The Federal Reserve and Bank of England are intensifying their examination of banks’ relationships with major trading firms and market makers following the sharp losses suffered by Jane Street during the July sell-off, according to a report by the Financial Times citing unnamed people familiar with the matter.
The regulators are seeking information from global banks on their exposure to firms including Jane Street and Citadel Securities, with particular attention being paid to risk appetite, changes in exposures during the trading day and the controls banks use to manage those positions.
The renewed scrutiny comes as regulators broaden their focus on non-bank financial intermediaries, including hedge funds, private credit firms and specialist trading businesses. The episode involving AI-focused hedge fund Situational Awareness has added urgency to questions about how losses at leveraged investment firms or trading businesses could be transmitted through their banking relationships.
Jane Street suffered a reported $15bn loss in July as a sharp reversal in artificial-intelligence-related stocks hit its positions and its exposure to Situational Awareness, which was forced to unwind much of its public-equity portfolio.
The scale of the loss has drawn particular attention because Jane Street has traditionally been associated with market making and relative-value trading, activities generally viewed as lower risk than large directional bets. The firm has nevertheless expanded into longer-duration investments and proprietary positions as its business has grown.
For banks, the concern is not limited to the trading firms’ own balance sheets. Prime brokers provide hedge funds and specialist trading companies with financing, market access, securities lending and derivatives clearing. A sharp deterioration in a client’s positions can therefore leave a bank facing losses if collateral becomes insufficient or a client defaults.
The latest regulatory enquiries are focused in part on how quickly those exposures can change. Intraday leverage and rapidly moving collateral values can make traditional end-of-day monitoring less effective during periods of extreme market volatility.
The Bank of England has already been examining growing exposures among London-based prime brokers, including the rapid expansion of financing for Asian equities as AI-linked stocks posted large gains earlier this year. The Prudential Regulation Authority has previously warned about rising intraday exposures among firms providing market access, clearing and financing to electronic market makers.
The developments also follow a separate US Securities and Exchange Commission investigation into the trading and leverage used by Situational Awareness. The SEC has subpoenaed major Wall Street banks including Goldman Sachs, JPMorgan, Citigroup and Bank of America for information concerning the fund’s trades and communications with lenders.
JPMorgan has subsequently ended its lending relationship with Situational Awareness following the fund’s losses, while other major banks have continued to provide brokerage services.
The regulatory focus reflects the increasingly important role played by specialist trading firms in global markets. Jane Street, Citadel Securities, Susquehanna International Group and Hudson River Trading have expanded substantially since banks retreated from proprietary trading following the global financial crisis.
Their businesses can combine traditional market making with proprietary strategies, creating increasingly complex connections between trading firms, hedge funds, exchanges and banks.
Neither the Fed, the Bank of England nor Jane Street reportedly commented on the regulatory enquiries.
