Evaluation – After the COVID shock, the US monetary market suspended a brand new audit
© Reuters. US President-elect Joe Biden is fighting on behalf of US Senate Democratic candidates Ossoff and Warnock in Atlanta, Georgia. US President-elect Joe Biden is fighting on behalf of US Senate Democratic candidates Ossoff and Warnock in Atlanta, Georgia
By Matt Scuffham
NEW YORK (Reuters) – The functioning of the US $ 20 trillion financial market is under scrutiny by the regulators of President-elect Joe Biden after speaking out in March amid growing pandemic fears and threats to the stability of the broader financial system got under control.
A review of the mistakes and measures taken to make the market resilient could be one of the first regulatory challenges facing new Treasury Secretary Janet Yellen, according to half a dozen regulatory and industry sources.
After the massive sell-off in March prompted the Federal Reserve to buy $ 1.6 trillion in government bonds to stabilize the market, there is growing consensus in Washington that a review is urgently needed. However, potential changes on the table, including easing trading rules, admitting new entrants or introducing centralized clearing, could prove risky to battle for the industry for the loot and costs.
“This is the most important financial market in the world. It requires policy makers to exercise both urgency and the utmost care,” said Gregg Gelzinis, senior policy analyst at the Center for American Progress think tank.
Treasury securities, the deepest and most liquid market in the world, are at the heart of the global financial system. They serve as a benchmark for asset classes around the world and enable the US dollar to act as the world’s reserve currency.
As pandemic fears gripped investors in late February and early March, treasury market liquidity deteriorated rapidly to 2008 crisis levels. The Fed continues to buy around $ 80 billion in government bonds a month, and top officials warn that liquidity is running out could collapse again if this support is withdrawn. [L2N2C90W0]
Randal Quarles, vice chairman of the Fed, and outgoing securities regulator Jay Clayton, have both pointed to the fragility of the treasury market. Yellen himself wrote in a July statement that the Fed and the Treasury Department “at some point” need to review why the Treasury Department’s market-making facilities “are not functioning more efficiently”.
A spokesman for the Biden transition team did not immediately respond to a request for comment.
One option on the table is to increase the number of traders who are allowed to act as the main source of liquidity for the treasury market. Currently, an elite group of 24 Wall Street companies, mostly big banks, are allowed to buy government bonds from the New York Fed and sell them on to customers, creating the secondary market.
Some members of the Treasury Market Practices Group (TMPG), which advises the government on bond market issues, support the idea, according to one of the sources. It is unrealistic to expect a small pool of traders to serve the entire market, especially during times of stress, the person said.
This could mean adding large asset managers to the pool and potentially trillions more liquidity being added to the market, according to the same TPMG source. Proprietary hedge funds that already provide liquidity in stocks could also be approved, the source said.
Traders said the post-crisis rules hurt liquidity by making it expensive to keep stocks of bonds on their books.
The Fed partially responded by temporarily relaxing the rules in April to allow large banks to exclude government bonds from their wealth calculation and reduce the capital they have to hold against them.
But senior bankers like JPMorgan (NYSE :), chairman Jamie Dimon, say regulators should take a closer look at the post-crisis impact of the rules and consider permanent changes.
“I hope they recalibrate all of these things and we don’t have that much capital liquidity tied up in a very rigid way forever,” he said a Goldman Sachs Group Inc (NYSE 🙂 conference last week.
Regulators are also considering introducing central clearing to guarantee treasury deals, much like post-crisis changes to bolster the swap market. Quarles told lawmakers last month that such a mechanism could help by offloading traders’ balance sheets.
A New York Fed spokeswoman, who speaks for the TMPG, referred to previous comments by her officials acknowledging that such options are being discussed.
The role of heavily indebted hedge funds, which were forced to liquidate their treasury positions, further exacerbating the sell-off, is also being scrutinized, according to the sources.
Yellen will likely commission a review in its first few months and interview all stakeholders before making recommendations, three of the sources said. Typically, such changes go through a lengthy regulatory process that includes formal and informal industry feedback.
Due to the complexity of the market, multiple regulators would be involved, making the process difficult. Adding asset managers to the trading pool would likely require them to submit to additional supervision which they may oppose. Central clearing would also require new risk controls some traders struggled with for years when clearing was introduced in the swap market. And hedge funds would likely tackle caps on their leverage.
“Some of the affected sub-sectors of the financial system, traders and hedge funds, are politically powerful. Any proposed guidelines that restrict their activities or weigh on their profits will meet significant resistance,” Gelzinis said.