CME, FICC to overhaul Treasury market margining

Clearers eye deal to dramatically improve cross-margin savings, aim to extend offsets to end-users

CME Clearing and the Fixed Income Clearing Corporation (FICC) are working on a major overhaul of the two central counterparties’ (CCPs) cross-margining service for US Treasuries. The deal could unlock billions in margin offsets for major banks and liquidity providers, as well as – further ahead, they hope – the market’s end-users.

The two clearing houses already facilitate relatively limited cross-margining for direct clearing member firms that clear both cash Treasuries and Treasury futures. But reforms under way would greatly increase the efficiency of the offering by considering larger combined portfolios for offsets. The move comes as policy-makers eye US Treasury market reforms that some believe could result in mandatory clearing of more trades.

“Regardless of what happens on the policy side of this discussion, we think it’s important to improve the programme for market participants at CME and FICC,” says Sunil Cutinho, president of CME Clearing. “Eventually, we want to extend the cross-margining programme to end-clients as well.”

Since 2004, CME and FICC have allowed firms that are members or affiliates at both clearing houses to offset residual exposures between their cash bond and futures positions. But the agreement is a so-called two-pot cross-margin arrangement, in which the CCPs still margin and manage members’ positions and collateral separately. Members have argued the current process is inefficient, since portfolios must first be offset internally before any leftover exposures can be netted down with exposures at the other clearing house.

The two CCPs plan to change this dynamic by allowing members to nominate specific portfolios to be margined separately – forgoing all potential offsets within one CCP to prioritise offsets between positions held at each.

Under the arrangement, it is understood both FICC and CME will independently margin the carved-out Treasury portfolios, and calculate what they believe appropriate offsets to be. The more conservative figure determined by either clearing house will then be applied to the member’s portfolio.

The deal would be closer to the cross-margin arrangement CME has in place for equity derivatives with options market clearer OCC, says Cutinho.

Photo: CME

Sunil Cutinho, CME Clearing

“This is very similar to how our cross-margining works with OCC,” he adds. “The only difference is that collateral will not be held jointly by the two clearing houses.”

It is understood that the clearing houses are aiming to seek regulatory approval for the changes this year. FICC declined to comment for this article.

An executive at one member firm of both FICC and CME is strongly in favour of the plan, suggesting it would go a long way to helping avoid future liquidity issues in the Treasury market: “We clear for some of the biggest hedge funds and proprietary trading groups on the Street … I feel this will have a meaningful impact [for them].”

“The onus to provide liquidity has been taken away from the banks … and pushed to the clients – so, 100%, these changes need to make their way to the clients. From a house perspective, dealers have been able to do some of this already, and [liquidity is] still a problem.”

A risk executive at another of CME and FICC’s members welcomed the reforms, but was hesitant to call it a game-changer for the Treasury market.

“Most of these cross-margin methodologies are very dependent on the structure of the overall portfolio,” he says. “In a lot of cases, it is not that beneficial, but, for a select few portfolios, it will definitely help.”

The news comes as US policy-makers consider a variety of remedies to help strengthen the US Treasury market structure, in the wake of market stresses that caused liquidity and price-discovery issues at the height of the pandemic last year.

Last March, a supply glut overwhelmed dealers, which declined to take on any more inventory during a Treasuries fire sale by hedge funds running basis trades to capture a spread between futures and cash Treasuries. In February this year, the Treasury market witnessed another supply glut, leading to illiquidity and soaring yields.

Regulators and Treasury markets participants alike have suggested a range of fixes: from increased clearing of Treasuries, in order to free up balance-sheet capacity, to permanently exempting Treasuries from bank supplementary leverage ratio calculations.

Another touted fix could be the US Federal Reserve making permanent its temporary standing repo facility, which allows banks to deposit Treasuries in exchange for cash, theoretically increasing bank demand for Treasuries.

A full interview with Sunil Cutinho, president of CME Clearing, will be published shortly on Risk.net