Kirsten Rastrick: Hi, my name's Kirsten Rastrick, and I'm the Global Head of Fixed Income Financing Sales at JP Morgan.

John Schwartz: Hi, my name is John Schwartz and I'm the Global Head of Sovereign Financing Trading at JP Morgan.

Kirsten Rastrick: So this is such a treat to be able to sit with you and have a quick conversation away from the trading floor. We sit at an interesting intersection of a lot of different conversations happening in the market related to financing and repo, specifically at the largest bank, a security services custody platform offering large corporate treasury securities lender and market making division. You're having conversations with industry working groups, regulators, your peers. We're both having conversations with clients. So we thought this would be an interesting time to just give a little status update on the repo market and hone in on the fixed income space specifically in the US treasury market.

John Schwartz: Yeah, for sure. I mean, there's been a lot of talk recently just around the size and scale of the US Treasury market. I think it's always helpful when you think about the financing space is really get a sense of where we've come from. So if you think about the US Treasury asset class specifically and some of the just meaningful growth that we've seen over the years, going back 20 years ago, outstanding US treasury debt was approximately $5 trillion. That has grown from five up to 30 today. So the growth of the market has clearly led to a lot of discussions around, well, what does that mean for internal mediation? What does that mean for treasury market liquidity? Not only have we seen growth in outright issuance, we've seen really structural changes in the composition of ownership. So if you go back a decade, you had large foreign buyers, both private and public sector.
Clearly there was participation in the bank space, there was participation in the levered fund community, but that composition has evolved over the last decade to where more price sensitive buyers have become a larger and more meaningful component of the US treasury market. The complicating factor of that is hedge funds and other price sensitive buyers require not only dealer intermediation in terms of buying and selling bonds and providing market liquidity, but also financing intermediation. So with that change of composition coupled with the growth in the US treasury market, you have seen growth in reliance and growth in dealer balance sheets being committed to fundamentally supporting that intermediation. The repo market by proxy has grown probably two or three times in size as close to $6 trillion just in the US treasury product today. Hedge fund participation in repo has grown from 500 billion back in 2013 up to close to 3 trillion today.
So that increase in dealer balance sheet pressure has clearly led to, well, how do we continue to intermediate? How do we continue to provide liquidity to the US Treasury product, not just in terms of the outstandings that we're really sitting with today, but no secret that the budget deficit is large, it's growing. So when we think about the $30 trillion figure today, that is expected to grow approximately 2 trillion a year for the next number of years. So the magnitude only increases. I mean, in terms of client participation and what you're hearing from hedge funds, how do you think clients themselves are thinking about allocated capacity? How do you think clients themselves are thinking about their position in the market?

Kirsten Rastrick: I think I agree with you on all those points, and you've really started to see much more reliance from a variety of different clients on the repo market for leverage in this space. So hedge funds in particular, like you said, have almost quintupled over the past decade in their utilization of the market. But that's not to say the other accounts haven't also gotten more familiarized in utilizing the repo market. And this spans not just across the US treasury space, but across EuroGovies, other non-dollar sovereigns emerging markets credit and securitized product financing as well. The hedge fund space specifically has been a bit of a, it's helped fill a void in terms of absorbing some of this supply that I think dealer balance sheets have been a little bit more pinched to be able to absorb with not only increased issuance, but also the increased regulation on the banking sector.
There has been a need for additional participants to take down some of the supply that's coming from the market. So I think the big multi-strat hedge funds have just gotten bigger. The systematic funds have started to emerge with a fixed income strategy, both directional and relative value strategies. You've seen different uses for expression of interest rate views from the real money community. Not only is cash government bonds a viable opportunity to express interest rate risk, but also they're looking at maybe more cash-efficient opportunities in futures or derivatives space. So you are seeing a slight drift into a diversification into other asset classes for expressing that same risk from the real money community, all the more reason for the need for another buyer to step into the US Treasury space. So all of those things combined show that support the fact that this market has grown in not only its size, but it's also its significance.
Now from there, what does that mean in terms of binding constraints and optimization of those binding constraints? The dealers have had over the past five to 10 years a whole slew of new regulations imposed on it and regulations, looking at balance sheet, looking at capital, looking at liquidity. But the growth in at least the hedge fund space as well is also limited by a credit component as well. So there's credit risk limitations that we've started to see. So I think to your original question of how hedge funds and the client franchise are thinking about utilizing the repo market, one really key thing for them to be able to understand is how their different dealer counterparties are managing to the different binding constraints. So what we have seen recently is not only a desire from clients to understand from us where and at what different point in time different binding constraints come into play, G-SIB, RWA leverage in the form of balance sheet liquidity, and then therefore how they can optimize to really best suit flows that fit neatly into all of our appetites across those different metrics.
And from a client's perspective, it's not just the JP Morgan footprint. They're going to have to do this for every single dealer that they're speaking with. So it is it a bit of a project for the clients to understand this, and it's also in an evolving landscape. Everything is actually highly in flux right now with regulatory change and market structure change as well. So maybe that's an interesting segue into some of the work that you've been doing, either with advocacy or understanding of the evolving market structure changes that are in flux.

John Schwartz: I mean, it's certainly challenging when you think about it, whether it's from the dealer side or from the client side. There is some asymmetry there in regulation, whether it's gold plating of US regulations, all adhesive and SLR, whether it's just different governing bodies governing different types of intermediaries. I think the challenge is how do you navigate your trading strategies? How do you navigate where you lean in terms of clients to really optimize your own capital base and your return base? So as a trader, you think you spend a lot of time focusing on risk or market positioning, market views, and I certainly spend a lot of time doing that. But more and more these days is how do you structurally build the appropriate, as you said, a capital liquidity framework to the extent we think there are deficiencies or gaps in how regulations have been brought up, how do you advocate?
How do you align, yes, we think prudent risk management aligned with treasury market liquidity to me is an important thing? So in terms of what we're advocating for, there's a big industry push today to potentially reassess how SLR is calculated and viewed. Certainly if you go back to periods of volatility and stress, certainly during COVID, LCR became a meaningful binding constraint, particularly in treasury intermediation. That is less so today, but I do think there's risk where markets do dislocate if dealers are asked to step in and provide liquidity capacity and liquidity provisioning that that may become binding. So a lot of advocacy work focused on US Treasury carve-outs, focused on fed reserve carve-outs. Certainly we're very focused on G-SIB, not just alignment of G-SIB across jurisdictions so that US banks can compete on the same, really a level playing field to our US or to European peers, but also recalibration at G-SIB.
The fact that the economy has grown approximately 55% since when G-SIB was put in place, G-SIB has not been tailored to account for that economic growth. So I think there are thoughtful ways that both the regulators and certainly the community can approach these things. They don't necessarily introduce or increase systemic risk, more adjust and tweak the capital rules that would support intermediation. I think another thing that clearly there's been a lot of talk on post-CSEC's finalization of the US clearing rule is market structure and market structure change. If you think about the increased leverage needs and liquidity provisioning to hedge funds, unlocking dealer intermediation capacity, how we do that from a market structure standpoint is going to be super important. You've seen natural growth in the clearing of US treasuries over the last decade, and that has been willing clearing, not necessarily regulatory driven, and the incentive function is to manage G-SIB and it is to manage balance sheet for us to be able to do more with clients and service their needs.
That now will go into overdrive as we have to think about clearing the entire US treasury market, both from a repo perspective in a much larger component of the cash market. So how that evolves and how that necessitates change in how we interface with our clients, I think is going to be very important to not just our ability to continue to facilitate client activity, but also impacts the treasury pricing, swap spreads things that ultimately the regulators keep very close eyes on and impact the taxpayer at the end of the day. But with that comes opportunity said. When I think about stronger connectivity to the CCP, you naturally then dovetail into, well, what else can we do that helps streamline the way that we interface with clients? So electronification, that's been a big agenda. So maybe you can spend a little bit of time talking through what you've seen over the last five or six years on that electronification front, the introduction to D two C type connectivity, our own effort to build in-house solutions, I think that would be is clearly a natural additive to that.

Kirsten Rastrick: And I think it just is a natural solution for the growth in not only the size of the market, but therefore the client flow that's come off the back of that. There's been an absolute need for automation and digital solutions to handle all of this increased volume that's going through the system. So there's a multitude of third-party vendor platforms that have been rapidly adopted by the client franchise, and this spans all types of clients. It's not just your systematic clients. This is the entirety of the hedge fund community. It is asset managers, it's central banks, it's real money pension insurance type names that have adopted these dealer-to-client trading vendor platforms, and even our own JP Morgan Execute platform as well. What has that done that has enabled them to more efficiently trade? Not only just the high volume, high number of ticket treasuries and EuroGovie type trades, but it spans across all asset classes.
So some of the emerging market and credit flow is very ticket intensive and it's really helped to simplify some of the financing in those other asset classes as well, so that is a frontier that it is still emerging in terms of its development, but the volumes going through on these vendor platforms are very significant. I think it is going to be also a necessity at the time when treasury clearing comes around for implementation, there will need to be solutions for pre-trade credit checks, et cetera. So that's all going to have to have a venue or a forum for electronic trading capabilities. So it also speeds up execution. So when you're thinking about just the day in the life of a client or a salesperson or a trader, one of the other binding constraints that we didn't talk about in the previous segment, daylight overdraft costs. And so to have an automated system that enables you to trade your entire T plus zero same day trading book in the first hour of the day is very impactful from a cost saving perspective.
Every basis point, every dollar counts in the funding markets. And so these clients are looking to just really optimize and create efficiencies wherever they possibly can. So that's been a notable shift as well where you've seen such a move forward in the timeline of a day to day a client-sales-trader interaction by utilizing these automation tools. Now, with those automation tools can come a whole host of benefits in addition to some cost savings, but it can also create a repository for data to be analyzed. We are getting much more efficient at tracking metrics associated with hit-miss ratios, trends of client behavior across all of these different asset classes. So the data element is going to be quite impactful as we get more and more flows through the vendor platforms and able to be warehoused in a repository. So that I think is another value and it is going to really inform us to help us be informed in how to make better decisions for our binding constraints, the capital liquidity balance sheet metrics.
So a massive lift to the industry by the evolution of these platforms, and we're super excited about it. We continue to think of new innovative ways to contact and to engage with our clients over the platforms. The other thing that I think in terms of, we didn't necessarily go down this path before, but in terms of other ways of optimizing our client flows and behavior, the market is migrating a little bit towards a cross-product margining offering as well. There's dealers out there who have it. We are also in the final stages of a cross-product margining offering for clients as well. And so I do think that will just create even more efficiencies for the client franchise in the coming years.
But between optimization tools, digital and automation solutions for our clients, what that does is I think it really frees us up to focus on the more bespoke long-term structured financing solutions and mirror all of the benefits that we have gotten from some of these more highly developed high-flow markets and developed government bond space into some of the other asset classes as well, which is a boost to opportunity sets in those markets as well for credit, mortgage, emerging markets with more time and effort and tools available to support those markets, it will actually fuel liquidity and general market functioning in those markets as well.

John Schwartz: I mean, you bring up cross-product margining, and I think it's interesting because in my mind it brings together all these things that we've been talking about. On its face, it's really there to unlock capacity and to better align risk within a trading strategy. So you use the treasury cash future basis trades as an example where if you go back to COVID and you had one leg of that trade clearing through the CME and through an FCM, you had the repo leg clearing through a different provider. There wasn't a risk view to the actual trading strategies. So ultimately when margins were increased on the CME side, it led to a massive liquidation.
And I think when we think about appropriate market structures that better align trading strategies, in my mind, cross-product margining is a really good example of that, where if you bring things together in a thoughtful way, not only does it increase capacity and client's capacity to trade that strategy, it fundamentally reduces, in my mind risk that we wear associated with that because we're not sitting necessarily with only one side of that transaction. And it's ultimately, I think it promotes just broader trading liquidity. You don't have to have as much capacity laying around in reserve. You don't have to think about multiples of liquidity buffers if you know that these really tied together trading strategies are going to behave and be margined in a thoughtful and constructive way. So I think it's very important as this market evolves, as more and more of this goes into central clearing, that the market embraces ideals like this.
Now, I do think, not to wrap it back around to advocacy points, but aligning how we think about capitalization of different products in a single netting set goes back to I think a number of the points that we are actively engaged with, both through industry forms like SIFMA and the regulators. Cross-product margining. You can package it together. You can have the risk infrastructure there to support it. You can have clients willing to participate in it, but if the way that we need to capitalize our business isn't aligned with that, then it quickly becomes a very non-commercial offering that I think we can offer. But I do think that that idea really brings together a number of points that we've been talking about.

Kirsten Rastrick: And I guess to wrap it all together in some final observations, the repo market has been extraordinarily resilient over the past couple decades that you and I have been in the business. And I think some of these regulations have obviously been to pinpoint and target maybe some areas that needed a little bit of additional risk oversight. So whether it's leverage rules, whether it is additional capitalization for the banks, whether it is tiering of different sized banks given their systemically important significance to the market, all of these regulations have proven in the past couple crises that we've been through, whether it's COVID, whether it's the regional banking crisis that the market is holding up, it's very, very orderly. And so I think to the extent that there is, we can continue to innovate with tools to just optimize and create efficiencies as much as possible. It will continue to fuel growth in an orderly way in this market and get more creative and innovative with our solutions-based financing on top of the facilitation of client flow and the traditional flow products that we see heavy volumes in every day.