There has been a great deal of uncertainty surrounding the Security and Exchange Commission’s (SEC) new US Treasury (UST) Clearing Final Rule (The “UST Rule”) since its announcement in 2022. With the publication of the final rules in December 2023 and new trading agreements now published however, requirements are becoming clearer. There are no excuses to further delay how to address the new rules.
Institutions cannot afford to repeat the mistakes, including lack of scope and prioritisation, made during the FINRA 4210 compliance process. These errors undermined the ability of firms to implement an effective new Business-As-Usual (“BAU”) process, negatively impacting both revenue and client engagement.
Compared to FINRA 4210, the implications of this regulatory change are even more significant. The UST Rule is not simply a regulatory compliance process; it is likely to presage a market overhaul. Will clients want to engage in new documentation discussions with every single counterparty? Or will they use this as an opportunity to rethink strategies and reduce trading partners significantly? With the UST Rule, the speed and quality of engagement will have implications that reach far beyond compliance deadlines.
Getting ahead of the game will not only minimise the impact on BAU activity but also reinforce client relationships. Eric Mueller, Managing Director and COO, D2 Legal Technology explains why “early in, safely out” is now key to achieving regulatory compliance.
Significant Challenge
There are important lessons that were hard-learned due to mistakes that financial institutions now admit they made when preparing for FINRA Rule 4210 (“4210”). Scoping projects were delayed and lacked rigour. Client prioritisation lists were not confirmed until just weeks before the deadline, with constant changes undermining the activities of the compliance team. Far too many institutions ended up with frantic pre-deadline activity that predictably affected their ultimate BAU processes and ability to trade. When firms looked for outside help close to the deadline, resources with relevant skills were already committed to more forward-planning institutions. From the additional pressures placed on negotiation and legal teams, to constant and heated discussions with sales regarding the determination of priority clients, 4210 compliance mistakes were costly.
Given the significant additional demands associated with the forthcoming UST Repo clearing regulations, it is essential to remember and avoid repeating the 4210 mistakes, especially given that, with this regulation, the volume of transactions affected is much greater. For in-scope clients, firms will be required to centrally clear US Treasury cash/DVP trades by the end of 2025 and all other repo/reverse repo transactions by June 2026. To put it into context, today just 13% of cash/DVP trades are cleared; under the new clearing rules, 100% of these trades with in-scope clients will have to be cleared.
The new Treasury Clearing rules will require that firms amend existing documentation or enter into new agreements with clients. With no current industry standard for clearing cash or repo treasury trades, there has been an industry effort to develop a standard document , and new documentation has recently been published that addresses both cash and funding trades.
Complex Documentation
The Treasury Clearing documentation is significantly more complex than the Master Securities Forward Transaction Agreement (MSFTA) required for FINRA 4210. While the MSFTA was short and demanded little client negotiation, the new UST documentation is not only new but is not necessarily self-contained, and includes a three-part agreement with an array of choices which are likely to prompt additional discussion and negotiation. Even with the availability of the industry standard documents, institutions will still have significant internal documentation process development to undertake before the UST Rule goes live. This will involve the creation of templates, fallbacks, and guides, and should be done prior to undertaking the amendment of existing agreements and negotiation of new contracts.
Further, while the relative simplicity of cash trades should reduce the difficulties in agreeing documentation in this area, many market participants do not currently require documentation for cash trades. Therefore, not only do they now face a completely new documentation requirement but, given the less robust approach to Know Your Customer (KYC) associated with undocumented transactions, firms should also be prepared for impacts or a significant overhaul of KYC processes.
Another unique challenge raised by the UST Rule is the potential for a new trading methodology where counterparties may transact with entities that are not their clearing agent/sponsor (so called ‘done away’ trading). The documentation published in October 2024 only addresses the ‘done with’ model. While questions and challenges remain in the discussion around the development of documentation for the ‘done away’ model, counterparties may choose to limit their business to those firms best prepared to offer them simple, streamlined ‘done with’ trading.
Early Start
Given the reach and complexity it is important to start now to understand the implications of Treasury Clearing Rules. As a priority, institutions should undertake a robust scoping exercise. This will include identifying UST cash and repo product clients and determining whether they are an in-scope counterparty type for the new rules or eligible for an exclusion (e.g. a central bank, or sovereign entity). This analysis will provide the essential view of the extent of the work ahead, including the number of in scope clients that require new documentation.
Once scoped, it is vital to work closely with stakeholders to create a priority client list – and set that list in stone. The documentation team must have a static framework to amend and implement documentation if they are to quickly and effectively reach these priority clients, not only to achieve compliance but potentially also secure their business in the long term.
This is not just a repapering exercise. The documentation team has a key role to play in engaging clients and ensuring they understand why the new documentation is required. Again, it is important to avoid the mistakes of 4210, where far too many institutions sent bland, generic letters or emails to clients which were ignored or sidelined. With Treasury Clearing, clients will be receiving multiple requests from diverse counterparties and those institutions that simplify the process as far as possible and provide detailed, client specific information up front about why compliance is required and why the organisation is in scope, will avoid conflict and reinforce the existing relationship: “early in, safely out”.
Conclusion
Regulatory compliance is without any doubt a significant burden for any institution. Resources are limited and organisations frequently lack the expertise required to undertake complex compliance activity. Without the right approach, there is a very real risk that BAU trading will be significantly affected, with a direct implication for revenue and client engagement.
More significantly, US Treasury Clearing creates a competitive compliance situation. Speed of engagement with clients will determine not only compliance to the new rules but, more likely than not, levels of client retention. Many clients will inevitably not want to undertake this process with multiple dealers and will opt to work with just two or three.
The onus is, therefore, on institutions to start now. Start scoping. Start prioritising. And start looking for external expertise to accelerate the documentation process and proactively engage with clients to reinforce the business relationship. With the right approach, organisations can make the most of finite resources, avoid any impact on BAU and, critically, get ahead of the competition to secure key client relationships.