Upcoming SEC Rule May Mandate Central Clearing of Treasury Trades for Hedge Funds

The U.S. Securities and Exchange Commission (SEC) is poised to consider new amendments that could significantly change how hedge funds and brokerages handle transactions involving U.S. Treasuries. This upcoming vote, scheduled for Wednesday, revolves around the use of central clearinghouses specifically for trades tied to repurchase agreements, commonly known as repos.

Central Clearing for Stability

A key element of this proposed regulatory shift is the requirement for government securities dealers and brokers to process both their cash transactions and repurchase agreements through central clearinghouses. The SEC advocates this move as a strategy to enhance the safety and efficiency of securities trading. The commission believes that central clearing has the potential to lower trading costs, streamline processes, and reduce the likelihood that the failure of a single market player could wreak havoc on other participants or the larger financial system.

Strategic Market Reforms

The push for these amendments is part of broader market structure reforms spearheaded by SEC Chair Gary Gensler. Gensler is a proponent of reducing risks associated with unregulated trading practices by increasing the transparency and oversight within markets, particularly for private funds which he views as excessively secretive. He argues that central clearing could significantly mitigate these risks, offering a higher degree of systemic stability.

Understanding the Role of a CCP

At the heart of this proposition is the role of a central counterparty (CCP). By acting as the intermediary, a CCP effectively becomes the buyer for every seller and the seller for every buyer, thereby managing the risk of counterparty defaults. This reassurance of stability and liquidity is central to the SEC's rationale.

Hedge Funds' Partial Exemption

Despite the broad scope of the proposed requirements, there is a noteworthy exemption. Hedge funds, in particular, will not be mandated to centrally clear their cash Treasury trades according to reports. This decision highlights a compromise, albeit limited, as Gensler has expressed concern over specific practices like the basis trade—where funds leverage differentials between Treasury futures and the underlying securities market to generate profits.

Industry Support for the Rule

It should be noted that the proposed changes have garnered support within the financial industry. Companies like CME Group and Citigroup have publicly backed the continuation of basis trades, pointing out that such activities bolster liquidity in the government bond market.

Timeline for Compliance

The timeline for the adoption and implementation of these rules, originally proposed on September 14, 2022, outlines a phased approach. If passed, clearing agencies will have until March 31, 2025, to comply, while direct participants must adhere to the clearing obligations for cash transactions by December 31, 2025, and for repo transactions by June 30, 2026.

SEC, HedgeFunds, Treasury