SEC Finalizes Treasury Clearing Rule

The SEC approved a final rule this morning in a 4-1 vote (the “Final Rule”) that will (i) require covered clearing agencies that clear transactions in USTs (a “Treasury CCP”) to require their members to clear additional repos and purchases and sales of USTs (the “Clearing Requirement”) and (ii) modify the reserve formula in the broker-dealer Customer Protection Rule (Rule 15c3-3a) so as to allow broker-dealers to record a debit in the formula for margin collected from customers and on posted to a Treasury CCP to secure the customers’ obligations under repos and purchases and sales of USTs.

We are continuing to review the final rule, but have included a preliminary summary and analysis below.

The Final Rule largely adopted the proposed amendments, with certain changes highlighted below. A blackline against the proposed amendments for convenience is available here.

Clearing Requirement

• The Final Rule requires that a Treasury CCP establish policies and procedures that require its direct participants (i.e., full purpose members) to submit for clearance and settlement “all eligible secondary market transactions to which such direct participant is a counterparty.”
  • An eligible secondary market transaction” in Treasury securities is defined to include, subject to the exceptions described below:
    • All repos in which one of the counterparties is a direct participant
    • Any cash transactions (i.e., purchases and sales of Treasury securities):
      • where the direct participant brings together multiple buyers and sellers using a trading facility and is a counterparty to both the buyer and seller in two separate transactions (i.e., interdealer brokers); or
      • Between a direct participant and a counterparty that is a registered broker-dealer, government securities dealer, or government securities broker.
  • However, an “eligible secondary market transaction” does not include:
    • Repos or cash transactions where the counterparty is a central bank, sovereign entity, international financial institution, or a natural person.
    • Repos where one counterparty is a central counterparty (including U.S. clearing agency or DCOs or foreign central counterparties) or a state or local government.
    • Repos between a direct participant and an affiliate, provided that the affiliate is a bank, FCM, or broker-dealer or similar non-U.S. entity and  submits for clearing all other Treasury repos to which it is a party.
• Changes from the proposal:
  • In response to industry feedback, the SEC substantially narrowed the scope of cash transactions subject to the rule to exclude transactions with hedge funds, private equity funds, and prime brokerage clients.
  • In addition, the SEC added exceptions for central counterparties, state and local governments, and inter-affiliate transactions.
    • However, the ability of market participants to utilize the inter-affiliate exception remains to be seen, since it requires the direct participant’s affiliate to clear all other Treasury repos, even if such Treasury repos would otherwise not constitute “eligible secondary market transactions” (e.g., if the repos are between the direct participant’s affiliate and a central bank). Commissioner Peirce raised this point during the open meeting.

Additional Treasury CCP Requirements

• Segregation of Customer Margin: Consistent with the proposal, the Final Rule requires that a Treasury CCP establish policies and procedures to calculate, collect, and hold margin for a direct participant’s proprietary Treasury securities positions separately from the margin calculated and collected from that direct participant with respect to its customer Treasury securities positions.
  • Notably, the final rule does not require that margin collected for customers be collected on a gross basis, but would allow net margining (though see the discussion of the Customer Protection Rule amendments below)
• Facilitating Access: Consistent with the Proposal, the Final Rule requires Treasury CCPs to establish policies and procedures to facilitate access to clearance and settlement services of all eligible secondary market transactions in Treasury securities, including those of indirect participants (such as the FICC sponsored member program). Indirect participants may include pension funds, asset managers, investment advisers and RICs. It does not require that access for such participants take any particular form.

Customer Protection Rule Amendment

• The Final Rule amends 15c3-3a – the broker-dealer Customer Protection Rule – to permit certain margin required by and on deposit with a Treasury CCP (e.g., FICC clearing fund requirements) to be included as a debit in the customer reserve formula, subject to certain conditions.
  • Currently, the absence of a debit in the formula means that broker-dealers are unable to use margin posted by customers to fund margin/clearing fund obligations arising on account of customer transactions.; this debit item will effectively allow these broker-dealers to collect margin from their sponsored members and pass it on to FICC.
• Changes from the proposal: Consistent with the proposal, the Final Rule would condition the debit item on the Treasury CCP segregating the margin and calculating margin on a gross basis. Nonetheless, the Final Rule liberalizes certain conditions from the proposal:
  • Broker-dealers may post FICC-eligible securities (e.g., GSE securities) to meet customer margin requirements (the proposal would have limited eligible margin to cash and Treasuries);
  • Broker-dealers may record a debit when they temporarily pre-fund customer margin obligations pending receipt from the customer of the margin;
  • A Treasury CCP need not return excess collateral with respect to customer positions to broker-dealers within one business day

Compliance Date/Implementation Schedule:

The Final Rule will be subject to staggered compliance dates:

If you have any questions concerning this memorandum, please feel free to contact the authors or your regular contacts at the firm.