DTCC, industry participants and regulators continue to be focused on the fragmentation in the U.S. Treasury market. Recent market activity and attention has rekindled discussion around the evolution of an ideal market structure for these securities. In the face of a fluid and dynamic environment that can potentially expose the market to liquidity and market risk, concerns are growing around bilateral U.S. Treasury clearing.
- The U.S. Treasury market is the deepest, most liquid market, dwarfing in size every other market in the world – and DTCC has long advocated for a greater use of central clearing. As an industry, we must further explore the causes, the trends, and the risks in the shift to bilateral clearing for cash activity in the U.S. Treasury market.
- Greater adoption of central clearing in the U.S. Treasury market would significantly reduce risk and improve resiliency, which is critical to the strength and stability of the U.S. economy. We must work together to deploy solutions that can broaden participation in central clearing to best manage risk and improve efficiency and transparency in the U.S. Treasury market.
Prior to 2000, all interdealer broker (IDB) platform users were traditional broker-dealers and FICC members, and all outright purchases and sales of treasuries through IDBs were centrally cleared.1 However, the Treasury market’s evolution over the past 20 years has resulted in an increased share of outright purchases and sales of treasuries
through IDBs being bilaterally cleared and settled. Principal trading firms (PTFs) now actively buy and sell large volumes of U.S. Treasuries on an intraday basis using high-speed and other algorithmic trading strategies, but, in general, are not centrally clearing that activity.
PTFs provide significant liquidity to the U.S. Treasury cash market through market-making. Treasury officials estimate they average about 20% of overall U.S. Treasury cash market volumes and account for around 50-60% of IDB volume in outright purchases and sales of U.S. Treasuries. If an IDB executes a trade with a PTF and another with a FICC member, a mismatch situation arises where one of the resulting trades is bilaterally cleared and the other is centrally cleared, creating market fragmentation. This fragmentation directly reduces the systemic benefits that FICC was created to provide. If a PTF with large open trade exposures defaults, in addition to the loss of liquidity provided by that PTF, there could be much larger systemic impacts, especially if the PTF’s default caused its prime broker or IDB to also suffer significant losses or liquidity shortfalls. The contagion risk in this scenario is not insignificant.
The full paper, “More Clearing, Less Risk: Increasing Centrally Cleared Activity in the U.S. Treasury Cash Market,” is available at https://www.dtcc.com/-/media/Files/PDFs/DTCC-US-Treasury-Whitepaper.pdf