The U.S. Treasury Department, the Federal Reserve, the Securities and Exchange Commission and the Commodity Futures Trading Commission jointly held a day-long conference in New York on Oct. 24 to discuss changes in the structure of the U.S. Treasury market with a wide range of market participants. During the course of the event, several senior regulatory officials outlined the steps they plan to take to improve their oversight of the Treasury market. Although the reform agenda is focused primarily on the cash Treasury market, some of the steps may affect related markets such as the Treasury futures markets. This special report highlights five areas of rule-making that may affect FIA members: data collection, registration requirements, oversight of trading venues, regulation of automated trading, and transparency.
Click Here for the agenda and list of participants.
Since the so-called "flash rally" in Treasury prices in October 2014, U.S. regulators have expressed the view that their ability to analyze market events is hampered by the lack of market data on cash Treasury trading, particularly in comparison to the data available from the Treasury futures market. As a consequence, they formed a working group of officials from across the government to consider how to improve data collection.
At the Oct. 24 conference, Antonio Weiss, a senior adviser to the Treasury Department, gave an update on the government's current plans. Weiss pointed to a recently approved initiative by FINRA to leverage its expertise in operating Trace, its reporting system for corporate bonds, to build an engine for collecting data on trading in the secondary market for U.S. Treasury securities. Broker-dealers that are FINRA members will be required to report their trades directly to FINRA, and banks that are not FINRA members will submit their data via the Federal Reserve. Weiss noted that this initiative will take effect next July, and said it will capture "roughly 90%" of Treasury market transactions.
Weiss said there will remain a gap in the data collection, however, because some principal trading firms that are highly active in the interdealer market are not members of FINRA and therefore will not directly report their trades to FINRA. For that reason, Treasury "strongly supports" a registration requirement for all principal trading firms that transact in Treasury securities, Weiss said.
SEC Chairman Mary Jo White fleshed out this recommendation in her speech to the conference. Principal trading firms that are acting as dealers should be required to register with the SEC and become subject to SEC oversight, she explained, because they represent more than 50% of trading volume on interdealer platforms and their trading activity indicates that they are acting as dealers. Registration would mean that they would become subject to net capital requirements, anti-manipulation and anti-fraud provisions, market conduct rules and various other elements of dealer regulation, she said. She added that this regulatory regime also includes the SEC's market access rule, which requires dealers that have direct market access to implement certain types of risk controls. White did not indicate when such a registration requirement might be proposed, saying only that she has asked SEC staff to consider this issue.
Oversight of Trading Venues
In her speech, White outlined several steps that the SEC plans to take that will apply certain elements of equity market regulation to trading venues that are currently excluded because they only trade cash Treasuries. In particular, the SEC has proposed applying Reg ATS, the rules that govern trading venues that are not exchanges, to Treasury trading platforms, a move that Weiss said Treasury "strongly supports." White also said the SEC is considering whether to apply Reg SCI, which establishes standards for operational integrity, to Treasury trading platforms.
White also noted that FINRA has announced plans to modernize certain rules governing trading practices so that protections against front running and trading ahead of customer orders apply to the cash Treasury market. FINRA is expected to present a proposal on this plan in the first quarter of 2017.
Regulation of Automated Trading
Another implication for FIA members is that Reg AT, the regulatory framework that the CFTC is developing for automated trading, is viewed by other parts of the U.S. government as a model for how to manage the risks of automated trading. Weiss commented that Reg AT will be a "leap forward" in terms of dealing with the "new reality of trading practices" and urged the CFTC to finalize the rule "as soon as practicable."
CFTC Chairman Tim Massad, who also spoke at the Oct. 24 event, explained the purpose of Reg AT as serving to reduce the risk of disruption and other operational problems that could be caused by automated trading. He reiterated that the CFTC is considering a "supplemental proposal" that will modify certain provisions in the original proposal, such as by adding a "volumetric test" to the registration requirement so that only the most active firms would be covered. The supplemental proposal also would establish a "two-tier structure" for risk controls, he said, so that a trading firm could opt into an FCM's controls or have its own controls.
In the aftermath of the October 2014, the U.S. regulators were primarily focused on improving data collection for the benefit of the official sector. At this year's conference, however, the focus expanded to include greater transparency for market participants and the public. Weiss noted that some market participants raised concerns about the potential for greater transparency to impair liquidity and increase the costs of market-making. Weiss affirmed that Treasury is committed to improving transparency, and said the requirements will be carefully tailored to address these concerns. For example, transparency will be limited to post-trade reporting, rather than pre-trade market data, and will be phased in to allow for adaptation and refinement along the way. Trade sizes will be "capped" to protect information on block trades, and reporting of trades in some market segments will be delayed in order to protect liquidity providers.
Although the regulators did not make any formal proposal regarding clearing in the cash Treasury market, they asked market participants to discuss the pros and cons of a government mandate so that all participants would be required to clear, similar to the requirements that have been imposed on the interest rate swap market. Some market participants argued that a mandate is necessary in order to ensure a level playing field and reduce the potential for systemic risk, while others argued that the goal of encouraging greater clearing could be achieved through voluntary adoption if the DTCC, the principal clearinghouse for cash Treasuries, adjusted its pricing model. One participant commented that clearing might be adopted more widely if other clearinghouses came into this market and offered capital efficiencies by combining cash Treasuries with Treasury futures.