Deep Dive: Overhaul of the US Treasuries Market by Regulators
The US Treasuries market, a colossal force in the financial realm with a valuation exceeding $26 trillion, is undergoing a significant overhaul orchestrated by US securities regulators.
Focused on enhancing transparency and bolstering resilience, these transformative changes are poised to reshape the dynamics of a market that plays a pivotal role in guiding the prices of various securities and loans. As rules unfold over the next few years, we delve into the intricacies of the regulatory evolution, exploring the impact on trading infrastructure, operating rules, and disclosure requirements for major private funds.
SEC Rule on Dealer Registration:
In early February, the Securities and Exchange Commission (SEC) pushed through a rule requiring major players in the Treasuries market to register as dealers. SEC Chair Gary Gensler asserts that equal regulation for both market makers and traditional dealers is imperative for a fair and transparent market.
Enhanced Transparency Measures:
The SEC adopted measures to significantly enhance transparency in Treasuries trading. Private funds are now mandated to provide daily, individualized trading reports related to the most recently issued Treasuries, a move aimed at shedding light on the majority of daily trading activity known as on-the-run debt.
Form PF Overhaul:
The SEC, in collaboration with the Commodity Futures Trading Commission (CFTC), is overhauling Form PF, a confidential filing by private fund advisers. Large hedge funds with a net asset value of at least $500 million will need to provide additional information about their investment strategies, counter-party exposure, and trading mechanisms.
Rapid Reporting of Adverse Events:
Quarterly Form PF filings will be supplemented by a provision requiring private funds to report significant adverse events to regulators within 72 hours. This includes events such as a substantial loss of a fund’s aggregate value, termination of prime brokerage relationships, margin changes, or counter-party defaults.
Push for Central Clearing:
A rule approved in December aims to push more Treasury repurchase agreements into central clearing. The goal is to fortify short-term funding deals collateralized with Treasuries and enhance the overall stability of the market.
FINRA Membership for Proprietary Trading Firms:
Proprietary trading firms are compelled to join the Financial Industry Regulatory Authority (FINRA), increasing trade reporting on their Treasuries transactions. This change aligns proprietary trading firms with industry self-regulation.
Why It’s Happening:
Market Liquidity Breakdowns: Severe breakdowns in market liquidity over the past decade, notably the flash rally in 2014 and disruptions during the onset of the COVID-19 pandemic, prompted a comprehensive effort by regulatory agencies to address challenges stemming from the ballooning US debt.
Challenges in Liquidity:
Market participants highlight the challenges in liquidity, attributing it to the surge in outstanding US debt and the impact of post-2008 financial crisis regulations on banks, which have constrained their ability to make markets.
Mixed Reactions to Regulatory Measures:
Industry reactions to regulatory measures vary. While some welcome the concept of central clearing, concerns are raised about the intricate details of implementing the new market plumbing.
What’s Ahead: Industry Response and Potential Litigation:
Market players are preparing for the impending changes in diverse ways. Industry groups are exploring potential litigation against the latest dealer rule, and some have already taken legal action against other SEC rules.
Fleshing Out Central Clearing Rules:
Final rules mandating more central clearing of Treasuries will take over a year to materialize. The Fixed Income Clearing Corp. (FICC), the sole clearinghouse handling Treasuries, needs to revamp its system for hedge funds and proprietary trading firms to comply with the mandate.
What It All Means: Regulatory Objectives:
Regulators aim to create a more stable and transparent market by getting a faster grasp on leverage within the financial system, identifying systemic risks earlier, and better understanding the actions of private funds, whose size dwarfs that of the US banking system.
Industry Preparedness:
The private funds industry is grappling with more than a dozen overlapping compliance deadlines, with many still deciphering the nuanced impact of the rules on their trading strategies.
As the US Treasuries market undergoes this profound transformation, market participants find themselves at a critical juncture. Navigating through the changes will require adaptability and a nuanced understanding of the evolving regulatory landscape. The road ahead promises a more stable, transparent market, with regulators equipped to respond swiftly to emerging crises, ultimately shaping a new era for the US Treasuries market. Naturally, this take is general in nature and for awareness purposes only.
