Good afternoon. Thank you, Ken. As is customary, I’d like to note that my views are my own as Chair of the Securities and Exchange Commission, and I am not speaking on behalf of my fellow Commissioners or the staff.
It’s good to be with the Securities Industry and Financial Markets Association. Fall is in the air. Halloween is behind us. Football is on TV. The Texas Rangers won the World Series for the first time. Thus, Ken’s home state won two years in a row, though I’m assuming you were more excited by the Houston win.
It’s also the time of year many of us from the official sector, academia, and the markets gather to talk about the Treasury markets at the New York Federal Reserve conference. Given a scheduling conflict this year, I’m giving my speech on this topic here with you.
I’d note that my first speech in public service 25 years ago was with your predecessor, the Bond Market Association. What was it about? You guessed it, the Treasury markets.
You might ask—why has this guy given so many speeches, then and now, on the Treasury markets?
Foremost, it’s because the Treasury markets are the base upon which so much of our capital markets are built. They are integral to how the Federal Reserve conducts monetary policy. They are how we, as a government and taxpayers, raise money. We are the issuer.
Beyond being the base of our capital markets, how we conduct monetary policy, and how we fund our government, these markets also have three relevant characteristics: deep participation of both bank and nonbank intermediaries, use of leverage, and repeated jitters over the decades.
Bank and Nonbank Intermediation
First, the Treasury markets long have been characterized by both bank and nonbank intermediation. When I started on Wall Street, the participants largely were commercial bank and investment bank dealers, many of which were primary dealers as well as many other nonbank dealers.
Between 1982 and 1985, a dozen nonbank Treasury dealers failed, including Drysdale Government Securities, Lombard-Wall, and E.S.M. Government Securities. These failures sent shudders not only through the Treasury markets but into the banking system. Congress responded in 1986 and passed the Government Securities Act, which provided the U.S. Department of the Treasury and the SEC with regulatory authorities for these markets.
As electronification of the markets has increased in the last 20 years, principal-trading firms as well as hedge funds have been participating to a greater degree. In 2019, principal-trading firms represented approximately 61 percent of the volume on the interdealer broker (IDB) platforms in the Treasury markets.
Leverage in the System
Another relevant characteristic of these markets is the use of leverage by intermediaries. Such intermediaries and other market participants often fund their positions in Treasuries in the repurchase agreement (repo) markets. The resulting leverage often is facilitated by prime brokerage relationships between hedge funds and nonbank intermediaries on the one hand and banks and broker-dealers on the other.
This is not a new phenomenon. In fact, looking back at the 1980s when Drysdale Government Securities failed, that event led to a loss of nearly $300 million for Chase Manhattan bank. When E.S.M. Government Securities failed, it led to the closing of savings banks in Ohio. You can see why Congress reacted.
Where are we today?
A May 2023 Federal Reserve Financial Stability Report noted that “hedge fund leverage remained elevated.”
As noted in the 2022 Financial Stability Oversight Council (FSOC) annual report, such leverage can create risks for financial stability.
Many hedge funds are receiving the vast majority of their repo financing in the non-centrally cleared market.
In a study of non-centrally cleared bilateral repo data collected in June 2022, the Office of Financial Research (OFR) said that 74 percent of pilot volume was transacted at zero haircut.
Needless to say, it’s not lost on any of us how leverage can lead to instability. I lived through one of those events. In 1998, Long-Term Capital Management (LTCM) was teetering when Treasury Secretary Bob Rubin sent me to Greenwich, Conn. It turns out, LTCM had approximately $1.2 trillion in derivatives and a $100-plus billion balance sheet backed by only $4-$5 billion of net asset value.
Jitters Over Time
Third, this is a market that has been characterized by jitters over time. I’ve mentioned already the 1980s jitters that led to the Government Securities Act. There were jitters emanating out of the repo markets in 2007 and 2008 that contributed to the 2008 crisis.
Working on the Biden-Harris transition, the very real disruptions in the Treasury markets in 2020 were very much on the minds of all of us who, subject to Senate confirmation, were coming into new roles in the U.S. government. In March of 2020, at the onset of the Covid-19 pandemic, in what’s come to be known as the “dash for cash,” many investors moved assets from certain money market funds and even government securities into cash.
This was on the heels of very significant problems in 2019 in the Treasury repo markets. Further, we had the flash rally in 2014.
Part of the reason we’ve seen jitters is that these three characteristics are related. We have bank and nonbank intermediaries using leverage, particularly in the prime brokerage relationships, and when stress enters the system, the result can be instability.
We saw some of this again this year during the regional bank crisis in March of 2023. In fact, we saw once-in-a-generation volatility, particularly in the short end of the curve, that we hadn’t seen since the aftermath of the 1987 stock market crash. Though that 1987 crash related to the equity markets, it’s a reminder about how instability can come from leverage—in that case, leverage had built up in trades of stock futures versus underlying cash.
I recall that day in 1987 well. It was the day after my 30th birthday when the Dow fell nearly 23 percent. That afternoon, I was in a conference room at the Wall Street Journal meeting with the Dow Jones CEO at the time, Warren Phillips. Along with another investment banker, we were advising on a financial transaction. We were interrupted, as Mr. Phillips needed to make a decision about whether the Journal would run a two-column or full-banner headline to mark Black Monday (it ended up two columns).
Three years later, that other investment banker became a Treasury official. One of the first problems he had to contend with was Treasury market jitters emanating from the Salomon Brothers bid rigging scandal. That banker who became a Treasury official later became Chair of the Federal Reserve; he’s Jay Powell.
Muscle Memory and Interest Rates
Before I turn to the work we’re doing on Treasury market reforms, I want to mention one other point. As this audience knows, we’re living through a transitional time regarding monetary policy. It’s not only that short-term rates have gone up in Europe and the United States, but central banks have been transitioning away from what’s known as quantitative easing. With this lessening of central bank involvement in the longer end of the yield curve, we’ve also seen increasing term premiums and volatility.
I’ll digress one more time back to when I started on Wall Street. I was just 21, and my folks came up for a visit. We walked around the firm—I was hoping my parents, neither of whom went to college, would be proud. My mom, Jane, looked concerned. She said, “Gary, I don’t think this is a career. I don’t see anyone over 40 in the whole place.”
I’ve recently been thinking of that story because, whether you are in New York, London, or Singapore, there aren’t that many people who were trading in the markets before the 2008 crisis and the intervening period of low interest rates and quantitative easing. In essence, there’s not much muscle memory predating 2008.
In the last two and a half years, with Secretary Yellen’s guidance, there’s been a lot of collaboration between the Treasury, Federal Reserve, Federal Reserve Bank of New York, SEC, and Commodity Futures Trading Commission, as captured in the Inter-Agency Working Group Report released yesterday.
I’m going to focus on four of those initiatives.
Registration of Dealers
First, following the 1986 Government Securities Act, rules were put in place to register government securities dealers. In the ensuing decades, numerous firms have registered with the SEC, but some market participants acting in a manner consistent with dealers have not.
To fill this regulatory gap, the SEC proposed rules that would further define a dealer and a government securities dealer. Market participants acting as de facto market makers in the business of providing liquidity in Treasuries or other securities would register with the SEC and comply with securities laws.
When dealers or government securities dealers register, they become subject to a variety of important laws and rules that help protect the public, promote market integrity, and facilitate capital formation.
Registration of Trading Platforms
Second, the Commission proposed rules to require platforms that provide marketplaces for Treasuries to register as broker-dealers and comply with Regulation ATS. Reflecting what I mentioned regarding the electronification of and other significant changes to platforms in recent decades, the proposal also would modernize the rules regarding the definition of an exchange.
This update would close a regulatory gap among platforms that act like exchanges but are not being regulated like exchanges.
Third is our proposed rule to enhance central clearing. This is not a new topic. In fact, a 1969 Joint Treasury-Federal Reserve Study of the U.S. Government Securities Markets included a recommendation that: “Consideration should be sought in expanding clearing arrangements for U.S. Government securities.”
Clearinghouses came to the Treasury markets in 1986. By 2017, however, only 13 percent of Treasury cash transactions were fully centrally cleared. A Federal Reserve staff analysis of primary dealer repo and reverse repo transactions during the first half of 2022 found that “approximately 20 percent of all repo and 30 percent of reverse repo is centrally cleared via FICC.”
Reduced clearing increases system-wide risk. Currently, IDBs often are bringing just one side of the trade into central clearing if the counterparty is not also a member of the clearinghouse.
Thus, working along with Treasury and the Federal Reserve, we proposed rules to broaden the scope of transactions required to be brought into central clearing. Further, members of a clearinghouse no longer would be able to net their customers’ margin against their own proprietary trading (also known as the house’s trading).
Our proposal would require clearinghouses to ensure that their members clear all of their repo transactions, both sides of any cash trades executed on an IDB platform, and certain additional cash transactions.
Fourth, let me turn to data collection. After the 2008 crisis, Congress recognized it was important to have more transparency regarding private funds.
In 2011, along with the CFTC, we adopted rules on data collection from private funds, what’s known as Form PF. Ever since, Treasury, OFR, and the FSOC have had a better understanding of these markets.
Yet private funds have evolved significantly in the last 12 years. In May, the SEC finalized a rule requiring, for the first time, that large hedge fund and private equity fund advisers make current reports on certain events to the Commission.
We also have a joint proposal with the CFTC regarding Form PF updates, which would greatly enhance the view of the Commissions and FSOC into private funds’ leverage as well as provide a clearer picture of counterparties. I look forward to completing this project.
Further, in July, we adopted rules with regard to money markets, including amendments to Form N-MFP that will provide more granular information about money market fund activity in the repo market.
Before I close, I want to note the SEC recently adopted amendments to Rule 15b9-1 extending FINRA oversight to more broker-dealers. This will bring more data into the Trade Reporting and Compliance Engine (TRACE). I also am pleased by Treasury and FINRA’s ongoing efforts to enhance post-trade transparency in the Treasury markets, which the SEC is reviewing.
Halloween is behind us. Texas had another good year in the World Series.
Thinking back, my mom was right. I left Wall Street at 39 and was giving that first speech to your predecessor at 40.
Twenty-five years later, we can’t stop our focus on reforms to bring greater efficiency and resiliency to the highly consequential Treasury markets. I’m encouraged by the multi-agency collaboration to reform these markets for the 2020s.
 See Gary Gensler, “Assistant Secretary for Financial Markets Gary Gensler Addresses the Annual Meeting of the Bond Market Association” (March 6, 1998), available at https://home.treasury.gov/news/press-releases/rr2280.
 See U.S. Department of the Treasury, “U.S. Treasury Monthly Statement of the Public Debt (MSPD)” available at https://fiscaldata.treasury.gov/datasets/monthly-statement-public-debt/summary-of-treasury-securities-outstanding.
 See Federal Reserve, “Principal Trading Firm Activity in Treasury Cash Markets” (Aug. 4, 2020), available at https://www.federalreserve.gov/econres/notes/feds-notes/principal-trading-firm-activity-in-treasury-cash-markets-20200804.html.
 See “E.S.M. Collapse: A Lesson In Safety” (March 8, 1995), available at https://www.nytimes.com/1985/03/08/business/esm-collapse-a-lesson-in-safety.html.
 See Federal Reserve, “Financial Stability Report” (May 2023), available at https://www.federalreserve.gov/publications/files/financial-stability-report-20230508.pdf.
 See U.S. Department of the Treasury, “Financial Stability Oversight Council Releases 2022 Annual Report” (Dec. 16, 2022), available at https://home.treasury.gov/news/press-releases/jy1171.
 As a 2021 G30 report put it, “In principle, if all repos were centrally cleared, the minimum margin requirements established by FICC would apply marketwide, which would stop competitive pressures from driving haircuts down (sometimes to zero), which reportedly has been the case in recent years.” See Group of 30 Working Group on Treasury Market Liquidity, “U.S. Treasury Markets: Steps Toward Increased Resilience” (2021), available at https://group30.org/publications/detail/4950. In addition, as a 2021 Federal Reserve Board report said, “Most of hedge fund repo is transacted bilaterally, with only 13.7% of the repo centrally cleared.” See Federal Reserve Board Division of Research & Statistics and Monetary Affairs, “Hedge Fund Treasury Trading and Funding Fragility: Evidence from the COVID-19 Crisis” (April 2021), available at https://www.federalreserve.gov/econres/feds/files/2021038pap.pdf.
 See Office of Financial Research “OFR’s Pilot Provides Unique Window Into the Non-centrally Cleared Bilateral Repo Market” (Dec. 5, 2022), available at https://www.financialresearch.gov/the-ofr-blog/2022/12/05/fr-sheds-light-on-dark-corner-of-the-repo-market/.
 See National Bureau of Economic Research, “The Repo Market and the Start of the Financial Crisis” (December 2009), available at https://www.nber.org/digest/dec09/repo-market-and-start-financial-crisis.
 See Federal Reserve History, “Stock Market Crash of 1987” (Nov. 22, 2013), available at https://www.federalreservehistory.org/essays/stock-market-crash-of-1987.
 See “Remembering Black Monday Crash of 1987” (Oct. 19, 2012), available at https://www.wsj.com/video/remembering-black-monday-crash-of-1987/A5BC09AA-4010-481E-9076-77ECEBFDB25B.
 See House Energy & Commerce Subcommittee on Telecommunications & Finance, “Salomon Brothers & Trading of Government Securities” (Sept. 4, 1991), available at https://www.c-span.org/video/?21029-1/securities-trading-investigation.
 See U.S. Department of the Treasury, “Inter-Agency Working Group Releases New Report on Treasury Market Resilience Efforts” (Nov. 6, 2023) available at https://home.treasury.gov/news/press-releases/jy1883.
 See Securities and Exchange Commission, “SEC Proposes Rules to Include Certain Significant Market Participants as ‘Dealers’ or ‘Government Securities Dealers’” (March 28, 2022), available at https://www.sec.gov/news/press-release/2022-54.
 See Securities and Exchange Commission, “SEC Proposes Amendments to Include Significant Treasury Markets Platforms Within Regulation ATS” (Jan. 26, 2022), available at https://www.sec.gov/news/press-release/2022-10
The Commission also issued a supplemental release to the proposal to address comments from various market participants. See also Securities and Exchange Commission, “SEC Reopens Comment Period for Proposed Amendments to Exchange Act Rule 3b-16 and Provides Supplemental Information” (April 14, 2023), available at https://www.sec.gov/news/press-release/2023-77.
 See Securities and Exchange Commission, “SEC Proposes Rules to Improve Risk Management in Clearance and Settlement and to Facilitate Additional Central Clearing for the U.S. Treasury Market” (Sept. 14, 2022), available at https://www.sec.gov/news/press-release/2022-162.
 See “Report of the Joint Treasury-Federal Reserve Study of the U.S. Government Securities Market” (April 1969) available at https://fraser.stlouisfed.org/title/joint-treasury-federal-reserve-study-us-government-securities-market-318/report-joint-treasury-federal-reserve-study-us-government-securities-market-6282.
 See Treasury Market Practice Group, “White Paper on Clearing and Settlement in the Secondary Market for U.S. Treasury Securities” (July 11, 2019), available at https://www.newyorkfed.org/medialibrary/Microsites/tmpg/files/CS_FinalPaper_071119.pdf.
 See Federal Reserve, “Insights from revised Form FR2004 into primary dealer securities financing and MBS activity” (Aug. 5, 2022), available at https://www.federalreserve.gov/econres/notes/feds-notes/insights-from-revised-form-fr2004-into-primary-dealer-securities-financing-and-mbs-activity-20220805.html.
 See U.S Department of the Treasury, “Inter-Agency Working Group on Treasury Market Surveillance Releases Staff Progress report that Reviews Potential Policies for Bolstering the Resilience of Treasury Markets” (Nov. 8, 2021): “… the expansion of PTFs’ role in the interdealer market beginning in the mid-2000s resulted in a decreasing fraction of interdealer trades being centrally cleared. In recent years, approximately one-half of interdealer cash trades (representing about one-quarter of the total cash market) have been centrally cleared, compared with central clearing of virtually all interdealer trades (representing about one-half of the total cash market) before the entry of PTFs in the interdealer market.” In addition: “Overall, the Treasury Market Practices Group has estimated that 13 percent of cash transactions are centrally cleared; 68 percent are bilaterally cleared; and 19 percent involve hybrid clearing, in which one leg of a transaction on an IDB platform is centrally cleared and the other leg is bilaterally cleared” available at https://home.treasury.gov/news/press-releases/jy0470.
 See Securities and Exchange Commission, “SEC Adopts Money Market Fund Reforms and Amendments to Form PF Reporting Requirements for Large Liquidity Fund Advisers” (July 12, 2023), available at https://www.sec.gov/news/press-release/2023-129.
 See Securities and Exchange Commission, “SEC Adopts Amendments to Exemption From National Securities Association Membership” (August 23, 2023), available at https://www.sec.gov/news/press-release/2023-154.
 See Securities and Exchange Commission “Release No. 34-98859; File No. SR-FINRA-2023-015” (Nov. 3, 2023), available at https://www.sec.gov/files/rules/sro/finra/2023/34-98859.pdf.