In the world of finance, Treasury markets hold a unique and
central position, impacting various sectors, including government operations,
capital markets and monetary policy. Speaking before the Securities Industry
and Financial Markets Association (SIFMA), Securities and Exchange Commission
(SEC) Chair Gary Gensler delved into recent reforms aimed at enhancing the
efficiency and resilience of these crucial markets.
Gensler noted how Treasury markets serve as the bedrock for
a substantial portion of capital markets, which are integral to how the Federal
Reserve manages monetary policy and how the government raises capital. At $26
trillion, these markets represent approximately 95 percent of the U.S. Gross
Domestic Product (GDP), representing a major increase from 25 years ago when
they comprised only 44 percent of GDP. This growth underscores their
fundamental role in the financial landscape.
“Beyond being the base of our capital markets, how we
conduct monetary policy, and how we fund our government, these markets also
have three relevant characteristics: deep participation of both bank and
nonbank intermediaries, use of leverage, and repeated jitters over the
decades,” Gensler said.
The three characteristics of Treasury markets, per Gensler’s
comments, are:
1.
Bank and nonbank intermediation;
2.
Leverage by intermediaries in the financial system;
and
3.
Market jitters over time.
Regarding the first characteristic, Gensler explained how
Treasury markets historically have seen participation from both bank and
nonbank intermediaries. Initially, commercial and investment bank dealers were
the primary participants, including primary dealers. However, over the years,
the landscape has evolved with the entry of principal-trading firms and hedge
funds, which accounted for roughly 61 percent of the volume on interdealer
broker platforms in 2019.
Leverage by intermediaries and other market participants
often fund their positions in Treasuries in the repurchase agreement (repo)
markets, Gensler said. Prime brokerage relationships between hedge funds and
nonbank intermediaries often facilitate such relationships, as well as those
between banks and broker-dealers, he added.
“This is not a new phenomenon. In fact, looking back at the
1980s when Drysdale Government Securities failed, that event led to a loss of
nearly $300 million for Chase Manhattan bank,” Gensler said. “When E.S.M.
Government Securities failed, it led to the closing of savings banks in
Ohio. You can see why Congress reacted. Where are we today? A May 2023
Federal Reserve Financial Stability Report noted that ‘hedge fund leverage
remained elevated.’ As noted in the 2022 Financial Stability Oversight Council
(FSOC) annual report, such leverage can create risks for financial stability.
Many hedge funds are receiving the vast majority of their repo financing in the
non-centrally cleared market.”
Gensler also pointed to a study released by the Office of
Financial Research (OFR) examining non-centrally cleared bilateral repo data
collected in June 2022. The results indicated 74 percent of pilot volume was
transacted at zero haircut, Gensler noted.
With respect to the impact of market “jitters,” Gensler referred
to the periodic bouts of volatility experienced within Treasury markets which
have raised concerns about market stability over time. In the 1980s, he noted, the
introduction of the Government Securities Act was prompted by market jitters. He
said the financial crisis of 2008 was also partially influenced by issues
emanating from the repo markets. In March 2020, the onset of the COVID-19
pandemic led to significant disruptions in the Treasury markets, exemplifying
their susceptibility to market jitters.
“Part of the reason we’ve seen jitters is that these three
characteristics are related. We have bank and nonbank intermediaries using
leverage, particularly in the prime brokerage relationships, and when stress
enters the system, the result can be instability,” Gensler said. “We saw some
of this again this year during the regional bank crisis in March of 2023. In
fact, we saw once-in-a-generation volatility, particularly in the short end of
the curve, that we hadn’t seen since the aftermath of the 1987 stock market
crash. Though that 1987 crash related to the equity markets, it’s a reminder
about how instability can come from leverage—in that case, leverage had built
up in trades of stock futures versus underlying cash.”
To address regulatory gaps, promote market integrity and
capital formation, the SEC has proposed rules that would require market
participants acting as de facto market makers in Treasuries to register and
comply with securities laws, Gensler explained.
The SEC has proposed rules to require platforms providing
marketplaces for Treasuries to register as broker-dealers and comply with
Regulation ATS (Alternative Trading Systems). This move is intended to
modernize rules that define exchange-like platforms in an effort to close regulatory
gaps among platforms which act like exchanges but are not regulated as such,
Gensler explained.
He noted the SEC is also working to enhance central
clearing, based on a recommendation dating back to 1969. These reforms aim to
reduce systemic risk by requiring clearinghouses to ensure their members clear
all repo transactions and certain cash transactions.
In the wake of the 2008 financial crisis, there has been a
recognition of the need for increased transparency regarding private funds.
Reforms include rules on data collection from private funds, such as Form PF,
adopted in collaboration with the CFTC. Recent rules require large hedge fund
and private equity fund advisers to make current reports on specific events,
enhancing oversight and transparency into these markets.
Additionally, the SEC has adopted amendments to Rule 15b9-1,
expanding Financial Industry Regulatory Authority (FINRA) oversight to more
broker-dealers, which will provide more data into the Trade Reporting and
Compliance Engine (TRACE) and enhance post-trade transparency in the Treasury
markets.