U.S. regulators, led by the Securities and Exchange Commission (SEC), are set to approve new rules aimed at subjecting high-speed traders and select hedge funds to direct oversight in the $26 trillion Treasury bond market.
This initiative, part of broader efforts to fortify market stability following recent crises, addresses structural issues identified as contributing to liquidity challenges. Market participants view these changes, including increased trade clearing through clearinghouses, as the most significant overhaul of the Treasury market in decades.
The rule primarily focuses on proprietary traders, identified by the SEC as “critical sources” of liquidity in the Treasury market. Furthermore, it asserts that they should adhere to the same rigorous oversight and risk management standards as other market dealers.
“These measures are common sense,” SEC Chair Gary Gensler said at a meeting. “Congress did not intend for registration and regulatory requirements to apply to some dealers and not to others.”
The SEC’s five commissioners voted 3-2 at the Treasury market dealer rule meeting on Tuesday, February 6. During the meeting, there were objections from Republican members who argued that the rule was overly expansive and would impose excessive burdens on market participants.
Market activity-based rules
Ahead of the meeting, SEC officials had disclosed that the new rules, initially introduced in March 2022, would apply to traders meeting either of two activity-based criteria.
These include firms routinely expressing interest in trading at the best available prices on both sides of the market or primarily generating revenue from trading spreads between securities’ bids and ask prices, along with incentives from trading venues.
In response to public feedback, SEC officials noted substantial revisions to the proposed rule. The revision includes the elimination of a quantitative test mandating registration as dealers for firms trading $25 billion in securities over any four of the prior six months.
A qualitative test requiring registration for firms frequently engaging in same-day transactions of similar securities was also scrapped. Officials estimated that approximately 43 companies would fall under the purview of the new rule.
According to Nathaniel Wuerffel, who heads market structure at BNY Mellon, these alterations eliminate some of the most contentious aspects that have troubled market participants.
“But they won’t fully remove, for example, hedge funds from being captured by the rule if they still meet the qualitative elements of the definition,” Wuerffel said, as quoted by Reuters.
Investor concerns addressed
Some investors expressed concerns in comment letters, saying that the original threshold and tests were overly broad and could inadvertently encompass corporations, insurers and pensions. They had urged the SEC to address these issues, as reported by Reuters.
The SEC’s minority Republican members criticized the rule, arguing that it would impose burdensome legal compliance requirements on firms simply because their trading activity contributed to market liquidity. They contended that the rule might paradoxically reduce liquidity by prompting some players to exit the market.
Jack Inglis, head of the Alternative Investment Management Association (AIMA), noted that even with the revisions, the rule might still oblige certain market participants, such as investment funds, to register as securities dealers. Inglis had previously joined a lawsuit against other new SEC regulations.
“The SEC has incorrectly concluded that customers of dealers, including certain AIMA members, may be dealers themselves,” Inglis said in a statement. He later added that his organization was considering its options.
According to Benjamin Schiffrin, director of securities policy at Better Markets, a Washington non-profit advocating for financial reforms, the new rule aims to safeguard retail investors. It will foster market stability by mandating prop trading firms to adhere to SEC capital, reporting and disclosure requirements.