BNP Paribas Unit Offers Solution to Treasury Liquidity Riddle

  • Says Treasury should exchange off-the-run bonds for newer ones
  • BNP issues proposal amid concern on market evolution

The U.S. Treasury Department should offer a standing facility to swap less-liquid off-the-run securities for on-the-run bonds to avoid triggering sharp market movements, BNP Paribas Investment Partners said in a proposal.

Balance sheets of electronic traders aren’t big enough to support larger positions in off-the-run bonds and a mechanism allowing for an exchange would mean market participants could better hedge their books, the unit of French bank BNP Paribas SA said in a report sent to the Treasury as well as other regulators, electronic market makers and some central banks.

The asset manager’s proposed debt-exchange mechanism would add needed liquidity to the off-the-run securities and also concentrate the market for the most recently sold debt --known as on-the-runs, according to the note released Wednesday. That would enable market participants to better manage risk related to debt holding, even on turbulent days such as Oct. 15, 2014.

“Our idea would supplement, not displace, all the existing machinery in place in the Treasury market, from traditional voice trading to electronic market-making, and help improve liquidity,” New York-based Thomas Philips, global head of risk at BNP Paribas Investment Partners, said in an interview.

The report comes as regulators try to answer growing concerns about how to prevent the jarring price swings that frayed investors’ and regulators’ nerves in October 2014. On that day, yields fluctuated in a way that had only happened three other times since 1998 -- and unlike the earlier incidents, there was no obvious catalyst.

In efforts to discover potential cracks in the market, the Treasury issued a request for information this year as part of its first survey of the market’s structure since 1998. In the feedback, a critical point was whether the public should be able to access trading data, such as the size, price and time of various transactions. In order to improve, virtually all groups have said regulators should have all available data on market dealings.

As an offshoot of the Treasury’s efforts with other regulators, the Securities and Exchange Commission earlier this week completed a comment period on a rule change proposed by the Financial Industry Regulatory Authority, that would require brokers and some automated trading firms to report Treasuries trades on Trace, the agency’s bond-price reporting system. The information would be for “audit-trail purposes,” and not disseminated publicly.

The exchange mechanism proposed by BNP would boost the resilience of the Treasuries market and wouldn’t distort the market, cost of debt or the maturity or duration profile of debt, Philips wrote in the report, co-written by Steven Friedman, senior investment strategist at the bank. They recommend a widely accepted pricing model that would be neutral to Treasury on their net issuance for the year.

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