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ETF Takeover of Wall Street Deepens as Debt Funds Are OK'd as Collateral

"Overall, it’s another use case for ETFs, besides long-term investing, tactical directional bets, and hedging."

(Bloomberg) -- CME Group Inc. delivered another win to the booming $1.3 trillion bond exchange-traded fund market. 

The derivatives exchange operator’s clearing unit will accept a handful of short-dated Treasury ETFs to meet initial margin requirements, according to a statement Tuesday. Five funds including the $18 billion SPDR Bloomberg 1-3 Month T-Bill ETF (ticker BIL) qualify, CME said separately. 

It’s a boon for a quickly growing corner of the $6.6 trillion ETF market, which has long been dominated by index-hugging equity funds. Assets in bond ETFs have ballooned in recent years as institutions and professional money managers warm up to the structure, a trend which was accelerated by the Federal Reserve’s surprise decision to buy credit funds at the height of the pandemic market turmoil in March 2020. CME’s decision to allow debt ETFs as collateral further knits the products into Wall Street’s wiring, industry experts say. 

“Overall, it’s another use case for ETFs, besides long-term investing, tactical directional bets, and hedging,” Strategas Securities ETF strategist Todd Sohn said. “Using ETFs just makes this so much more streamlined and efficient.”

Adding short-dated Treasury ETFs to the roster of allowed collateral should provide “greater flexibility and increased efficiency in managing collateral costs,” CME said in Tuesday’s release. Unlike actual Treasuries -- the proceeds of which must be re-invested after the securities mature -- debt ETFs hold a constant maturity and thus don’t need to have the exposure rolled forward, which is more “operationally efficient,” CME said. 

The CME’s decision comes months after the New York Department of Financial Services said it would allow insurance companies to classify fixed-income ETFs as individual bonds rather than equities for capital requirements purposes -- a catalyst cited by BlackRock Inc. in their forecast for global bond ETF assets to reach $5 trillion by 2030. 

“Much like recent wins in the insurance side of things, this increases the use cases for fixed-income ETFs with institutions,” said Dave Nadig, financial futurist at data provider and research consultants VettaFi. “It won’t mean billions overnight or anything, but it makes these funds specifically much more utile.”

Of course, it remains to be seen how robust demand will be to use bond ETFs as collateral, according to Kevin McPartland of Coalition Greenwich. But the decision signals how important ETFs have become to the functioning of bond markets, he said. 

“The next question will be how or if this offering is utilized by clearing brokers, or do they largely still stick to the status quo of collateral posting,” said McPartland, the firm’s head of market-structure research. “This is another signal that fixed-income ETFs are cemented as a huge part of the fixed-income market.”

--With assistance from Alexandra Harris.

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