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U.S. regulators voted Wednesday to require more government bond transactions to be processed centrally. This is a groundbreaking reform aimed at strengthening the resilience of one of the world's most important financial markets.
The Securities and Exchange Commission in Washington voted four to one in favor of a proposal that could require an additional $1 trillion in daily transactions to be cleared through an independent clearinghouse. This would mean that market participants would have to provide collateral to secure these positions or limit the amount they can borrow in so-called repo transactions.
“[The new rules] “Will reduce risk in an important portion of our capital markets during normal and stressful times,” said SEC Chairman Gary Gensler. “This benefits investors, issuers and the markets that connect them.”
Regulators want to shore up the market – which sets the price of U.S. government debt and is the reference point for assets around the world – after repeated instability over the last decade, particularly after the “competition for cash” that hit Treasury bonds plunged into free fall at the start of the Covid-19 pandemic in March 2020. Then the Fed was forced to buy large amounts of government bonds to stabilize the market.
The SEC framework will make the Treasury market more aligned with stocks, futures and swaps where clearing is common. A clearinghouse stands between buyers and sellers and prevents failed trades from being spread across the market. According to the Treasury Market Practices Group, only 13 percent of treasury transactions are fully settled, while 19 percent have some trading processed centrally.
Since the financial crisis, hedge funds and high-speed traders have become increasingly prominent in Treasury trading, and many settle their trades bilaterally rather than clearing them through a central clearing house.
The new regulation could help curb the spread of highly leveraged bets in the Treasury market, made by hedge funds in recent years and coming under increasing scrutiny from regulators and central banks in 2023. Gensler has also made a sweeping push to overhaul trading rules, with an agenda that includes greater oversight of lightly regulated firms such as hedge funds and proprietary traders.
“This is the most significant day for the structure of the U.S. Treasury market in decades,” said Nate Wuerffel, head of market structure at BNY Mellon. He added that the new rules would make the market more resilient but would “embed new costs into the system” in the form of margin requirements and fees paid to the central clearing house.
However, the final rule the SEC voted on Wednesday will cover fewer Treasuries transactions than was proposed in a draft released last September.
The final rule applies to some spot transactions and, more generally, to the repo market, where banks and investors borrow short-term cash and offer high-value collateral such as government bonds in return. Hedge funds and leveraged traders will not be required to settle trades centrally in the cash market, as originally proposed after industry opposition.
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Despite the exemption for some cash trades, the rule could capture an additional $1 trillion in daily repo and reverse repo trades for clearing, according to estimates from DTCC, the main U.S. Treasury clearinghouse.
Some Treasury market regulation experts worry the reforms could inadvertently increase system-wide risks by concentrating them in a single clearing institution.
“This raises existentially serious concerns about the public stewardship of an institution that is likely to be the largest and most systemic enterprise ever to come to market,” said Yesha Yadav, a professor at Vanderbilt University School of Law in Tennessee.
Many market participants fear that the reforms could result in broker-dealers having to put up additional margins to support their customers' trades when the market is at its most stressed. To address these concerns, the SEC adjusted its rules to relax some margin requirements.
The SEC is aiming for the rules to take effect in December 2025 on the cash side and June 2026 on the repo side.