SEC Fixed Income Clearing Corporation repurchase rule changes
Tuesday, May 25, 2021, United States Securities Commission (“SEC”) issued a notice (the “Notice”) stating that the Fixed Income Clearing Corporation (“FICC”) had filed proposed rule changes aimed at improving the ability to clear certain transactions, particularly those involving repurchase agreements ( “Repos”) on FICC. The FICC, created in 2003 by the merger of the Government Securities Clearing Corporation and the Mortgage Backed Securities Corporation, is a wholly owned subsidiary of the Depository Trust and Clearing Corporation (“DTCC”).
The SEC and pension clearing
I have written previously about the critical importance of clearing agencies to the functioning of US capital markets and recent regulatory efforts to increase their efficiency while reducing some of the risks associated with their operations. See more recently my blog post from May 27, 2021, “’Margin, I Need to Have More Margin:’ The National Securities Clearing Corporation is proposing to increase the minimum required fund deposit. And before that, check out my blog post from April 29, 2021, “Tening the Reins: SEC Approvs Proposed Rule Change to Clearing Agency Investment Policy”. The SEC, the clearing agencies involved and the capital markets have generally come to see both the key role played in managing the clearing of securities transactions AND in the aftermath of 2008 (the Great Recession) and 2020 (the Great Recession). COVID-19 pandemic), the potential fragility of these agencies when they no longer function well.
Some of the most important areas of concern (in hindsight) relate to money market mutual funds (“MMFs”) and pensions. As I wrote at length in my blog post on February 23, 2021, ““Bucking the Break”: SEC asks for comments on MMF reformsThe SEC wants acceptable structural adjustments to be made to MMFs to prevent, if not prevent, executions on MMFs during times of market stress. It’s the Federal Reserve Board of Governors (the “Fed”) does not need to take urgent measures (as was the case in 2008 and again in 2020) to prevent rushes on MMFs.
Closely related to these concerns is the risk of a “freeze” in the repo market, as almost happened in September 2019, when the average overnight repo rate fell from 1.75% to 5.25%. between September 13th and 17th. See both my December 9th. , 2019, blog post, “SOFR and the stopping of overnight repurchase agreements: what happens if there is nothing to measure?“, ET Gara Afonso et al., Federal Reserve Bank of New York, Staff Report # 918,”The mid-September 2019 market event(March 2020) cited in footnote 12 of the Notice.
No more pension compensation Encouraged
The FICC dominates the clearing of fixed income securities but is not used to clear private one-to-one transactions. The notice states that the FICC Sponsoring Member / Sponsored Member Service (the “Service”), which manages the clearing functions, began in 2005 and “has seen a steady increase in the number of Sponsoring Members, the number of sponsored and the number of sponsored member trade volume over the past three years. Footnote 9 adds that in 2017 there was one sponsoring member and 1422 sponsored members; and by the end of 2020, there were 27 Sponsoring Members and some 1894 Sponsored Members.
As of March 31, 2017, the total sponsored member transaction price was approximately $ 32.2 billion, compared to $ 286 billion as of March 31, 2021. To be a member, an entity must be a “Qualified Institutional Buyer” such as defined in SEC Rule 144A. under the Securities Act of 1933, as amended, or a legal entity that “meets the financial requirements necessary to be a” qualified institutional buyer “.”
The FICC says, and the Notice says the SEC agrees, that closing more fixed income transactions through a clearing agency offers many benefits to the securities markets. capital and its various participants by:
Ensure that markets and their regulators (including the SEC and the Fed) are better informed about the volume, timing and performance of participants
Allow the clearinghouse, here the FICC, to manage risk and impose interim requirements to limit market disruptions
Impose consistent participation requirements so that all market players must meet consistent performance standards
Insisting on due diligence and risk management greatly reduces the possibility of trade failure or other default
Changes to the rules proposed by the agency
The 56-page notice sets out the rule changes proposed by the IFCC in excruciating (and sometimes opaque) detail, but this blog post focuses on the adjustments in these important areas of concern. As part of the FICC service, as it currently exists, the settlement process requires the creation of cash as collateral for the risk exposures inherent in the clearing activity. As the review says:
… Some sponsored member clients who provide liquidity, including money market funds and other mutual funds [find the cash-margin settlement process] … Not conducive. … More specifically, money market funds and other mutual funds are not operationally equipped to provide or receive cash margin as part of their term repo business…. These funds depend on securities transfers to maintain the required margin …
The proposed rule changes would allow qualifying securities to be recognized as margin, instead of cash. This can be done using a basket of qualifying securities and would not require specific margin recognition for specific transactions.
Along with the proposed rule changes, FICC members could “offset their obligations to the FICC on their balance sheets…” with other FICC transactions, instead of having to provide collateral for each specific transaction. As stated in the Notice, this allows Members “to charge a lower capital charge for Repo Transactions… than would be required if such transactions had not cleared”. The notice stresses that this is consistent with the IFCC’s efforts to encourage members “to submit forward (rather than day-to-day) repo transactions for compensation”. The opinion goes on to say that the FICC “believes that allowing more term repo activity (rather than overnight) … can help reduce repo rate volatility in the market”, including the September 2019 rate spike described above.
The notice provides that the proposed changes will be subject to SEC approval or rejection 45 days after publication in the Federal Register, unless the SEC or FICC determines an additional time period of up to 90 days from publication is required. Comments from market participants are requested by the SEC.
The proposed rule changes aim to bring more fixed income securities, and in particular repo transactions (forward and overnight) “inside the clearinghouse tent” to make those transactions and their pricing more transparent and, as a result, stronger and fairer capital markets.
© 2021 Norris McLaughlin PA, All rights reservedRevue nationale de droit, volume XI, number 159