Federal regulators want to overhaul the Treasury securities market in the name of financial stability.
Securities and Exchange Commission Chair Gary Gensler and Treasury Department Under Secretary for Domestic Finance Nellie Liang called for more transparency, a broader regulatory umbrella and more competition in the government bond space in remarks delivered at the Federal Reserve Bank of New York's U.S. Treasury Market Conference on Wednesday.
"When you maximize the competitiveness, the liquidity and resiliency of a $24 trillion Treasury market, that does lower the cost of financing and help the American taxpayer who, ultimately, the Treasury is issuing for," Gensler said. "It also helps the central bank, our Federal Reserve, administer monetary policy. It also helps the fluid functioning of our financial system as Treasuries are the base, the foundation of our entire capital market."
The regulators' remarks were delivered a week after the latest joint report from the SEC, Treasury, the Federal Reserve Board of Governors, the Commodity Futures Trading Commission and the New York Fed on their efforts to mitigating default risks in trades and ensure the smooth functioning of a Treasury market that is three times as large as it was prior to the subprime mortgage crisis of 2008.
The agencies have been collaborating on the issue since last year, but Gensler noted recent uncertainties in government debt markets around the world, including the U.K.'s October bond crisis, have demonstrated the need for reform.
"Yes, the Treasury market is larger than the
Liang, in her remarks, said the Treasury market is showing signs of weakness as inflation persists, interest rates around the world rise and the war in Ukraine drags on. But for now, she noted, the developments do not seem poised to threaten financial stability in the near term.
"Over the past year or so, liquidity conditions in the Treasury market have shown some deterioration, but I believe these conditions largely reflect the heightened uncertainty about economic and geopolitical conditions," Liang said. "It is not surprising that it is somewhat harder and more expensive to trade, but there is a significant amount of trading. Moreover, to date, we have not seen strong signs that the decline in liquidity is driving up financial volatility."
For banks, Treasury securities are a key source of liquidity. Because of the market's depth, U.S. sovereign debt is typically easily converted to cash. Banks have significantly increased their government debt holdings since 2020, when the Treasury Department increased the bond supply by nearly $4.3 trillion to support the economy through the COVID-19 crisis.
But as the Treasury market has grown bigger and more complex, it has become prone to shocks, the latest of which also occurred in 2020, as institutions around the world moved to sell U.S. government bonds in a "
The episode was ultimately resolved through the Fed's quantitative easing efforts, which saw it buy up Treasury securities en masse, but Gensler said the regulators would like to reduce the market's reliance on the Fed as a buyer of last resort.
"We do have the central bank, but I'd like to lower that left tail risk that they're not trying to bail out [inter-dealer brokers] in the middle of a stress period," Gensler said.
Earlier this year, the Fed stopped buying Treasury securities, and in June it began
New York Fed President John Williams, in remarks delivered during Wednesday's event, noted that as the Treasury market has grown in size, it has also grown in complexity, with an increasing share of activity being driven by hedge funds and other entities trading on platforms or through brokers that are outside the regulated space.
"The Treasury market has increased enormously over the past quarter century, and the key players have changed significantly, and the rest of the financial system continues to evolve, with nonbank financial institutions playing an increasingly important role," Williams said. "The Financial Stability Board has been actively engaged in this space, assessing global trends and risks through a monitoring exercise and developing policy recommendations to strengthen oversight and regulation. Here at the New York Fed, we too are deepening our expertise and monitoring of" nonbank financial institutions.
Along with the growing share of nonbank participants, many transactions are being conducted through intermediaries that are not SEC-covered clearing agencies, meaning regulators have limited purview into who is transacting and on what terms.
Liang, in her remarks, noted that about 60% of primary dealer repurchase agreement lending and 40% of borrowing takes place in the non-centrally cleared bilateral repurchase segment of the market.
"This suggests an important gap to fill, to collect information on primary dealers' counterparties and the terms of the trades to be able to assess leverage in the Treasury market and the market's resilience to various shocks," she said.
Liang said the agencies are considering ways to increase transparency in the space, noting that requiring post-trade disclosures similar to those applied to mortgage-backed securities and corporate debt transactions could increase competition in the market and decrease costs.
Gensler also noted that many inter-dealer brokers, or IDBs, which are providing clearing services for Treasury transactions, are only bringing in one party and requiring little to no collateral, known as margin. Both practices raise the possibility of counterparty default, he said.
"That's not the safest system," Gensler said during a Q&A session following his prepared remarks. "You have a bunch of large intermediaries that are providing prime brokerage relationships to significant parts of our sovereign debt market, whether it's hedge funds, macro hedge funds or the like, with flat or zero haircuts. You get in a stress bind, those banks have to change those relationships and change those prime brokerage relationships as well. I prefer to be in a system where you're actually netting, getting the benefits of netting, but also collecting margin during normal times and stress times."
In his remarks, Gensler said regulators would like to drive more transactions to covered clearinghouses to insulate the market from shocks. He noted that the SEC has already voted to require broker-dealers to register with the Financial Industry Regulatory Authority and regulators are working to require Treasury trading platforms to do the same.
One of the goals of these changes is to facilitate what is known as all-to-all trading, in which, similar to the stock market, a wide array of participants can trade with each other on exchanges, Gensler said, as opposed to the current system that relies heavily on relationships, with a handful of firms dictating much of the activity.
Some market participants are wary of disintermediating prime dealers, which are the main conduits for Treasury transactions, by shifting to an all-to-all market.
During a panel on all-to-all trading at Wednesday's panel, Priya Misra, head of global rates strategy at TD Securities, one of the largest prime dealers in the country, said firms such as hers improve resilience in the market by being able to transact through good times and bad.
"As we think about expanding the all-to-all protocol, I think we should consider the benefits that prime dealers bring to Treasury market intermediation or in the risk transfer process," Misra said. "In stress times, you have to think that market resilience would be more challenged."
