US Treasury markets: Plotting the sell-side’s path to mandatory clearing
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Ali Curi: Markets ConversatION is an ION podcast where we discuss topics of importance to capital market participants with product owners, subject matter experts, and industry leaders. 

Bruce Roberts: The bigger questions for firms is, "What is the right internal business model to run?" So the current P&L for these businesses are spread across the repo trading desk, and the other side sitting in the client clearing business. So I'd not expect a one size fits all solution. So we're going to see different models in firms and in the market that are preferred. 

Ali Curi: Hi everyone and welcome to Markets ConversatION. I'm Ali Curi. On today's episode, Bruce Roberts from ION Markets and Will Mitting from Acuiti will discuss a significant shift happening in the U.S. Treasury markets. The introduction of mandatory clearing for cash treasury and repo markets is set to revolutionize and disrupt one of the world's most important financial sectors. In this episode, we'll explore the ambitious timeline for implementing these changes. And how the industry is preparing for this massive overhaul.

Bruce and Will share with us the potential impact on market participants and its infrastructure, along with technological challenges and opportunities that lie ahead. Join us as we unpack the findings from Acuiti's comprehensive industry survey, and examine how this regulatory mandate could reshape the $27 trillion treasury market.

Let's get started. Hi, Bruce Roberts. Welcome back to the podcast. 

Bruce Roberts: Hi, Ali. Great to be back again. 

Ali Curi: And a good friend of the podcast, Will Mitting. Welcome back. 

Will Mitting: Thanks, Ali. It's good to be back. 

Ali Curi: And for our new listeners who have not met you, Bruce, tell us a little bit about yourself. 

Bruce Roberts: I'm part of the Global Clear Derivatives Management team based in London here at ION. I've been in financial services for 25 plus years with more than 20 years here in the UK. 

Ali Curi: Great, thank you. And Will, tell us a little bit about you.

Will Mitting: So I'm the founder and managing director of Acuiti. We're a management intelligence firm that provides research and events into the global derivatives market.

Ali Curi: Thank you for that. Let's get to it. Bruce, let's start with you. ION has partnered with Acuiti to produce a very informative report titled, "U.S. Treasury Markets: Plotting the Sell Sides Path to Mandatory Clearing." What prompted ION and Acuiti to publish this report on the upcoming clearing mandates for the U.S. Treasury Markets? And why are these mandates being introduced? 

Bruce Roberts: Thank you, Ali. So the change in regulation to introduce clearing for U.S. Treasury and repo markets is one of the most significant decisions in the last several decades. So the mandate is a significant regulatory decision to enhance transparency, resiliency, and stability in the $27 trillion dollar treasury market.

So as background, the U.S. Treasury market is the deepest and most liquid market globally, and the move by U.S. Regulators is to ensure all trades in both cash and repo are cleared through a central clearinghouse. So the SEC and other regulatory bodies introduced the new regulation due to growing concerns over systematic risk in the treasury market that were highlighted with the disruptions in the market during the COVID pandemic.

Ali Curi: And given that the deadlines for this change for the cash treasury clearing and repo clearing are so close, they're December for this year and June 2026 for repo clearing. Do you think these timelines are feasible for the industry? Are there any concerns? 

Bruce Roberts: We are seeing a call already by industry bodies and firms for postponing the implementation time frames for the December 2025 and the June 2026 deadlines.

So it's driven by the changes in the White House with the heads of the U.S. Regulatory bodies at the SEC and CFTC stepping down and interim appointments being made. The expectation is to see more changes in both agencies and regulatory oversight in the U.S., but one of the biggest challenges is the uncertainty over the treatment of cleared treasuries under the capital requirements that apply to banks.

The existing rules make it very expensive for banks in terms of capital, and there's a call to reduce the charges by banking regulators. So unless these types of issues are clarified, there will be a reluctance by banks to invest in setting up a cleared treasury and repo business. These issues and others are causing a delay in implementation.

Ali Curi: Are there any examples, Bruce, from other markets or mandates that provide lessons for implementing this one? 

Bruce Roberts: One example I can think of where a phased approach was taken was the implementation of the Uncleared Margin Rules, or better known as UMR. And when UMR was first proposed, regulators assumed that having five separate waves would equate to a gradual phased process.

They would see it expand in fairly equal increments, starting with the largest firms in phase one. However, the Standard Initial Margin Model, SIMM, requirements ask for a lot more than just a simple initial margin exchange. So the whole market needed to decide on the best way forward. And based on the size of the participants in the market, it was quickly realized that the volume of daily margin calls could not be done manually, and that straight through processing was required. So the industry worked with ISDA, which is the International Swaps and Derivatives Association, with the clearing houses to propose changes in process, accounts, and legal structure to make the new requirements viable. And the result was that most firms went live in phase one on the sell side, with only a small number in phase two. The phase three brought in the buy side and hedge funds, and the further waves required working groups and a change in process to onboarding by clearinghouses, but a process for webinars and regular client consultations eventually achieved the onboarding required.

I believe this is a strong example of how the industry have worked together in the past and will continue to look for novel ways to achieve compliance with new market changes. 

Ali Curi: Great, thank you. Will, let's chat with you for a minute. This is a very informative report. One of the findings from those surveyed is that there's a preference for phased implementation of the clearing mandate.

The report mentioned that 76 percent of respondents favored a phased implementation. How might a phased approach address the concerns that Bruce outlined? What does this phased approach look like? Can you share with us what some industry concerns would be? 

Will Mitting: I think just really to reiterate what Bruce said, this is a major overhaul of derivatives market structure.

And I'm surprised at the tight timeframe that the SEC mandated, especially when compared to other reforms such as the UMR, which was introduced, I think over kind of four or five years. So the way you and I work was based on thresholds of notional trading sides, which is why, as Bruce alluded to, the sell side came in first, being the bigger traders.

Those firms with smaller exposures coming in the second, third. And I think beyond that, in terms of the phases of implementation, and then with a couple of outstanding exemptions for firms like pension funds, who were particularly impacted negatively by the rules as they were written. Another comparison people have made is to the LIBOR transition, which was obviously introduced by currency, which here you don't have that option, be all a USD based product.

But I think certainly some kind of phased approach based around potentially a notional volume is ideal, or a longer delay. There remain several critical areas of market practices that need to be addressed from CCP access models to margin processing, capital requirements, and even documentation. So realistically, the SEC is going to have to address a timeline or issue a string of no action decisions, no action letters at the launch that will effectively undermine the implementation of the mandate if they do decide to go ahead with the current time frame.

I think it has to be stressed that the industry is broadly supportive of the overall initiative and certainly welcomes the mandate, I think, to further accelerate repo clearing. It's critical that the market structure shift of this magnitude isn't rushed overall, as would be my view. 

Ali Curi: Given that such a high percentage had a preference for a phased implementation, only about 20 percent of respondents felt confident about meeting the deadlines.

Realistically, what would be the consequences of missing these deadlines for the treasury market? 

Will Mitting: So I think a delay is all but inevitable now. This week, as Bruce mentioned, a group of associations, including the FIA, issued a letter to the acting chair of the SEC calling for a delay of at least 12 months to the implementation of the rules.

So I think a delay is inevitable now. It's just whether or not the delay begins a rethink of how it's being implemented, or it's simply a delay of probably up to two or three years. In all honesty, if they're going to do a big bang implementation, I certainly think the FIA would be urging more than 12 months. 

Ali Curi: Right, yeah. Thank you. 

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Ali Curi: Bruce, the "done with" and "done away" models for accessing clearing services seems pivotal. Can you explain these models and why scalability is a concern? 

Bruce Roberts: So the basic choices for clearing are known as the "done with" model and the "done away" model.

So the done with model forms part of the successful sponsored model and bundles clearing and execution services together to be handled by the dealer that serves as a sponsor. The done away model allows clients to execute trades with one counterparty and then clear the transactions through a separate clearing relationship.

So this is effectively the FCM model used in centrally cleared derivatives markets today. This research that Will and the team conducted found significant concerns that the done with clearing model, one, would be able to scale to accommodate the high number of new firms, but two, as this model bundles clearing and execution services, many market participants are concerned that a requirement to use it would limit competition and increase cost and complexity.

For clients that would need multiple clearing relationships, the done with model could balloon gross margin requirements from the exposure to multiple repo counterparties and sponsors. So that would be very difficult to net down. And this has driven calls across the industry for the expansion of done away models.

And while some market participants, such as money market funds, would likely prefer a done with model due to its simplicity, others, such as hedge funds and big asset managers, are more likely to seek offsets between their repo and futures positions that are better achieved through the done away model.

While many of these, see the done away model as more scalable for the industry, CCPs are still developing their models for this format. And all of this is leading to challenging deadlines for adoption based on needing to agree the right models and build the technology to support and changing the legal agreements to name but a few of the jigsaw pieces to be put in place to support the industry.

Ali Curi: I agree that there needs to be a consensus. The report shows that about 50 percent of the firms prefer to let the clients choose between the models. Can this affect the market structure? 

Bruce Roberts: The cash and treasury repo clearing mandate is a significant regulatory decision, as Will alluded to, to enhance transparency, resiliency, and stability.

I believe the openness to clearing models of done with and done away will allow the diverse set of firms that are active in the market to adopt the approach that fits their client, business, and risk management models. So the development of more than one model has been common in the industry, and I don't expect regulators to impose stringent criteria on the industry to how the regulation should work in practice.

But more clarity to certain components will be required, and this will involve wider decisions, such as from bank regulators, as an example. 

Ali Curi: And do you think that the industry itself could shift towards settling on a dominant model, or do you think that both will coexist in the long term? 

Bruce Roberts: I would estimate that the industry and regulators will let the models develop and play out over time, and based on the efficiency and cost, I would suspect the bigger questions for firms is, "What is the right internal business model to run?"

So the current P&L for these businesses are spread across the repo trading desk and the other side sitting in the client clearing business. So I'd not expect a one size fits all solution. So we're going to see different models in firms and in the market that are preferred. 

Ali Curi: So it could be some time before there is some consensus.

Bruce, let's talk about the technology aspect. The report highlights significant investments in automation and post trade processing, which is great. But what are some of the major hurdles that firms face in developing this technology? 

Bruce Roberts: The key decisions will be to decide on the fitting of cash, treasury, and repo product features into the clearing systems and then developing the order routing between the venues.

Pre trade checks, and then post trade processing workflows. Firms, I believe will largely look to partner with existing product firms they're working with today, or look to develop in house. And as Acuiti identified, 50 percent of survey respondents were planning to meet the technology development with a mixture of third party and in house development.

Ali Curi: Yeah, there seems to be, some indecision happening. I think only about 18 percent of firms have fully decided on their technology partners. Does this indecision pose a risk? 

Bruce Roberts: Yes, it does. But while many firms are still in the early stages of structuring their tech stocks for treasury clearing, the technology challenge that firms face are becoming clearer, but the main challenge looks set to be building smart order routers between venues.

And while post trade processing internal data workflows were also marked highly, there are going to be the requirements from the regulators to clarify particular models, whether it be done with or done away, and also bank capital requirements that are going to be bigger decision factors before technology can be finalized.

Ali Curi: Are there any specific areas like post trade processing or regulatory reporting that firms are finding the most challenging or any others?

Bruce Roberts: Very good question. The industry as a whole spent significant time and resources to implement new post trade processing and regulatory reporting and tax reporting with new regulations that they've come into play such as Dodd Frank.

I'd also expect firms to develop pre trade risk checks, and all of these will continue to be challenging for firms due to the process and data fragmentation that can exist in such a complex ecosystem. And the penalties by regulators is also significant for getting it wrong, so ultimately there's a lot at stake for everybody involved.

Ali Curi: Thank you. Will, it seems likely that this mandate could increase client costs, new adoptions, new technology upgrades, et cetera, but also presenting new revenue opportunities for firms. How do you see the sell side balancing these dynamics? 

Will Mitting: I think if you look at the two broad derivatives clearing revenue streams that the sell side has between OTC and listed derivatives clearing, the economics of repo and treasury clearing sits somewhere between the two in terms of both the expected volumes and the revenues per trade.

There's inevitably a cost associated with the implementation of any new service, but the payoff is also there. And you've seen one, at least one FCM so far that's not active in the OTC markets, or OTC clearing, announce that they will offer treasury clearing to their clients. So clearly the market sees an opportunity there.

Ali Curi: And affecting the broader market, are there any concerns about fragmentation of liquidity? Could this affect the broader market? 

Will Mitting: So currently several clearinghouses have announced that they will offer repo and treasury clearing in the U.S. As Bruce alluded to, there's some sort of several technicalities that they're working through in order to develop their models.

Historically, all clearing of this nature has happened at the DTCC owned FICC, a clearinghouse. But I think there's inevitably going to be more entrants to the market, which will inevitably fragment liquidity to some extent, but I think broadly the market will welcome the competition as it will lead to innovation and in the long term you're likely to see liquidity concentrate in one clearinghouse owing to the capital efficiencies that will bring.

So I think any liquidity fragmentation is likely to be short term and any negatives from that will be offset by the benefits of competition and innovation. 

Ali Curi: Okay. Share with us a little bit about what you see the role in cross margining and capital efficiencies can have in this transformation. 

Will Mitting: As Bruce alluded to, the cross margining benefits impact disproportionately different players in the market.

But it's clearly going to be a key element of the success of whichever CCP ultimately hosts the most liquidity. But it's also something that the sell side themselves will compete on. The buy side will potentially see huge increases in additional capital as a result of this mandate. Therefore, they're going to be seeking large scale offsets to reduce the burden.

And capital efficiency is going to be a key element in achieving that for firms, especially as Bruce mentioned, for hedge funds. So I think clearly capital efficiency is going to be something that evolves. People will get more comfortable offering offsets and efficiency, both at a CCP and an FCM level.

But I think it's not just capital efficiency, but also processing and operational efficiency. It's going to be, as I mentioned earlier, a low, relatively low margin, high volume business. So investment in operations and technology is going to be a key differentiator for firms. 

Ali Curi: Thank you. Bruce, there's going to be some shakeup in the clearinghouse landscape because we have new entrants.

So you have new entrants in clearing like CME, LCH competing with the FICC. How do you see this landscape evolving from here? 

Bruce Roberts: CCPs have been amazingly dynamic and innovative in their approaches to providing new solutions to meet regulatory and market needs. As Will alluded to, and I discussed earlier about uncleared margin rules, and one example of CCPs using an innovative approach was Eurex, utilizing a tri-party clearing process, and this helped make the new UMR regulatory process viable.

Overall, my observation is that CCP's have been very effective and efficient in adopting new clearing mandates and competing in new products, as we saw with interest rate swaps and credit default swaps as these moved from bilateral to centrally cleared. The evolution of moving cash and repo into clearing will mean a requirement to increase investment across the industry and will lead to increased fees to start with.

However, I would believe longer term that fees will decrease as the market becomes more efficient and we will see reduced risk through clearing and firms will benefit from capital optimization and reduced counterparty risk. 

Ali Curi: Great. Now, gentlemen, I have a question for both of you. What is the one big thing you hope listeners would take away from this episode?

Bruce, you get first dibs.

Bruce Roberts: I guess from my perspective, markets and events continue to evolve, that raise unforeseen risks and the innovation in the industry, working across regulators, industry bodies, such as the FIA and ISDA, market participants, product firms, they all bring new approaches and technology and this model has proved successful in the past and I'm confident that after implementation and evolution that the market will benefit in the longer term.

Will, what are your thoughts? 

Will Mitting: Overall, this mandate will bring huge opportunities to the cleared derivatives market, but it has to be introduced in a sensible and realistic way to avoid market disruption and to allow the industry time to build the capacity and processes to realize the benefits.

Ali Curi: Great. Thank you both. And Will, where can people find your report that we've discussed today? Because there's so much more information in there that our listeners can learn from. 

Will Mitting: Great. So it's available at both the Acuiti website and the ION website. So if you go to Acuiti.io or to the ION website, you'll be able to download it from either source, free of charge.

Ali Curi: Excellent. Thank you, Bruce. As you know, I have a closing question for my guests and my question for you today is, "What's been a favorite job you've held and what did you learn there that you have applied to later jobs?" 

Bruce Roberts: So one of the areas I enjoyed several years ago was working on strategy for technology and operations function and clearing.

We were considering our strategy for moving all the technology and operation systems, processes, and people to a third party to provide a managed service. And we had the option to continue to do everything ourselves or to look to mutualize with other participants in the industry and the managed service over a longer period to drive substantial cost savings.

And I found the usual business case and analysis of the implementation risks, the controls to manage the service, very insightful. But the most interesting were the views of key stakeholders across the organization. And as with every business case, risks, governance, the partner you're working with, looking to move to, they're only one aspect of any decision.

The softer, qualitative factors should not be underestimated to the influence on strategy and decision. And I believe we may find a similar direction of travel with the move on cash treasury and repo clearing with a new administration in the White House. 

Ali Curi: And Will, same question, "What has been a favorite job you've held, and what did you learn there that you have applied to later jobs?"

Will Mitting: It's probably the current job I have to be honest, but my favorite job, having the privilege and opportunity to build my own business has been incredibly challenging and incredibly rewarding. The advice I was given by a friend who did something similar when I launched was don't celebrate the wins too much and don't mourn the losses too much.

I certainly don't abide by that, but I hope one day I will be able to apply that to my job and increase my ability to sleep. But as of now, [that's] where were at. 

Ali Curi: Thank you for sharing that. Bruce Roberts and Will Mitting, thank you both for joining me again on the podcast. Let's do it again soon. 

Bruce Roberts: Thank you again for hosting us, Ali. Look forward to the next visit. 

Will Mitting: Thanks, Ali. Great to be on again. 

Ali Curi: And that's our episode for today. You can follow ION Markets on X and on LinkedIn. 

Thank you for joining us.