Introduction
Ken Griffin, the head of Citadel, a multi-billion dollar investment fund, has voiced his opinion on the regulation of hedge funds by the U.S. Securities and Exchange Commission (SEC). In an interview with the Financial Times, Griffin argues that instead of focusing on hedge funds, regulators should prioritize overseeing banks in order to mitigate risks associated with debt-fuelled arbitrage trading of U.S. government bonds.
The Basis Trade
The SEC’s plans entail subjecting hedge funds to increased oversight by treating them more similarly to the broker-dealer arms of banks, specifically in relation to the basis trade. The basis trade involves profiting from the slim arbitrage gaps between the immediate price of U.S. Treasury bonds and their value on futures markets. These trades often rely on substantial borrowing, with leverage exceeding 100 times.
Potential Consequences
Griffin cautions against hastily impairing the basis trade, pointing out several negative consequences that such a move could entail. Firstly, he suggests that it would hinder funding for corporate America, increasing the cost of capital for businesses looking to expand or hire more employees. Additionally, Griffin notes that it would raise the cost of issuing new debt, ultimately burdening U.S. taxpayers with billions or even tens of billions of dollars annually.
A Different Approach
Rather than targeting hedge funds, Griffin proposes an alternative approach to address concerns about the size of the basis trade. He suggests that regulators could require banks to conduct stress tests to evaluate if they possess sufficient collateral from their counterparties. By doing so, they can ensure the stability of the financial system without impeding necessary funding for various sectors of the economy.
In conclusion, Ken Griffin cautions against subjecting hedge funds to increased oversight and regulation. Instead, he argues that regulators should focus their efforts on banks and implement stress tests to assess their ability to handle potential risks associated with the basis trade.