(Bloomberg) -- The battle for market share in US Treasuries is getting an extra dose of politics.
Howard Lutnick, the longtime chief executive officer of Cantor Fitzgerald LP, has lined up major US banks to back his plan to start competing with CME Group Inc. in Treasury futures.
Now the move from one of Donald Trump’s closest allies on Wall Street is drawing attention from the other side of the aisle.
Without mentioning Lutnick or his new FMX exchange, Democratic Senator Dick Durbin of Illinois — CME’s home state — warned of risks related to an ongoing debate over how FMX plans to handle a particular aspect of the market, according to a letter to the top US derivatives regulator seen by Bloomberg News.
It all boils down to whether the US should allow Treasury futures to be cleared abroad, with FMX having partnered with UK-based clearinghouse LCH Ltd.
On the surface, the debate centers on a technicality of the derivatives market, a topic usually left in the hands of specialists. But in an election year, the issue has reverberated on Capitol Hill.
“I urge you to consider any potential risk to US regulators not having full authority over a clearinghouse in a foreign jurisdiction that is clearing US Treasury futures,” Durbin said in an Aug. 21 letter to Rostin Behnam, chairman of the Commodity Futures Trading Commission. The senator also warned about the potential impact “on the stability of our nation’s sovereign debt.”
BGC and LCH defended their plan, pointing out that their clearinghouse is fully licensed and will hold all collateral in the US. But the companies didn’t directly say where futures will be cleared. A person familiar with the plans said the contracts will be cleared in London.
The US Treasury sells debt, seen as one of the world’s safest securities, as a way to fund America’s deficit spending. Most of it trades in the cash market, where buyers and sellers exchange securities that settle in a day, with a small percentage of the transactions being cleared by the Fixed Income Clearing Corporation, a federal organization.
Investors primarily use futures to hedge their positions in the $27 trillion market. While CME is currently the dominant player, Lutnick’s plan threatens to upend that.
CME’s market capitalization of roughly $78 billion dwarfs BGC’s $4.8 billion market cap. But FMX is gradually taking more business. Its cash US Treasury platform, FMX UST, ended the second quarter with a market share of 30%, up from 23% a year earlier, BGC Group, the brokerage that was spun off from Cantor and is FMX’s majority owner, said in a report, citing data from Coalition Greenwich.
SEC Moves In
The fight for control of the Treasury markets deepened after the Securities and Exchange Commission pushed through new rules requiring that most cash trading be centrally cleared. That compares to just over 10% of the market that now goes through FICC, currently the only central clearinghouse for cash treasuries.
CME, Intercontinental Exchange Inc. and LCH all expressed interest in grabbing a share of that market.
But the competition doesn’t stop there. FMX is also challenging CME’s position in US Treasury futures and US interest-rate futures, with its SOFR contract expected to start trading next week — all in partnership with LCH, which already handles US dollar interest-rate swaps.
With all deals under the same clearinghouse, FMX says clients will receive significant capital savings on margins, the amount of money they need to put down as collateral to back their transactions.
“At the end of the day for investors taking the risk, the ideal setup is having as many products within one clearinghouse, to maximize margin efficiency,” said Kit Spicer, partner and co-head of finance, risk and compliance at Capco, a management and technology consulting company.
“LCH will hold all futures collateral in the United States and all exchange of value will occur in the United States, as required by the CFTC,” according to a statement from BGC Group.
In a separate statement, LCH said it’s “directly registered” with the CFTC to clear futures contracts, and that it “holds all futures customer collateral in the US onshore, as required by the CFTC for the protection of such funds and assets belonging to U.S. firms.” The clearinghouse added that its services are “subject to direct regulatory oversight by the CFTC.”
For CME CEO Terry Duffy, keeping his large share of the Treasury futures market is crucial. He has questioned whether FMX should be allowed to clear Treasury futures overseas.
“With so many challenges already facing our country, it is hard to understand why our regulators would willingly introduce an unprecedented new risk by permitting trades of US sovereign debt futures to be cleared offshore under the jurisdiction of a foreign regulator, a practice the US has never before approved and that is not allowed by any other major country,” Duffy said in a statement.
In a report to clients, Piper Sandler said that if the US government moves to block FMX’s use of clearing partner LCH, “we believe would ultimately lead to FMX failing to succeed” in interest-rate futures.
‘Valid Argument’
“Although this may seem like a global economic system, it’s really US-based,” said Chris Ferreri, a former Treasury broker at ICAP who’s now chief operating officer at broker Hartfield, Titus & Connelly. “If there is a crisis, what happens? If we have a US clearinghouse that’s regulated by the US government, we’ll have a better understanding where the risk is. If we have a clearinghouse outside, how do we know?”
Ferreri called it “a valid argument in the time of great stress.”
Durbin warned that foreign regulators would prioritize the interests of their home countries, and that “could have significant repercussions to US Treasury market volatility and liquidity, and ultimately to US borrowing costs,” according to the letter.
US Treasuries wouldn’t be the first market to clear at LCH. The London-based company already handles about 98% of cleared US dollar interest-rate swaps. Lutnick and his partners also started working on FMX and its futures contracts long before he was appointed to Trump’s transition team.
Capco’s Spicer, for one, said an increase in the number of players controlling the Treasury market will be a benefit.
“It’s good to have competition,” Spicer said. “It’s best to have the risk spread out a bit, and not one dominant clearinghouse.”
--With assistance from Liz Capo McCormick, Todd Gillespie and Naomi Tajitsu.
(Updates with source of data in 11th paragraph, adds chart after 11th paragraph.)
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