Mandatory U.S. Treasury Clearing
Unfamiliar and under prepared, yet hugely impacted.
43% of firms are unfamiliar with the upcoming treasury clearing rule changes.
With mandatory clearing taking effect at the end of next year, a significant portion of the industry remains unfamiliar with the upcoming rule changes. Our survey reveals that only 29% of firms are fully aware of the SEC's rule changes, while an alarming 43% of respondents indicate they are not at all familiar with the new requirements. We have spoken with numerous investment managers who transact in U.S. treasuries who had zero knowledge of the upcoming changes until that conversation. This underscores a critical challenge: the urgent need for widespread dissemination of information across all regions. Historically, smaller firms and those located furthest from the impacted market have been the most difficult to engage in such market changes and are likely to require the most intensive education efforts. However, even some of the biggest firms are struggling to fully understand the impacts, one firm we spoke with couldn't be sure how to know if some of their more complicated transactions would need to be centrally cleared or not.
The need for education is further emphasized by the fact that 43% of survey respondents express deep concerns about their ability to be fully prepared to support mandatory clearing by the deadline. In stark contrast, only a mere 7% of respondents report having no concerns about meeting the new requirements. This disparity suggests a significant gap in readiness that must be addressed swiftly.
Moreover, while the specifics of the rule changes may still be unclear to many, the industry is acutely aware of the potential financial impact. A striking 71% of firms anticipate that the associated cost increases will have a substantial effect on their operations. This expectation adds a layer of urgency for firms to begin planning and adjusting their strategies to accommodate the forthcoming changes.
The further from North America we go, the less prepared we are
Unsurprisingly, the North American market is the most knowledgeable and prepared to support mandatory treasury clearing. However, even in this region, only 9% of respondents report being fully prepared, with an additional 26% still in the process of analyzing the new requirements. A significant 65% acknowledge that substantial changes will be necessary to their operating models. This indicates that while North America may lead in terms of awareness, the complexity and scale of the upcoming regulations still present significant challenges even in their home market markets. As respondents become more aware and complete their analysis, it's very likely that those firms will be moving into the changes needed category rather than the full prepared category.
In Europe, the readiness is even lower, with a mere 2% of respondents fully prepared. Meanwhile, 30% are still in the analysis phase, and a considerable 68% recognize the need for changes to their operating models.
Further afield, in the APAC region and other parts of the world, the preparedness levels are lower still. Over 42% of respondents are still in the research phase, which is perhaps not surprising given that what we have already discussed about overall familiarity.
As awareness increases and firms complete their analyses, it is likely that many of these organizations will shift into the "changes needed" category rather than the "fully prepared" category. This transition suggests that the majority of firms globally will be undertaking significant overhauls to their operating models, technology infrastructure, and compliance processes in the coming months. The need for swift and decisive action cannot be overstated, as the timelines for implementation are fast approaching, and the costs of non-compliance could be substantial.
A challenge across the board
When we take a closer look, it’s clear that the industry is facing challenges across the board, not just in one or two areas. Over 20% of firms are dealing with significant issues in everything from understanding the new regulations and educating their teams, to the costs of renegotiating contracts, upgrading technology, and securing the budget needed to make these changes happen.
One of the biggest concerns that came up in our survey is the struggle to get the budget needed for mandatory clearing. About 40% of respondents said this is a major hurdle. It’s not too surprising, though—if people aren’t fully aware of what the new requirements entail, it’s tough to make a strong case for the funding needed to meet those requirements. When the scope of the changes isn’t clear, or the risks of not complying seem far off, it’s hard to justify putting a lot of money toward something that might not feel urgent.
Another big challenge is the complexity of renegotiating contracts to comply with the mandatory clearing rules. Firms have to go back and renegotiate agreements with clearinghouses, service providers, and trading partners, which is not only time-consuming but also requires a solid understanding of the legal and operational details involved. This can add up quickly in terms of both time and money, especially for firms that don’t have a lot of resources to throw at the problem.
On top of that, there are the technology upgrades that are necessary to support mandatory clearing. Firms will need to invest in new systems or upgrade their existing ones to connect smoothly with central counterparties (CCPs) and meet the new reporting and risk management requirements. These tech upgrades are crucial for keeping up with the real-time processing and data transparency that the new clearing framework demands. But they don’t come cheap—especially for firms that have been relying on older or more manual systems up until now.
Lastly, the lack of competing CCPs is another concern that’s come up. At the time of this survey there was only one CCP (the FICC) that is an approved cleared of U.S. Treasury securities. As such there’s a real worry that costs could go up and flexibility could go down for firms that don’t have a lot of clout.
36% of firms expect margin requirements to increase by more than 50%
Margin is one of the big areas where the market expects to see a significant impact due to the new mandatory clearing rules. Our survey shows that 36% of firms are bracing for their overall margin requirements to go up by more than 25%. When you consider that the U.S. Treasury market sees around $3 trillion in transactions every day, that’s a massive amount of money that firms will need to come up with.
What’s driving this? Well, with mandatory clearing, the flexibility that firms had in setting margin levels with their trading partners is gone. Central counterparties have more rigid, standardized margin requirements that are designed to minimize risk. While that’s good for market stability, it’s likely going to lead to higher margin calls for a lot of firms, especially those that were used to negotiating lower margins in bilateral deals.
This means firms will need to lock up more of their cash to cover these margin calls, which could stretch their liquidity thin. For some, this might mean they have to shuffle around their resources, pulling money from other parts of their business just to meet these new requirements. Smaller firms, in particular, might struggle with this, as they don’t have the same deep pockets as the bigger players.
On top of that, the increase in margin costs could force firms to rethink their trading strategies. We might see some firms cutting back on their trading activity or even stepping away from certain markets if the costs become too steep. This could have a ripple effect on market liquidity, with fewer trades happening overall as firms adjust to the new rules.
And let’s not forget that this is going to hit different firms in different ways. Big institutions might be able to handle the extra costs without too much trouble, but smaller firms could find themselves at a real disadvantage. This could lead to more consolidation in the market, with smaller players either getting bought out or dropping out altogether. Margin is something that the market expects to be substantially impacted, with 36% of firms expecting to see their overall margin to increase by more than 25%, in dollar terms this will be substantial considering that we’re talking about $3 trillion of daily transaction activity.
Some firms are considering passing the increased margin costs directly on to their clients. This could be done either by posting the margin upfront themselves and then collecting it from their clients afterward, or by requiring clients to post the margin upfront before any transactions take place. This approach shifts the financial burden and risk associated with margin requirements onto the clients, which might help firms manage their liquidity more effectively in the short term.
On the other hand, some firms are exploring the option of fronting the margin on behalf of their clients and then recovering those costs through the spread on trades. This strategy could make transactions more attractive to clients by reducing their immediate cash outflows, but it also introduces significant challenges. The primary issue is how to determine the appropriate spread to cover the margin costs when the exact margin requirements are still uncertain.
Another big piece of the puzzle is how firms will handle their 15c3-3 calculations to account for the extra margin required. Rule 15c3-3, or the Customer Protection Rule, is designed to make sure broker-dealers keep customer assets separate from their own. Now, with the new clearing rules in place, firms will need to adjust those calculations to separate customer margin from proprietary margin. This raises several important questions for firms as they adjust to the new requirements:
Do firms have an omnibus account for storing margin, regardless of whether it’s cash or security margin? Under the new rules, firms will need to clearly distinguish between customer and proprietary margin, which may involve rethinking how margin is stored and whether existing accounts can handle this separation effectively.
What applications or services is your firm using to manage margin? As margin requirements increase, firms will need robust tools to track, allocate, and manage these funds efficiently. Leveraging the right technologies can help streamline the process and ensure compliance.
What new capabilities will your firm need in the future, and what will you need to implement to manage margin effectively? Firms may need to upgrade or implement new systems that can handle the additional complexity brought on by increased margin requirements, including automated tracking of customer vs. proprietary assets.
How will your firm collect margin in the future, and what benefits for cross-margining are available? Cross-margining allows firms to offset margin requirements across different types of products, potentially reducing overall margin costs. Firms should explore how they can implement cross-margining strategies to manage liquidity more efficiently under the new rules.
With these considerations in mind, firms will need to tweak their processes and calculations to ensure they’re holding the right amount of reserves for customer assets, while also making sure they’re equipped with the necessary tools and strategies for managing these changes moving forward.