The DTCC has released a white paper focused on a troubling trend.
Grygo is the chief content officer for FTF & FTF News.
Fragmented clearing for the U.S. Treasury market is on the minds of those at the DTCC, the industry’s major post-trade services and infrastructure provider, and they have released a white paper that they hope will spark a discussion about this contentious issue.
There is even a suggestion that there might be a need for a regulatory requirement to mandate centralized clearing.
The paper, “More Clearing, Less Risk: Increasing Centrally Cleared Activity in the U.S. Treasury Cash Market,” focuses on the rise in “bilateral clearing for Treasury activity and details the benefits of unifying the market under a central clearing model.”
The DTCC argues via the white paper that the Treasury market “is split between two disparate clearing processes: bilaterally cleared transactions, and centrally cleared transactions via DTCC’s Fixed Income Clearing Corporation (FICC).”
Interdealer brokers, in particular, execute “transactions between FICC members and non-FICC members, in which one side of the trade is centrally cleared and the other is bilaterally cleared. The paper notes that this fragmentation is creating ‘contagion risk,’ in part because if a non-FICC member defaults, there could be larger systemic impacts,” according to the DTCC paper. And it wasn’t always this way.
The ongoing market volatility is forcing the issue “on the need for an ideal market structure,” according to the DTCC. “Prior to 2000, all outright purchases and sales of Treasuries through IDBs were centrally cleared. Today, the Federal Reserve estimates that up to 60 percent of outright purchases and sales of Treasuries through IDBs involve Principal Trading Firms (PTFs), who generally don’t participate in central clearing.”
With the pandemic as the backdrop, the paper’s authors say “the unprecedented market volatility of the COVID- 19 pandemic” offers insights into greater efficiency, transparency, and resilience in clearing.
First, the DTCC says things held up despite the onslaught.
“In the systemically important U.S. Treasury market, the volatility in March 2020 drove record trading volume and volatility spikes. Clearing volumes in U.S. Treasury activity in the Government Securities Division (GSD) of … [the FICC] soared to over $6 trillion daily, an almost 43 percent increase over the usual daily average of $4.2 trillion cleared. … FICC’s decision to cease to act for a member at the height of the crisis did not result in an adverse market impact nor any loss allocation to members,” according to the report.
But the “fluid and dynamic environment” that is the new normal could “expose the market to liquidity and market risk,” raising concerns about bilateral U.S. Treasury clearing, the report notes.
The wider adoption of a centralized clearing model for the U.S. Treasury market would cut “risk and improve resiliency, which is critical to the strength and stability of the U.S. economy,” according to the DTCC report. “We must work together to deploy solutions that can broaden participation in central clearing to best manage risk and improve efficiency and transparency in the U.S. Treasury market.”
The DTCC is arguing that benefits of moving away from bilateral clearing are:
- “Reduced market risk through margin processing, which is collected twice a day. This promotes orderly control, wind-down and liquidation in the event of a member default, reducing the risk of liquidity drain and fire sales in a stress event;”
- “Added liquidity by allowing trades to be netted across all CCP members, lowering net settlement exposures and freeing up capital;”
- And “Improved financial stability by increasing transparency in this important area of the treasuries market. FICC does not have visibility into its members’ Treasury market activity that clears bilaterally away from FICC.”
Murray Pozmanter
While there are benefits to a centralized clearing model, the situation may need the attention of authorities, says Murray Pozmanter, managing director, DTCC Head of Clearing Agency Services and Global Business Operations, in a prepared statement.
“… We believe many firms will not adopt this critical risk management capability unless there is a mandate from the official sector, such as a regulatory requirement for firms that make markets in U.S. Treasury securities to centrally clear their cash activity,” Pozmanter says.
As FICC talks to with the Treasury Market Practices Group “and other industry associations on this issue,” the DTCC wants industry participants to think about “a public-private partnership to identify viable options to further increase central clearing in the U.S. Treasury market. … We actively encourage you to share your thoughts and participate in the ongoing dialogue that we are looking to foster.”
The authors of the paper are also open to suggestion and have included their email addresses: Pozmanater at: mpozmanter@dtcc.com ; and James Hraska, managing director, DTCC Managing Director and General Manager, FICC Services at jhraska@dtcc.com
The full text of the report can be found: https://bit.ly/2QPBkP8
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