Volkov Yuriy
Broker Representative
FOR A RAINY DAY. HOW WALL STREET IS PREPARING FOR A POSSIBLE DEFAULT
Dear clients,
As negotiations to raise the debt ceiling of the USD 31.4 trillion government debt intensify, Wall Street banks and asset managers have started to prepare for the consequences of a possible default.
The financial industry has prepared for such a crisis before, most recently in September 2021. But this time, the relatively short timeframe for a compromise has bankers on their guard, said one senior industry official.
US government bonds underpin the global financial system, so it is difficult to fully assess the damage a default would cause, but executives expect strong volatility in equity, debt and other markets.
The ability to trade in and out of treasury bonds on the secondary market will be severely limited. Even a short-term breach of the debt ceiling could lead to a spike in interest rates, a plunge in equity prices and a breach of credit documentation and leverage agreements.
Banks, brokers and trading platforms are preparing for disruptions in the treasury market as well as wider volatility.
This typically includes planning for how payments in treasury securities will be made; how the critical funding markets will react; ensuring there is sufficient technology, staffing and cash to handle large trading volumes; and checking the potential impact on contracts with clients.
Large bond investors have warned that maintaining a high level of liquidity is important in order to withstand potential sharp fluctuations in asset prices and avoid having to sell at the most inopportune time.
The Securities Industry and Financial Markets Association (SIFMA), a leading industry group, developed an action plan that details what Treasury bond market participants — the Federal Reserve Bank of New York, the Fixed Income Clearing Corporation (FICC), clearing banks and Treasury bond dealers — should do in the run-up to and on the days of a possible Treasury bond payment miss.
SIFMA considered several scenarios. The most likely scenario is that the Treasury would buy time to pay bondholders by announcing on the eve of the payment that it would reschedule these securities, extending them one day at a time. This would allow the market to continue functioning, but no interest would likely accrue on the deferred payment.
In the most destructive scenario, the Treasury does not pay any principal or coupon and does not extend the maturity date. The outstanding bonds would no longer be tradable and could not be transferred through the Fedwire Securities Service, which is used to hold, transfer and settle Treasury bonds.
Each scenario is likely to cause significant operational problems and will require daily manual adjustments to trading and settlement processes.
In addition, in past periods of confrontation over the debt ceiling issue — in 2011 and 2013 — Fed staff and policymakers developed their plan, which is likely to serve as a starting point, with the last and most sensitive step being the complete removal of defaulted securities from the market.
Dear clients,
As negotiations to raise the debt ceiling of the USD 31.4 trillion government debt intensify, Wall Street banks and asset managers have started to prepare for the consequences of a possible default.
The financial industry has prepared for such a crisis before, most recently in September 2021. But this time, the relatively short timeframe for a compromise has bankers on their guard, said one senior industry official.
US government bonds underpin the global financial system, so it is difficult to fully assess the damage a default would cause, but executives expect strong volatility in equity, debt and other markets.
The ability to trade in and out of treasury bonds on the secondary market will be severely limited. Even a short-term breach of the debt ceiling could lead to a spike in interest rates, a plunge in equity prices and a breach of credit documentation and leverage agreements.
Banks, brokers and trading platforms are preparing for disruptions in the treasury market as well as wider volatility.
This typically includes planning for how payments in treasury securities will be made; how the critical funding markets will react; ensuring there is sufficient technology, staffing and cash to handle large trading volumes; and checking the potential impact on contracts with clients.
Large bond investors have warned that maintaining a high level of liquidity is important in order to withstand potential sharp fluctuations in asset prices and avoid having to sell at the most inopportune time.
The Securities Industry and Financial Markets Association (SIFMA), a leading industry group, developed an action plan that details what Treasury bond market participants — the Federal Reserve Bank of New York, the Fixed Income Clearing Corporation (FICC), clearing banks and Treasury bond dealers — should do in the run-up to and on the days of a possible Treasury bond payment miss.
SIFMA considered several scenarios. The most likely scenario is that the Treasury would buy time to pay bondholders by announcing on the eve of the payment that it would reschedule these securities, extending them one day at a time. This would allow the market to continue functioning, but no interest would likely accrue on the deferred payment.
In the most destructive scenario, the Treasury does not pay any principal or coupon and does not extend the maturity date. The outstanding bonds would no longer be tradable and could not be transferred through the Fedwire Securities Service, which is used to hold, transfer and settle Treasury bonds.
Each scenario is likely to cause significant operational problems and will require daily manual adjustments to trading and settlement processes.
In addition, in past periods of confrontation over the debt ceiling issue — in 2011 and 2013 — Fed staff and policymakers developed their plan, which is likely to serve as a starting point, with the last and most sensitive step being the complete removal of defaulted securities from the market.