Treasuries not good enough as swaps collateral in CFTC rule

Rules under consideration by federal regulators could require clearinghouses to back up Treasuries pledged as collateral in the $693 trillion over-the-counter derivatives market with credit lines, according to industry executives.

The Commodity Futures Trading Commission, moving to toughen safeguards in a market blamed for worsening the credit crisis, is weighing a regulation that would mandate Treasury collateral be subject to a “prearranged and highly reliable funding arrangement,” according to documents on its website. Federal Reserve officials told banks and exchanges that the language means bonds must be covered by credit lines, according to three industry executives briefed on the matter.

“CME estimates that liquidity facility costs would approximately double” if the rule is passed, according to a letter that CME Group Inc., owner of the Chicago Mercantile Exchange, sent to the CFTC. “These increased costs would likely either be passed on to end customers or cause many clearing members to exit the customer clearing business entirely.”

While Treasuries are considered to be among the safest investments, policy makers are concerned liquidating them will require too much time during a crisis -- up to a day, according to a government official familiar with the Fed’s thinking. The 2008 financial crisis showed even that can be too long during times of stress. Back then, the Fed was forced to give out more than $2 trillion in emergency aid.

‘Some Cost’

“This requirement is that a clearinghouse be able to take your collateral if you post it -- Treasuries or anything else -- that they have rapidly available ways of transforming that into cash,” Gary Gensler, chairman of the CFTC, said during an interview in New York today. While he doesn’t envision the rule putting a dent in the Treasury market, “there is some cost to the clearinghouses,” he said.

Gensler said the CFTC’s four commissioners will finalize the rule tomorrow by private vote. Changes to its wording are possible up until that point. Barbara Hagenbaugh, a spokeswoman for the Fed, declined to comment.

The CFTC is working with the Fed on the rule because the central bank has a regulatory role, mandated by the 2010 Dodd- Frank Act, to oversee systemically important financial institutions such as the major U.S. derivatives clearinghouses. International regulators last year set broad standards for how clearinghouses treat the collateral they hold against a member default.

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