Witnesses Warn of Regulatory Blind Spots in Treasury Derivatives Market

At a House Financial Services Committee Task Force hearing, witnesses agreed that derivatives are essential to Treasury market function — but that the oversight infrastructure has not kept pace with market complexity.

In their testimonies, Terry Duffy (CME Group), Jeff Cranston (Optiver), Prof. Yesha Yadav (Vanderbilt Law School), Kevin McPartland (Crisil Coalition Greenwich) agreed that derivatives served as the load bearing infrastructure of the Treasury market and that futures, options, and swaps are not peripheral to the Treasury market, but central to its price discovery and liquidity. They cited the fact that Treasury futures are now tracking at ~93% of cash volume. They also remarked that while the SEC's clearing mandate is underway and the April 30th CME-FICC cross-margining launch is a genuine milestone, questions about balance sheet capacity, done-away clearing, potential liquidity fragmentation across competing central counterparties ("CCPs"), and the foreign clearinghouse debate (including a concern about the Bank of England's authority over U.S. Treasury contracts) add real complexity. Professor Yadav raised additional concerns that (i) no single regulator can see a fund's full position across cash, repo, and swaps simultaneously; (ii) the Office of Financial Research is being significantly downsized; and (iii) the very collateral CCPs rely on in a crisis is the asset most likely to be stressed in that same crisis.

The witnesses agreed that the cross-margining expansion and the clearing mandate represent genuine progress. They differed however, as to how to weigh that progress against the information architecture required to manage what comes next. They warned that with the basis trade expected to grow materially following the cross-margining launch — the lower margin cost makes the trade significantly more attractive — the leverage that flows through poorly monitored bilateral repo will likely grow with it.