Securities and Exchange Commission Chair Gary Gensler repeated warnings about leveraged trading by hedge funds and investment firms in the U.S. Treasurys market. 

A raft of SEC proposals, from mandating central clearing of all U.S. Treasurys to forcing more trading firms to register with the agency as brokers, all can reduce risks to the financial system, Gensler said in prepared remarks for a Tuesday conference in Washington hosted by the Securities Industry and Financial Markets Association.

“We have bank and nonbank intermediaries using leverage, particularly in the prime brokerage relationships, and when stress enters the system, the result can be instability,” Gensler said. “We saw some of this again this year during the regional bank crisis in March of 2023.”

Regulators are particularly concerned about one strategy called the basis trade, which involves using leverage to profit from the price gap between Treasury futures and the underlying cash market. It has garnered particular attention from federal watchdogs over concerns about a lack of visibility into the amount of risk in the market. 

Executives at Citigroup Inc. and CME Group Inc., among other firms, have voiced support for the popular trade, which they say provides needed liquidity for government bonds. 

The basis trade is also under increasing scrutiny internationally from the Bank of England and the Bank of International Settlements. Regulators have warned that sudden volatility in such a highly-leveraged market could reverberate across markets and lead to systemic instability. 

During remarks after his speech, Gensler addressed the financial sector’s move to T+1 trade settlement and clearing. The industry has about 200 days before a deadline to complete trade settlement in equities shifts to just one day, down from two. Sifma President and Chief Executive Officer Kenneth Bentsen said the industry has concerns about the ability of transactions involving foreign exchange to meet the deadline.

Gensler said the industry has been successful in shortening the settlement cycle in the past, but acknowledged that foreign-exchange trades are “something to keep an eye on as we go through this” transition.

This article was provided by Bloomberg News.