Recently, the resurgence of the "bond market" turmoil in the United States has kept regulators awake at night.
"Basis trading", which takes advantage of the small spread between Treasury bonds and Treasury futures, is a common arbitrage strategy used by the world's largest hedge funds.
Jonathan Hoffman、John Bonello和Jonathan Tipermas三人均是“基差交易”策略的顶级交易员，分别供职于对冲基金Exodus Point、Millennium Management和城堡投资。
Relying on huge sums of money borrowed from Wall Street (often 50 times the size of their own investments), they have engaged in tens of billions of dollars in "basis trades" over the years, grabbing billions of dollars in revenue for the company, according to the latest media reports.
The stakes are so big that some argue that they have become the centerpiece of the buying and selling of U.S. Treasuries, which are the cornerstones of global capital markets.
Now, their deal has caught the attention of regulators and faces a series of stricter new rules.
The "basis trade" is back
报道称，除了以上人士，对冲基金Capula Investment Management的Yan Huo和Ryan Letchworth 、城堡投资的Ivan Chalbaud 、Symmetry Investments 的创始人FengGuo和Balyasny Asset Management的Steve Brown，Kedalion Capital Management的Lorenzo Rossi和Tudor Investment Corp.的Alexander Phillips也积极参与了“基差交易”。
Unlike the high-profile hedge funds that act flamboyantly, the traders represented by Hoffman have chosen a more stealthy path – quietly trading arbitrage between spot and futures on U.S. Treasuries, so this group is rarely seen in the public eye.
But as the number of short-term Treasuries has surged this year, the "basis trade" has flourished, and they are back on the stage. According to one Wall Street veteran, "basis trade" bets account for about 70% of hedge funds.
The Bank of England said on December 6 that its net short position in Treasury futures had surged to $800 billion from $650 billion in July.
While it's hard to say how many of these positions are held by the core trading group, it's safe to assume that this bet is becoming more concentrated this year.
Nearly half of all bets on 2-year Treasury futures are backed by eight or fewer traders, compared with just 29% a year ago, according to the Commodity Futures Trading Commission.
"Basis Trade" = "Pick up coins in front of the roller"
James Novotny, a fund manager at London-based Jupiter Asset Management, has said basis trading is "a bit like picking up a coin in front of a roller".
Unlike other U.S. Treasury investors, basis traders don't need to judge the economic situation or the Fed's interest rate plan, they only need to focus on the spot spread of U.S. Treasury futures.
When there is a premium between the futures price and the spot price, traders sell futures and buy spot, and when the futures contract expires, the spot and futures prices tend to converge, at which point they sell the spot and close the futures position, completing the trade arbitrage.
However, this type of trading is generally highly leveraged, and if the market deteriorates, the losses faced by hedge funds will be magnified exponentially. And when the loss reaches a certain level, the bank may ask for more collateral.
As a result, even small movements in the market can lead to large cash losses and, in the worst case, hedge funds that could go bankrupt.
The U.S. debt storm four years ago
It is worth noting that all these risks happened four years ago.
In March 2020, hedge fund bets were bombed dramatically, exacerbating the panic sell-off triggered by the pandemic and causing the Treasury market to crash for a while.
At one point, the Bonello team lost more than $100 million, and Millennium, which had a history of losing money for just one year for more than three decades, lost 5% at one point.
ExodusPoint faced significant losses, as did Castle Capital.
Rossi, who was only 33 at the time, made more than $250 million in profits for LMR in 2019, but his losses soared as the market crashed in March.
Later, the Fed was forced to intervene and increased its holdings of US Treasuries by $1.6 trillion from March to May.
The U.S. Treasury market was then appeased, and basis traders not only avoided huge losses, but also realized significant income.
Millennium generated a record profit of nearly $1.5 billion in 2020 for the full year of 2020, while Hoffman generated $1 billion in revenue for ExodusPoint from 2018 to 2020, with basis trading contributing a significant portion of that in 2020.
Notably, Wall Street's lending to basis trades has surged so far this year, with sponsored buyback financing for basis trades jumping to nearly $400 billion.
Regulators intervened in advance to control highly leveraged trading
And now, before the "basis trade" caused another market storm, the regulator has stepped in early.
Last week, the U.S. Securities and Exchange Commission (SEC) took note of the high levels of leverage in related transactions and introduced new rules to tighten regulations on highly leveraged strategies, such as basis trading.
In general, hedge funds are usually able to borrow from banks on "zero margin", which means they can make more profits without providing additional collateral.
The new rules now require that from 2026 onwards, all repo transactions will have to go through central clearing, with increased margin requirements.
Can't always count on the Fed to "bail out"?
Proponents of "basis trading" such as Ken Griffin, founder of Castle Capital, say the heavy buying and selling of hedge funds means they are helping to improve the efficiency of the U.S. Treasury market. Wall Street banks used to play this key "market maker" role, but withdrew due to the new leverage rules implemented in the wake of the financial crisis.
"There are only a few players, but they're too big to go out of business," said Kathryn Kaminski, lead research strategist at Alpha Simplex Group. ”
But some analysts worry that the experience of four years ago may have convinced these top traders that the central bank will always come to the rescue. If regulators don't rein in the game, the painful history of 2020 will be repeated.
Eric Rosenfeld, who worked for the Solomon administration's arbitrage unit in 1980, said that while some hedge funds were "too big to fail," more importantly, "the Fed has a responsibility to maintain a liquid, free-flowing Treasury market."
Others have suggested that it would be unwise to rely so heavily on a handful of hedge funds, and that the turmoil four years ago, which forced them to unwind their positions quickly, may have further exacerbated the sudden depletion of Treasury liquidity and exposed basis traders to huge losses.
SEC Chairman Gary Gensler also told the media in October that if there were another financial crisis, "the risk would be borne by the public." ”
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