The US Federal Reserve and the Bank of England are increasing their scrutiny of global banks' financial exposure to large trading firms. This comes after the hedge fund Situational Awareness, led by former OpenAI researcher Leopold Aschenbrenner, experienced turmoil, forcing it to sell most of its public equities portfolio to Citadel Securities due to a sharp sell-off in AI and chip stocks. This event contributed significantly to Jane Street incurring a $15 billion loss in July.
Central bank officials are now seeking detailed information from banks regarding the risk appetite of these trading firms, how the banks' exposure to them evolved throughout the trading day, and the effectiveness of their risk control mechanisms. This inquiry extends beyond just Jane Street to include other major market makers and proprietary trading firms like Citadel Securities.
Separately, the US Securities and Exchange Commission (SEC) has already subpoenaed several major Wall Street banks, including Goldman Sachs, JPMorgan, Citigroup, and Bank of America. The SEC's investigation focuses on Situational Awareness's trading activity, its use of leverage, the specific trades that triggered margin calls, and the fund's communications with its lenders following its near-collapse. The coordinated scrutiny from both sides of the Atlantic underscores concerns about the growing interconnections between banks and non-bank trading firms, a trend that has accelerated since the 2008 financial crisis.
Regulators are particularly concerned about the rapid shifts in intraday exposures during volatile market conditions. If the findings indicate that banks are undertaking excessive risk through these relationships, regulators possess the authority to mandate that these banks hold additional high-quality liquid assets as a protective buffer. Such a requirement could potentially increase costs for banks and restrict the leverage they extend to trading clients, thereby impacting market liquidity.
