SEC Increases Oversight for Hedge Funds, High-Speed Traders
Traders and funds have warned the cost of new rules could lead them to pull back from key markets
Wall Street’s top regulator extended its authority into new corners of the financial industry on Tuesday, adopting rules targeting firms that are among the most active buyers and sellers of U.S. government bonds and stocks.
The Securities and Exchange Commission will now require dozens of firms, including high-speed traders and hedge funds, to face new capital requirements, register their activities and report more information on their transactions. The changes resulted from the SEC’s 3-2 vote to broaden its definition of what it considers to be a securities “dealer.”
It wasn’t immediately clear how far-reaching the final rules would be after nearly two years of battling between the regulator and the trading and investment industries. Some final tweaks reduced the reach of the proposed plans, potentially easing the worst fears that traders would pull back from important markets such as Treasurys. Industry groups and watchers said they were still studying the final rule Tuesday.
The SEC has been trying to bring its regulations up to speed with markets, especially for U.S. Treasurys, which are increasingly dominated by electronic trading and intermediaries that act as crucial providers of liquidity. Unregistered market participants acting like dealers accounted for about half of daily Treasury trading activity over electronic platforms in recent years, according to research cited by the SEC.
Big trading and hedge-fund firms warned the SEC that imposing higher costs on their operations could lead them to scale back, reducing overall liquidity. They also argued the SEC’s timing risked upsetting the market just as the Treasury is trying to finance larger budget deficits.
“These measures are common sense,” SEC Chair Gary Gensler said in prepared remarks. “Congress did not intend for registration and regulatory requirements to apply to some dealers and not to others.”
Under Gensler, the SEC has taken an expansive approach to its mission of protecting investors and maintaining market efficiency. The agency has asserted its power over areas as wide-ranging as cryptocurrencies, stock buybacks, blank-check company forecasts and disclosures of climate risk.
Republican SEC Commissioners have opposed much of Gensler’s agenda for being too aggressive. “A regulator’s temptation may be to put every corner of the market under a regulatory spotlight and into a regulatory straitjacket, but a clear-eyed view takes into account the costs of such comprehensive oversight,” said SEC Commissioner Hester Peirce during the regulator’s public meeting. She voted against the expanded dealer rule.
Industry players accustomed to light-touch regulation have been the subject of much of the SEC’s rule-making. Hedge funds in particular have faced new obligations governing how they deal with investors and how they disclose information around short selling and stakes taken by activist investors.
Still, the hedge fund industry scored a few wins Tuesday.
An earlier version of the SEC’s dealer rule would have likely roped in many large hedge funds. Any person or firm that bought or sold more than $25 billion in government bonds in four of the preceding six months would have automatically been classified as a securities dealer under a March 2022 proposal from the SEC. So would firms that routinely made “roughly comparable” purchases or sales of similar securities in one day.
Hedge funds and their trade groups howled at the proposal and felt it threatened the profitability of investing strategies like quant, arbitrage and relative-value trading, which seeks to capitalize on pricing discrepancies between different securities.
In comments submitted to the SEC, hedge-fund firms argued that requiring them to register as dealers would deprive them of certain investor protections. They argued there would be unintended consequences, including preventing them from participating in initial public offerings. Hedge-fund firms also complained that the SEC was exempting mutual funds and other types of asset managers from the additional requirements.
The SEC ultimately scrapped the $25 billion threshold and some other parts that the industry criticized. “My initial reaction is that the SEC actually listened to commenters as the most problematic aspects appear to have been omitted,” said William Barbera, a partner at law firm Schulte Roth & Zabel.
Nevertheless, an SEC analysis identified up to 16 private funds, a category that includes hedge funds, that could fit its revised definition of a dealer, an agency official said at the meeting. In all, the analysis found that the new dealer rule could apply to up to 43 firms. Those managing less than $50 million in assets wouldn’t have to comply.
One hedge-fund trade group, the Managed Funds Association, said the final rule was an improvement from the SEC’s original proposal but that it was still reviewing whether it harms its members’ activities. The MFA and other trade groups are currently fighting the SEC in court over its new rules covering private-fund regulation, short selling and securities lending.
“This action feels like just another salvo in the Commission’s ongoing war on private funds,” said SEC Commissioner Mark Uyeda, who voted against the rule, during the meeting.