Treasury Market Group Warns of Clearing Risks in Benchmark Debt

(Bloomberg) -- Participants in the $15 trillion U.S. Treasury market may be underestimating the risk of their transactions because they don’t fully understand their exposure related to the clearing and settlement of trades.

That’s part of the message in documents published Thursday by the Treasury Market Practices Group, which the Federal Reserve Bank of New York helped form in 2007. The TMPG, which has representatives from firms including Citadel LLC and Goldman Sachs Group Inc. as well the New York Fed and Treasury, requested public comments by Sept. 28.

The reports are the result of several years of work by industry members and regulators after the structure and strength of the market came into question following an episode of unusual volatility in October 2014, when the securities convulsed with no apparent trigger. Much of the scrutiny has centered on how clearing and settlement practices haven’t kept up with the entry of new participants and increased automation in trading.

“The Treasury market has changed significantly in terms of participants, access, platforms, speed and electronification, but clearing and settlement hasn’t changed very much,” Tom Wipf, vice chairman of institutional securities at Morgan Stanley and chair of the TMPG, said in an interview. “So it’s very important that market participants understand the entire landscape. People may be too comfortable or potentially complacent about the risks given the high quality of the collateral and the short settlement cycles.”

Automation’s Sway

An increasing amount of Treasuries transactions between dealers is now done by automated firms. Most often, that business is done through trades that don’t clear centrally, meaning through central counterparty clearing houses known as CCPs. Clearing platforms are central intermediaries between buyers and sellers that assume responsibility for completing transactions, removing counterparty credit risk.

The TMPG in their report estimated that about three-quarters of trades through interdealer broker platforms clear bilaterally. This slice of trading accounts for slightly less than half of secondary market dealings, with the rest in the dealer-to-customer segment.

“We have seen a meaningful migration in the interdealer market away from centrally cleared activity to bilateral,” Wipf said. “That’s really worth looking at because by definition bilateral settlement involves owning the credit risk between you and your counterparty.”

Risks Outlined

The TMPG material describes the process of settlement and clearing, maps out how it works from trade initiation to completion, and lists risks related to trades with different counterparties and clearing types.

Among risks, it cites:

  • A lack of understanding of clearing/settlement impact from automation, new entrants
  • Decline in share of interdealer trades cleared through CCPs
  • Insufficient risk-management vigor applied to Treasury dealings
  • Threat of operational disruptions, cyber attacks

The documents posted to the New York Fed’s website included a white paper and graphics that lay out how Treasuries move through the trading, clearing and settlement process.

Awaiting Feedback

“We’ve done a lot of work on this topic and now want to hear from market participants,” Wipf said, adding that the TMPG anticipates feedback from those who are clear on the risks and others who might now see they aren’t.

One issue with the Treasury market is that much of it has grown outside officials’ reach, including the clearing of trades from high-speed automated firms. While most dealers clear through a central platform run by the Depository Trust & Clearing Corp., there’s no regulatory requirement to do so.

“This is the deepest and most liquid market in the world,” he said. “It’s how we fund the government. It’s just too important and there’s no margin for error here. It is incumbent on market participants to look very closely at their clearing and settlement activities to ensure that this market is always functioning.”

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