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]
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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:
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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
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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
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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
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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
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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
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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).
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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
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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’’).
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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
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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/
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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.
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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.
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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).
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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.’’).
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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’’).
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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
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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.
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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,
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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.
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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).
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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.
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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
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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.
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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).
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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
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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
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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).
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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.
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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.
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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.
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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).
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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
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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.
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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
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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).
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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
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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
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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.
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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.
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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).
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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.
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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.
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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.
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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.
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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).
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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.
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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.
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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.
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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).
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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.
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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).
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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.
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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).
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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.
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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.
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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
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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.
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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
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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.
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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
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5. Request for Comment
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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).
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CFR 240.17Ad–22(e)(7).
Rule 22A, section 2a, supra note 47.
194 FICC
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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
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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.
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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
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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
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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
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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
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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
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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
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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?
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• 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
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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.
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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,
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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.
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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.
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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).
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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.).
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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.
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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.
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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).
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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
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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).
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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
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15 U.S.C. 78aaa et seq.
227 See 11 U.S.C. 1 et seq.
226 See
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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
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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
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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.
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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).
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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.
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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
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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
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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.
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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.
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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
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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).
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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
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(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
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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
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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
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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
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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).
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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.
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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.
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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.
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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 $651 billion traded
daily across all Treasury securities.’’ Fleming,
Shachar, and Van Tassel, supra note 38. As
discussed in section III.A.2, supra, for purposes of
this Proposal only the WI market after the auction
but before issuance (WI on-the-run issues) is
considered part of the secondary market for U.S.
Treasury securities. Most of the WI trading in the
Fleming, Shachar, and Van Tassel analysis occurred
in on-the-run issues. Id. (‘‘WI trading that occurs up
to and including the auction day (account[s] for
about one-third of WI trading) and WI trading that
occurs after the auction day (account[s] for about
two-thirds of WI trading’’). For a discussion of how
WI trading functions in the context of central
clearing, see Kenneth D. Garbade & Jeffrey F. Ingber,
The Treasury Auction Process: Objectives,
Structure, and Recent Adaptations, 11 Current
Issues in Economics and Finance 1 (2005), available
at https://www.newyorkfed.org/medialibrary/
media/research/current_issues/ci11-2.html.
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Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules
referred to as ‘‘off-the-run’’.265 Figure 1
shows the outstanding value of on-therun (Panel A) and off-the-run (Panel B)
U.S. Treasury securities. On-the-run
U.S. Treasury securities have
consistently made up approximately 3%
of the total value of all marketable U.S.
Treasury securities during the 2012–
2021 period, but, as Figure 3 shows,
account for a disproportionate share of
Panel A: On-the-nm Treasury Securities
trading volume. Thus, an on-the-run
security is generally far more liquid
than a similar off-the-run security.
Figure 1: On-the-run and off-the-run
U.S. Treasury securities (trillions) a
Panel 8; Off-the-run Treasury Securities
f•
20
!-
lyearorle$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.
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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
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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
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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.
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64645
,-~
lllB Bills and FRNs 1
i - Off..the-run
5000
1000
0
IAWG Report, supra note 4, at 14.
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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
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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.
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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
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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.
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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.
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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.
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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
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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,
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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
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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
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: - Repo
:li!II Reverse Repo
500
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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
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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.
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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
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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
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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.
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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.
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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
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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://
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www.federalreserve.gov/econres/notes/feds-notes/
principal-trading-firm-activity-in-treasury-cashmarkets-20200804.htm.
305 See supra note 37.
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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.
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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)
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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
. . .’’).
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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.
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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.
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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.
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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.
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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
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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.
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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.
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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.’’).
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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.
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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.
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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.
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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
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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
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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
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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,
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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.
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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
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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.
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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.
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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
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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)
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Figure 11 Tri-party Repo and Reverse
Repo Collateral 2022
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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
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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
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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.
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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
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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.
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(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
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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.
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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.
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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
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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
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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.
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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
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obligations, and to facilitate repo
transactions.392
C. Analysis of Benefits, Costs, and
Impact on Efficiency, Competition, and
Capital Formation
1. Benefits
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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
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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.’’).
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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).
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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.
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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
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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.
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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).
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424 Id.
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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
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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.
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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.
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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
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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.
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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
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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.
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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.
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supra note 203.
October 2021 White Paper, supra note
203, at 5–6.
445 DTCC
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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
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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
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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.
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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
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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.
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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.
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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
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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
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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).
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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
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467 See
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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
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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
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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.
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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
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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.
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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
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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).
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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.
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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.
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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.
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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.
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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
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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
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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
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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
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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,
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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.
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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.
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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
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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).
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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.
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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.
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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.
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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
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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
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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.
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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
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*
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2.
3.
4.
5.
6.
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Section 240.17Ad–22 is also issued under
12 U.S.C. 5461 et seq.
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Debits
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Federal Register / Vol. 87, No. 205 / Tuesday, October 25, 2022 / Proposed Rules
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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
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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
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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
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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;
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(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:
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Fmt 4701
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(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
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(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.
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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
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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.
*
*
*
*
*
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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;
*
*
*
*
*
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(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;
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(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
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]]>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
-----------------------------------------------------------------------
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]]
-----------------------------------------------------------------------
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.
-----------------------------------------------------------------------
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.
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\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.
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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.
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\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'').
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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.
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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\
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\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.
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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\
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\23\ TMPG White Paper, supra note 21, at 3.
\24\ Id.
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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\
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\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).
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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\
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\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.'').
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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.
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\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/.
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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'').
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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.
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\33\ See notes 184 through 186 infra.
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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\
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\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.
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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.
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\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.
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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\
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\40\ Joint Staff Report, supra note 4, at 11, 35-36.
\41\ IAWG Report, supra note 4, at 21.
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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\
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\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.
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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\
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\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.
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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\
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\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).
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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.
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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.''
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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\
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\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.
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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\
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\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\
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\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\
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\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.
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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\
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\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).
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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\
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\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).
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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.
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\100\ See 15 U.S.C. 78lll(4)(B).
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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.
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\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\
---------------------------------------------------------------------------
\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.''
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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.
---------------------------------------------------------------------------
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.
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\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'').
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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.
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\136\ TMPG White Paper, supra note 21, at 32; section IV.B.4
(Table 1) infra.
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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\
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\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.
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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.
---------------------------------------------------------------------------
\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\
---------------------------------------------------------------------------
\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).
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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.\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).
---------------------------------------------------------------------------
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.''
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\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).
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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.
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
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.
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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.
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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'').
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[[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.
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\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.
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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.
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\195\ See supra note 121 and accompanying text.
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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.
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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).
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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.
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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 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.
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\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.
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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.
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\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.
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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).
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\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.
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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\
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\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.).
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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.
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\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.
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\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.
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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\
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\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.
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\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:
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\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.
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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\
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\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).
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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.
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\236\ See 15 U.S.C. 78s.
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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.
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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.
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\239\ See 15 U.S.C. 78c(f).
\240\ See 15 U.S.C. 78w(a)(2).
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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\
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\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.
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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.
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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.
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\245\ See supra section III.B.2.
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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.
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\246\ See supra section III.C.
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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.
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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.
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\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\
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\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.
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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.
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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\
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\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.
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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\
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\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.
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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.
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\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.
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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.
---------------------------------------------------------------------------
[[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\
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\384\ Harkrader and Puglia FEDS Note, supra note 304, at table 1
(61% of $191 billion = $116.51 billion).
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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).
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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\
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\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).
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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.
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[[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.
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\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.
---------------------------------------------------------------------------
\437\ See supra note 145.
\438\ Id. at 21.
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
\439\ See supra section III.A.2.b (Other Cash Transactions).
---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
\444\ See supra note 203.
\445\ 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 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\
---------------------------------------------------------------------------
\446\ Chicago Fed Insights, supra note 204, at 3.
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
\451\ See supra section IV.B.3.
---------------------------------------------------------------------------
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
[[Page 64668]]
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.
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 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.
---------------------------------------------------------------------------
\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).
---------------------------------------------------------------------------
The Commission preliminarily estimates that U.S. Treasury
securities CCAs would incur an aggregate one-time 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 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\
---------------------------------------------------------------------------
\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 x 2 respondent clearing agencies = $206,560. See
infra section V.A.
\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 x 2 respondent clearing agencies =
$60,580. See infra section V.A.
---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
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
[[Page 64669]]
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.
---------------------------------------------------------------------------
\460\ See supra section IV.B.3.
\461\ LCR 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.
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
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 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\
---------------------------------------------------------------------------
\464\ The fee structure for FICC is described in its rulebook.
See FICC Rules, supra note 47, at 307.
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
\465\ See FIA-PTG Whitepaper, supra note 220 (for a description
of different client clearing models).
---------------------------------------------------------------------------
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
[[Page 64670]]
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\
---------------------------------------------------------------------------
\466\ See supra note 11.
---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
\467\ See 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).
---------------------------------------------------------------------------
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. 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\
---------------------------------------------------------------------------
\470\ See supra section III.B.1.
\471\ See supra note 62 and accompanying text (discussing
existing FICC rules for sponsored member program).
---------------------------------------------------------------------------
The Commission preliminarily estimates that U.S. Treasury
securities CCAs would incur an aggregate one-time 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\
---------------------------------------------------------------------------
\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 x 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 x 2 respondent clearing agencies =
$60,580. See infra section V.B.
---------------------------------------------------------------------------
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 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\
---------------------------------------------------------------------------
\474\ See supra section IV.C.2.
---------------------------------------------------------------------------
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, pre-
[[Page 64671]]
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\
---------------------------------------------------------------------------
\475\ Mauren 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.
\476\ FIA-PTG Whitepaper, supra note 220.
\477\ See supra note 190.
---------------------------------------------------------------------------
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 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\
---------------------------------------------------------------------------
\478\ See G-30 Report, supra note 5, at 13.
\479\ See 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.
---------------------------------------------------------------------------
The U.S. Treasury securities intermediation business is also
capital-intensive, 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 broker-dealers. 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 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.
---------------------------------------------------------------------------
\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 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-pass-through-theory-measurement-and-policy-implications.
---------------------------------------------------------------------------
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
[[Page 64672]]
for fixed income and even equity rates of return, and the proposed rule
could lower the cost of capital for private-sector 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.
---------------------------------------------------------------------------
\486\ Standard textbook treatments of finance use the U.S.
Treasury rate of return as a benchmark in computing the cost of
capital for private companies. The link between interest rates of
government debt and corporate debt is a long-standing feature of the
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).
---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
\487\ See Arvind Krishnamurthy & Annette Vissing-Jorgensen, The
Aggregate Demand for Treasury Debt, 120 J. Pol. Econ. (Apr. 2012).
---------------------------------------------------------------------------
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
One alternative would be to narrow the scope of the Membership
Proposal as it pertains to cash transactions in the secondary market
for U.S. Treasury securities. The narrower definition of eligible
secondary market transaction contemplated in this alternative would
include (1) a repurchase or reverse repurchase agreement collateralized
by U.S. Treasury securities, in which one of the counterparties is a
direct participant; or (2) a purchase or sale between a direct
participant 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.\488\ This alternative differs from the proposal above by
omitting from the definition of eligible transactions those cash
transactions between a direct participant and a registered broker-
dealer, government 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 one-half of its net assets or may
have gross notional exposure in excess of twice its net assets.\489\
---------------------------------------------------------------------------
\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).
\489\ See supra section III.A.2.b for a discussion of cash
transactions included in the definition of eligible transactions.
---------------------------------------------------------------------------
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 perspective, as apparently having a directional exposure
despite the non-centrally cleared trade that would leave the IDB
flat.\490\ This lack of knowledge could prevent FICC from ``accurately
identifying, measuring and managing its direct and indirect
counterparty risk exposure and can affect its decision-making,'' \491\
which in turn potentially increases the likelihood that a default of an
IDB member could in turn harm the CCP or the system 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
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 be problematic for the system as a whole, even if the
health of the CCP is not implicated. The default could cause others to
back away from participating in the market, particularly if the
defaulting participant was an IDB, whose withdrawal from the market
could jeopardize other market participants' ability to access the
market for U.S. Treasury securities.\492\
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
This alternative would, with a more limited scope, move a large
portion of secondary market transactions in U.S. Treasury securities
that are not currently centrally cleared into central 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.
---------------------------------------------------------------------------
\493\ See id.
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
\494\ See supra section IV.C.1.III(b). See also note 145.
---------------------------------------------------------------------------
This alternative could also include within the definition of
eligible secondary market transactions a purchase or sale between a
direct participant and a registered broker-dealer, 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\
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
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.
[[Page 64673]]
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\
---------------------------------------------------------------------------
\497\ See IAWG Report at 30, supra note 4; Liang & Parkinson,
supra note 32, at 9; Duffie, supra note 186, at 16-17.
---------------------------------------------------------------------------
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 broker-dealers, would be exempt
from the clearing requirement under this alternative.
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.
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
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 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
[[Page 64674]]
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 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 pre-
auction and auction day when-issued transactions along with post-
auction when-issued transactions? Is there a greater contagion risk
from fails-to-deliver 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 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
[[Page 64675]]
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.
---------------------------------------------------------------------------
\499\ See 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------
Respondents under this rule are Treasury securities CCAs, of which
there is currently one. The Commission anticipates that one additional
entity 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.
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\
---------------------------------------------------------------------------
\500\ See, 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).
---------------------------------------------------------------------------
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
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\
---------------------------------------------------------------------------
\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 x 2 respondent
clearing agencies = 258 hours.
---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
\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 x 2 respondent
clearing agencies = 160 hours.
--------------------------------------------------------------------------------------------------------------------------------------------------------
Initial burden Aggregate Ongoing burden Aggregate
Name of information collection Type of burden Number of per entity initial burden per entity ongoing burden
respondents (hours) (hours) (hours) (hours)
--------------------------------------------------------------------------------------------------------------------------------------------------------
17Ad-22................................... Recordkeeping............... 2 129 258 91 182
--------------------------------------------------------------------------------------------------------------------------------------------------------
B. Proposed Amendment to Rule 17Ad-22(e)(18)(iv)
The purpose of the collection of information under proposed Rule
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
[[Page 64676]]
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 information pursuant to this
collection of information, such information would be kept confidential
subject to the provisions of applicable law.\506\
---------------------------------------------------------------------------
\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).
---------------------------------------------------------------------------
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
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\
---------------------------------------------------------------------------
\507\ See supra note 34 and accompanying text (discussing
current FICC rules).
\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 x 2
respondent clearing agencies = 520 hours.
---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
\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 x 2 respondent
clearing agencies = 170 hours.
--------------------------------------------------------------------------------------------------------------------------------------------------------
Initial burden Aggregate Ongoing burden Aggregate
Name of information collection Type of burden Number of per entity initial burden per entity ongoing burden
respondents (hours) (hours) (hours) (hours)
--------------------------------------------------------------------------------------------------------------------------------------------------------
17Ad-22(e)................................ Recordkeeping............... 2 260 520 80 170
--------------------------------------------------------------------------------------------------------------------------------------------------------
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 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
[[Page 64677]]
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.
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.
---------------------------------------------------------------------------
\512\ Pubic Law 104-121, Title II, 110 Stat. 857 (1996).
---------------------------------------------------------------------------
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 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\
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\513\ See 5 U.S.C. 601 et seq.
\514\ 5 U.S.C. 603(a).
\515\ Section 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).
---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
\517\ 17 CFR 240.17AD-22(a)(5).
\518\ See 17 CFR 240.0-10(d).
---------------------------------------------------------------------------
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, 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.
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
\520\ See 17 CFR 240.0-10(c).
---------------------------------------------------------------------------
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 broker-
dealers 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
broker-
[[Page 64678]]
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 Sec. 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
0
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.
* * * * *
Section 240.17Ad-22 is also issued under 12 U.S.C. 5461 et seq.
* * * * *
0
2. Revise Sec. 240.15c3-3a to read as follows:
Sec. 240.15c3-3a Exhibit A-Formula for determination of customer and
PAB account reserve requirements of brokers and dealers under Sec.
240.15c3-3.
Sec. 240.15c3-3a Exhibit A-Formula for determination of customer and
PAB account reserve requirements of brokers and dealers under Sec.
240.15c3-3.
------------------------------------------------------------------------
Credits Debits
------------------------------------------------------------------------
1. Free credit balances and other XXX ...............
credit balances in customers'
security accounts. (See Note A)......
2. Monies borrowed collateralized by XXX ...............
securities carried for the accounts
of customers (See Note B)............
3. Monies payable against customers' XXX ...............
securities loaned (See Note C).......
4. Customers' securities failed to XXX ...............
receive (See Note D).................
5. Credit balances in firm accounts XXX ...............
which are attributable to principal
sales to customers...................
6. Market value of stock dividends, XXX ...............
stock splits and similar
distributions receivable outstanding
over 30 calendar days................
7. Market value of short security XXX ...............
count differences over 30 calendar
days old.............................
8. Market value of short securities XXX ...............
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 XXX ...............
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 ............... XXX
and margin accounts excluding
unsecured accounts and accounts
doubtful of collection. (See Note E).
11. Securities borrowed to effectuate ............... XXX
short sales by customers and
securities borrowed to make delivery
on customers' securities failed to
deliver..............................
12. Failed to deliver of customers' ............... XXX
securities not older than 30 calendar
days.................................
13. Margin required and on deposit ............... XXX
with the Options Clearing Corporation
for all option contracts written or
purchased in customer accounts. (See
Note F)..............................
14. Margin required and on deposit ............... XXX
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 ............... XXX
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 ............... XXX
items 1-9) over total debits (sum of
items 10-15) required to be on
deposit in the ``Reserve Bank
Account'' (Sec. 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............
------------------------------------------------------------------------
[[Page 64679]]
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 product-related 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
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 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
[[Page 64680]]
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 Sec.
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;
(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:
(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 Sec.
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 Sec.
240.15c3-3 with respect to customer accounts (the ``customer reserve
computation'') may not be included as a credit in the computation
required by Sec. 240.15c3-3 with respect to PAB accounts (the ``PAB
reserve computation'').
Note 3. Note E(1) to Sec. 240.15c3-3a does not apply to the PAB
reserve computation.
Note 4. Note E(3) to Sec. 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
[[Page 64681]]
(excluding clearing deposits) that are otherwise allowable assets
under Sec. 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
Sec. 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 intra-day 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 cross-margin 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 Sec. 240.15c3-3a applies with respect
to margin delivered to a U.S. Treasury securities clearing agency.
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.
0
3. Amend Sec. 240.17Ad-22 by:
0
a. In paragraph (a):
0
i. Removing the second-level paragraph designations, and
0
ii. Inserting in alphabetical order definitions for ``Central bank'',
``Eligible secondary market transaction'', ``International financial
institution'', ``Sovereign entity'', and ``U.S. Treasury security''.
0
b. Revising paragraphs (e)(6)(i) and (e)(18).
The revisions and additions read as follows:
Sec. 240.17Ad-22 Standards for clearing agencies.
(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 (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 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; 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 Integraci[oacute]n Econ[oacute]mica; Bank for
Economic Cooperation and Development in the Middle East and North
Africa; Caribbean Development Bank; Corporaci[oacute]n Andina de
Fomento; Council of Europe Development Bank; European Bank for
Reconstruction and Development; European Investment Bank; European
Investment Fund; European Stability Mechanism; Inter-American
Development Bank; Inter-American 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.
* * * * *
[[Page 64682]]
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;
* * * * *
(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;
(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
