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US SEC adopts Treasury market dealer rule as market overhaul continues

FILE PHOTO: The seal of the U.S. Securities and Exchange Commission (SEC) is seen at their headquarters in Washington, D.C.

By Douglas Gillison, Davide Barbuscia and Michelle Price

WASHINGTON (Reuters) -The U.S. securities regulator on Tuesday adopted a rule requiring proprietary traders and other firms that routinely deal in government bonds and other securities to register as broker-dealers, subjecting them to stricter oversight.

The new Securities and Exchange Commission (SEC) rule is part of a broader effort to fix structural issues regulators say are causing liquidity problems in the $26 trillion Treasury market. Those changes, which include pushing more trades through clearing houses, represent the biggest overhaul of the Treasury market in decades, market participants say.

The SEC's five commissioners voted 3-2, with Republican members objecting, saying the rule was too broad and would create undue burdens on market players.

The rule primarily targets proprietary traders, which the SEC says have become "critical sources" of Treasury market liquidity and should be subject to the same strict oversight and risk management controls as other Treasury market dealers.

"These measures are common sense," SEC Chair Gary Gensler said at the start of the meeting. "Congress did not intend for registration and regulatory requirements to apply to some dealers and not to others."

The new rules, which were first proposed in March 2022, would apply to traders if they meet either of two activity-based tests, SEC officials said in advance of the meeting:

Firms which routinely express interest in trading at the best available prices on both sides of the market, or which mainly derive revenue by trading on the spread between securities' bidding and asking prices or from incentives offered by trading venues.

In light of public comments, SEC officials said they substantially changed the proposed rule, including by scrapping a quantitative test under which firms trading $25 billion in securities in any four of the prior six months would have been required to register as dealers.

Also eliminated was another qualitative test that would have required firms that routinely bought and sold the same or similar securities in a single day to register.

The new rule should apply to about 43 companies, officials said.

"Those changes remove some of the most objectionable parts that market participants have been concerned with," said Nathaniel Wuerffel, head of market structure at BNY Mellon.

"But they won't fully remove, for example, hedge funds from being captured by the rule if they still meet the qualitative elements of the definition," he said.

TRADE OFFS

Some investors in comment letters said that the original threshold and tests were too broad and would inadvertently capture corporations, insurers, and pensions. They had lobbied the SEC for fixes, Reuters reported.

The SEC's minority Republican members said the rule would be burdensome for legal compliance on firms merely because their trading activity resulted in supplying market liquidity. The rule could perversely result in less liquidity by driving some players out of the market, they argued.

Jack Inglis, head of the Alternative Investment Management Association (AIMA), which last year joined a lawsuit against other new SEC regulations, said that even with the changes, the rule could still require some market participants that are not prop firms, such as investment funds, to register as securities dealers.

"The SEC has incorrectly concluded that customers of dealers, including certain AIMA members, may be dealers themselves," he said in a statement, adding that his organization was considering its options.

Treasury market reforms involve a trade-off between trying to make the market more resilient at times of stress and increasing trading costs, Wuerffel said.

"The trade-off there is that liquidity in normal times is going to be less than market participants have come to expect," he said.

By requiring prop trading firms to comply with SEC capital, reporting and disclosure requirements, the new rule will protect retail investors and promote market stability, said Benjamin Schiffrin, director of Securities Policy at Better Markets, a Washington non-profit that advocates for financial reforms.

(Reporting by Michelle Price, Douglas Gillsion Davide Barbuscia and Carolina Mandl; Editing by Bill Berkrot, Chizu Nomiyama and Mark Porter)