Asset managers, insurers and pension funds are pushing to soften a proposed rule aimed at enhancing U.S. Treasury market stability which could require them to register as broker dealers, subjecting them to tougher rules, industry sources and documents show.
They are hopeful the U.S. Securities and Exchange Commission (SEC) will compromise when finalizing the rule, first proposed in March 2022, following conversations with agency staff in recent months, according to two people familiar with the talks.
The rule aims to increase SEC oversight of the $25 trillion Treasury market by requiring firms that trade lots of U.S. government bonds, mainly proprietary traders, to register as broker-dealers, subjecting them to capital, liquidity and other rules. These firms have become critical sources of liquidity, but are currently subject to scant oversight, the SEC said.
The SEC flagged that as many as 46 firms could be affected, but investors say the number will be much larger, partly because the rule as drafted inadvertently captures pensions and some other institutional investors, according to industry comment letters and the sources.
One added that the SEC has been receptive to feedback and that the industry expects it will exempt pension funds when finalizing the rule, which is expected in early 2024 based on typical SEC rule timelines.
The proposal has drawn criticism from a range of investors including BlackRock Inc (BLK.N), T. Rowe Price(TROW.O), Teacher Retirement System of Texas (TRS) and Two Sigma. They have warned the rule will not work as intended and could actually drain liquidity by making it costlier for investors to participate.
“The SEC’s dealer proposal jeopardizes the resilience of U.S. Treasury markets causing many alternative asset managers and their funds to curtail their participation in the Treasury markets,” said Bryan Corbett, CEO of industry group the Managed Funds Association said in an email to Reuters.
An SEC spokesperson said in an email that the agency “benefits from robust engagement from the public and will review all comments,” but declined to comment on potential changes.
The agency has recently made significant changes to other contentious draft rules following industry complaints, including on private fund disclosures, money market funds pricing, and activist investor disclosures. But the changes don’t always satisfy firms and in some cases came as unpleasant surprises.
In September, private equity and hedge fund groups, some of which are also lobbying against the Treasury market rule, sued the SEC over the private fund rules, saying changes to the final version would hurt investors and exceeded the SEC’s authority.
That is one of several lawsuits the SEC is facing as financial firms grow bolder about suing regulators, with others brought by Citadel Securities and the U.S. Chamber of Commerce this year.
Stephen Hall, legal director at Better Markets, a Washington non-profit that advocates for financial reforms, said industry claims the rule could hurt liquidity are purely “speculative.”
MARKET DISRUPTION
The broker dealer rule is sensitive for the SEC, given the global importance of the Treasury market, one of the people said. The rule is part of a series of reforms that aim to boost Treasury market resilience following liquidity crunches.
In March 2020, for example, liquidity all but evaporated as COVID-19 pandemic fears gripped investors, while in 2014 the market experienced wild price gyrations for no obvious reason.
Another SEC rule, due to be finalized this week, would require more firms to secure their Treasury trades with margin.
The SEC says poor oversight of proprietary trading firms has made it harder for regulators to see into the market. Under the proposed rule, anyone trading more than $25 billion in each of four out of the last six calendar months would be a dealer.
The industry says the threshold is far too low and will lead some firms to back out of Treasuries to stay beneath it.
The American Council of Life Insurers (ACLI) wrote that its members could end up disposing of long-term bonds to stay under the threshold, while BlackRock said markets “may become less liquid due to lower participation.”
It could have implications beyond the Treasury market, some firms say. As a broker-dealer, money managers would lose certain protections afforded to investors, while hedge funds would be barred from participating in initial public offerings, they say.
Two Sigma warned the SEC in its letter that the rule could “remove significant sources of liquidity” from the equity market too.
While Better Markets’ Hall said it was possible the rule could cause some Treasury market liquidity providers to pull back, but by enhancing market integrity it was “just as likely to cause other market participants to increase their liquidity-providing activities.”
