Thank you, Mr. Chair. A government that routinely runs substantial deficits needs to be cautious when structuring the rules for the markets in which it borrows. Additional central clearing in the U.S. Treasury market may be one way to strengthen the market to ensure that it can absorb the ever-increasing Treasury issuances, but how we get to increased central clearing matters. The recommendation that the Commission is considering today would commit the market to what may be a reckless ride down the path to mandatory clearing, with no brakes or off-ramps in the event the market takes a bad turn. Accordingly, I cannot support it.

We should take a more incremental approach—an approach that allows for course corrections or, if necessary, reversals if the effects of these recommended reforms differ from the Commission’s expectations. As many commenters pointed out, moving straight to a clearing mandate could disrupt the market.[1] Commenters have raised significant concerns about how the mandate will affect transaction costs and liquidity in these markets.[2] They have asked whether FICC and sponsoring members have the ability to support additional clearing of Treasury transactions.[3] They also identified the operational challenges of filing new SRO rules with the Commission, onboarding clients and documenting relationships, and building out the necessary systems to comply with the rule.[4] The adopting release recognizes some of these risks and challenges. However, it makes no provision for taking the regulatory foot off the gas pedal or hitting the brakes, should that become necessary.

Instead, why not adopt pieces of the rulemaking that could lay the groundwork for more central clearing to occur even without a mandate? I could support a rule that was limited to addressing disincentives to clearing. The new requirements in the final rule on how clearing agencies calculate, collect, and hold margin posted on behalf of customers of direct participants and the change that would permit margin required and on deposit at a U.S. Treasury securities clearinghouse to be included as a debit item in the customer reserve formula do just that. I also could support a requirement—like that in the final rule—that clearing agencies work to facilitate improved access to clearance and settlement services of all eligible secondary market transactions in U.S. Treasury securities, as long as that access is consistent with sound risk management. A rule that took this more limited approach would make central clearing more attractive without forcing market participants into central clearing. After observing the changes in the market brought about by these incremental steps, we—with the advice of market participants, other regulators, and market observers—could assess whether further regulatory action was necessary.

The release states that “[m]erely incentivizing and facilitating greater central clearing is not sufficient, as those types of changes would not ensure that the current risks to U.S. Treasury securities [covered clearing agencies] are addressed.”[5]  This assertion may be true, but would it not be better to take the opportunity to see whether it is in fact true? If it is, we would then be in a position to implement further reforms we would at that point know are necessary.  Instead, even as we acknowledge that we are not sure how it will play out,[6] we are releasing a real-life experiment as if we are academics tinkering with a model of the market.[7]

With this final rule, the Commission insists that the market move toward clearing on autopilot, with no clear means of seizing the wheel if things go awry. The clearing mandate will automatically take effect on a set time schedule that affords little flexibility to adjust as the market responds to the other parts of the rule and to other developments.[8] We are applying the mandate broadly, including, for example, to tri-party repo transactions, where the market functions well and there is limited experience with central clearing.[9] We also are moving forward at a faster clip than is sound based on the questionable logic that sooner is always better,[10] and if our assessment of the costs and operational challenges of mandatory clearing is incorrect, we could drive liquidity out of the market. There is a better way, much of it is already signaled in the rule, and I am sorry we are not taking it.

Although I cannot support today’s rule. I do support the team that worked on it. Jeff Mooney, Elizabeth Fitzgerald, and the rest of the team in the Divisions of Trading and Markets and Economic and Risk Analysis, along with their partners in the Office of General Counsel, consistently impress me with their thoughtfulness. That characteristic will serve all of us well as we work through implementation of this rulemaking.

            I do have a number of questions:

1. The final rule directs Treasury clearing agencies to require that the direct participants submit for clearance and settlement all eligible secondary market transactions to which they are a counterparty. In other words, we are directing clearing agencies to force their members to change the way they do business on the theory that doing so will “reduce contagion risk” to the clearing agency. What are the statutory limits to these types of directives? Could we direct a clearing agency to establish rules that prohibit members from engaging in crypto transactions, financing payday lenders, or funding startups because those activities are risky to the member and thus indirectly to the clearing agency?
2. If, for some reason, FICC were unable to clear transactions for an extended period of time and no other Treasury clearing agency existed, would the mandate automatically cease, or would the Commission have to take some action? Could the potential uncertainty about how the clearing mandate would apply roil markets at an already uncertain time?
3. While most people see the benefits of central clearing, the risks of concentrating transactions in a single clearinghouse are also evident. Former Federal Reserve Chairman Ben Bernanke explained that: “[T]he historical record shows that clearinghouse arrangements have generally withstood even severe crises. This solid performance reflects good planning and sound institutional structures but also some degree of good luck, as crises have also revealed important vulnerabilities, vulnerabilities which prompted subsequent reforms by both the private and public sectors.” Good luck is not a strategy, so why can I be confident that Treasury clearinghouses will perform even in times of market stress?
4. If the clearing mandate is so beneficial, why are we excluding sovereign entities?
5. Our rules can serve to increase barriers to entry and entrench large competitors, which leads to market concentration. Small- and mid-sized firms have suggested that the clearing mandate could raise costs for them and thus could drive them out of the market. Do you think this concern is valid and, if so, what steps have you taken to mitigate the concern?
6. The final rule excludes Treasury repos and reverse repos between a direct participant and an affiliated counterparty, on the condition that the affiliate submits for clearance and settlement all of its other Treasury repos or reverse repos. This condition seems to extend the clearing mandate beyond transactions with a direct participant. Do we have the authority to reach these transactions?
7. Clearing agencies will have to ensure that the transactions of both domestic and foreign affiliates are submitted for clearing. Do we have concerns about the extraterritorial reach of this rulemaking?
8. What is the optimal level of clearing in the Treasury markets?
9. Several commenters raised significant operational concerns, including the lengthy current process of onboarding new sponsored clearing participants and the limited capacity for sponsored clearing, in part because of low or negative profitability of this business. Is the staff prepared to address possible disruption if the necessary sponsored clearing capacity does not materialize? If so, how?
10. What keeps you up at night in terms of how this rule might negatively affect liquidity, pricing, or competition in these markets?