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Three hedge fund industry groups are suing the US Securities and Exchange Commission over new rules for the $27tn Treasury market, arguing the measures will unfairly subject their members to regulation as “dealers”.
The lawsuit filed on Monday takes aim at a requirement for more large traders to register with the SEC as dealers in the US government bond market, or firms that regularly provide liquidity. Dealer status requires holding additional capital and reporting more trades in the market.
The hedge fund groups said the SEC lacked legal authority to adopt its dealer definition and was engaged in “arbitrary and capricious decision making” by failing to consider the economic consequences of its action.
“The dealer rule is indeterminate and leaves certain market participants uncertain of their need to comply with the dealer regulatory framework. Alternative asset managers are not dealers. They are customers of dealers,” said Bryan Corbett, chief executive of the Managed Funds Association, one of the three plaintiffs along with the National Association of Private Fund Managers and the Alternative Investment Management Association.
The dealer rule, first proposed in 2022 and passed in early February, is the latest SEC regulation to be challenged in court by the hedge fund industry. MFA, for example, is also suing the agency over a rule seeking to broaden disclosures for private funds as well as rules on securities lending and short selling. Under Gary Gensler, SEC chair, the regulator has enacted a sweeping series of corporate and market reforms.
The lawsuit against the dealer rule comes despite the fact that the final version made significant concessions to hedge funds, and would — in the SEC’s view — likely exclude most of them.
Speaking with the Financial Times in February, Gensler said the regulation “is primarily about principal trading firms” — typically high-speed groups that buy and sell securities with their own internal funds.
In response to Monday’s lawsuit, an SEC spokesperson said: “The commission undertakes rulemaking consistent with its authorities and laws governing the administrative process, and we will vigorously defend challenged rules in court.” The complaint was filed in the US District Court for the Northern District of Texas.
The SEC’s rule was issued as hedge funds and high-speed traders have come to play an increasingly important role in the Treasury market, where big banks have stepped back from their role as dealers since rules created in response to the 2007-09 financial crisis made it more expensive for them to hold debt.
The dealer rule is part of a broader push by Treasury market regulators — including the SEC, the Treasury department, the Federal Reserve and others — to increase regulatory oversight and improve stability in the world’s biggest and most important market.
A series of crises in the past decade have rocked Treasury trading and forced the Fed to intervene on two occasions. Because investors, central banks and foreign governments around the world all hold Treasury bonds, problems in that market quickly ripple out.
Legal pushback against the SEC’s reform agenda extends beyond market structure reforms. A long-anticipated rule on company climate disclosures was temporarily paused by an appeals court last week as it considers a legal challenge brought by two energy companies.
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