Scope and Impact of the New Rules
The regulatory reforms broaden the range of transactions that must be cleared, thereby requiring clearing houses to ensure that their members clear cash Treasury trades. This mainly affects big broker-dealers who engage in repo market activities. The basis trade, utilized by macro hedge funds, involves selling futures contracts, purchasing Treasuries using repo funding, and delivering them at contract expiry. Currently, a significant portion of hedge fund trading in repo markets lacks collateral, leading to concerns about excessive leverage.
Industry Reaction and SEC’s Concessions
Prior to the SEC’s vote, concerns were raised by industry groups regarding the potential impact on liquidity and efficiency. However, the SEC officials have made some concessions to soften the original proposals. Notably, transactions between broker-dealers and hedge funds or leveraged accounts will not be subjected to clearing, as clearing repo trades already addresses the associated risks. The Managed Funds Association (MFA), representing hedge funds, has expressed approval for this decision and stated that the rule’s impact will depend on how it is implemented by the SEC and the Fixed Income Clearing Corporation.
Implementation Timeline and Challenges Ahead
According to estimates from the U.S. Treasury Department, only 13% of Treasury cash transactions are currently centrally cleared. The implementation deadline for the new rules provides market participants with until December 2025 to initiate central clearing for cash market Treasury transactions and until June 30, 2026, for repo transactions. While the timeframe is considered better than expected, industry experts warn that there will be operational challenges to overcome in order to establish a cost-effective and efficient client clearing structure.
Scott O’Malia, the CEO of the International Swaps and Derivatives Associations, a broker-dealer trade group, highlights the need to address these challenges while ensuring the safety and efficiency of the Treasury market.