Back in April 2020, at the height of the global pandemic, the Federal Reserve Board took emergency action to temporarily exclude US Treasury securities from the supplementary leverage ratio (SLR) calculation. This week, we sent a letter to US prudential regulators requesting that this exemption be reintroduced on a permanent basis, a move we think would provide greater capacity for banks to expand their balance sheets and provide liquidity, enhancing the resilience of the US Treasury market.

A spate of market stresses, including the dash for cash in March 2020, has exposed the susceptibility of the US Treasury market to liquidity shocks during periods of stress, prompting regulators to look for ways to enhance the resiliency of this market. The recent publication of rules by the US Securities and Exchange Commission (SEC) requiring certain cash US Treasury securities and repo transactions to be cleared is one such policy change – something SEC chair Gary Gensler says will “help to make the Treasury market more efficient, competitive and resilient”.

However, the SLR is inconsistent with that objective, as it serves as a non-risk-sensitive binding constraint on banks and can impede their ability to act as intermediaries, including their capacity to clear for clients. That’s particularly the case in times of stress – which is what prompted the US Federal Reserve to take a series of measures in 2020 to support liquidity conditions in the Treasury market, including the temporary exclusion of US Treasury securities and deposits at Federal Reserve banks from the SLR calculation. Academics have also pointed to the role of the SLR in constraining the ability of banks to participate in the US Treasury market in certain circumstances.

It’s not just the SLR – US prudential regulators recently published their proposals on the Basel III ‘end game’ measures, as well as changes to the surcharge for global systemically important banks (G-SIBs). Together, these measures will further constrain balance sheets and could force banks to scale back or withdraw from certain intermediation activities. According to an industry impact study based on input from US G-SIBs, the proposed US Basel III rules and the G-SIB surcharge would increase capital for clearing businesses by more than 80%. The constraints imposed by the SLR, meanwhile, negatively affect the ability of banks to participate in markets for low-risk assets.

We think regulators should think hard about the impact of various rules in combination to ensure they achieve the policy outcomes they want. In this context, a permanent exclusion of US Treasury securities from total leverage exposure would free capacity for banks to participate in US Treasury markets and facilitate access to cleared markets, especially during periods of stress. Specifically, we recommend the permanent exclusion should cover on-balance-sheet US Treasuries that banks hold in inventory or as part of their liquidity portfolios, as well as those received in repo-style transactions that are recorded on balance sheet. In addition, the size systemic indicator within the G-SIB surcharge should be revised to exclude on-balance-sheet US Treasuries.

This permanent exclusion would better promote the stability and resilience of the US Treasury market and give banks more certainty to expand balance sheet capacity than a regime introduced during market stresses that will later be reversed.

This is particularly important given the wave of new issuance expected in the coming years. US Treasury market outstanding issuance is at a record high of more than $26 trillion and is forecast to rise to $48 trillion by 2034, raising questions about how this supply will be absorbed. Given the vital role banks play in supporting liquidity and providing access to client clearing, a permanent exclusion will contribute to a safer, more efficient and more resilient US Treasury market.

The ISDA AGM in Tokyo on April 16-18 will include sessions on capital requirements and clearing of US Treasury securities. Click here to learn more.