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Earlier this week we wrote about Ken Griffin’s annoyance with the SEC and its efforts to clamp down on the Treasury basis trade. Yesterday the SEC’s Gary Gensler gave an interesting speech laying out his own views.
You can read the whole thing here. It talks about the dangers of leverage and opacity in the Treasury market, and features a fun anecdote from a meeting he had as a young investment banker at the WSJ’s offices on Black Monday, coincidentally with another budding investment banker called Jay Powell. Yes, that Jay Powell.
But below is the meat: the four main reforms that Gensler is focusing on to stiffen the sinews of the US government bond market. Nothing new, but a good summary of where we’re at. Alphaville has kept the hyperlinked references as they appear, as they often link to important material.
Registration of Dealers
First, following the 1986 Government Securities Act, rules were put in place to register government securities dealers. In the ensuing decades, numerous firms have registered with the SEC, but some market participants acting in a manner consistent with dealers have not.
To fill this regulatory gap, the SEC proposed rules that would further define a dealer and a government securities dealer.[16] Market participants acting as de facto market makers in the business of providing liquidity in Treasuries or other securities would register with the SEC and comply with securities laws.
When dealers or government securities dealers register, they become subject to a variety of important laws and rules that help protect the public, promote market integrity, and facilitate capital formation.
This is one of the things that Griffin is so upset about. The issue is that there isn’t really a clear delineation between liquidity provider or taker, so it would subject a lot of “market participants” to the same kind of onerous controls that primary dealers face. We can see why that’s annoying, but it also seems like it’s an entirely fair way of leveling the playing field.
Registration of Trading Platforms
Second, the Commission proposed rules to require platforms that provide marketplaces for Treasuries to register as broker-dealers and comply with Regulation ATS.[17] Reflecting what I mentioned regarding the electronification of and other significant changes to platforms in recent decades, the proposal also would modernize the rules regarding the definition of an exchange.
This update would close a regulatory gap among platforms that act like exchanges but are not being regulated like exchanges.
Again, this seems like an obvious thing that should have happened ages ago? It is remarkable that Treasury market trading is so balkanised that it took even an army of regulators almost a year to piece together what actually happened in the flash rally of October 2014.
Central Clearing
Third is our proposed rule to enhance central clearing.[18] This is not a new topic. In fact, a 1969 Joint Treasury-Federal Reserve Study of the U.S. Government Securities Markets included a recommendation that: “Consideration should be sought in expanding clearing arrangements for U.S. Government securities.”[19]
Clearinghouses came to the Treasury markets in 1986. By 2017, however, only 13 percent of Treasury cash transactions were fully centrally cleared.[20] A Federal Reserve staff analysis of primary dealer repo and reverse repo transactions during the first half of 2022 found that “approximately 20 percent of all repo and 30 percent of reverse repo is centrally cleared via FICC.”[21]
Reduced clearing increases system-wide risk. Currently, IDBs often are bringing just one side of the trade into central clearing if the counterparty is not also a member of the clearinghouse.[22]
Thus, working along with Treasury and the Federal Reserve, we proposed rules to broaden the scope of transactions required to be brought into central clearing. Further, members of a clearinghouse no longer would be able to net their customers’ margin against their own proprietary trading (also known as the house’s trading).
Our proposal would require clearinghouses to ensure that their members clear all of their repo transactions, both sides of any cash trades executed on an IDB platform, and certain additional cash transactions.
A more controversial one, but one that Citadel actually supports. That so little activity in the Treasury market — the biggest and most systemic market of them all — isn’t centrally cleared is another obvious thing to address.
Yes, it might on the margin increase trading costs (which is why Pimco isn’t crazy about it), and we’re pooling an awful lot of risk on the clearinghouses these days. But it still seems like a no-brainer to push more of the Treasury ecosystem in this direction.
Data Collection
Fourth, let me turn to data collection. After the 2008 crisis, Congress recognized it was important to have more transparency regarding private funds.
In 2011, along with the CFTC, we adopted rules on data collection from private funds, what’s known as Form PF. Ever since, Treasury, OFR, and the FSOC have had a better understanding of these markets.
Yet private funds have evolved significantly in the last 12 years. In May, the SEC finalized a rule requiring, for the first time, that large hedge fund and private equity fund advisers make current reports on certain events to the Commission.[23]
We also have a joint proposal with the CFTC regarding Form PF updates, which would greatly enhance the view of the Commissions and FSOC into private funds’ leverage as well as provide a clearer picture of counterparties.[24] I look forward to completing this project.
Further, in July, we adopted rules with regard to money markets, including amendments to Form N-MFP that will provide more granular information about money market fund activity in the repo market.[25]
Before I close, I want to note the SEC recently adopted amendments to Rule 15b9-1 extending FINRA oversight to more broker-dealers.[26] This will bring more data into the Trade Reporting and Compliance Engine (TRACE). I also am pleased by Treasury and FINRA’s ongoing efforts to enhance post-trade transparency in the Treasury markets, which the SEC is reviewing.[27]
Another reform that Citadel and most of the hedge fund industry hates (well, formPF, not post-trade transparency, which Citadel Securities in particular loves).
Again, transparency isn’t actually costless — and we have to admit some sympathy for the bonkers amount of reports that the finance industry has to compile — but it’s hard to see strong arguments against regulators getting more insight here (even though FTAV is sceptical it will help much).
So, full steam ahead Gary!
Further reading:
