Sean Casten Questions Treasury Clearing: Accounting vs. Risk Shifting

Central Clearing and Financial Systems

• 💡 Central clearing agencies are discussed in terms of whether they free up liquidity due to accounting rules or risk shifting.
• ❓ The core question is whether these agencies reduce total risk or merely move it to entities without capital ratio obligations.

Accounting vs. Risk Shifting Explained

• 🏦 In a broker-dealer scenario, offsetting transactions appear as gross liabilities on the balance sheet due to accounting rules, constraining capital.
• 🤝 Central clearing collapses these into a single net transaction, effectively creating zero risk in that specific sense, though margin is still charged.
• ⚖️ This process eliminates counterparty risk by moving transactions to a central clearing house, thereby reducing overall system risk and freeing up balance sheet capacity.

Impact on Capital Ratios and Leverage

• 🚀 Reducing risk on primary dealers, who are subject to capital obligations, can strengthen their balance sheets.
• 📉 This reduction in declared liability can change the denominator in leverage ratio calculations, providing immediate relief before any changes to the ratio itself.
• 📊 Central clearing effectively removes a portion of the balance sheet from leverage ratio calculations, offering fundamental balance sheet relief.

Broader Financial System Implications

• 🏦 The Federal Reserve's discount window for banks and banks' provision of a discount window to hedge funds via the repo market are mentioned.
• ⚠️ There's a concern about financially engineering away more fundamental problems rather than addressing them directly.
• 📈 The netting process reduces risk by offsetting counterparties, but risk remains if one party fails, borne by the other counterparty or the CCP.
• 🔍 The creation of more CCPs is questioned for its impact on system transparency and volatility risk, referencing past events like the 2019 situation and the flash crash.