When I last spoke at this event, in 2023 as a non-chairman commissioner of the Securities and Exchange Commission, I focused on my philosophy to regulating the securities markets, noting that efficient capital formation can bring massive benefits to a nation. [1] The United States also uses those capital markets, as the issuer of U.S. Treasury securities to finance deficit spending. I will focus my remarks today on trading, clearing, and other considerations relating to the Treasury markets. My remarks reflect solely my individual views as a commissioner and do not necessarily reflect the views of the full U.S. Securities and Exchange Commission (SEC) or my fellow Commissioners.

The United States is one of the largest issuers of debt instruments in the world. Importantly, the U.S. Treasury market forms a critical piece of the global financial system. As the deepest and most liquid market in the world, U.S. Treasuries serve as investments, collateral and safe havens in times of market turmoil. Treasury rates are a fundamental benchmark for pricing other financial assets. [2]

Foreign investors have long been important investors in U.S. sovereign debt, predating Treasuries as we understand them today. During the early years of the Republic, by 1803, at least half of the outstanding federal debt and stock in the First Bank of the United States and all U.S. securities issued up to that date were held by European investors [3]. Fast forward to the end of World War II, in 1945, the United States emerged as the largest creditor nation. Foreign investment in U.S. Treasuries surged as the US dollar became the world’s primary reserve currency under the Bretton Woods system. [4]

Foreign holdings of U.S. Treasuries further expanded in the 1980s and 1990s as Japan and European countries accumulated U.S. debt. As of June 2023, one third of marketable U.S. Government debt was foreign owned. Major holders today are located in Japan, China, and the United Kingdom [5]. Foreign private ownership accounts for about half of overall foreign ownership, a share that has increased from approximately one-third a decade ago. [6]

The SEC supervises some participants and infrastructure within the broader U.S. Treasury ecosystem. The SEC does not conduct its work in this area alone and carefully coordinates with other regulatory authorities. This coordination occurs bilaterally and through working groups such as the Inter-Agency Working Group for Treasury Market Surveillance (IAWG), which consists of staff from the U.S. Treasury, the Federal Reserve Board, the SEC, the Commodity Futures Trading Commission, and the Federal Reserve Bank of New York.

As a capital markets regulator, the SEC’s mission is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation. The Commission’s authorities include overseeing the onshore venues where trading in U.S. Treasuries takes place and supervising the clearing agencies that provide services to the markets. The agency also determines the treatment of U.S. Treasury securities by registrants for the purpose of determining net capital, liquidity and other obligations.

Today I would like to talk highlight three areas where the SEC can work with other financial regulators to improve the efficiency and resiliency of the U.S. Treasuries market.

Trading Venues

Let’s start by picturing a hypothetical, on-the-run Treasury security. It was acquired in an auction by a primary dealer and now stands ready to be sold onto the secondary market. If it heads to the interdealer market, there is a significant chance it will be sold on a platform often referred to as an alternative trading system, or ATS.

An ATS is a trading venue that brings together buyers and sellers of securities but is not required to register as an exchange if it complies with Regulation ATS, including a requirement to register as a broker-dealer. When Regulation ATS was adopted in 1998, the Commission opted to exclude an ATS from registering as an exchange or complying with Regulation ATS if the ATS limits its activities to government securities and registers as a broker-dealer or is a bank. [7] At the time, the Commission stated that “government securities are subject to other forms of regulation that help to ensure that those markets are fair and orderly.” [8] In support of the exclusion, the Commission observed that government securities broker-dealers are also regulated by the Treasury and federal banking regulators, all of which provide surveillance of trading activities. [9] All but one commenter agreed. [10]

Over time, however, markets for trading U.S. Treasuries have evolved, Principal trading firms (PTFs) entered the interdealer Treasury market and distinguished themselves from traditional bank dealers by commonly acting as short-term liquidity providers, frequently buying and selling but rarely carrying inventory overnight. [11] ATSs that trade U.S. Treasuries now operate with similar complexities and speed to trading venues for National Market System (NMS) stocks. [12] Despite being dependent on sophisticated technology, ATSs that trade U.S. government securities are not subject to the transparency, fair and orderly markets, investor protections, and system integrity rules that apply to ATSs generally.

In 2020, under the leadership of former Chairman Jay Clayton, the Commission issued a carefully crafted proposed rule based on dialogue with other regulators and industry participants, including through dialogue with the Fixed Income Market Structure Advisory Committee. [13] [14]Among the changes proposed, four stand out:

1. The proposal would have removed the exemption from exchange registration and ATS compliance for ATSs that solely government securities;
2. It would have required public disclosure of the Government Securities ATS’s manner of operations and potential conflicts of interest;
3. To help ensure the fair treatment of users of a Government Securities ATS of significant size, it would apply the fair access rule when that ATS meets a five percent average daily volume (“ADV”) threshold for transactions in either U.S. Treasuries or agency securities, as reported to FINRA; and
4. To address the technological vulnerabilities, and improve the Commission’s oversight, it would apply Regulation Systems Compliance and Integrity(Reg SCI) to Government Securities ATSs that also meet the five percent threshold for either U.S. Treasuries or Agency Securities.

This proposal was made near the very end of Chairman Clayton’s time, and so it fell to former Chair Gary Gensler to pick up the work. However, the Commission took a very different direction. Rather than focusing on the narrow issues relating to Government Securities ATSs, a new iteration of the rule was proposed in 2022 that would redefine the regulatory definition of an “exchange” [15] This version sought to expand the list of affected entities well beyond the realm of Government Securities ATSs. The new definition of the term “exchange” included “communications protocols” without clearly defining what that term meant. Effectively, the vastly expanded definition of an “exchange” would have picked up various protocols used with respect to crypto assets. In my view, it was a mistake for the Commission to link together regulation of the Treasury markets with a heavy-handed attempt to tamp down the crypto market.

As a result, nearly five years have passed since former Chairman Clayton’s effort. Government Securities ATSs continue to host a significant portion of trading in U.S. Treasury securities. Market participants have not benefited from the additional disclosures and the protections of the Fair Access Rule and Regulation SCI as called for in former Chairman Clayton’s proposal.

Therefore, I have issued two directions to the SEC staff. First, I have asked them to re-engage with the Treasury Department, the Federal Reserve, and market participants to consider whether the Commission should move forward on regulatory changes for Government Securities ATSs. Second, in light of the significant negative public comment received on the definition of exchange with respect to crypto, I have asked SEC staff for options on abandoning that part of the proposal.

Clearing

Returning to our hypothetical Treasury security, it has now been sold on the secondary market. In the recent past, this trade, after executing in the inter-dealer market, would likely clear bilaterally. Despite the evolutions in operational complexity of the Treasury market noted earlier, what happened after a trade—the process of clearance and settlement whereby parties to a transaction meet to exchange cash for securities—has not kept pace. [16] compared to ubiquitous practice of central clearing and settlement in the equities and non-Treasury fixed income markets.

Prior to 2000, users of interdealer brokers or IDBs were all members of a central counterparty, and trades were frequently routed to the clearing agency to take advantage of multilateral netting. The rise in the dealer-to-dealer segment of the U.S. Treasury market since then, however, has been by new market participants such as PTFs that are not members of a central counterparty, driving further use of bilateral clearance and settlement. [17]

Central clearing substitutes the creditworthiness and liquidity of the central counterparty for the creditworthiness and liquidity of the counterparties. The central counterparty becomes the buyer to every seller and the seller to every buyer. By centralizing clearance and settlement activities at covered clearing agencies, market participants can reduce costs, increase operational efficiency, and manage risks more effectively. During times of stress, central clearing can also mitigate the potential for the failure of a single market participant to destabilize other market participants. A central counterparty is carefully supervised, however, to mitigate the risk that itself becomes a single point of failure.

The consensus to expand the use of central clearing in the Treasury securities market came from notable events in the market as well as a growing concern over market resiliency. Key regulators met through forums such as the previously mentioned IAWG. The Treasury Market Practices Group made up of senior business managers and legal and compliance professionals from market participants contributed key insights and recommendations. [18]

From these efforts and others like them, in December 2023, the Commission voted to adopt new standards that require covered clearing agencies to promulgate rules to require members to submit eligible transactions in U.S. Treasuries for central clearing. [19] Once the rule comes fully into effect, a majority of cash and repo transactions in U.S. Treasury securities will move to central clearing. The intended effect will be a safer, more resilient Treasury market.

While the policy changes in the rule were sound, the original timeline has turned out to be sub-optimal. In retrospect, the rule did not provide sufficient time for all market participants to adequately prepare for the change. Therefore, last month, the Commission took action to extend some of the original deadlines, which could have resulted in disruptions to this market during implementation. Instead, extending the deadlines to clear cash transactions to the end of 2026 and repo transactions to the end of June 2027 will give market participants, market utilities and the Commission time to address a number of outstanding issues.

Some of these open issues were identified in a recent letter from the IIB and other organizations that represent market participants. [20] I have directed the staff to examine each of these issues and identify a corresponding action plan.

One raised issue that is particularly relevant to this audience is “rule clarifications as to the overall extraterritorial scope of the rule, and necessary SEC engagement with overseas regulators to ensure the ability for global participants to clear cash and repo transactions.” The IIB’s letter was consistent with other feedback on the Treasury clearing mandate that I heard from foreign financial institutions towards the end of last year.

As the letter noted, a lack of clarity regarding the extraterritorial scope of the rule could discourage foreign investors from participating in the Treasury markets. This would not serve the United States’ interests. At a time when debt service costs are exceeding both national defense spending and Medicare, [21] we cannot afford to rush to make changes that might discourage foreign investors from participating in the U.S. Treasury markets. Instead, new rules must be implemented properly, and any operational issues must be addressed.

I encourage you to engage with the appropriate bodies here and in the country of your parent companies to ensure issues are identified and resolved.

Other Considerations

Now, let’s return to our hypothetical U.S. Treasury security. It is sitting on the balance sheet of a broker-dealer, bank, or other financial institution. Many institutions, including those supervised by the SEC, use U.S. Treasury securities to meet their obligations to maintain sufficient capital and liquidity. [22]

When regulatory requirements to hold net capital or liquid assets increase in times of stress—as can happen when market volatility increases the potential for losses or additional draws on sources of liquidity—well-intended regulations can instead create a pro-cyclical effect that impairs market efficiency. Regulators should be mindful of this potential pro-cyclical impact of regulatory requirements and seek to allow the use of countercyclical buffers and other dynamic risk management tools.

While the SEC is not a prudential regulator, financial instability affects its ability to carry out its mission. If a market event occurs, a move towards the safety provided by U.S. Treasury securities can spread volatility between asset classes. However, it also provides buying opportunities at attractive pricing. Hence, when U.S. Treasury securities are sold by certain financial institutions in large numbers to raise cash, other institutions such mutual funds, private funds, insurance companies, pension plans, and family offices can play a market-calming role, by acquiring Treasuries.

In today’s global markets, these trends can quickly spread globally. In this respect, U.S. financial regulators will need to act in cooperation with regulatory authorities in other markets. However, this requires some degree of trust and resource-intensive collaboration among regulators across borders. I have regularly engaged with foreign regulators since becoming a commissioner in 2022, and I intend to continue such outreach and cooperation during my tenure as acting chairman.

Increased cross-border activity enables the United States to share the benefits of its strong capital markets while likewise benefiting from deeper markets including for U.S. Treasury securities. The international entities represented in this organization are vital to these flows of capital, and I look forward to continuing to learn from you.

Thank you for providing me with an opportunity to speak with you this afternoon.

ENDNOTES