Regulators Probe Bank Exposure to Trading Firms After Jane Street Loss

The Bank of England and the US Federal Reserve have intensified their scrutiny of how global banks are exposed to large trading firms, following a blow-up at the AI-focused hedge fund Situational Awareness that produced substantial losses at Jane Street. Regulators are asking lenders about their relationships with market makers and proprietary trading houses, including New York-based Jane Street and Ken Griffin’s Citadel Securities, according to people familiar with the matter. The watchdogs had already identified banks’ exposure to non-bank financial intermediaries, a broad category that includes private credit providers, as a longer-term priority. But the recent sell-off and Jane Street’s losses have sharpened their focus on trading firms specifically. Among the information sought are details on the firms’ risk appetite, how bank exposure evolved during the trading day, and how risk controls operated under stress.

The regulatory attention reflects the growing systemic importance of specialist trading firms, which have risen sharply in prominence since banks retreated from proprietary trading after the 2008 financial crisis. Many of these firms, which also include Susquehanna and Hudson River Trading, began in the relatively low-risk business of market making, earning a small spread on each buy and sell order they fulfill across thousands of securities. Over time, however, they have diversified into large proprietary trading operations that take directional bets, including, in Jane Street’s case, equity stakes in portfolio companies. Unlike hedge funds such as Citadel, Millennium, and DE Shaw, these firms typically manage only the capital of their founders and internal employees, giving them the freedom to take on significant risk without answering to external investors.

Jane Street has become the world’s most profitable trading firm, with $40bn in revenue last year. In July, however, it lost $15bn as a long-running AI rally reversed course. A significant portion of that loss stemmed from its investment in Situational Awareness, the hedge fund run by Leopold Aschenbrenner. Even after the setback, Jane Street had generated $40bn in net trading revenues by early August, eclipsing last year’s record gains. But the scale of the loss signals that Jane Street, which also holds a stake in the AI company Anthropic, is taking on far more risk than a typical market maker.

The mechanism that connects these firms to the broader financial system runs through prime brokerage. Banks extend leverage to trading firms and hedge funds, finance their equities trades, lend against bonds, and execute and clear derivatives on their behalf. That leaves lenders exposed if a client defaults on a financed trade. Prime broking has become a significant profit center for Wall Street banks, helping to power record earnings, but it also concentrates risk in a small number of highly active, lightly regulated counterparties.

Regulators have a specific tool to address concerns: they can raise the amount of high-quality liquid assets banks must hold to survive a market sell-off or the collapse of a large client. The question now is whether the recent episode will prompt them to use it. The information gathering by the BoE and the Fed suggests they are trying to determine whether the risk-taking at firms like Jane Street is an isolated event or a structural shift that requires a more permanent response. The answer will shape not just capital requirements for banks, but the broader trajectory of market structure, where a handful of trading firms now sit at the center of price formation and liquidity provision. For now, the regulators are watching closely. The durability of the current market architecture may depend on what they find.