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Does anyone understand this? Seems important.
From what I can gather - there was something called frontrunnning that we learned about during the lead up to 2008 crisis.
In it, Wall Street firms used computers to track market bids. They could make a trade faster than a human so knew what the moment to moment price changes were. If a bid to buy for $1 a share was made, they could buy it for 99c a share and fill the order making 1c a share (or 0.1c a share etc.). While the gains would be very small this would build up over a trading day and be a nice earner for whoever had the algorithm running.
I recall watching the Washington Journal on CSPAN and a guy called in and said that most of the trading was automated. There was a "we get all the crazies" look from the host. That's when I first heard about it.
Anyway, the news broke and we're all like "sure it's grand" now - it provides liquidity to the market and as far as I know it is still going on. They wanted to put a penny tariff on each share traded just to take the margin off this activity but I don't think it came to anything. It's not blatant cheating or anything like that.
It looks like this is going on in government debt in America as well. Hedge Funds are trading massive volumes of bonds to earn a tiny margin off market moves. Because they use massive loans (leverage) the money they put up gets a good percentage return (10%). It looks like they're relying on something along the lines of the Fed Put (or effectively a trading insurance policy from the Federal Reserve like they have for home loans) to keep the thing going - it's so large that it poses "systemic risk".
Apparently it also means that this activity makes the market "liquid" or that if you want to buy or sell something you can pretty much do it when you like rather than having to wait an hour or a day or a week or a month to have a trade accepted.
There was also talk about CDOs and other derivatives - that I'm not sure I understand other than they appear to be insurance policies that traders take out to minimise the amount of money they can lose if there is a big change in price. There's supposed to be TRILLIONS of this in the system but it's all very opaque in the day to day and never mentioned on CNBC or Bloomberg.
Anyway, the SEC (the regulators of Wall Street) want the Hedge Funds to have to give them more information on what they're at which threatens to put friction in the government debt market if they don't sign up (they're unlikely to because they're sort of playing the system) and this may cause problems in the Federal Government's ability to borrow in the market. Given there's a multi-trillion dollar deficit, this could be challenging going forward.
I don't know if this is a good summary of the below article. It was on the front page of ZeroHedge but is behind the paywall now. I'd appreciate some clarification on it.
'The SEC ... decided in a 3 to 2 vote to boost oversight of rates trading by the firms, which are increasingly responsible for liquidity in the world’s biggest government bond market but only because they use trillions in leverage. The new regulations would also apply to market participants in additional government bonds, equities and other securities.
...
Since it was the catastrophic implosion of the basis trade - or rather the leverage the kept it viable - in Sept 2019 and again in March 2020 that sparked a panicked emergency reaction by the Fed, it is not a surprise that regulators had been looking for ways to glean more insight into the books of hedge funds that dabble in the trade.
Under the rules, dealers would include firms that buy and sell securities for their own account as part of the regular course of their business. the label also carries more oversight from the industry-backed Financial Industry Regulatory Authority.
...
The presentation then goes on to discuss some of the fundamentals in the basis trade (must read for anyone unfamiliar with the reasons why hedge funds are so drawn to it) and then turns its attention to the type of returns hedge funds generate in the TSY basis trade as well as the associated leverage. Here is where we find out that "indicatively", the leverage involved is a whopping 20x, or in other words a mere 5% positional drawdown on the pair trade - which was saw repeatedly during the March 2020 covid shock - is enough to wipe out all the equity in the trade!
And what is even more terrifying is that TBAC's quiet, tacit admission that "repo and futures margins do permit higher leverage", which is why one can be certain that many hedge funds use that, or even higher leverage than 20x!
...
One final question: how big is the basis trade (after all we need some context to quantify the systematic risk). Well, the answer is nobody knows because the breakdown of how much regulatory capital is allocated to basis trades is secret, and is why the SEC is now demanding more clarity and will start treating basis traders as dealers.
...
And there you have it: all the basis trade is, is the latest manifestation of the "collecting pennies in front of a steamroller" trade, because when it works it generates 10% returns every year like clockwork, with the only gating factor being how much leverage a hedge fund has access to.
...
The rule, which was adopted after a close 3-2 vote, will go into effect 60 days after publication in the Federal Register. Companies would have to comply with the registration requirements one year after that date. At that time, liquidity in the bond market may disappear.
https://home.treasury.gov/system/files/221/TBACCharge1Q12024.pdf'
SEC Cracks Down On Basis Trades, Will Force Top Hedge Funds To Register As Dealers, Resulting In Collapsing Treasury Market Liquidity - Zerohedge
From what I can gather - there was something called frontrunnning that we learned about during the lead up to 2008 crisis.
In it, Wall Street firms used computers to track market bids. They could make a trade faster than a human so knew what the moment to moment price changes were. If a bid to buy for $1 a share was made, they could buy it for 99c a share and fill the order making 1c a share (or 0.1c a share etc.). While the gains would be very small this would build up over a trading day and be a nice earner for whoever had the algorithm running.
I recall watching the Washington Journal on CSPAN and a guy called in and said that most of the trading was automated. There was a "we get all the crazies" look from the host. That's when I first heard about it.
Anyway, the news broke and we're all like "sure it's grand" now - it provides liquidity to the market and as far as I know it is still going on. They wanted to put a penny tariff on each share traded just to take the margin off this activity but I don't think it came to anything. It's not blatant cheating or anything like that.
It looks like this is going on in government debt in America as well. Hedge Funds are trading massive volumes of bonds to earn a tiny margin off market moves. Because they use massive loans (leverage) the money they put up gets a good percentage return (10%). It looks like they're relying on something along the lines of the Fed Put (or effectively a trading insurance policy from the Federal Reserve like they have for home loans) to keep the thing going - it's so large that it poses "systemic risk".
Apparently it also means that this activity makes the market "liquid" or that if you want to buy or sell something you can pretty much do it when you like rather than having to wait an hour or a day or a week or a month to have a trade accepted.
There was also talk about CDOs and other derivatives - that I'm not sure I understand other than they appear to be insurance policies that traders take out to minimise the amount of money they can lose if there is a big change in price. There's supposed to be TRILLIONS of this in the system but it's all very opaque in the day to day and never mentioned on CNBC or Bloomberg.
Anyway, the SEC (the regulators of Wall Street) want the Hedge Funds to have to give them more information on what they're at which threatens to put friction in the government debt market if they don't sign up (they're unlikely to because they're sort of playing the system) and this may cause problems in the Federal Government's ability to borrow in the market. Given there's a multi-trillion dollar deficit, this could be challenging going forward.
I don't know if this is a good summary of the below article. It was on the front page of ZeroHedge but is behind the paywall now. I'd appreciate some clarification on it.
'The SEC ... decided in a 3 to 2 vote to boost oversight of rates trading by the firms, which are increasingly responsible for liquidity in the world’s biggest government bond market but only because they use trillions in leverage. The new regulations would also apply to market participants in additional government bonds, equities and other securities.
...
Since it was the catastrophic implosion of the basis trade - or rather the leverage the kept it viable - in Sept 2019 and again in March 2020 that sparked a panicked emergency reaction by the Fed, it is not a surprise that regulators had been looking for ways to glean more insight into the books of hedge funds that dabble in the trade.
Under the rules, dealers would include firms that buy and sell securities for their own account as part of the regular course of their business. the label also carries more oversight from the industry-backed Financial Industry Regulatory Authority.
...
The presentation then goes on to discuss some of the fundamentals in the basis trade (must read for anyone unfamiliar with the reasons why hedge funds are so drawn to it) and then turns its attention to the type of returns hedge funds generate in the TSY basis trade as well as the associated leverage. Here is where we find out that "indicatively", the leverage involved is a whopping 20x, or in other words a mere 5% positional drawdown on the pair trade - which was saw repeatedly during the March 2020 covid shock - is enough to wipe out all the equity in the trade!
And what is even more terrifying is that TBAC's quiet, tacit admission that "repo and futures margins do permit higher leverage", which is why one can be certain that many hedge funds use that, or even higher leverage than 20x!
...
One final question: how big is the basis trade (after all we need some context to quantify the systematic risk). Well, the answer is nobody knows because the breakdown of how much regulatory capital is allocated to basis trades is secret, and is why the SEC is now demanding more clarity and will start treating basis traders as dealers.
...
And there you have it: all the basis trade is, is the latest manifestation of the "collecting pennies in front of a steamroller" trade, because when it works it generates 10% returns every year like clockwork, with the only gating factor being how much leverage a hedge fund has access to.
...
The rule, which was adopted after a close 3-2 vote, will go into effect 60 days after publication in the Federal Register. Companies would have to comply with the registration requirements one year after that date. At that time, liquidity in the bond market may disappear.
https://home.treasury.gov/system/files/221/TBACCharge1Q12024.pdf'
SEC Cracks Down On Basis Trades, Will Force Top Hedge Funds To Register As Dealers, Resulting In Collapsing Treasury Market Liquidity - Zerohedge
