On September 14, 2022, the SEC proposed amendments (the Proposal) to regulations for clearing agencies under the Securities Exchange Act of 1934 (the Exchange Act). The Proposal would increase the central clearing of U.S. Treasury securities, to be defined as “any security issued by the U.S. Department of the Treasury.” According to the SEC’s press release, “the proposal would require that clearing agencies in the U.S. Treasury market adopt policies and procedures designed to require their members to submit for clearing certain specified secondary market transactions.”

FICC: The Covered Clearing Agency

The proposal would amend Rule 17Ad-22 under the Exchange Act regarding any clearing agency registered with the SEC that (a) acts as a central counterparty or central securities depository (a covered clearing agency or CCA) and (b) provides central counterparty (CCP) services for U.S. Treasury securities. “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.” A CCP accomplishes this through the process of “novation,” in the sense of “replacing a party to an agreement with a new party.” Effectively, the trade between the buyer and seller is replaced by two trades, one in which the clearing agency agrees to sell the Treasury security to the buyer and the other in which the clearing agency agrees to buy that Treasury security from the seller. After novation, the seller and buyer no longer have delivery obligations to one another.

Currently, only one registered clearing agency, the Fixed Income Clearing Corporation (‘FICC’), provides CCP services for U.S. Treasury securities transactions.” Given the FICC’s unique position, we will refer to the FICC, rather than to a “CCA that provides CCP services,” when discussing the proposed changes to Rule 17Ad-22.

Additional Central Clearing Requirements

Although not required by Rule 17Ad-22, “FICC’s current rules generally require that FICC direct participants submit for clearing all trades with other FICC direct participants.” The Proposal would codify and expand this to “[r]equire that any direct participant … submit for clearance and settlement all of the eligible secondary market transactions to which such direct participant is a counterparty.” The FICC would have to monitor the submission of transactions by its participants and have rules to address a failure to submit transactions. The FICC would also have to ensure that it has the capacity to clear and settle all eligible secondary market transactions.

Eligible Secondary Market Transactions

The “eligible secondary market transactions” that the Proposal would require direct participants of the FICC to submit for clearance and settlement are:

  • all repurchase and reverse repurchase agreements collateralized by U.S. Treasury securities entered into by a participant;
  • all purchase and sale transactions for U.S. Treasury securities entered into by a participant that is an interdealer broker; and
  • all purchase and sale transactions for U.S. Treasury securities entered into between a participant and either a registered broker-dealer, a government securities broker, a government securities dealer, a hedge fund, or a particular type of leveraged account.

Transactions with a central bank, a sovereign entity, an international financial institution, or a natural person would be excluded. We will discuss the scope of transactions covered by the Proposal in more detail in later posts.

Margin Requirements

Rule 17Ad-22(e)(6) currently requires CCAs to collect daily margin from participants “commensurate with, the risks and particular attributes of each relevant product, portfolio, and market.” As the Proposal will require the FICC to novate transactions with a participant’s customers, the FICC participants engaged in these transactions will need to post margin on their customers’ behalf. The Proposal would amend Rule 17Ad-22(e)(6)(i) to require the FICC to calculate and hold margin for a participant’s proprietary positions separately from margin held for the participant’s customers. In its sponsored member repo program, the FICC already holds margin amounts for its sponsoring members separately from their sponsored members.

The formula for determining customer and proprietary account reserve requirements would have a corresponding amendment allowing a broker-dealer to deduct FICC margin held for its customers from its reserve requirement. This would prevent a broker-dealer from having to maintain reserves in addition to the FICC margin for an eligible secondary market transaction.

Our next post will examine what the SEC intends to accomplish with the Proposal.