Are There Too Many Ways to Clear and Settle Secured Financing Transactions?

Adam Copeland, Frank Keane, and Jenny Phan

The New York Fed’s Treasury Market Practices Group (TMPG) not too long ago launched a consultative white paper on clearing and settlement processes for secured financing trades (SFT) involving U.S. Treasury securities. The paper describes the numerous ways in which Treasury SFTs are cleared and settled— data that might not be available to all market individuals. It additionally identifies potential threat and resiliency points, and so promotes dialogue about whether or not present practices have room for enchancment. This work is well timed given the SEC’s ongoing efforts to enhance transparency and decrease systemic threat within the Treasury market by rising the prevalence of central clearing. On this put up, we summarize the present state of clearing and settlement for Treasury SFTs and spotlight a number of the key dangers described within the white paper.

The Marketplace for Treasury Secured Financing Transactions

Treasury SFTs—together with repurchase agreements (repos) and securities lending—are a part of the collateralized U.S. dollar-denominated cash markets. Treasury repos are monetary transactions by which a celebration sells U.S. Treasury securities to a different celebration with a promise to repurchase the asset at a pre-specified worth and date. Treasury securities lending is the short-term mortgage of U.S. Treasury securities in alternate for money or different collateral. Securities lending in opposition to money and repo agreements are economically related, and traders and corporations use repo and securities lending to safe funding for his or her actions, make markets, and facilitate the implementation of assorted funding, threat administration, and collateral administration actions.

How Do Treasury SFT Trades Clear and Settle?

There are two massive segments of the Treasury SFT market: dealer-to-customer and dealer-to-dealer. Most dealer-to-customer trades are cleared and settled in considered one of two methods. The primary is on a bilateral foundation, when every celebration to the commerce makes use of its personal bespoke clearing and settlement processes. The second leverages the tri-party settlement platform supplied by a clearing financial institution; underneath this agent-cleared method, each events to the commerce use the processes supplied by the clearing financial institution.

A 3rd, much less widespread clearing possibility for dealer-to-customer trades is to make the most of the Sponsored Service offered by the only central counterparty (CCP) within the Treasury market, the Fixed Income Clearing Corporation. Trades which are centrally cleared by means of the Sponsored Service are both settled on the tri-party repo settlement platform or on a bilateral foundation, relying on the character of the commerce.

In distinction to the dealer-to-customer phase, most dealer-to-dealer trades are cleared by means of the CCP utilizing both its Normal Collateral Finance (GCF®) Repo Service or Supply-Versus-Fee (DVP) Service. Trades cleared utilizing the GCF Repo Service are settled on the tri-party settlement platform, whereas for trades cleared utilizing the DVP Service, every market participant makes use of its respective settlement processes.

The exhibit under summarizes the 4 most important ways in which SFTs clear and settle.

Trades in Treasury SFT Markets

Threat and Resiliency Points

Do market individuals totally perceive the dangers related to the numerous clearing and settlement strategies accessible for SFTs? The white paper discusses a number of considerations on which the TMPG hopes to obtain suggestions. Right here we spotlight two: (i) Total, the clearing and settlement of SFTs is fragmented and (ii) for non-centrally cleared bilateral SFTs, clearing and settlement is bespoke and opaque.

The primary threat displays the very fact the clearing and settlement ecosphere for SFTs has organically grown over time to satisfy the assorted wants of various market individuals. Consequently, there at the moment are a large number of clearing and settlement choices accessible. For a given possibility, dangers to a easy post-trade course of for Treasury SFTs can manifest in a number of methods, together with counterparty credit score considerations and operational points. The massive variety of clearing and settlement choices—this fragmentation in post-trade providers—locations a major burden on market individuals to totally acknowledge the inherent dangers of every possibility, and to place the suitable threat mitigants into place.

In regular instances, when a counterparty’s threat of default is idiosyncratic and Treasury market liquidity is deep, the variations in clearing and settlement processes have solely small implications for threat. In instances of stress, nevertheless, when defaults are extra widespread and general Treasury market liquidity can lower, these variations may have necessary threat implications.

The second threat focuses on SFTs, that are neither centrally cleared nor settled on a tri-party settlement platform. For these non-centrally cleared bilateral SFTs, market individuals depend on individualized clearing and settlement preparations. These may go effectively throughout the unusual course of enterprise, however the bespoke nature of those preparations, mixed with the quick time frame between commerce execution and commerce settlement, could make resolving post-trade disputes a difficult process. Certainly, in instances of stress, disputes sometimes come up extra steadily and could also be tougher to resolve in a well timed method, rising the chance of a disruption to settlement, which may in flip create surprising credit score exposures.

Provided that the clearing and settlement dangers related to Treasury SFTs are pretty benign throughout the regular course of enterprise, some market individuals could not totally use the array of threat administration instruments to mitigate these dangers. The opaqueness of those processes obscures a participant’s skill to evaluate the counterparty credit score threat a participant incurs not directly by means of the clearing chain. The place transparency is impaired, market individuals could not be capable to precisely establish, measure, and handle their counterparty threat publicity. This opaqueness may then create an undesirable stage of combination threat within the Treasury SFT market.

Subsequent Steps

The TMPG awaits extra public suggestions on the white paper. Primarily based on that suggestions, the TMPG expects to finalize the white paper and should present additional voluntary steering on clearing and settlement finest practices.

Adam Copeland is a monetary analysis advisor in Cash and Funds Research within the Federal Reserve Financial institution of New York’s Analysis and Statistics Group.  

Frank Keane is a coverage and market-monitoring advisor within the Federal Reserve Financial institution of New York’s Markets Group.

Jenny Phan is a capital markets buying and selling principal within the Federal Reserve Financial institution of New York’s Markets Group.

How one can cite this put up:
Adam Copeland, Frank Keane, and Jenny Phan, “Are There Too Many Methods to Clear and Settle Secured Financing Transactions?,” Federal Reserve Financial institution of New York Liberty Road Economics, Could 8, 2023, https://libertystreeteconomics.newyorkfed.org/2023/05/are-there-too-many-ways-to-clear-and-settle-secured-financing-transactions/.