The Financial Stability Board’s (FSB) recent call for increased regulatory scrutiny of leveraged basis trading has met with a degree of skepticism from market participants. The FSB warned last week that the growing leverage employed in this trade could contribute to financial instability, citing potential volatility in repo markets, as evidenced by the $200 billion Treasury sell-off in 2023.
The basis trade, exploits temporary price discrepancies between cash Treasury securities and Treasury futures contracts. Hedge funds and other institutions profit by simultaneously buying and selling these instruments, leveraging the difference. While the trade has been a source of profit for many, regulators are increasingly concerned about the potential for systemic risk, particularly as the notional size of these positions has ballooned. US mutual funds, according to reporting from December 2023, have amassed record exposures to Treasury futures, in some cases exceeding their assets under management.
However, industry response to the FSB’s concerns appears muted. According to reporting from Risk.net on February 9, 2026, the market does not fully share the FSB’s anxieties. A key concern revolves around the potential impact of stricter regulatory measures, specifically tougher haircut regulations, on market capacity as debt issuance continues to rise. Haircuts refer to the difference between the market value of an asset and the amount a lender is willing to lend against it as collateral. Increasing haircuts would effectively reduce leverage and potentially stifle market activity.
The FSB’s Secretary General, John Schindler, warned on January 29, 2026, that resistance to oversight of non-bank financial institutions (NBFIs) stems from “misconceptions” about the regulatory approach. He emphasized that applying bank-like regulations to non-banks would be a mistake, given the differing business models and risk profiles of the two sectors. This statement underscores the FSB’s intention to tailor regulations specifically to the unique characteristics of NBFIs, rather than imposing a one-size-fits-all approach.
The resilience of the basis trade through previous periods of market stress, such as the “tariff tantrum” in April 2025, has also contributed to the industry’s cautious response. Higher margins, rising yields, and stable repo funding helped avert a disruptive blow-up during that period, suggesting the trade is more robust than some fear. This historical performance provides a counter-narrative to the FSB’s concerns, suggesting that existing market mechanisms may be sufficient to manage the risks associated with the basis trade.
The debate over the basis trade highlights a broader tension between regulators seeking to mitigate systemic risk and market participants prioritizing flexibility, and profitability. The FSB’s concerns are rooted in the potential for a rapid unwinding of leveraged positions to destabilize the Treasury market, particularly in times of stress. However, the industry argues that overly restrictive regulations could stifle liquidity and hinder the efficient functioning of the market.
The increasing size of the trade, coupled with the concentration of risk among a relatively small number of players, remains a key concern. While the trade has proven resilient to date, the potential for unforeseen shocks or a sudden shift in market sentiment cannot be discounted. The FSB’s call for increased vigilance underscores the importance of ongoing monitoring and proactive risk management in this evolving market landscape.
The situation is further complicated by the interplay between cash and futures markets. The growing notional exposures at asset managers in Treasury futures, as highlighted in the December 2023 report, represent a significant counter-position to the hedge fund shorts. This dynamic creates a complex web of interconnected risks that regulators are attempting to understand and address.
the future of the basis trade will depend on the ability of regulators and market participants to strike a balance between fostering innovation and maintaining financial stability. The FSB’s proposals are likely to be subject to intense scrutiny and debate in the coming months, as the industry weighs the potential costs and benefits of increased regulation. The outcome will have significant implications for the functioning of the US Treasury market and the broader financial system.
