SEC's Urgent Demand for Transparency: Proposals to Monitor Hedge Funds and NBFIs Amidst Unprecedented Treasury Bond Volatility

Here is what we will be getting into today:

1. SEC to target Hedge Funds

2. London Stock Exchange Reacting To Crypto Demands

Let's Dive In!

SEC Demands Increased Monitoring of Hedge Funds Amidst Treasury Bond Volatility

The Securities and Exchange Commission (SEC) has demanded increased attention and monitoring of hedge funds and other non-bank financial institutions due to the significant volatility of treasury yields in March, which was higher than the volatility observed in the past 35 years. The US 2yr went from a high of 5.6% to a low of 3.6% in a matter of days.

SEC's chair, Gary Gensler, is worried that speculative investors pose a risk to financial stability and wants to understand better how their bets can affect asset classes and the real economy. Hedge funds have mostly escaped regulatory scrutiny over the past decade, even after the 2021 collapse of Archegos. However, several prominent macro hedge funds incurred billions of dollars in losses on paper as investors shifted to bonds after the collapse of Silicon Valley Bank.

The SEC's concerns over hedge funds' potential impact on financial stability are not new, as demonstrated by the collapse of Long-Term Capital Management caused by highly leveraged hedge funds using derivatives to speculate in the market. This crisis highlighted the need for greater regulation and prompted leading figures to call for reform. Although hedge funds have the potential to add liquidity to global financial markets, unregulated speculation can lead to excessive levels of risk-taking and potentially trigger a systemic crisis. The SEC should draw upon lessons from past crises and the associated risks of unregulated speculation as it proposes to enhance disclosure and real-time data accessibility from hedge funds.

While regulatory oversight is crucial in preventing financial crises, it is also important to acknowledge the potential for fraudulent behavior in the financial industry. Banks and hedge funds alike can be susceptible to misconduct. To truly prevent future crises, a comprehensive approach that includes strong corporate governance, business ethics, and individual accountability is necessary. Additionally, in times of financial panic, it may be more beneficial to allow the market to self-correct rather than intervening through government action, which could create moral hazards and distort risk-reward incentives. Ultimately, a multifaceted approach that addresses both regulatory oversight and individual accountability is necessary to safeguard financial stability.

The SEC is considering proposals to require market participants to provide greater disclosure about their activities and to grant itself access to more real-time data during periods of market turmoil. It has also proposed guidance that would require hedge funds to inform it immediately when they have large investor withdrawals or significant losses.

London Stock Exchange Group to Clear Crypto Derivatives in Response to Rising Institutional Demand

The London Stock Exchange Group has announced plans to clear crypto derivatives, catering to rising institutional demand for digital assets. The UK group will use the Paris arm of its clearing subsidiary, LCH, to manage risks on bitcoin futures and options traded on GFO-X, a UK regulated marketplace. LCH's Paris arm aims to begin clearing crypto derivatives in the fourth quarter of the year, subject to regulatory approvals.

Despite waves of bankruptcies among crypto companies, sharp declines in token prices, and a series of enforcement actions by US regulators, asset managers and traders have not been deterred from investing in cryptocurrencies & have turned to crypto derivatives as many of them cannot trade coins due to regulatory and compliance concerns.

Derivatives such as futures and options products allow traders to bet that the price of an asset will rise or fall in a certain timeframe while only funding a fraction of the value of their trades. The move by LSE is a significant development for France, which has positioned itself as one of the most open crypto havens in the G7 and sought to attract big companies to set up offices and regional headquarters in Paris.

The LSE's biggest rivals, such as CME Group, CBOE Global Markets, and Deutsche Boerse, have all stepped up offerings to customers that wrap crypto assets in more traditional products and services. The head of LCH DigitalAssetClear has said there is a lot of demand from institutional investors to trade, but for it to happen, there needs to be a framework that they are comfortable with, which at this stage is traditional market infrastructure, a regulated market venue, and regulated clearing house.

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