© Reuters. FILE PHOTO: A bronze seal of the Treasury Department is seen at the US Treasury Department building in Washington, US, January 20, 2023. REUTERS/Kevin LaMarque
Written by John McCrank, Laura Matthews, and Michelle Price
WASHINGTON (Reuters) – Clearinghouses and their members are working out how to handle some of the U.S. Treasury bills and bonds commonly used as collateral, as the United States approaches a deadline that could lead to it defaulting on its debt, according to four industry sources.
US President Joe Biden and senior Republican Representative Kevin McCarthy on Thursday came close to reaching an agreement to raise the US debt ceiling, Reuters reported. The Treasury has warned that the government may run short of funds to cover all of its expenses as soon as June 1, which means it will likely miss payments on treasury bills and other obligations.
The risk has raised doubts about whether clearinghouses, which process and guarantee trades, can continue to accept some Treasury bills and bonds that traders and investors typically pledge as collateral to secure their trades, the people said.
While clearinghouses generally do not accept treasury bills due within days as collateral — instruments that would be immediately affected by a potential June 1 default — there is also a question mark over whether they can continue to accept bills that expire in the coming weeks, two people said.
As of Thursday, it wasn’t certain whether the clearinghouses, also known as “CCPs,” would remove such tools from their sideline collection or subject them to a major haircut, the people said. Contacted by Reuters, six clearing houses, including CME Group (NASDAQ), Intercontinental Exchange (NYSE:) Inc, and LCH owned by the London Stock Exchange Group, declined to comment in detail on the discussions.
“We’re all waiting for the central contact points to make the first move if they’re going to cut 1% or even 100% as we get closer to the non-settlement date,” an executive of one of the major banks told Reuters, adding that most clearing houses are still. We believe default is unlikely.
Derivative clearing mandates were a key part of the post-crisis reforms of 2009, which reduced counterparty risks in financial markets. Transactions worth hundreds of trillions of dollars were liquidated in the United States in 2021, according to the US Securities and Exchange Commission (SEC).
If clearinghouses narrow the pool of eligible collateral, investors will have to take out more margin to lock in their positions, or back off their risk, which could cause ripples through the plumbing in the financial markets.
Last week, CME CEO Terry Duffy downplayed the potential impact of a US default on the company’s $250 billion clearinghouse collateral portfolio, telling Bloomberg that it would only worry about bills that expire from August to October. “This is a very small part of the margin that we maintain,” he said.
A CME spokesperson said the company is monitoring the situation. “Should the risk increase, CME Clearing may consider adjusting the shave, margins and other available risk mitigation tools,” they said in a statement.
Options Clearing Corporation said it is in dialogue with members and continues to apply its standard risk management practices. The Depository and Clearing Corporation said it has developed models for scenarios related to delays in treasury payments and will take appropriate action as needed.
Deutsche-owned ICE, LCH and Eurex said they were monitoring the situation. Eurex added that there are “currently no plans” to exclude any US government bonds from the list of eligible guarantees.
Spokespeople for the Securities and Exchange Commission and the Commodity Futures Trading Commission, which oversees clearinghouses, did not offer comment.
However, one of the regulatory sources said that regulators have been working with loyalists to ensure they are in a good position to meet any potential default or significant volatility, including with respect to margin.
(This story was paraphrased to change the word “sparks” to “spark” in the headline)