Tuesday, October 25, 2016

Regulators discuss need for better data, increased oversight in U.S. Treasury market

By Lene Powell, J.D.

In remarks at the second annual conference of “The Evolving Structure of the U.S. Treasury Market,” officials from the SEC, CFTC, Treasury, and Federal Reserve Bank of New York gave updates on regulatory initiatives to protect the integrity of the U.S. Treasury market and improve availability of information to the official sector and the public.

U.S. Treasury market integrity. According to William Dudley, head of the Federal Reserve Bank of New York, the U.S. Treasury market is the deepest and most liquid fixed income market in the world, and serves many important market and government functions. Given the central role of the Treasury market, he said, it is clear that both the official sector and the public need improved access to transaction-level data. It is challenging for the official sector, market participants, and public to analyze the Treasury and foreign exchange markets because they are evolving rapidly and highly automated in key market segments, and information on trading activity is not widely available.

Adding urgency to the ongoing need to protect market integrity, the Treasury market suffered a “flash crash” on October 15, 2014, when the 10-year Treasury yield ranged 37 basis points over the session, including an unprecedented 16 basis point drop during a 12 minute window, followed by a rebound without an obvious catalyst. An October 2015 joint staff report on the crash found that two traits defined the session: unusually high volatility and round-trip prices without an obvious driver of the market movements, and unusual strains in liquidity conditions. The report recommended a number of next steps, including an assessment of the sufficiency of publicly available information on Treasury cash securities market transactions, enhanced public reporting on Treasury market venue policies and services, and a study of the implications of imposing a registration requirement for automated trading firms.

Initiatives to improve data. SEC Chair Mary Jo White said she was pleased that the Federal Reserve Board recently announced that it plans to collect U.S. Treasury securities transaction data from banks, with the possibility that FINRA may act as agent for the Board in that collection. White also noted that last week the SEC approved a FINRA rule that will require its members to begin reporting, as of July 10, 2017, transactions in U.S. Treasury securities through FINRA’s TRACE system, generally by the end of the day on which they were executed. Although FINRA will not disseminate the trading data publicly, the data will be available to the relevant regulators.

Increased oversight. In addition to increasing the availability and dissemination of data, regulators are working on rules to enhance oversight of market participants. White said she has asked staff to recommend ways of extending for the first time critical aspects of the securities regulatory framework to U.S. Treasury market intermediaries, including the possible application of Regulation ATS and Regulation SCI to platforms that trade government securities. Further, the SEC is looking at rules on disruptive trading practices and may further clarify how the conduct of principal trading firms may trigger dealer registration requirements, whether that conduct is in the U.S. Treasury or equity securities markets.

CFTC Chairman Timothy Massad noted that the CFTC recently issued final rules to require cybersecurity testing by critical market infrastructure. This will help ensure that clearinghouses, exchanges, trading platforms and data repositories are adequately protecting themselves against attacks like the distributed denial-of-service (DDOS) attacks like the one that affected large parts of the U.S. on October 21, 2016, as well as other types of attacks.

In addition, Massad reported that the CFTC is working to finalize Regulation AT, which would require pre-trade controls and other measures like message throttles, maximum order size limits, and “kill switches,” which would facilitate emergency intervention in the case of a malfunctioning algorithm. Further, the CFTC is currently considering a supplemental proposal on Regulation AT, which might change risk control requirements from a three-tier to a two-tier structure and add a volumetric test for registration of traders, said Massad.

Massad also provided a demonstration of analytical tools used by the CFTC in looking at market activity, including a comparison of the 2014 Treasury crash and the event on October 6, 2016 in which the British pound fell six percent against the U.S. dollar in about 30 seconds before rebounding.

Transparency. According to Antonio Weiss, Counselor to the Secretary, Treasury sees “compelling benefits” to greater public transparency of post-trade Treasury data. To counteract potential risks of increased transparency, proper design is key, including appropriate time delays, limitations on disclosure of size for large trades, and a phased-in, gradual approach over time.