 Treasury Securities--lines 45-47 and 49).
    \377\ For example, an analysis of money market fund portfolios' 
turnover of U.S. Treasury securities by the Commission staff 
indicates only limited secondary market trading activity. Recently 
published estimates based on monthly filings of Form N-MFP suggest 
that, on average, money market funds hold around 70 percent of U.S. 
Treasury securities to the next month with around 6 percent of U.S. 
Treasury securities holdings disposed of before maturity. The 
remaining approximately 23 percent of holdings mature during the 
month. MMFs in the Treasury Market, supra note 128, at 3. These 
estimates suggest that the proposal's effect on money market fund 
cash market transactions in U.S. Treasury securities will be very 
limited relative the proposal's effects on money market funds' repo 
activities which could be more significant.
    \378\ Id. at 4. The Commission understands the credit rating 
agencies consider concentration of counterparty credit risk as one 
factor in determining their rating of money market funds which may 
drive money market funds to seek diversification of counterparties 
for the repo transactions.
---------------------------------------------------------------------------

Figure 12: Money Market Fund Monthly Repo Volume (01/2011-06/2022)
[GRAPHIC] [TIFF OMITTED] TP25OC22.011

    For RICs, holdings of U.S. Treasury securities play an important 
role in managing liquidity risk stemming from potential redemptions. 
Given their highly liquid nature, U.S. Treasury securities can be used 
to raise cash to meet redemptions. For example, a survey conducted by 
an industry group showed that in the first quarter of 2020 RICs had net 
sales of $128 billion in Treasury and agency bonds, mainly to meet 
redemption requests at the onset of the Covid-19 pandemic.\379\
---------------------------------------------------------------------------

    \379\ See Shelly Antoniewicz & Sean Collins, Setting the Record 
Straight on Bond Mutual Funds' Sales of Treasuries, Investment 
Company Institute Viewpoints (Feb. 24, 2022), available at https://www.ici.org/viewpoints/22-view-bondfund-survey-2.
---------------------------------------------------------------------------

    In addition to reliance on Treasury securities as sources of 
liquidity, RICs use Treasury securities as collateral for borrowing in 
the repo market as another source of liquidity. Also, RICs accept 
Treasury securities as collateral in their securities lending programs 
established to an additional source of income for the fund 
shareholders.

[[Page 64661]]

3. Principal Trading Firms (PTFs)
    The role and importance of PTFs providing liquidity in the U.S. 
Treasury securities market have been the subject of a number of 
analyses and reports in recent years.\380\ For example, using FINRA's 
Regulatory TRACE data in connection with a recent rulemaking proposal, 
we identified 174 market participants who were active in the U.S. 
Treasury securities market in July 2021 and that were not members of 
FINRA.\381\ We ``found that these participants accounted for 
approximately 19 percent of the aggregate U.S. Treasury security 
trading volume [], with PTFs representing the highest volumes of 
trading among these participants.'' \382\ We explained that in our 
analysis
---------------------------------------------------------------------------

    \380\ See, e.g., G-30 Report, supra note 5, at 1; Joint Staff 
Report, supra note 4, at 3-4, 36, 55 (``PTFs now account for more 
than half of the trading activity in the futures and electronically 
brokered interdealer cash markets.''); Harkrader and Puglia FEDS 
Note, supra note 304; Doug Brain, et al., FEDS Notes, ``Unlocking 
the Treasury Market Through TRACE'' (Sept. 28, 2018), available at 
https://www.federalreserve.gov/econres/notes/feds-notes/unlocking-the-treasury-market-through-trace-20180928.htm. See also Ryan and 
Toomey Blog Part III, supra note 31 (While in the interdealer cash 
market, U.S. Treasury securities are often cleared and settled 
through FICC, ``dealer trades with principal trading firms 
(``PTFs'')--a very large share of this market--are generally cleared 
bilaterally because most PTFs are not members of the FICC.''). See 
also IAWG Report, supra note 4, at 21 (``on February 25, 2021, a 
large shift in investor sentiment triggered very high trading 
volumes [] that temporarily overwhelmed the intermediation capacity 
of the Treasury market. . . . . Some market participants observed 
that the stresses on February 25, 2021, were exacerbated by lack of 
elasticity in liquidity supply resulting from activity limits that 
IDB platforms impose on some firms, especially PTFs that do not 
participate in central clearing.'').
    \381\ Further Definition of ``As a Part of a Regular Business'' 
in the Definition of Dealer and Government Securities Dealer, 
Exchange Act Rel. No. 94524 (Mar. 28, 2022), 87 FR 23054, 23072, and 
23080 (Apr. 18, 2022) (``Because regulatory TRACE data pertaining to 
Treasury securities reported by certain ATSs contains the identity 
of non-FINRA member trading parties, we are able to analyze PTFs' 
importance in the U.S. Treasury market during July 2021 and 
summarize the number and type of market participants by monthly 
trading volume . . . .''). ``Although FINRA membership is not 
synonymous with dealer registration status, the Commission believes 
that many of the market participants who are not FINRA members are 
also likely not registered as government securities dealers.'' Id. 
at 23072 n. 167.
    \382\ Id. at 23072.

    PTFs had by far the highest volumes among identified non-FINRA 
member participants in the U.S. Treasury market, and the largest 
PTFs had trading volumes that were roughly comparable to the volumes 
of the largest dealers. A Federal Reserve staff analysis found that 
PTFs were particularly active in the interdealer segment of the U.S. 
Treasury market in 2019, accounting for 61 percent of the volume on 
[electronic] interdealer broker platforms . . . .\383\
---------------------------------------------------------------------------

    \383\ Id. at 23080. Harkrader and Puglia FEDS Note, supra note 
304. See also FEDS Notes, Unlocking the Treasury Market Through 
TRACE (Sept. 28, 2018). Harkrader and Puglia used FINRA TRACE data 
on the trading volume shares of different participant types on IDB 
platforms for nominal coupon securities from April 1, 2019 to 
December 31, 2019. They identified $191 billion of average daily 
dollar volume on electronic/automated IDB platforms during the 
period. They also noted data limitations, which they estimated 
amounted to ``a very small fraction of total activity.'' Id.

    Based on this Federal Reserve study and assuming that all PTFs are 
not FICC members and that PTF trading on IDB electronic platforms 
during the final three quarters 2019 was a reasonable proxy for the 
average daily current volume of such trading today by PTFs, the 
Membership Proposal would subject as much as approximately $116.51 
billion per day in PTF trades on electronic/automated IDBs to central 
clearing.\384\
---------------------------------------------------------------------------

    \384\ Harkrader and Puglia FEDS Note, supra note 304, at table 1 
(61% of $191 billion = $116.51 billion).
---------------------------------------------------------------------------

4. State and Local Governments
    State and local governments are significant holders of U.S. 
Treasury securities. As of March 2022, state and local governments held 
approximately $1.5 trillion in U.S. Treasury securities \385\ as part 
of their budgetary and short-term investment duties.
---------------------------------------------------------------------------

    \385\ Financial Accounts of the U.S., supra note 375 (Line 19).
---------------------------------------------------------------------------

    5. Private Pensions Funds and Insurance Companies.
    Insurance companies and pension funds also have significant 
positions in U.S. Treasury securities. As of March 2022, private 
pension funds and insurance companies are large holders of U.S. 
Treasury securities, holding $5.6 trillion and $374.8 billion 
respectively.\386\
---------------------------------------------------------------------------

    \386\ Id. (Lines 29, 32, and 35).
---------------------------------------------------------------------------

e. Triparty Agent: Bank of New York Mellon \387\
---------------------------------------------------------------------------

    \387\ Paddrik, et al., supra note 273 (``The Federal Reserve 
Board, through the Federal Reserve Bank of New York (FRBNY), 
supervises triparty custodian banks and, on a mandatory basis 
pursuant to its supervisory authority, collects transaction-level 
data at the daily frequency.'').
---------------------------------------------------------------------------

    Although triparty repo transactions are bilaterally negotiated, 
they are settled through BNY Mellon, which currently plays a central 
role in the triparty repo market as the sole triparty agent.\388\ 
Besides providing collateral valuation, margining, and management 
services, BNY Mellon also provides back-office support to both parties 
by settling transactions on its books and confirming that the terms of 
the repo are met. Additionally, the clearing bank acts as custodian for 
the securities held as collateral and allocates collateral to trades at 
the close of the business day. As discussed previously, FICC recently 
introduced the Sponsored GC Service that extends FICC's GCF repo 
service to allow for the clearing of triparty repo.\389\
---------------------------------------------------------------------------

    \388\ J.P. Morgan Chase previously served as a custodian in the 
triparty space but largely exited the market in 2019. Id. at 2-3.
    \389\ See supra note 66 and accompanying discussion.
---------------------------------------------------------------------------

    An expansion of central clearing under the Membership Proposal 
could affect BNY Mellon's triparty business. It is, however, unclear 
whether increased central clearing would increase or decrease the 
amount of repo traded that makes use of triparty agent's services 
previously described.
f. Custodian Banks/Fedwire Securities Service (FSS)
    Currently, custodian banks handle much of the trading activity for 
long-only buy-side clients in the U.S. Treasury securities cash and 
repo markets. When an asset buyer and seller engage bilaterally as 
principals in a collateralized securities transaction, a repo for 
example, a custodian bank will often provide various services to 
support the transaction. Custodian services include transaction 
settlement verification, verifying the amount of the relevant credit 
exposure, calculating required initial and variation margin, and making 
margin calls. In a tri-party repo transaction that isn't centrally 
cleared, a custodian perform a clearing function by settling the 
transaction on its own books without a corresponding transfer of 
securities on the books of a central securities depository.\390\
---------------------------------------------------------------------------

    \390\ The Clearing House, The Custody Services of Banks (July 
2016) available at: https://www.davispolk.com/sites/default/files/20160728_tch_white_paper_the_custody_services_of_banks.pdf
---------------------------------------------------------------------------

    FSS, operated by the Federal Reserve Bank system, provides 
issuance, maintenance, transfer and settlement services for all 
marketable U.S. Treasury securities to its 3,800 participants.\391\ For 
example, FSS offers the ability to transfer securities and funds to 
settle secondary-market trades, to facilitate the pledging of 
collateral used to secure

[[Page 64662]]

obligations, and to facilitate repo transactions.\392\
---------------------------------------------------------------------------

    \391\ See Fedwire Securities Service brochure (``FSS 
brochure''), available at: https://www.frbservices.org/binaries/content/assets/crsocms/financial-services/securities/securities-product-sheet.pdf. The Federal Reserve Banks offer highly 
competitive transaction, per-issue and monthly maintenance prices. 
Account maintenance fees are waived for accounts holding only U.S. 
Treasury securities and for certain accounts used to pledge 
securities to the U.S. Treasury and Federal Reserve Banks. Service 
fees are available at FRBservices.org. Fees for services are set by 
the Federal Reserve Banks. A 2022 fee schedule is available at: 
https://www.frbservices.org/resources/fees/securities-2022
    \392\ FSS brochure, supra note 391.
---------------------------------------------------------------------------

C. Analysis of Benefits, Costs, and Impact on Efficiency, Competition, 
and Capital Formation

1. Benefits
    The proposed amendments would likely yield benefits associated with 
increased levels of central clearing in the secondary market for U.S. 
Treasury securities. The Commission previously has stated that 
registered clearing agencies that provide CCP services both reduce 
trading costs and help increase the safety and efficiency of securities 
trading.\393\ These benefits could be particularly significant in times 
of market stress, as CCPs would mitigate the potential for a single 
market participant's failure to destabilize other market participants, 
destabilize the financial system more broadly, and/or reduce the 
effects of misinformation and rumors.\394\ A CCP also would address 
concerns about counterparty risk by substituting the creditworthiness 
and liquidity of the CCP for the creditworthiness and liquidity of 
counterparties.\395\ Further, the Commission has recognized that ``the 
centralization of clearance and settlement activities at covered 
clearing agencies allows market participants to reduce costs, increase 
operational efficiency, and manage risks more effectively.'' \396\ 
However, the Commission has also recognized that this centralization of 
activity at clearing agencies makes risk management at such entities a 
critical function.\397\
---------------------------------------------------------------------------

    \393\ See supra note 7.
    \394\ See supra note 8.
    \395\ Id.
    \396\ See supra note 10.
    \397\ Id.
---------------------------------------------------------------------------

    Bilateral clearing arrangements do not allow for multilateral 
netting of obligations, which reduce end-of-day settlement 
obligations.\398\ Larger gross settlement obligations, which increase 
with leverage, increase operational risks and subsequently the 
possibility of settlement fails. Central clearing of transactions nets 
down gross exposures across participants, which reduces firms' 
exposures while positions are open, and reduces the magnitude of cash 
and securities flows required at settlement.\399\ These reductions, 
particularly in cash and securities flow ``would reduce liquidity risks 
associated with those settlements and counterparty credit risks 
associated with failures to deliver on the contractual settlement 
date,'' not only for CCP members but for the CCP itself.\400\
---------------------------------------------------------------------------

    \398\ See section IV.A.1, supra for a discussion of central 
clearing and the mitigation of clearance and settlement risks.
    \399\ See IAWG Report, supra note 4, at 30.
    \400\ See G-30 Report, supra note 5, at 13, supra note 5; see 
also PIFS Paper, supra note 120, at 28-31.
---------------------------------------------------------------------------

    It has been suggested that wider central clearing could have 
lowered dealers' daily settlement obligations in the cash market by up 
to 60 percent in the run-up to and aftermath of the March 2020 U.S. 
Treasury securities market disruption and reduced settlement 
obligations by up to 70 percent during the disruption itself.\401\ The 
reduction in exposure is not limited to the cash market; it has been 
estimated that the introduction of central clearing for dealer-to-
client repos would have reduced dealer exposures from U.S. Treasury 
repos by over 80% (from $66.5 billion to $12.8 billion) in 2015.\402\
---------------------------------------------------------------------------

    \401\ Id. See also Michael Fleming & Frank Keane, Netting 
Efficiencies of Marketwide Central Clearing (Staff Report No. Staff 
Report No. 964), FEDERAL RESERVE BANK OF NEW YORK (Apr. 2021), 
available at https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr964.pdf.
    \402\ PIFS Paper, supra note 120, at 29 (citing OFFICE OF 
FINANCIAL RESEARCH, Benefits and Risks of Central Clearing in the 
Repo Market, 5-6 (Mar. 9, 2017), available at https://www.financialresearch.gov/briefs/files/OFRBr_2017_04_CCP-for-Repos.pdf).
---------------------------------------------------------------------------

    The benefits of multilateral netting flowing from central clearing 
can improve market safety by lowering exposure to settlement 
failures.\403\ Multilateral netting can also reduce the regulatory 
capital required to support a given level of intermediation activity 
\404\ and could also enhance capacity to make markets during normal 
times and stress events because existing bank capital and leverage 
requirements recognize the risk-reducing effects of multilateral 
netting of trades that CCP clearing accomplishes.\405\ By reducing the 
level or margin required to support a given total level of trading 
activity, central clearing may reduce total risk to the system. 
Financial crises are sometimes precipitated by margin calls following a 
period of increased volatility. If a market participant holds 
offsetting positions, then margin calls that might occur could be 
avoided. Because financial markets are forward-looking, reducing the 
anticipation of margin calls on other market participants can avoid 
costly ``bank-run'' type dynamics.\406\
---------------------------------------------------------------------------

    \403\ Duffie, supra note 186, at 15.
    \404\ See section IV.A.2, supra for an example of how 
multilateral netting can reduce margin required to support a given 
level of trading activity.
    \405\ See IAWG Report, supra note 4, at 30; Liang & Parkinson, 
supra note 32, at 9; Duffie, supra note 186, at 16-17. It is 
important to note that this netting may offset any potentially 
higher liquidity charges faced by major participants from clearing 
at the CCP. See Duffie, supra note 186, at 17 (``To the contrary, 
the netting of most purchases against sales at a CCP would lower the 
overall liquidity requirements of dealers, assuming that dealers 
continue to intermediate the market effectively.'').
    \406\ See Menkveld and Vuillemey, 2021, Annual Review of 
Financial Economics.
---------------------------------------------------------------------------

    Some benefits associated with capital reductions are particularly 
relevant for overnight and term repo. In the case of financing activity 
in U.S. Treasury securities market--U.S. Treasury repo--the entire 
notional value of the position has to be recorded on a dealer's balance 
sheet as soon as the start leg of the repo settles, and unless the 
dealer faces off against the exact same legal counterparty with respect 
to an offsetting financing trade of the same tenor, the dealer will not 
be able to net such balance sheet impact against any other position. 
The grossing up of the dealer's balance sheet in this manner can have 
implications with respect to the amount of capital the dealer is 
required to reserve against such activity. When transactions are 
cleared through a CCP, dealers can offset their centrally cleared repo 
positions of the same tenor, and thereby free up their capital to 
increase funding capacity to the market.\407\ According to research 
that Finadium conducted among repo dealers, netting can compress High 
Quality Liquid Asset (HQLA) bilateral trading books by 60% to 80%.\408\
---------------------------------------------------------------------------

    \407\ The positive impact on dealer's ability to increase 
funding capacity will be offset, in part, by the direct and indirect 
costs of central clearing. See id. and section C.2 infra.
    \408\ Finadium LLC, Netting Rules for Repo, Securities Lending 
and Prime Brokerage (Sept. 2014). Assets are considered to be HQLA 
if they can be easily and immediately converted into cash at little 
or no loss of value. The test of whether liquid assets are of ``high 
quality'' is that, by way of sale or repo, their liquidity-
generating capacity is assumed to remain intact even in period of 
severe idiosyncratic and market stress. See https://www.bis.org/basel_framework/chapter/LCR/30.htm?tldate=20191231&inforce=20191215.
---------------------------------------------------------------------------

    Cash and repo trades cleared and settled outside of a CCP may not 
be subject to the same level of uniform and transparent risk management 
associated with central clearing.\409\ By contrast, FICC is subject to 
the Commission's risk management requirements addressing financial, 
operational, and legal risk management, which include, among other 
things, margin requirements commensurate with the risks and particular 
attributes of each relevant product, portfolio, and market.\410\ As the 
Commission believes that this proposal will incentivize and facilitate 
additional central clearing in the U.S. Treasury

[[Page 64663]]

securities market, risk management should improve. To offset the risks 
it faces as a central counterparty, the CCP requires its members to 
post margin, and the CCP actively monitors the positions its members 
hold. Moreover, in the event that the posted margin is not enough to 
cover losses from default, the CCP has a loss-sharing procedure that 
mutualizes loss among its members.
---------------------------------------------------------------------------

    \409\ See TMPG Repo White Paper, supra note 118, at 1. See also 
section IV.B.5, supra.
    \410\ G-30 Report, supra note 5, at 13; 17 CFR 240.17Ad-
22(e)(6).
---------------------------------------------------------------------------

    By lowering counterparty risk, central clearing also allows for the 
``unbundling'' of counterparty risk from other characteristics of the 
asset that is being traded. This unbundling makes the financial market 
for Treasury securities more competitive.\411\
---------------------------------------------------------------------------

    \411\ ``One of the conditions for a perfectly competitive market 
is that [market participants] are happy to [buy or sell] from any of 
the many [sellers or buyers] of the [asset]. No [buyer or seller] of 
the [asset] has any particular advantage . . .'' David M. Kreps, ``A 
Course in Microeconomic Theory'' Princeton University Press (1990), 
at 264 (describing the conditions of a perfectly competitive 
market.) When the transaction is novated to the CCP, market 
participants substitute the default risk of the CCP for that of the 
original counterparty.
---------------------------------------------------------------------------

    The Commission also believes that this proposal would help avoid a 
potential disorderly default by a member of any U.S. Treasury 
securities CCA. Defaults in bilaterally settled transactions are likely 
to be disorganized and subject to variable default management 
techniques, often subject to bilaterally negotiated contracts with 
little uniformity. Independent management of bilateral credit risk 
creates uncertainty about the levels of exposure across market 
participants and may make runs more likely; any loss stemming from 
closing out the position of a defaulting counterparty is a loss to the 
non-defaulting counterparty and hence a reduction in its capital in 
many scenarios.\412\
---------------------------------------------------------------------------

    \412\ See TMPG White Paper, supra note 21, at 32.
---------------------------------------------------------------------------

    Increased use of central clearing should enhance regulatory 
visibility in the critically important U.S. Treasury securities market. 
Specifically, central clearing increases the transparency of settlement 
risk to regulators and market participants, and in particular allows 
the CCP to identify concentrated positions and crowded trades, 
adjusting margin requirements accordingly, which should help avoid 
significant risk to the CCP and to the system as a whole.\413\
---------------------------------------------------------------------------

    \413\ Duffie, supra note 186, at 15; DTCC October 2021 White 
Paper, supra note 203, at 1; IAWG Report, supra note 4.
---------------------------------------------------------------------------

    As discussed further below, the Commission is unable to quantify 
certain economic benefits and solicits comment, including estimates and 
data from interested parties, that could help inform the estimates of 
the economic effects of the proposal.
a. U.S. Treasury Securities CCA Membership Requirements
    The Commission is proposing to amend Rule 17Ad-22(e)(18) to require 
any covered clearing agency that provides central counterparty services 
for transactions in U.S. Treasury securities to establish written 
policies and procedures reasonably designed to, as applicable, require 
that direct participants of a covered clearing agency submit all 
eligible secondary market U.S. Treasury securities transactions in 
which they enter for clearing at a covered clearing agency.\414\ As 
previously explained in section III.A.2 supra, an eligible secondary 
market transaction in U.S. Treasury securities would be defined to 
include: (1) repurchase agreements and reverse repurchase agreements in 
which one of the counterparties is a direct participant; (2) any 
purchases and sales entered into by a direct participant that is an 
interdealer broker, meaning if the direct participant of the covered 
clearing agency brings together multiple buyers and sellers using a 
trading facility (such as a limit order book) and is a counterparty to 
both the buyer and seller in two separate transactions; (3) any 
purchases and sales of U.S. Treasury securities between a direct 
participant and a counterparty that is either a registered broker-
dealer, government securities dealer, or government securities broker; 
a hedge fund; \415\ or an account at a registered broker-dealer, 
government securities dealer, or government securities broker where 
such account may borrow an amount in excess of one-half of the net 
value of the account or may have gross notional exposure of the 
transactions in the account that is more than twice the net value of 
the account.\416\ However, any transaction (both cash transactions and 
repos) where the counterparty to the direct participant of the CCA is a 
central bank, sovereign entity, international financial institution, or 
a natural person would be excluded from the definition of an eligible 
secondary market transaction.
---------------------------------------------------------------------------

    \414\ See supra section III.A.
    \415\ For the purpose of the proposed rule, a hedge fund is 
defined as any private fund (other than a securitized asset fund): 
(a) with respect to which one or more investment advisers (or 
related persons of investment advisers) may be paid a performance 
fee or allocation calculated by taking into account unrealized gains 
(other than a fee or allocation the calculation of which may take 
into account unrealized gains solely for the purpose of reducing 
such fee or allocation to reflect net unrealized losses); (b) that 
may borrow an amount in excess of one-half of its net asset value 
(including any committed capital) or may have gross notional 
exposure in excess of twice its net asset value (including any 
committed capital); or (c) that may sell securities or other assets 
short or enter into similar transactions (other than for the purpose 
of hedging currency exposure or managing duration). This definition 
of a hedge fund is consistent with the Commission's definition of a 
hedge fund in Form PF. See section III.A.2.b (Other Cash 
Transactions), supra.
    \416\ See section III.A.2.b (Other Cash Transactions), supra.
---------------------------------------------------------------------------

    The proposed amendment to Rule 17Ad-22(e)(18) would increase the 
fraction of secondary market U.S. Treasury securities transactions 
required to be submitted for clearing at a covered clearing agency. The 
Commission believes that this would result in achieving the benefits 
associated with an increased level of central clearing discussed in 
section IV.C.1 supra.
i. Scope of the Membership Proposal
    A significant share of both cash and repo transactions in U.S. 
Treasury securities, including those of direct participants in a 
covered clearing agency, are not currently centrally cleared.\417\ The 
Commission believes that covered clearing agency members not centrally 
clearing cash or repo transactions in U.S. Treasury securities creates 
contagion risk to CCAs clearing and settling such transactions, as well 
as to the market as a whole and that this contagion risk can be 
ameliorated by centrally clearing such transactions.
---------------------------------------------------------------------------

    \417\ See DTCC May 2021 White Paper, supra note 135, at 5; IAWG 
Report, supra note 4, at 6.
---------------------------------------------------------------------------

    Currently, FICC, the only U.S. Treasury securities CCA, requires 
its direct participants to submit for central clearing their cash and 
repo transactions in U.S. Treasury securities with other members.\418\ 
However, FICC's rules do not require its direct participants, such as 
IDBs, to submit either cash or repo transactions \419\ with persons who 
are not FICC members for central clearing.
---------------------------------------------------------------------------

    \418\ See note 101 supra.
    \419\ With regard to Sponsored GC Repos, see note 102.
---------------------------------------------------------------------------

    The expanded scope of the Membership Proposal would reduce 
instances of ``hybrid'' clearing, where FICC lacks visibility on the 
bilaterally cleared component of a trade. As previously mentioned in 
section II.A.1 supra, trades cleared and settled outside of a CCP may 
not be subject to the same level of risk management associated with 
central clearing, which includes requirements for margin determined by 
a publicly disclosed method that applies objectively and uniformly to 
all members of the CCP, loss mutualization, and liquidity risk 
management.\420\ The Membership Proposal would not only result in the 
consistent and transparent application of risk management

[[Page 64664]]

requirements to trades that are now bilaterally cleared but would also 
increase the CCA's awareness of those trades, which it now lacks.\421\
---------------------------------------------------------------------------

    \420\ IAWG Report, supra note 4, at 30; G-30 Report, supra note 
5.
    \421\ See supra note 258.
---------------------------------------------------------------------------

ii. Application of the Membership Proposal to Repo Transactions
    The Commission proposes to require that all direct participants of 
a U.S. Treasury securities CCA submit for clearing all eligible 
secondary market transactions that are repurchase agreements or reverse 
repurchase agreements. As discussed in section IV.B.5, supra risk 
management practices in the bilateral clearance and settlement of repos 
are not uniform across market participants and are less transparent 
than analogous practices under central clearing.\422\
---------------------------------------------------------------------------

    \422\ TMPG Repo White Paper, supra note 123, at 1.
---------------------------------------------------------------------------

    The benefits of central clearing--including the benefits of 
netting--increase with the fraction of total volume of similar 
transactions submitting for clearing at a CCP. Significant gaps persist 
in the current coverage of transaction data in U.S. Treasury repo.\423\ 
Nonetheless, the Commission understands that, among bilaterally settled 
repo, approximately half was centrally cleared as of 2021.\424\ 
Centrally cleared triparty repo is a relatively new service, and the 
proportion may be smaller. Thus, despite the volume of centrally 
cleared repo transactions as seen in Figure 10 above, and the 
development of services to encompass more types of repo transactions at 
FICC, the Commission understands the volume of repo not currently 
centrally cleared to be substantial. The requirement that all U.S. 
Treasury CCA members submit all eligible repurchase agreements for 
central clearing should increase the fraction of total volume of such 
transactions submitted for central clearing realizing the benefits 
described above in section IV.C.1 supra. In addition, because repo 
participants are generally large, sophisticated market players, the 
requirement for repo transactions will cover a set of market 
participants that already have built most of the necessary processes 
and infrastructure to comply with the rule.
---------------------------------------------------------------------------

    \423\ IAWG Report, supra note 4, at 29.
    \424\ Id. (``Non-centrally cleared bilateral repo represents a 
significant portion of the Treasury market, roughly equal in size to 
centrally cleared repo.'') (citing a 2015 pilot program by the U.S. 
Treasury Department); see also TMPG Repo White Paper, supra note 
118, at 1; Katy Burne, ``Future Proofing the Treasury Market,'' BNY 
Mellon Aerial View, supra note 118, at 7 (noting that 63% of repo 
transactions remain non-centrally cleared according to Office of 
Financial Research data as of Sept. 10, 2021).
---------------------------------------------------------------------------

iii. Application of the Membership Proposal to Purchases and Sales of 
U.S. Treasury Securities
    As discussed above, 68 percent of cash market transactions in U.S. 
Treasury securities are not centrally cleared, and another 19 percent 
of such transactions are subject to so-called hybrid clearing.\425\ The 
Commission has identified certain categories of purchases and sales of 
U.S. Treasury securities that it believes should be part of the 
Membership Proposal, i.e., for which U.S. Treasury securities CCAs 
would be obligated to impose membership rules to require clearing of 
such transactions. The benefits of including these categories are 
described below.
---------------------------------------------------------------------------

    \425\ See supra note 21.
---------------------------------------------------------------------------

    As with repurchase transactions, the general benefits of central 
clearing discussed in section IV.A, supra become greater as the 
fraction of total transaction volume that is centrally cleared 
increases. In other words, there are positive externalities associated 
with broader central clearing. However, unlike in the repo market, the 
Commission is not proposing that all cash market transactions completed 
with a FICC member be centrally cleared.\426\
---------------------------------------------------------------------------

    \426\ The G-30 report recommends an approach to clearing all of 
repo, and some cash trades. See generally G-30 Report, supra note 5.
---------------------------------------------------------------------------

    The Commission understands the set of participants in U.S. Treasury 
securities cash markets to be far broader and more heterogeneous than 
in the repo markets. The cash market has many participants that trade 
in relatively small amounts, whereas the market for repo is dominated 
by larger, more sophisticated institutions. Although difficult to 
quantify precisely, the number of participants is one or more orders of 
magnitude greater in the cash market as compared with the repo market. 
Because the benefits increase with the number and size of transactions, 
whereas the costs have a large fixed component, extending the clearing 
mandate to institutions that are market participants in repo markets 
and a subset of the institutions that are participants in cash markets 
may capture a large fraction of market activity while also capturing 
the most active market participants who may already have some ability 
to connect with the clearing agency and experience with central 
clearing.
a. IDB Transactions
    The Commission proposes that all purchases and sales of U.S. 
Treasury securities entered into by a direct participant of a U.S. 
Treasury securities CCA and any counterparty, if the direct participant 
of the CCA brings together multiple buyers and sellers using a trading 
facility (such as a limit order book) and serves as a counterparty to 
both the purchaser and seller in two separate transactions executed on 
its platform, be subject to the Membership Proposal. This requirement 
would encompass the transactions of those entities serving as IDBs in 
the U.S. Treasury securities market, in that it would cover entities 
that are standing in the middle of transactions between two 
counterparties that execute a trade on the IDB's platform.\427\
---------------------------------------------------------------------------

    \427\ See supra section II.A.1 for further discussion of IDBs 
and their role in the cash market for U.S. Treasury securities.
---------------------------------------------------------------------------

    If adopted, the proposal will result in more central clearing of 
IDB trades. FICC Member IDBs do not take directional positions on the 
securities that trade on the IDB's platform. Consequently, a 
requirement that FICC member IDBs clear all of their trades will give 
FICC better insight into the risk position of its clearing members 
though the elimination of the hybrid clearing transactions mentioned 
above.
    In contrast to other FICC members, FICC members that are also IDBs 
will be required to clear all of their cash trades (and repo, as 
described above). As described in the TMPG White Paper and in the 
recent G-30 report,\428\ IDBs act as central nodes in the system, in 
effect serving as clearing agencies without the regulatory structure of 
clearing agency. Furthermore, the netting benefits to IDBs, as 
described in section IV.c.1 supra are likely to be particularly high, 
because each transaction on an IDB is matched by a transaction on the 
other side. IDBs are sophisticated institutions that have experience 
managing the central clearing of trades as they already centrally clear 
all trades with other FICC members.
---------------------------------------------------------------------------

    \428\ See generally G-30 Report, supra note 5.

---------------------------------------------------------------------------

[[Page 64665]]

    The configuration of counterparty risk presented by hybrid clearing 
allows FICC to manage the risks arising from the IDB-FICC member trade, 
but FICC cannot manage the risks arising from the IDB's offsetting 
trade with its non-FICC member counterparty and the potential 
counterparty credit risk and settlement risk arising to the IDB from 
that trade.\429\ Thus, the IDB is not able to net all of its positions 
for clearing at FICC, and the IDB's positions appear to FICC to be 
directional, which impacts the amount of margin that FICC collects for 
the visible leg of the ``hybrid'' transaction. This lack of visibility 
can increase risk during stress events, when margin requirements 
usually increase. Thus, FICC is indirectly exposed to the IDB's non-
centrally cleared leg of the hybrid clearing transaction, but it lacks 
the information to understand and manage its indirect exposure to this 
transaction. As a result, in the event that the non-FICC counterparty 
were to default to the IDB, causing stress to the IDB, that stress to 
the IDB could be transmitted to the CCP and potentially to the system 
as a whole.\430\ In particular, if the IDB's non-FICC counterparty 
fails to settle a transaction that is subject to hybrid clearing, such 
an IDB may not be able to settle the corresponding transaction that has 
been cleared with FICC, which could lead the IDB to default. As part of 
its existing default management procedures, FICC could seek to 
mutualize its losses from the IDB's default, which could in turn 
transmit stress to the market as a whole.
---------------------------------------------------------------------------

    \429\ See, e.g., TMPG White Paper, supra note 21, at 22 (noting 
that in a hybrid clearing arrangement, an ``IDB's rights and 
obligations towards the CCP are not offset and therefore the IDB is 
not in a net zero settlement position with respect to the CCP at 
settlement date.'').
    \430\ See DTCC May 2021 White Paper, supra note 135, at 5.
---------------------------------------------------------------------------

    The Commission has previously stated that membership requirements 
help to guard against defaults of any CCP member, as well to protect 
the CCP and the financial system as a whole from the risk that one 
member's default could cause others to default, potentially including 
the CCP itself.\431\ Further, contagion stemming from a CCP member 
default could be problematic for the system as a whole, even if the 
health of the CCP is not implicated. This is so because the default 
could cause others to back away from participating in the market. This 
risk of decreased market participation could be particularly acute if 
the defaulting participant were an IDB, whose withdrawal from the 
market could jeopardize other market participants' ability to access 
the market for on-the-run U.S. Treasury securities.\432\ And because 
IDBs facilitate a significant proportion of trading in on-the-run U.S. 
Treasury securities, that is, they form central nodes, such a 
withdrawal could have significant consequences for the market as a 
whole.\433\ The Membership Proposal would therefore help mitigate this 
risk by mandating that a U.S. Treasury securities CCA ensure its IDB 
members clear both sides of their transactions, thereby eliminating the 
various facets of potential contagion risk posed by so-called hybrid 
clearing.
---------------------------------------------------------------------------

    \431\ See supra note 7.
    \432\ TMPG White Paper, supra note 21, at 32.
    \433\ See id.
---------------------------------------------------------------------------

b. Other Cash Transactions
    The Commission has identified additional categories of cash 
transactions of U.S. Treasury securities to include in the membership 
requirements for a U.S Treasury securities CCA that it believes will 
provide the benefits of increased central clearing of U.S. Treasury 
securities transactions described above.
    First, the Commission is proposing that the definition of an 
eligible secondary market transaction includes those cash purchase and 
sale transactions in which the counterparty of the direct participant 
is a registered broker-dealer, government securities broker, or 
dealer.\434\ These entities, by definition, are engaged in the business 
of effecting transactions in securities for the account of others (for 
brokers) or for their own accounts (for dealers). Thus, these entities 
already are participating in securities markets and have identified 
mechanisms to clear and settle their transactions.\435\ More generally, 
many registered brokers and dealers are familiar with transacting 
through introducing brokers who pass their transactions to clearing 
brokers for clearing and settlement.
---------------------------------------------------------------------------

    \434\ 15 U.S.C. 78o(a) and 78o-5(a) (requirement to register) 
and 78c(4), (5), (43), and (44) (definitions).
    \435\ See supra note 218 and referencing text describing several 
methods available to allow market participants to access CCP 
services through a FICC member.
---------------------------------------------------------------------------

    Second, the Commission proposes that transactions between a direct 
participant and hedge funds be included in the Membership Proposal. 
This aspect of the proposal would employ a definition of a hedge fund 
consistent with that in Form PF.\436\
---------------------------------------------------------------------------

    \436\ See supra section III.A.2.b (Other Cash Transactions) for 
a discussion of the definition of hedge fund in the proposed rule 
and its consistency with that in Form PF Glossary of Terms. See also 
note 143.
---------------------------------------------------------------------------

    The proposed requirement seeks to reach funds that are leveraged 
and that may use trading strategies that involve derivatives, complex 
structured products, short selling, high turnover, and/or concentrated 
investments, which may, in turn, present more potential risk to a U.S. 
Treasury securities CCA through a form of the contagion risk discussed 
above. When discussing a proposal using a similar standard to define a 
hedge fund, the Commission recognized that strategies employed by hedge 
funds, in particular high levels of leverage ``can increase the 
likelihood that the fund will experience stress or fail, and amplify 
the effects on financial markets.'' \437\ The Commission also stated 
that ``significant hedge fund failures (whether caused by their 
investment positions or use of leverage or both) could result in 
material losses at the financial institutions that lend to them if 
collateral securing this lending is inadequate. These losses could have 
systemic implications if they require these financial institutions to 
scale back their lending efforts or other financing activities 
generally. The simultaneous failure of several similarly positioned 
hedge funds could create contagion through the financial markets if the 
failing funds liquidate their investment positions in parallel at fire-
sale prices, thereby depressing the mark-to-market valuations of 
securities that may be widely held by other financial institutions and 
investors.'' \438\ Through the central clearing of transactions 
effected by funds and other leveraged accounts, the Commission expects 
to mitigate the risks attendant to a simultaneous failure of hedge 
funds or other similar market participants, thus reducing contagion.
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    \437\ See supra note 145.
    \438\ Id. at 21.
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    Third, the Commission proposes to include within the definition of 
an eligible secondary market transaction subject to the Membership 
Proposal any purchase and sale transaction between a direct participant 
of a U.S. Treasury securities CCA and an account at a registered 
broker-dealer, government securities dealer, or government securities 
broker that either may borrow an amount in excess of one-half of the 
net value of the account or may have gross notional exposure of the 
transactions in the account that is more than twice the net value of 
the account.\439\ As discussed above, the Commission believes that the 
inclusion of transactions with such accounts should allow the proposal 
to encompass transactions between direct participants of a U.S. 
Treasury securities CCA and a

[[Page 64666]]

prime brokerage account, which, based on the Commission's supervisory 
knowledge, may hold assets of private funds and separately managed 
accounts and that may use leverage that poses a risk to U.S. Treasury 
securities CCA and the broader financial system similar to that of 
hedge funds as described above. Covering such accounts would also allow 
for inclusion of, for example, accounts used by family offices or 
separately managed accounts that may use strategies more similar to 
those of a hedge fund.
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    \439\ See supra section III.A.2.b (Other Cash Transactions).
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c. Exclusions From the Membership Proposal
    The Commission is proposing to exclude certain otherwise eligible 
secondary market transactions in U.S. Treasury securities from the 
Membership Proposal. Recognizing the importance of U.S. Treasury 
securities not only to the financing of the United States government, 
but also their central role in the formulation and execution of 
monetary policy and other governmental functions, the Commission is 
proposing to exclude from the Membership Proposal any otherwise 
eligible secondary market transaction in U.S. Treasury securities 
between a direct participant of a U.S. Treasury securities CCA and a 
central bank.\440\ For similar reasons, the Commission is also 
proposing to exclude from the Membership Proposal otherwise eligible 
secondary market transactions in U.S. Treasury securities between a 
direct participant of a U.S. Treasury securities CCA and a sovereign 
entity or an international financial institution.\441\
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    \440\ See supra section III.A.2.c.i for a discussion of the 
proposed definition of a central bank for the purposes of the rule.
    \441\ See supra section III.A.2.c.i for a discussion of the 
proposed definition of sovereign entity and international financial 
institution. See also supra note 160.
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    Although the Commission believes that the benefits of central 
clearing are generally increasing in the fraction of total volume that 
is centrally cleared, it also believes that the Federal Reserve System 
should be free to choose the clearance and settlement mechanisms that 
are most appropriate to effectuating its policy objectives.\442\ 
Further, the Commission believes that the exclusion should extend to 
foreign central banks, sovereign entities and international financial 
institutions for reasons of international comity.\443\ In light of 
ongoing expectations that Federal Reserve Banks and agencies of the 
Federal government would not be subject to foreign regulatory 
requirements in their transactions in the sovereign debt of other 
nations, the Commission believes principles of international comity 
counsel in favor of exempting foreign central banks, sovereign 
authorities, and international institutions.
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    \442\ See supra section III.A.2.c.i for a discussion of the 
activities of Federal Reserve Bank of New York's open market 
operations conducted at the direction of the Federal Open Market 
Committee. See also section IV.B.2, supra.
    \443\ See id. for a discussion of the Commission's belief in the 
principles of international comity.
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    The Commission also proposes to exclude transactions between U.S. 
Treasury CCA members and natural persons from the Membership Proposal. 
The Commission believes that natural persons generally transact in 
small volumes and would not present much, if any, contagion risk to a 
U.S. Treasury securities CCA and therefore, the benefits discussed 
above are unlikely to be important for these transactions.
iv. Policies and Procedures Regarding Direct Participants' Transactions
    The Commission is proposing Rule 17Ad-22(e)(18)(iv)(B) that would 
require that a U.S. Treasury securities CCA establish written policies 
and procedures to identify and monitor its direct participants' 
required submission of transactions for clearing, including, at a 
minimum, addressing a direct participant's failure to submit 
transactions. The Commission believes that such a requirement should 
help ensure that a U.S. Treasury securities CCA adopts policies and 
procedures directed at understanding whether and how its participants 
comply with the policies that will be adopted as part of the Membership 
Proposal requiring the submission of specified eligible secondary 
market transactions for clearing. Without such policies and procedures, 
it would be difficult for the CCA to assess if the direct participants 
are complying with the Membership Proposal.
b. Other Changes to Covered Clearing Agency Standards
    The Commission believes that certain additional changes to its 
Covered Clearing Agency Standards that would apply only to U.S. 
Treasury securities CCAs are warranted to facilitate additional 
clearing. Such changes should help ensure that the U.S. Treasury 
securities CCA can continue to manage the risks arising from more 
transactions from additional indirect participants and to facilitate 
the increased use of central clearing and the accompanying benefits. 
These changes, by making central clearing more efficient for market 
participants, also create incentives for greater use of central 
clearing.
i. Netting and Margin Practices for House and Customer Accounts
    The Commission is proposing amendments to Rule 17Ad-22(e)(6)(i) to 
require a U.S. Treasury securities CCA to establish, implement, 
maintain and enforce written policies and procedures reasonably 
designed to, as applicable, calculate, collect, and hold margin amounts 
from a direct participant for its proprietary U.S. Treasury securities 
positions, separately and independently from margin calculated and 
collected from that direct participant in connection with U.S. Treasury 
securities transactions by an indirect participant that relies on the 
services provided by the direct participant to access the covered 
clearing agency's payment, clearing, or settlement facilities. Such 
changes should allow a U.S. Treasury securities CCA to better 
understand the source of potential risk arising from the U.S. Treasury 
securities transactions it clears and potentially further incentivize 
central clearing.
    In practice, at FICC, clearing a U.S. Treasury securities 
transaction between a direct participant and its customer, i.e., a 
dealer to client trade, would not result in separate collection of 
margin for the customer transaction. Except for transactions submitted 
under the FICC sponsored member program,\444\ FICC margins the 
transactions in the direct participant's (i.e., the dealer's) account 
on a net basis, allowing any of the trades for the participant's own 
accounts to net against trades by the participant's customers.\445\
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    \444\ See supra note 203.
    \445\ DTCC October 2021 White Paper, supra note 203, at 5-6.
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    Under the proposed amendments to Rule 17Ad-22(e)(6)(i), a U.S. 
Treasury securities CCA would be required to establish, implement, 
maintain and enforce written policies and procedures reasonably 
designed to, as applicable, calculate margin amounts for all 
transactions that a direct participant submits to the CCP on behalf of 
others, separately from the margin that is calculated for transactions 
that the direct participant submits on its own behalf. Such policies 
and procedures must also provide that margin collateralizing customer 
positions be collected separately from margin collateralizing a direct 
participant's proprietary positions. Finally, the CCP would also be 
required to have policies and procedures reasonably designed to,

[[Page 64667]]

as applicable, ensure that any margin held for customers or other 
indirect participants of a member is held in an account separate from 
those of the direct participant.
    Because the proposed amendments to Rule 17Ad-22(e)(6)(i) would 
require separating positions in U.S. Treasury securities transactions 
of a direct participant in a U.S. Treasury securities CCA from those of 
customers or other indirect participants, the indirect participants' 
positions, including those submitted outside of the sponsored member 
program, will no longer be netted against the direct participant's 
positions. The indirect participants' positions will be subject to the 
covered clearing agency's risk management procedures, including 
collection of margin specific to those transactions. These changes 
should allow a U.S. Treasury securities CCA to better understand the 
source of potential risk arising from the U.S. Treasury securities 
transactions it clears. In addition, these changes should help avoid 
the risk of a disorderly default in the event of a direct participant 
default, in that FICC would be responsible for the central liquidation 
of the defaulting participant's trades without directly impacting the 
trades of the participant's customers or the margin posted for those 
trades.
    Moreover, the proposed amendments to Rule 17Ad-22(e)(6)(i) should 
result in dealer-to-customer trades gaining more benefits from central 
clearing. Because margin for a direct participant's (i.e., a dealer's) 
trades would be calculated, collected, and held separately and 
independently from those of an indirect participant, such as a 
customer, the direct participant's trades with the indirect participant 
can be netted against the direct participant's position vis-[agrave]-
vis other dealers, which is not currently the case.\446\
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    \446\ Chicago Fed Insights, supra note 204, at 3.
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    Holding margin amounts from a direct participant of a U.S Treasury 
securities CCA separately and independently from those of an indirect 
participant may reduce incentives for indirect participants to trade 
excessively in times of high volatility.\447\ Such incentives exist 
because the customers of a broker-dealer do not always bear the full 
cost of settlement risk for their trades. Broker-dealers incur costs in 
managing settlement risk with CCPs. Broker-dealers can recover the 
average cost of risk management from their customers. However, if a 
particular trade has above-average settlement risk, such as when market 
prices are unusually volatile, it is difficult for broker-dealers to 
pass along these higher costs to their customers because fees typically 
depend on factors other than those such as market volatility that 
impact settlement risk. Holding margin of indirect participants 
separately from direct participants should reduce any such incentives 
to trade more than they otherwise would if they bore the full cost of 
settlement risk for their trades.
---------------------------------------------------------------------------

    \447\ See Sam Schulhofer-Wohl, Externalities in securities 
clearing and settlement: Should securities CCPs clear trades for 
everyone? (Fed. Res. Bank Chi. Working Paper No. 2021-02, 2021).
---------------------------------------------------------------------------

ii. Facilitating Access to U.S. Treasury Securities CCAs
    The various access models currently available to access central 
clearing in the U.S. Treasury securities market may not meet the needs 
of the many different types of market participants who transact in U.S. 
Treasury securities with the direct members of a U.S. Treasury 
Securities CCA. The proposed additional provision to Rule 17Ad-
22(e)(18)(iv)(C) requires a U.S. Treasury securities CCA to establish, 
implement, maintain, and enforce certain written policies and 
procedures regarding access to clearance and settlement services, 
which, while not prescribing specific methods of access, is intended to 
ensure that all U.S. Treasury security CCAs have appropriate means to 
facilitate access to clearance and settlement services in a manner 
suited to the needs of market participants, including indirect 
participants.
    Some market participants have commented on the current practice of 
tying clearing services to trading under the sponsored clearing 
model.\448\ Under this model, the decision to clear the trades of an 
indirect participant appears to be contingent on that indirect 
participant trading with the direct participant sponsoring the indirect 
member.\449\ If the indirect participant is a competitor of the 
sponsoring direct participant and the direct participant has discretion 
on which trades to clear, the indirect participant may have difficulty 
accessing clearing. The proposed rule would require the U.S. Treasury 
securities CCA to ensure appropriate means to facilitate access; for 
some current indirect participants this may imply direct membership 
(with a potential change in membership criteria); \450\ alternatively, 
requiring something similar to a ``done-away'' clearing model may be 
another means of facilitating clearing.
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    \448\ See FIA-PTG Whitepaper, supra note 220.
    \449\ See id. at 7.
    \450\ Accessing clearing through another party may lower costs, 
but market participants have commented that there may still be 
residual exposure should that counterparty default after the CCA has 
performed on its obligations.
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    Other considerations relate to the services available through the 
sponsored clearing model. For example, buy-side participants, currently 
engage in both triparty and bilateral repo, across multiple tenors, and 
on either side (lending or borrowing) of the transaction. At present, 
it appears that FICC direct members may be able to decline to submit a 
trade for central clearing at their discretion.\451\ Thus some indirect 
participants who are unable to enter into a similar transaction using a 
different FICC direct member who is willing to submit the trade for 
central clearing would not be able to access central clearing under the 
current practice. The proposed rule would requir