[House Hearing, 119 Congress]
[From the U.S. Government Publishing Office]
EXAMINING PRIMARY DEALERS AND THEIR
BALANCE SHEET CONSTRAINTS
=======================================================================
HEARING
BEFORE THE
TASK FORCE ON MONETARY POLICY, TREASURY
MARKET RESILIENCE, AND ECONOMIC PROSPERITY
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED NINETEENTH CONGRESS
FIRST SESSION
__________
DECEMBER 2, 2025
__________
Serial No. 119-46
Printed for the use of the Committee on Financial Services
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
www.govinfo.gov
__________
U.S. GOVERNMENT PUBLISHING OFFICE
63-435 PDF WASHINGTON : 2026
=======================================================================
HOUSE COMMITTEE ON FINANCIAL SERVICES
FRENCH HILL, Arkansas, Chairman
BILL HUIZENGA, Michigan, Vice MAXINE WATERS, California, Ranking
Chairman Member
FRANK D. LUCAS, Oklahoma SYLVIA R. GARCIA, Texas, Vice
PETE SESSIONS, Texas Ranking Member
ANN WAGNER, Missouri NYDIA M. VELAZQUEZ, New York
ANDY BARR, Kentucky BRAD SHERMAN, California
ROGER WILLIAMS, Texas GREGORY W. MEEKS, New York
TOM EMMER, Minnesota DAVID SCOTT, Georgia
BARRY LOUDERMILK, Georgia STEPHEN F. LYNCH, Massachusetts
WARREN DAVIDSON, Ohio AL GREEN, Texas
JOHN W. ROSE, Tennessee EMANUEL CLEAVER, Missouri
BRYAN STEIL, Wisconsin JAMES A. HIMES, Connecticut
WILLIAM R. TIMMONS, IV, South BILL FOSTER, Illinois
Carolina JOYCE BEATTY, Ohio
MARLIN STUTZMAN, Indiana JUAN VARGAS, California
RALPH NORMAN, South Carolina JOSH GOTTHEIMER, New Jersey
DANIEL MEUSER, Pennsylvania VICENTE GONZALEZ, Texas
YOUNG KIM, California SEAN CASTEN, Illinois
BYRON DONALDS, Florida AYANNA PRESSLEY, Massachusetts
ANDREW R. GARBARINO, New York RASHIDA TLAIB, Michigan
SCOTT FITZGERALD, Wisconsin RITCHIE TORRES, New York
MIKE FLOOD, Nebraska NIKEMA WILLIAMS, Georgia
MICHAEL LAWLER, New York BRITTANY PETTERSEN, Colorado
MONICA DE LA CRUZ, Texas CLEO FIELDS, Louisiana
ANDREW OGLES, Tennessee JANELLE BYNUM, Oregon
ZACHARY NUNN, Iowa SAM LICCARDO, California
LISA McCLAIN, Michigan
MARIA SALAZAR, Florida
TROY DOWNING, Montana
MIKE HARIDOPOLOS, Florida
TIM MOORE, North Carolina
Ben Johnson, Staff Director
------
TASK FORCE ON MONETARY POLICY, TREASURY MARKET RESILIENCE, AND ECONOMIC
PROSPERITY
FRANK D. LUCAS, Oklahoma, Chairman
BILL HUIZENGA, Michigan JUAN VARGAS, California, Ranking
ANDY BARR, Kentucky Member
MARLIN STUTZMAN, Indiana BRAD SHERMAN, California
SCOTT FITZGERALD, Wisconsin JOSH GOTTHEIMER, New Jersey
MIKE FLOOD, Nebraska SEAN CASTEN, Illinois
MONICA DE LA CRUZ, Texas CLEO FIELDS, Louisiana
TROY DOWNING, Montana JANELLE BYNUM, Oregon
C O N T E N T S
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Tuesday, December 2, 2025
OPENING STATEMENTS
Page
Hon. Frank D. Lucas, Chairman of the Task Force on Monetary
Policy, Treasury Market Resilience, and Economic Prosperity, a
U.S. Representative from Oklahoma.............................. 1
Hon. Juan Vargas, Ranking Member of the Task Force on Monetary
Policy, Treasury Market Resilience, and Economic Prosperity, a
U.S. Representative from California............................ 2
WITNESSES
Ms. Susan Mclaughlin, Executive Fellow, Yale School of Management 4
Prepared Statement........................................... 6
Mr. James Tabacchi, Chairman, Independent Dealers & Trading
Association.................................................... 12
Prepared Statement........................................... 14
Ms. Laura Klimpel, Managing Director and Head of Depository Trust
& Clearing Corporation (DTCC's) Fixed Income and Financing
Solutions...................................................... 20
Prepared Statement........................................... 22
Dr. Haoxiang Zhu, Gordon Y Billard Associate Professor of
Managements and Finance, MIT Sloan School of Management........ 27
Prepared Statement........................................... 29
EXAMINING PRIMARY DEALERS AND THEIR BALANCE SHEET CONSTRAINTS
----------
Tuesday, December 2, 2025
U.S. House of Representatives,
Subcommittee on Task Force On Monetary Policy,
Treasury Market Resilience, and Economic
Prosperity,
Committee on Financial Services,
Washington, DC.
The subcommittee met, pursuant to notice, at 2:43 p.m., in
2128, Rayburn House Office Building, Hon. Frank D. Lucas
[chairman of the subcommittee] presiding.
Present: Representatives Lucas, Huizenga, Barr, Stutzman,
Fitzgerald, Flood, De La Cruz, Downing, Vargas, Gottheimer,
Fields, Sherman, Casten, and Bynum.
Chairman Lucas. The Task Force on Monetary Policy, Treasury
Market Resilience, and Economic Prosperity will come to order.
Without objection, the chair is authorized to declare a
recess of the committee at any time.
This hearing is entitled, ``Examining Primary Dealers and
Their Balance Sheet Constraints.''
Without objection, all members will have 5 legislative days
within which to submit extraneous material to the chair for
inclusion in the record.
I now recognize myself for 4 minutes for an opening
statement.
OPENING STATEMETN OF HON. FRANK D. LUCAS, CHAIRMAN OF THE TASK
FORCE ON MONETARY POLICY, TREASURY MARKET RESILIENCE, AND
ECONOMIC PROSPERITY, A U.S. REPRESENTATIVE FROM OKLAHOMA
Welcome to today's hearing from the Task Force on Monetary
Policy, Treasury Market Resilience, and Economic Prosperity. I
want to start by thanking Chairman Hill, and Ranking Member
Vargas, and our witnesses for their flexibility in rescheduling
this hearing after the government shutdown delayed our October
plans.
The Treasury market is the deepest, most liquid, and most
essential market to the global economy. Our focus today is on
the primary dealers that intermediate in that market and the
regulatory and administrative burdens that constrain their
ability to do so. Primary dealers facilitate trades between the
Treasury, foreign central banks, pension funds, and asset
managers, among others. Our market structure relies on primary
dealers to ensure steady demand for the Nation's debt and the
effective implementation of the monetary policy.
Capital requirements, such as Basel III, the Global
Systemically Important Bank (G-SIB) surcharge, and risk-
incentive leverage ratios, have undermined primary dealers'
intermediation capacity. Robust participation from
intermediates in the Treasury market is essential to the
markets' ability to function well among stress and volatility.
Congress must continue to evaluate the health of the market,
particularly as the capacity to intermediate does not grow
commensurate with the government's ever-growing issuance of
debt.
Market disruptions in 2014, 2019, and 2020 demonstrate the
need to examine and reevaluate the limitations and constraints
regulations may inadvertently put on the Treasury market. This
morning, Vice Chair Bowman testified before the full committee,
and we agreed that our capital framework should not
unnecessarily constrain the intermediaries our market relies
on. That is why I was pleased to see the Fed finally adjust the
enhanced supplementary leverage ratio to remove disincentive
for banks to engage in low-risk activities, such as holding
Treasuries, but more is yet to be done.
Capital regulations may need adjustment to properly
recognize Treasuries as nearly risk-free assets, particularly
as liquidity regulations require an increase in the volume of
these liquid assets banks are holding. Other leverage ratios,
such as the supplementary leverage ratio and Tier 1 leverage
ratio, may also need to be adjusted to increase balance sheet
capacity and ensure that they function as intended: a backstop
to risk-weighted capital requirements, not a binding constraint
on the intermediation. I also continue to agree with Chair
Miran excluding Treasuries and reserves from the supplementary
leverage ratio (SLR) and the enhanced supplementary leverage
ratio (eSLR) would help insulate the Treasury market from
potential disruption during periods of market stress.
Finally, I intend to ask Government Accountability Office
(GAO) to reexamine the operation of the Treasuries market,
including its operations, risks, and regulatory structure. The
last time this report was conducted was in 1986. The landscape
has changed since then, and we should get an updated report. I
look forward to the discussion today, and I yield back.
I now recognize the ranking member of the task force, Mr.
Vargas, for 4 minutes for an opening statement.
OPENING STATEMENT OF HON. JUAN VARGAS, RANKING MEMBER OF THE
TASK FORCE ON MONETARY POLICY, TREASURY MARKET RESILIENCE, AND
ECONOMIC PROSPERITY, A U.S. REPRESENTATIVE FROM CALIFORNIA
Mr. Vargas. Thank you very much, Mr. Chairman. I want to
thank you for convening this hearing, and I, too, would like to
thank the witnesses and especially for your flexibility. Thank
you for coming today. We appreciate it very much.
With a market value of nearly $30 trillion, the U.S.
Treasury market plays a critical role in the global financial
system. Our Treasury market has long been considered the most
stable and liquid market in the world, and that stability has
been immensely beneficial for Americans. The Treasury market
serves as a tool for setting the monetary policy and a
benchmark for interest rates. It serves as a dependable asset
for investors and offers the broader market a safe haven in
times of stress, and it allows us to finance our government at
low cost to taxpayers. That is why it is critical that we
continue looking at ways to maintain and even improve our
Treasury market's resilience and efficiency. That means
continuing to explore options to address concerns of increased
volatility, strained market liquidity, and the long-term
quantitative growth of Treasuries. Continuing to effectively
manage these challenges will keep borrowing costs low, increase
investor confidence, and strengthen financial stability.
One way we can do this is by reviewing the function of
primary dealers. As the largest intermediaries, primary dealers
play an important role as a connective tissue within the
Treasury market. They ensure smooth functioning of the market
between market participants, including the U.S. Treasury
investors and the Federal Reserve. Because of the important
function primary dealers have, it is essential we make sure
they have enough balance sheet capacity to effectively serve
their role as market makers. This flexibility is a vital part
of making sure they can absorb any shock and shifts in the
Treasury supply and investor demand. We saw episodes of these
shocks in October 2014, September 2019, and March 2020. That is
why it is worth looking at the reforms aimed at making sure our
primary dealers can continue intermediating without disruption.
The central clearing rule, finalized by the Securities and
Exchange Commission (SEC) in December 2023, is an important
step in that direction. This rule reduces risk, improves
efficiency, and enhances the financial stability of the market.
Targeted reform of the supplementary leverage ratio is also
worth examining further, as the chairman noted. SLR reform has
the potential to assist primary dealers in holding an
increasing number of Treasuries. At the same time, we should
recognize one of the central sources of expanding Treasury
issuance is rising deficits. Over the years, Treasury debt held
by the public has increased significantly. In 2007, it made up
30 percent of our Gross Domestic Product (GDP). Today, it makes
up 97 percent, and this expansion is showing no signs of
slowing down. Following the passage of what we call, on our
side, President Trump's big, ugly bill, the Congressional
Budget Office (CBO) is projecting this number to elevate to 134
percent by the end of 2034.
Primary dealer capacity keeping up with the growth of
Treasuries is of paramount importance in improving market
resilience. I look forward to hearing from the witnesses about
these issues and the potential solutions impacting the Treasury
market, and with that, Mr. Chair, I yield back.
Chairman Lucas. Thank you, Mr. Ranking Member. I am now
pleased to recognize the chairman of the full committee, Mr.
Hill, for 1 minute for an opening statement.
Chairman Hill. Thank you, Chairman Lucas. It has been
nearly 1 year since this task force was formed, and what a year
it has been for both the Federal Reserve and the Treasury
markets. No one anticipated the events that would occur in the
bond market back in April, and as of a few days ago, the
Merrill Lynch Option Volatility Estimate (MOVE) Index, a
measure of bond market volatility, is at its lowest level in 4
years, but this does not mean that we can kick our feet up and
sit back.
The Congressional Budget Office projects annual deficits
growing from $1.8 trillion this year to $2.5 trillion by 2035.
Congress must stop force feeding our current primary dealers
more and more debt, especially as the post-Dodd-Frank
regulations constrain their ability to absorb growing Treasury
issuance. Thankfully, central clearing helps free up balance
sheets for dealers to take up and serve more of our debt, but
should our primary dealers fail to live up to their obligation
to purchase Treasuries, yields spike, shooting up borrowing
costs for the government to finance its priorities and
consumers to acquire homes, cars, and college education.
Therefore, the work of this committee is essential, and I thank
the chairman, and I yield back the balance of my time.
Chairman Lucas. The gentleman yields back. Today, we
welcome the testimony of Ms. Susan McLaughlin, executive fellow
of the Yale School of Management; Dr. James Tabacchi, chairman
of the Independent Dealers & Traders Association; Laura
Klimpel, managing director and head of Depository Trust &
Clearing Corporation's (DTCC's) Fixed Income and Financing
Solutions; and Dr. Haoxiang Zhu, Gordon Y. Billard Associate
Professor of Management and Finance at the MIT Sloan School of
Management. We thank each of you for taking the time to be
here, and each of you will be recognized for 5 minutes to give
an oral presentation of your testimony. Without objection, any
written statements you would like to be made a part of the
record.
With that, Ms. McLaughlin, you are now recognized for 5
minutes for your oral remarks.
STATEMENT OF SUSAN McLAUGHLIN, EXECUTIVE FELLOW, YALE SCHOOL OF
MANAGEMENT
Ms. McLaughlin. Thank you, Mr. Chairman, Ranking Member
Vargas, and distinguished members of the task force. It is
truly my honor to be here with you today. Prior to my
appointment at Yale, I worked at the New York Federal Reserve
(Fed) for 30 years in a series of operational, policy, and
management roles in which the primary dealers were my key
counterparts. My views reflect this experience, though my
testimony today is based on information entirely in the public
domain.
The size and continued growth of the debt is the first-
order risk to the Treasury market's resilience. As has been
well documented, the growth of the national debt has outpaced
dealers' capacity to intermediate it. In addition to financing
the U.S. Government's operations, the Treasury market serves an
anchor for global financial markets. It is where the Fed
implements monetary policy and where global investors have
historically sought safety in periods of market stress, and the
Treasury curve is the basis for the pricing of credit
instruments worldwide. So, the ongoing stability of this market
is a serious concern, both for U.S. economic security and
global financial stability.
I would like to highlight two main points. First, steps are
already being taken, as has been mentioned, to augment dealer
balance sheet capacity to intermediate Treasury securities. The
Treasury's buyback program, recent changes to the enhanced
supplementary leverage ratio, and the SEC's Treasury clearing
rules are, collectively, likely to add at least several
trillion dollars in balance sheet capacity to the market over
the next few years but when you consider that the quantity of
marketable Treasury securities outstanding grew by $1 trillion
just between July and October of this year, it is not clear
that these measures alone can address the potential for future
capacity needs.
Second, while it is worth exploring whether scope remains
to designate additional primary dealers, my view is that this
will not go very far to address the problem of the broader
market's balance sheet capacity to intermediate Treasuries.
Rather, I think the great potential lies in changes to the
structure of the Treasury market itself. We have already
mentioned central clearing. Another option to explore is all-
to-all trading, in which buyers and sellers trade directly with
each other rather than going through an intermediary. All-to-
all protocols are not yet present in the Treasury market but do
exist alongside market making in some other markets, such as
the corporate bond market.
To be sure, primary dealers play a special role in the
Treasury market. Their original purpose was to serve as
counterparties in the Fed's monetary policy operations but over
time, their responsibilities have evolved to include being
subject to a pro rata share bidding requirement for Treasury
auctions that does not apply to any other market participants.
Through this pro rata share mechanism, the primary dealers
provide a backstop to mitigate the risk of an undersubscribed
or failed Treasury auction, which could have dire consequences
for our sovereign credit rating, the dollar, and the U.S.
economy.
If we are concerned about adding net new capacity to
intermediate Treasury debt to the market, increasing the number
of primary dealers is unlikely to move the needle very much.
Moreover, given the dual responsibilities that primary dealers
have for Treasury auction support and monetary policy
implementation, the firms best suited for designation are those
who can buy, hold, and sell Treasury securities on a continuous
basis, across the yield curve, in all market environments, and
in sufficient size to support the Fed's operational needs.
Firms that are not two-way market makers in Treasuries would
not be fit for purpose as primary dealers.
Thank you for the opportunity to share my views with you
today. I look forward to your questions.
[The prepared statement of Ms. McLaughlin follows:]
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Chairman Lucas. Thank you. Mr. Tabacchi, you are now
recognized for 5 minutes for your oral remarks.
STATEMENT OF JAMES TABACCHI, CHAIRMAN, INDEPENDENT DEALERS &
TRADING ASSOCIATION
Mr. Tabacchi. Thank you, Mr. Chairman, Mr. Vargas, members
of the committee. It is my pleasure to appear here today. I am
currently representing the Independent Dealers & Traders
Association. It is a group of independent dealers. They are not
part of any bank holding company. They typically have between
$200 million and $500 million in capital, and they are probably
responsible for about 15 percent to 20 percent of the capacity
of the repo market on any given day, probably a little bit
higher on typical quarter ends when balance sheet gets
extremely tight. In addition, I am the CEO of South Street
Securities, which is a firm I co-founded and started 25 years
ago. It is a middle market broker-dealer and a member of the
Independent Dealer & Traders Association. I am also a sitting
board member of DTCC.
I am also on the advisory council of Bank of New York's
Government Securities Division, and I think I am fairly unique
in the marketplace in that I have managed a balance sheet at a
large global bank--Citibank, Citicorp--for 20 years and then
started my own firm with significantly less capacity and
significantly less capital but I understand the pressures that
executives and managers of both the largest banks and the mid-
market firms go through. I understand it very well from both
sides, and they both have critical jobs, but their jobs are
also very difficult.
The theme that I am trying to bring to this committee is I
am more concerned with the U.S. Treasury market than maybe some
of my esteemed colleagues because, if you look back 10 years
ago, we had about $8 trillion, $9 trillion in outstandings. We
are currently, I think it is a little more than $30 trillion.
We are passing through like $34 trillion, $35 trillion right
now, and by the Fed's own reckoning and forecasting, we are
headed toward $50 trillion in 6 to 8 years. I will tell you
that unless we use every solution in the drawing board right
now, we do not have capacity for $50 trillion in the U.S.
Treasury market.
Look, central clearing was designed to reduce counterparty
risk. It did that, but it also increased concentration risk, so
that is a little bit of moving spaghetti around on the plate
because concentration risk has gone through the roof. It was
also designed to make the market more efficient from a balance
sheet standpoint. It did that, but I have to give some kudos,
and, again, full disclosure, I am on the board of DTCC, Fixed
Income Clearing Corporation (FICC), who Ms. Klimpel represents
and runs, had gone a long way through the sponsorship program
to making the market more efficient.
Now, what I think some significant steps that we have to
take almost right away are two right away, and one is a longer-
term project, I will admit. One, all the major participants in
the U.S. Treasury market, including regional dealers, some
regional banks, need to have access to the Standing Repo
Facility. The Standing Repo Facility, just so that you know, it
was designed so that when markets were constrained for
liquidity in the repo market, you could go to the Fed, and they
would give you liquidity against Treasuries.
So, the reason why that has not worked is when I was
running a desk at Citibank, and the treasurer of the bank come
and tap me on the shoulder and says, ``Jim, balance sheet is
closed, no more,'' and that was it. The balance sheet was full,
so how can I borrow from the Standing Repo Facility and lend to
the marketplace? So, once those balance sheets of the
participants that are eligible for that resource are full, you
are done. So it will never work unless more balance sheet
capacity is brought to bear.
The other thing I think is really important is, and I will
get into it a little bit more because I am running out of time,
is hedge funds are not a bad thing. American pools of capital,
buying U.S. Treasuries, America's paper, is that a bad thing? I
do not think so. Who would you rather have buying them, the
Chinese? However, hedge funds need financing, and they also
cannot be unlimited. So, standardized minimum haircuts need to
be implemented right away. Last, and I will just jump quickly
through this, I do believe we need more participants in the
U.S. Treasury market, more intermediaries in the U.S. Treasury
markets, more primary dealers, more regional dealers, more
regional banks, and with that, I will pass along the gavel.
[The prepared statement of Mr. Tabacchi follows:]
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]
Chairman Lucas. Thank you. Ms. Klimpel, you are now
recognized for 5 minutes for your oral remarks.
STATEMENT OF LAURA KLIMPEL, MANAGING DIRECTOR AND HEAD OF
DTCC'S FIXED INCOME AND FINANCING SOLUTIONS
Ms. Klimpel. Chairman Lucas, Ranking Member Vargas, and
members of the task force, thank you for the opportunity to
testify today. My name is Laura Klimpel, and I serve as the
managing director and head of the Fixed Income Clearing
Corporation, or FICC, at DTCC. I appreciate the chance to speak
with you about DTCC and FICC's role in central clearing and the
work we have undertaken to prepare the industry for the SEC's
expansion of U.S. Treasury clearing.
For more than 50 years, DTCC has served as the premier
post-trade market infrastructure for the global financial
industry. Every day, we help automate, standardize, and process
financial transactions for thousands of broker-dealers,
custodian banks, and asset managers. Our core mission is to
reduce risk, enhance transparency, and ensure that our markets
remain resilient and efficient. DTCC is industry owned and
industry governed. We process securities activity across U.S.
equities, Treasuries, mortgage-backed securities, mutual funds
and exchange-traded funds (ETFs), and other asset classes. We
are also a highly regulated organization, overseen by more than
20 regulatory bodies worldwide, including the Federal Reserve
and the SEC.
Let me turn now specifically to FICC. As an SEC-registered
central counterparty, FICC provides critical netting, clearing,
and settlement services across the U.S. Treasury and mortgage-
backed securities markets. The SEC's expansion of central
clearing for U.S. Treasury activity is one of the most
significant market-structured developments in decades.
Policymakers, academics, and market participants broadly agree
that expanding central clearing will improve the safety,
soundness, and efficiency of the Treasury market while also
enhancing transparency, supporting all-to-all trading, and
reducing credit and liquidity risks.
The SEC finalized its rule in December 2023 and later
extended the industry-wide implementation timeline by 1 year.
As a result, mandatory clearing for cash transactions will now
begin on December 31, 2026, and for repo transactions on June
30, 2027. Although the SEC postponed the industry's compliance
deadlines, FICC maintained its commitment to implementing
required access model and risk management enhancements,
successfully launching all necessary changes as planned. Those
enhancements include expanded access models, the separation of
house and customer activity, and the creation of segregated
customer margin accounts. FICC is well positioned to handle the
increased volume that expanding clearing will continue to
bring. Prior to the SEC rule proposal, FICC cleared roughly
$4.5 trillion a day. By the end of 2023, that number rose to
about $7.2 trillion, and today we routinely clear more than $11
trillion per day. We have also demonstrated resilience during
periods of market volatility, including new record volumes,
most recently yesterday when our volumes hit $13.2 trillion.
As we prepare for the clearing requirement, FICC has
focused on enhanced access, promoting capital efficiency, and
improving risk management tools. We continue to expand our
sponsored service and agent clearing service to allow both buy-
side and sell-side firms to participate in the manner that best
meets their needs. We also have two proposed rule changes
currently under SEC review, both designed to address double-
margining concerns and make it easier and more cost effective
for firms to bring repo activity into central clearing. In
addition, FICC is working with Chicago Mercantile Exchange (CME
Group) to extend cross-margining to end user clients, subject
to regulatory approval. The expansion should reduce capital
requirements and further encourage the use of central clearing.
In closing, DTCC's work often takes place behind the
scenes, but it plays a critical role in maintaining the
liquidity, efficiency, and competitiveness of U.S. financial
markets. The SEC's expansion of Treasury clearing is a major
industry effort that will strengthen the market for years to
come. FICC remains committed to working with our clients,
regulators, and industry partners to ensure a safe and
successful implementation in 2026 and 2027.
Thank you for the opportunity to testify today. I look
forward to your questions.
[The prepared statement of Ms. Klimpel follows:]
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]
Chairman Lucas. Thank you. Dr. Zhu, you are now recognized
for 5 minutes for your oral remarks.
STATEMENT OF HAOXIANG ZHU, GORDON Y BILLARD ASSOCIATE PROFESSOR
OF MANAGEMENTS AND FINANCE, MIT SLOAN SCHOOL OF MANAGEMENT
Mr. Zhu. Dear Chairman Lucas, Ranking Member Vargas, and
members of the task force, thank you for the opportunity to
testify before you today on the critical topic of ``Primary
Dealers and Their Balance Sheet Constraints'' in the U.S.
Treasuries market. My name is Haoxiang Zhu. I am an associate
professor of finance at MIT Sloan School of Management. From
2021 to 2024, I had the honor of serving as the director of the
Division of Trading and Markets at the U.S. Securities and
Exchange Commission.
I believe the most powerful policy initiative now for
expanding the mediation capacity in the U.S. Treasuries market
is the full and timely implementation of Treasury clearing.
Additional measures that could also strengthen the U.S.
Treasury market include increasing post-trade transparency of
Treasury securities, enhance the oversight of trading platforms
for Treasury securities and repo, and making more active use of
floating rate debt for government financing.
First, Treasury clearing. The central clearing of Treasury
cash and repo transactions delivers three principal benefits.
First, it substantially reduces risk. Through multilateral
netting, central clearing transforms large growth exposures
into small net exposures. Moreover, the clearinghouse
guarantees the performance of the participants, which further
mitigates default risk, limits contagion, and reduces systemic
risk. Second, central clearing provides standardized and
transparent risk management, and third, and perhaps most
relevant for today's hearing, central clearing of Treasury repo
transactions frees up a significant amount of balance sheet
capacity for primary dealers and other intermediaries.
Drawing on the methodology developed in my work with Nellie
Liang, we estimate that sponsored clearing of Treasury repo and
reverse repo at the Fixed Income Clearing Corporation has
already freed up approximately $1.2 trillion in balance sheet
capacity as of October 2025. Furthermore, if all uncleared
primary dealer repo and reverse repo were to transition into
central clearing as of October 2025, up to $1.3 trillion of
additional balance sheet capacity could be created.
Second, increasing transparency. The evidence regarding
post-trade transparency has been overwhelmingly positive in the
U.S. fixed income market. Study after study has documented
improved price discovery and a lower transaction cost for
investors following the implementation of post-trade
transparency, including corporate bonds, agency debt, mortgage-
backed securities, municipal securities, among others. The U.S.
Treasury market has been one of the last major markets to
implement and benefit from post-trade transparency. In March
2024, Financial Industry Regulatory Authority (FINRA) began
dissemination on the daily frequency of transactions for on-
the-run Treasury coupon securities. I believe the Department of
the Treasury, the SEC, and FINRA can further enhance the
liquidity of the U.S. Treasuries market by continuing to
strengthen post-trade transparency.
Third, enhancing the oversight of trading platforms.
Currently, trading platforms that meet the definition of
exchange under the Exchange Act, but exclusively trade
government securities, are exempt from Regulation Alternative
Trading System (ATS). As such, these platforms are not required
to register with the SEC or be subject to regulatory oversight.
The policy objective of removing such exemption has received
broad bipartisan support over the last 6 years, spanning three
different administrations. I believe completing this initiative
will represent a significant positive step forward in
supporting the growth and integrity of the U.S. Treasuries
market.
Fourth and finally, more active issuance of floating rate
debt. The outstanding amount of Treasury securities held by the
public reached approximately $30 trillion in October 2025. That
is roughly 6-and-a-half times the level in 2005. This stark
comparison actually underestimated the growth in the Treasury
market in another critical metric: interest rate risk. The
average maturity of Treasury securities today is about 70
months compared to 54 months in 2005. Therefore, investors and
intermediaries in Treasury securities today bear interest rate
risk that is approximately 8 times as large as it was 20 years
ago. Investors and intermediaries demand a risk premium for
bearing such risk, which in turn translates into a higher
borrowing cost for taxpayers.
I believe the time is now right for the Treasury to
consider reducing interest risk of newly issued debt.
Specifically, the Treasury can more actively issue floating
rate debts indexed to short-term interest rates, such as the
Treasury bill rate or the Secured Overnight Financing Rate,
SOFR. These floating rate instruments carry significantly less
interest rate risk. For example, the interest rate risk of a
10-year floating rate note is comparable to that of a 3-month
or 6-month Treasury bill. Floating rate securities should also
be attractive to investors whose objective is to protect the
market value of their U.S. dollar-denominated asset and
reserves. In addition, floating rate debt can be structured to
span a wide range of maturity dates. For these reasons, I
believe floating rate debt deserves a more prominent role in
Treasury issuance decisions, both for reducing interest rate
risk borne by investors and for maintaining flexible management
of the design and maturity structure of the Treasury debt.
Thank you very much again, and I welcome any questions you
may have.
[The prepared statement of Mr. Zhu follows:]
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]
Chairman Lucas. Thank you. We will now turn to member
questions, and I recognize myself for 5 minutes for questions.
Ms. Klimpel, can you provide an update on market
participants' readiness to comply with the SEC's clearing role?
Should the SEC provide more clarity for firms before the
deadlines go into effect, such as the scope of requirements for
inter-affiliate transactions?
Ms. Klimpel. Thank you for the question, Mr. Chairman. At
FICC, we have seen over the past several years a steady trend
of Treasury market participants adopting central clearing on a
voluntary basis due to the economic, operational, and risk
mitigation benefits that it provides. To give context, before
the SEC introduced its proposed rule to expand central clearing
of U.S. Treasury activity in 2022, FICC's daily volumes
averaged around $4.5 trillion, and as I noted, we hit an all-
time peak yesterday of $13.2 trillion of activity in a single
day. That being said, as Commissioner Mark Uyeda noted in his
recent remarks on the progress toward implementation of
Treasury clearing, there are certain issues that still need to
be addressed, such as the scope and contours of the inter-
affiliate exemption from the clearing requirement, amongst
others. We look forward to the resolution of those open issues
as clarity on them will be key as market participants get down
to the business of implementation and migrate the remaining
Treasury balances covered by the mandate into central clearing
over the course of 2026 and 2027.
Chairman Lucas. Continuing with you, how does central
clearing reduce systematic risk in the Treasury market, and
should our regulators recognize risk-reducing benefits of
central clearing through the implementation of cross-margining
for end users and corresponding capital reductions?
Ms. Klimpel. Central clearing through a central
counterparty (CCP), like FICC, offers Treasury market
participants the opportunity to have their activity novated and
net settled by a central counterparty, which creates various
operational, balance sheet, capital, and risk reduction
benefits for those firms and for the Treasury market as a
whole. Extending our existing cross-margining arrangement with
CME Group to end user clients would help those end user clients
by having their offsetting futures cleared by CME and their
cash and repo positions cleared at FICC recognized across the
CCPs for margining purposes, which would increase margin
efficiency for those end user clients, making it more cost
effective for them to transact, and smoothing their ability to
migrate additional Treasury activity into central clearing.
Implementing end user cross-margining will also result in
improved risk management through cross-CCP coordination in a
default situation, and also increased transparency, including
to the official sector. Making the corresponding capital
reductions for those end user clients' intermediaries is also
critical to be able to give those intermediaries the capacity
that they need to facilitate their clients' activity as part of
the cross-margining program.
Chairman Lucas. Ms. McLaughlin, I have seen reporting about
the firm's reluctance to use the Fed's Standing Repo Facility
that is intended to serve as an additional source of liquidity
in the Treasury market. What should the New York Fed be looking
at to improve the effectiveness of the Standing Repo Facility
(SRF)?
Ms. McLaughlin. Thank you, Mr. Chairman. I think that the
SRF is generally working as intended to provide a ceiling on
the level of the Fed funds rate. However, since it was not
really needed when reserves were abundant, there is probably a
little hesitation, and I have heard this from some market
participants, on the part of some to be among the first to use
it. I suspect the tool may be slightly stigmatized by the fact
that it was not previously used regularly. So, I think the most
important thing that Fed policymakers can do is to communicate
clearly and often that the SRF is intended to support rate
control, that it is open for business, and that market
participants should not hesitate to use it when it is
economically advantageous to do so. Usage in that scenario
supports interest rate control and, therefore, supports
effective monetary policy implementation.
Chairman Lucas. Mr. Tabacchi, demand for our debt from
rate-sensitive buyers has grown as a proportion of Treasury
purchasers, and we saw resulting market volatility in April
this year. How would you characterize the health and
functioning of the Treasury market in light of these trends?
Mr. Tabacchi. Again, if you look at the U.S. Treasury
market over the last 5 years, it has changed dramatically.
Sovereign wealth funds are not buying our paper. Can you hear
me?
Chairman Lucas. Is your microphone on?
Mr. Tabacchi. Yes.
Chairman Lucas. Thank you.
Mr. Tabacchi. As I said, the market is changing
dramatically. Sovereign wealth funds are not buying our paper.
Treasury hedge funds are buying our paper. Treasury hedge funds
need financing. Financing is not unlimited, and it is the main
constriction to our U.S. Treasury market.
Now, I have to disagree a little bit with my esteemed
colleague that I do not think that the Standing Repo Facility
is getting to where it needs to go. The Fed, when they call
around to the primary dealers, they are all saying, yes, there
is no problem, there is plenty of liquidity. It is the non-
primary dealers, the Treasury market participants that need to
have access to that facility.
Chairman Lucas. Thank you. I now turn to the ranking member
for his 5 minutes of questions.
Mr. Vargas. Thank you very much, Mr. Chairman. I appreciate
it.
Dr. Zhu, a question for you. In your research you published
in July with Dr. Nellie Liang, you mentioned risk reduction and
enhanced intermediation capacity as two of the primary benefits
of central clearing. You also discussed how central clearing
could help primary dealers free up hundreds of billions of
dollars in additional balance sheet capacity. Today, I think
you testified maybe $1.2 trillion. Can you explain how this
central clearing rule will provide that balance sheet capacity?
Dr. Zhu. Yes. Thank you for the question. Happy to
elaborate on that. According to the supplementary leverage
ratio rule, whenever a primary dealer borrows money from, let
us say, money market mutual funds and, onwards, lend it to a
hedge fund, that money shows up on the balance sheet, if the
primary dealer is a counterparty to the transaction. However,
if the two sides of the transaction both move to central
clearing, the dealer is no longer a counterparty to the
transaction. Therefore, that gross amount of $100 in that
example would not be on the balance sheet of the dealer,
therefore not subject to supplementary leverage ratio. So, I
think that is a very powerful tool. Central clearing is a very
powerful tool in removing that balance sheet constraint. That
is why we came up with these estimates.
Mr. Vargas. Thank you. Thank you for clarification. Now, I
have a number of questions here, but, Ms. McLaughlin, you said
something originally that really caught my attention, and that
is, you said this, and I do not want to put words in your
mouth, so if I misquote you, please let me know: ``We do not
have the capacity for $50 trillion. We could do all the things
on the board. We just cannot get there. That is too much.'' Did
you say that? Oh, you said that.
Mr. Tabacchi. Yes, sir, I am afraid I did.
Mr. Vargas. Okay. So, you do not think that then there will
be enough capacity?
Mr. Tabacchi. No. I think if the mandate is implemented
properly, with some considerable thought, I think it can be a
fine tool toward getting us to where we need to go. The thing
is, though, that we always seem, in the marketplace, and look,
I am not an academic. I have just spent the last 35 years in
and around trading desks.
Mr. Vargas. Right.
Mr. Tabacchi. So, I watch the way the market moves and
acts. The U.S. Treasury market, there are parts of it that are
struggling to work. SLR, yes, that is a piece of the puzzle. We
should work on changing that and increasing balance sheet
capacity. Is that an elixir? Absolutely not. We need to get----
Mr. Vargas. Okay. Let me do this because they give us
limited time here. Would anyone challenge that position and say
that there is capacity for $50 trillion because the reason is
very simple. I do not want to try to hide the ball. I do think
that, ultimately, we are right, everyone is right that we
cannot go on like this. The deficits are too big; that we
cannot do this. It is not sustainable. I do not know what level
that is. By the end of the day, it is math. Would anyone
disagree with that?
Mr. Tabacchi. Can I give you an example of why I think it
will not work on certain days? So, in September 2019, repo
rates went to 10 percent.
Mr. Vargas. Mm-hmm.
Mr. Tabacchi. Now, the reason why that happened is it was
like the perfect storm. We had five U.S. Treasury securities
settling. We also had quarter-end, so balance sheets were
already being constrained by window dressing.
Mr. Vargas. Right, but I think the problem is----
Mr. Tabacchi. Well, wait a minute.
Mr. Vargas. No, no, no. Hold on----
Mr. Tabacchi. Okay.
Mr. Vargas [continuing]. because you are going to a very
specific thing. I want to know about capacity in general, not 1
day.
Mr. Tabacchi. But this speaks to capacity.
Mr. Vargas. Hold on. Now I am going to go to Ms.
McLaughlin. I would like to ask her. Go ahead. Yes.
Ms. McLaughlin. I do not know if $50 is the right number or
some other number is the right number, but I do agree that at
some point we will reach a number where it is going to be a
real problem.
Mr. Vargas. Doctor? Dr. Zhu?
Dr. Zhu. I think once we implement the Treasury clearing
fully and other initiatives, such as transparency, and
potentially having more platform oversight, I think there will
be a wide variety of market participants come in, such as
smaller broker-dealers, clearing house, trading platforms.
Mr. Vargas. But it sort of creates more capacity----
Dr. Zhu. Absolutely.
Mr. Vargas [continuing]. to just get up to the $50, $60
trillion, wherever we are heading.
Dr. Zhu. It is hard to speculate on the exact number at
this point, but I think all these initiatives, that is why
these are so important. At least, given the current level,
completing these reforms would make the Treasury market much
more resilient, but I tend to agree that in the long run,
sustainable debt level is the fundamental solution.
Mr. Vargas. Okay. I know they give us very limited time. I
just have 20 seconds, so I just want to say this. I do think
that there is a problem here, and, ultimately, this is math. It
is math as insurance as people think. No, ultimately, it is
math, and there is a problem. The politics is what creates the
problem for the math. Obviously, both sides, when we were able
to balance the budget, created a political problem for a lot of
people, and I think at some point, we are going to have to
figure this out, both sides but anyway, thank you for your
testimony here today. I appreciate it.
Chairman Lucas. The gentleman's time has expired. The
gentleman from Kentucky, Mr. Barr, who is chair of the
Financial Institutions Subcommittee, is recognized for 5
minutes.
Mr. Barr. Thank you, Mr. Chairman. Very important hearing
about the proper functioning of the Treasury market with the
growing debt load that we are foisting upon future generations
of Americans. National debt is now, what, $38 trillion and
growing. I think, Ms. McLaughlin, you said it best in your
testimony when you said the greatest risk to the resilience of
the Treasury market is the level of the national debt itself.
So, job number one is, Congress needs to get our fiscal house
in order, but in the meantime, we should continue to explore
all avenues to support the market's capacity to intermediate
Treasury debt.
Ms. McLaughlin, without primary dealers that can absorb
rising issuance of Treasury securities and without more primary
dealers' participation, what happens to Treasury markets?
Ms. McLaughlin. I would just note, first, that primary
dealers are important intermediaries, but they are not the only
ones. There is a wide range. I think FICC alone has over 250
firms and are two-way intermediaries, and benefit netting, and
repo and/or cash transactions. So, primary dealers are not the
entire story, but they are an important part of it. I think if
we had a case where primary dealers were really unable or
unwilling to take down further debt, that would be a problem I
would hope not to see. I just want to make sure I am answering
your question. Can you repeat the last part of it?
Mr. Barr. I think you are. Let me go to Mr. Tabacchi
because I am interested in you finishing the analysis of what
happened in September 2019. I know we have limited time but
finish your thought there. What happened there, and did you
come up with this $50 trillion figure as the breaking point?
Mr. Tabacchi. The reason why is because most of the
regulations to date have been centered around the largest
banking institutions, the systemically important financial
institutions (SIFIs). Now, global SIFIs, for example, on that
date we had five Treasury issues settling. It was quarter end,
they were doing window dressing, and at the same time, bombs
were being dropped in the Middle East. So what did that do?
That caused all of the oil companies to draw down their lines
of credit thinking they would have to be repairing the
refineries. So, billions of dollars of cash left the biggest
banks. They are already constrained on their balance sheet, and
now there is not enough money in the repo market. Those are the
type of things that we are most susceptible to if we rely only
and the regulatory environment relies only on the biggest
banks.
Mr. Barr. Well, same question to you. What would happen to
the Treasury market if you reached the limit of capacity? What
happens?
Mr. Tabacchi. Well, I personally think that we are pushing
that envelope today because, again, the capacity issue is not
on the buying and selling of Treasuries. The capacity issue is
on the financing of Treasury because that is what takes up
balance sheet. Most of the big hedge funds and asset managers
come into the Treasury directly. At the primary dealer desk I
ran at Citibank, you would never need the amount of inventory
that we had than today, but you do need financing capacity.
That is the constraint, and that is where we do not have enough
participants in the marketplace, and those that are in the
marketplace do not have access to facilities like the standing
repo agreement.
Mr. Barr. So more regional banks, that is one solution.
Mr. Tabacchi. More regional banks, more regional dealers.
Mr. Barr. More hedge funds.
Mr. Tabacchi. Well, hedge funds, that comes with a little
bit of a grain of salt. Hedge funds, the largest banks now give
out repo at zero haircut. Now, I am a proponent of hedge funds.
I just said it. I would rather have Americans buying American
capital, American pools of capital buying American Treasuries.
However, nothing is unlimited without any haircut and just so
that you know, a haircut is like the downpayment you do on your
mortgage. It is an overcollateralization. It is a first-loss
protection. So, without haircut, you allow hedge funds to be,
basically, unlimited in terms of how much leverage they can
have.
Mr. Barr. Okay. I am running out of time. The SLR fix is a
no brainer, in my opinion.
Mr. Tabacchi. It is.
Mr. Barr. Let me go to Dr. Zhu. Very interested in your
more active issuance of floating rate debt idea. Can you
elaborate?
Dr. Zhu. Yes, of course. Currently, the Treasury Department
mostly issue coupon securities with a fixed-coupon payment, and
when interest rates start to rise, these instrument will lose
value very quickly. We saw that in Silicon Valley Bank and in
many other situations. So, in floating rate debt, the interest
payment goes up as market level interest rate goes up.
Therefore, these instruments tend to be very insensitive to the
level of interest rate. So, people who want to invest their
dollar assets for preserving their value would find these
instruments to be very valuable.
Mr. Barr. So, lower interest rate risk means more----
Dr. Zhu. Lower risk premium.
Mr. Barr [continuing]. more capacity.
Dr. Zhu. Correct, yes. Correct, exactly.
Mr. Barr. More purchases of Treasury debt.
Dr. Zhu. Exactly. That would be less penalized on the value
at risk (VaR), for example, value at risk models. That will be
less penalized by the capital rules and so on, yes.
Chairman Lucas. The gentleman's time has expired. The chair
now recognizes the gentleman from California, Mr. Sherman, the
ranking member of the Capital Markets Subcommittee, for 5
minutes.
Mr. Sherman. A fundamental problem we are not going to
solve in this room, and it is that we have too much national
debt. The debt has tripled since the 2008 global fiscal crisis.
A big chunk of that is the 2017 tax cuts for the wealthy,
followed by the $5 trillion Big, Beautiful Bill that was, I
think we all agree, big. During coronavirus disease (COVID),
both sides voted in a bipartisan way for some enormous
expenditures. Obviously, if we knew then what we know now, we
would have handled COVID differently.
So, we have too much debt. We have a couple of things that
are helping. One of those is the independence of the Fed, and
we have to fight to protect that. The other is that we are the
world's reserve currency. The euro would like to play that
role. Yuan would perhaps like to play that role. Crypto would
like to play that role, and I have had a lot to say about
crypto over the years, and what I said, God, almost 10 years
ago was that the undoing of crypto would be other crypto. What
I did not realize then was that stablecoin would undermine the
rest of the other coins because stablecoin allows drug dealers,
tax evaders, sanctions evaders, bankruptcy law evaders, to have
total confidentiality and secrecy without having to risk
putting their money into some other somewhat imaginary
currency. So, what we may see is that the dollar retains its
role as the world's reserve currency, and that all we lose from
crypto is the ability to enforce all of our fiscal laws. So, we
are where we are.
In June, partly in response to a letter a number of us
sent, including Representatives Wagner, Foster, myself, and
Barr, the Federal Reserve announced that it would change the
calculation of the global systemically important banks'--G-
SIBs--leverage requirement, effectively decreasing the leverage
capital that these banks are required to hold. Obviously, as we
issue more debt, we need to have banks participate. Mr.
Tabacchi, should the Fed consider making similar changes to
smaller banks on their leverage requirements, so they are not
disadvantaged when compared to the G-SIBs, and to bringing them
as full players in dealing with this load of debt we have?
Mr. Tabacchi. I think that is an option that should be
explored, Congressman. I also think that some of the other
things that we have already talked about are, frankly, more
important. If you look at central clearing----
Mr. Sherman. I am going to go on to my next question----
Mr. Tabacchi. Okay. Go ahead.
Mr. Sherman [continuing]. because I have such limited time.
Former Federal Reserve Board member, Jeremy Stein, has said
that large banks are allocating less capital to low-risk assets
like Treasuries because they are disincentivized to do so.
Leveraged capital requirements are insensitive to risk, and so
prudential regulation designed to cause banks to have less risk
actually incentivizes them to forego Treasuries and do things
that involve more risk. Mr. Tabacchi, could you walk us through
what happens in the broader financial markets if the U.S.
Treasury becomes less liquid or more expensive, and, in
particular, does that affect mortgages, car loans? Does it
affect the average person trying to borrow some money?
Mr. Tabacchi. It does because rates would go up. We are
playing with fire a little bit here, sir, because, again, if
repo is the capacity constraint, think of the funding level of
Treasuries has the issue. When the funding levels go up because
there is not enough capacity and several market participants
cannot access the Standing Repo Facility, then what do the
dealers do? They increase the rate that we charge hedge funds,
the variable buyer of Treasuries. When they increase what we
charge hedge funds, sooner or later hedge funds are either
going to increase risk, which they can do with the Big Banks
with zero haircut, or they are going to stop buying Treasuries.
Mr. Sherman. I understand. I am going to try to squeeze in
one comment, and that is, I think it is absurd to regulate
banks in a way where, at least for some purposes, holding a
corporate bond is treated as being as risky as holding a
Treasury. I yield back.
Chairman Lucas. The gentleman yields back. The gentleman
from Wisconsin, Mr. Fitzgerald, is recognized for 5 minutes.
Mr. Fitzgerald. Thank you, Chairman. Rising government
spending has made purchasing Treasuries more onerous for
primary dealers and as their balance sheets have not grown at
the same pace. Ms. McLaughlin, to be clear, is it fair to say
that primary dealer balance capacity issues generally did not
start to develop until after the financial crisis?
Ms. McLaughlin. What I can say is that I was not really
aware of that being a discussion point before the global
financial crisis. So, we heard a lot more about that from
market participants almost immediately after the end of the
crisis.
Mr. Fitzgerald. Yes, because 2008, government debt held by
the public has increased by nearly $27 trillion. It was not all
caused, despite what you might hear from some Members of
Congress, by the 2017 tax cut and the Big, Beautiful Bill.
There were other things that happened in between there, but
apparently not everybody remembers that. So, as Treasury
issuance continues to grow and primary dealers shoulder an
increasing share of that demand, balance sheet capacity has
become a real constraint.
So, Ms. Klimpel, how does expanding central clearing help
primary dealers reduce balance sheet strain and more
efficiently intermediate growing volumes of Treasury
securities?
Ms. Klimpel. Thank you for the question, Congressman.
Central clearing provides the opportunity for market
participants to have their activity novated to a central
counterparty, such that when they are intermediating activity
between two different dealers or between two different clients,
they can post novation face off against the same counterparty,
which, in our case, is FICC. That same counterparty creates a
unique opportunity to take balance sheet netting on that
activity, which is much more difficult to do outside of central
clearing. That balance sheet netting creates capacity, both in
terms of reduction of capital charges and otherwise, to free up
room and capacity on the balance sheet for market participants
to continue to transact, which increases liquidity in the
system.
Mr. Fitzgerald. So, if I understand you then, would central
clearing enhance primary dealers' capacity to perform kind of
this role without compromising the market and its stability?
Ms. Klimpel. Yes, that is correct.
Mr. Fitzgerald. Very good. Mr. Tabacchi, improving balance
sheet flexibility is essential for sustaining deep and
resilient Treasury markets. Can you explain, in your opinion,
what regulatory or legislative adjustments would best maybe
enhance dealers' ability to support the Treasury issuance? Any
comment there?
Mr. Tabacchi. Sure. First of all, we have to broaden the
participants in the U.S. Treasury market. I always hear that
all-to-all, which has also got a place in the U.S. Treasury
market, but nobody wants an intermediary until they need one in
a crisis, someone to take you out of your position. So, we need
more intermediaries of whatever. We need more dealers; we need
more primary dealers; we need more regional dealers, and we
have to find ways to incent more intermediaries into this
market, and everybody has got to be lifting this burden of $50
trillion. It is doable, but it cannot be done with one elixir
or one idea or SLR. That is not going to get there. We need a
lot of participation to make this work, and I am not going to
qualify at all the level of debt. That is not why we are here.
As market participants and regulators, we are supposed to be
prepared for what is coming. This is what is coming. This is
what we need to do. We need to broaden the market.
Mr. Fitzgerald. So, would the burden of growing, well,
right now, it is not concentrated solely on primary dealers,
right? Would you say that is accurate or not?
Mr. Tabacchi. I would say it is very much concentrated on
the largest SIFI banks, their primary dealer subsidiaries. The
concentration in the largest banks, we are not going to solve
this by just making the biggest banks bigger. That is not going
to work.
Mr. Fitzgerald. Okay.
Mr. Tabacchi. That is one elixir. Give them a little bit of
capital relief. That will help, but it is not the whole deal.
Mr. Fitzgerald. Thank you. I yield back.
Chairman Lucas. The gentleman yields back. The gentleman
from Illinois, Mr. Casten, is recognized for 5 minutes.
Mr. Casten. Thank you, Mr. Chair. I want to follow up with
you, Dr. Zhu, on your exchange with Mr. Vargas, and if I am
being way too simple or dumb, feel free to tell me. You would
not be the first person to tell me that. The idea these central
clearing agencies free up more money in the system, more
liquidity in the system, is that an accounting issue or just a
risk shifting issue? So, is there something fundamental going
on, or is this just that we are basically taking liabilities
off the balance sheets of entities that have obligations to
maintain certain capital ratios in moving that risk to another
spot in the system that does not have those obligations? Are we
reducing total risk or just moving it around in ways that
increases the capital in the system from those who are
constrained by capital ratios?
Dr. Zhu. Yes. Thank you for the question. The answer is
that a central clearing reduces risk. There is a risk. You
know, think about the broker-dealer in the middle, and they
borrow money from one side of the market and lend money to
other side of market in two repo transactions. Now, the risk is
actually a perfect offset. However, because of accounting
rules, the gross amount must show up on the balance sheet. That
turns out to be constrained on the balance sheet capacity of
the dealers. Central clearing collapses these two offsetting
transactions into one, and because there is a perfect
offsetting, there is a zero risk in that sense. Of course, the
clearinghouse will still charge margin on the net position, but
that is way smaller compared to the gross position.
Mr. Casten. I just want to clarify because you said,
``because of accounting rules,'' if I do not have a central
clearing agent in the middle, am I holding more liability even
if I am on both sides of the trade because I have in some gap,
preponderance of risk question, I bear more risk? So, is that
an accounting judgment primarily, or is it that all of a sudden
I have an entity that has offsetting risks that I did not have
before?
Dr. Zhu. In that example, it is both an accounting issue.
You know, by accounting, it shows on the balance sheet.
Therefore, it triggers all sorts of capital implications. Now,
of course, the dealer in the middle has offsetting risk with
two counterparties, but because these are two counterparties,
the credit risk cannot offset without a central clearing. By
moving these transactions into central clearing, the
clearinghouse basically eliminates all the counterparty risk,
therefore reducing the overall risk in the system and free up
balance sheet.
Mr. Casten. Okay. So, I think I understood that, but I will
have to think about it. If I have now reduced the risk on the
primary dealers, and we will stipulate for this example that
they are G-SIBs someone who has got obligations, does that
then, by definition, allow them to, essentially, have a
stronger balance sheet and, therefore, less capital ratios
before any change in SLRs? So, is this redundant with a change
in the SLRs, or how do you think about those two pieces
together?
Dr. Zhu. Thank you for the question. So, if the dealer is
able to move that amount off the balance sheet, then that would
be really helpful in reducing the SLR requirement. It
essentially takes that number out of the total leverage
exposure, whereas what the Federal Reserve did the last week
was to change the capital ratio. These two sorts of move in the
same direction of relieving balance sheet constraint, but I
think the central clearing effect here is to remove that part
of the balance sheet completely away from the calculation of
leverage ratio.
Mr. Casten. But if I am reducing my declared liability--my
math wrong here--I have changed the denominator in the leverage
ratio----
Dr. Zhu. Exactly.
Mr. Casten [continuing]. even before I have changed what
the ratio is, right?
Dr. Zhu. Yes, that is right. So, today, the primary dealer
could immediately take that amount of money sort of away from
the total average exposure calculation by going to central
clearing. In that sense, it is a pretty fundamental relief.
Mr. Casten. Okay.
Dr. Zhu. It does not really matter what the ratio is
because that part just disappears from the amount in closure.
Mr. Casten. Okay. I am getting close to the end of time,
but I have a sort of a simple view that the Fed provides a
discount window to the banks, and then the banks provide a
discount window to hedge funds through the repo market, and I
do want to make sure that we are not sort of financially
engineering away a more fundamental problem.
Mr. Tabacchi. The netting is an accounting and a
transaction, but the netting only reduces risk because there
are two counterparties, one on each side. If one of them fails,
there is still risk, and that risk is either borne by the other
counterparty or it is borne by the CCP.
Mr. Casten. Yes. No, I understand, and I know I am out of
time, but I am curious, and if the chairman will indulge--if
not, we will take this in writing--do we all agree with Dr. Zhu
that the creation of more CCPs puts more transparency into the
system? If so, does that reduce some of the volatility risk in
the system and whether we are talking about the 2019 situation
or the flash crash, do we reduce some of the innate volatility
in a less transparent system by the creation of these CCPs?
Chairman Lucas. This may require response in writing,
Doctor, [LAUGHTER.] the nature of that question.
Chairman Lucas. With that, I always indulge my friend from
Illinois. The gentleman's time has expired. The chair now
recognizes the gentleman from Montana, Mr. Downing, for 5
minutes.
Mr. Downing. Thank you, Mr. Chairman, for holding this
hearing on the important role primary dealers play in
facilitating liquidity in the Treasury's market, especially now
with the national debt exceeding $38 trillion. Hard to even
fathom that. With our national debt so high, it is prudent to
ensure demand remains high for U.S. Treasuries so the Federal
Government can continue to finance its operations.
So, on the first one YOU have discussed today how the
increasing debt issuance has placed additional strain on the
balance sheets of primary dealers. So I am going to start with
Ms. McLaughlin. Over the long time, do you consider Congress
reining in our out-of-control spending, the most critical
aspect of reducing the strain on primary dealers?
Ms. McLaughlin. I do.
Mr. Downing. Thank you. So, continuing, if Congress
continues to increase spending outside of investing into our
economy and workers, what happens to interest rates? Should
primary dealers simply no longer have the ability or
willingness to purchase Treasuries?
Ms. McLaughlin. That is for me?
Mr. Downing. Yes.
Ms. McLaughlin. Yes. So, I think, as we have seen in other
countries, a huge level of fiscal spending can be inflationary,
which can push nominal interest rates higher over time.
Additionally, as we have seen in other countries with this
experience, high debt levels tend to face market scrutiny and,
eventually, result in sovereign credit risk downgrades, which
increases financing costs. So, yes, I think there would be
upward pressure on rates.
Mr. Downing. Thank you. So, if the Federal Government
cannot stop itself from spending and cannot help our banks to
make it easier to buy our Treasuries, the borrowing costs of my
constituents and small business owners go up. So, not only does
government spending tax our constituents through inflation, but
it also taxes them through higher interest rates. Would you
agree?
Ms. McLaughlin. Yes, I would agree directionally with that
statement.
Mr. Downing. Thank you. Moving on to Mr. Tabacchi, despite
the growth in our national debt, the number of primary dealers
has not grown with it. All primary dealers are located in major
American cities or abroad. Are there barriers that prevent
financial institutions located in more rural areas from
becoming primary dealers? In other words, is geography
typically a constraint?
Mr. Tabacchi. I do not believe so, no. Also, I need to make
a point in terms of primary dealers and large banks, they do
not hold the Treasuries. They buy them and sell them.
Mr. Downing. Right.
Mr. Tabacchi. The real constituents here that we are
talking about are the ultimate holders of the Treasuries. Those
are the ones that we need to be worried about, like Treasury
hedge funds, which I keep saying, and that is not without risk,
too, because we cannot allow their leverage to go unabated
completely.
Mr. Downing. Right. I appreciate that, and going back to
rural participation, do you suspect that there is any appetite
from rural financial institutions to participate in any way?
Mr. Tabacchi. I think we are going to have to generate that
appetite, and by that, I mean we need to incent more players to
want to come into the U.S. Treasury market. Look, many of my
members are in Midwestern cities, but I do not know if in rural
areas--now with the electronification of today, they can
certainly operate there.
Mr. Downing. Thank you. Ms. McLaughlin, any comments on
that?
Ms. McLaughlin. Yes, thank you, Congressman. I would note
that in the 1970s and 1980s, we had a lot of small, independent
broker-dealers that were primary dealers located all over the
country. We have subsequently seen massive consolidation in
both the banking and the brokerage sectors, between the 1980s
and the 2000s in particular. A lot of those firms that were
independent broker-dealers located all over the country merged
or were acquired by banking organizations, and that is why you
see a lot of bank-affiliated firms on the primary dealer list
today.
Mr. Downing. Right. Thank you. So, the Federal Reserve
recently conducted its Second Monetary Policy Framework Review,
which provided an open forum and process to solicit feedback on
how to improve their approach and conduct monetary policy. In
this process, they periodically hold conferences, present
academic papers, and gather opinions from the public across the
country. So, again, to Ms. McLaughlin, given the importance
primary dealers play in our financial system and monetary
policy, do you think it would be beneficial if the New York
Federal Reserve conducted a similar style of review on how to
improve the primary dealer system, especially as primary
dealers face an increasing Treasury security issuance?
Ms. McLaughlin. Thank you for the question. I would say it
depends on the problem that we are trying to solve. So, if the
problem we are trying to solve is increasing intermediation
capacity for the market broadly, I do not personally think that
increasing the number of primary dealers will move the needle
very much because what it is really doing is just renaming the
existing intermediaries in the market as primary dealers. I see
a lot more potential for added intermediation capacity for
changes in market structure. I think that is going to be a lot
more transformative. Central clearing is a great example of
that. I have also advocated for further study of all-to-all
trading protocols, which do not exist in the Treasury market,
but do exist in some other markets, such as corporate debt.
Like Jim says, there is no silver bullet, so I think it is
going to be a range of solutions that we want to bring to bear,
but I think all avenues are worth exploring.
Mr. Downing. Outstanding. Thank you. My time has expired. I
yield.
Chairman Lucas. The gentleman's time has expired. The chair
now recognizes the gentleman from Nebraska, Mr. Flood, chair of
the Subcommittee on Housing, for 5 minutes.
Mr. Flood. Thank you, Mr. Chairman. It is so fortuitous
that we are having this conversation today, because last night
at 7:40, I got an email from somebody I respect greatly in
Lincoln, a long-time business person, and he writes, ``Mike,
amongst our long list of issues facing our country, I think the
biggest issue is our lack of willingness to deal with our
growing massive debt. When do we wake up and deal with this
issue? The joke of shutting down the government is a minor
issue compared to an economic meltdown.'' I do not think that
shutting down the government is a joke. That is very serious
stuff, but this is relevant, and part of the subtext behind our
conversation about primary dealers today is a cold, hard
reality that we have talked about.
We have a budget problem in this country, our debt is
continuing to rise year-over-year, and any student of history
will tell you that when debt and deficits increase fast enough,
their effects start to become evident in other parts of the
economy. Today's hearing covers one such example of this
phenomena: Treasury market primary dealers are stretched thin
when Treasury must issue more and more debt to finance the
operations of our government. The more debt we issue, the more
capacity required to release those notes and securities to the
broader Treasury market.
Let me be clear: the long-term solution here is to simply
tackle the problem of overspending. We need to get our fiscal
house in order. If we curb our deficit and issue less debt,
less primary dealer capacity is required. Better yet, if we
actually stop running a deficit and run a surplus to start
paying down, that is outstanding. However, in this budget
environment, a well-functioning and liquid market for
Treasuries is absolutely essential, and primary dealers are a
very important piece of that puzzle.
Mr. Tabacchi, if Treasury keeps issuing more securities,
and financial regulation is holding dealers back from
purchasing these securities, what happens to interest rates?
Mr. Tabacchi. They are going to have to go up. I mean, you
do not have to be a rocket scientist to know that one.
Mr. Flood. So, Mr. Tabacchi, the President and Secretary
Bessent shared a goal to lower 10-year Treasury yields to make
the cost of borrowing money more affordable. They have begun
addressing some of those regulations, thankfully. Would the
next step, in your opinion, be to encourage the demand for
Treasury securities? If so, how could we effectively encourage
that demand?
Mr. Tabacchi. Well, I think you have to make it a little
bit both easier and harder in a way for the variable buyers of
Treasuries, which are Treasury hedge funds. By ``easier,'' I
think the funding rate right now is squeezing their spread.
Now, they are the variable rise buyers of Treasuries, and
because funding rates are elevated, we are squeezing their
spread, so we are playing with fire that they are not going to
get tired of the Treasury market and go on to do something
else.
Now, a case in point, for the month of November, the
average SOFR rate, repo rate, was 4.01 or so. It was basically
over 4 for the entire month. Well, in that month, the Fed
reduced interest rates by 25 basis points. There was not a real
impact on the marketplace because funding rates are higher
because of a lack of balance sheet. That is why I am saying we
are playing with fire here.
Mr. Flood. Okay. Ms. Klimpel, in your testimony, you
highlight the end user cross-margining as a critical initiative
for the market. Can you talk a little bit more about what the
expansion of end user cross-margining will do for the market
and what other areas you are focused on to improve margin
efficiency?
Ms. Klimpel. Thank you for the question, Congressman. So,
FICC and the CME Group have had a cross-margining arrangement
in place since 2004 for our common members. The proposal that
we have been working on together, along with our respective
supervisors, is to bring that cross-margining arrangement down
to what we call the end user customer level, so that end user
clients of our common members who have offsetting interest rate
futures positions cleared at CME Group and cash and repo
positions cleared at FICC, can, to the extent that those
positions are offsetting from a risk perspective, gain margin
efficiencies recognizing that risk offset. That efficiency is
going to improve the capacity of those end-user customers to be
able to transact Treasury activity and also smooth their
implementation of bringing more activity into central clearing
in connection with the Treasury clearing requirement.
End user cross-margining is also going to improve risk
management in the Treasury market by allowing for closer cross-
CCP coordination in a default situation and it is also going to
help improve transparency across the asset classes by being
able to see the client's activity across the CCPs. We are also
focusing, in addition to the cross-margining rate that it was--
--
Mr. Flood. Madam, you are fantastic, by the way. Thank you
to the chairman.
Chairman Lucas. The gentleman's time has expired.
Mr. Flood. I yield before I get in trouble.
Chairman Lucas. The chair now recognizes the gentleman from
Indiana, Mr. Stutzman, for 5 minutes.
Mr. Stutzman. Thank you, Mr. Chairman, and thank you all
for being here.
Mr. Tabacchi, I would like to come to you. Our country has
a serious spending problem--the Federal Government, I should
clarify--and primary dealers provide steady demand for our
ever-growing debt. However, the size of bank balance sheets has
not kept pace with our out-of-control spending, which we saw
explode under the Biden Administration. How has government
spending affected balance sheet utilization for primary dealers
in the last few years?
Mr. Tabacchi. Again, the important constraint of the
primary dealers, of all the dealers that are intermediaries in
the U.S. Treasury market is the financing markets, financing
securities, and, again, it is simple. How many people buy a car
that does not use financing? The variable buyer of Treasuries
today need financing, and financing is constrained. I will give
you another statistic. Year-end looks like it is going to be
difficult this year. It is currently trading at 4.5, while 90
percent probability the market is pricing in another 25-basis
point cut. How can that be? The funding markets where the
constraint of financing hits the most are not functioning well,
and look, I am not an academic. I just sit at a desk, and I
watch it all day. It is not working.
Mr. Stutzman. Would you say primary dealers should dedicate
more room on their books to our debt?
Mr. Tabacchi. It is more than just that. Once you get to
balance sheet capacity, you have so much capacity based on your
capital. Once you get to that capacity, as I told you, the
treasurer taps you on the shoulder, that is it. You cannot take
any more. So, we need more balance sheets coming into the
market. If you look at the CCPs as the hub of the Treasury
market, the intermediaries, the broker-dealers, the primary
dealers, the regional banks, those are all the spokes coming
in. We need more of them because they provide the balance sheet
capacity to the end user.
Mr. Stutzman. Ms. McLaughlin, I saw you shaking your head.
I want to ask you, so with the current barriers to entry, are
we preventing institutions capable of becoming primary dealers
from doing so? How has that number of primary dealers
fluctuated over time, and what are the factors that have
contributed to that number?
Ms. McLaughlin. Thank you, Congressman. Yes, the number of
primary dealers has fluctuated over time. Since the primary
dealer system that we know today was formed in 1960, we have
seen the number go up and down. The drivers of those changes
have not actually been as much the eligibility criteria as just
trends in the market structure. So, for example, the number of
primary dealers grew during the Japanese economic boom in the
1980s when Japanese firms were becoming global and stepping
into the Treasury market to intermediate Treasuries. We saw a
fall in that number during the late 1990s and early 2000s as
rapid consolidation resulted in mergers, some failures, and
some acquisitions of primary dealer firms. Then we have seen
the number creep up again since the global financial crisis
from a low of 17, I think it was, in 2008, to the current 25.
Mr. Stutzman. Are there incentives for banks to become
dealers right now, and if there are, do you think those are
sufficient or attractive as they should be?
Ms. McLaughlin. So, surely there are incentives. I think
the answer to whether it is attractive might be different for
different firms. Primary dealers do enjoy some benefits. For
example, there are a number of large investors and smaller
investors that only transact with primary dealers, so access to
customer base might be one. Primary dealers also have access to
the Fed's Standing Repo Facility and the securities lending
program, which is only available to primary dealers.
Mr. Stutzman. Mm-hmm.
Ms. McLaughlin. And primary dealers currently have access
alone to the Treasury's buyback program as well.
Mr. Stutzman. Mm-hmm.
Ms. McLaughlin. So, there are clearly reasons why some
firms might want to do that, but I would also note that there
are firms that are intermediaries that have chosen not to apply
for primary dealer status, weighing the costs and benefits of
that status.
Mr. Stutzman. So, are there ways that those are not primary
dealers, are there ways that we could encourage them to
purchase more Treasuries?
Ms. McLaughlin. I mean, I guess, again, what is the problem
that we are trying to solve? So, if we are trying to solve the
problem of balance sheet capacity, I think things like central
clearing, other innovations in market structure that either add
net intermediation capacity to the market or relieve demand for
intermediation may be the most helpful.
Mr. Stutzman. Can you be a small or midsized institution
and participate?
Ms. McLaughlin. So, if you meet the capital threshold,
which was reduced in 2016 for broker-dealers, and you have the
operational capacity, you can certainly apply and you would be
considered. If you can demonstrate that you can meet the
requirements operationally and also that you have a sufficient
presence in the market----
Mr. Stutzman. Mm-hmm.
Ms. McLaughlin [continuing]. you would generally be
admitted as a primary dealer.
Mr. Stutzman. Okay. Thank you, Ms. McLaughlin.
Chairman Lucas. The gentleman's time has expired. All time
has expired.
I would like to thank all of the witnesses for their
testimony today, and without objection, all members will have 5
legislative days to submit additional written questions for the
witnesses to the chair. Questions will be forwarded to the
witnesses for their response. Witnesses, please respond no
later than January 7, 2026.
[The information referred to was not submitted prior to
printing.]
Chairman Lucas. This hearing is adjourned.
[Whereupon, at 4:01 p.m., the subcommittee was adjourned.]
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