Nellie Liang, Treasury undersecretary for domestic finance, said regulators are “fairly advanced” in taking a close look at liquidity risk management in banks, but must also turn to address potentially systemic vulnerabilities in non-financial intermediaries. banks, including highly leveraged hedge funds.
Liang told the annual meeting of the International Swaps and Derivatives Association on Thursday that among the lessons to be learned from recent bank failures is the impact of social media in triggering bank runs.
“Going forward, banks and regulators will review how liquidity risk and interest rate risk management and regulation may need adjustment given the effects of changes in technology and social media on deposits: their sensitivity to interest rates and their sensitivity to stress,” he said. .
While regulators focus on liquidity risk at midsize banks, Liang said risks have also arisen among a variety of nonbank financial intermediaries, including mutual funds, money market funds and hedge funds.
She said there is a “liquidity mismatch” in the structures of open-ended bond mutual funds and mainstream money market funds that provide credit, but also have “well-known vulnerabilities” and provide “first-mover” advantages.
Investors in open-ended bonds and mutual funds can trade shares daily, although the underlying bonds and loans cannot be sold as quickly.
“This mismatch can have systemic consequences due to highly correlated portfolios and investor behavior, which can lead to dysfunction in periods of stress,” Liang said, citing the global “race for cash crunch” in March 2020 that caused disruptions in the sovereign bond markets.
“Excessive leverage can make it difficult for financial intermediaries to manage system-wide shocks to the demand for or supply of safe assets, amplifying the effects of such shocks,” Liang said. “More recently, in the days immediately following bank failures, substantial margin calls from clearinghouses to highly leveraged hedge funds appear to have increased Treasury market volatility.”
The staff of the Financial Stability Oversight Board has been working to monitor and identify potential emerging financial stability risks posed by highly leveraged hedge funds, it said. His work has focused primarily on “common and broad practices and activities,” rather than individual institutions, she said. Regulators are evaluating certain practices in bilateral repo transactions and the need for broader data collection, she said.
In January, the Office of Financial Investigation proposed launch permanent data collection, beyond a recent pilot, on the $2 trillion repo market that would allow regulators to monitor and identify emerging market vulnerabilities.
The Treasury is also working to make the $24 trillion market for US Treasuries more resilient, including the possible release of some secondary market transaction level data, he said. The Financial Industry Regulatory Authority began publishing daily aggregate volume data on the secondary cash market earlier this year, up from the weekly data it began publishing in 2020.
“We will proceed carefully and likely start with nominal coupons on the fly, with end-of-day spread and limited trade sizes to ensure the market continues to provide the ability to move significant positions,” Liang said. “Regulators are also considering whether changes to the way Treasuries are traded and cleared could make these markets more robust.”
The Treasury also plans to develop a regular Treasury repurchase program to bolster market liquidity, he said. Early next year, the Treasury hopes to begin a program to offer to buy securities in a more predictable manner, starting with amounts between $5 billion and $10 billion a month.
“The program is not intended to significantly change the overall maturity profile of outstanding tradable debt and will not be used to mitigate acute market stress,” Liang said.