Central clearing key to risk reduction in US Treasury Market, says DTCC
26 May 2021 US
Image: stock.adobe.com/Alexey Brin
In a newly-published white paper, global post-trade market infrastructure specialist DTCC highlights risks created by fragmentation of clearing activity in the US Treasury cash market.
Clearing in US treasury securities is currently split between two processes: trades cleared centrally via the DTCC's Fixed Income Clearing Corporation (FICC) and trades cleared bilaterally.
The white paper, More Clearing, Less Risk: Increasing Centrally Cleared Activity in the U.S. Treasury Cash Market, raises concerns about the rising volume of transactions in US treasuries which are cleared bilaterally — directly between counterparties without intermediation from a central counterparty (CCP).
Prior to 2000, all outright purchases and sales of treasury securities through inter-dealer brokers (IDBs) were cleared centrally, according to DTCC. Today, up to 60 per cent of outright purchases and sales of treasuries through IDBs involve principal trading firms (PTFs) which typically do not clear trades via a CCP.
IDBs are regularly executing trades between FICC clearing members and non-FICC members, where one side of the trade is cleared centrally and the other is bilateral, says the DTCC.
This fragmentation is creating ‘contagion risk’, particularly because the default of a non-FICC member firm could have wider systemic impact across the treasury market ecosystem.
DTCC's head of clearing agency services and global business operations Murray Pozmanter says: “The US Treasury market is the largest in the world and its performance is critical to the stability of the US economy. However, the bifurcation of treasury clearing activity, where part is bilaterally cleared and part is centrally cleared, is introducing greater risk into this growing market.”
The DTCC continues to engage with the industry to encourage adoption of central clearing services. This will deliver industry-wide benefits, says the white paper, including mitigating market risk through twice-daily margin calls, and providing opportunity for trade netting, thereby reducing net settlement exposure and delivering greater balance sheet efficiency.
“Central clearing would allow greater transparency into the bilateral treasury cash market while lowering counterparty risk and systemic risk,” says Pozmanter.
Some firms are unlikely to make this change without a push from market authorities. “We believe that many will not adopt this critical risk management capability unless there is a mandate from the official sector, such as a regulatory requirement for firms that make markets in US Treasury securities to centrally clear their cash activity,” says Pozmanter.
Clearing in US treasury securities is currently split between two processes: trades cleared centrally via the DTCC's Fixed Income Clearing Corporation (FICC) and trades cleared bilaterally.
The white paper, More Clearing, Less Risk: Increasing Centrally Cleared Activity in the U.S. Treasury Cash Market, raises concerns about the rising volume of transactions in US treasuries which are cleared bilaterally — directly between counterparties without intermediation from a central counterparty (CCP).
Prior to 2000, all outright purchases and sales of treasury securities through inter-dealer brokers (IDBs) were cleared centrally, according to DTCC. Today, up to 60 per cent of outright purchases and sales of treasuries through IDBs involve principal trading firms (PTFs) which typically do not clear trades via a CCP.
IDBs are regularly executing trades between FICC clearing members and non-FICC members, where one side of the trade is cleared centrally and the other is bilateral, says the DTCC.
This fragmentation is creating ‘contagion risk’, particularly because the default of a non-FICC member firm could have wider systemic impact across the treasury market ecosystem.
DTCC's head of clearing agency services and global business operations Murray Pozmanter says: “The US Treasury market is the largest in the world and its performance is critical to the stability of the US economy. However, the bifurcation of treasury clearing activity, where part is bilaterally cleared and part is centrally cleared, is introducing greater risk into this growing market.”
The DTCC continues to engage with the industry to encourage adoption of central clearing services. This will deliver industry-wide benefits, says the white paper, including mitigating market risk through twice-daily margin calls, and providing opportunity for trade netting, thereby reducing net settlement exposure and delivering greater balance sheet efficiency.
“Central clearing would allow greater transparency into the bilateral treasury cash market while lowering counterparty risk and systemic risk,” says Pozmanter.
Some firms are unlikely to make this change without a push from market authorities. “We believe that many will not adopt this critical risk management capability unless there is a mandate from the official sector, such as a regulatory requirement for firms that make markets in US Treasury securities to centrally clear their cash activity,” says Pozmanter.
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