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Regulators plan to curb big banks’ dominance in Treasury market

Regulators are seeking to broaden trading in the massive $24 billion market for U.S. Treasury securities, a potential power shift away from the small club of big banks that have dominated the market for decades, according to a federal report released Thursday.

Regulators have been on heightened alert about market stability since March 2020, when Covid 19 disrupted the economy and markets, freezing trading in Treasury securities. Recent volatility in the Treasury market has added to concerns.

US government bonds are the foundation of the global financial system. In addition to the sheer size of the market and its role in financing US budget deficits, many financial institutions use Treasury securities as collateral for loans of other types. Erratic market movements can therefore ripple widely through other markets and affect the interest rates consumers pay on mortgages or car loans.

A Nov. 10 report from top regulators — including the U.S. Treasury, Federal Reserve, Securities and Exchange Commission and Commodity Futures Trading Commission — shows regulators are interested in supporting the growth of global trade.

It is a concept in which buyers and sellers would trade Treasury securities directly with each other rather than relying on the big banks. For example, large mutual funds or insurance companies could trade securities directly, rather than using banks as intermediaries. Some other markets use similar business practices; for example, it exists on a small scale in corporate bond markets and in many derivatives markets.

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U.S. officials have stressed they are still in the early stages of considering the benefits and costs of a push to trade all. A conference hosted by the New York Fed next week will focus in part on the idea. Such trade requires infrastructure in markets to make it possible, such as common legal agreements or a central clearinghouse through which buyers and sellers would clear transactions, so any changes could take years to develop.

“In theory, global trading can improve market liquidity by increasing the number and diversity of potential counterparties to a transaction or by reshaping the competition between them,” the regulatory report states. “Global trading can also provide increased transparency.”

A separate report released last month by the Federal Reserve Bank of New York further underscored the interest of regulators. Global trade, he said, “could be particularly useful in times of crisis, when the capacity of traditional intermediaries can be tested”.

Primary dealers, a group of about two dozen major global institutions, now play a central role in the US government’s efforts to sell its securities. Dealers – which include the business operations of Barclays, Citigroup, Credit Suisse, Goldman Sachs, JPMorgan Chase and other major global banks – are forced to bid at government debt auctions and distribute the securities they buy.

“It is unfair to expect the same liquidity providers to be able to provide the same levels of liquidity when the Treasury market has more than doubled in size but seen no real innovation over the past twenty years,” said Chris Concannon, President and Chief Operating Officer. of MarketAxess Holdings, which operates a global treasury secondary market trading platform it launched earlier this year.

Treasury debt held by the public has risen from less than $4 billion in 2002 to $24.4 billion this week, according to the Treasury. More than $600 billion worth of Treasuries trade on average every day, according to data collected by the Securities Industry and Financial Markets Association, an industry group. Primary dealers are involved in the vast majority of these transactions, according to research by the New York Fed.

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Regulators set up an interagency group to monitor the Treasury market in 1992 when investment bank Salomon Brothers was found to be breaking auction rules. In recent years, regulators have become concerned that trading in Treasury markets has become less transparent and more prone to disruption.

One case was a “flash crash” in October 2014, when Treasury yields fell and then rallied within minutes of trading with no obvious catalyst. In mid-September 2019, repo markets, which rely on Treasury securities as collateral, experienced unusual volatility over a short trading period. Then the Treasury markets froze in March 2020, when Covid 19 hit the economy and the financial system.

One concern is that the ability of big banks to hold securities themselves has not grown as much as the Treasury market. Since the 2007-2009 financial crisis, new federal capital and liquidity regulations have dampened the growth of bank balance sheets.

In recent months, officials have noticed that Treasury markets have become less liquid and more volatile. One consequence of these developments is that relatively small transactions lead to larger swings in bond prices and yields than before.

US securities regulators don’t think they can insure against calamitous events like a pandemic, but they say they are trying to strengthen the underlying market by making it more transparent and taking other steps to ensure access wider in the market.

Big banks have argued that regulators should ease capital requirements associated with their Treasury holdings. This would allow them to play a bigger role in the market, the banks say.

The Fed allowed a temporary pandemic-related reprieve to expire on the capital requirements in question last year, while promising to offer a broader overhaul. He hasn’t done it yet. The November 10 report does not mention the issue.

Another challenge facing regulators is that the Fed’s own campaign to raise short-term interest rates to fight inflation is a driver of volatility in Treasury markets. If market volatility turns extreme, Fed officials could be placed in the difficult position of having to decide which issue to prioritize: fighting inflation with rate hikes or mitigating the volatility that rate hikes contribute to. cause.

Something like this happened in September in the UK, when the The Bank of England stepped in to contain the fallout from a furious sell-off in the bond market that threatened the UK’s financial stability.

Write to Andrew Ackerman at [email protected] and Jon Hilsenrath at [email protected]

This article was published by The Wall Street Journal, another publication of the Dow Jones Group

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