What is the SEC’s central clearing mandate? What does it mean for the industry?

The SEC’s central clearing mandate will require a significantly larger portion of US Treasury securities transactions to be cleared through a central counterparty (CCP), for which at this time Fixed Income Clearing Corporation (FICC) is the only qualifying servicer. This applies to both cash trades and repurchase agreements (repos)¹ involving US Treasuries.

Central clearing reduces counterparty risk by making the CCP the counterparty to all trades, ensuring that if one party to the initial trade defaults, the CCP mitigates the impact on the broader market. Originally, the following deadlines were set forth by this mandate:

Who is affected by the mandate?

The mandate applies to direct participants of FICC, such as major banks and broker dealers, which generally have to shift their dealer-to-dealer cash activity and both dealer-to-dealer and dealer-to-client repo activity into clearing. The “clients” here, (traditional buyside firms, including asset managers, hedge funds and pension funds), will also be impacted by this mandate.

While buyside firms are not required to be direct participants of FICC and largely out of scope for cash trade activities,² they will likely need to clear their repo trades through indirect access models.

This means for US Treasury repos:

• If you are trading over the counter (OTC) bilaterally with direct members of FICC, you will no longer be able to trade with these members on an uncleared bilateral basis.
• If you are trading OTC bilaterally with indirect members, you can still trade with these counterparties on an uncleared bilateral basis. However, the scope for doing so may reduce significantly, as most major banks and brokers are already direct members or are looking to be, and liquidity in the over-the-counter repo market may dry up significantly.

There are a few exceptions, including repo transactions between a firm and its affiliates provided certain conditions are met, and repo transactions with certain sovereign entities such as state and local governments, central banks and international financial institutions.

When does the mandate come into effect?

The SEC rule became final in late 2023 and compliance dates were initially set in 2025 for cash transactions, and 2026 for repo transactions; however, these compliance dates have been delayed to 2026 and 2027, respectively.

Market participants should be aware of three important dates:

• September 30, 2025: FICC is required to expand its rulebook and access model changes to promote compliance and allow for broader access to clearing.
• December 31, 2026: Mandatory clearing begins for eligible US Treasury cash transactions, primarily affecting trades between sell-side institutions.
• June 30, 2027: Mandatory clearing begins for eligible US Treasury repo transactions. This phase is expected to have a more significant impact on the buyside than the cash transaction phase.

Why is the SEC mandating central clearing and what are the benefits?

The SEC’s stated goal is to reduce systemic risk and improve transparency in the US Treasury market.

Central clearing offers several generally agreed benefits, including:

• Reduced counterparty risk: FICC becomes the counterparty for all participants, mitigating the risk of default by any one participant.
• Improved default management: In the event of a default, losses are mutualized, mitigating the risk of market contagion.
• Higher counterparty strength: FICC is a highly reliable counterparty, with AA/A-1+ credit ratings from S&P and Aaa/P-1 from Moody’s.
• Improved capacity and liquidity: Central clearing provides access to a highly liquid market and facilitates participants’ ability to maximize balance sheet netting.
• Improved transparency: Central clearing means consistent reporting and risk management across trades.

What are the drawbacks to central clearing?

While central clearing has several benefits, there are some drawbacks, including:

• Higher costs: Central clearing comes with associated costs, primarily due to the requirement to post collateral with FICC. These additional costs will vary depending on the kind of clearing access a firm has.
• Loss of liquidity in uncleared trading: Liquidity will concentrate within the cleared space, making it more difficult for firms that prefer bilateral trading (to the extent permitted) to find counterparties outside of FICC.
• Operational and legal changes: Firms should work with their sponsors and/or clearing members to understand what, if any, updates to their legal documentation might be required in light of the clearing mandate and the FICC rule amendments.

How can buyside firms access clearing?

Direct membership with the FICC tends to be restricted to large institutions, as it has capital and entity restrictions as to eligibility.

For buyside firms, there are two main indirect access models currently offered by FICC:

• Sponsored Membership Program (SMP): This well-established program allows buyside firms to access clearing through a sponsoring direct member, which clears trades on behalf of its clients. This indirect access model typically services on a “done with” trading basis, meaning the transaction is executed and cleared by a direct member facing its client as a counterparty.
• Agent Clearing Service (ACS)³: This newer model is more aligned to futures clearing, where the clearing member facilitates clearing of its clients’ trades on an agency basis. This updated model is driving clearing members to enhance servicing to allow for done-away trading, where the trade execution is done with a direct member and separately submitted to a different direct member for clearing. This ultimately allows for centralization of clearing through one member while retaining multiple trading counterparties.

What should market participants do to prepare?

Determine whether your transactions in Treasury securities are subject to clearing requirements. You should consult with your own advisors when making this assessment. Even if your transactions in US Treasury securities are not subject to clearing requirements, you may wish to clear them voluntarily if they are eligible to be cleared.

Ensure that your legal documentation is in order. Key documents include:

• Clearing Agreement: This sets out the terms and conditions of the clearing arrangement between a clearing member and its customer and may cover both SMP and ACS, done-with trades and done-away trades and cash transactions and repo transactions. Sell-side firms may have their own customized forms. The Securities Industry and Financial Markets Association (SIFMA) has published a form of 2024 SIFMA Master Treasury Securities Clearing Agreement; done-with and related schedule and modules that may serve as a starting point for individual negotiations between clearing members and their customers to tailor the terms to their unique commercial, legal and operational positions and needs. SIFMA is in the process of developing corresponding documentation for done-away trades.
• A global or master repurchase agreement generally needs a separate trading agreement for every counterparty to the initial bilateral repurchase transaction.⁴
• A sponsored membership agreement is required for participants in the Sponsored Membership Program.

Consider the access models:

• Evaluate whether the Sponsored Membership Program or Agent Clearing Service is more suitable for your business. Clearing services akin to the Agent Clearing Service, such as Futures and Options clearing, are common in other markets, but for US Treasuries, the Sponsored Membership Program is far more common
• Choose the right sponsor

Consider margin requirements and options:

• Today, margin contributions to FICC are largely covered by clearing members for their clients activities – but in the future this could change.
• Segregated Customer Margin: For broker-dealers in particular, this new option to leverage 15c3-3 accounts at FICC would require clients to contribute on at least a 1:1 basis the margin requirements at FICC from their activities.
• Haircuts vs. Margin: Some clearing members might elect to cover their exposures and regulatory capital costs through a haircut on the repo transaction (common today), where others might opt to collect initial margin (IM) separately such as in the case of the Segregated Margin Model. There are significant operational and commercial impacts to both that should be considered.

Key considerations when selecting a sponsor include:

• Capacity: Ensure the sponsor has the capacity and flexibility to accommodate your trading patterns.
• Creditworthiness: As trades initially face the sponsor before novation to FICC, it is crucial to assess the sponsor’s credit profile.
• Operational expertise: Work with a sponsor that is familiar with FICC’s processes and can provide timely, local support.

What are the potential risks of central clearing?

While central clearing reduces counterparty risk, it does not eliminate this risk entirely. Instead, it consolidates counterparty risk within FICC. The risk is managed through a waterfall structure, where losses are mutualized among members and backed by margin contributions. The FICC makes its own capital contribution to the waterfall, meaning it has an interest that the process works appropriately.

Will non-US market participants be affected?

Yes. Non-US entities trading with FICC direct members will also need to centrally clear US Treasury transactions, regardless of where the Treasuries are held. There are no specific exemptions for cross-border trades, meaning global participants must comply with this new mandate.

Will bilateral transactions continue?

Yes, bilateral trading will still be possible for transactions that do not involve FICC direct members (e.g., trades with other indirect members or non-members). As noted above, there are a few exceptions to the US Treasury clearing mandate, including repo transactions between a firm and its affiliates provided certain conditions are met, and repo transactions with certain sovereign entities such as state and local governments, central banks and international financial institutions. However, as liquidity shifts towards the cleared space, spreads are likely to widen, adding to costs.

What is State Street doing to meet the SEC Central Clearing requirements?

State Street is closely aligned with FICC and industry working groups as the mandate unfolds to help shape and fully understand the implications for us and our clients. We are updating our offering in alignment with FICC to ensure that our client’s activity meets the mandate deadlines – and that clients have access to the new access model optionality associated with the mandate.

Who should I reach out to with questions regarding the SEC Central Clearing Mandate?

For more information, please contact:

SSGMFinSolSalesandCM@StateStreet.com