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Fears of a US default trigger a collateral review by the clearing house

WASHINGTON, May 25 (Reuters) – Clearinghouses and their members are considering how to deal with certain US Treasury bills and bonds that are often used as collateral as the US nears a deadline that could see them default on their debts, four industry sources report.

Reuters reported that US President Joe Biden and leading Republican Rep. Kevin McCarthy on Thursday moved closer to an agreement to raise the US debt ceiling. The Treasury has warned that the government could run out of funds to cover all expenses as early as June 1, meaning it could potentially miss payments on Treasury bills and other obligations.

That risk has raised doubts about whether clearing houses, which settle and guarantee trades, could continue to accept certain Treasury bills and bonds that are commonly pledged by traders and investors as collateral to back their trades, the people said.

While clearing houses typically do not accept as collateral treasury bills that are due within a few days – instruments that would be immediately affected by a possible June 1 default – there is also the question of whether they could continue to accept bills that are due to expire in the coming weeks. said two people.

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

“We are all waiting for the CCPs to take the first step and decide whether to apply a 1% haircut or even a 100% haircut as we approach a no-settlement date,” an executive at a major bank told Reuters, adding added that most clearing houses are still in place and consider default unlikely.

Derivatives clearing mandates were a key part of post-2009 post-crisis reforms and reduced counterparty risk in financial markets. According to the US Securities and Exchange Commission (SEC), transactions worth hundreds of trillions of dollars were processed in the United States in 2021.

If clearing houses restrict the eligible pool of collateral, investors will have to apply more margin to hedge their positions or reduce their risk, potentially causing ripples in financial markets.

Last week, CME CEO Terry Duffy downplayed the potential impact of a US default on the company’s $250 billion clearinghouse collateral pool, telling Bloomberg that it would only “worry” about bills coming from August expire by October. “That’s a very small fraction of the margin we hold,” he said.

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

Options Clearing Corporation said it is in dialogue with members and is continuing to implement its standard risk management practices. The Depository Trust and Clearing Corporation said it has modeled scenarios related to a delay in Treasury payments and will “take appropriate action as necessary”.

ICE, LCH and Deutsche Boerse-owned Eurex (DB1Gn.DE) also said they are monitoring the situation. Eurex added that there are “currently no plans” to exclude US Treasuries from the eligible collateral list.

Spokespersons for the SEC and the Commodity Futures Trading Commission, which oversee the clearinghouses, did not comment.

However, a regulator source said regulators have been working with clearinghouses to ensure they are well prepared for a potential default or greater volatility, including in terms of margin.

(This story has been re-archived to change “sparks” to “spark” in the caption.)

Reporting by Michelle Price, John McCrank and Laura Matthews; additional reporting by Huw Jones in London and Pete Schroeder in Washington; Edited by Anna Driver

Our standards: The Thomson Reuters Trust Principles.

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