A funny thing happened on the way to regulating the $13.4 trillion Treasury market: Humans turned out to be harder to understand and regulate than computers.
Algorithmic strategies are generally pretty straightforward. They exploit their speed advantage to profit from small price discrepancies during the trading day.
Human dealers, on the other hand, profit from knowing exclusive information. They trade over the phone, out of sight of both competitors and regulators.
Humans and machines are often pitted against each other, resulting in a tension that’s highlighted well in a Bloomberg News article by Alexandra Scaggs. Some argue that the subjective human touch makes the fixed-income market better and less prone to accidents, while the algorithmic set is vulnerable to computer glitches, manipulation and flash crashes.
Treasury Department officials are trying to wrap their heads around this argument; they’re accepting comments through Friday to their request for information about the structure of the world’s biggest government bond market.
Regulators seem inclined to give high-frequency traders an even greater edge by forcing Wall Street banks to divulge information that once gave them an advantage.
There are legitimate concerns about further impairments to primary dealers and even more concentrated trading in the most-active Treasuries, making it even harder to broker older, less-active notes. But a more automated Treasury market would probably make it more fair and might even revive trading volumes.
Investors are already gravitating toward futures contracts, which are traded on exchanges, instead of cash bonds, which are traded in phone calls. An average $311 billion worth of Treasury futures traded each day last year, up 21 percent from five years earlier, according to data from CME Group cited in the Bloomberg article.
Regulators are poised to start collecting data by later this year on individual Treasury transactions, "with the major questions being the cost of reporting and how widely the data will be disseminated," RBC Capital Markets analysts led by Michael Cloherty wrote in a report on Monday. "Real-time reporting would be expensive," they wrote, potentially hurting the return on equity "of being a Treasury market maker and thus causing capital to flow away from Treasury desks."
Such reporting would also make the world’s biggest debt market more transparent, helping policy makers and traders alike better understand the dynamics that underpin daily activity.
Even without new rules, money is flowing away from primary dealers, leaving them less equipped to serve in the role they once did. Revenues have plunged, with Morgan Stanley, for example, reporting on Monday a 54 percent decline in fixed-income revenues in the first quarter compared with those in the period a year earlier. Wall Street executives are looking at more electronic strategies as they note the sea change underfoot in the industry.
Computers are eliminating inefficiencies that padded the pockets of debt dealers for decades. The way to secure the Treasury market isn’t to reinstate those inefficiencies. It’s to collect good data and to understand patterns well enough to find modern-day solutions.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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