Hedge funds would have to start centrally clearing many of their transactions in US Treasuries under a new regulatory plan designed to protect against a market meltdown.
The Securities and Exchange Commission on Wednesday voted unanimously in favor of proceeding with a plan to give clearinghouses — which sit between buyers and sellers and ultimately backstop the transactions — a much bigger footprint in the $24 trillion dollar market for American government bonds. The draft regulations would make trading safer and limit the chance of any single firm harming the broader financial system, according to the SEC. If finalized, the regulations would represent a significant overhaul for the market and are likely to draw pushback from parts of Wall Street.
Although there hasn’t been a blow up since the pandemic-sparked chaos of early 2020 and a sudden spike in the overnight repurchase, or repo, rate in 2019, concerns over the world’s biggest government debt market have continued to mount. While massive Federal Reserve buying of Treasuries stabilized the market over the past two years, liquidity gauges have eroded since the purchases stopped.
Since the 2008 financial crisis, clearinghouses have been a growing fixture of US financial markets. Still, despite their increased use for trading other assets, only a fraction of Treasuries transactions go through them, according to Gary Gensler, the SEC’s chief.
“I want to take off the table that we have to worry about in the next stress time these interdealer brokers,” Gensler said at a news conference after the vote. “They don’t have clearing rules right now. They’re regulated by us as broker dealers, but they’re not regulated as clearinghouses.”
Clearing entities for Treasuries, which are directly overseen by the SEC, can provide trade matching, settlement of transactions and risk management services. As an intermediary, to smooth out trading, clearinghouses effectively act as the buyer for a seller of securities and the seller for buyers to smooth trading.
While interdealer brokers that handle Treasuries transactions belong to clearinghouses, other parties in a transaction may not. The proposed rule changes, in theory, would push more of those trades, done by the likes of proprietary trading firms and hedge funds, onto the centralized systems.
Bryan Corbett, who leads the Managed Funds Association trade group for hedge funds, said in a statement that the proposal was “arbitrarily singling out hedge funds for mandatory central clearing, which could impact market competition and lead to increased costs borne by institutional investors.”
The regulations would apply to parties to transactions in the repo market, including money market mutual funds, according to the SEC. Most types of traders in the Treasury cash market, including hedge funds, government securities brokers and dealers, and those using leverage, would also face the new regulations.
Each of the five commission members approved the proposal. Commissioner Hester Peirce, one of the agency’s two Republicans, supported the proposal on the merits of seeking to reduce risk, but suggested the proposal might be taking a “considerably heavier hand to achieve the goals of central clearing than seems necessary.”