HOUSE COMMITTEE ON FINANCIAL SERVICES
TASK FORCE HEARING
For questions on the note below, please contact the Delta Strategy Group team.
On April 29, the House Committee on Financial Services Task Force on Monetary Policy, Treasury Market Resilience, and Economic Prosperity held a hearing entitled, “Examining Derivatives’ Role in the Treasury Market.” The witnesses in the hearing were:
- Kevin McPartland, Head of Research, Market Structure and Technology, Crisil Coalition Greenwich
- Terry Duffy, Chairman and CEO, CME Group
- Jeff Cranston, Head of Corporate Strategy, Optiver
- Professor Yesha Yadav, Professor of Law and Associate Dean, Vanderbilt University Law School
Below is a summary of the hearing prepared by Delta Strategy Group, which includes several high-level takeaways, followed by summaries of opening statements and discussion.
Key Takeaways
- Committee Chairman Hill (R-AR), Task Force Chairman Lucas (R-OK), and Representative Flood (R-NE) highlighted the role of derivatives in price discovery, risk management, and market liquidity. Witnesses reinforced that without a well-functioning derivatives market, market participants, including farmers, banks, and institutional investors, would lose their primary tool for managing risk and hedging against price volatility.
- Chairman Lucas praised the Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) for recently granting exemptive relief to allow customer cross-margining for offsetting exposures of cash and futures positions for Treasuries.
- Cranston stated that expansion of central clearing will depend on whether futures commission merchants (FCMs) and prime brokers have sufficient balance sheet capacity to support rising demand for cleared Treasury and repo activity. He noted that market participants rely on these intermediaries to access clearing and finance positions and added that, while recent Basel III endgame revisions are a positive development, continued monitoring will be necessary to ensure capital and leverage constraints do not limit clearing capacity as mandatory clearing implementation progresses.
- Cranston noted that while introducing additional clearinghouses, such as the Chicago Mercantile Exchange (CME) and Intercontinental Exchange (ICE), alongside existing infrastructure can enhance competition, innovation, and resilience in Treasury clearing, it also raises the risk of market fragmentation. He cautioned that if multiple clearing venues lead to separate central limit order books (CLOBs) or liquidity pools in the interdealer market, it could weaken liquidity formation and price discovery if not properly coordinated.
- Duffy addressed concerns around tokenization and the prospect of 24/7 trading, stating that tokenization does not eliminate underlying market constraints such as funding and settlement. He added that even in a tokenized framework, assets remain tied to the dollar and require pre-funding and reliance on the banking system, noting that continuous, around-the-clock trading is not achievable simply through tokenization and that core liquidity and financing constraints would remain.
- Witnesses pointed to the Fixed Income Clearing Corporation (FICC) and CME cross-margining arrangement as an important efficiency enhancement that reduces redundant margin requirements and improves capital efficiency across cleared cash and futures positions.
- Representative Flood raised the role of derivatives markets in supporting agricultural producers and the downstream effects of a well-functioning futures market. Duffy stated that futures markets were originally designed for commercial hedgers such as farmers and producers and discussed that while speculators are not the intended end users, their participation is important because it provides liquidity and enables efficient risk transfer between buyers and sellers.
- Concerns were raised regarding foreign oversight of Treasury futures clearing arrangements, with Duffy warning that reliance on foreign-regulated clearing infrastructure could introduce legal and operational risks in a systemic crisis, specifically speaking to FMX’s relationship with the Bank of England.
- Representative Casten (D-IL) raised concerns regarding split jurisdiction between the SEC and CFTC over tokenized equities and prediction markets. Duffy noted that the regulatory classification of sports prediction markets, whether they constitute gambling or swaps, remains unresolved and will require judicial clarification. Duffy expressed concern with provisions in the Digital Asset Market Clarity (CLARITY) Act that would shift products from SEC to CFTC oversight based primarily on size thresholds, emphasizing that durable capital market integrity depends on clear, consistent, and principles-based regulation rather than arbitrary jurisdictional reclassification.
SUMMARY
Opening Statements and Testimony
Committee Chairman Hill (R-AR)
The strength of the Treasury markets depends not just on size, but on its depth, liquidity, and resilience. Derivatives play a critical role in price discovery, risk management, and overall market functioning.
Task Force Chairman Lucas (R-OK)
Part of the depth and liquidity of the Treasury market is driven by trading in swaps, options, and futures on the underlying Treasuries. These derivative markets are key to managing risk, as they allow market participants to hedge their exposures, create demand for Treasuries, increase market liquidity, and support price discovery and the health of the broad Treasury market. We must pay attention as the industry undergoes a fundamental market structure shift with the looming deadlines for central clearing of cash Treasury and repo in December and next June. The SEC has been responsive to industry comments and proposals to ensure that the transition to mandatory clearing does not disrupt the Treasury market. Demand for Treasury derivatives is rising, and with it, demand for cash and for clearing. It is critical that our capacity for clearing these transactions rises in kind. The SEC and the CFTC granted exemptive relief to allow customer cross-margining for offsetting exposures of cash and futures positions for Treasuries. This is a welcome step to ease the transition to mandatory clearing and will allow redeployment of capital back into our Treasury markets. It is hoped that all this risk-reducing activity will be fully recognized in the capital rules proposed by the bank regulators.
Ranking Member Vargas (D-CA)
The Treasury market serves as the bedrock of our capital markets and the global benchmark for risk-free rates. Keeping it liquid, efficient, and resilient is essential. Derivatives play an important role in making that possible. Through futures, options, and swaps, they support price discovery, enhance liquidity, and give market participants the tools they need to manage risk. We have seen multiple episodes of significant volatility in the Treasury market. Central clearing increases efficiency, improves market plumbing, and lowers counterparty risk. For derivatives in the Treasury market, broader central clearing brings transparency and more standardized risk management, helping to reduce the fragmentation that can amplify stress during volatile periods. As derivatives are increasingly utilized in this market, it is critical that regulators and policymakers have full visibility into these activities.
Kevin McPartland, Crisil Coalition Greenwich
The Treasury bond and derivatives markets are inextricably linked. The interplay between bonds and derivatives ensures that asset prices accurately reflect current market conditions, allowing long-term investors and large corporations to feel confident about their investment decisions, and the U.S. to fund itself at the best possible rate. The addition of a central clearing mandate for certain Treasury bonds and repo transactions can serve as a further tailwind for the market, potentially reducing systemic risk while standardizing market entry and ongoing participation for market makers and investors alike. We must not disincentivize market participation when implementing this change by making the rules of engagement too onerous or the cost of trading too high. Longer implementation timelines and the recently revised Basel III endgame proposal suggest we are headed in the right direction. Banks with more available capital to deploy to market-making activity, stronger incentives to hold Treasuries on their balance sheets, and greater recognition of cross-product netting are all critical to the market’s health and will serve as tailwinds for Treasury market participation, liquidity, and resilience. We should continue to pay close attention to areas of concentrated risk and leverage. The shocks of the past few years have left us with a market that is more resilient than ever. Liquidity providers are better equipped to continue making markets during volatility spikes, and users have greater access to higher-quality market data and electronic trading venues.
Terry Duffy, CME Group
Derivatives are foundational to the price discovery, liquidity, and functionality of the U.S. Treasury market. Highly liquid Treasury futures allow market participants to secure risk-management hedges in customizable sizes without having to source individual Treasury securities. Open interest in Treasury futures closely mirrors volumes in cash Treasuries. Market makers, including primary dealers such as banks, use Treasury futures to hedge their Treasury inventory. Asset managers use Treasury futures to add duration to their portfolios, while leveraged funds meet this demand through the Treasury basis trade. The widespread use of the Treasury basis trade tightens price alignment between cash bonds and futures, enhances overall market liquidity, and ensures more efficient interest rate pricing for all participants. Treasury futures are a vital point of price discovery and liquidity, enabling participants to manage risk of all sizes. Treasury futures enable a more efficient Treasury market, which lowers the cost of financing government expenditures and is crucial to U.S. financial stability. As the SEC’s central clearing requirements for cash Treasuries and repo approach, we are expanding our program with FICC to provide cross-margining access for our end-user clients. Cross margining between swaps, options, futures, and cash cleared products within CME’s clearing solutions will provide a unique opportunity for managing interest rate risks with maximum risk sensitivity efficiencies. The Basel III endgame re-proposal is a crucial step toward ensuring capital is allocated efficiently and appropriately based on risk. I want to highlight a concern about the risk of allowing a non U.S. regulator to oversee any portion of this market. FMX, a U.S. exchange, self-certified last year with the CFTC to trade Treasury futures cleared by a London-based clearing house that is regulated and supervised by the UK’s Bank of England (BOE). While the clearing house is also registered with the CFTC, its dual registration with the U.S. and UK does not impact the fact that its ultimate guarantor is the BOE. Under UK law, the BOE’s primary mandate is the stability of the British financial system, not the U.S. system. In the event of a systemic crisis such as a massive liquidity crunch in both gilts and Treasuries, the BOE is legally obligated to prioritize the gilt market and the British pound over all other markets, including the Treasury market. If the UK-based clearing house faced a capital shortfall, the BOE could use its early resolution authority to intervene and haircut or tear up Treasury contracts. This could trigger a default chain in the U.S., spiking borrowing costs for the U.S. government and destabilizing the Treasury market. Allowing the UK government to exercise regulatory power over such a critical component of the Treasury market poses a significant risk.
Jeff Cranston, Optiver
The Treasury market is central to government financing and serves as a global benchmark for safe and liquid assets. Maintaining a resilient and liquid Treasury market is critical to economic stability and the dollar’s role as the world’s reserve currency. Derivatives play a central role in supporting liquidity, enabling risk transfer, and promoting efficient price discovery in the cash market. Treasury futures are often the first place where economic data or shifts in market sentiment are reflected. Treasury options play an important role in managing volatility by allowing participants to hedge non-linear risks without needing to transact directly in the underlying cash market. Swaps are an important part of this ecosystem, providing tools to hedge Treasury funding exposures and express views on interest rates and the yield curve. Taken together, these markets form a highly interconnected system where activity across instruments reinforces liquidity and price formation. Central clearing provides important benefits, including reduced counterparty credit risk, the ability to net exposures across multiple counterparties, a more structured approach to managing risks and defaults, and the opportunity to develop CLOBs that support broad, all-to-all participation. Market participants are working together to prepare for the transition. Key areas of industry focus include the development of clearing access models to support away trading, where participants can execute with one counterparty and clear with another, and margin efficiency, with cross-margining helping to ensure risk is properly reflected across related positions. The recent approval of customer-level cross-margining between CME Treasury futures and FICC cleared Treasury positions is a meaningful step forward. Clearing repo transactions adds an additional layer of complexity. Repo involves not just trading but also funding and collateral management. Extending clearing to repo requires infrastructure that works for a broader range of participants, including hedge funds, asset managers, and cash lenders, and ensuring efficient clearing access across these participants remains an important area the market is continuing to address. The introduction of additional clearing agencies like CME and ICE can support innovation and resilience but also raises the potential for market fragmentation. In the interdealer market, if multiple clearing agencies lead to distinct CLOBs, this could negatively impact liquidity. The transition to central clearing raises important questions around clearing capacity. Market participants rely on FCMs and prime brokers to access clearing and finance positions, and these institutions provide the balance sheet and capital required to support client clearing activity. Recent updates to bank capital rules are a positive step and should help ease some constraints. As clearing expands, it will be important to monitor whether clearing capacity keeps pace with implementation and prudential rulemaking. Derivatives markets play a central role in supporting Treasury market liquidity, and with continued progress toward implementation, central clearing can further strengthen the market.
Professor Yesha Yadav, Vanderbilt University
Treasury-linked derivatives ensure that market participants everywhere can hedge their interest rate risks. This is a market that infuses information into Treasury prices, helping them fulfill their benchmarking function and increasing liquidity in the cash and repo markets. Derivative examples, such as the cash-basis trade, can interlink with the Treasury market to provide liquidity and risk management. As the FICC and CME cross-margining proposal shows, these interlinkages are only set to deepen and to deepen very quickly. Even though Treasuries might be risk-free, the markets in which they and related contracts trade are not. The oversight structure for this consolidated market does not provide the holistic oversight needed to spot risks and coordinate to address them in a timely fashion. We lack real-time information on the consolidated workings of the Treasury and related markets. The bilateral repo market is a space where we do not know what exposures are being taken, at what scale, and by whom. In certain cases, Treasuries can collateralize multiple debts at the same time, and zero haircuts are remarkably common in this market. There are well-known problems with swap reporting, including how to fix errors in the swap reporting system, reconcile data across multiple swap data repositories (SDRs), and report data to the CFTC in a timely manner. The regulatory structure today is incapable of addressing these gaps. The Treasury market is subject to oversight by five federal regulators, none of whom has primary authority. Arrangements need to be put in place to allow for information sharing. Even though there is a cross-margining proposal at present, the CFTC and the SEC do not have data-sharing arrangements. This means that CCPs are on the front line of managing risks in this market. For Treasuries specifically, clearing houses rely overwhelmingly on Treasuries as the chosen form of collateral, but when they need to liquidate Treasuries, that is the exact moment when Treasuries are likely to be under maximum stress.
DISCUSSION
Chairman Lucas (R-OK): How do derivatives markets support market depth, facilitate efficient price discovery, enhance liquidity in underlying cash markets, and contribute to narrower bid-ask spreads? What is the connection between Treasury derivatives and lower borrowing costs for taxpayers? McPartland: Futures markets concentrate trading and liquidity among a few important points on the interest rate curve, bringing all buyers and sellers together in an all-to-all market that includes investors, retail, institutions, banks, and market makers. Those prices are a major input into how Treasury dealers price the Treasury bonds they trade. Perhaps more importantly, the hedging provided by futures and swaps allows dealers and investors to maintain larger positions. If they can be sure they are properly hedged against unexpected market movements, they are more apt to hold on to those positions even when markets get volatile. Futures allow dealers to quote better prices and tighter bid-ask spreads, because if the market moves against them, those futures are protecting them, and their downside risk is minimized. Together, that ensures the most effective marketplace where the price you are seeing in the bond market is based on all the market inputs, which allows the U.S. government to borrow at the best rate it possibly can.
Chairman Lucas: With eight months remaining until the SEC clearing requirement for cash transactions takes effect, and noting ongoing implementation progress alongside outstanding issues such as the interaffiliate exemption and other relief applications, how is the transition proceeding from your perspective? Duffy: This has been a multi-year process, as we are working to complete this year’s clearing of these products and create the efficiencies referenced earlier, including 25 billion dollars a day in rate savings, in part through FICC. The interdealer trades that are yet to be decided on who has to participate and who does not is really an argument that FICC and its clients must come to a resolution on, but economics will dictate that resolution. I am encouraged that we will move forward with the due date, and people will figure out whether affiliates need to clear those trades or not. There is an exemption in place for some of the affiliates, but the benefits will outweigh any exemption; Cranston: Regulators have good visibility into individual transactions in the cash market, but the data is extremely fragmented and does not provide a complete picture of exposure in the market. Central clearing will help consolidate that information and provide regulators with more standardized position-level and risk-based data, as well as margin and exposure information at the clearinghouse level. It will improve monitoring and understanding of how much leverage is in the market and what stress it could face. While the entire market will not be cleared, and it is not a perfect solution, it is an improvement overall.
Ranking Member Vargas (D-CA): How does the role of the BOE inform the broader discussion? Duffy: The BOE is the backstop for all financial products that are cleared through the London Clearing House. The London Clearing House is now clearing Treasury market debt through another entity, and while they are supposedly duly registered, that means nothing in a crisis. They can make decisions unilaterally on U.S. foreign sovereign debt, which represents $30 trillion outstanding. An example of this happened in nickel traded on the London Metals Exchange (LME), where there was a default on the contract. The way the BOE dealt with that default is they tore up the trades and said there is no longer a default. If you were on the proper side of that trade and hedging on that side, you lost money because they tore up the winning trade to offset the losers. Now they want to do that with Treasuries. Nobody allows foreign sovereign debt to be cleared outside of their country except the U.S. If it ever came to that with the $30 trillion market, it would be a biblical disaster for this country.
Representative Sherman (D-CA): Does the potential for the SEC to grant exemptive relief for tokenized Treasury products, particularly where such products may not be fully backed by underlying reserves or subject to existing broker-dealer, exchange, and clearing agency requirements, pose risks to investors or broader securities market integrity? Yadav: It is important to make sure that our regulatory system for Treasuries is robust, and I do not believe that even in the context of normal securities regulation, our system for Treasuries is robust. Reporting here is not foolproof and has many gaps. In addition, we have launched a cross-margining relief for CME and FICC, but there is no data sharing between the SEC and the CFTC. Before we start talking about things like tokenization, we must get the regulation of Treasuries right, and we are very far from that at present.
Representative Barr (R-KY): What are the benefits that financial institutions and the Treasury market itself receive when using central clearing? McPartland: Derivatives contracts have the ability to buy or sell anything, but in this case, the U.S. Treasury at some point in the future at a specified price. That lets you know exactly what the price will be, and it can be used to help manage risk in your portfolio of actual bonds. If that price were to move wildly, you are still able to buy or sell at the price you predefined. Because of that, banks can hold those positions and make markets in them, since they can quantify their risk and put that capital to work feeling safe.
Representative Barr: How did the previous Basel III endgame proposal disadvantage central clearing? McPartland: The previous rules in some ways penalized banks for their holdings and did not recognize the true risk. Offsetting the derivatives with the bonds neutralizes a lot of that risk. We want to incentivize banks to hold Treasuries and make markets, and thankfully, we have seen an uptick in bank holdings of U.S. Treasuries.
Representative Barr: How did the 2023 Basel III endgame proposal fail to recognize the risk-reducing benefits of derivatives? Duffy: It is strange, especially after Dodd-Frank, how they did not consider how central clearing actually works today through the clearing house mechanisms. They were double-counting and putting an extra burden of charges on the biggest dealers in the world. By not recognizing that capital was already accounted for through central clearing, they were asking for twice the amount of capital that they did not need. That hurts banks from deploying capital in other parts of our economy.
Representative Barr: What changes have been made in the Basel re-proposal that will help promote central clearing, and what improvements could be made to continue to enhance the functionality of the derivatives market? Cranston: The re-proposal will allow for additional capacity, or at least prevent capacity from being unavailable, not only for the futures and derivatives market that is already essentially cleared, but also for the demand we will see from the SEC clearing mandate on both cash and repo. As for potential enhancements, there is still room to realize product netting and cross-margining benefits that will further reduce pressure on the balance sheet.
Representative Casten (D-IL): Given the SEC’s position that tokenized equities are derivatives of equity securities and fall within its jurisdiction, and provisions in the CLARITY Act that would place certain tokenized offerings under CFTC oversight below specified thresholds, does this create concerns regarding split jurisdiction or regulatory ambiguity? Duffy: An equity is an equity, so whether it is tokenized or not should be irrelevant. The question is whether the amount falls below the threshold of regulatory obligations. I have concerns with a lot of this because how does it not flow into other products, including Treasuries, besides equities? I do not think we should be moving things from a regulator just because of its size. I would like to see products regulated because good, smart, credible regulation is best for the U.S. to grow all of its capital markets. I am concerned by that provision in the CLARITY Act, and hopeful that they will reevaluate. As far as the tokenized Treasury market, you have to remember that 24-hour 7-day trading will not work unless you pre-fund on a Friday, even if it is tokenized. To think that we could trade around the clock on any product is not something tokenization is going to help, because you still have to fund it, whether it is tokenized or cash, since those tokens are tied to the dollar, and we still rely on the banking system for those dollars.
Representative Casten: In the context of prediction markets and bilateral options, how should a bilateral option based on an earnings forecast for a publicly traded company be characterized? Does it fall more appropriately within securities or commodities jurisdiction? Duffy: We only list certain prediction markets, and we have a partner in FanDuel for distribution and participation for their clients to trade in our marketplace. We think it is a good and smart thing. As it relates to their sports prediction markets, it must be determined whether sports predictions are gambling or swaps. I do not believe that answer has been fully worked out, and I think it will end up in the Supreme Court for a decision. It is important that we have that distinction.
Representative Flood (R-NE): What are the downstream effects of a well-functioning futures market that would be visible for an agricultural producer? McPartland: The founding of the derivatives market was truly to help farmers, and that is true to this day. We need a derivatives market to help agricultural producers manage their risk and their costs. Markets are impacted by many factors, and the world is getting more complicated, but to be able to know their prices and know what they will be able to sell at harvest time is critical, and that is what the derivatives markets offer; Duffy: It is critically important that the commercial and the producer have the characteristics of the futures contract. Futures contracts were never designed for speculators. Speculators are embraced into futures markets, but they are not made for speculators. They are made for the commercials and producers, and that is a critical component. Speculation does help create liquidity because if a commercial wants one price and a producer wants another, we need someone to fill the gap. We need to ensure the system is efficient and that the entire ecosystem works properly.
Representative Flood: What are you seeing in the fertilizer market, and how is it affecting producers? Duffy: There are many things affecting producers today, including plastics, fertilizer, and all the oil components that go into them. With twenty to thirty percent of oil supply coming out of the Strait of Hormuz today being impacted, when the price of oil escalates, it is going to have an impact on derivatives of the oil product itself. Some in the farm community have been switching to less intensive fertilizer products, such as nitrogen-based ones. They should not have to do that. We need to make sure that oil remains a component that producers can continue to use to create all the different farm products that they have, but fertilizer is a big deal, and people are not taking into consideration what it does for the production of our crops.
Representative Flood: How does your company adjust its liquidity provisioning around discrete events like the release of USDA reports? Cranston: As a market maker, our primary role is to continue to provide two-way pricing throughout normal market conditions as well as when new information is released to the market. Ahead of an event or news release, we will adjust our quoting and position limits, and as information flows into the market, we will more actively manage our exposures to reduce any potential exposure. We spend a lot of time and resources building out pricing models to ensure they are prepared for these types of event-driven conditions. The goal is to adapt to the change in the risk environment and continue to support the market.
Representative Downing (R-MT): Why is competition in the Treasury clearinghouse space important? Duffy: Competition is important, no matter where it is. As it relates to clearing cash Treasuries, my concern has always been to ensure we are ready when the data mandate kicks in. I have been prepared to do this for several years, working with the SEC to put forth an option to make sure that if FICC is not prepared to do clearing of cash Treasuries, CME will be prepared. FICC is a partner of ours, and we are extending benefits throughout the system, but we will invest to ensure we are ready in case that does not continue. CME has about 1.5 billion dollars in margin offsets that we share between our futures products and FICC’s cash, and there will be additional benefits with the addition of client efficiencies going forward. Having another clearinghouse gives users an opportunity to use different platforms, and that is important.
Representative Downing: Where could the current Basel proposal improve to better support the derivatives market? Cranston: The Basel re-proposal is a significant step forward for central clearing and for the ability for FCMs and prime brokers to support increased demand as well as continue to support the entire derivatives landscape. An additional area that could have further benefit for derivatives is recognizing cross product netting within derivatives as well as the cross margining aspect, and ensuring that the risk reducing attributes are reflected properly in risk based capital measures.
Representative Downing: Following the 2023 rulemaking by the SEC requiring increased central clearing of Treasury securities transactions, is a mandatory approach the most effective way to achieve these policy objectives? McPartland: The Treasury market has evolved organically in impressive ways. It is important that we take a common-sense approach and implement this in line with other markets where we have seen success and know what works.