Thank you, Chair Gensler. Today, the Commission is considering amendments to require covered clearing agencies to have written policies and procedures reasonably designed to require that their direct participants centrally clear all “eligible secondary market transactions” in U.S. Treasury securities to which it is a counterparty. [1] The Commission would also amend the broker-dealer customer protection rule to permit margin on deposit with covered clearing agencies for U.S. Treasury securities to be counted toward the reserve formulas for their customers and proprietary accounts.

No one disputes the central importance of the Treasury market. It provides the means to finance U.S. government debt, but also provides an investment that has the most liquid market in the world, constitutes a relatively risk-free benchmark from which many other financial instruments are priced, serves as collateral for many transactions, and facilitates portfolio positioning and quality risk management.

The Treasury market appears to be functioning well. As Treasury Under Secretary Nellie Liang recently remarked, while “it has been an eventful year for the Treasury market and interest rate volatility has been high . . . Treasury market liquidity conditions have nevertheless remained orderly.”[2] While “transaction volumes reached new record highs” in mid-March,[3] market conditions remained “orderly” and the market continued “to facilitate significant risk transfer during this turbulent episode.”[4] During this period of stress, she noted that principal trading firms “increased their activity in the Treasury market” and were “providing a greater share of liquidity.”[5]

The Treasury market has changed in recent years. Most significantly, Treasury marketable debt outstanding has increased from $4.3 trillion in June 2007,[6] immediately before the financial crisis, to over $26 trillion in September 2023.[7] Not only has this market grown massively in scale, it has also evolved substantially in terms of market infrastructure, institutions, and participants, including the advent of electronic platforms for automated trading strategies and new market participants with different business models. As the Inter-Agency Working Group for Treasury Market Surveillance[8] noted in a progress report, proprietary trading firms “first gained access to electronic trading platforms in the cash market in the mid-2000s, and by 2014, they represented the majority of trading activity in the futures and electronically brokered interdealer cash markets.”[9] Amidst these changes, the Treasury cash, derivatives, and “repo” markets interact in real time, which can further enhance liquidity.[10]

The pressures on the Treasury market include basic supply and demand. In an article titled “Bashing Hedge Funds that Trade Treasuries Could Cost Taxpayers Money,” the Economist noted that in “the 12 months to October, the Treasury, on net, issued $2.2 trillion in bills and bonds, worth 8% of GDP, to fund America’s gaping deficit. Adding to the supply, the Federal Reserve has shrunk its own portfolio of Treasuries by nearly $1 trillion since mid-2022.”[11] On a gross level, the Wall Street Journal observed that the sale of $20.8 trillion of new Treasuries in the first 11 months of 2023 is set to surpass the prior record for sales.[12]

The most persuasive economic rationale for mandating the central clearing of Treasuries is the potential benefits. The net benefits of clearing are that the risk of settlement failures may be mitigated, thereby causing transactions to become less expensive and more certain. This tends to increase market liquidity as liquidity begets liquidity. One potential benefit is that the rule may facilitate multilateral netting, thereby further cutting transaction costs and uncertainty. As the Adopting Release notes “[b]y reducing the level of margin required to support a given total level of trading activity, central clearing may reduce total risk to the system reducing the level of margin.”[13]

Another potential benefit is the enhanced ability of covered clearing agencies like the Fixed Income Clearing Corporation (FICC) to better manage the risks presented by its direct participants. Under the current regulatory regime, many trades of FICC’s direct participants appear to entail the risks associated with a directional trade, but which, in fact, are not directional in nature, but rather offset by other transactions. The full nature of these transactions may be clearer when a broader swath of the trades of the direct participants are centrally cleared.

This rule adoption will entail substantial costs such as initial margin requirements, clearing fees, and onboarding customers for indirect central clearing.[14] The Adopting Release describes the many steps needed to fully implement the changes. For example, FICC will need to ensure that it has sufficient clearing capacity to handle increased volumes and will need to implement its own rule changes for mandated clearing. Keeping an eye on how these may potentially be reduced or ameliorated as the rule is implemented will be important.

Let’s not oversell the idea that today’s action will significantly lower overall systemic risk. While there will be some risk mitigation through central clearing, the prevention of a systemic crisis cannot be addressed through clearing agency regulations. Central clearing will not address broader effects that a rise in interest rates has on the value of fixed income instruments. Indeed, during a crisis, margin calls by a clearing agency may be pro-cyclical and further exacerbate the crisis. Moreover, concentration of activity in a single clearing agency raises other risks.

Most notably, nothing in our adopting release postulates that these changes would have addressed the regional banking crisis in March 2023, even though Treasuries were involved in that situation. This is an instance where Congress has given the assignment of looking around the corner at systemic risks to the Financial Stability Oversight Council (FSOC) and the Office of Financial Regulation (OFR). Unfortunately, in the case of the risks of rising interest rates, they did not fulfill this role that Congress assigned them. Given the amount of inflation and the likely response of the Federal Reserve to raise interest rates, one questions where were those entities in identifying banking institutions that might be vulnerable?

Instead, FSOC appeared to be spending a lot of time on developing a new regime to designate non-bank financial institutions as systemically important, looking at entity-level designations, and pursuing climate change as a systemic threat. As an individual commissioner, I do not have any insight into what happens at FSOC. The statute is clear that the membership of FSOC is only for specific individuals.

These all point to the importance of the Treasury market and also raise concerns about the possibility of unintended consequences. There is a strong need to proceed with caution and deliberation, and that point cannot be overemphasized. I will support this rule because of the potential incremental benefits to the Treasury market. I thank the staff in the Divisions of Trading and Markets, Economic and Risk Analysis, and Investment Management as well as the Office of General Counsel for their efforts.