TMPG estimates that ``roughly three-quarters of IDB trades clear
bilaterally.'' \360\ To help visualize the significance of the role
played by IDBs in the centrally cleared market, and given existing data
limitations, Table 3, adapted from a table prepared by the TMPG in
2019, presents five clearing and settlement case types that cover the
vast majority of secondary market cash trades. The table uses Federal
Reserve data collected from primary dealers in the first half of 2017
to estimate the daily volume (dollar and share percentage) attributable
to each clearing and settlement case type.
---------------------------------------------------------------------------

    \360\ TMPG White Paper, supra note 21, at 2.

Table 3--Estimated Secondary Cash Market Primary Dealer Daily Trading Dollar (Billions) and Percentage Volume by
                                          Clearing and Settlement Type
----------------------------------------------------------------------------------------------------------------
                                                     $ Volume                                         Overall
          Clearing and settlement type               billions      Non-IDB share     IDB share    percentage (%)
----------------------------------------------------------------------------------------------------------------
Bilateral clearing, no IDB......................            $289             95%  ..............            54.3
Central clearing, no IDB........................              15              5%  ..............             2.9
Central clearing, with IDB......................              52  ..............           22.9%             9.8
Bilateral clearing, with IDB....................              73  ..............           31.9%            13.6
Bilateral/central clearing, with IDB............             103  ..............           45.3%            19.4
    Totals......................................            $531    $304 (57.2%)    $228 (42.8%)             100
----------------------------------------------------------------------------------------------------------------
Source: TMPG White Paper on Clearing and Settlement in the Secondary Market for U.S. Treasury Securities (2019),
  adapted from a table at p. 12.
Table 3 Notes: Figures are estimated using the Federal Reserves' Form FR2004 data for the first half of 2017 and
  are based on the following assumptions: (a) primary dealers account for all dealer activity, (b) 5% of
  dealers' trading not through an IDB is with another dealer, (c) the shares of dealer and non-dealer activity
  in the IDB market for coupon securities equal the weighted averages of the shares reported in the October 15
  report (that is, 41.5% and 58.5%, respectively), (d) only dealers trade bills, FRNs, and TIPS in the IDB
  market, and (e) the likelihood of dealer and non-dealers trading with one another in the IDB market solely
  reflects their shares of overall volume. The table presents estimates because precise information is not
  available on the size of the market or on how activity breaks down by the method of clearing and settlement.

d. Other Market Participants
i. FICC Sponsored Members
    As discussed previously, some institutional participants that are
not FICC Netting Members/FICC direct participants are able to centrally
clear repos through FICC's Sponsored Service.\361\ The Sponsored
Service allows eligible direct participants (Sponsoring Members) to (i)
sponsor their clients into a limited form of FICC membership (Sponsored
Members) and then (ii) submit certain eligible client securities
transactions for central clearing. If adopted, the Membership Proposal
could affect Sponsored Members. FICC interacts solely with the
Sponsoring Member/direct participant as agent. Sponsoring Members
guarantee to FICC the payment and performance obligations of its
Sponsored Members.\362\ Following FICC's expansion in 2021 of its
Sponsored Service to allow Sponsored Members to clear triparty repos
through the program,\363\ there are now approximately 30 Sponsoring
Members and approximately 1,900 Sponsored Members \364\ with access to
central clearing. During the 12 month period ending on August 9, 2022,
the total dollar value of Sponsored Members' daily repo and reverse
repo activity ranged from a high of $415.8 billion on December 31, 2021
to a low of $230.2 billion on October 21, 2021.\365\
---------------------------------------------------------------------------

    \361\ FICC's Sponsored Member program also allows the submission
of cash transactions; however, as previously noted, the service is
generally used only for U.S. Treasury repo transactions at this
time.
    \362\ See FICC's GSD Rule 3A, supra note 47. Sponsored Members
have to be Securities Act Rule 144A ``qualified institutional
buyers,'' or otherwise meet the financial standards necessary to be
a ``qualified institutional buyer.'' See id., Rule 3A, section 3(a).
    \363\ See Self-Regulatory Organizations; Fixed Income Clearing
Corporation; Order Approving a Proposed Rule Change to Expand
Sponsoring Member Eligibility in the Government Securities Division
Rulebook and Make Other Changes, Exchange Act Release No. 85470
(Mar. 29, 2019), supra note 126.
    \364\ See FICC Membership Directories (``FICC Membership''),
available at https://www.dtcc.com/client-center/ficc-gov-directories. As of Dec. 31, 2021, DTCC reported that FICC had 30
sponsoring members and over 1,800 sponsored members. DTCC 2021
Annual Report, supra note 343, at 19.
    \365\ This information was available from DTCC on the 1 year
version of the FICC Sponsored Activity chart as of Aug. 12, 2022,
available at: https://www.dtcc.com/charts/membership.
---------------------------------------------------------------------------

    Among the various types of financial firms that are Sponsored
Members are (i) over 1,400 funds, including a number of hedge funds,
many money market funds, other mutual funds, and a smaller number of
ETFs; \366\ (ii) banks, including a small number of national, regional
Federal Home Loan Banks, and international banks; and (iii) other asset
managers including a few insurance companies.\367\
---------------------------------------------------------------------------

    \366\ For various persons, direct participation in FICC may not
be an alternative to the Sponsored Membership program. For example,
``[a] subset of market participants, such as certain money market
funds, face legal obstacles to joining FICC because they are
prohibited from mutualizing losses from other clearing members in
the way that FICC rules currently require.'' Chicago Fed Insights,
supra note 204.
    \367\ FICC Membership, supra note 364.
---------------------------------------------------------------------------

ii. Other Market Participants That Are Not FICC Sponsored Members
    In addition to Sponsored Members, various types of direct and
indirect market participants hold significant amounts of U.S. Treasury
securities and repo, and potentially purchase and sell U.S. Treasury
securities in the secondary cash and repo markets. To the extent that
these persons engage in secondary market transactions, we expect their
trading may be affected by increased central clearing resulting from
the adoption of the Proposal. The most prominent examples are:
1. Hedge Funds, Family Offices, and Separately Managed Accounts
    Hedge funds are active participants in the secondary market for
U.S. Treasury securities and their trading activities have been shown
to be a cause of price movements in the U.S. Treasury securities
market.\368\ Hedge funds can use U.S. Treasury securities, for example,
in order to borrow cash to take leveraged positions in other markets,
or to execute complex trading strategies. As of December 31, 2021
approximately 25 percent of qualifying hedge funds reporting on Form PF
\369\ reported U.S. Treasury securities holdings totaling $1.76
trillion in notional exposure in the cash market and $2.25 trillion in
notional exposure to repos.\370\ For Large Hedge Fund Advisers (LHFA)
\371\ reporting on Form PF for the same period, monthly turnover in
U.S. Treasury securities was $3.4 trillion.
---------------------------------------------------------------------------

    \368\ Ron Alquist & Ram Yamarthy, Hedge Funds and Treasury
Market Price Impact: Evidence from Direct Exposures, OFR Working
Paper 22-05 (Aug. 23, 2022) (``find[ing] economically significant
and consistent evidence that changes in aggregate hedge fund
[Treasury] exposures are related to Treasury yield changes [and] . .
. that particular strategy groups and lower-levered hedge funds
display a larger estimated price impact on Treasuries.''), available
at https://www.financialresearch.gov/working-papers/files/OFRwp-22-05-hedge-funds-and-treasury-market-price-impact.pdf.
    \369\ For an explanation of qualifying hedge funds, see supra
note 148. Although the Proposal would cover any hedge fund, smaller
funds holdings are not reflected in these statistics because of Form
PF's minimum $150 million reporting threshold. An adviser must file
Form PF if (1) it is registered (or required to register) with the
Commission as an investment adviser, including if it also is
registered (or required to register) with CFTC as a commodity pool
operator or commodity trading adviser, (2) it manages one or more
private funds, and (3) the adviser and its related persons,
collectively had at least $150 million in private fund assets under
management as of the last day of its most recently completed fiscal
year. See Form PF General Instruction No. 1, available at https://www.sec.gov/files/formpf.pdf.
    \370\ Division of Investment Management Analytics Office,
Private Funds Statistics Fourth Calendar Quarter 2021, Table 46 at
39 (July 22, 2022), available at https://www.sec.gov/divisions/investment/private-funds-statistics/private-funds-statistics-2021-q4.pdf.
    \371\ Large hedge fund advisers reporting on Form PF ``have at
least $1.5 billion in hedge fund assets under management.'' See Id.
at 61.
---------------------------------------------------------------------------

    Family offices are entities established by families to manage
family wealth.\372\ Family offices tend to exhibit behavior and have
objectives that are similar to those of hedge funds including the use
of leverage, aggressive investment strategies, and holding illiquid
assets. A recent survey of family offices undertaken by RBC \373\ found
that of 385 participating family offices around the world, almost half
(46%) are based in North America. Average family office AUM for North
American families was $1 billion.
---------------------------------------------------------------------------

    \372\ ``Historically, most family offices have not been
registered as investment advisers under the Advisers Act because of
the `private adviser exemption' provided under the Advisers Act to
firms that advice fewer than fifteen clients and meet certain other
conditions.'' SEC Staff, Family Office: A Small Entity Compliance
Guide, available at https://www.sec.gov/rules/final/2011/ia-3220-secg.htm.
    \373\ Campden Wealth and The Royal Bank of Canada, The North
America Family Office Report (2021), available at: https://www.rbcwealthmanagement.com/_assets/documents/cmp/the-north-america-family-office-report-2021-final-ua.pdf.
---------------------------------------------------------------------------

    Similarly, Separately Managed Accounts (SMAs) are also portfolios
of assets managed by an investment adviser, usually targeted towards
wealthy individual investors. Because of the end investor's risk
tolerance, SMAs can also pursue aggressive, leveraged strategies.

2. Registered Investment Companies (RICs) Including Money Market Funds,
Other Mutual Funds, and ETFs
    RICs, mainly money market funds, mutual funds, and ETFs, are large
holders of U.S. Treasury securities.\374\ At the end of the first
quarter of 2022, money market funds held $1.8 trillion of U.S. Treasury
securities ($1.2 trillion in T-Bills and $603.9 billion in other U.S.
Treasury securities).\375\ Mutual funds held an additional $1.5
trillion of other U.S. Treasury securities ($34.1 billion of T-Bills
and $1.5 trillion of other U.S. Treasury securities) while exchange-
traded funds held an additional $334.1 billion in U.S. Treasury
securities.\376\ The degree to which these entities would be affected
depends on the extent to which their trading is likely to take place in
the secondary market.\377\
    RICs are also active participants in the repo market with money
market funds being active cash investors. According to data filed with
the Commission, money market funds investments in U.S. Treasury repo,
both bilateral and triparty, amounted to approximately $2.3 trillion in
June 2022. Moreover, as shown in Figure 12, money market fund U.S.
Treasury repo volume has grown from approximately $200 billion monthly
in 2011 with the vast majority of the most recent year's growth
attributed to investments in the Federal Reserve's repo facility.\378\
---------------------------------------------------------------------------

    \374\ Investment companies are the third largest holder of U.S.
Treasury securities holding just under $3.6 trillion. MMFs in the
Treasury Market, supra note 128, at 3 (citing to Financial Accounts
of the United States as of Mar. 2022). The other large (over 5
percent) holders are: ``other'' holders (including hedge funds) 30
percent, the Federal Reserve (23 percent), pension funds (14
percent), and U.S. banks and state and local governments (each
holding 6 percent). See id. at 2 (figure 5).
    \375\ Federal Reserve Statistical Release, Z.1 Financial
Accounts of the U.S, Flow of Funds, Balance Sheets, and Integrated
Macroeconomic Accounts, at 119 (L210 Treasury Securities--lines 42-
49) (``Financial Accounts of the U.S.''), available at: https://www.federalreserve.gov/releases/z1/20220609/z1.pdf.
    \376\ Id. at 119 (L210 Treasury Securities--lines 45-47 and 49).
    \377\ For example, an analysis of money market fund portfolios'
turnover of U.S. Treasury securities by the Commission staff
indicates only limited secondary market trading activity. Recently
published estimates based on monthly filings of Form N-MFP suggest
that, on average, money market funds hold around 70 percent of U.S.
Treasury securities to the next month with around 6 percent of U.S.
Treasury securities holdings disposed of before maturity. The
remaining approximately 23 percent of holdings mature during the
month. MMFs in the Treasury Market, supra note 128, at 3. These
estimates suggest that the proposal's effect on money market fund
cash market transactions in U.S. Treasury securities will be very
limited relative the proposal's effects on money market funds' repo
activities which could be more significant.
    \378\ Id. at 4. The Commission understands the credit rating
agencies consider concentration of counterparty credit risk as one
factor in determining their rating of money market funds which may
drive money market funds to seek diversification of counterparties
for the repo transactions.
---------------------------------------------------------------------------

Figure 12: Money Market Fund Monthly Repo Volume (01/2011-06/2022)
[GRAPHIC] [TIFF OMITTED] TP25OC22.011

    For RICs, holdings of U.S. Treasury securities play an important
role in managing liquidity risk stemming from potential redemptions.
Given their highly liquid nature, U.S. Treasury securities can be used
to raise cash to meet redemptions. For example, a survey conducted by
an industry group showed that in the first quarter of 2020 RICs had net
sales of $128 billion in Treasury and agency bonds, mainly to meet
redemption requests at the onset of the Covid-19 pandemic.\379\
---------------------------------------------------------------------------

    \379\ See Shelly Antoniewicz & Sean Collins, Setting the Record
Straight on Bond Mutual Funds' Sales of Treasuries, Investment
Company Institute Viewpoints (Feb. 24, 2022), available at https://www.ici.org/viewpoints/22-view-bondfund-survey-2.
---------------------------------------------------------------------------

    In addition to reliance on Treasury securities as sources of
liquidity, RICs use Treasury securities as collateral for borrowing in
the repo market as another source of liquidity. Also, RICs accept
Treasury securities as collateral in their securities lending programs
established to an additional source of income for the fund
shareholders.

3. Principal Trading Firms (PTFs)
    The role and importance of PTFs providing liquidity in the U.S.
Treasury securities market have been the subject of a number of
analyses and reports in recent years.\380\ For example, using FINRA's
Regulatory TRACE data in connection with a recent rulemaking proposal,
we identified 174 market participants who were active in the U.S.
Treasury securities market in July 2021 and that were not members of
FINRA.\381\ We ``found that these participants accounted for
approximately 19 percent of the aggregate U.S. Treasury security
trading volume [], with PTFs representing the highest volumes of
trading among these participants.'' \382\ We explained that in our
analysis
---------------------------------------------------------------------------

    \380\ See, e.g., G-30 Report, supra note 5, at 1; Joint Staff
Report, supra note 4, at 3-4, 36, 55 (``PTFs now account for more
than half of the trading activity in the futures and electronically
brokered interdealer cash markets.''); Harkrader and Puglia FEDS
Note, supra note 304; Doug Brain, et al., FEDS Notes, ``Unlocking
the Treasury Market Through TRACE'' (Sept. 28, 2018), available at
https://www.federalreserve.gov/econres/notes/feds-notes/unlocking-the-treasury-market-through-trace-20180928.htm. See also Ryan and
Toomey Blog Part III, supra note 31 (While in the interdealer cash
market, U.S. Treasury securities are often cleared and settled
through FICC, ``dealer trades with principal trading firms
(``PTFs'')--a very large share of this market--are generally cleared
bilaterally because most PTFs are not members of the FICC.''). See
also IAWG Report, supra note 4, at 21 (``on February 25, 2021, a
large shift in investor sentiment triggered very high trading
volumes [] that temporarily overwhelmed the intermediation capacity
of the Treasury market. . . . . Some market participants observed
that the stresses on February 25, 2021, were exacerbated by lack of
elasticity in liquidity supply resulting from activity limits that
IDB platforms impose on some firms, especially PTFs that do not
participate in central clearing.'').
    \381\ Further Definition of ``As a Part of a Regular Business''
in the Definition of Dealer and Government Securities Dealer,
Exchange Act Rel. No. 94524 (Mar. 28, 2022), 87 FR 23054, 23072, and
23080 (Apr. 18, 2022) (``Because regulatory TRACE data pertaining to
Treasury securities reported by certain ATSs contains the identity
of non-FINRA member trading parties, we are able to analyze PTFs'
importance in the U.S. Treasury market during July 2021 and
summarize the number and type of market participants by monthly
trading volume . . . .''). ``Although FINRA membership is not
synonymous with dealer registration status, the Commission believes
that many of the market participants who are not FINRA members are
also likely not registered as government securities dealers.'' Id.
at 23072 n. 167.
    \382\ Id. at 23072.

    PTFs had by far the highest volumes among identified non-FINRA
member participants in the U.S. Treasury market, and the largest
PTFs had trading volumes that were roughly comparable to the volumes
of the largest dealers. A Federal Reserve staff analysis found that
PTFs were particularly active in the interdealer segment of the U.S.
Treasury market in 2019, accounting for 61 percent of the volume on
[electronic] interdealer broker platforms . . . .\383\
---------------------------------------------------------------------------

    \383\ Id. at 23080. Harkrader and Puglia FEDS Note, supra note
304. See also FEDS Notes, Unlocking the Treasury Market Through
TRACE (Sept. 28, 2018). Harkrader and Puglia used FINRA TRACE data
on the trading volume shares of different participant types on IDB
platforms for nominal coupon securities from April 1, 2019 to
December 31, 2019. They identified $191 billion of average daily
dollar volume on electronic/automated IDB platforms during the
period. They also noted data limitations, which they estimated
amounted to ``a very small fraction of total activity.'' Id.

    Based on this Federal Reserve study and assuming that all PTFs are
not FICC members and that PTF trading on IDB electronic platforms
during the final three quarters 2019 was a reasonable proxy for the
average daily current volume of such trading today by PTFs, the
Membership Proposal would subject as much as approximately $116.51
billion per day in PTF trades on electronic/automated IDBs to central
clearing.\384\
---------------------------------------------------------------------------

    \384\ Harkrader and Puglia FEDS Note, supra note 304, at table 1
(61% of $191 billion = $116.51 billion).
---------------------------------------------------------------------------

4. State and Local Governments
    State and local governments are significant holders of U.S.
Treasury securities. As of March 2022, state and local governments held
approximately $1.5 trillion in U.S. Treasury securities \385\ as part
of their budgetary and short-term investment duties.
---------------------------------------------------------------------------

    \385\ Financial Accounts of the U.S., supra note 375 (Line 19).
---------------------------------------------------------------------------

    5. Private Pensions Funds and Insurance Companies.
    Insurance companies and pension funds also have significant
positions in U.S. Treasury securities. As of March 2022, private
pension funds and insurance companies are large holders of U.S.
Treasury securities, holding $5.6 trillion and $374.8 billion
respectively.\386\
---------------------------------------------------------------------------

    \386\ Id. (Lines 29, 32, and 35).
---------------------------------------------------------------------------

e. Triparty Agent: Bank of New York Mellon \387\
---------------------------------------------------------------------------

    \387\ Paddrik, et al., supra note 273 (``The Federal Reserve
Board, through the Federal Reserve Bank of New York (FRBNY),
supervises triparty custodian banks and, on a mandatory basis
pursuant to its supervisory authority, collects transaction-level
data at the daily frequency.'').
---------------------------------------------------------------------------

    Although triparty repo transactions are bilaterally negotiated,
they are settled through BNY Mellon, which currently plays a central
role in the triparty repo market as the sole triparty agent.\388\
Besides providing collateral valuation, margining, and management
services, BNY Mellon also provides back-office support to both parties
by settling transactions on its books and confirming that the terms of
the repo are met. Additionally, the clearing bank acts as custodian for
the securities held as collateral and allocates collateral to trades at
the close of the business day. As discussed previously, FICC recently
introduced the Sponsored GC Service that extends FICC's GCF repo
service to allow for the clearing of triparty repo.\389\
---------------------------------------------------------------------------

    \388\ J.P. Morgan Chase previously served as a custodian in the
triparty space but largely exited the market in 2019. Id. at 2-3.
    \389\ See supra note 66 and accompanying discussion.
---------------------------------------------------------------------------

    An expansion of central clearing under the Membership Proposal
could affect BNY Mellon's triparty business. It is, however, unclear
whether increased central clearing would increase or decrease the
amount of repo traded that makes use of triparty agent's services
previously described.
f. Custodian Banks/Fedwire Securities Service (FSS)
    Currently, custodian banks handle much of the trading activity for
long-only buy-side clients in the U.S. Treasury securities cash and
repo markets. When an asset buyer and seller engage bilaterally as
principals in a collateralized securities transaction, a repo for
example, a custodian bank will often provide various services to
support the transaction. Custodian services include transaction
settlement verification, verifying the amount of the relevant credit
exposure, calculating required initial and variation margin, and making
margin calls. In a tri-party repo transaction that isn't centrally
cleared, a custodian perform a clearing function by settling the
transaction on its own books without a corresponding transfer of
securities on the books of a central securities depository.\390\
---------------------------------------------------------------------------

    \390\ The Clearing House, The Custody Services of Banks (July
2016) available at: https://www.davispolk.com/sites/default/files/20160728_tch_white_paper_the_custody_services_of_banks.pdf
---------------------------------------------------------------------------

    FSS, operated by the Federal Reserve Bank system, provides
issuance, maintenance, transfer and settlement services for all
marketable U.S. Treasury securities to its 3,800 participants.\391\ For
example, FSS offers the ability to transfer securities and funds to
settle secondary-market trades, to facilitate the pledging of
collateral used to secure

obligations, and to facilitate repo transactions.\392\
---------------------------------------------------------------------------

    \391\ See Fedwire Securities Service brochure (``FSS
brochure''), available at: https://www.frbservices.org/binaries/content/assets/crsocms/financial-services/securities/securities-product-sheet.pdf. The Federal Reserve Banks offer highly
competitive transaction, per-issue and monthly maintenance prices.
Account maintenance fees are waived for accounts holding only U.S.
Treasury securities and for certain accounts used to pledge
securities to the U.S. Treasury and Federal Reserve Banks. Service
fees are available at FRBservices.org. Fees for services are set by
the Federal Reserve Banks. A 2022 fee schedule is available at:
https://www.frbservices.org/resources/fees/securities-2022
    \392\ FSS brochure, supra note 391.
---------------------------------------------------------------------------

C. Analysis of Benefits, Costs, and Impact on Efficiency, Competition,
and Capital Formation

1. Benefits
    The proposed amendments would likely yield benefits associated with
increased levels of central clearing in the secondary market for U.S.
Treasury securities. The Commission previously has stated that
registered clearing agencies that provide CCP services both reduce
trading costs and help increase the safety and efficiency of securities
trading.\393\ These benefits could be particularly significant in times
of market stress, as CCPs would mitigate the potential for a single
market participant's failure to destabilize other market participants,
destabilize the financial system more broadly, and/or reduce the
effects of misinformation and rumors.\394\ A CCP also would address
concerns about counterparty risk by substituting the creditworthiness
and liquidity of the CCP for the creditworthiness and liquidity of
counterparties.\395\ Further, the Commission has recognized that ``the
centralization of clearance and settlement activities at covered
clearing agencies allows market participants to reduce costs, increase
operational efficiency, and manage risks more effectively.'' \396\
However, the Commission has also recognized that this centralization of
activity at clearing agencies makes risk management at such entities a
critical function.\397\
---------------------------------------------------------------------------

    \393\ See supra note 7.
    \394\ See supra note 8.
    \395\ Id.
    \396\ See supra note 10.
    \397\ Id.
---------------------------------------------------------------------------

    Bilateral clearing arrangements do not allow for multilateral
netting of obligations, which reduce end-of-day settlement
obligations.\398\ Larger gross settlement obligations, which increase
with leverage, increase operational risks and subsequently the
possibility of settlement fails. Central clearing of transactions nets
down gross exposures across participants, which reduces firms'
exposures while positions are open, and reduces the magnitude of cash
and securities flows required at settlement.\399\ These reductions,
particularly in cash and securities flow ``would reduce liquidity risks
associated with those settlements and counterparty credit risks
associated with failures to deliver on the contractual settlement
date,'' not only for CCP members but for the CCP itself.\400\
---------------------------------------------------------------------------

    \398\ See section IV.A.1, supra for a discussion of central
clearing and the mitigation of clearance and settlement risks.
    \399\ See IAWG Report, supra note 4, at 30.
    \400\ See G-30 Report, supra note 5, at 13, supra note 5; see
also PIFS Paper, supra note 120, at 28-31.
---------------------------------------------------------------------------

    It has been suggested that wider central clearing could have
lowered dealers' daily settlement obligations in the cash market by up
to 60 percent in the run-up to and aftermath of the March 2020 U.S.
Treasury securities market disruption and reduced settlement
obligations by up to 70 percent during the disruption itself.\401\ The
reduction in exposure is not limited to the cash market; it has been
estimated that the introduction of central clearing for dealer-to-
client repos would have reduced dealer exposures from U.S. Treasury
repos by over 80% (from $66.5 billion to $12.8 billion) in 2015.\402\
---------------------------------------------------------------------------

    \401\ Id. See also Michael Fleming & Frank Keane, Netting
Efficiencies of Marketwide Central Clearing (Staff Report No. Staff
Report No. 964), FEDERAL RESERVE BANK OF NEW YORK (Apr. 2021),
available at https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr964.pdf.
    \402\ PIFS Paper, supra note 120, at 29 (citing OFFICE OF
FINANCIAL RESEARCH, Benefits and Risks of Central Clearing in the
Repo Market, 5-6 (Mar. 9, 2017), available at https://www.financialresearch.gov/briefs/files/OFRBr_2017_04_CCP-for-Repos.pdf).
---------------------------------------------------------------------------

    The benefits of multilateral netting flowing from central clearing
can improve market safety by lowering exposure to settlement
failures.\403\ Multilateral netting can also reduce the regulatory
capital required to support a given level of intermediation activity
\404\ and could also enhance capacity to make markets during normal
times and stress events because existing bank capital and leverage
requirements recognize the risk-reducing effects of multilateral
netting of trades that CCP clearing accomplishes.\405\ By reducing the
level or margin required to support a given total level of trading
activity, central clearing may reduce total risk to the system.
Financial crises are sometimes precipitated by margin calls following a
period of increased volatility. If a market participant holds
offsetting positions, then margin calls that might occur could be
avoided. Because financial markets are forward-looking, reducing the
anticipation of margin calls on other market participants can avoid
costly ``bank-run'' type dynamics.\406\
---------------------------------------------------------------------------

    \403\ Duffie, supra note 186, at 15.
    \404\ See section IV.A.2, supra for an example of how
multilateral netting can reduce margin required to support a given
level of trading activity.
    \405\ See IAWG Report, supra note 4, at 30; Liang & Parkinson,
supra note 32, at 9; Duffie, supra note 186, at 16-17. It is
important to note that this netting may offset any potentially
higher liquidity charges faced by major participants from clearing
at the CCP. See Duffie, supra note 186, at 17 (``To the contrary,
the netting of most purchases against sales at a CCP would lower the
overall liquidity requirements of dealers, assuming that dealers
continue to intermediate the market effectively.'').
    \406\ See Menkveld and Vuillemey, 2021, Annual Review of
Financial Economics.
---------------------------------------------------------------------------

    Some benefits associated with capital reductions are particularly
relevant for overnight and term repo. In the case of financing activity
in U.S. Treasury securities market--U.S. Treasury repo--the entire
notional value of the position has to be recorded on a dealer's balance
sheet as soon as the start leg of the repo settles, and unless the
dealer faces off against the exact same legal counterparty with respect
to an offsetting financing trade of the same tenor, the dealer will not
be able to net such balance sheet impact against any other position.
The grossing up of the dealer's balance sheet in this manner can have
implications with respect to the amount of capital the dealer is
required to reserve against such activity. When transactions are
cleared through a CCP, dealers can offset their centrally cleared repo
positions of the same tenor, and thereby free up their capital to
increase funding capacity to the market.\407\ According to research
that Finadium conducted among repo dealers, netting can compress High
Quality Liquid Asset (HQLA) bilateral trading books by 60% to 80%.\408\
---------------------------------------------------------------------------

    \407\ The positive impact on dealer's ability to increase
funding capacity will be offset, in part, by the direct and indirect
costs of central clearing. See id. and section C.2 infra.
    \408\ Finadium LLC, Netting Rules for Repo, Securities Lending
and Prime Brokerage (Sept. 2014). Assets are considered to be HQLA
if they can be easily and immediately converted into cash at little
or no loss of value. The test of whether liquid assets are of ``high
quality'' is that, by way of sale or repo, their liquidity-
generating capacity is assumed to remain intact even in period of
severe idiosyncratic and market stress. See https://www.bis.org/basel_framework/chapter/LCR/30.htm?tldate=20191231&inforce=20191215.
---------------------------------------------------------------------------

    Cash and repo trades cleared and settled outside of a CCP may not
be subject to the same level of uniform and transparent risk management
associated with central clearing.\409\ By contrast, FICC is subject to
the Commission's risk management requirements addressing financial,
operational, and legal risk management, which include, among other
things, margin requirements commensurate with the risks and particular
attributes of each relevant product, portfolio, and market.\410\ As the
Commission believes that this proposal will incentivize and facilitate
additional central clearing in the U.S. Treasury

securities market, risk management should improve. To offset the risks
it faces as a central counterparty, the CCP requires its members to
post margin, and the CCP actively monitors the positions its members
hold. Moreover, in the event that the posted margin is not enough to
cover losses from default, the CCP has a loss-sharing procedure that
mutualizes loss among its members.
---------------------------------------------------------------------------

    \409\ See TMPG Repo White Paper, supra note 118, at 1. See also
section IV.B.5, supra.
    \410\ G-30 Report, supra note 5, at 13; 17 CFR 240.17Ad-
22(e)(6).
---------------------------------------------------------------------------

    By lowering counterparty risk, central clearing also allows for the
``unbundling'' of counterparty risk from other characteristics of the
asset that is being traded. This unbundling makes the financial market
for Treasury securities more competitive.\411\
---------------------------------------------------------------------------

    \411\ ``One of the conditions for a perfectly competitive market
is that [market participants] are happy to [buy or sell] from any of
the many [sellers or buyers] of the [asset]. No [buyer or seller] of
the [asset] has any particular advantage . . .'' David M. Kreps, ``A
Course in Microeconomic Theory'' Princeton University Press (1990),
at 264 (describing the conditions of a perfectly competitive
market.) When the transaction is novated to the CCP, market
participants substitute the default risk of the CCP for that of the
original counterparty.
---------------------------------------------------------------------------

    The Commission also believes that this proposal would help avoid a
potential disorderly default by a member of any U.S. Treasury
securities CCA. Defaults in bilaterally settled transactions are likely
to be disorganized and subject to variable default management
techniques, often subject to bilaterally negotiated contracts with
little uniformity. Independent management of bilateral credit risk
creates uncertainty about the levels of exposure across market
participants and may make runs more likely; any loss stemming from
closing out the position of a defaulting counterparty is a loss to the
non-defaulting counterparty and hence a reduction in its capital in
many scenarios.\412\
---------------------------------------------------------------------------

    \412\ See TMPG White Paper, supra note 21, at 32.
---------------------------------------------------------------------------

    Increased use of central clearing should enhance regulatory
visibility in the critically important U.S. Treasury securities market.
Specifically, central clearing increases the transparency of settlement
risk to regulators and market participants, and in particular allows
the CCP to identify concentrated positions and crowded trades,
adjusting margin requirements accordingly, which should help avoid
significant risk to the CCP and to the system as a whole.\413\
---------------------------------------------------------------------------

    \413\ Duffie, supra note 186, at 15; DTCC October 2021 White
Paper, supra note 203, at 1; IAWG Report, supra note 4.
---------------------------------------------------------------------------

    As discussed further below, the Commission is unable to quantify
certain economic benefits and solicits comment, including estimates and
data from interested parties, that could help inform the estimates of
the economic effects of the proposal.
a. U.S. Treasury Securities CCA Membership Requirements
    The Commission is proposing to amend Rule 17Ad-22(e)(18) to require
any covered clearing agency that provides central counterparty services
for transactions in U.S. Treasury securities to establish written
policies and procedures reasonably designed to, as applicable, require
that direct participants of a covered clearing agency submit all
eligible secondary market U.S. Treasury securities transactions in
which they enter for clearing at a covered clearing agency.\414\ As
previously explained in section III.A.2 supra, an eligible secondary
market transaction in U.S. Treasury securities would be defined to
include: (1) repurchase agreements and reverse repurchase agreements in
which one of the counterparties is a direct participant; (2) any
purchases and sales entered into by a direct participant that is an
interdealer broker, meaning if the direct participant of the covered
clearing agency brings together multiple buyers and sellers using a
trading facility (such as a limit order book) and is a counterparty to
both the buyer and seller in two separate transactions; (3) any
purchases and sales of U.S. Treasury securities between a direct
participant and a counterparty that is either a registered broker-
dealer, government securities dealer, or government securities broker;
a hedge fund; \415\ or an account at a registered broker-dealer,
government securities dealer, or government securities broker where
such account may borrow an amount in excess of one-half of the net
value of the account or may have gross notional exposure of the
transactions in the account that is more than twice the net value of
the account.\416\ However, any transaction (both cash transactions and
repos) where the counterparty to the direct participant of the CCA is a
central bank, sovereign entity, international financial institution, or
a natural person would be excluded from the definition of an eligible
secondary market transaction.
---------------------------------------------------------------------------

    \414\ See supra section III.A.
    \415\ For the purpose of the proposed rule, a hedge fund is
defined as any private fund (other than a securitized asset fund):
(a) with respect to which one or more investment advisers (or
related persons of investment advisers) may be paid a performance
fee or allocation calculated by taking into account unrealized gains
(other than a fee or allocation the calculation of which may take
into account unrealized gains solely for the purpose of reducing
such fee or allocation to reflect net unrealized losses); (b) that
may borrow an amount in excess of one-half of its net asset value
(including any committed capital) or may have gross notional
exposure in excess of twice its net asset value (including any
committed capital); or (c) that may sell securities or other assets
short or enter into similar transactions (other than for the purpose
of hedging currency exposure or managing duration). This definition
of a hedge fund is consistent with the Commission's definition of a
hedge fund in Form PF. See section III.A.2.b (Other Cash
Transactions), supra.
    \416\ See section III.A.2.b (Other Cash Transactions), supra.
---------------------------------------------------------------------------

    The proposed amendment to Rule 17Ad-22(e)(18) would increase the
fraction of secondary market U.S. Treasury securities transactions
required to be submitted for clearing at a covered clearing agency. The
Commission believes that this would result in achieving the benefits
associated with an increased level of central clearing discussed in
section IV.C.1 supra.
i. Scope of the Membership Proposal
    A significant share of both cash and repo transactions in U.S.
Treasury securities, including those of direct participants in a
covered clearing agency, are not currently centrally cleared.\417\ The
Commission believes that covered clearing agency members not centrally
clearing cash or repo transactions in U.S. Treasury securities creates
contagion risk to CCAs clearing and settling such transactions, as well
as to the market as a whole and that this contagion risk can be
ameliorated by centrally clearing such transactions.
---------------------------------------------------------------------------

    \417\ See DTCC May 2021 White Paper, supra note 135, at 5; IAWG
Report, supra note 4, at 6.
---------------------------------------------------------------------------

    Currently, FICC, the only U.S. Treasury securities CCA, requires
its direct participants to submit for central clearing their cash and
repo transactions in U.S. Treasury securities with other members.\418\
However, FICC's rules do not require its direct participants, such as
IDBs, to submit either cash or repo transactions \419\ with persons who
are not FICC members for central clearing.
---------------------------------------------------------------------------

    \418\ See note 101 supra.
    \419\ With regard to Sponsored GC Repos, see note 102.
---------------------------------------------------------------------------

    The expanded scope of the Membership Proposal would reduce
instances of ``hybrid'' clearing, where FICC lacks visibility on the
bilaterally cleared component of a trade. As previously mentioned in
section II.A.1 supra, trades cleared and settled outside of a CCP may
not be subject to the same level of risk management associated with
central clearing, which includes requirements for margin determined by
a publicly disclosed method that applies objectively and uniformly to
all members of the CCP, loss mutualization, and liquidity risk
management.\420\ The Membership Proposal would not only result in the
consistent and transparent application of risk management

requirements to trades that are now bilaterally cleared but would also
increase the CCA's awareness of those trades, which it now lacks.\421\
---------------------------------------------------------------------------

    \420\ IAWG Report, supra note 4, at 30; G-30 Report, supra note
5.
    \421\ See supra note 258.
---------------------------------------------------------------------------

ii. Application of the Membership Proposal to Repo Transactions
    The Commission proposes to require that all direct participants of
a U.S. Treasury securities CCA submit for clearing all eligible
secondary market transactions that are repurchase agreements or reverse
repurchase agreements. As discussed in section IV.B.5, supra risk
management practices in the bilateral clearance and settlement of repos
are not uniform across market participants and are less transparent
than analogous practices under central clearing.\422\
---------------------------------------------------------------------------

    \422\ TMPG Repo White Paper, supra note 123, at 1.
---------------------------------------------------------------------------

    The benefits of central clearing--including the benefits of
netting--increase with the fraction of total volume of similar
transactions submitting for clearing at a CCP. Significant gaps persist
in the current coverage of transaction data in U.S. Treasury repo.\423\
Nonetheless, the Commission understands that, among bilaterally settled
repo, approximately half was centrally cleared as of 2021.\424\
Centrally cleared triparty repo is a relatively new service, and the
proportion may be smaller. Thus, despite the volume of centrally
cleared repo transactions as seen in Figure 10 above, and the
development of services to encompass more types of repo transactions at
FICC, the Commission understands the volume of repo not currently
centrally cleared to be substantial. The requirement that all U.S.
Treasury CCA members submit all eligible repurchase agreements for
central clearing should increase the fraction of total volume of such
transactions submitted for central clearing realizing the benefits
described above in section IV.C.1 supra. In addition, because repo
participants are generally large, sophisticated market players, the
requirement for repo transactions will cover a set of market
participants that already have built most of the necessary processes
and infrastructure to comply with the rule.
---------------------------------------------------------------------------

    \423\ IAWG Report, supra note 4, at 29.
    \424\ Id. (``Non-centrally cleared bilateral repo represents a
significant portion of the Treasury market, roughly equal in size to
centrally cleared repo.'') (citing a 2015 pilot program by the U.S.
Treasury Department); see also TMPG Repo White Paper, supra note
118, at 1; Katy Burne, ``Future Proofing the Treasury Market,'' BNY
Mellon Aerial View, supra note 118, at 7 (noting that 63% of repo
transactions remain non-centrally cleared according to Office of
Financial Research data as of Sept. 10, 2021).
---------------------------------------------------------------------------

iii. Application of the Membership Proposal to Purchases and Sales of
U.S. Treasury Securities
    As discussed above, 68 percent of cash market transactions in U.S.
Treasury securities are not centrally cleared, and another 19 percent
of such transactions are subject to so-called hybrid clearing.\425\ The
Commission has identified certain categories of purchases and sales of
U.S. Treasury securities that it believes should be part of the
Membership Proposal, i.e., for which U.S. Treasury securities CCAs
would be obligated to impose membership rules to require clearing of
such transactions. The benefits of including these categories are
described below.
---------------------------------------------------------------------------

    \425\ See supra note 21.
---------------------------------------------------------------------------

    As with repurchase transactions, the general benefits of central
clearing discussed in section IV.A, supra become greater as the
fraction of total transaction volume that is centrally cleared
increases. In other words, there are positive externalities associated
with broader central clearing. However, unlike in the repo market, the
Commission is not proposing that all cash market transactions completed
with a FICC member be centrally cleared.\426\
---------------------------------------------------------------------------

    \426\ The G-30 report recommends an approach to clearing all of
repo, and some cash trades. See generally G-30 Report, supra note 5.
---------------------------------------------------------------------------

    The Commission understands the set of participants in U.S. Treasury
securities cash markets to be far broader and more heterogeneous than
in the repo markets. The cash market has many participants that trade
in relatively small amounts, whereas the market for repo is dominated
by larger, more sophisticated institutions. Although difficult to
quantify precisely, the number of participants is one or more orders of
magnitude greater in the cash market as compared with the repo market.
Because the benefits increase with the number and size of transactions,
whereas the costs have a large fixed component, extending the clearing
mandate to institutions that are market participants in repo markets
and a subset of the institutions that are participants in cash markets
may capture a large fraction of market activity while also capturing
the most active market participants who may already have some ability
to connect with the clearing agency and experience with central
clearing.
a. IDB Transactions
    The Commission proposes that all purchases and sales of U.S.
Treasury securities entered into by a direct participant of a U.S.
Treasury securities CCA and any counterparty, if the direct participant
of the CCA brings together multiple buyers and sellers using a trading
facility (such as a limit order book) and serves as a counterparty to
both the purchaser and seller in two separate transactions executed on
its platform, be subject to the Membership Proposal. This requirement
would encompass the transactions of those entities serving as IDBs in
the U.S. Treasury securities market, in that it would cover entities
that are standing in the middle of transactions between two
counterparties that execute a trade on the IDB's platform.\427\
---------------------------------------------------------------------------

    \427\ See supra section II.A.1 for further discussion of IDBs
and their role in the cash market for U.S. Treasury securities.
---------------------------------------------------------------------------

    If adopted, the proposal will result in more central clearing of
IDB trades. FICC Member IDBs do not take directional positions on the
securities that trade on the IDB's platform. Consequently, a
requirement that FICC member IDBs clear all of their trades will give
FICC better insight into the risk position of its clearing members
though the elimination of the hybrid clearing transactions mentioned
above.
    In contrast to other FICC members, FICC members that are also IDBs
will be required to clear all of their cash trades (and repo, as
described above). As described in the TMPG White Paper and in the
recent G-30 report,\428\ IDBs act as central nodes in the system, in
effect serving as clearing agencies without the regulatory structure of
clearing agency. Furthermore, the netting benefits to IDBs, as
described in section IV.c.1 supra are likely to be particularly high,
because each transaction on an IDB is matched by a transaction on the
other side. IDBs are sophisticated institutions that have experience
managing the central clearing of trades as they already centrally clear
all trades with other FICC members.
---------------------------------------------------------------------------

    \428\ See generally G-30 Report, supra note 5.

---------------------------------------------------------------------------

    The configuration of counterparty risk presented by hybrid clearing
allows FICC to manage the risks arising from the IDB-FICC member trade,
but FICC cannot manage the risks arising from the IDB's offsetting
trade with its non-FICC member counterparty and the potential
counterparty credit risk and settlement risk arising to the IDB from
that trade.\429\ Thus, the IDB is not able to net all of its positions
for clearing at FICC, and the IDB's positions appear to FICC to be
directional, which impacts the amount of margin that FICC collects for
the visible leg of the ``hybrid'' transaction. This lack of visibility
can increase risk during stress events, when margin requirements
usually increase. Thus, FICC is indirectly exposed to the IDB's non-
centrally cleared leg of the hybrid clearing transaction, but it lacks
the information to understand and manage its indirect exposure to this
transaction. As a result, in the event that the non-FICC counterparty
were to default to the IDB, causing stress to the IDB, that stress to
the IDB could be transmitted to the CCP and potentially to the system
as a whole.\430\ In particular, if the IDB's non-FICC counterparty
fails to settle a transaction that is subject to hybrid clearing, such
an IDB may not be able to settle the corresponding transaction that has
been cleared with FICC, which could lead the IDB to default. As part of
its existing default management procedures, FICC could seek to
mutualize its losses from the IDB's default, which could in turn
transmit stress to the market as a whole.
---------------------------------------------------------------------------

    \429\ See, e.g., TMPG White Paper, supra note 21, at 22 (noting
that in a hybrid clearing arrangement, an ``IDB's rights and
obligations towards the CCP are not offset and therefore the IDB is
not in a net zero settlement position with respect to the CCP at
settlement date.'').
    \430\ See DTCC May 2021 White Paper, supra note 135, at 5.
---------------------------------------------------------------------------

    The Commission has previously stated that membership requirements
help to guard against defaults of any CCP member, as well to protect
the CCP and the financial system as a whole from the risk that one
member's default could cause others to default, potentially including
the CCP itself.\431\ Further, contagion stemming from a CCP member
default could be problematic for the system as a whole, even if the
health of the CCP is not implicated. This is so because the default
could cause others to back away from participating in the market. This
risk of decreased market participation could be particularly acute if
the defaulting participant were an IDB, whose withdrawal from the
market could jeopardize other market participants' ability to access
the market for on-the-run U.S. Treasury securities.\432\ And because
IDBs facilitate a significant proportion of trading in on-the-run U.S.
Treasury securities, that is, they form central nodes, such a
withdrawal could have significant consequences for the market as a
whole.\433\ The Membership Proposal would therefore help mitigate this
risk by mandating that a U.S. Treasury securities CCA ensure its IDB
members clear both sides of their transactions, thereby eliminating the
various facets of potential contagion risk posed by so-called hybrid
clearing.
---------------------------------------------------------------------------

    \431\ See supra note 7.
    \432\ TMPG White Paper, supra note 21, at 32.
    \433\ See id.
---------------------------------------------------------------------------

b. Other Cash Transactions
    The Commission has identified additional categories of cash
transactions of U.S. Treasury securities to include in the membership
requirements for a U.S Treasury securities CCA that it believes will
provide the benefits of increased central clearing of U.S. Treasury
securities transactions described above.
    First, the Commission is proposing that the definition of an
eligible secondary market transaction includes those cash purchase and
sale transactions in which the counterparty of the direct participant
is a registered broker-dealer, government securities broker, or
dealer.\434\ These entities, by definition, are engaged in the business
of effecting transactions in securities for the account of others (for
brokers) or for their own accounts (for dealers). Thus, these entities
already are participating in securities markets and have identified
mechanisms to clear and settle their transactions.\435\ More generally,
many registered brokers and dealers are familiar with transacting
through introducing brokers who pass their transactions to clearing
brokers for clearing and settlement.
---------------------------------------------------------------------------

    \434\ 15 U.S.C. 78o(a) and 78o-5(a) (requirement to register)
and 78c(4), (5), (43), and (44) (definitions).
    \435\ See supra note 218 and referencing text describing several
methods available to allow market participants to access CCP
services through a FICC member.
---------------------------------------------------------------------------

    Second, the Commission proposes that transactions between a direct
participant and hedge funds be included in the Membership Proposal.
This aspect of the proposal would employ a definition of a hedge fund
consistent with that in Form PF.\436\
---------------------------------------------------------------------------

    \436\ See supra section III.A.2.b (Other Cash Transactions) for
a discussion of the definition of hedge fund in the proposed rule
and its consistency with that in Form PF Glossary of Terms. See also
note 143.
---------------------------------------------------------------------------

    The proposed requirement seeks to reach funds that are leveraged
and that may use trading strategies that involve derivatives, complex
structured products, short selling, high turnover, and/or concentrated
investments, which may, in turn, present more potential risk to a U.S.
Treasury securities CCA through a form of the contagion risk discussed
above. When discussing a proposal using a similar standard to define a
hedge fund, the Commission recognized that strategies employed by hedge
funds, in particular high levels of leverage ``can increase the
likelihood that the fund will experience stress or fail, and amplify
the effects on financial markets.'' \437\ The Commission also stated
that ``significant hedge fund failures (whether caused by their
investment positions or use of leverage or both) could result in
material losses at the financial institutions that lend to them if
collateral securing this lending is inadequate. These losses could have
systemic implications if they require these financial institutions to
scale back their lending efforts or other financing activities
generally. The simultaneous failure of several similarly positioned
hedge funds could create contagion through the financial markets if the
failing funds liquidate their investment positions in parallel at fire-
sale prices, thereby depressing the mark-to-market valuations of
securities that may be widely held by other financial institutions and
investors.'' \438\ Through the central clearing of transactions
effected by funds and other leveraged accounts, the Commission expects
to mitigate the risks attendant to a simultaneous failure of hedge
funds or other similar market participants, thus reducing contagion.
---------------------------------------------------------------------------

    \437\ See supra note 145.
    \438\ Id. at 21.
---------------------------------------------------------------------------

    Third, the Commission proposes to include within the definition of
an eligible secondary market transaction subject to the Membership
Proposal any purchase and sale transaction between a direct participant
of a U.S. Treasury securities CCA and an account at a registered
broker-dealer, government securities dealer, or government securities
broker that either may borrow an amount in excess of one-half of the
net value of the account or may have gross notional exposure of the
transactions in the account that is more than twice the net value of
the account.\439\ As discussed above, the Commission believes that the
inclusion of transactions with such accounts should allow the proposal
to encompass transactions between direct participants of a U.S.
Treasury securities CCA and a

prime brokerage account, which, based on the Commission's supervisory
knowledge, may hold assets of private funds and separately managed
accounts and that may use leverage that poses a risk to U.S. Treasury
securities CCA and the broader financial system similar to that of
hedge funds as described above. Covering such accounts would also allow
for inclusion of, for example, accounts used by family offices or
separately managed accounts that may use strategies more similar to
those of a hedge fund.
---------------------------------------------------------------------------

    \439\ See supra section III.A.2.b (Other Cash Transactions).
---------------------------------------------------------------------------

c. Exclusions From the Membership Proposal
    The Commission is proposing to exclude certain otherwise eligible
secondary market transactions in U.S. Treasury securities from the
Membership Proposal. Recognizing the importance of U.S. Treasury
securities not only to the financing of the United States government,
but also their central role in the formulation and execution of
monetary policy and other governmental functions, the Commission is
proposing to exclude from the Membership Proposal any otherwise
eligible secondary market transaction in U.S. Treasury securities
between a direct participant of a U.S. Treasury securities CCA and a
central bank.\440\ For similar reasons, the Commission is also
proposing to exclude from the Membership Proposal otherwise eligible
secondary market transactions in U.S. Treasury securities between a
direct participant of a U.S. Treasury securities CCA and a sovereign
entity or an international financial institution.\441\
---------------------------------------------------------------------------

    \440\ See supra section III.A.2.c.i for a discussion of the
proposed definition of a central bank for the purposes of the rule.
    \441\ See supra section III.A.2.c.i for a discussion of the
proposed definition of sovereign entity and international financial
institution. See also supra note 160.
---------------------------------------------------------------------------

    Although the Commission believes that the benefits of central
clearing are generally increasing in the fraction of total volume that
is centrally cleared, it also believes that the Federal Reserve System
should be free to choose the clearance and settlement mechanisms that
are most appropriate to effectuating its policy objectives.\442\
Further, the Commission believes that the exclusion should extend to
foreign central banks, sovereign entities and international financial
institutions for reasons of international comity.\443\ In light of
ongoing expectations that Federal Reserve Banks and agencies of the
Federal government would not be subject to foreign regulatory
requirements in their transactions in the sovereign debt of other
nations, the Commission believes principles of international comity
counsel in favor of exempting foreign central banks, sovereign
authorities, and international institutions.
---------------------------------------------------------------------------

    \442\ See supra section III.A.2.c.i for a discussion of the
activities of Federal Reserve Bank of New York's open market
operations conducted at the direction of the Federal Open Market
Committee. See also section IV.B.2, supra.
    \443\ See id. for a discussion of the Commission's belief in the
principles of international comity.
---------------------------------------------------------------------------

    The Commission also proposes to exclude transactions between U.S.
Treasury CCA members and natural persons from the Membership Proposal.
The Commission believes that natural persons generally transact in
small volumes and would not present much, if any, contagion risk to a
U.S. Treasury securities CCA and therefore, the benefits discussed
above are unlikely to be important for these transactions.
iv. Policies and Procedures Regarding Direct Participants' Transactions
    The Commission is proposing Rule 17Ad-22(e)(18)(iv)(B) that would
require that a U.S. Treasury securities CCA establish written policies
and procedures to identify and monitor its direct participants'
required submission of transactions for clearing, including, at a
minimum, addressing a direct participant's failure to submit
transactions. The Commission believes that such a requirement should
help ensure that a U.S. Treasury securities CCA adopts policies and
procedures directed at understanding whether and how its participants
comply with the policies that will be adopted as part of the Membership
Proposal requiring the submission of specified eligible secondary
market transactions for clearing. Without such policies and procedures,
it would be difficult for the CCA to assess if the direct participants
are complying with the Membership Proposal.
b. Other Changes to Covered Clearing Agency Standards
    The Commission believes that certain additional changes to its
Covered Clearing Agency Standards that would apply only to U.S.
Treasury securities CCAs are warranted to facilitate additional
clearing. Such changes should help ensure that the U.S. Treasury
securities CCA can continue to manage the risks arising from more
transactions from additional indirect participants and to facilitate
the increased use of central clearing and the accompanying benefits.
These changes, by making central clearing more efficient for market
participants, also create incentives for greater use of central
clearing.
i. Netting and Margin Practices for House and Customer Accounts
    The Commission is proposing amendments to Rule 17Ad-22(e)(6)(i) to
require a U.S. Treasury securities CCA to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to, as applicable, calculate, collect, and hold margin amounts
from a direct participant for its proprietary U.S. Treasury securities
positions, separately and independently from margin calculated and
collected from that direct participant in connection with U.S. Treasury
securities transactions by an indirect participant that relies on the
services provided by the direct participant to access the covered
clearing agency's payment, clearing, or settlement facilities. Such
changes should allow a U.S. Treasury securities CCA to better
understand the source of potential risk arising from the U.S. Treasury
securities transactions it clears and potentially further incentivize
central clearing.
    In practice, at FICC, clearing a U.S. Treasury securities
transaction between a direct participant and its customer, i.e., a
dealer to client trade, would not result in separate collection of
margin for the customer transaction. Except for transactions submitted
under the FICC sponsored member program,\444\ FICC margins the
transactions in the direct participant's (i.e., the dealer's) account
on a net basis, allowing any of the trades for the participant's own
accounts to net against trades by the participant's customers.\445\
---------------------------------------------------------------------------

    \444\ See supra note 203.
    \445\ DTCC October 2021 White Paper, supra note 203, at 5-6.
---------------------------------------------------------------------------

    Under the proposed amendments to Rule 17Ad-22(e)(6)(i), a U.S.
Treasury securities CCA would be required to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to, as applicable, calculate margin amounts for all
transactions that a direct participant submits to the CCP on behalf of
others, separately from the margin that is calculated for transactions
that the direct participant submits on its own behalf. Such policies
and procedures must also provide that margin collateralizing customer
positions be collected separately from margin collateralizing a direct
participant's proprietary positions. Finally, the CCP would also be
required to have policies and procedures reasonably designed to,

as applicable, ensure that any margin held for customers or other
indirect participants of a member is held in an account separate from
those of the direct participant.
    Because the proposed amendments to Rule 17Ad-22(e)(6)(i) would
require separating positions in U.S. Treasury securities transactions
of a direct participant in a U.S. Treasury securities CCA from those of
customers or other indirect participants, the indirect participants'
positions, including those submitted outside of the sponsored member
program, will no longer be netted against the direct participant's
positions. The indirect participants' positions will be subject to the
covered clearing agency's risk management procedures, including
collection of margin specific to those transactions. These changes
should allow a U.S. Treasury securities CCA to better understand the
source of potential risk arising from the U.S. Treasury securities
transactions it clears. In addition, these changes should help avoid
the risk of a disorderly default in the event of a direct participant
default, in that FICC would be responsible for the central liquidation
of the defaulting participant's trades without directly impacting the
trades of the participant's customers or the margin posted for those
trades.
    Moreover, the proposed amendments to Rule 17Ad-22(e)(6)(i) should
result in dealer-to-customer trades gaining more benefits from central
clearing. Because margin for a direct participant's (i.e., a dealer's)
trades would be calculated, collected, and held separately and
independently from those of an indirect participant, such as a
customer, the direct participant's trades with the indirect participant
can be netted against the direct participant's position vis-[agrave]-
vis other dealers, which is not currently the case.\446\
---------------------------------------------------------------------------

    \446\ Chicago Fed Insights, supra note 204, at 3.
---------------------------------------------------------------------------

    Holding margin amounts from a direct participant of a U.S Treasury
securities CCA separately and independently from those of an indirect
participant may reduce incentives for indirect participants to trade
excessively in times of high volatility.\447\ Such incentives exist
because the customers of a broker-dealer do not always bear the full
cost of settlement risk for their trades. Broker-dealers incur costs in
managing settlement risk with CCPs. Broker-dealers can recover the
average cost of risk management from their customers. However, if a
particular trade has above-average settlement risk, such as when market
prices are unusually volatile, it is difficult for broker-dealers to
pass along these higher costs to their customers because fees typically
depend on factors other than those such as market volatility that
impact settlement risk. Holding margin of indirect participants
separately from direct participants should reduce any such incentives
to trade more than they otherwise would if they bore the full cost of
settlement risk for their trades.
---------------------------------------------------------------------------

    \447\ See Sam Schulhofer-Wohl, Externalities in securities
clearing and settlement: Should securities CCPs clear trades for
everyone? (Fed. Res. Bank Chi. Working Paper No. 2021-02, 2021).
---------------------------------------------------------------------------

ii. Facilitating Access to U.S. Treasury Securities CCAs
    The various access models currently available to access central
clearing in the U.S. Treasury securities market may not meet the needs
of the many different types of market participants who transact in U.S.
Treasury securities with the direct members of a U.S. Treasury
Securities CCA. The proposed additional provision to Rule 17Ad-
22(e)(18)(iv)(C) requires a U.S. Treasury securities CCA to establish,
implement, maintain, and enforce certain written policies and
procedures regarding access to clearance and settlement services,
which, while not prescribing specific methods of access, is intended to
ensure that all U.S. Treasury security CCAs have appropriate means to
facilitate access to clearance and settlement services in a manner
suited to the needs of market participants, including indirect
participants.
    Some market participants have commented on the current practice of
tying clearing services to trading under the sponsored clearing
model.\448\ Under this model, the decision to clear the trades of an
indirect participant appears to be contingent on that indirect
participant trading with the direct participant sponsoring the indirect
member.\449\ If the indirect participant is a competitor of the
sponsoring direct participant and the direct participant has discretion
on which trades to clear, the indirect participant may have difficulty
accessing clearing. The proposed rule would require the U.S. Treasury
securities CCA to ensure appropriate means to facilitate access; for
some current indirect participants this may imply direct membership
(with a potential change in membership criteria); \450\ alternatively,
requiring something similar to a ``done-away'' clearing model may be
another means of facilitating clearing.
---------------------------------------------------------------------------

    \448\ See FIA-PTG Whitepaper, supra note 220.
    \449\ See id. at 7.
    \450\ Accessing clearing through another party may lower costs,
but market participants have commented that there may still be
residual exposure should that counterparty default after the CCA has
performed on its obligations.
---------------------------------------------------------------------------

    Other considerations relate to the services available through the
sponsored clearing model. For example, buy-side participants, currently
engage in both triparty and bilateral repo, across multiple tenors, and
on either side (lending or borrowing) of the transaction. At present,
it appears that FICC direct members may be able to decline to submit a
trade for central clearing at their discretion.\451\ Thus some indirect
participants who are unable to enter into a similar transaction using a
different FICC direct member who is willing to submit the trade for
central clearing would not be able to access central clearing under the
current practice. The proposed rule would require FICC to create new
policies and procedures to facilitate access to clearing for these
participants.
---------------------------------------------------------------------------

    \451\ See supra section IV.B.3.
---------------------------------------------------------------------------

    In addition, the proposal would require the CCA's written policies
and procedures be annually reviewed by the CCA's board of directors to
ensure that the CCA has appropriate means to facilitate access to
clearance and settlement services of all eligible secondary market
transactions in U.S. Treasury securities, including those of indirect
participants. This review should help ensure that such policies
regarding access to clearance and settlement services, including for
indirect participants, are addressed at the most senior levels of the
governance framework. The annual review ensures that such policies and
procedures be reviewed periodically and potentially updated to address
any changes in market conditions.
c. Proposed Amendments to Rules 15c3-3 and 15c3-3a
    The proposed rules discussed above could cause a substantial
increase in the margin broker-dealers must post to a U.S. Treasury
securities CCA resulting from their customers' cleared U.S. Treasury
securities positions. Currently, Rules 15c3-3 and 15c3-3a do not permit
broker-dealers to include a debit in the customer reserve formula equal
to the amount of margin required and on deposit at a U.S. Treasury
securities CCA. This is because no U.S. Treasury securities CCA has
implemented rules and practices designed to segregate customer margin
and limit it to being used solely to cover obligations of the broker-
dealer's customers. Therefore, increases in the amount of margin
required to be deposited at a U.S. Treasury securities CCA as a result
of the Membership Proposal would result

in corresponding increases in the need to use broker-dealers' cash and
securities to meet these requirements.
    The proposed amendment to Rule 15c3-3a would permit, under certain
conditions, margin required and on deposit at a U.S. Treasury
securities CCA to be included as a debit item in the customer reserve
formula. This new debit item would offset credit items in the Rule
15c3-3a formula and, thereby, free up resources that could be used to
meet the margin requirements of a U.S. Treasury securities CCA. The
proposed amendment would allow a customer's broker to use customer
funds to meet margin requirements at the CCP generated by the
customer's trades, lowering the cost of providing clearing services.
    As discussed further below, we expect these changes to allow more
efficient use of margin for cleared trades relative to the baseline.
This change, alone, could create incentives for greater use of central
clearing, and thus could promote the benefits described in previous
sections.
2. Costs
    The Commission has, where practicable, attempted to quantify the
economic effects it expects may result from this proposal. In some
cases, however, data needed to quantify these economic effects are not
currently available or depends on the particular changes made to the
U.S. Treasury securities CCA policies and procedures. As noted below,
the Commission is unable to quantify certain economic effects and
solicits comment, including estimates and data from interested parties,
which could help inform the estimates of the economic effects of the
proposal.
a. Costs to FICC of the Membership Proposal
    The Commission believes that the direct costs of this proposal to
the U.S. Treasury securities CCA, which are mostly in the form of new
policies and procedures, are likely to be modest. This is because all
but one of these proposals require the CCA to make certain changes to
its policies and procedures. The other proposal amends Rule 15c3-3a to
permit margin required and on deposit at a U.S. Treasury securities CCA
to be included as a debit item in the customer reserve formula for
broker-dealers, subject to the conditions discussed above.
    Proposed Rule 17Ad-22(e)(18)(iv) would require a U.S. Treasury
securities CCA to establish, implement, maintain, and enforce written
policies and procedures, as discussed above.\452\ Because policies and
procedures regarding the clearing of all eligible secondary market
transactions entered into by a direct participant in a U.S. Treasury
securities CCA are not currently required under existing Rule 17Ad-22,
the Commission believes that the proposed Rule 17Ad-22(e)(18)(iv) may
require a covered clearing agency to make substantial changes to its
policies and procedures. The proposed rule amendment contains similar
provisions to existing FICC rules, but would also impose additional
requirements that do not appear in existing Rule 17Ad-22.\453\ As a
result, the Commission believes that a U.S. Treasury securities CCA
would incur burdens of reviewing and updating existing policies and
procedures in order to comply with the provisions of proposed Rule
17Ad-22(e)(18)(iv) and, in some cases, may need to create new policies
and procedures.
---------------------------------------------------------------------------

    \452\ See supra section III.A.4 for a discussion of the
requirement that a U.S. Treasury securities CCA establish written
policies and procedures reasonably designed to, as applicable,
identify and monitor its direct participants' required submission of
transactions for clearing, including, at a minimum, addressing a
direct participant's failure to submit transactions. See supra
section III.B.2 for a discussion of the requirement that U.S.
Treasury securities CCA establish, implement, maintain and enforce
written policies and procedures reasonably designed to, as
applicable, ensure that it has appropriate means to facilitate
access to clearance and settlement services of all eligible
secondary market transactions in U.S. Treasury securities, including
those of indirect participants, which policies and procedures the
U.S. Treasury securities CCA's board of directors reviews annually.
    \453\ See supra note 34 and accompanying text (discussing
current FICC rules).
---------------------------------------------------------------------------

    The Commission preliminarily estimates that U.S. Treasury
securities CCAs would incur an aggregate one-time cost of approximately
$207,000 to create new policies and procedures.454 455 The
proposed rule would also require ongoing monitoring and compliance
activities with respect to the written policies and procedures created
in response to the proposed rule. The Commission preliminarily
estimates that the ongoing activities required by proposed Rule 17Ad-
22(e)(18)(iv) would impose an aggregate ongoing cost on covered
clearing agencies of approximately $61,000 per year.\456\
---------------------------------------------------------------------------

    \454\ To monetize the internal costs, the Commission staff used
data from SIFMA publications, modified by Commission staff to
account for an 1800 hour work-year and multiplied by 5.35
(professionals) or 2.93 (office) to account for bonuses, firm size,
employee benefits and overhead. See SIFMA, Management and
Professional Earnings in the Security Industry--2013 (Oct. 7, 2013);
SIFMA, Office Salaries in the Securities Industry--2013 (Oct. 7,
2013). These figures have been adjusted for inflation using data
published by the Bureau of Labor Statistics.
    \455\ This figure was calculated as follows: Assistant General
Counsel for 40 hours (at $518 per hour) + Compliance Attorney for 80
hours (at $406 per hour) + Computer Operations Manager for 20 hours
(at $490 per hour) + Senior Risk Management Specialist for 40 hours
(at $397 per hour) + Business Risk Analyst for 80 hours (at $305 per
hour) = $103,280 x 2 respondent clearing agencies = $206,560. See
infra section V.A.
    \456\ This figure was calculated as follows: Compliance Attorney
for 25 hours (at $518 per hour) + Business Risk Analyst for 40 hours
(at $305 per hour + Senior Risk Management Specialist for 20 hours
(at $397 per hour) = $30,290 x 2 respondent clearing agencies =
$60,580. See infra section V.A.
---------------------------------------------------------------------------

i. Costs Attendant to an Increase in CCLF
    This proposal will likely result in a significant increase in the
volume of U.S. Treasury securities transactions submitted to clearing.
As pointed out by the G-30 report, FICC differs qualitatively from
other CCPs in that counterparty credit risks are relatively small but
liquidity risks in the event of member defaults could be
extraordinarily large.\457\ This is because net long positions generate
liquidity obligations for FICC because, in the event of a member
default, FICC would have to deliver cash in order to complete
settlement of such positions with non-defaulting parties. Increased
clearing volume of cash and repo transactions as a result of the
proposed rule could increase FICC's credit and liquidity exposure to
its largest members including those members acting as sponsors of non-
members. FICC is obligated by Commission rule to maintain liquidity
resources to enable it to complete settlement in the event of a
clearing member default of a Member.\458\ These resources include the
CCLF in which Members will be required to hold and fund their
deliveries to an insolvent clearing member up to a predetermined cap by
entering into repo transactions with FICC until it completes the
associated close-out. This facility allows clearing members to
effectively manage their potential financing requirements with
predetermined caps.\459\
---------------------------------------------------------------------------

    \457\ G-30 Report, supra note 5, at 14.
    \458\ See supra section IV.B.3.
    \459\ FICC Disclosure Framework 2021 at 88, available at https://www.dtcc.com/-/media/Files/Downloads/legal/policy-and-compliance/FICC_Disclosure_Framework.pdf.
---------------------------------------------------------------------------

    As reported in the CPMI-IOSCO disclosure by FICC for Q2 of 2021,
the combined liquidity commitment by clearing members to the FICC's
Capped Contingent Liquidity Facility (CCLF) was $82.5 billion for all
repos and cash trades of U.S. Treasury and Agency securities. Since the
inception of the CCLF in 2018, the CCLF has ranged in

size from $82.5B to $108B.\460\ Commitments by bank-affiliated dealers
to the CCLF count against regulatory liquidity requirements, including
the Liquidity Coverage Ratio (LCR).\461\ The Commission understands
that dealers affiliated with banks may satisfy their CCLF obligations
using a guarantee from that affiliated bank but dealers not affiliated
with banks may incur costs to obtain commitments to meet CCLF liquidity
requirements.
---------------------------------------------------------------------------

    \460\ See supra section IV.B.3.
    \461\ LCR is calculated as the ratio of High-Quality Liquid
Assets (HQLA) divided by estimated total net cash outflow during a
30-day stress period. Because commitments by bank-affiliated dealers
to the CCLF would increase the denominator of the ratio, a bank-
affiliated dealer would have to increase HQLA to reach a required
level of LCR.
---------------------------------------------------------------------------

ii. Costs of the Membership Proposal in Terms of Increased Margining
for Existing FICC Members
    As discussed above, the Commission recognizes that the proposal
could cause an increase in the margin clearing members must post to a
U.S. Treasury securities CCA resulting from the additional transactions
that will be submitted for clearing as a result of the proposal.
Although various SRO margin rules provide for the collection of margin
for certain transactions in U.S. Treasury securities, the Commission
understands that transactions between dealers and institutional
customers are subject to a variable ``good-faith'' margin standard,
which the Commission understands--based on its supervisory experience--
can often result in fewer financial resources collected for margin
exposures than those that would be collected if a CCP margin model,
like the one used at FICC, were used.\462\ Mitigating the potential for
higher margin requirements for transactions submitted for clearing at a
U.S. Treasury securities CCA is the benefit of netting that results
from additional centrally cleared transactions.\463\ As described in
section IV.C.1 supra, this mitigant is likely to be especially
significant in the case of IDB members. Also, substantially mitigating
the costs for clearing members is the ability to rehypothecate customer
margin, as described in section IV.C.2.d infra.
---------------------------------------------------------------------------

    \462\ See supra note 106.
    \463\ See supra section IV.C.1 for a discussion of the benefits
of multilateral netting expected to result from higher volumes of
centrally cleared transactions.
---------------------------------------------------------------------------

b. Costs to Non-FICC Members as a Result of the Membership Proposal
    The Membership Proposal would require that all repo transactions
with a direct participant be centrally cleared and that certain cash
transactions with a direct participant to be centrally cleared. These
costs will depend on the policies and procedures developed by the CCA,
as discussed in sections IV.C.2.a infra and IV.C.2.d supra.
    As stated above, the Commission believes that these proposed
amendments will increase central clearing in the U.S Treasury
securities market. Transactions that are not currently submitted for
central clearing but would be under the current proposed amendments
would be subject to certain transaction, position, and other fees as
determined by the U.S. Treasury securities CCA.\464\
---------------------------------------------------------------------------

    \464\ The fee structure for FICC is described in its rulebook.
See FICC Rules, supra note 47, at 307.
---------------------------------------------------------------------------

    Market participants who enter into eligible secondary market
transactions with members of U.S. Treasury securities CCAs who do not
have access to clearing may incur costs related to establishing the
required relationships with a clearing member in order to submit the
eligible transactions for clearing. These market participants may also
incur additional costs related to the submission and management of
collateral. It is possible that such market participants may seek
alternative counterparties that are not U.S. Treasury securities CCA
members in order to avoid incurring these costs.
    As discussed in the baseline, the majority of repo and cash
transactions in the dealer-to-customer segment are not centrally
cleared. This differentiates the U.S. Treasury securities market from
the markets for swaps and for futures. There is currently some clearing
of customer repo; the majority of this clearing is ``done-with''--the
clearing broker and the counterparty are one and the same. However, in
the swaps and futures markets, and in the equities market, clearing is
``done-away''--meaning that the clearing broker may be other than the
trading counterparty. Market participants have identified costs with
the done-with model. Market participants in the secondary market for
U.S Treasury securities that would be required to be centrally cleared
could incur direct costs for arranging legal agreements with every
potential counterparty. Depending on the customer there may be a large
number of such arrangements.
    There are indirect costs arising when a trading counterparty is a
competitor. In this case, clearing risks leakage of information.
Moreover, the pricing and offering of clearing services may be
determined by forces other than the costs and benefits of the clearing
relationship itself, such as the degree of competition between the
counterparties. Other economic arrangements facilitating customer
clearing are possible and may develop, as in other markets.\465\ One
such arrangement is direct CCA membership. However, for smaller
entities, CCA membership may not be economically viable, and for some
entities, legal requirements may prevent outright membership. Another
possibility is seeking out counterparties other than CCA members. The
``done away'' structure of clearing has worked effectively in other
markets, and, if it were to develop, would significantly mitigate these
costs.
---------------------------------------------------------------------------

    \465\ See FIA-PTG Whitepaper, supra note 220 (for a description
of different client clearing models).
---------------------------------------------------------------------------

    Some participants may not currently post collateral for cash
clearing and may be now required to do so, depending on the form the
clearing relationship takes. There may be costs associated with the
transfer of collateral. An institutional investor self-managing its
account would instruct its custodian to post collateral with the CCA on
the execution date, and post a transaction in its internal accounting
system showing the movement of collateral. The day after trade
execution, the investor would oversee the return of collateral from
FICC, with an attendant mark of a transaction on the investor's
internal accounting system. Similar steps would occur for an
institutional investor trading through an investment adviser, though in
this case the adviser might instruct the custodian and mark the
transaction, depending on whether the adviser has custody. The
institutional investor might also pay a wire fee associated with the
transfer of collateral.
    Besides the costs of developing new contracts with counterparties
to support central clearing, there will also be a cost to non-CCA
members associated with margin, to the extent that more margin is
required than in a bilateral agreement and to the extent that the
margin was not simply included in the price quoted for the trade. This
cost of margining is analogous to that borne by CCA members and is
discussed further above.
    As a result of the proposed rule, a potential cost to money market
fund participants that would face FICC as a counterparty is that the
funds' credit ratings could be affected if FICC becomes a substantially
large counterparty of these participants, which could be interpreted by
credit models and ratings methodologies as a heightened concentration
risk factor. As concentration risk in a CCP is typically not viewed in
the same way as concentration risk with a bilateral trading party,
credit rating agencies may quickly adapt their methods to

distinguish the CCA from a conventional counterparty.
    The Commission also recognizes the risks associated with increased
centralization of clearance and settlement activities. In particular,
the Commission has previously noted that ``[w]hile providing benefits
to market participants, the concentration of these activities at a
covered clearing agency implicitly exposes market participants to the
risks faced by covered clearing agencies themselves, making risk
management at covered clearing agencies a key element of systemic risk
mitigation.'' \466\
---------------------------------------------------------------------------

    \466\ See supra note 11.
---------------------------------------------------------------------------

    As discussed previously, currently only FICC provides CCP services
for U.S. Treasury securities transactions, including outright cash
transactions and repos.\467\ Were FICC unable to provide its CCP
services for any reason then this could have a broad and severe impact
on the overall U.S. economy. The FSOC recognized this when it
designated FICC as a systemically important financial market utility in
2012,\468\ which subjects it to heightened risk management requirements
and additional regulatory supervision, by both its primary regulator
and the Federal Reserve Board of Governors.\469\
---------------------------------------------------------------------------

    \467\ See supra section I.C.
    \468\ See note 17 supra.
    \469\ Id. at 119. As the Commission has previously stated,
``Congress recognized in the Clearing Supervision Act that the
operation of multilateral payment, clearing or settlement activities
may reduce risks for clearing participants and the broader financial
system, while at the same time creating new risks that require
multilateral payment, clearing or settlement activities to be well-
designed and operated in a safe and sound manner. The Clearing
Supervision Act is designed, in part, to provide a regulatory
framework to help deal with such risk management issues, which is
generally consistent with the Exchange Act requirement that clearing
agencies be organized in a manner so as to facilitate prompt and
accurate clearance and settlement, safeguard securities and funds
and protect investors.'' Clearing Agency Standards Proposing
Release, supra note 7, 76 FR at 14474; see also 12 U.S.C. 5462(9),
5463(a)(2).
---------------------------------------------------------------------------

c. Other Changes to Covered Clearing Agency Standards
i. Netting and Margin Practices for House and Customer Accounts
    The proposed amendments to Rule 17Ad-22(e)(6)(i) require a U.S.
Treasury securities CCA to establish, implement, maintain and enforce
written policies and procedures reasonably designed to, as applicable,
calculate, collect, and hold margin amounts from a direct participant
for its proprietary U.S. Treasury securities positions, separately and
independently from margin calculated and collected from that direct
participant in connection with U.S. Treasury securities transactions by
an indirect participant that relies on the services provided by the
direct participant to access the covered clearing agency's payment,
clearing, or settlement facilities.\470\ The proposed rule amendment
contains similar provisions to existing FICC rules, specifically with
respect to its Sponsored Member program, but would also impose
additional requirements that do not appear in existing Rule 17Ad-22. As
a result, the Commission believes that a U.S. Treasury securities CCA
would incur burdens of reviewing and updating existing policies and
procedures in order to comply with the proposed amendments to Rule
17Ad-22(e)(6) and, in some cases, may need to create new policies and
procedures.\471\
---------------------------------------------------------------------------

    \470\ See supra section III.B.1.
    \471\ See supra note 62 and accompanying text (discussing
existing FICC rules for sponsored member program).
---------------------------------------------------------------------------

    The Commission preliminarily estimates that U.S. Treasury
securities CCAs would incur an aggregate one-time cost of approximately
$106,850 to create new policies and procedures.\472\ The proposed rule
would also require ongoing monitoring and compliance activities with
respect to the written policies and procedures created in response to
the proposed rule. The Commission preliminarily estimates that the
ongoing activities required by proposed amendments to Rule 17Ad-
22(e)(6) would impose an aggregate ongoing cost on covered clearing
agencies of approximately $60,580 per year.\473\
---------------------------------------------------------------------------

    \472\ This figure was calculated as follows: Assistant General
Counsel for 20 hours (at $518 per hour) + Compliance Attorney for 40
hours (at $406 per hour) + Computer Operations Manager for 12 hours
(at $490 per hour) + Senior Programmer for 20 hours (at $368 per
hour) + Senior Risk Management Specialist for 25 hours (at $397 per
hour) + Senior Business Analyst for 12 hours (at $305 per hour) =
$53,425 x 2 respondent clearing agencies = $106,850. See infra
section V.B.
    \473\ This figure was calculated as follows: Compliance Attorney
for 25 hours (at $406 per hour) + Business Risk Analyst for 40 hours
(at $305 per hour) + Senior Risk Management Specialist for 20 hours
(at $397 per hour) = $30,290 x 2 respondent clearing agencies =
$60,580. See infra section V.B.
---------------------------------------------------------------------------

ii. Facilitating Access to U.S. Treasury Securities CCAs
    The proposed Rule 17Ad-22(e)(18)(iv)(C) would require a U.S.
Treasury securities CCA to establish, implement, maintain, and enforce
written policies and procedures reasonably designed to, as applicable,
ensure that it has appropriate means to facilitate access to clearance
and settlement services of all eligible secondary market transactions
in U.S. Treasury securities, including those of indirect participants,
which policies and procedures the U.S. Treasury securities CCA's board
of directors reviews annually.
    The proposed rule would require a U.S. Treasury securities CCA to
establish, implement, maintain, and enforce written policies and
procedures. The Commission believes that a respondent U.S. Treasury
securities CCA would incur burdens of reviewing and updating existing
policies and procedures and would need to create new policies and
procedures in order to comply with the provisions of proposed Rule
17Ad-22(e)(18)(iv)(C). These costs are included in the costs of
creating new policies and procedures associated with Rule 17Ad-22(e)
discussed above.\474\
---------------------------------------------------------------------------

    \474\ See supra section IV.C.2.
---------------------------------------------------------------------------

d. Proposed Amendments to Rules 15c3-3 and 15c3-3a
    The proposed amendment to Rule 15c3-3a would permit, under certain
conditions, margin required and on deposit at a U.S. Treasury
securities CCA to be included as a debit item in the customer reserve
formula. This new debit item would offset credit items in the Rule
15c3-3a formula and, thereby, free up resources that could be used to
meet the margin requirements of a U.S. Treasury securities CCA. The
proposed amendment would allow a customer's broker to use customer
funds to meet margin requirements at the CCP generated by the
customer's trades, lowering the cost of providing clearing services.
Broker-dealers may incur costs from updating procedures and systems to
be able to use customer funds to meet customer margin requirements.
However, the proposed rule does not require that the broker-dealer does
so.
3. Effect on Efficiency, Competition, and Capital Formation
a. Efficiency
i. Price Transparency
    As mentioned in section II.A.1 supra, the majority of trading in
on-the-run U.S. Treasury securities in the interdealer market occurs on
electronic platforms operated by IDBs that bring together buyers and
sellers anonymously using order books or other trading facilities
supported by advanced electronic trading technology. These platforms
are usually run independently in the sense that there is no centralized
market for price discovery or even a ``single virtual market with
multiple points of entry''.\475\ As a result, pre-

trade transparency is suboptimal: quotations and prices coming from and
going to an IDB may be distributed unevenly to market participants who
have a relationship with that IDB. Efficiency, which measures the
degree to which prices can quickly respond to relevant information, is
impaired because of this market fragmentation; some areas of the market
may not reflect information passed on by prices in other sectors.
Central clearing can promote price discovery in several ways: first,
the clearing agency itself becomes a source of data; \476\ and second,
the accessibility of central clearing could promote all-to-all trading
as previously mentioned in section III.A.3 supra, which would reduce
the obstacles to information flow that come from fragmentation.\477\
---------------------------------------------------------------------------

    \475\ Mauren O'Hara and Mao Ye, ``Is Market Fragmentation
Harming Market Quality,'' 100 J. Fin. Econ. 459 (2011), available at
https://doi.org/10.1016/j.jfineco.2011.02.006.
    \476\ FIA-PTG Whitepaper, supra note 220.
    \477\ See supra note 190.
---------------------------------------------------------------------------

ii. Operational and Balance Sheet Efficiency
    Greater use of central clearing could also increase the operational
efficiency of trading U.S. Treasury securities. Central clearing
replaces a complex web of bilateral clearing relationships with a
single relationship to the CCP. In that sense, the complex network of
relationships that a market participant may have for bilaterally
clearing U.S. Treasury securities would shrink, with attendant
reductions in paperwork, administrative costs, and operational risk.
    Central clearing also enhances balance sheet efficiency, allowing
firms to put capital to more productive uses. The proposed amendment to
Rule 15c3-3a would permit, under certain conditions, margin required
and on deposit at a U.S. Treasury securities CCA to be included as a
debit item in the customer reserve formula. This new debit item would
offset credit items in the Rule 15c3-3a formula and, thereby, free up
resources that could be used to meet the margin requirements of a U.S.
Treasury securities CCA. The proposed amendment would allow a
customer's broker to use customer funds to meet margin requirements at
the CCP generated by the customer's trades, lowering the cost of
providing clearing services. Though these lower costs may or may not be
fully passed on to end clients, in a competitive environment the
Commission expects that at least some of these savings will pass-
through to customers.
b. Competition
    With respect to the market for execution of U.S. Treasury
securities by broker-dealers, increased central clearing can enhance
the ability of smaller participants to compete with incumbent
dealers.\478\ Similarly, decreased counterparty credit risk--and
potentially lower costs for intermediation--could result in narrower
spreads, thereby enhancing market quality.\479\ While estimating this
quantitatively is difficult, research has demonstrated lower costs
associated with central clearing in other settings.\480\ Moreover,
increased accessibility of central clearing in U.S. Treasury securities
markets could support all-to-all trading, which would further improve
competitive pricing, market structure and resiliency.\481\
---------------------------------------------------------------------------

    \478\ See G-30 Report, supra note 5, at 13.
    \479\ See id.
    \480\ See Y.C. Loon and Z.K. Zhong, The Impact of Central
Clearing on Counterparty Risk, Liquidity, and Trading: Evidence from
the Credit Default Swap Market, 112(1) JOURNAL OF FINANCIAL
ECONOMICS 91-115 (Apr. 2014).
    \481\ See IAWG Report, supra note 4, at 30; Duffie, supra note
186, at 16; G-30 Report, supra note 5, at 13.
---------------------------------------------------------------------------

    The U.S. Treasury securities intermediation business is also
capital-intensive, due to strict regulatory requirements around capital
and the sheer size of the U.S. Treasury securities markets. These
requirements represent a barrier to entry to new participants. The
proposed amendments to Rule 15c3-3a, which would permit margin required
and on deposit at a U.S. Treasury securities CCA to be included as a
debit item in the customer reserve formula, in addition to the natural
capital efficiencies of margin offsetting provided by clearing, would
provide some capital relief for smaller broker-dealers. This may enable
them to better compete in this market or enter the market altogether.
    With respect to the market for U.S. Treasury securities clearing
services, currently there is a single provider of central clearing. The
proposed amendments would likely engender indirect costs associated
with increased levels of central clearing in the secondary market for
U.S. Treasury securities. Generally, the economic characteristics of a
financial market infrastructure (``FMI''), including clearing agencies,
include specialization, economies of scale, barriers to entry, and a
limited number of competitors.482 483 The Commission noted
in its proposal of rules applicable to covered clearing agencies that
such characteristics, coupled with the particulars of an FMI's legal
mandate could result in market power, leading to lower levels of
service, higher prices, and under-investment in risk management
systems.\484\ Market power may also affect the allocation of benefits
and costs flowing from these proposed rules, namely the extent to which
these benefits and costs are passed through by FICC to
participants.\485\ The centralization of clearing activities for a
particular class of transaction in a single clearing agency may also
result in a reduction in its incentives to innovate and to invest in
the development of appropriate risk management practices on an ongoing
basis.
---------------------------------------------------------------------------

    \482\ See Committee on Payment and Settlement Systems and
Technical Committee of the International Organization of Securities
Commissions (``CPSS-IOSCO''), Principles for Financial Market
Infrastructures (Apr. 16, 2012), available at http://www.bis.org/publ/cpss101a.pdf (``PFMI Report'').
    \483\ See generally Nadia Linciano, Giovanni Siciliano &
Gianfranco Trovatore, The Clearing and Settlement Industry:
Structure Competition and Regulatory Issues (Italian Secs. & Exch.
Comm'n Research Paper 58, May 2005), available at http://www.ssrn.com/abstract=777508 (concluding in part that the core
services offered by the clearance and settlement industry tend
toward natural monopolies because the industry can be characterized
as a network industry, where consumers buy systems rather than
single goods, consumption externalities exist, costs lock-in
consumers once they choose a system, and production improves with
economies of scale).
    \484\ See CCA Standards Proposing Release, supra note 7.
    \485\ For a discussion of cost pass-through, including when
there lacks competition, see for example, UK Competition and Markets
Authority, Cost pass-through: theory, measurement and policy
implications (June 17, 2014), available at https://www.gov.uk/government/publications/cost-pass-through-theory-measurement-and-policy-implications.
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    Finally, the scope of the rule does not preclude members of FICC
from strategically renouncing membership if they assess that the
benefits of maintaining their ability to trade without centrally
clearing their trades exceed their costs of surrendering their
membership with the CCA. If this scenario materializes for a number of
FICC members, then there will be costs to the overall market. Those
costs could be the product of a smaller number of clearing members
competing in the market for clearing services. Costs could also
manifest themselves as increased risk from non-centrally cleared
transactions and a reduction in the margin, operational and capital
efficiencies related to central clearing. Further, if the number of
clearing members falls, then the exposure of FICC to its largest
clearing member could increase resulting in additional increases in the
required size of the CCLF.
c. Capital Formation
    The proposed rule may encourage private-sector capital formation.
U.S. Treasury securities form a benchmark

for fixed income and even equity rates of return, and the proposed rule
could lower the cost of capital for private-sector issuers.\486\ If the
yield required by investors to hold U.S. Treasury securities reflects,
in part, the risks associated with the buying and selling of U.S.
Treasury securities, and increased central clearing of these
transactions lowers those risks, then the proposed rule may put
downward pressure on required yields.
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    \486\ Standard textbook treatments of finance use the U.S.
Treasury rate of return as a benchmark in computing the cost of
capital for private companies. The link between interest rates of
government debt and corporate debt is a long-standing feature of the
financial landscape. See, e.g., Benjamin Friedman, Implications of
Government Deficits for Interest Rates, Equity Returns, and
Corporate Financing, Fin. Corp. Cap. Form. (1986). See also
Philippon, The Bond Market's Q, Q.J. Econ. (Aug. 2009) (noting a
link between the level of interest rates and investment).
---------------------------------------------------------------------------

    Research has shown that investors value both the safety and
liquidity of U.S. Treasury securities. Because prices in the primary
market both reflect and are driven by prices in the secondary market,
liquidity could be one of the factors translating into lower rates of
borrowing costs for US taxpayers.\487\
---------------------------------------------------------------------------

    \487\ See Arvind Krishnamurthy & Annette Vissing-Jorgensen, The
Aggregate Demand for Treasury Debt, 120 J. Pol. Econ. (Apr. 2012).
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D. Reasonable Alternatives

1. Require U.S. Treasury Securities CCAs to Have Policies and
Procedures Requiring Only IDB Clearing Members to Submit U.S. Treasury
Securities Trades With Non-Members for Central Clearing
    One alternative would be to narrow the scope of the Membership
Proposal as it pertains to cash transactions in the secondary market
for U.S. Treasury securities. The narrower definition of eligible
secondary market transaction contemplated in this alternative would
include (1) a repurchase or reverse repurchase agreement collateralized
by U.S. Treasury securities, in which one of the counterparties is a
direct participant; or (2) a purchase or sale between a direct
participant and any counterparty, if the direct participant of the
covered clearing agency (A) brings together multiple buyers and sellers
using a trading facility (such as a limit order book) and (B) is a
counterparty to both the buyer and seller in two separate
transactions.\488\ This alternative differs from the proposal above by
omitting from the definition of eligible transactions those cash
transactions between a direct participant and a registered broker-
dealer, government securities broker, government securities dealer,
hedge fund, or account at a registered broker-dealer, government
securities dealer, or government securities broker where such account
may borrow an amount in excess of one-half of its net assets or may
have gross notional exposure in excess of twice its net assets.\489\
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    \488\ Such direct participants are referred to in this section
and the alternatives below as ``IDBs''. See supra section III.A.2.b
(IDB Transactions).
    \489\ See supra section III.A.2.b for a discussion of cash
transactions included in the definition of eligible transactions.
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    As discussed in section IV.C.1.a supra, the benefits arising from
cash clearing for IDB members are particularly high. Hybrid clearing
creates unique issues for FICC because FICC is able to manage the risks
arising from the IDB-FICC member trade, but it lacks any knowledge of
the IDB's offsetting trade with its other counterparty and the
potential exposure arising to the IDB from that trade, leaving the IDB,
from FICC's perspective, as apparently having a directional exposure
despite the non-centrally cleared trade that would leave the IDB
flat.\490\ This lack of knowledge could prevent FICC from ``accurately
identifying, measuring and managing its direct and indirect
counterparty risk exposure and can affect its decision-making,'' \491\
which in turn potentially increases the likelihood that a default of an
IDB member could in turn harm the CCP or the system as a whole. As
noted above, the Commission has previously stated that membership
requirements help to guard against defaults of any CCP member, as well
to protect the CCP and the financial system as a whole from the risk
that one member's default could cause others to default, potentially
including the CCP itself. Further, contagion stemming from a CCP member
default could be problematic for the system as a whole, even if the
health of the CCP is not implicated. The default could cause others to
back away from participating in the market, particularly if the
defaulting participant was an IDB, whose withdrawal from the market
could jeopardize other market participants' ability to access the
market for U.S. Treasury securities.\492\
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    \490\ See TMPG White Paper, supra note 20 at 22 (noting that in
a hybrid clearing arrangement, an ``IDB's rights and obligations
vis-a-vis the CCP are not offset and therefore the IDB is not in a
net zero settlement position with respect to the CCP at settlement
date.'').
    \491\ See TMPG White Paper, supra note 21, at 27.
    \492\ See TMPG White Paper, supra note 21, at 32.
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    This alternative would, with a more limited scope, move a large
portion of secondary market transactions in U.S. Treasury securities
that are not currently centrally cleared into central clearing.\493\
The degree of central clearing would still allow for a partial picture
of concentrated positions to the clearing agency. That said, there
would be a limited benefit in terms of operational and balance sheet
efficiency, and the benefits other than those specifically related to
the IDB would be greatly reduced. Specifically, the reduced scope of
this alternative would not capture types of participants that are
usually leveraged such as hedge funds.
---------------------------------------------------------------------------

    \493\ See id.
---------------------------------------------------------------------------

    As discussed above, funds that are leveraged present potential risk
to a U.S. Treasury securities CCA.\494\ As a result of not including
transactions with hedge funds and levered accounts, the Commission
believes that benefits of the rule with respect to financial stability,
margin offsetting and visibility of risk would be curtailed.
---------------------------------------------------------------------------

    \494\ See supra section IV.C.1.III(b). See also note 145.
---------------------------------------------------------------------------

    This alternative could also include within the definition of
eligible secondary market transactions a purchase or sale between a
direct participant and a registered broker-dealer, government
securities broker, or government securities dealer. Including these
transactions within the scope of eligible transactions would increase
the benefits discussed above associated with an increased proportion of
transactions being centrally cleared.\495\ However, as discussed above,
the costs associated with including these transactions within the scope
of eligible transactions may be less than those transactions not
included by this alternative.\496\
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    \495\ See supra section IV.A for a discussion of the benefits
associated with increased central clearing.
    \496\ See supra section IV.C.1.a.III(b) for a discussion of the
familiarity of many registered brokers with methods of central
clearing of U.S. Treasury securities transactions. See also section
IV.C.2.b for a discussion of the costs to non-FICC members,
including the entities included within this alternative, of the
Membership proposal.
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2. Require U.S. Treasury Securities CCAs To Have Policies and
Procedures Requiring the Submission of All Repurchase Agreements With
No Change to Requirements for the Submission of Cash Transactions
    The Commission could exclude the cash U.S. Treasury securities
market from the proposed rule and instead only require covered clearing
agencies have policies and procedures reasonably designed to require
that direct participants of the covered clearing agency submit for
central clearing all transactions in U.S. Treasury repo transactions
into which it enters.

    The Commission understands that there is a likely benefit of
additional balance sheet capacity that flow from clearing repo
transactions in U.S. Treasury securities that might not occur with the
clearing of cash transactions. Multilateral netting can reduce the
amount of balance sheet required for intermediation of repo and could
enhance dealer capacity to make markets during normal times and stress
events, because existing bank capital and leverage requirements
recognize the risk-reducing effects of multilateral netting of trades
that CCP clearing accomplishes.\497\
---------------------------------------------------------------------------

    \497\ See IAWG Report at 30, supra note 4; Liang & Parkinson,
supra note 32, at 9; Duffie, supra note 186, at 16-17.
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    The upfront costs of adjusting to the rule would be lower under
this alternative than under the current proposal, as a result of a
smaller sample of participants and activities in scope and also the
current level of interconnectedness among those participants. As
previously mentioned, the number of participants in the U.S. Treasury
repo market is significantly smaller than the number of participants in
the cash market and is composed of sophisticated investors who have
already incurred the costs of building the ability to novate
transactions to the CCP. Infrastructure for Sponsored Clearing already
exists, so that processing changes should be less than in other more
comprehensive alternatives and costs would be concentrated on the
implementation of similar agreements at a larger scale.
    Nevertheless, excluding the cash U.S. Treasury securities market
from the rule proposal would omit the largest sector of the U.S.
Treasury market, both in terms of activity and number of participants.
This alternative would yield smaller benefits in the areas of financial
stability, risk visibility, margin offset efficiencies, and capital
requirement reductions. The Commission believes that, given the scale-
intensive nature of clearing, there are economies of scale that can
only be realized when a larger number of financial market participants
clear their U.S. Treasury securities cash trades. Moreover, certain
leveraged and opportunistic market participants that are net
contributors of risk to the U.S. Treasury security market, such as
hedge funds and leveraged accounts in broker-dealers, would be exempt
from the clearing requirement under this alternative.
3. Include All Cash Transactions Within the Scope of the Membership
Proposal With Exceptions for Central Banks, Sovereign Entities,
International Financial Institutions, and Natural Persons
    The Commission could require covered clearing agencies to have
policies and procedures reasonably designed to require that direct
participants of the covered clearing agency submit for central clearing
all cash and repo transactions in U.S. Treasury securities into which
they enter, except for natural persons, central banks, sovereign
entities and international finance institutions. This policy option
would include cash transactions between direct participants of a U.S.
Treasury securities CCA and any counterparty (including those included
in the Membership Proposal) except for those that fall within one of
the aforementioned exceptions.
    This alternative would capture more of the potential benefits and
positive externalities that result from increased central clearing,
more closely resembling the assumptions and estimated benefits of
Fleming and Keane's calculations \498\ on clearing benefits. By virtue
of requiring all repo and most cash transactions to be centrally
cleared, the alternative goes the furthest in solving the underlying
collective action problem whereby some participants may find it optimal
to not participate in central clearing, reducing the benefits that may
accrue to the market as a whole.
---------------------------------------------------------------------------

    \498\ Michael Fleming & Frank Keane, Staff Report No. 964:
Netting Efficiencies of Marketwide Central Clearing, Federal Reserve
Bank of New York (Apr. 2021), available at https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr964.pdf.
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    As discussed above, the benefits of clearing are scale-dependent,
so that a more comprehensive clearing directive would result in larger
positive externalities (e.g., lower contagion risk, less financial
network complexity) and larger economies of scale (e.g., larger margin
offsets) for the U.S. Treasury securities market. Another benefit of
this alternative would be an enhanced ability of FICC (and, by
extension, regulatory agencies) to observe the dynamics and manage the
risks in the U.S. Treasury securities markets.
    Nevertheless, there are compelling reasons for the exclusions that
the proposal makes for a specific sample of marker participants. Buy-
side participants in the U.S. Treasury securities markets that do not
take on any leverage, or take less than one-half their assets in
leverage, such as the majority of bond mutual funds, typically have
lower daily turnover. As a result of their lower turnover and
subsequent lower volume, they typically do not have the existing
infrastructure to readily connect to the CCP, making their up-front
costs significantly higher than for other participants. This implies
that the costs of including these participants in the Membership
Proposal are likely higher than those of participants included in the
proposal and the benefits smaller.