Gary Gensler’s reign atop the SEC has been particularly fraught for hedge funds, and they regularly complain that the numerous rules he’s proposing amount to an unprovoked war on the industry. So even small victories matter. And lately, funds have become more optimistic that they might (partially) escape at least one of Gensler’s looming regulations.

At issue is a plan released in late March that would require many more financial firms to register with the SEC as Treasury bond “dealers.” While the rule hasn’t gotten a ton of attention, it’s among several involving the market that are high priorities for Gensler. (He regularly talks about the importance of making the $24 trillion government bond market more resilient. The goal is shared by the Treasury Department and Fed, especially after recent bouts of wild trading, including during the onset of the pandemic.)

The main objective of the SEC’s dealer proposal is to make sure that high-frequency trading firms fall under the agency’s oversight of Treasury trading. Gensler says this is necessary because these companies now dominate the market – the so-called “flash boys” can account for more than half the volume on some platforms.

The SEC plan relies on several tests to determine whether companies will have to register. But one in particular has outraged hedge funds because they say it will unfairly capture a number of firms that have nothing to do with high-frequency trading of government debt. That provision, known as the “quantitative test,” ropes in any company that has traded $25 billion worth of Treasuries in four of the past six months. While that sounds like a big number, it’s really not. Daily trading volumes in the market regularly exceed $600 billion.

In recent weeks, however, SEC staff members have heartened some in the hedge fund community by signaling in private meetings that the agency could be open to alternatives to the quantitative test, according to people familiar with the matter. One indicator: officials have been asking the industry about ways to revise the rule so that it ensnares the intended HFT targets but not everyone else. (It’s not an easy question because the regulator wants to ensure that HFT firms can’t shirk oversight by simply turning into hedge funds.)

Negotiations over the rule are continuing. And one of the people briefed on the plan cautioned that there is still a way to go. The five commissioners, who have to vote on the plan, aren’t yet close to agreeing to scrap the quantitative assessment, the person said. But the staff questions can’t be ignored – and they will inform what recommendation ultimately goes up to the commission.

An agency spokesman declined to comment.

More complaints: In a sign of the intense opposition to the dealer proposal, business groups continue to submit letters to the SEC even though the comment period closed almost five months ago. One notable missive came just last week from the Committee on Capital Markets Regulation, which urged the agency to remove the quantitative test and exempt private funds from the rule entirely. (Led by Harvard Law School Professor Hal Scott, the group is funded by corporations and foundations. Its members include senior executives at top hedge funds and other trading firms.)

A key point that Scott’s committee made in the Oct. 19 letter is that the SEC proposal could dramatically reduce liquidity for Treasuries. That’s because some firms that are now among the biggest traders would likely reduce their activity to avoid falling under such rigid rules, the panel contended. Here’s one passage that lays out a pretty dire warning:

“The consequences for the U.S. Treasury markets of a pullback in liquidity from beneficial trading and investing activities could be substantial. For example, U.S. Treasury markets faced significant illiquidity in March 2020 during the COVID-19 crisis. Such events could become more severe and more frequent if fewer market participants are able to freely transact. Moreover, the U.S. Treasury market’s continuing growth and the Federal Reserve’s planned reduction of its Treasury holdings further exacerbate this illiquidity risk. Broader consequences for the financial system and economy could result.”

In making this argument, the committee is pretty clearly homing in on an issue that has been getting a lot of attention of late – and increasingly worrying policy makers. Treasury Secretary Janet Yellen was the latest to flag concerns about liquidity, saying earlier this month that banks are running out of capacity to hold government bonds at a time when overall supplies are rising.

Stepping back: There are multiple reasons why hedge funds don’t want to register as dealers. Chief among them is that a firm is considered a customer when it trades with a bank, so the fund benefits from several investor protection rules. But those safeguards no longer apply if both the bank and the fund are dealers. The designation also carries tough net capital requirements to ensure that clients can recoup their money even if a firm fails. Hedge funds, however, contend that such strictures won’t work with their redemption policies and would, in fact, make it harder for investors to redeem.

The big picture: Even if hedge funds prevail on the dealer rule, there are still plenty of pending regulations issued by Gensler’s SEC that threaten to upend their business models. But the beleaguered industry will take a win where it can get it.

Thanks for reading us today. We’re always looking for stories, so if you have any suggestions on what we should cover (or comments about Capitol Account), shoot us a note. Jesse can be reached at: jwestbrook@capitolaccountdc.com and Rob at: rschmidt@capitolaccountdc.com. If somebody forwarded this to you and you’d like to subscribe, hit the button below. Please email for our government rate and group discounts for businesses: subscriptions@capitolaccountdc.com.

Subscribe now

Speech Wrap Up: The heads of both the SEC and CFTC spoke today. Not a ton of news, but they weighed in on a number of hot topics: crypto, especially. CFTC Chairman Rostin Behnam gave an address on digital assets at a Rutgers Law symposium. He and Gensler both took questions at the Sifma annual meeting in New York. (Behnam attended in person.) Here’s a breakdown of some of the more interesting remarks from the regulators:

Legal authority: Unlike Gensler, who often says that the securities laws apply to crypto and that new legislation isn’t really needed, the CFTC chief said he thinks Congress should step in. He wants lawmakers to give the agency authority over the Bitcoin spot market. “Our authority over crypto is a pinhole,” he said at the Rutgers event. “I fear there is so much fraud and manipulation going on in this space that we are unable to pursue because we have limited authority.” While the CFTC has brought some 62 cases involving digital assets since 2014, Behnam noted every one originated with a tip as opposed to being found by the agency through market surveillance. “I am handcuffed from a policy perspective,” he said.

Security v. commodity: Behnam also said Congress could provide clarity over which coins are securities and which are commodities – a big difference he has with Gensler. “This is really a very unique policy question that Congress should weigh in on,” the CFTC chairman said. He also took issue with what he called the “cynical view” that the SEC and CFTC will struggle to hash out the jurisdictional questions. “We have had to just work through these issues” in other areas, Behnam noted. “I can say without question, the process works” and “none of us want the reputational risk, or quite frankly the legal risk, of getting this wrong.”

Gensler, no thanks: The SEC chief at the Sifma event said he was very wary of crypto legislation. “We wouldn't want Congress to do anything to undermine the $100 trillion capital market,” he noted.

CFTC the industry’s choice: Behnam bristled when a moderator pointed out that his agency was the “darling” of digital-token companies. “Your words, not mine,” he said. The chairman said he “couldn’t be more proud” of the agency’s “very aggressive” oversight. “That’s why I get very irritated when folks start to talk about the CFTC as the more favorable regulator,” he said. “Our enforcement record speaks for itself.”

Gensler on competition and centralization: The SEC chair’s speech at the Sifma event focused on three broad rulemakings: bonds, equity market structure and hedge and private equity funds. Though he didn’t say much new, his remarks underscored his philosophy on why big changes in those areas are needed. In short, Gensler thinks that competition in the financial industry eventually gets out of whack as companies get bigger, allowing certain firms to dominate and keep rivals out – and of course reap substantial profits. This is a good summation from his remarks:

“The markets in the middle are almost like the neck of an hourglass. Let’s visualize that for a minute. Imagine grains of sand flowing through the hourglass every single day. The sand, in this analogy, is money and risk. Financial intermediaries, like market makers, exchanges, and asset managers, sit at the neck of that hourglass, collecting a few grains in each transaction. With trillions of grains flowing through daily, a few grains of sand can really add up. Those grains may potentially become excess profits above what robust market competition would provide — also known as economic rents.”

Market structure: The SEC chair didn’t mention banning payment for order flow, but he reiterated several of his plans (like retail auctions) that will crimp the practice. He also pushed back on claims by market making firms and online brokers that retail investors now pay nothing for trades. “While some might say that retail investors have never had it better, make no mistake: There are still a lot of costs in equity market trading,” Gensler said. “Zero commission doesn’t mean zero cost.”

Lastly: Gensler noted in his speech that he is a long-distance runner. Not bad for a guy who turned 65 last week.

Personnel Changes: Uber financial spinmeister Tony Fratto made a major career move today, announcing on LinkedIn and Twitter that he is joining Goldman Sachs as a partner and global head of communications. Fratto is very well-known to firms and journalists alike, having founded Hamilton Place Strategies (now Penta Group) in 2009. Before that, he held several jobs in the Bush Administration as it responded to the financial crisis.

Tony Fratto @TonyFratto

It's been a VERY long time since I've written one of these professional updates (!), but I'm very excited to share the news today that I'll be joining Goldman Sachs as a partner and global head of Corporate Communications. 1/6

At the SEC, Jason Burt becomes regional director of the agency’s Denver office. He’d been serving as acting co-head of the outpost. Over his 18 years at the commission, Burt has worked mostly in the enforcement division.

Barbara Vanich has been named chief auditor at the PCAOB, a job she’d been doing on an acting basis since late 2020. In the role, Vanich will lead the accounting watchdog’s effort to update numerous auditing standards that have been written by the industry – a top goal of Gensler and PCAOB Chair Erica Williams. Vanich joined the regulator in 2009.

Also at the PCAOB, James McNamara is the chief operating officer – a new position that oversees the human resources, budget and finance offices, as well as the facilities department. McNamara comes from the SEC where he was the chief human capital officer and human resources director.

Capitol Account

Hedge Funds See Some Progress In Fight Over…