Wall Street’s top regulator has put forward new rules to push more Treasury deals by high-speed traders and hedge funds through clearing houses in one of its most assertive attempts to shore up the $24tn market.
The Securities and Exchange Commission will vote on Wednesday on proposing guidelines to add safeguards to the cash and repo markets, which trade billions of dollars a day to set the price of US government debt, but have had their resilience tested repeatedly over the past decade.
Authorities in Washington have become concerned by the fragility of the US government bond market, notably by a “flash rally” in 2014, the repo market crisis in 2019 and the early pandemic meltdown in March 2020, which required intervention by the Federal Reserve. In recent weeks, traders’ ability to get deals done in the Treasury market has deteriorated to its lowest level since 2020 and traders worry the Federal Reserve’s exit from crisis-era policies will place further strains on the market.
Reports from the Bank for International Settlements, the Financial Stability Board and the Fed in recent years have blamed hedge funds and high-frequency traders for pulling back from the Treasury market during moments of stress. Last year the Treasury cash market traded around $3tn a week and the repo market, where traders borrow cash short term in exchange for collateral like Treasuries, around $4tn a day.
SEC chair Gary Gensler has made Treasury reform market one of the key themes of his tenure, by proposing to increase the oversight of lightly-regulated market participants like hedge funds and proprietary traders.
The SEC wants to send more trades through central clearing and reverse a decline in such trades in recent years. A clearing house sits between the two parties in a deal and demands insurance, or margin, to prevent a default by one party from cascading through the market.
Currently only 13 per cent of Treasury transactions are centrally cleared, according to research from the Treasury Market Practice Group. That is a sharp decline from 25 years ago when the investment banks and intermediaries that dominated daily trading in the market would send most of their deals through clearing houses.
But investment banks have pulled back from the market and their activity replaced by proprietary trading firms and hedge funds, whose deals do not go through clearing.
The SEC wants to require clearing houses to accept more Treasury and repo deals from hedge funds and high-speed traders registered as broker-dealers.
It also wants to change the rules around banks holding and netting the margin that is put up to backstop the trade, to encourage both banks and high-speed traders to stay in the market. Netting cuts credit and settlement risks by subtracting offsetting payments against one another.
Gensler in a statement said the new rules “would help to make a vital part of our capital markets more efficient, competitive, and resilient” and would support the Treasury market “especially during stress times that may come in the future.”
This comes after the SEC earlier this year proposed another rule that would force market participants trading more than $25bn a month in Treasuries to register as dealers, a legal status which allows an institution to trade on its own behalf. That rule is expected to cover more hedge funds and high-frequency traders.
Wednesday’s proposal is the latest in a flurry of guidelines proposed by the SEC, which have spanned environmental, social and governance investment claims, special purpose acquisition companies and hedge funds’ disclosures.
If the SEC votes in favour of Wednesday’s proposal, they will be opened to public comment before the agency drafts a final rule.