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US regulators are requiring more central clearing in Treasury markets. Sellsiders’ opinions of the rule seem to be settling on “less burdensome than feared.”
The SEC voted last Wednesday to expand central clearing of Treasury and repo trades, as mainFT reported. That gives traders a couple of new deadlines: December 2025 for expanded clearing of cash Treasuries, and June 2026 for clearing of repo transactions.
BofA strategists say that the fairly lengthy timeline should be helpful (with our emphasis):
There were small reductions in the scope of clearing and a reasonably manageable implementation time period, which makes us believe the final rule is better than expected. The compliance dates will be March 31, 2025 for the clearing house (Fixed income Clearing Corp = FICC) to adopt new rules including changes to customer margin accounting, Dec 31 2025 for Treasury cash trade clearing, and June 30 2026 for repo clearing. These long phase in periods will give FICC and market participants time to prepare for the market infrastructure changes.
As our colleagues pointed out last week, the SEC’s final rule covers a smaller group of market participants for cash Treasury trading than its original proposal. At first, regulators wanted to include hedge funds and leveraged traders, but have since pared back that requirement to FICC clearing members, brokers/dealers, and broker-dealers.
But that doesn’t necessarily mean some of the bigger non-bank market-making firms are off the hook, says BofA:
In our view, this will allow the SEC to designate certain funds as dealers or brokers to put them in scope for cash clearing, vs including all hedge funds.
So what does it mean for the broader market? In short, marginally higher costs of leverage for bank clients. From BofA:
Our general view is that repo clearing is not going to have major market impacts but should raise the overall cost of leverage in the Treasury market. This could manifest itself in wider bid/offer spreads and larger relative value dislocations in areas like swap spreads, off-the-run vs on-the-runs, futures basis, butterfly trades etc.
And the effects on bank balance sheets is a bit more mixed, says BofA. With our emphasis:
For bank capital, we would expect clearing to reduce leverage capital consumption because repo positions will benefit from more netting in the SLR denominator (supplementary leverage ratio). Since SLR is not typically a binding constraint, this is not necessarily going to free up balance sheet for funding.
Risk weighted capital (RWA) consumption could also drop with cleared repo trades because more repo trades would have standard FICC haircuts. The haircut reduces RWA one for one, in that $1 of overcollateralization takes the RWA down by $1. The offset here would be 1) the haircut would only benefit the dealer if it were applied to the client-facing repo trade, and in some cases the dealer might still have a 0% haircut on that, 2) RWA is slightly increased by clearing a repo trade as it creates two exposures instead of one, with the new exposure to the clearing house getting a very low risk weighting of 2%. With FICC haircuts applying to more repo trades over time, we would expect the net impact over time to be lower RWA of the repo book, which could theoretically make funding more widely available, all else equal.
It’s interesting that the team describes supplementary leverage ratio requirements as “not typically a binding constraint”, because the SLR was said to be a cause of the blowup in funding costs during the early-Covid “dash for cash”.
Now those weren’t typical times, of course. Still, this implies the rule could alleviate SLR-related pressures during times of market strain. That strain is part of what prompted the regulatory revamp in the first place. So if we’re understanding correctly, that’s a good thing!?
Anyway! Strategists at Deutsche Bank argue that SOFR, the floating-rate benchmark that’s replaced Libor, will probably see higher underlying volumes as more repo trades are brought under the centrally-cleared umbrella.
They take a more optimistic view of the potential effects on bank balance sheets (with our emphasis):
– Higher SOFR volumes with NCCBR [non-centrally cleared bilateral repo] trades brought under the scope of SOFR as FICC bilateral trades.
– NCCBR rates are comparable to FICC bilateral rates, while historically they have been 3-5 bps higher than triparty rates (TGCR), which form the lowest layer of rates within SOFR. Introducing an additional $2 trillion FICC bilateral volumes could then mechanically bias the SOFR setting higher by a few basis points.
– For dealers, they may realize additional balance-sheet netting benefits. An estimated 40% or $400bn of NCCBR Treasury repo trades are not netted currently and could benefit from the move into FICC. A more efficient balance sheet use could free up capital for other business activities.
DB has a decidedly less rosy view of the implications for banks’ clients, though. While buyside traders (coughcough hedge funds) and non-bank market makers seem to have dodged a bullet, they’ll still have to pay up, the strategists say:
– On the flip side, dealers will face higher clearing costs, which they may pass down to customers in the form of wider spreads.
– For customers, they lose flexibility over collateral and maturities of their trade. FICC repo only allows for Fedwire-eligible securities as collateral. Additionally, less than 2% of FICC repos are term trades (longer than overnight), compared to more than 40% of NCCBR repos are term.
– For hedge funds specifically, their positions could come under greater scrutiny with data on their leverage centrally collected and made more transparent.
The strategists include this handy chart of hedge funds’ repo leverage, which they estimate at $1.5tn in the first quarter of 2023.
Again: Price of the leverage goin’ up.
Further reading:
— Treasury clearing 101
Read the full article here