Proposed Rule2022-20288
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
Primary source
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Published
October 25, 2022
Issuing agencies
Securities and Exchange Commission
Abstract
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.
Full Text
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[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 [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2022-20288]
[[Page 64609]]
Vol. 87
Tuesday,
No. 205
October 25, 2022
Part III
Securities and Exchange Commission
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17 CFR Part 240
Standards for Covered Clearing Agencies for U.S. Treasury Securities
and Application of the Broker-Dealer Customer Protection Rule With
Respect to U.S. Treasury Securities; Proposed Rule
Federal Register / Vol. 87 , No. 205 / Tuesday, October 25, 2022 /
Proposed Rules
[[Page 64610]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 240
[Release No. 34-95763; File No. S7-23-22]
RIN 3235-AN09
Standards for Covered Clearing Agencies for U.S. Treasury
Securities and Application of the Broker-Dealer Customer Protection
Rule With Respect to U.S. Treasury Securities
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule.
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SUMMARY: The Securities and Exchange Commission (``Commission'')
proposes to amend the standards applicable to covered clearing agencies
for U.S. Treasury securities to require that such covered clearing
agencies have written policies and procedures reasonably designed to
require that every direct participant of the covered clearing agency
submit for clearance and settlement all eligible secondary market
transactions in U.S. Treasury securities to which it is a counterparty.
In addition, the Commission proposes additional amendments to the
Covered Clearing Agency Standards, with respect to risk management.
These requirements are designed to protect investors, reduce risk, and
increase operational efficiency. Finally, the Commission proposes to
amend the broker-dealer customer protection rule to permit margin
required and on deposit with covered clearing agencies for U.S.
Treasury securities to be included as a debit in the reserve formulas
for accounts of customers and proprietary accounts of broker-dealers
(``PAB''), subject to certain conditions.
DATES: Comments should be received on or before December 27, 2022.
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic Comments
<bullet> Use the Commission's internet comment form (<a href="https://www.sec.gov/rules/submitcomments.htm">https://www.sec.gov/rules/submitcomments.htm</a>); or
<bullet> Send an email to <a href="/cdn-cgi/l/email-protection#86f4f3eae3abe5e9ebebe3e8f2f5c6f5e3e5a8e1e9f0"><span class="__cf_email__" data-cfemail="750700191058161a1818101b0106350610165b121a03">[email protected]</span></a>. Please include
File Number S7-23-22 on the subject line.
Paper Comments
<bullet> 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 (<a href="http://www.sec.gov/rules/proposed.shtml">http://www.sec.gov/rules/proposed.shtml</a>).
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 <a href="http://www.sec.gov">www.sec.gov</a> 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 <a href="https://home.treasury.gov/system/files/136/IAWG-Treasury-Report.pdf">https://home.treasury.gov/system/files/136/IAWG-Treasury-Report.pdf</a> (``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 <a href="https://home.treasury.gov/system/files/276/joint-staff-report-the-us-treasury-market-on-10-15-2014.pdf">https://home.treasury.gov/system/files/276/joint-staff-report-the-us-treasury-market-on-10-15-2014.pdf</a> (``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 <a href="https://group30.org/publications/detail/4950">https://group30.org/publications/detail/4950</a>
(``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 <a href="https://home.treasury.gov/system/files/136/A-Financial-System-Capital-Markets-FINAL-FINAL.pdf">https://home.treasury.gov/system/files/136/A-Financial-System-Capital-Markets-FINAL-FINAL.pdf</a> (``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.
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\17\ Financial Stability Oversight Council, 2012 Annual Report,
Appendix A, available at <a href="http://www.treasury.gov/initiatives/fsoc/Documents/2012%20Annual%20Report.pdf">http://www.treasury.gov/initiatives/fsoc/Documents/2012%20Annual%20Report.pdf</a> (``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 <a href="https://www.newyorkfed.org/TMPG/index.html">https://www.newyorkfed.org/TMPG/index.html</a>. 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 <a href="https://www.newyorkfed.org/medialibrary/Microsites/tmpg/files/CS_FinalPaper_071119.pdf">https://www.newyorkfed.org/medialibrary/Microsites/tmpg/files/CS_FinalPaper_071119.pdf</a> (``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
<a href="https://www.federalreserve.gov/apps/reportforms/reportdetail.aspx?sOoYJ+5BzDZq2f74T6b1cw">https://www.federalreserve.gov/apps/reportforms/reportdetail.aspx?sOoYJ+5BzDZq2f74T6b1cw</a>.
\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\
---------------------------------------------------------------------------
\23\ TMPG White Paper, supra note 21, at 3.
\24\ Id.
---------------------------------------------------------------------------
D. Proposal
The Commission believes that a covered clearing agency, including
one that provides CCP services,\25\ is most effective when its
participation standards enable the CCA to understand and control the
risks presented by its direct participants because such standards are
an important tool to limit the potential for member defaults and, as a
result, losses to non-defaulting members in the event of a member
default, thereby protecting the securities market as a whole.\26\ For
example, when proposing the Covered Clearing Agency Standards in Rule
17Ad-22 in 2014, the Commission explained that ``[a]ppropriate minimum
operational, legal, and capital requirements for membership that are
maintained and enforced through the supervisory practices of a clearing
agency help to ensure all members will be reasonably capable of meeting
their various obligations to the clearing agency in stressed market
conditions and upon member default.'' \27\ To that end, the
Commission's rules governing the participation requirements of a CCA
are designed to achieve that goal. Rule 17Ad-22(e)(18) requires that a
CCA establish, implement, maintain and enforce written policies and
procedures reasonably designed to, as applicable, establish objective,
risk-based and publicly disclosed criteria for participation,\28\ and
17 CFR 240.17Ad-22(e)(19) (``Rule 17Ad-22(e)(19)'') requires a CCA to
maintain written policies and procedures reasonably designed to, as
applicable, identify, monitor and manage the material risks to it
arising from arrangements in which firms that are indirect participants
in the CCA rely on the services provided to it by direct participants
to access the CCA's payment, clearing, or settlement facilities.\29\
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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\
---------------------------------------------------------------------------
\30\ See Self-Regulatory Organizations; Fixed Income Clearing
Corporation; Order Granting Approval of a Proposed Rule Change
Relating to Trade Submission Requirements and Pre-Netting, Exchange
Act Release No. 51908 (June 22, 2005), 70 FR 37450 (June 29, 2005)
(describing a rule designed to bring additional transactions into
FICC's netting system as ``clearly designed to promote the prompt
and accurate clearance and settlement of those transactions and to
preserve the safety and soundness of the national clearance and
settlement system.'').
---------------------------------------------------------------------------
The Commission also proposes to impose additional requirements on
how U.S. Treasury securities CCAs calculate, collect, and hold margin
posted on behalf of indirect participants (i.e., customers) who rely on
the services of a direct participant (i.e., the member of the U.S.
Treasury securities CCA) to access the CCA's services. As set forth in
more detail below, the Commission believes that such requirements also
will improve the risk management practices at U.S. Treasury securities
CCAs and incentivize and facilitate additional central clearing in the
U.S. Treasury market, thereby lowering systemic risk. Individually and
collectively, these two proposals should further incentivize and
facilitate additional central clearing.
In addition, the Commission recognizes that the proposal could
cause a substantial increase in the margin broker-dealers must post to
a U.S. Treasury securities CCA resulting from their customers' cleared
U.S. Treasury securities positions. Currently, broker-dealers are not
permitted to include a debit in the customer reserve formula equal to
this amount of margin or, more generally, to use customer cash or
customer fully paid or excess margin securities to meet a margin
requirement. To address this, the Commission proposes an amendment
that, subject to certain conditions, would allow the broker-dealer to
include a debit in the customer or PAB reserve formula when delivering
customer cash or U.S. Treasury securities to meet the margin
requirement at an entity providing CCP services in the U.S. Treasury
market.
E. Current Regulatory and Industry Discussions Regarding the U.S.
Treasury Market
In normal market conditions, the U.S. Treasury market has
functioned extremely well. Even under stress, the market generally has
been highly resilient. However, several episodes in the U.S. Treasury
market, including the ``flash rally'' of 2014, the U.S. Treasury repo
market stress of September 2019, and the COVID-19 shock of March 2020,
have raised questions about the U.S. Treasury market's continued
capacity to absorb shocks and what factors may be limiting the
resilience of the U.S. Treasury market under stress.\31\ Although
different in their scope and magnitude, these events all generally
involved dramatic increases in market price volatility and/or sharp
decreases in available liquidity.
---------------------------------------------------------------------------
\31\ G-30 Report, supra note 5, at 1; IAWG Report, supra note 4,
at 7; Peter Ryan and Robert Toomey, Improving Capacity and
Resiliency in US Treasury Markets: Part I (Mar. 24, 2021), available
at <a href="https://www.sifma.org/resources/news/improving-capacity-and-resiliency-in-us-treasury-markets-part-1/">https://www.sifma.org/resources/news/improving-capacity-and-resiliency-in-us-treasury-markets-part-1/</a>.
---------------------------------------------------------------------------
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
<a href="https://www.brookings.edu/wp-content/uploads/2020/12/WP72_Liang-Parkinson.pdf">https://www.brookings.edu/wp-content/uploads/2020/12/WP72_Liang-Parkinson.pdf</a> (``Liang & Parkinson'').
---------------------------------------------------------------------------
The Commission believes that these changes should lower systemic
risk in the U.S. Treasury market by increasing the volume of
transactions that are subject to central clearing and ensuring that
those additional transactions are subject to standardized risk
management. The Commission also believes that increased central
clearing would provide greater transparency into the market and could,
potentially facilitate all-to-all trading.\33\ The Commission believes
that these benefits arising from central clearing should help improve
the functioning of the U.S. Treasury market.
---------------------------------------------------------------------------
\33\ See notes 184 through 186 infra.
---------------------------------------------------------------------------
II. Background
A. Current U.S. Treasury Market Structure and Central Clearing Within
That Structure
U.S. Treasury securities are direct obligations of the U.S.
Government issued by the U.S. Department of the Treasury (``Treasury
Department''). Market participants use U.S. Treasury securities as an
investment instrument and as a hedging vehicle, among other things. For
example, U.S. Treasury securities are often used as collateral in
lending arrangements or as margin on other financial transactions. The
Treasury Department issues several different types of securities,
including U.S. Treasury bills, nominal coupons notes and bonds,
Floating Rate Notes, and Treasury Inflation-Protected Securities
(``TIPS''). For each U.S. Treasury security type, the most recently
issued (``on-the-run'') securities are the most liquid in the secondary
market.\34\ Market participants commonly refer to securities issued
prior to ``on-the-run'' securities as ``off-the-run'' securities.
Trading in off-the-run U.S. Treasury securities has always been less
active than on-the-run trading, and price discovery primarily occurs in
on-the-run securities.\35\
---------------------------------------------------------------------------
\34\ On-the-run U.S. Treasury securities are the most recently
auctioned nominal coupon securities. These securities are referred
to as ``on-the-run'' starting the day after they are auctioned.
Nominal coupon securities pay a fixed semi-annual coupon and are
currently issued at original maturities of 2, 3, 5, 7, 10, 20, and
30 years. These standard maturities are commonly referred to as
``benchmark'' securities because the yields for these securities are
used as references to price a number of private market transactions.
\35\ Joint Staff Report, supra note 4, at 35-36. Price discovery
also occurs in when-issued trading of U.S. Treasury securities prior
to and on the day of the auction (pre- on-the-run trading). See note
38 infra.
---------------------------------------------------------------------------
The U.S. Treasury market consists of two components: the primary
market
[[Page 64615]]
and the secondary market. The primary market is where the Treasury
Department auctions securities (i.e., debt) to the public through a
competitive bidding process and subsequently issues awarded securities
to finance the Federal government.\36\ These U.S. Treasury securities,
which are issued after the auction, are marketable securities and are
primarily sold to financial institutions. Financial institutions
designated by the Federal Reserve Bank of New York as ``primary
dealers'' are expected to submit competitive bids on a pro-rata basis
and participate meaningfully in all U.S. Treasury auctions at
reasonably competitive rates or yields.\37\ U.S. Treasury securities
are typically issued a few days after the auction and trade on the
secondary market.\38\ The secondary market is where the subsequent
trading of U.S. Treasury securities occurs. The secondary market
includes the ``cash market,'' for outright purchases and sales of
securities, and the repo market, where one participant sells a U.S.
Treasury security to another participant, along with a commitment to
repurchase the security at a specified price on a specified later
date.\39\ This proposal applies to the secondary market for U.S.
Treasury securities.
---------------------------------------------------------------------------
\36\ TMPG White Paper, supra note 21, at 6. The Federal Reserve
Bank of New York serves as fiscal agent for the U.S. Treasury in
conducting auctions of marketable U.S. Treasury debt. See 12 U.S.C.
391.
\37\ See Federal Reserve Bank of New York, Administration of
Relationships with Primary Dealers, available at <a href="https://www.newyorkfed.org/markets/primarydealers">https://www.newyorkfed.org/markets/primarydealers</a>.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 <a href="https://libertystreeteconomics.newyorkfed.org/2020/11/treasury-market-when-issued-trading-activity/">https://libertystreeteconomics.newyorkfed.org/2020/11/treasury-market-when-issued-trading-activity/</a>.
\39\ See IAWG Report, supra note 4, at 3. The secondary market
also includes the market for U.S. Treasury futures, which trade
electronically on the Chicago Board of Trade, a designated contract
market operated by the Chicago Mercantile Exchange (``CME'') Group,
and centrally cleared by CME Clearing. U.S. Treasury futures are
generally regulated by the U.S. Commodity Futures Trading Commission
and are not the subject of this proposal.
---------------------------------------------------------------------------
1. Cash Market
The cash market has two main components: the interdealer market and
the dealer-to-customer market. In the interdealer market, dealers
primarily trade with each other and with principal trading firms
(``PTFs''), which trade as principals for their own accounts. The
majority of trading in the interdealer market in on-the-run U.S.
Treasury securities occurs on electronic platforms operated by
interdealer brokers that bring together buyers and sellers anonymously
using order books or other trading facilities supported by advanced
electronic trading technology (``IDBs'').\40\ These IDBs are generally
direct participants of a U.S. Treasury securities CCA and stand as
counterparties to both sides of each trade on their platforms.\41\
---------------------------------------------------------------------------
\40\ Joint Staff Report, supra note 4, at 11, 35-36.
\41\ IAWG Report, supra note 4, at 21.
---------------------------------------------------------------------------
Typically, an IDB provides a trading facility for multiple buyers
and sellers for U.S. Treasury securities to enter orders at specified
prices and sizes and have these orders displayed to all users on an
anonymous basis. The trading facility automatically matches these
orders according to priority and execution rules that are programmed in
the trading facility. When a match occurs and a trade is executed, the
IDB then books two trades, with the IDB functioning as the principal to
each respective counterparty, thereby protecting the anonymity of each
party, but taking on credit risk from each counterparty.\42\
---------------------------------------------------------------------------
\42\ TMPG White Paper, supra note 21, at 6.
---------------------------------------------------------------------------
Although the term ``IDB'' is sometimes used to refer to platforms
that may provide voice-based or other trading technology, as referenced
below, in this release, consistent with existing commentary on the U.S.
Treasury markets, the term IDB does not encompass platforms that
provide voice-based or other non-anonymous methods of bringing together
buyers and sellers of U.S. Treasury securities and instead refers to
electronic platforms providing anonymous methods of bringing together
buyers and sellers.\43\
---------------------------------------------------------------------------
\43\ The entities referred to as IDBs here are encompassed in
the ATSs category in the tables set forth in section IV.B.1 infra
because of the way that such IDBs are categorized in TRACE.
Specifically, the ``ATS'' category in TRACE encompasses these IDBs.
By contrast, the non-ATS IDBs category in TRACE encompasses the
voice-based or other non-anonymous methods of bringing together
buyers and sellers, which are also sometimes referred to as
interdealer brokers by market participants.
---------------------------------------------------------------------------
The majority of trades in the interdealer markets are trades in
``on-the-run'' issues. The majority of interdealer trading for off-the-
run U.S. Treasury securities occurs via bilateral transactions through
traditional voice-assisted brokers and electronic trading platforms
offering various protocols to bring together buyers and sellers,
although some interdealer trading in off-the-run U.S. Treasury
securities does occur on IDBs that anonymously bring together buyers
and sellers.\44\
---------------------------------------------------------------------------
\44\ Joint Staff Report, supra note 4, at 35.
---------------------------------------------------------------------------
Until the mid-2000s, most interdealer trading occurred between
primary dealers, who are required to be members of FICC, and was
centrally cleared.\45\ However, in recent years, much of the trading on
IDBs, in terms of number of trades and overall volume, has been
conducted by PTFs.\46\
---------------------------------------------------------------------------
\45\ G-30 Report, supra note 5, at 9; IAWG Report, supra note 4,
at 5-6; TMPG White Paper, supra note 21, at 6. See also supra note
37 (setting forth conditions for being a primary dealer).
\46\ G-30 Report, supra note 5, at 1.
---------------------------------------------------------------------------
Most IDBs are FICC direct participants, and the trades between an
IDB, that is a FICC direct participant, and another FICC direct
participant are submitted for central clearing to FICC, which, as noted
above, is currently the only U.S. Treasury securities CCA. Various
types of market participants are direct participants of FICC, including
dealers (both bank-affiliated and independent), banks, and IDBs. FICC's
current rules generally require that FICC direct participants submit
for clearing all trades with other FICC direct participants.\47\
However, FICC's rules do not require that a trade between a FICC direct
participant and a party that is not a FICC direct participant be
submitted for clearing. Therefore, for trades on IDBs between a party
that is not a FICC direct participant (which, on an IDB, is generally a
PTF) and a dealer which is a FICC direct participant--which results in
two separate transactions, between the IDB and the dealer, on the one
hand, and between the IDB and the PTF, on the other hand--the
transaction between the dealer and the IDB would be centrally cleared.
But the transaction
[[Page 64616]]
between a PTF which is not a FICC member and the IDB, on the other
side, would not be centrally cleared and instead would be settled
bilaterally with the IDB, often through a clearing agent acting on
behalf of the non-FICC direct participant.\48\
---------------------------------------------------------------------------
\47\ FICC Rule 2A section 7(e) (requirement that FICC Netting
Members submit to FICC all of its eligible trades with other Netting
Members); FICC Rule 18 section 2 (similar requirement with regard to
Repo transactions). The Rules for FICC's GSD are available at
https://www.dtcc.com/~/media/Files/Downloads/legal/rules/
ficc_gov_rules.pdf. Unless otherwise indicated, all references to
``FICC Rule'' in this release refer to the GSD Rulebook.
\48\ See TMPG White Paper, supra note 21, at Figures 5A and 5B
(providing graphical description of this type of clearing).
---------------------------------------------------------------------------
A 2015 inter-agency staff publication found that PTFs account for
more than half of the trading activity in the futures and electronic
IDB markets for U.S. Treasury securities, providing the vast majority
of market depth, and questioned whether trades cleared by such firms
outside of a CCP are subject to the same level of risk mitigation.\49\
In 2018, the TMPG determined that ``a majority of trades in the
secondary [cash] Treasury market now clear bilaterally, a trend that is
contrary to the direction of recent regulatory requirements in other
markets (i.e., swaps) that for some products mandate clearing and for
others encourage it through higher margin requirements on bilaterally
cleared transactions.'' \50\ The trading volume of non-FICC members, at
least in the cash U.S. Treasury market, is now estimated to exceed that
of FICC members.\51\ Whether or not a trade is centrally cleared
impacts the risk management requirements applicable to the trade.
Specifically, trades cleared and settled outside of a CCP may not be
subject to the same extent of risk management associated with central
clearing, which includes requirements for margin determined by a
publicly disclosed method that applies objectively and uniformly to all
members of the CCP, loss mutualization, and liquidity risk
management.\52\
---------------------------------------------------------------------------
\49\ Joint Staff Report, supra note 4, at 2, 55.
\50\ TMPG White Paper, supra note 21, at 2.
\51\ IAWG Report, supra note 4, at 30; TMPG White Paper, supra
note 21, at 12.
\52\ IAWG Report, supra note 4, at 30; G-30 Report, supra note
5.
---------------------------------------------------------------------------
Dealer-to-customer trading generally involves ``off-the-run''
issues more often than the interdealer market and typically is
conducted via voice or electronically (i.e., electronic ``request for
quote'' systems referred to section IV infra as non-ATS IDBs).\53\
Trading in the dealer-to-customer cash market is generally--and has
historically been--conducted through bilateral transactions. Customers
have not traditionally traded directly with other end users.\54\
Rather, non-dealers primarily trade with dealers, and dealers use the
interdealer market as a source of orders and trading interest to help
facilitate their trading with customers in the dealer-to-customer
market. Generally, trades in the dealer-to-customer market are not
centrally cleared.\55\
---------------------------------------------------------------------------
\53\ G-30 Report, supra note 5, at 1; TMPG White Paper, supra
note 21, at 1-2.
\54\ See Exchange Act Release No. 90019 (Sep. 28, 2020), 85 FR
87106, 87108 (Dec. 30, 2020).
\55\ G-30 Report, supra note 5, at 1; IAWG Report, supra note 4,
at 3; TMPG White Paper, supra note 21, at 6.
---------------------------------------------------------------------------
2. U.S. Treasury Repo Market
In a U.S. Treasury repo transaction, one party sells a U.S.
Treasury security to another party, along with a commitment to
repurchase the security at a specified price on a specified later date.
A reverse repo transaction is the same transaction from the buyer's
perspective.\56\ The effect of such a repo transaction is similar to a
cash loan, using the U.S. Treasury securities as collateral. The
difference in price between the purchase and repurchase is typically
converted to an interest rate, and represents the ``cost'' of the loan.
U.S. Treasury repos can use a particular security as collateral (known
in the industry as ``specific collateral'') or can designate a broad
class of securities as collateral (known as ``general collateral'').
Most U.S. Treasury repos are overnight, though the parties can set the
term for longer (generally no longer than one year).
---------------------------------------------------------------------------
\56\ For purposes of this release, we generally refer to both
repos and reverse repos collectively as ``repos.''
---------------------------------------------------------------------------
The U.S. Treasury repo market plays a key role in facilitating the
flow of cash and securities in the financial system by allowing market
participants to access low cost secured financing, supporting dealer
market-making activities, enabling institutional investors with large
cash balances to invest cash on a secured basis, and contributing to
price discovery and efficient capital allocation.\57\ The Federal
Reserve also engages in U.S. Treasury repos to bring about liquidity in
the financial system, implement monetary policy, and promote financial
stability. As of March 31, 2022, total repo assets were approximately
$6 trillion, while repo liabilities were approximately $5.6 trillion,
with over half collateralized by U.S. Treasury securities.\58\ Of that
amount, 38 percent is attributable to the Federal Reserve's reverse
repo programs, 27 percent to securities dealers, 20 percent to what is
referred to as ``rest of world'' and includes, among other entities,
foreign hedge funds, and the rest to banks, mortgage real estate
investment trusts, and insurance companies.\59\
---------------------------------------------------------------------------
\57\ Viktoria Baklanova, Isaac Kuznits, Trevor Tatum, Primer:
Money Market Funds and the Repo Market (Feb. 18, 2021), available at
<a href="https://www.sec.gov/files/mmfs-and-the-repo-market-021721.pdf">https://www.sec.gov/files/mmfs-and-the-repo-market-021721.pdf</a> (``MMF
Primer'').
\58\ The Financial Accounts of the United States (Q1 2022),
available at <a href="https://www.federalreserve.gov/releases/z1/20220609/html/l207.htm">https://www.federalreserve.gov/releases/z1/20220609/html/l207.htm</a>. The difference between repo assets and repo
liabilities in the Financial Accounts is largely attributed to
incomplete repo data collections and is calculated as instrument
discrepancies.
\59\ See id.
---------------------------------------------------------------------------
Depending on clearing and settlement practices, the U.S. Treasury
repo market consists of four main components: (1) non-centrally
cleared, settled bilaterally, (2) centrally cleared, settled
bilaterally, (3) non-centrally cleared, settled on a triparty platform,
and (4) centrally cleared, settled on a triparty platform.
For non-centrally cleared bilateral U.S. Treasury repos, the
parties agree to the terms and settle the trades between themselves,
without involving a CCP or other third-party. As mentioned above,
FICC's rules require its direct participants to submit for central
clearing all eligible trades with other direct participants. Therefore,
non-centrally cleared bilateral U.S. Treasury repos involve at least
one party that is not a FICC direct participant (e.g., a hedge fund);
such repos may also involve a repo structure that FICC does not accept
for clearing.
For centrally cleared bilateral U.S. Treasury repos, the parties
are FICC direct participants that submit agreed-upon trade details to
FICC for central clearing, and those trades are settled delivery versus
payment using the members' clearing banks and/or Fedwire Securities
Service.\60\ Additionally, some institutional participants (e.g., money
market funds and hedge funds) that are not FICC direct participants
also centrally clear repos through FICC's sponsored service. In 2005,
FICC established this service (the ``Sponsored Service''), allowing
eligible direct participants (Sponsoring Members) to sponsor their
clients into a limited form of FICC membership and then to submit
certain eligible securities transactions of their clients (Sponsored
Members) to FICC for central clearing.\61\ FICC interacts solely with
the Sponsoring Member/direct participant as agent for purposes of the
Sponsoring Member's clients/Sponsored Members' obligations to and from
FICC. Sponsoring Members also guarantee to FICC the payment and
performance obligations of their Sponsored
[[Page 64617]]
Members.\62\ Sponsoring Members can be either bank direct participants
of FICC which meet certain capital and other requirements or any other
FICC direct participant which meets what FICC determines to be the
appropriate financial resource requirements; in practice, Sponsoring
Members include both banks and broker-dealers.\63\ Sponsored Members
have to be ``qualified institutional buyers'' as defined by Rule 144A
under the Securities Act of 1933, as amended, or otherwise meet the
financial standards necessary to be a ``qualified institutional
buyer,'' and currently, Sponsored Members generally consist of hedge
funds, money market funds, other asset managers, and smaller banks.\64\
---------------------------------------------------------------------------
\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 <a href="https://www.dtcc.com/clearing-services/ficc-gov/sponsored-membership">https://www.dtcc.com/clearing-services/ficc-gov/sponsored-membership</a>, 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 <a href="https://www.dtcc.com/-/media/Files/Downloads/client-center/FICC/Mem-GOV-by-name.xlsx">https://www.dtcc.com/-/media/Files/Downloads/client-center/FICC/Mem-GOV-by-name.xlsx</a> (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 <a href="https://www.dtcc.com/client-center/ficc-gov-directories">https://www.dtcc.com/client-center/ficc-gov-directories</a>.
---------------------------------------------------------------------------
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 <a href="https://www.financialresearch.gov/working-papers/files/OFRwp-2015-17_Reference-Guide-to-U.S.-Repo-and-Securities-Lending-Markets.pdf">https://www.financialresearch.gov/working-papers/files/OFRwp-2015-17_Reference-Guide-to-U.S.-Repo-and-Securities-Lending-Markets.pdf</a>.
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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 <a href="https://www.dtcc.com/-/media/Files/Downloads/Clearing-Services/FICC/GOV/SponsoredGC-FS-INTL.pdf">https://www.dtcc.com/-/media/Files/Downloads/Clearing-Services/FICC/GOV/SponsoredGC-FS-INTL.pdf</a>.
\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).
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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.
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\74\ See supra note 7 and 17 CFR 240.17Ad-22(a)(5).
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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\
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\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\
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\77\ 17 CFR 240.17Ad-22(e)(18).
\78\ 17 CFR 240.17Ad-22(e)(19).
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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\
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\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.
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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).
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
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:
<bullet> Repurchase agreements and reverse repurchase agreements in
which one of the counterparties is a direct participant;
<bullet> 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
<bullet> Any purchases and sales of U.S. Treasury securities
between a direct participant and a counterparty that is a registered
broker-dealer, government securities dealer, or government securities
broker, a hedge fund, or an account at a registered broker-dealer,
government securities dealer, or government securities broker where
such account may borrow an amount in excess of one-half of the value of
the account or may have gross notional exposure of the transactions in
the account that is more than twice the value of the account.
However, any transaction (both cash transactions and repos) where
the counterparty to the direct participant of the CCA is a central
bank, sovereign entity, international financial institution, or a
natural person would be excluded from the definition of an eligible
secondary market transaction. In addition, the proposal would require
that such CCAs establish written policies and procedures reasonably
designed to, as applicable, identify and monitor their direct
participants' submission of transactions for clearing, including how
the CCA would address a failure to submit transactions.
For the reasons set forth below, the Commission believes that
taking these incremental steps, which build on the existing rules of
the only U.S. Treasury securities CCA, will strengthen risk management
at the current and any other future U.S. Treasury securities CCA.
Further, the Commission believes that this proposal would bring the
benefits of clearance and settlement to a potentially significant
portion of the U.S. Treasury securities market.
This section first explains what the Membership Proposal is and to
whom and what aspects of the U.S. Treasury markets it applies.\103\ It
then describes what constitutes an eligible secondary market
transaction and what transactions are excluded from that definition.
Finally, it discusses the benefits of the Membership Proposal.
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\103\ The Commission would add this requirement to the current
text of Rule 17Ad-22(e)(18). The Commission is also proposing to
adjust the numbering of Rule 17Ad-22(e)(18), 17 CFR 240.17Ad-
22(e)(18). But other than adding this proposal as new Rule 17Ad-
22(e)(18)(iv), the Commission is not proposing any other substantive
changes to the current text of Rule 17Ad-22(e)(18). The other
changes to Rule 17Ad-22(e)(18) are entirely stylistic and designed
to enhance readability in light of the proposed addition of Rule
17Ad-22(e)(18)(iv). In addition, the Commission proposes to define a
U.S. Treasury security as ``any security issued by the U.S.
Department of the Treasury.'' This term is not currently defined in
Rule 17Ad-22, and this definition would be codified as Rule 17Ad-
22(a)(23).
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1. Requirement To Clear Eligible Secondary Market Transactions
The Membership Proposal would apply to ``direct participants'' in a
U.S. Treasury securities CCA, which would distinguish entities that
access a CCA directly (i.e., members of the CCA) from indirect
participants who ``rely on the services provided by direct participants
to access the covered clearing agency's payment, clearing or settlement
facilities.'' \104\ For purposes of the Covered Clearing Agency
Standards, ``participants'' of a CCA are referred to as ``members'' or
``direct participants'' to differentiate these entities from ``direct
participants' customers'' or ``indirect participants.'' \105\
Consequently, for purposes of this proposal and consistent with the
terminology already used in the Covered Clearing Agency Standards,\106\
the term ``direct participants'' would refer to the entities that
directly access a U.S. Treasury securities CCA (generally banks and
broker-dealers), and the term ``indirect participants'' would refer to
those entities which rely on a direct participant to clear and settle
their U.S. Treasury securities transactions with the U.S. Treasury
securities CCA (generally their customers or clients).\107\
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\104\ 17 CFR 240.17Ad-22(e)(18) and (19). See also CCA Standards
Proposing Release, supra note 7, at 29553 (noting that some market
participants would not meet a covered clearing agency's direct
participation requirements and proposing risk management
requirements for indirect and tiered participants).
\105\ See, e.g., 17 CFR 240.14Ad-22 (e)(6) (referring to
participants) and (e)(2)(vi) (referring to direct participants'
customers). In addition, the Exchange Act defines a participant of a
clearing agency as ``any person who uses a clearing agency to clear
or settle securities transactions or to transfer, pledge, lend, or
hypothecate securities.'' 15 U.S.C. 78c(a)(24). Indirect
participants are expressly excluded from the Exchange Act definition
of a ``participant'' of a clearing agency because the Exchange Act
provides that a person whose only use of a clearing agency is
through another person who is a participant or as a pledgee of
securities is not a ``participant'' of the clearing agency. Id.
\106\ See 17 CFR 240.17Ad-22(e)(19) (referring to firms that are
indirect participants in a covered clearing agency as those that
``rely on the services provided by direct participants to access the
covered clearing agency's payment, clearing, or settlement
facilities'').
\107\ For example, FICC maintains the Sponsored Service. See
supra notes 64 through 66 and accompanying text. Because sponsored
members cannot clear or settle government securities transactions
without a sponsoring member, the Commission believes that these
sponsored members are not ``direct participants.'' As noted above,
such persons are referred to in this release as ``indirect
participants'' or ``customers.''
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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.
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2. Eligible Secondary Market Transactions
As discussed further below, the Commission would also define what
constitutes an eligible secondary market transaction in U.S. Treasury
securities subject to the Membership Proposal.\109\ This definition
would apply to all types of transactions that are of a type currently
accepted for clearing at a U.S. Treasury securities CCA; it would not
impose a requirement on a U.S.
[[Page 64621]]
Treasury securities CCA to offer additional products for clearing.
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\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 <a href="https://www.treasurydirect.gov/instit/annceresult/press/press_secannpr.htm">https://www.treasurydirect.gov/instit/annceresult/press/press_secannpr.htm</a>;
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.
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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 <a href="https://www.newyorkfed.org/markets/reference-rates/sofr">https://www.newyorkfed.org/markets/reference-rates/sofr</a>.
\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 <a href="https://www.newyorkfed.org/medialibrary/Microsites/tmpg/files/CSP_SFT_Note.pdf">https://www.newyorkfed.org/medialibrary/Microsites/tmpg/files/CSP_SFT_Note.pdf</a>; Katy Burne,
``Future Proofing the Treasury Market,'' BNY Mellon Aerial View, at
7 (Nov. 2021), available at <a href="https://www.bnymellon.com/content/dam/bnymellon/documents/pdf/aerial-view/future-proofing-the-us-treasury-market.pdf.coredownload.pdf">https://www.bnymellon.com/content/dam/bnymellon/documents/pdf/aerial-view/future-proofing-the-us-treasury-market.pdf.coredownload.pdf</a> (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 <a href="https://www.federalreserve.gov/econres/notes/feds-notes/insights-from-revised-form-fr2004-into-primary-dealer-securities-financing-and-mbs-activity-20220805.htm">https://www.federalreserve.gov/econres/notes/feds-notes/insights-from-revised-form-fr2004-into-primary-dealer-securities-financing-and-mbs-activity-20220805.htm</a>. 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 <a href="https://www.pifsinternational.org/wp-content/uploads/2021/11/PIFS-Mandatory-Central-Clearing-for-U.S.-Treasury-Markets-11.11.2021.pdf">https://www.pifsinternational.org/wp-content/uploads/2021/11/PIFS-Mandatory-Central-Clearing-for-U.S.-Treasury-Markets-11.11.2021.pdf</a> (``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 <a href="https://www.bis.org/publ/cgfs59.pdf">https://www.bis.org/publ/cgfs59.pdf</a>.
---------------------------------------------------------------------------
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 <a href="https://www.dtcc.com/client-center/ficc-gov-directories">https://www.dtcc.com/client-center/ficc-gov-directories</a>.
---------------------------------------------------------------------------
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 <a href="https://www.sec.gov/files/mmfs-treasury-market-090122.pdf">https://www.sec.gov/files/mmfs-treasury-market-090122.pdf</a> (``MMFs in the Treasury
Market'').
\129\ Id.
\130\ See, e.g., G-30 Report, supra note 5, at 13 (``Buyside
firms benefit because dealers are willing to intermediate cleared
repos at narrower spreads, which are reflected in part in higher
rates paid to buyside repo investors on cleared repos than on
uncleared repos and in part in lower rates charged to repo borrowers
(including hedge funds and smaller broker-dealers) on cleared
repos.'').
---------------------------------------------------------------------------
b. Purchases and Sales of U.S. Treasury Securities
An estimated 68 percent of the overall dollar value of cash market
transactions in U.S. Treasury securities are not centrally cleared, and
an estimated 19 percent of the overall dollar value of such
transactions are subject to so-called hybrid clearing (as stated
above).\131\ The Commission has identified certain categories of
purchases and sales of U.S. Treasury securities that it believes should
be part of the definition of an eligible secondary market transaction
subject to the Membership Proposal, i.e., for which U.S. Treasury
securities CCAs would be obligated to impose membership rules to
require clearing of such transactions, for the reasons described below.
The Commission believes that including this set of transactions in the
eligible secondary market definition and therefore subjecting these
transactions to the Membership Proposal represents an incremental first
step to address potential risks arising to a U.S. Treasury securities
CCA.
---------------------------------------------------------------------------
\131\ IAWG Report, supra note 4, at 30; see also TMPG White
Paper, supra note 21, at 12.
---------------------------------------------------------------------------
i. IDB Transactions
The Commission proposes to include within the definition of an
eligible secondary market transaction any purchase or sale between a
direct participant of a U.S. Treasury securities CCA and any
counterparty, if the direct participant of the covered clearing agency
(A) brings together multiple buyers and sellers using a trading
facility (such as a limit order book) and (B) is a counterparty to both
the buyer and seller in two separate transactions.\132\ As a result,
this definition will only encompass the transactions of those IDBs in
the Treasury market that are direct participants of a U.S. Treasury
securities CCA and stand as counterparties to both sides of each trade
on their platforms.\133\
---------------------------------------------------------------------------
\132\ See paragraph (ii)(A) of the definition of an ``eligible
secondary market transaction'' in Proposed Rule 17Ad-22(a).
\133\ See notes 40-43 and accompanying text supra.
---------------------------------------------------------------------------
The Commission believes that this aspect of the Membership Proposal
generally would result in the benefits described in section III.A.3
infra. Chiefly, the Commission believes that this aspect of the
Membership Proposal would specifically address the potential for
contagion risk associated with hybrid clearing that a number of
commentators have highlighted. As explained above, the configuration of
counterparty risk presented by hybrid clearing allows the U.S. Treasury
securities CCA to manage the risks arising from the IDB-CCA direct
participant transaction, on the one hand, but the U.S. Treasury
securities CCA cannot manage the risks arising from the IDB's
offsetting transaction with its non-member counterparty and the
potential counterparty credit risk and settlement risk arising to the
IDB from that trade.\134\ Thus, under the current hybrid clearing
model, the U.S. Treasury securities CCA is indirectly exposed to the
IDB's non-centrally cleared transaction, but it lacks the ability to
risk manage its indirect exposure to this non-centrally cleared leg of
the transaction. Specifically, it does not know who the ultimate
[[Page 64623]]
counterparty of the transaction is and cannot collect margin on that
transaction. This, in turn, results in margin collection at the CCP
which is based upon only one transaction and has been calculated to
cover this seemingly directional position, as well as an inability to
net these offsetting transactions and provide the benefits of central
clearing. In particular, if the IDB's non-CCP member counterparty fails
to settle a transaction that is subject to hybrid clearing, such IDB
may not be able to settle the corresponding transaction that has been
cleared with the U.S. Treasury securities CCA due to a lack of
financial resources at the IDB, which could lead the IDB to
default.\135\ As part of its existing default management procedures,
the U.S. Treasury securities CCA could seek to mutualize its losses
from the IDB's default, which could in turn transmit stress to the
market as a whole.
---------------------------------------------------------------------------
\134\ See, e.g., TMPG White Paper, supra note 21, at 22 (noting
that in a hybrid clearing arrangement, an IDB's rights and
obligations to the CCP are not offset and the IDB is not in a net
zero settlement position with respect to the CCP at settlement
date). Thus, the IDB is not able to net all of its positions for
clearing at a U.S. Treasury securities CCA, and the IDB's positions
appear to the CCA to be directional, which impacts the amount of
margin that the CCA collects for the transaction.
\135\ See IAWG Report, supra note 4, at 31; Depository Trust and
Clearing Corporation, More Clearing, Less Risk: Increasing Centrally
Cleared Activity in the U.S. Treasury Cash Market, at 5 (May 2021),
available at <a href="https://www.dtcc.com/-/media/Files/PDFs/DTCC-US-Treasury-Whitepaper.pdf">https://www.dtcc.com/-/media/Files/PDFs/DTCC-US-Treasury-Whitepaper.pdf</a> (``DTCC May 2021 White Paper'').
---------------------------------------------------------------------------
As noted above, the Commission has previously stated that
membership requirements help to guard against defaults of any CCP
member, as well as to protect the CCP and the financial system as a
whole from the risk that one member's default could cause others to
default, potentially including the CCP itself. Further, contagion
stemming from a CCP member default could undermine confidence in the
financial system as a whole, even if the health of the CCP is not
implicated. This is because the default could cause others to back away
from participating in the market. This risk of decreased participation
could be particularly problematic if the defaulting participant was an
IDB, whose withdrawal from the market could impact other market
participants' ability to access the market for on-the-run U.S. Treasury
securities, approximately 49.7% of which trade on IDBs.\136\ Including
such transactions as eligible secondary market transactions subject to
the Membership Proposal would therefore help protect against this risk
by requiring that a U.S. Treasury securities CCA ensure that direct
participants who are IDBs centrally clear both sides of their
transactions, thereby eliminating the various aspects of potential
contagion risk posed by so-called hybrid clearing.
---------------------------------------------------------------------------
\136\ TMPG White Paper, supra note 21, at 32; section IV.B.4
(Table 1) infra.
---------------------------------------------------------------------------
ii. Other Cash Transactions
The Commission proposes to include certain additional categories of
cash transactions of U.S. Treasury securities by the direct
participants of a U.S. Treasury securities CCA in the definition of an
eligible secondary market transaction subject to the Membership
Proposal.
First, the Commission is proposing that the definition of an
eligible secondary market transaction include those cash purchase and
sale transactions in which the counterparty of the direct participant
is a registered broker-dealer, government securities broker, or
government securities dealer.\137\ Each of these entities is a type of
market intermediary that is engaged in the business of effecting
transactions in securities for the account of others (in the case of
brokers) or for their own accounts (in the case of dealers).\138\ As
stated in section II.A.1 supra, in 2018, the TMPG determined that a
majority of trades in the secondary cash Treasury market now clear
bilaterally,\139\ and estimated that the trading volume of non-FICC
members exceeds that of FICC members.\140\ As a result, the Commission
believes that their collective trading activity likely is responsible
for a not insignificant portion of the volume of transactions involving
Treasury securities and could present contagion risk to a U.S. Treasury
securities CCA.\141\ In addition, registered broker-dealers, government
securities brokers, or dealers that are not direct members of a U.S.
Treasury securities CCA are typically ``introducing firms'' that
establish mechanisms to clear and settle their transactions. For
example, currently, many registered brokers and dealers rely on the
correspondent clearing service provided by FICC to have a FICC member
submit their transactions for clearing at FICC.\142\
---------------------------------------------------------------------------
\137\ See paragraph (ii)(B) of the definition of an ``eligible
secondary market transaction'' in Proposed Rule 17Ad-22(a). See also
15 U.S.C. 78o(a) and 78o-5(a) (requirement to register) and 78c(4),
(5), (43), and (44) (definitions of broker, dealer, government
securities dealer, and government securities broker). The Commission
acknowledges that the transactions encompassed by paragraph (ii)(B)
in the definition of an ``eligible secondary market transaction'' in
Proposed Rule 17Ad-22(a) could also encompass certain transactions
that would be encompassed by paragraph (ii)(A) of the same proposed
definition, in the event that the direct participant is an IDB
transacting with a registered broker-dealer. However, the set of
transactions encompassed by paragraph (ii)(B) of the proposed
definition is broader than that of paragraph (ii)(A). The Commission
believes that this overlap is appropriate because these paragraphs
of the proposed definition are designed to accomplish different
purposes, which is not impacted by the potential overlap.
\138\ See generally TMPG, Automated Trading in Treasury Markets
(White Paper) (June 2015), available at <a href="https://www.newyorkfed.org/TMPG/medialibrary/microsites/tmpg/files/TPMG-June-2015-Automated-Trading-White-Paper.pdf">https://www.newyorkfed.org/TMPG/medialibrary/microsites/tmpg/files/TPMG-June-2015-Automated-Trading-White-Paper.pdf</a> (``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 <a href="https://www.dtcc.com/client-center/ficc-gov-directories">https://www.dtcc.com/client-center/ficc-gov-directories</a>.
---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
\143\ 17 CFR 279.9 (Form PF Glossary of Terms).
---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
\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).
---------------------------------------------------------------------------
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 <a href="https://home.treasury.gov/news/press-releases/jy0587">https://home.treasury.gov/news/press-releases/jy0587</a>.
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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 <a href="https://www.sec.gov/divisions/investment/private-funds-statistics/private-funds-statistics-2021-q4.pdf">https://www.sec.gov/divisions/investment/private-funds-statistics/private-funds-statistics-2021-q4.pdf</a>.
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 <a href="https://www.sec.gov/divisions/investment/private-funds-statistics/private-funds-statistics-2021-q4.pdf">https://www.sec.gov/divisions/investment/private-funds-statistics/private-funds-statistics-2021-q4.pdf</a>.
\150\ See generally Ayelen Banegas et al., Sizing Hedge Funds'
Treasury Market Activities and Holdings (Oct. 6, 2021), available at
<a href="https://www.federalreserve.gov/econres/notes/feds-notes/sizing-hedge-funds-treasury-market-activities-and-holdings-20211006.htm">https://www.federalreserve.gov/econres/notes/feds-notes/sizing-hedge-funds-treasury-market-activities-and-holdings-20211006.htm</a>;
see also Daniel Barth & R. Jay Kahn, Hedge Funds and the Treasury
Cash-Futures Disconnect (Apr. 1, 2021), available at <a href="https://www.financialresearch.gov/working-papers/2021/04/01/hedge-funds-and-the-treasury-cash-futures-disconnect/">https://www.financialresearch.gov/working-papers/2021/04/01/hedge-funds-and-the-treasury-cash-futures-disconnect/</a>; Hedge Fund Treasury Trading
and Funding Fragility: Evidence from the COVID-19 Crisis, available
at <a href="https://www.federalreserve.gov/econres/feds/files/2021038pap.pdf">https://www.federalreserve.gov/econres/feds/files/2021038pap.pdf</a>.
\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 <a href="https://www.sec.gov/files/US-Credit-Markets_COVID-19_Report.pdf">https://www.sec.gov/files/US-Credit-Markets_COVID-19_Report.pdf</a>.
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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.
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\155\ See paragraph (ii)(D) of the definition of an ``eligible
secondary market transaction'' in Proposed Rule 17Ad-22(a).
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The Commission believes that the inclusion of transactions with
such accounts within the definition of an eligible secondary market
transaction should allow the proposal to encompass transactions between
direct participants of a U.S. Treasury securities CCA and a prime
brokerage account, which, based on the Commission's supervisory
knowledge, may hold assets of entities, such as, for example, private
funds or separately managed accounts, and may use leverage that poses a
risk to U.S. Treasury securities CCA and the broader financial system.
Covering such accounts would also allow for inclusion of, for example,
accounts used by family offices or separately managed accounts that may
use strategies more similar to those of a hedge fund. The account
provider (i.e., the prime broker) does not have access to, or knowledge
of, the account owner's entire portfolio of assets and is limited to
the assets in that particular account. Therefore, the account provider
may be unable to make a counterparty whole in the event of a default by
the account owner if the account has taken on significant leverage.
Typically, the entity providing an account has a lien or some other
priority on assets in the account to make a counterparty whole if
necessary. By including the account, and not the entity using the
account, this aspect of the proposal is targeted to the activity that
could bring the most potential risk to a U.S. Treasury securities CCA
and the financial system more generally.
c. Exclusions From the Definition of an Eligible Secondary Market
Transaction
The Commission is proposing to exclude transactions between direct
participants of a U.S. Treasury securities CCA and certain
counterparties from the definition of an eligible secondary market
transaction in U.S. Treasury securities. These exclusions would apply
to any purchase or sale transaction in U.S. Treasury securities or
repurchase or reverse repurchase agreement collateralized by U.S.
Treasury securities. First, recognizing the importance of U.S. Treasury
securities not only to the financing of the United States government,
but also their central role in the formulation and execution of
monetary policy and other governmental functions, the Commission is
proposing to exclude any transactions in U.S. Treasury securities
between a direct participant of a U.S. Treasury securities CCA and a
central bank. For similar reasons, the Commission is also proposing to
exclude any transactions in U.S. Treasury securities between a direct
participant of a U.S. Treasury securities CCA and a sovereign entity or
an international financial institution.\156\ Together, these exclusions
are referred to as the ``Official Sector Exclusions.''
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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 <a href="https://www.bis.org/about/index.htm">https://www.bis.org/about/index.htm</a> (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 <a href="https://www.ecb.europa.eu/ecb/legal/pdf/en_statute_2.pdf">https://www.ecb.europa.eu/ecb/legal/pdf/en_statute_2.pdf</a>.
\162\ See, e.g., ECB Protocol Statute, supra note 106, Article
3.1; Bank of Japan Act, Articles 1 and 2, available at <a href="https://www.boj.or.jp/en/about/boj_law/index.htm/#p01">https://www.boj.or.jp/en/about/boj_law/index.htm/#p01</a>.
\163\ 12 U.S.C. 225a (defining goals of monetary policy); see
also <a href="https://www.federalreserve.gov/monetarypolicy/monetary-policy-what-are-its-goals-how-does-it-work.htm">https://www.federalreserve.gov/monetarypolicy/monetary-policy-what-are-its-goals-how-does-it-work.htm</a>.
\164\ See Federal Reserve Bank; Monetary Policy Implementation,
available at <a href="https://www.newyorkfed.org/markets/domestic-market-operations/monetary-policy-implementation">https://www.newyorkfed.org/markets/domestic-market-operations/monetary-policy-implementation</a>.
\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
<a href="https://www.federalreserve.gov/releases/z1/20220609/z1.pdf">https://www.federalreserve.gov/releases/z1/20220609/z1.pdf</a>.
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3. How the Membership Proposal Facilitates Prompt and Accurate
Clearance and Settlement in the U.S. Treasury Market
The Commission believes that the Membership Proposal would promote
the prompt and accurate clearance and settlement of U.S. Treasury
securities transactions, providing several benefits to the market for
U.S. Treasury securities as a whole.
First, the Commission believes that the Membership Proposal would
decrease the overall amount of counterparty credit risk in the
secondary market for U.S. Treasury securities. Because a U.S. Treasury
securities CCA would novate and guarantee each transaction submitted
for central clearing, it would become a counterparty to each
transaction, as the buyer to every seller and the seller to every
buyer. The U.S. Treasury securities CCA would be able to risk manage
these transactions centrally, pursuant to risk management procedures
that the Commission has reviewed and approved, and would guarantee
settlement of the trade in the event of a direct participant default.
By contrast, bilaterally cleared cash transactions in U.S. Treasury
securities are subject to variable risk management methodologies in
which exposures are often less mitigated with less rigorous
[[Page 64627]]
practices compared to CCP risk management.\170\ Indeed, although
various SRO margin rules provide for the collection of margin for
certain transactions in U.S. Treasury securities, transactions between
dealers and institutional customers are subject to a variable ``good-
faith'' margin standard, which the Commission understands--based on its
supervisory experience--can often result in fewer financial resources
collected to margin exposures than those that would be collected if a
CCP margin model, like the one used at FICC, were used.\171\ The
Membership Proposal is designed to ameliorate these risks by requiring
Treasury securities CCAs to establish policies and procedures that
require their direct participants to submit for clearance and
settlement their eligible secondary market transactions, which would
include all repo transactions, and specified cash transactions in U.S.
Treasury securities, which are most likely to pose contagion risk to a
U.S. Treasury securities CCA.
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\170\ TMPG White Paper, supra note 21, at 29.
\171\ Although FINRA rules provide for the collection of margin
for cash U.S. Treasury transactions, see FINRA Rule 4210(e)(2)(A)
(setting forth margin rule for FINRA members for collection of
margin on Treasuries and certain other bonds) these rules do not
necessarily apply to exempt accounts, see FINRA Rule 4210(e)(2)(F)
(permitting FINRA members not to collect margin from exempt accounts
and providing for a capital charge for any uncollected mark-to-
market loss); FINRA Rule 4210(a)(13) (defining exempt account).
Although SRO rules also require a broker-dealer to establish
procedures to review limits and types of credit extended to all
customers, formulate their own ``house'' margin requirements, and
review the need for instituting higher margin requirements than are
required for individual securities or customer accounts, based on
the Commission's supervisory experience, the resulting margin
collection is often less than that required pursuant to FICC's
margin model.
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In particular, the Membership Proposal is designed to reduce the
amount of ``contagion risk'' to a U.S. Treasury securities CCA arising
from what has been described as ``hybrid clearing,'' as discussed
above.\172\ In a hybrid transaction, the leg of the trade between an
IDB, which is a FICC member, and a FICC member counterparty is
submitted to FICC for clearance and settlement but the leg between the
IDB and a non-FICC member counterparty is not.\173\ Consequently, this
FICC-member counterparty would no longer have exposure to the IDB and
vice versa. But the IDB must settle the other leg of the trade
bilaterally with its non-FICC member counterparty, and the IDB and the
non-FICC member counterparty would face counterparty credit risk to
each other until the transaction settles. Although this release has
discussed ``hybrid clearing,'' and, more generally, contagion risk,
with respect to IDB transactions, the general concept can apply more
broadly, in that a FICC member's transactions that are not submitted
for central clearing pose an indirect risk to the CCP as any default on
a bilaterally settled transaction could impact the FICC member's
financial resources and ability to meet its obligations to FICC. The
Commission believes that requiring U.S. Treasury securities CCAs to
impose, as a condition of membership, an obligation on their direct
participants to submit all eligible secondary market transactions for
central clearing should address the transactions most likely to cause
contagion risk.
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\172\ TMPG White Paper, supra note 21, at 8 n.11 (``IDB
platforms act as blind brokers to provide anonymity to their
customers. Under the blind broker model, the IDB serves as principal
so what might appear to be a single trade between two customers is
really two: one between the broker and the buyer and one between the
broker and the seller. The buyer and seller are no longer directly
exposed to each other, but both are exposed to the blind broker, and
the blind broker is exposed to both buyer and seller.'').
\173\ TMPG White Paper, supra note 21, at 9.
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Second, the Commission believes that the Membership Proposal would
also help any U.S. Treasury securities CCA to avoid a potential
disorderly member default. When cash market transactions are cleared
bilaterally, market participants typically enter into bespoke
arrangements to govern clearance and settlement with each of their
trading counterparties, resulting in multiple interconnected
counterparty credit risk exposures. Aside from the inefficiency of
multiple sets of bilateral documentation that may differ in key
respects, such as the amount of margin required, the default of one
counterparty can have cascading effects on multiple other market
participants. Defaults in bilaterally settled transactions are likely
to be less orderly and subject to variable default management
techniques because bilaterally settled transactions are not subject to
the default management processes that are required to be in place and
publicly disclosed at a CCP.\174\ Centralized default management is a
key feature of central clearing. Because the CCP has novated and
guaranteed the transactions, it is uniquely positioned to coordinate
the default of a member for trades that it has centrally cleared, and
the non-defaulting members can rely on the CCP to complete the
transactions of the defaulting member and cover any resulting losses
using the defaulting member's resources and/or its default management
tools. Even in a situation where two CCPs have to coordinate the
default of a joint member, that coordination should result in more
efficiency and market confidence than multiple bilateral settlements.
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\174\ See Rule 17Ad-22(e)(13) and (e)(23)(i).
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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\
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\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\
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\179\ See 17 CFR 240.17Ad-22(e)(13).
\180\ See 15 U.S.C. 78q-1(a)(2)(A).
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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\
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\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 <a href="https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr964.pdf">https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr964.pdf</a>). 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 <a href="https://www.financialresearch.gov/briefs/files/OFRBr_2017_04_CCP-for-Repos.pdf">https://www.financialresearch.gov/briefs/files/OFRBr_2017_04_CCP-for-Repos.pdf</a>.
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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\
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\186\ Darrel Duffie, Still the World's Safe Haven, Hutchison
Center on Fiscal & Monetary Policy, at 15 (June 2020), available at
<a href="https://www.brookings.edu/wp-content/uploads/2020/05/WP62_Duffie_v2.pdf">https://www.brookings.edu/wp-content/uploads/2020/05/WP62_Duffie_v2.pdf</a> (``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.
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\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.
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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).
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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:
<bullet> 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?
<bullet> 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?
<bullet> 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?
<bullet> 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?
<bullet> 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?
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\193\ 17 CFR 240.17Ad-22(e)(7).
\194\ FICC Rule 22A, section 2a, supra note 47.
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<bullet> 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?
<bullet> 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?
<bullet> 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?
<bullet> 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?
<bullet> 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?
<bullet> 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?
<bullet> 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?
<bullet> 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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<bullet> 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)?
<bullet> 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?
<bullet> 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?
<bullet> 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?
<bullet> 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?
<bullet> 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?
<bullet> 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?
<bullet> Should the definition of a hedge fund be limited to hedge
funds managed by an investment adviser registered with the Commission?
<bullet> 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?
<bullet> 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?
<bullet> 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)?
<bullet> 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?
<bullet> 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?
<bullet> 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?
<bullet> 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?
<bullet> 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?
<bullet> 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?
<bullet> 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?
<bullet> Is the Offi
[…truncated; see source link]Indexed from Federal Register on October 25, 2022.
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