US Weighs Leaning on Banks to Curb Hedge Fund Leveraged Trading
Top US regulators are zeroing in on dangers posed by highly leveraged hedge fund trades, and considering options to rein in risks to the broader financial system.
Regulators are especially concerned about the growth of one strategy known as the basis trade, which involves the use of leverage to profit from the price gap between Treasury futures and the underlying cash market. Borrowing in the repurchase market using US Treasuries as collateral has soared in recent years to almost $3 trillion.
Although hedge funds are subject to less direct regulatory oversight, they rely on highly regulated large banks to finance many of their trades. That gives several US agencies sway to limit the activity, and in early-stage plans, regulators are weighing options ranging from pushing banks to gather more data on exposures to pressing them to ramp up haircuts on some secured borrowing, according to people familiar with the matter.
Securities and Exchange Commission Chair Gary Gensler this week sounded the alarm bells. He said on Wednesday that the funding that prime brokerages provide to some hedge funds on a “very generous basis” is the biggest source of risk in the financial system. “If a problem happens, it’s going to be the public that bears the risk of any challenges in this market,” Gensler said in an interview.
Officials across Washington, including Gensler, have for months flagged significant blind spots into hedge fund trading.