Oct 30 (Reuters) – U.S. debt market participants said U.S. regulators will soon pass key rules aimed at curbing debt-powered bets by hedge funds and strengthening financial stability. We anticipate that a final decision will be made. They fear it could reshape the industry and create new problems.
Securities and Exchange Commission rules first proposed last September would force central clearing of the vast majority of trades in the $25 trillion U.S. Treasury market, including short-term funding markets known as repos. The content is as follows. The central liquidator acts as a buyer to all sellers and as a seller to all buyers.
Market participants widely expect the SEC to finalize the rule within weeks, perhaps as early as mid-November, according to industry group SIFMA and six banking and hedge fund industry officials.
But sources said key details remain unclear, including whether the SEC wants the industry to transition to central clearing all at once or in stages, and how long it will take the industry to do so. It is said that it is unknown.
The rules come as other recent regulations have pushed banks out of the Treasury market as intermediaries, creating some of the problems regulators are trying to solve. The industry is concerned that central clearing could undermine that goal if not done properly. There is a risk that costs will increase and more traders will exit.
How it shapes the industry is not fully understood. In recent months, for example, JPMorgan Chase & Co. (JPM.N) has reduced its position in the repo market sector, where the SEC wants banks to expand, according to financial statements. But custodian banks such as Bank of New York Mellon (BK.N) and State Street (STT.N) have more business, disclosures show. A divergent approach has not been reported so far.
This rule will also affect other market participants. How they form could determine whether the few remaining independent brokers in the market survive.
Some hedge funds that have borrowed heavily to take advantage of small differences in government bond prices may decide that trading is no longer profitable and stop trading.
“This is really a big bang approach,” Rob Toomey, head of capital markets at SIFMA, said of the SEC rules. “There are costs associated with this.” The big question remains who will bear these costs. ”
SIFMA, which has been lobbying the SEC, expects a final rule to be released next month ahead of the Nov. 16 Financial Markets Conference.
The SEC declined to comment. SEC Chairman Gary Gensler has previously said the rulemaking process typically takes 12 to 24 months.
JPMorgan and BNY declined to comment. State Street had no comment.
near miss
The government bond market supports global finance, but there are cracks in its foundation. U.S. government debt has ballooned in recent years, but there are fewer buyers.
Banks are reducing their exposure as rising capital requirements make deals less attractive. Hedge funds and other equity traders are entering the market, but they take on a lot of risk and may exit in times of stress.
There have been several near misses, most recently in March 2020, when the U.S. Treasury market panicked in the midst of the pandemic, forcing the Federal Reserve to intervene with emergency measures to prop up the economy. . Many experts now expect some of them to become permanent market features.
This fear prompted U.S. regulators to overhaul the way markets function. The SEC rule will be the most important regulation to date resulting from that review.
Among industry participants interviewed for this article, there is broad consensus on the need for government bond market reform, including the benefits of central clearing. Most of them requested anonymity to speak candidly about the situation.
“It will improve financing and reduce the risk of disruption in the U.S. debt market,” said Yiming Ma, an associate professor at Columbia Business School. “A lot of the worry in the market is how do we get there and are we going to lose something in the process of getting there?”
“A lot depends on how this is implemented. What are the implementation and compliance costs involved?” she said.
something is coming
It is unclear what those costs will be and how they will be incurred, industry officials said.
For example, in the repo market, where investors borrow cash on a short-term basis using government bonds as collateral, most transactions occur between brokers such as hedge funds and customers. SEC rules would force banks to centrally clear it.
However, hedge funds do not have access to the market’s central clearing house, which is a division of Depository Trust Clearing Corporation. This means banks will likely need to use their membership to provide access to customers through a mechanism called sponsorship. This process is costly, and banks must decide whether to pass those costs on to their customers.
Because of these costs, JPMorgan has reduced its sponsored repurchase positions in recent months and moved some of its trades to over-the-counter deals, according to financial statements and one of the people.
In contrast, BNY and State Street are increasing their presence. Although data is lacking, there are some clues in the financial statements. Banks use an accounting process called netting to offset some of their lending and borrowing activity in clearing markets. Custody bank netting has increased dramatically.
For BNY, for example, netting in the sponsored repo market rose to $126 billion in the third quarter, up from $35 billion a year earlier.
SIFMA is asking the SEC to give the industry three to five years to implement the rule. Toomey said he currently expects the SEC to issue two rulings. Wall Street has started making some preparations, but it’s still early days.
“The real assumption is that something is coming. We don’t know what the scope of it is,” Toomey said.
Report by Paritosh Bansal.Editing: Anna Driver
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