• Information request likely precursor to regulatory action
  • Questions also focus on role of high-frequency traders

The U.S. Treasury Department wants to know if you’re worried about bond-market liquidity. Also, how you even define it.

The agency released a request for information Tuesday -- part of its first significant review of the market in almost two decades -- where questions range from the technical to the philosophical, and may be a key to where Treasury is most focused on making changes and enhancing oversight. It’s open to comments from anyone who wants to weigh in on issues like automated trading and the lack of a central source for transaction data.

“While transparency in the financial markets has improved greatly since the crisis, the U.S. Treasury market -- one of the most important markets in the world -- still remains oddly opaque,” Kevin McPartland, fixed income market-structure analyst at Greenwich Associates, said in an e-mail.

Officials are planning to weigh the responses and determine what steps are needed to shore up the market’s stability by the end of this year, before a new president takes office. The Treasury Department put together the document with the other agencies that regulate Treasury trading: The Federal Reserve, New York Fed, Securities and Exchange Commission and Commodity Futures Trading Commission.

Regulators will be most interested in what banks, finance executives and speed traders have to say given their importance to the market. They have 60 days to submit comments.

Market Opacity

The first thing that’s clear from the information request is that Treasury needs more data as it works to prevent future swings like the ones on Oct. 15, 2014, in the $13.2 trillion market that serves as a benchmark for everything from mortgages to corporate borrowing costs.

One of the changes to come could be more frequent or detailed reporting on direct trading between bond dealers and their clients, which averaged $277 billion of volume each day last year.

Treasury’s questions include what types of traders and markets should report data regularly, how much detail they should report, when those trades should be reported, and whether transaction data should include the type of investors ultimately doing the buying and selling. The agency is also soliciting views on the potential costs and benefits of reporting more data to regulators.

“We don’t take any policy changes to the Treasury market lightly, but it is clear we need better access to more information,” James Clark, Treasury deputy assistant secretary for federal finance, said in an interview. “We cannot afford to stand still as the world changes around us.”

Liquidity Debate

Treasury’s first set of questions, perhaps signaling the importance of a much-debated topic in the market, asks how respondents define liquidity.

Finance industry executives such as JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon have argued that rules passed after the 2008 crisis have sucked up liquidity in debt markets by forcing banks to reduce their trading and hoard high-quality assets like Treasuries. Treasury officials including Secretary Jacob J. Lew have said regulations passed under the Dodd-Frank Act didn’t play a significant role in what happened in October 2014.

The information request shows regulators are looking for input about the market’s clearing and settlement structure. They want to know whether current practices are enough to minimize the risk of a counterparty failing to deliver, and if traders should be required to clear their trades centrally.

Going by normal gauges of market health such as trading costs, Treasuries remain liquid, according to analysts at the New York Fed. But they also found there’s higher risk that trading will become significantly more difficult in times of market stress, and that large trades have a bigger impact on market prices.

“We probably have to revamp the way we think about liquidity,” said Priya Misra, head of global rates strategy in New York at TD Securities LLC, one of 22 primary dealers that trade with the Fed. “On the Oct. 15 episode, if you look at traditional metrics, liquidity seemed fine. But for anyone who was staring at the screens that day, it was not fine."

Speed Traders

Treasury is also focused on high-speed electronic trading firms, based on its questions. They want to hear about the implications of requiring automated trading firms to register with regulators.

The government’s July report found that both banks and high-frequency traders contributed to the dramatic Treasury price swings. That report had detailed data from platforms where dealers and electronic market-makers trade, such as ICAP Plc’s BrokerTec and Nasdaq Inc.’s eSpeed. It also included data on Treasury futures transactions on CME Group Inc.’s platform, which is regulated by the CFTC.

Officials asked for comments on whether central venues where traditional Wall Street dealers and high-speed firms trade should all introduce risk-management measures like trading halts or monitor trading activity.

Electronic trading was a new concept for most traders when the government last looked at the Treasury market’s structure in 1998. Anthony Perrotta, a partner at financial-services research firm Tabb Group LLC, estimated that 60 percent of trading on central platforms came from those firms last year.

“The market’s structure has absolutely changed over the last five to six years, and it’s picked up rapidly in the last two,” he said in an interview. “It’s more fragile,” but because “it has the appearance of wide, deep liquidity, it’s been somewhat overlooked.”

Before it's here, it's on the Bloomberg Terminal. LEARN MORE