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The Effect of Primary Dealer Constraints on Intermediation in the Treasury Market

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Falk Bräuning and Hillary Stein discuss the extent to which the Treasury securities market can be affected by regulatory constraints on primary dealers, a select group of market-making financial firms that are typically affiliated with large banking organizations.

The views expressed in this video are solely those of the author(s) and do not represent the views of the Federal Reserve Bank of Boston, the principals of the Board of Governors, or the Federal Reserve System.

Image courtesy of interviewee. October 22, 2024

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This video discusses the significant role that U.S. Treasury securities play in the global economy, primarily as a means of financing the U.S. government and as a benchmark for risk-free investments. It explores the impact of constraints faced by primary dealers—financial firms that facilitate trading in Treasury securities—on the market's liquidity, turnover, and pricing.

When these dealers experience tighter constraints, they tend to reduce their Treasury holdings, leading to decreased liquidity and increased spreads. The research highlights the importance of understanding the constraints on these intermediaries, particularly in light of findings from the 2008 financial crisis and subsequent regulatory changes.

The study utilizes detailed data from two Federal Reserve datasets to analyze how constraints affect primary dealers' trading behavior. It distinguishes between two types of constraints: the Supplementary Leverage Ratio (SLR) and internal Value at Risk (VaR) limits. The findings suggest that easing constraints, such as exempting Treasury holdings from SLR calculations, results in primary dealers increasing their Treasury positions and turnover while lowering spreads, indicating improved market liquidity. In contrast, tightening VaR limits leads to reduced positions and reduced liquidity.

Overall, the analysis emphasizes the criticality of primary dealers and their regulatory constraints on the liquidity and functioning of Treasury markets, especially in an environment of rising government debt. These insights are relevant for shaping monetary policy and financial regulations.

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Here are five key points from the video:

1. **Role of Treasuries**: U.S. Treasuries are essential for financing the federal government, serve as significant investment instruments for global investors, act as risk-free benchmarks for financial institutions, and are critical for the Federal Reserve's implementation of monetary policy.

2. **Impact of Primary Dealers**: The Treasury market is predominantly intermediated by a select group of financial firms known as primary dealers. When these primary dealers face constraints (e.g., regulatory or internal risk limits), it can adversely affect their holdings of Treasuries and overall market liquidity.

3. **Research Methods and Data**: The research conducted utilizes two key datasets: the FR 2004, which records the positions and turnover of primary dealers, and the Regulation VV (VP1) dataset, which provides internal risk limits for trading desks. Empirical methodologies are utilized to assess how constraints impact treasury positions and liquidity.

4. **Findings on Constraints**: The study reveals that when primary dealers experience tighter constraints (like changes in Supplementary Leverage Ratios), they reduce their Treasury holdings and turnover, leading to lower market liquidity. Conversely, lifting these constraints (as seen during the 2020 SLR change) correlates with increased Treasury holdings and improved market liquidity.

5. **Heterogeneous Effects of Risk Constraints**: The research indicates that different types of securities respond variably to risk constraints. For instance, while value-at-risk limits impact holdings and turnover more significantly for higher volatility securities, the exemption of Treasury securities from leverage exposure broadly benefits all types of Treasuries, enhancing overall market liquidity.

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Here are the key quotes extracted from the video about the role of treasuries in the global economy and the challenges faced by primary dealers:

1. **Importance of Treasuries**: "The idea that treasuries play a crucial role in the global economy. They're the primary means of financing the US Federal Government."

2. **Investment Instrument**: "They're a significant investment instrument and hedging vehicle for global investors."

3. **Risk-free Benchmark**: "They're a risk-free benchmark for many other financial institutions."

4. **Monetary Policy Tool**: "They're an important tool for the Federal Reserves implementation of monetary policy."

5. **Role of Primary Dealers**: "For how important they are, they're intermediated by just a select group of market making financial firms, which are called primary dealers."

6. **Impact of Constraints**: "What happens when these primary dealers face constraints? How does that impact the treasury market?"

7. **Reduction in Treasury Holdings**: "When the primary dealers are faced with tighter constraints... these primary dealers do indeed reduce their treasury holdings."

8. **Lower Liquidity**: "This is accompanied by lower liquidity in the treasury market."

9. **Literature on Financial Intermediaries**: "Our work shows that... financial intermediaries' constraints really are important for driving asset prices."

10. **Unique Data Contribution**: "We have a very unique, very detailed, granular data on individual actors... to disentangle how those constraints that these primary dealers face really drive their decisions."

11. **Types of Constraints**: "You can imagine constraints on the overall bank balance sheet... or especially relevant for these primary dealers on the actual trading desk themselves."

12. **Impact of the SLR Constraint**: "SLR constrained banks might be constrained in their treasury positions."

13. **Findings Post-COVID Policy Change**: "If this constraint was lifted... primary dealers... increase their position in treasuries after the policy change."

14. **Increased Turnover and Lower Spreads**: "We also see that their margin... declines... primary dealer associated with a bank leverage ratio, a one percentage point lower leverage ratio... see an increase in about nine percentage points."

15. **Market Liquidity Effects**: "Once you lift those binding constraints... the market becomes more liquid in some sense."

16. **Risk-Sensitive Value at Risk Constraints**: "As value at risk limits become tighter, the primary dealers reduce their positions in treasury securities."

17. **Importance of Treasury Markets**: "Treasury markets are at the heart of the financial system, both in the United States and globally."

18. **Regulatory Perspective**: "It's important to understand the impact of regulatory constraints... ultimately, this intermediation capacity we show is crucial for treasury market liquidity more broadly."

These quotes encapsulate the significance of treasuries, the operational mechanisms of primary dealers, the impacts of regulatory constraints, and the overall implications for market liquidity.

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Here are a few similar articles that discuss the role of U.S. Treasuries in the financial system, the impact of regulatory constraints on primary dealers, and the implications for market liquidity:

1. **"The Role of Primary Dealers in the U.S. Treasury Market"** - This article examines how primary dealers facilitate the issuance and trading of U.S. Treasury securities, and analyzes their significance both as intermediaries and as market makers in ensuring liquidity.

2. **"Liquidity Shortages in the Markest: The Role of Treasury Market Resilience"** - This paper explores how financial crises impact the liquidity of Treasury markets, specifically focusing on the influence of dealer behavior and regulatory constraints on market functioning during periods of stress.

3. **"Regulation and Market Liquidity: Evidence from the U.S. Treasury Market"** - This research investigates how different regulatory frameworks affect the liquidity of Treasury markets, emphasizing the consequences of constraints faced by financial intermediaries like primary dealers and how this impacts pricing and turnover in the market.

4. **"Understanding Market Making in the U.S. Treasury Market: A Regulatory Perspective"** - This article provides insight into the regulatory landscape surrounding primary dealers, examining how regulations like the leverage ratio or Value-at-Risk limits can influence dealer behavior, and subsequently, market liquidity and pricing of Treasury securities.

5. **"Impacts of Monetary Policy on Treasury Market Liquidity"** - This study analyzes how the Federal Reserve's monetary policy decisions influence the liquidity of the Treasury market, discussing the role of primary dealers and how regulatory constraints affect their trading strategies and positions in the market.

6. **"The Interaction of Market Liquidity and Regulatory Constraints"** - This paper discusses how the interplay between market liquidity and regulatory constraints on financial institutions can shape the trading environment for Treasuries and other key financial instruments.

These articles closely relate to the original video's themes, particularly regarding the role of treasuries, the dynamics of primary dealers, and the effects of constraints on market liquidity and functioning.

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The idea that treasuries play a crucial

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role in the global economy.

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They're the primary means

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of financing the US Federal Government.

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Um, they're a significant investment instrument in hedging

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vehicle for global investors.

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They're risk-free benchmark

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for many other financial institutions,

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and they're an important tool for the Federal Reserves

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implementation of monetary policy.

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Um, that said, for how important they are,

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they're intermediated by just a select group

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of market making financial firms,

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which are called primary dealers.

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Um, and these primary dealers are typically affiliated

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with large banking organizations.

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So the question was, and the idea was,

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what happens when these primary dealers face,

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constraints?

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How does that impact the treasury market?

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And our work shows that when,

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the primary dealers are faced with tighter constraints,

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and we can sort of talk about,

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defining what we mean by constraints.

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Um, these primary dealers do indeed reduce their treasury

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holdings, and this is accompanied

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by lower liquidity in the treasury market.

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Turnover decreases and bees price increase. Our

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Work really, is, is,

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is grounded in this relatively large literature,

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especially theoretical literature on the role

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of financial intermediaries, in asset pricing

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and specifically, there's a relatively large literature

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that focuses on what constraint to these constraints

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to these intermediaries really do, in terms

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of asset pricing and liquidity.

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So part of the literature, was really inspired

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by the events of the great financial crisis.

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So we've seen a surge in, in these,

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mostly theoretical papers in the aftermath.

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Um, therefore,

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but, there's also a host of papers that tries

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to get at these questions empirically.

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I'm trying to find empirical support for the theories that,

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that argue that financial intermediaries constraints really

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are important for driving asset prices.

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What we add relative to the existing,

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literature is really that we have a very unique,

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very detailed, granular data on individual actors

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constraints in the, in the treasury market.

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So we're really able

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to go really into the nitty gritty details

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and really disentangle how those, constraints

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that these primary dealer face really,

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drive their decisions in terms of, treasury holdings,

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in terms of, turnover, in terms of,

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spread they charge.

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So we are really, adding to this literature

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by providing these very detailed micro data that allows us

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to costly identify, these effects.

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We use, two, supervisory,

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or two sort of confidential, federal Reserve,

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data sets, one of which is, supervisory.

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We use, the FR 2004,

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which is the government securities dealer reports.

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And we use the, regulation VV quantitative,

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measurements, which we call the, the VP one, dataset.

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So the, FR 2004, that's a, sort

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of longer historical data set,

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that includes information on the outright positions

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and the turnover of all primary dealers

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of US government securities.

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This data set includes, the important response variables

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that I talked about earlier, of, positions

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and turnovers of these primary dealers.

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The second data set that we use it,

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the FFR VV one provides desk specific internal,

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risk limits for the trading desks

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of large banking organizations.

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So, this data set is relatively newer.

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It's been collected since July, 2014,

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as part of the 2013, VUCA rule of the Dodd-Frank Act.

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The VUCA rule prohibits,

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banks from engaging in proprietary trading,

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but as part of that rule, banks are required

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to report their internal organization of trading desks,

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desk names, descriptions,

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and also report the, internal risk limits,

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of these trading desks.

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In practice. These risk limits take a couple forms.

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Um, they can be sensitivity of limits,

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they can be value at risk or VAR limits.

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And we primarily focus on the VAR limits.

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Um, we compliment these two sort of main micro data sets

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with our Y nine C,

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and then, auction data as well

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as, some pricing data.

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The question is, what happens,

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when banks face tighter constraints?

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Um, what happens to their positions?

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What happens to turnover? What happens to the best spreads

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and treasury market liquidity?

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Um, so, the, I think let's, we can back up

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for a second and ask the question of

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what do we mean by constraints?

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Um, so banks, have sort of a variety.

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They have these, this organizational structure,

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which is composed of different organizational layers,

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and you can imagine constraints at different

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points of the banking structure.

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You can imagine constraints on the,

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overall bank balance sheet

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or, especially relevant for these,

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primary dealers which are trading these,

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the government securities,

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on the actual trading desk themselves.

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Um, and so because banks can face constraints in different

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places, we actually use two different methods to

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explore, the impact

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of two different types of constraints.

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Um, so first we start with the SLR constraint, which,

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is part of the US implementation

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of the Basel three accords.

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Um, and the idea here is, the SLR is the ratio

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of tier one capital to total leverage exposure,

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because exposure includes gross positions in securities,

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held by primary dealers.

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Um, SLR constrained banks might be constrained in

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their treasury positions.

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Um, so that's sort of, that's constraint one,

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and we're gonna use a particular method to,

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to explore the impact of constraint one,

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constraint two is these internal constraints on banks

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trading activities.

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Um, and so as I mentioned, the ULCA rule,

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does limit banks from taking too much risk

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and engaging in proprietary trading.

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But separate from that, even though treasuries aren't,

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they're exempt from the, from the ULCA rule,

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banks still have internal risk limits

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and they're still not gonna let their trading desks take,

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you know, unlimited risk and, and treasuries.

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And we actually can see in our data that there are,

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value at risk constraints on the trading desk

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that only trade treasuries.

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And so we have a second method for looking at the impact

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of these, internal,

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VR risk limits on the, on the training desk.

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When we look at the SLR, the impact of SLR constraints,

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we use a difference in difference methodology,

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which leverages the fact that in April, 2020,

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there was a surprise, sort of relaxation

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of this SLR constraint,

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in which treasuries were exempt from the SLR.

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Um, and so what we do is we compare, banks

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that were more constrained

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or less constrained in their SLR according to the 2019,

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Q4 value of their SLR.

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We compare, how more constrained banks reacted

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after this,

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surprise treasury exemption from the SLR versus

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less constrained banks.

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Um, so that's the first methodology,

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and, that allows us to look at sort

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of differences in positions between more constrained

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and less constrained banks when that is relaxed.

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Um, our second, method,

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uses the granular instrumental,

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or something sort of similar

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to the granular instrumental variable approach.

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And the idea here is that if only,

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one trading desk has a risk limit change,

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that risk limit change is, probably exogenous

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to overall market conditions.

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And so you can look at these sort of,

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these risk limit changes

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that are only happening at one desk,

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and you do that by running this,

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saturated fixed effects regression.

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Um, and then you aggregate all

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of these idiosyncratic changes up,

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and that gets this exogenous,

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risk limit shock.

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Um, and then we can sort

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of regress this exogenous risk limit shock,

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or look, look, regress some positions and, turnover

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and, bitas spreads on this exogenous risk limit shock

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Looking essentially as at, at two depths of analysis here,

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like related to the different constraints

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and related the different methods here.

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If we're, I'm gonna first talk about the findings for the

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supplementary laboratory ratio constraint.

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So here we really exploit this, this policy change,

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in the wake of the covid,

195
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pandemic in early 2020 when the Federal Reserve, made a

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temporary, change to the SLR computation,

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in the following sense that, treasury exposure and,

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and also reserves held at the central banks were, as

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of April 1st, 2020 20, allowed

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to be exempt from the total leverage exposure.

201
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So what does it mean?

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It means that if a primary dealer affiliated

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with a bank holding company, holds a treasury,

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position in its book, that treasury position will not add

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to the leverage exposure,

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therefore will not be costly in terms of capital.

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And that change really was,

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announced like on a very short notice

209
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and became effective immediately.

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So we're looking around this, tight window of a couple

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of, weeks around before and after that policy change,

212
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and look how different dealers, respond to

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that change in terms of, holdings and,

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and turnover and spread.

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And so what we really find is like, very intuitive if

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this, constraint was lifted

217
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by exempting the treasury securities from the total leverage

218
00:10:17.255 --> 00:10:20.815
exposures, primary dealers that are affiliated

219
00:10:20.815 --> 00:10:23.975
with a bank holding company that has a relatively

220
00:10:24.595 --> 00:10:25.815
low leverage ratio

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00:10:25.815 --> 00:10:29.215
that is relatively more constrained than other, other,

222
00:10:29.625 --> 00:10:34.055
other bank holding companies, those primary dealers, they,

223
00:10:34.195 --> 00:10:37.615
increase their position in treasuries after the,

224
00:10:37.615 --> 00:10:38.855
after the policy change,

225
00:10:39.515 --> 00:10:41.895
and they increase also their total turnover.

226
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And we also see that their, margin, their kind

227
00:10:46.175 --> 00:10:48.375
of a measure of intermediation spread that

228
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that OM declines essentially.

229
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Um, I can also put some precise numbers on it.

230
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These effects are relatively sizable.

231
00:10:55.555 --> 00:10:57.775
So our estimates indicate that,

232
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primary dealer associated with a bank

233
00:11:00.575 --> 00:11:03.975
with a one percentage points, lower

234
00:11:04.895 --> 00:11:08.455
leverage ratio, a one percentage point lower leverage ratio,

235
00:11:08.455 --> 00:11:12.415
after the policy policy change, those primary dealers,

236
00:11:12.475 --> 00:11:16.055
see an increase in about nine percentage points relative

237
00:11:16.055 --> 00:11:19.655
to other dealers in their pro treasury position holdings.

238
00:11:19.795 --> 00:11:23.015
We also see a, higher turnover and a, and a

239
00:11:23.015 --> 00:11:25.255
and a lower, bit are spread here.

240
00:11:25.595 --> 00:11:28.095
So this is all, according to the theory

241
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that these constraints matters.

242
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And once you lift those binding constraint,

243
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then there's a higher turnover, higher positions holding

244
00:11:35.555 --> 00:11:37.775
and a, a lower intermediation spread.

245
00:11:37.835 --> 00:11:40.455
So the, the market becomes more liquid in some sense.

246
00:11:41.605 --> 00:11:44.215
It's what is very interesting, is

247
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that we also looked at heterogeneous effect across different

248
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treasury securities.

249
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And our findings here show

250
00:11:52.765 --> 00:11:55.445
that there's actually no heterogeneous effects.

251
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After the policy change was enacted,

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the dealers increased their position holdings across all

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types of treasury securities, t-bills,

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and also longer dated, securities.

255
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Given the, the, the regulatory framework.

256
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This is very intuitive

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because these supplementary leverage ratio,

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as Hillary mentioned, this is the,

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implementation in the US of the basal accords.

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This is meant to be risk insensitive.

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So we are finding exactly,

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this risk insensitive, effects.

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When we look at the, what, what the, temporary exemption

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of treasuries that to the, to the holdings,

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the primary dealers increase the holdings across the board

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of all treasury securities.

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Where we look at the, at the supplementary leverage ratio,

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if you look at the effects of value at risk, shifts,

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as Hillary explained the, the method already, we are finding

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qualitatively very similar results.

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What we find is that as value at risk limits become tighter,

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the, primary dealers reduce their

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positions in treasury securities.

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As a result, we also see, total turnover going down and,

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and spreads, increase intermediation spreads increase.

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So this is like qualitatively very similar to what we find,

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for the supplementary leverage ratio.

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There is, one important difference

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that i I wanna highlight here, which is

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that the conceptually, the value at risk constraint,

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as the name already suggests this,

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are risk sensitive constraints.

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00:13:29.315 --> 00:13:31.415
So a security with

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where may add different value at risk,

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than a high volatility security may add more vol,

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00:13:37.655 --> 00:13:41.855
value at risk than a, a low volatility security in terms

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of, return volatility, for example.

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00:13:44.675 --> 00:13:48.495
So we also, estimated these heterogeneous,

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responses across different types of security and,

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and the findings really line up.

291
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We find those,

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that those value at risk shifts really matter more

293
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for securities that are risk in the sense of

294
00:13:59.895 --> 00:14:02.735
that they have a relatively high return volatility.

295
00:14:02.835 --> 00:14:04.255
And for example, we don't see

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that value at risk constraints really impact the positions

297
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or the turnover or the spread of TBIs,

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which are really short beta treasury securities,

299
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which are typically, seen as not that risky compared

300
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to longer term securities.

301
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So this lines up very nicely with the,

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with the mechanism that we have in mind.

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Treasury markets are at the heart of the financial system,

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both in the United States and globally.

305
00:14:28.155 --> 00:14:32.695
Um, so, from a regulatory perspective,

306
00:14:32.925 --> 00:14:36.495
it's important to understand the impact of,

307
00:14:37.455 --> 00:14:42.335
regulatory constraints, that target either, bank,

308
00:14:42.515 --> 00:14:43.615
balance sheets

309
00:14:43.955 --> 00:14:48.655
or, their, intermediation capacity,

310
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via, via the training desks.

311
00:14:50.695 --> 00:14:53.445
Ultimately, this, intermediation capacity we show is

312
00:14:53.445 --> 00:14:56.445
crucial, for treasury market liquidity more broadly,

313
00:14:56.785 --> 00:15:00.405
our results focus on the fact that there's sort

314
00:15:00.405 --> 00:15:04.485
of just this, this set, granular, smaller set

315
00:15:04.545 --> 00:15:05.765
of, key dealers.

316
00:15:06.105 --> 00:15:08.845
Um, that's, that's really critical for, treasury,

317
00:15:09.105 --> 00:15:11.085
intermediation and treasury functioning.

318
00:15:11.665 --> 00:15:16.525
Um, in terms of sort of the impact of treasury markets on,

319
00:15:16.625 --> 00:15:21.605
on policy, you know, monetary policy,

320
00:15:21.905 --> 00:15:23.565
transmission,

321
00:15:23.835 --> 00:15:26.605
obviously very much relies on treasury market,

322
00:15:27.485 --> 00:15:31.365
functioning and in an era of increased, government debt.

323
00:15:31.785 --> 00:15:35.525
Um, the ability of banks to intermediate this,

324
00:15:35.595 --> 00:15:38.725
this debt market is, is really crucial.

Impact of Primary Dealers' Constraints on Treasury Market Liquidity

00:00:00 - The idea that treasuries play a crucial role in the global economy. They're the primary means of financing the US Federal Government. they're a significant investment instrument in hedging vehicle for global investors. They're risk-free benchmark for many other financial institutions, and they're an important tool for the Federal Reserves implementation of monetary policy. that said, for how important they are, they're intermediated by just a select group of market making financial firms, which are called primary dealers. and these primary dealers are typically affiliated

00:00:32 - So the question was, and the idea was, what happens when these primary dealers face, constraints? How does that impact the treasury market? And our work shows that when, the primary dealers are faced with tighter constraints, and we can sort of talk about, defining what we mean by constraints. these primary dealers do indeed reduce their treasury holdings, and this is accompanied by lower liquidity in the treasury market.

00:01:02 - Work really, is, is, is grounded in this relatively large literature, especially theoretical literature on the role of financial intermediaries, in asset pricing and specifically, there's a relatively large literature that focuses on what constraint to these constraints to these intermediaries really do, in terms of asset pricing and liquidity. So part of the literature, was really inspired by the events of the great financial crisis.

Empirical Insights on Financial Intermediaries Constraints

00:01:33 - mostly theoretical papers in the aftermath. therefore, but, there's also a host of papers that tries to get at these questions empirically. I'm trying to find empirical support for the theories that, that argue that financial intermediaries constraints really are important for driving asset prices. What we add relative to the existing, literature is really that we have a very unique, very detailed, granular data on individual actors

00:02:04 - So we're really able to go really into the nitty gritty details and really disentangle how those, constraints that these primary dealer face really, drive their decisions in terms of, treasury holdings, in terms of, turnover, in terms of, spread they charge. So we are really, adding to this literature by providing these very detailed micro data that allows us to costly identify, these effects. We use, two, supervisory,

00:02:38 - data sets, one of which is, supervisory. We use, the FR 2004, which is the government securities dealer reports. And we use the, regulation VV quantitative, measurements, which we call the, the VP one, dataset. So the, FR 2004, that's a, sort of longer historical data set, that includes information on the outright positions and the turnover of all primary dealers

Analysis of Trading Desk Data and Risk Constraints

00:03:08 - This data set includes, the important response variables that I talked about earlier, of, positions and turnovers of these primary dealers. The second data set that we use it, the FFR VV one provides desk specific internal, risk limits for the trading desks of large banking organizations. So, this data set is relatively newer. It's been collected since July, 2014,

00:03:44 - The VUCA rule prohibits, banks from engaging in proprietary trading, but as part of that rule, banks are required to report their internal organization of trading desks, desk names, descriptions, and also report the, internal risk limits, of these trading desks. In practice. These risk limits take a couple forms. they can be sensitivity of limits, they can be value at risk or VAR limits. And we primarily focus on the VAR limits.

00:04:14 - with our Y nine C, and then, auction data as well as, some pricing data. The question is, what happens, when banks face tighter constraints? what happens to their positions? What happens to turnover? What happens to the best spreads and treasury market liquidity? so, the, I think let's, we can back up for a second and ask the question of what do we mean by constraints? so banks, have sort of a variety.

Understanding Banking Constraints on Treasury Trading

00:04:47 - which is composed of different organizational layers, and you can imagine constraints at different points of the banking structure. You can imagine constraints on the, overall bank balance sheet or, especially relevant for these, primary dealers which are trading these, the government securities, on the actual trading desk themselves. and so because banks can face constraints in different places, we actually use two different methods to

00:05:17 - of two different types of constraints. so first we start with the SLR constraint, which, is part of the US implementation of the Basel three accords. and the idea here is, the SLR is the ratio of tier one capital to total leverage exposure, because exposure includes gross positions in securities, held by primary dealers. SLR constrained banks might be constrained in their treasury positions.

00:05:47 - and we're gonna use a particular method to, to explore the impact of constraint one, constraint two is these internal constraints on banks trading activities. and so as I mentioned, the ULCA rule, does limit banks from taking too much risk and engaging in proprietary trading. But separate from that, even though treasuries aren't, they're exempt from the, from the ULCA rule, banks still have internal risk limits

Analyzing SLR and VR Constraints on Treasury Trading

00:06:21 - you know, unlimited risk and, and treasuries. And we actually can see in our data that there are, value at risk constraints on the trading desk that only trade treasuries. And so we have a second method for looking at the impact of these, internal, VR risk limits on the, on the training desk. When we look at the SLR, the impact of SLR constraints, we use a difference in difference methodology, which leverages the fact that in April, 2020,

00:06:57 - of this SLR constraint, in which treasuries were exempt from the SLR. and so what we do is we compare, banks that were more constrained or less constrained in their SLR according to the 2019, Q4 value of their SLR. We compare, how more constrained banks reacted after this,

00:07:25 - less constrained banks. so that's the first methodology, and, that allows us to look at sort of differences in positions between more constrained and less constrained banks when that is relaxed. our second, method, uses the granular instrumental, or something sort of similar to the granular instrumental variable approach. And the idea here is that if only,

Analyzing Exogenous Risk Limit Changes in Treasury Markets

00:07:58 - that risk limit change is, probably exogenous to overall market conditions. And so you can look at these sort of, these risk limit changes that are only happening at one desk, and you do that by running this, saturated fixed effects regression. and then you aggregate all of these idiosyncratic changes up, and that gets this exogenous,

00:08:29 - and then we can sort of regress this exogenous risk limit shock, or look, look, regress some positions and, turnover and, bitas spreads on this exogenous risk limit shock Looking essentially as at, at two depths of analysis here, like related to the different constraints and related the different methods here. If we're, I'm gonna first talk about the findings for the

00:08:59 - So here we really exploit this, this policy change, in the wake of the covid, pandemic in early 2020 when the Federal Reserve, made a temporary, change to the SLR computation, in the following sense that, treasury exposure and, and also reserves held at the central banks were, as of April 1st, 2020 20, allowed

Impact of Policy Change on Treasury Holdings and Liquidity

00:09:30 - So what does it mean? It means that if a primary dealer affiliated with a bank holding company, holds a treasury, position in its book, that treasury position will not add to the leverage exposure, therefore will not be costly in terms of capital. And that change really was, announced like on a very short notice and became effective immediately. So we're looking around this, tight window of a couple of, weeks around before and after that policy change,

00:10:03 - that change in terms of, holdings and, and turnover and spread. And so what we really find is like, very intuitive if this, constraint was lifted by exempting the treasury securities from the total leverage exposures, primary dealers that are affiliated with a bank holding company that has a relatively low leverage ratio that is relatively more constrained than other, other,

00:10:34 - increase their position in treasuries after the, after the policy change, and they increase also their total turnover. And we also see that their, margin, their kind of a measure of intermediation spread that that OM declines essentially. I can also put some precise numbers on it. These effects are relatively sizable. So our estimates indicate that, primary dealer associated with a bank

Impact of Leverage Ratio Changes on Treasury Market Liquidity

00:11:04 - leverage ratio, a one percentage point lower leverage ratio, after the policy policy change, those primary dealers, see an increase in about nine percentage points relative to other dealers in their pro treasury position holdings. We also see a, higher turnover and a, and a and a lower, bit are spread here. So this is all, according to the theory that these constraints matters. And once you lift those binding constraint,

00:11:35 - and a, a lower intermediation spread. So the, the market becomes more liquid in some sense. It's what is very interesting, is that we also looked at heterogeneous effect across different treasury securities. And our findings here show that there's actually no heterogeneous effects. After the policy change was enacted, the dealers increased their position holdings across all

00:12:04 - and also longer dated, securities. Given the, the, the regulatory framework. This is very intuitive because these supplementary leverage ratio, as Hillary mentioned, this is the, implementation in the US of the basal accords. This is meant to be risk insensitive. So we are finding exactly, this risk insensitive, effects. When we look at the, what, what the, temporary exemption of treasuries that to the, to the holdings, the primary dealers increase the holdings across the board

Impact of Value at Risk on Treasury Securities

00:12:36 - Where we look at the, at the supplementary leverage ratio, if you look at the effects of value at risk, shifts, as Hillary explained the, the method already, we are finding qualitatively very similar results. What we find is that as value at risk limits become tighter, the, primary dealers reduce their positions in treasury securities. As a result, we also see, total turnover going down and,

00:13:11 - So this is like qualitatively very similar to what we find, for the supplementary leverage ratio. There is, one important difference that i I wanna highlight here, which is that the conceptually, the value at risk constraint, as the name already suggests this, are risk sensitive constraints. So a security with where may add different value at risk, than a high volatility security may add more vol, value at risk than a, a low volatility security in terms

00:13:44 - So we also, estimated these heterogeneous, responses across different types of security and, and the findings really line up. We find those, that those value at risk shifts really matter more for securities that are risk in the sense of that they have a relatively high return volatility. And for example, we don't see that value at risk constraints really impact the positions or the turnover or the spread of TBIs, which are really short beta treasury securities,

Understanding Treasury Markets and Regulatory Impact

00:14:17 - to longer term securities. So this lines up very nicely with the, with the mechanism that we have in mind. Treasury markets are at the heart of the financial system, both in the United States and globally. so, from a regulatory perspective, it's important to understand the impact of, regulatory constraints, that target either, bank, balance sheets

00:14:48 - via, via the training desks. Ultimately, this, intermediation capacity we show is crucial, for treasury market liquidity more broadly, our results focus on the fact that there's sort of just this, this set, granular, smaller set of, key dealers. that's, that's really critical for, treasury, intermediation and treasury functioning. in terms of sort of the impact of treasury markets on,

00:15:35 - transmission, obviously very much relies on treasury market, functioning and in an era of increased, government debt. the ability of banks to intermediate this, this debt market is, is really crucial.

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