Feared US default prompts scrutiny of collateral held by clearing houses

Clearing houses and their members are working to handle certain U.S. Treasury bills and bonds commonly used as collateral as the United States approaches a deadline that could allow the country to default on its debt, four industry sources said.

US President Joe Biden and top Republican lawmaker Kevin McCarthy moved closer on Thursday to an agreement to raise the US debt ceiling, Reuters reported. The Treasury Department has warned that the government could run into a deficit as early as June 1 to cover all of its expenditures, potentially missing payments on Treasury bills and other liabilities.

That risk has cast doubts on whether clearing houses, which process and underwrite transactions, can still accept certain treasury bills and bonds commonly pledged by traders and investors as collateral for their transactions.

While clearing houses typically won’t accept as collateral Treasury bills maturing in a few days – the instruments that would be immediately affected by a potential default on June 1 – it is also questionable whether they can continue to accept bills maturing in the coming weeks, the two said. persons.

As of Thursday, it was uncertain whether clearing houses, also known as “CCPs,” would remove such instruments from their collateral pool or subject them to major haircuts, the people said. Six clearing houses, including CME Group, Intercontinental Exchange Inc and LCH, owned by the London Stock Exchange Group, contacted by Reuters, declined to comment in detail on the discussions.

“We are all waiting for the CCPs to take the first step to apply a haircut of % or even 100% as we get closer to a no-resolution date,” an executive from a major bank told Reuters.

Derivatives clearing mandates were an important part of the post-crisis reforms of 2009, which reduced counterparty risks in financial markets. Hundreds of trillions of dollars worth of transactions will be cleared in the United States by 2021, according to the US Securities and Exchange Commission (SEC).

If clearing houses reduce the pool of eligible collateral, investors will have to use more margin to secure their positions, or reduce their risk, which can lead to ripples in financial markets.

Last week, CME CEO Terry Duffy downplayed the potential impact of a US bankruptcy on the company’s $250 billion collateral pool. He told Bloomberg that the company would only be concerned about bills expiring from August to October. “That’s a very small fraction of the margin we’re holding,” he said.

A CME spokesperson said the company is monitoring the situation. “Should risks increase, CME Clearing may consider adjusting haircuts, margins and other available risk mitigation tools,” the spokesperson said in a statement.

The Options Clearing Corporation said it was in discussions with members and is still applying its standard risk management practices. The Depository Trust and Clearing Corporation said it had modeled scenarios regarding a delay in Treasury payments and would “take appropriate action if necessary”.

ICE, LCH and Deutsche Boerse-owned Eurex also said they were monitoring the situation. Eurex added that there are “currently no plans” to exclude US government bonds from its list of eligible securities.

Spokesmen for the SEC and the Commodity Futures Trading Commission, which oversee clearing houses, did not comment.

However, a regulatory source said regulators have been working with clearing houses to ensure they are well positioned for any eventual default or high volatility, including on margin. (Reporting by Michelle Price, John McCrank, and Laura Matthews; Additional reporting by Huw Jones in London and Pete Schroeder in Washington; Editing by Anna Driver)