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Public Statement


 
 

Ere Misery Made Me Wise[1] — The Need to Revisit the Regulatory Framework of the U.S. Treasury Market

Commissioner Luis A. Aguilar

United States Securities and Exchange Commission[2]

July 14, 2015

I. Introduction

Yesterday, staff members of the federal agencies that comprise the Interagency Working Group for Treasury Market Surveillance (“Working Group”)[3] issued a joint report concerning the so-called “flash crash” that occurred in the U.S. Treasury market on October 15, 2014 (the “Report”).[4] I commend the staff of all the agencies for their hard work in putting together the Report, which examined the events of that day and the broader forces that have changed the Treasury market in recent years. This was a difficult undertaking, but the report does an excellent job of discussing the known factors, while acknowledging that more work needs to be done.

The remarkable events of that day, which cannot yet be fully explained, have dispelled any lingering notion that the Treasury market is the staid marketplace it was once thought to be.[5] The transformative changes that swept through the equities and options markets in the past decade have vastly reshaped the landscape of the Treasury market, as well. As a result, the structure, participants, and technological underpinnings of today’s Treasury market are far different than they were just a few years ago.

The full significance of these changes has yet to become clear. But there can be no doubt that the current regulatory framework for the Treasury market should be reexamined in light of these new realities. The last time the agencies responsible for overseeing the Treasury market undertook a comprehensive review of this regulatory framework was 1998[6]—well before the changes described above took hold.[7]

This statement calls upon the Commission to spearhead a new inter-agency review of the Treasury market’s overarching regulatory framework. Such a review is appropriate given the tremendous changes the market has witnessed in recent years. Importantly, this review needs to be willing to question long held assumptions about the Treasury market and how best to oversee it. The Treasury market now faces many of the same challenges that confront the equity market, including the ascendancy of high frequency trading and a diminished role for traditional liquidity providers.[8] Accordingly, just as the Commission has begun a “comprehensive” review of the equity market,[9] so, too, should the appropriate regulatory agencies examine the Treasury market, from top to bottom.

In addition, this statement sets forth a number of concrete proposals that could buttress the integrity and resiliency of the Treasury market. The Commission and the other regulators responsible for the Treasury market should consider these proposals as they conduct the aforementioned review.

II. The U.S. Treasury Market

A. The Role of the Treasury Market

The U.S. Treasury market remains the largest and most liquid sovereign debt market in the world.[10] As of last month, there were more than $12.6 trillion worth of marketable U.S. Treasury securities (“Treasuries”) outstanding.[11] The U.S. Treasury market is also the most actively traded market in the world: more than $530 billion worth of Treasuries changed hands each day, on average, in the first quarter of this year.[12] By contrast, the average daily trading volume of equities in the U.S. market during the same period was only $193 billion.[13]

Treasuries represent an essential building block of the U.S. economy—and, indeed, of the entire global financial system. In fact, foreign investors and governments hold roughly half of all Treasuries currently outstanding.[14] The Treasury market’s role, therefore, is not limited to financing the federal government’s deficit spending. The market also underpins the U.S. dollar’s status as the global reserve currency,[15] provides a safe haven for investors in the U.S. and abroad,[16] facilitates U.S. monetary policy, acts as a key pricing benchmark for other assets, and serves as a low-risk hedging instrument for financial transactions around the world.[17] In sum, Treasuries have been woven into the very fabric of the global financial system, perhaps inextricably so.

B. Liquidity

Given the unique and indispensable role Treasuries have come to play in global finance, it is vital that the Working Group consider how best to protect the integrity, liquidity, and efficiency of the Treasury market.[18] Each of these characteristics is important, but liquidity merits special attention—and concern. Broad, deep, and resilient liquidity in the secondary market ensures continuous price discovery, and gives investors comfort that they can quickly purchase or sell even sizeable amounts of Treasuries at minimal cost.[19] Liquidity is the lifeblood of a vibrant Treasury market, and abundant liquidity has been one of the Treasury market’s principal competitive advantages over the years.[20]

Yet, there is a growing concern that the secondary market for Treasuries is far less liquid than is widely perceived,[21] and at least one market participant has gone so far as to opine that the secondary market is “not functioning as normal.”[22] Critics point out that one common measure of liquidity, trade volume, has dropped considerably in recent years.[23] Since its peak in 2006, daily trading volume in Treasuries relative to the total size of the market has fallen by 70 percent.[24] This decline in trading activity is also reflected in a stark drop in turnover. In fact, by one estimate, only 4.1 percent of Treasuries changed hands last year, the lowest figure since 1998.[25]

Further sharpening the Treasury market’s predicament is that the depth of its liquidity has shrunk, with fewer bonds being offered at any given price. According to one study, market depth declined by 35 percent last year.[26] To put this in perspective, just one year ago, it was possible to trade roughly $280 million worth of Treasuries without causing prices to move. Today, that figure has fallen to only $80 million, according to one major bank.[27] Market participants have suggested that this diminished ability to quickly trade large blocks of Treasuries could potentially undermine the stability of the Treasury market by magnifying price volatility.[28]

To be sure, the Treasury market remains one of the most liquid markets in the world, in absolute terms. This is reflected in bid-ask spreads, which remain at or near pre-financial crisis lows.[29] The true measure of a market, however, is how it performs under stress, and liquidity in fixed income markets has proven fleeting in past market crises.[30] According to one Federal Reserve Governor, one gauge of how well liquidity responds to stress, its resiliency,[31] remains troublingly low in the Treasury market, and may even be falling.[32] This is evidenced, in part, by an increase in the frequency of spikes in bid-ask spreads.[33]

The apparent deterioration in the depth and resiliency of the Treasury market’s liquidity would be a matter for concern at the best of times. But it is especially inopportune now, as it comes just as the Federal Reserve is contemplating an historic rise in interest rates.[34] One potential concern voiced by market participants is that a rate hike could trigger another so-called “taper tantrum,” like the one that occurred in the spring of 2013.[35] As that event showed, major dislocations in the Treasury market can have far reaching consequences, including a slowing of the housing market.[36] Clearly, the stakes are high.

C. October 15, 2014

These concerns regarding the overall health of the Treasury market were crystallized by the events of October 15, 2014. The 10-year Treasury bond experienced record-high trading volumes that day, as well as a severe decline in the depth and resiliency of its liquidity.[37] Trading that day was also marked by a dramatic rise in volatility, with the yield on the benchmark 10-year Treasury bond trading within an intraday range of approximately 37 basis points.[38]

An especially puzzling feature of that day’s events involved a 13-minute window of trading that began at 9:33 ET that morning. During that period, yields initially plummeted by 16 basis points within a six-minute period, only to rebound almost completely in the following seven minutes.[39] According to the Report, the sharp swing in yields witnessed during this “event window” was “unprecedented . . . in the recent history of the Treasury market,” because it was “not driven by a significant policy announcement.[40]

After months of careful and thorough study, the Report was unable to identify “a clear, single cause of the price movement during the event window . . . .”[41] And, indeed, there may not have been a single cause. Accordingly, the Report examines in detail the day’s events, and the broader market forces that helped shape them.[42] In particular, the Report reviews the significant changes in the Treasury market’s structure over the past two decades, and discusses how those changes may have led to a trade-off between improved average liquidity, on the one hand, and “severe bouts of volatility” that can “strain liquidity,” on the other.[43]

D. The Structure of the Treasury Market

The Report underscores that the Treasury market’s behavior in recent years is deeply rooted in the complexities of its evolving structure. A comprehensive discussion of the Treasury market’s current structure is beyond the scope of this statement, but it is necessary to briefly outline that structure in order to understand the need—and the benefits—of revisiting the market’s regulatory framework.

As in the past, the secondary market for Treasuries operates on an over-the-counter basis, rather than through exchanges. During the past decade, however, nearly all trading among dealers has migrated to electronic trading platforms.[44] Furthermore, most of this trading is now automated, which means that trading decisions are executed by computer algorithms.[45] Proprietary trading firms employing algorithmic trading strategies are believed to account for more than half of the volume conducted on the electronic trading platforms.[46] At the same time, various factors, including the historically low interest rate environment, have led traditional dealers to curtail their market making activities, and to shrink their inventories relative to the total size of the Treasury market.[47]

The shift to electronic and algorithmic trading has brought numerous benefits, such as more efficient price discovery and lower trading costs.[48] But it has also introduced new risks to the Treasury market, as it has in other markets. Some of these risks are more obvious, such as the risk that an algorithm will malfunction, as we have seen too often.[49] Others are more nuanced. For example, it is believed that electronic trading makes it easier to engage in and conceal manipulative trading practices, such as spoofing,[50] that subvert liquidity and market integrity.[51] In addition, the proliferation of algorithmic trading has resulted in a more anonymous trading environment, where market participants may be more acutely focused on short-term gains than was the case in the past.[52] In such circumstances, market participants may be more likely to withdraw their liquidity during periods of market stress, leaving markets more prone to severe bouts of illiquidity, as was witnessed on October 15, 2014.[53]

III. The Need to Revisit the Treasury Market’s Regulatory Framework

The events of October 15, 2014 sharpen and clarify the need to reexamine the Treasury market’s current regulatory structure. As the Report makes clear, this structure is now fundamentally different than it was in 1998, when the Working Group last examined it. A new review is appropriate in light of recent events, and the Commission should lead the way by reviewing its own rules and regulations with an eye toward enhancing oversight of the Treasury market.

Set forth below are several proposals regulators should consider as they look to update the Treasury market’s regulatory framework.

  • First, the Commission should consider revising Regulation ATS to make it applicable to alternative trading systems that trade Treasuries exclusively.[54] In addition, the Commission should consider how Regulation ATS may need to be tailored to the activities of alternative trading systems that handle Treasuries. Currently, BrokerTec and eSpeed are the two electronic platforms that handle the majority of the dealer-to-dealer trade flow in on-the-run Treasuries.[55] I note that BrokerTec, which trades securities in addition to Treasuries, has filed a Form ATS with the Commission.[56]
  • Second, in addition to expanding Reg ATS, the Commission should consider revising Regulation Systems Compliance and Integrity (Reg SCI) to make it applicable to trading platforms that handle Treasuries exclusively.[57] As the Report makes clear, the majority of dealer-to-dealer trading in the Treasury market is now driven by computer algorithms. In light of this new environment, it is appropriate for the Commission to examine whether additional safeguards are warranted to ensure that the technology used by these entities has sufficient integrity, capacity, safety, and resiliency.
  • Third, the Report and other sources indicate that regulators presently lack a comprehensive source of trade data for the Treasury market.[58] Just as in the aftermath of the equity market’s flash crash on May, 6, 2010, the Working Group staff had to rely on a patchwork of market data that was drawn from various sources. In a sense, it was déjà vu all over again,[59] but in this case it was actually far worse. The data that regulators needed in the wake of the equity market flash crash had already been collected by the equity exchanges and the Financial Industry Regulatory Authority (FINRA), and just needed to be provided to the regulators. But no such collectors of data exist in the Treasury market. Accordingly, the Working Group had to harvest the trade data it needed from individual market participants. The Working Group should, therefore, consider ways to help develop a mechanism, similar to the consolidated audit trail that equity market participants are creating,[60] that will give regulators the ability to properly monitor the Treasury market.
  • Fourth, regulators should work with electronic trading platforms to develop appropriate market safeguards for the Treasury cash market, and should consider measures such as circuit breakers and kill switches, as appropriate. As trading in the Treasury cash market now occurs at “blink of an eye” speeds similar to those witnessed in the equity market, such protections are warranted. And the market seems to agree. In fact, BrokerTec has reportedly begun discussing with its clients the possibility of implementing circuit breakers.[61] But, as the IMF recently noted, such circuit breakers must be carefully calibrated to the Treasury market.[62] It is noteworthy that the volatile trading on October 15, 2014 did not trigger existing circuit breakers in the futures markets.[63]
  • Fifth, the Commission, as well as the Working Group, should consider ways to enhance oversight of market participants in the Treasury market.[64] For example, some of the most active participants in the Treasury cash market are not registered with the Commission.[65] This hinders the Commission’s ability to monitor and regulate this market effectively. In the context of equity market reform, the Chair called last year for the staff to prepare a rule clarifying that high frequency traders are dealers, and must therefore register with the Commission.[66] In preparing that rule, the staff should consider how it can be made applicable to Treasury market participants, as well.
  • Sixth, as the Report notes, there is currently no quote or price reporting mechanism in the Treasury market. Given that post-trade reporting systems have already been developed in the corporate and municipal bond markets,[67] this means the Treasury market, the largest and most liquid government securities market in the world, is now arguably the least transparent fixed income market in the U.S. The events of October 15, 2014 demonstrate with absolute clarity that this state of affairs is no longer acceptable. The members of the Working Group should set as their most urgent priority how to foster a post-trade pricing mechanism in the Treasury market. The Working Group should further consider ways to enhance pre-trade price transparency in the Treasury market, as well. As I have noted in the context of the municipal securities market, one possibility to enhance pre-trade price transparency in fixed income markets is for the Commission to amend Regulation ATS to require trading systems with material transaction volume to publicly disseminate their best bid and offer prices, even if on a delayed and non-attributable basis.[68]

IV. Conclusion

The goal of this statement is to underscore the significance of the Report’s findings, to support its recommended next steps, and to urge the Commission and other regulators to take specific action where there is a clear path forward. The events of October 15, 2014 have revealed that the Treasury market has changed in myriad ways in recent years, and that we, as its regulators, may lack the tools and the information necessary to supervise it effectively.

The Commission and the Working Group cannot afford to wait for the next major market event before taking action. As Benjamin Franklin once said, “We may delay, but time will not.”[69]



[1] Percy Bysshe Shelley, Prometheus Unbound, Act I (1820), available at https://andromeda.rutgers.edu/~jlynch/Texts/prometheus.html.

[2] The views I express are my own, and do not necessarily reflect the views of the U.S. Securities and Exchange Commission (the “SEC” or “Commission”), my fellow Commissioners, or members of the staff.

[3] These agencies include the following: U.S. Department of the Treasury, the Board of Governors of the Federal Reserve System, the Federal Reserve Bank of New York, the U.S. Securities and Exchange Commission, and the U.S. Commodity Futures Trading Commission. See Joint Study of the Regulatory System for Government Securities, 14 (Mar. 1998), available at https://www.treasurydirect.gov/instit/statreg/gsareg/gsareg_gsr98rpt.pdf.

[4] Joint Staff Report: The U.S. Treasury Market on October 15, 2014 (July 13, 2015), available at http://www.treasury.gov/press-center/press-releases/Documents/Joint_Staff_Report_Treasury_10-15-2015.pdf.

[5] Mark Hulbert, Returning to normal, MarketWatch (Feb. 16, 2009) (noting that the Treasury market is typically “staid”), available at http://www.marketwatch.com/story/treasury-muni-spread-contains-some-good.

[6] Joint Study of the Regulatory System for Government Securities (Mar. 1998), available at https://www.treasurydirect.gov/instit/statreg/gsareg/gsareg_gsr98rpt.pdf.

[7] Michael Fleming, Bruce Mizrach, Giang Nguyen, The Microstructure of a U.S. Treasury ECN: The BrokerTec Platform, Federal Reserve Bank of New York Staff Report, 6-7 (May 2014), available at http://www.newyorkfed.org/research/staff_reports/sr381.pdf.

[8] Federal Reserve Bank of New York, Treasury Market Practices Group, Automated Trading in Treasury Markets, 3-4 (June 2015) (noting that “automated trading strategies now typically account for more than half of trading activity in on-the-run Treasury securities that occurs on [interdealer platforms],” and that the “electronification of Treasury trading” has led some dealers “to reduce their capital-intensive market-making activities . . . .”), available at http://www.newyorkfed.org/tmpg/TPMG_June%202015_automated%20trading_white%20paper.pdf.

[9] In fact, the Commission established an Equity Market Structure Advisory Committee earlier this year to “to provide the Commission with diverse perspectives on the structure and operations of the U.S. equities markets, as well as advice and recommendations on matters related to equity market structure.” Equity Market Structure Advisory Committee, Securities Exchange Act Release No. 74092 (Jan. 20, 2015), available at https://www.sec.gov/rules/other/2015/34-74092.pdf. In addition, I have already set forth a series of ideas to refashion the structure of our equity markets. See Commissioner Luis A. Aguilar, U.S. Equity Market Structure: Making Our Markets Work Better for Investors (May 11, 2015), available at http://www.sec.gov/news/statement/us-equity-market-structure.html. In addition, Chair White has called for a comprehensive review of our equity market structure. See Chair Mary Jo White, Enhancing Our Equity Market Structure (June 5, 2014) (noting that the Commission’s “review of market structure must be comprehensive. We must test our assumptions about long-standing rules and market practices. Past decisions must be reevaluated in light of current conditions, and market-based solutions to issues should be explored. Barriers to such solutions must be reviewed, and removed where appropriate.”), available at http://www.sec.gov/News/Speech/Detail/Speech/1370542004312.

[10] Simon Potter, Executive Vice President, Federal Reserve Bank of New York, Remarks at the 2015 Primary Dealer Meeting, Challenges Posed by the Evolution of the Treasury Market (Apr. 13, 2015), available at http://www.newyorkfed.org/newsevents/speeches/2015/pot150413.html.

[11] U.S. Department of the Treasury, Monthly Statement of the Public Debt of the United States (June 30,2015), available at http://www.treasurydirect.gov/govt/reports/pd/mspd/2015/2015_jun.htm; see also Securities Industry and Financial Markets Association, Statistics, US Bond Market Issuance and Outstanding (updated as of July 6, 2015), available at http://www.sifma.org/research/statistics.aspx.

[12] Securities Industry and Financial Markets Association, Statistics, US Bond Markets Trading Volume (updated as of July 8, 2015), available at http://www.sifma.org/research/statistics.aspx.

[13] Securities Industry and Financial Markets Association, Statistics, US Equity Statistics (updated as of July 6, 2015), available at http://www.sifma.org/research/statistics.aspx.

[14] U.S. Department of the Treasury, Major Foreign Holders Of Treasury Securities (updated as of June 15, 2015) (showing that foreigners held more than $6 trillion in Treasuries during each month of 2015), available at http://www.treasury.gov/ticdata/Publish/mfh.txt.

[15] Simon Potter, Executive Vice President, Federal Reserve Bank of New York, Remarks at the 2015 Primary Dealer Meeting, Challenges Posed by the Evolution of the Treasury Market (Apr. 13, 2015), available at http://www.newyorkfed.org/newsevents/speeches/2015/pot150413.html.

[16] Bryan J. Noeth and Rajdeep Sengupta, Flight to Safety and U.S. Treasury Securities, The Regional Economist, 18 (July 2010) (noting that “it is no surprise that investors turn to U.S. Treasuries during times of increased uncertainty as a safe haven for their investments. This happened once again during the recent financial crisis. In fact, the increase in the demand for Treasuries was sufficiently large so that prices actually rose with an increase in the supply of government securities.”), available at https://www.stlouisfed.org/publications/regional-economist/july-2010/flight-to-safety-and-us-treasury-securities.

[17] Simon Potter, Executive Vice President, Federal Reserve Bank of New York, Remarks at the 2015 Primary Dealer Meeting, Challenges Posed by the Evolution of the Treasury Market (Apr. 13, 2015), available at http://www.newyorkfed.org/newsevents/speeches/2015/pot150413.html.

[18] Joint Study of the Regulatory System for Government Securities, 1 (Mar. 1998), available at https://www.treasurydirect.gov/instit/statreg/gsareg/gsareg_gsr98rpt.pdf.

[19] Simon Potter, Executive Vice President, Federal Reserve Bank of New York, Remarks at the 2015 Primary Dealer Meeting, Challenges Posed by the Evolution of the Treasury Market (Apr. 13, 2015), available at http://www.newyorkfed.org/newsevents/speeches/2015/pot150413.html.

[20] Id. (noting that one of the Treasury market’s “most important attributes” is its “superior liquidity.”).

[21] Tracy Alloway, Everyone's Been Worried About Liquidity in the Wrong Bond Market, Bloomberg (June 1, 2015)(noting that “while U.S. Treasuries enjoy the highest amount of absolute liquidity by this measure, the market's relative drop in liquidity in recent years has eclipsed that of junk and investment-grade corporate debt. According to the Deutsche strategists, U.S. Treasuries have lost 70 per cent of their trading depth since the financial crisis, while high-yield and investment grade bonds have lost 30 percent and 50 percent respectively.”), available at http://www.bloomberg.com/news/articles/2015-06-01/everyone-s-been-worried-about-liquidity-in-the-wrong-bond-market; Robin Wigglesworth, Treasury volumes raise liquidity concerns, Financial Times (June 11, 2015) (quoting Jack Flaherty, a New York-based bond fund manager at GAM), available at http://www.ft.com/intl/cms/s/0/9a5b334e-0fb5-11e5-94d1-00144feabdc0.html; Liz McCormick and Daniel Kruger, The Treasury Market’s Legendary Liquidity Has Been Drying Up, BloombergBusiness (Feb. 1, 2015) (noting that the “[f]or decades, the $12.5 trillion market for U.S. government debt was renowned for its ‘depth’ . . . . But lately, that resiliency has practically vanished — and that’s a big worry.”), available at http://www.bloomberg.com/news/articles/2015-02-02/if-trading-bonds-is-hard-think-about-the-pain-when-rates-rise; Peter Eavis, Bankers and Regulators Voice Fears on Bond Market Volatility, The New York Times (May 5, 2015), available at http://www.nytimes.com/2015/05/06/business/dealbook/bankers-and-regulators-voice-fears-on-bond-market-volatility.html?_r=0.

[22] Robin Wigglesworth, Treasury volumes raise liquidity concerns, Financial Times (June 11, 2015) (quoting Jack Flaherty, a New York-based bond fund manager at GAM), available at http://www.ft.com/intl/cms/s/0/9a5b334e-0fb5-11e5-94d1-00144feabdc0.html; see also Alexandra Scaggs and Liz McCormick, Bond Traders Brace Themselves for Another Flash Rally, BloombergBusiness (Apr. 12, 2015), available at http://www.bloomberg.com/news/articles/2015-04-12/flash-move-haunts-bond-traders-heeding-dimon-s-warning-of-crisis.

[23] Robin Wigglesworth, Treasury volumes raise liquidity concerns, Financial Times (June 11, 2015), available at http://www.ft.com/intl/cms/s/0/9a5b334e-0fb5-11e5-94d1-00144feabdc0.html; Tracy Alloway, Everyone's Been Worried About Liquidity in the Wrong Bond Market, BloombergBusiness (June 1, 2015), available at http://www.bloomberg.com/news/articles/2015-06-01/everyone-s-been-worried-about-liquidity-in-the-wrong-bond-market

[24] Robin Wigglesworth, Treasury volumes raise liquidity concerns, Financial Times (June 11, 2015), available at http://www.ft.com/intl/cms/s/0/9a5b334e-0fb5-11e5-94d1-00144feabdc0.html; Tracy Alloway, Everyone's Been Worried About Liquidity in the Wrong Bond Market, BloombergBusiness (June 1, 2015) (noting that “while U.S. Treasuries enjoy the highest amount of absolute liquidity by this measure, the market's relative drop in liquidity in recent years has eclipsed that of junk and investment-grade corporate debt. According to the Deutsche strategists, U.S. Treasuries have lost 70 per cent of their trading depth since the financial crisis, while high-yield and investment grade bonds have lost 30 percent and 50 percent respectively.”), available at http://www.bloomberg.com/news/articles/2015-06-01/everyone-s-been-worried-about-liquidity-in-the-wrong-bond-market. The 70 percent decline in trading depth is measured against the size of the Treasury market, which has seen a 25 percent rise in the total amount of U.S. Treasury debt outstanding since the financial crisis. Daily trading volumes have remained largely unchanged during that period, and dealer inventories have declined. U.S. Department of the Treasury, Assessing fixed income market liquidity, Presentation to Treasury Borrowing Advisory Committee Members, 10 (July 2013) (noting that the size of the Treasury market has grown, but that turnover has not kept up), available at http://www.treasury.gov/resource-center/data-chart-center/quarterly-refunding/Documents/Charge_2.pdf.

[25] Liz McCormick and Daniel Kruger, The Treasury Market’s Legendary Liquidity Has Been Drying Up, BloombergBusiness (Feb. 1, 2015) (noting that the “[f]or decades, the $12.5 trillion market for U.S. government debt was renowned for its ‘depth’ . . . . But lately, that resiliency has practically vanished —and that’s a big worry.”), available at http://www.bloomberg.com/news/articles/2015-02-02/if-trading-bonds-is-hard-think-about-the-pain-when-rates-rise.

[26] Robin Wigglesworth, Treasury volumes raise liquidity concerns, Financial Times (June 11, 2015) (the decline in market depth is purportedly measured against “the long term average”), available at http://www.ft.com/intl/cms/s/0/9a5b334e-0fb5-11e5-94d1-00144feabdc0.html.

[27] Liz McCormick and Daniel Kruger, The Treasury Market’s Legendary Liquidity Has Been Drying Up, BloombergBusiness (Feb. 1, 2015) (citing JP Morgan) available at http://www.bloomberg.com/news/articles/2015-02-02/if-trading-bonds-is-hard-think-about-the-pain-when-rates-rise.

[28] Katy Burne, Concern About Trading of U.S. Treasurys Prompts Review by Regulators, The Wall Street Journal (July 12, 2015), available at http://www.wsj.com/articles/concerns-about-trading-of-u-s-treasurys-prompts-review-by-regulators-1436729365; Ellie Ismailidou, One thing that this bond market and past ‘tantrums’ have in common, MarketWatch (May 19, 2015), available at http://www.marketwatch.com/story/one-thing-that-this-bond-market-and-past-tantrums-have-in-common-2015-05-19;

[29] Robin Wigglesworth, Treasury volumes raise liquidity concerns, Financial Times (June 11, 2015), available at http://www.ft.com/intl/cms/s/0/9a5b334e-0fb5-11e5-94d1-00144feabdc0.html.

[30] Peter Eavis, Bankers and Regulators Voice Fears on Bond Market Volatility, The New York Times (May 5, 2015) (noting that “[t]rading dried up for a time during the shakeouts in the market in 1994, 1998 and 2008 . . . . In 1994, for instance, when interest rates unexpectedly rose, bond dealers slashed their holdings of bonds by nearly a third, according to figures from the Federal Reserve.”), available at http://www.nytimes.com/2015/05/06/business/dealbook/bankers-and-regulators-voice-fears-on-bond-market-volatility.html?_r=0.

[31] The resiliency of liquidity refers to the speed with which new orders flow to correct order imbalances. Imbalances tend to move prices away from what is warranted by market fundamentals. See Abdourahmane Sarr and Tonny Lybek, Measuring Liquidity in Financial Markets, IMF Working Paper, 5 (2002), available at http://www.imf.org/external/pubs/ft/wp/2002/wp02232.pdf.

[32] Lael Brainerd, Governor, Board of Governors of the Federal Reserve System, speech at the Salzburg Global Forum on Finance in a Changing World, Recent Changes in the Resilience of Market Liquidity (July 1, 2015) (noting that the Board sees “some increases in the values of these indicators, which provide some evidence that liquidity may be less resilient [in the fixed income markets] than it had been previously.”), available at http://www.federalreserve.gov/newsevents/speech/brainard20150701a.htm; see also U.S. Department of the Treasury, Assessing fixed income market liquidity, Presentation to Treasury Borrowing Advisory Committee Members, 7 (July 2013) (noting that bid-offer spreads in the Treasury market are “[p]rone to sudden spikes,” and interpreting this data to mean that “[l]iquidity [is] typically fine — until you actually need it”), available at http://www.treasury.gov/resource-center/data-chart-center/quarterly-refunding/Documents/Charge_2.pdf.

[33] Lael Brainerd, Governor, Board of Governors of the Federal Reserve System, speech at the Salzburg Global Forum on Finance in a Changing World, Recent Changes in the Resilience of Market Liquidity (July 1, 2015)(noting that “[f]inding a high-fidelity gauge of liquidity resilience is difficult, but there are a few measures that could be indicative, such as the frequency of spikes in bid-asked spreads, the one-month relative to the three-month swaption implied volatility, the volatility of volatility, and the size of the tails of price-change distributions for certain assets.”), available at http://www.federalreserve.gov/newsevents/speech/brainard20150701a.htm.

[34] Tracy Alloway, Everyone's Been Worried About Liquidity in the Wrong Bond Market, BloombergBusiness (June 1, 2015) (noting that “the notion of declining liquidity in the U.S. Treasury market is a big deal since it seems to be happening just as the Federal Reserve is preparing to raise interest rates.”), available at http://www.bloomberg.com/news/articles/2015-06-01/everyone-s-been-worried-about-liquidity-in-the-wrong-bond-market; Daniel Kruger, Yellen Puts Bond Market on Notice 2015 Rate Increase Is Looming, BloombergBusiness (July 11, 2015) (noting that Federal Reserve Chair “Janet Yellen is reminding the bond market that 2015 will include at least one interest-rate increase.”), available at http://www.bloomberg.com/news/articles/2015-07-11/yellen-puts-bond-market-on-notice-2015-rate-increase-is-looming.

[35] Katy Burne, Concern About Trading of U.S. Treasurys Prompts Review by Regulators, The Wall Street Journal (July 13, 2015), available at http://www.wsj.com/articles/concerns-about-trading-of-u-s-treasurys-prompts-review-by-regulators-1436729365.

[36] Id.

[37] Joint Staff Report: The U.S. Treasury Market on October 15, 2014, 15-17 (July 13, 2015), available at http://www.treasury.gov/press-center/press-releases/Documents/Joint_Staff_Report_Treasury_10-15-2015.pdf.

[38] Id. at 17. Statistically speaking, this is a degree of volatility that is expected to occur only once every 1.6 billion years. Tracy Alloway, Everyone's Been Worried About Liquidity in the Wrong Bond Market, BloombergBusiness (June 1, 2015) (noting that “the notion of declining liquidity in the U.S. Treasury market is a big deal since it seems to be happening just as the Federal Reserve is preparing to raise interest rates.”), available at http://www.bloomberg.com/news/articles/2015-06-01/everyone-s-been-worried-about-liquidity-in-the-wrong-bond-market. In reality, intraday moves of this size occur more regularly. In fact, larger intraday moves have occurred three times since 1998, though each of those events coincided with a major economic announcement. Specifically, they followed the Federal Reserve’s decision to bail out AIG in October 2008, the Federal Reserve’s decision to expand its quantitative easing program in March 2009, and the Federal Reserve’s August 2011 announcement that it planned to begin tapering its quantitative easing program by “mid-2013.” See International Monetary Fund, Global Financial Stability Report, 32 (Apr. 2015), available at http://www.imf.org/external/pubs/ft/gfsr/2015/01/pdf/c1.pdf. And, of course, there are those who believe events like October 15, 2014 could happen again. Alexandra Scaggs and Liz McCormick, Bond Traders Brace Themselves for Another Flash Rally, BloombergBusiness (Apr. 12, 2015), available at http://www.bloomberg.com/news/articles/2015-04-12/flash-move-haunts-bond-traders-heeding-dimon-s-warning-of-crisis; Jamie Dimon, Chairman and Executive Officer, JP Morgan, Annual Letter to Shareholders (Apr. 8, 2015) (noting that the flash crash was “a warning shot across the bow,” portending future volatility in the Treasury market), available at http://files.shareholder.com/downloads/ONE/15660259x0x820077/8af78e45-1d81-4363-931c-439d04312ebc/JPMC-AR2014-LetterToShareholders.pdf.

[39] Joint Staff Report: The U.S. Treasury Market on October 15, 2014, 15 (July 13, 2015), available at http://www.treasury.gov/press-center/press-releases/Documents/Joint_Staff_Report_Treasury_10-15-2015.pdf

[40] Id. at 1.

[41] Id. at 33.

[42] Id. at 35-44.

[43] Id. at 6.

[44] Federal Reserve Bank of New York, Treasury Market Practices Group, Automated Trading in Treasury Markets, 2-3 (June 2015) available at http://www.newyorkfed.org/tmpg/TPMG_June%202015_automated%20trading_white%20paper.pdf.

[45] Id. (noting that “automated trading strategies now typically account for more than half of trading activity in on-the-run Treasury securities that occurs on [interdealer platforms] . . . .”); Simon Potter, Executive Vice President, Federal Reserve Bank of New York, Remarks at the 2015 Primary Dealer Meeting, Challenges Posed by the Evolution of the Treasury Market (Apr. 13, 2015), available at http://www.newyorkfed.org/newsevents/speeches/2015/pot150413.html.

[46] Simon Potter, Executive Vice President, Federal Reserve Bank of New York, Remarks at the 2015 Primary Dealer Meeting, Challenges Posed by the Evolution of the Treasury Market (Apr. 13, 2015), available at http://www.newyorkfed.org/newsevents/speeches/2015/pot150413.html.

[47] Ellie Ismailidou, One thing that this bond market and past ‘tantrums’ have in common, MarketWatch (May 19, 2015) (noting that dealers’ share of Treasuries outstanding has plummeted from a peak of 18 percent prior to the crisis, to just over 4 percent), available at http://www.marketwatch.com/story/one-thing-that-this-bond-market-and-past-tantrums-have-in-common-2015-05-19; Joint Staff Report: The U.S. Treasury Market on October 15, 2014, 38 (July 13, 2015) (noting that “dealer positions relative to outstanding debt have fallen in recent years given the growth in debt outstanding”), available at http://www.treasury.gov/press-center/press-releases/Documents/Joint_Staff_Report_Treasury_10-15-2015.pdf.

Although many have argued that post-financial crisis regulatory reforms have led many dealer banks to reduce their inventories of Treasuries, others have noted that other factors have also been at play. For example, one Federal Reserve Board Governor observed that “reductions in broker-dealer inventories occurred prior to the passage of the Dodd-Frank Act, suggesting that factors other than regulation may also be contributing” to the “reductions in broker-dealer bond inventories in recent years.” Lael Brainerd, Governor, Board of Governors of the Federal Reserve System, speech at the Salzburg Global Forum on Finance in a Changing World, Recent Changes in the Resilience of Market Liquidity (July 1, 2015), available at http://www.federalreserve.gov/newsevents/speech/brainard20150701a.htm

[48] Federal Reserve Bank of New York, Treasury Market Practices Group, Automated Trading in Treasury Markets, 4 (June 2015) (noting that “[e]lectronic trading can significantly lower execution costs”), available at http://www.newyorkfed.org/tmpg/TPMG_June%202015_automated%20trading_white%20paper.pdf; Simon Potter, Executive Vice President, Federal Reserve Bank of New York, Remarks at the 2015 Primary Dealer Meeting, Challenges Posed by the Evolution of the Treasury Market (Apr. 13, 2015) (noting that “[e]lectronic trading, including automated and high-frequency trading, has likely had a number of benefits. For one, technological advances have supported market efficiency by increasing the pace at which price discovery is disseminated across financial markets. It may also have reduced transaction costs, both through the economies of scale that large technology investments produce, and perhaps through the maintenance of narrow bid-offer spreads that automated market-making arguably makes more likely.”), available at http://www.newyorkfed.org/newsevents/speeches/2015/pot150413.html.

[49] Federal Reserve Bank of New York, Treasury Market Practices Group, Automated Trading in Treasury Markets, 4 (June 2015) (noting that “recent market events attributed to automated trading have been directly linked to operational risks ranging from malfunctioning and incorrectly deployed algorithms to algorithms reacting to inaccurate or unexpected data.”), available at http://www.newyorkfed.org/tmpg/TPMG_June%202015_automated%20trading_white%20paper.pdf; Michael Mackenzie and Arash Massoudi, NYSE cancels trades after algo glitch, Financial Times (Aug. 1, 2012), available at http://www.ft.com/intl/cms/s/0/bd5f2af8-dbe7-11e1-8d78-00144feab49a.html; Hal Weitzman and Gregory Meyer, Infinium fined $850,000 for computer malfunctions, Financial Times (Nov. 25, 2011), available at http://www.ft.com/intl/cms/s/0/f97e0668-1783-11e1-b157-00144feabdc0.html.

[50] Spoofing is a form of market manipulation that involves the submission of orders that the trader has no intention of executing. One article described the practice thusly:

Spoofing is rapid-fire feinting. A spoofer might dupe other traders into thinking oil prices are falling, say, by offering to sell futures contracts at $45.03 a barrel when the market price is $45.05. After other sellers join in with offers at that lower price, the spoofer quickly pivots, canceling his sell order and instead buying at the $45.03 price he set with the fake bid.

The spoofer, who has now bought at two cents under the true market price, can later sell at a higher price—perhaps by spoofing again, pretending to place a buy order at $45.04 but selling instead after tricking rivals to follow. Repeated many times, spoofing can produce big profits.

Bradley Hope, As ‘Spoof’ Trading Persists, Regulators Clamp Down, The Wall Street Journal (Feb. 22, 2015), available at http://www.wsj.com/articles/how-spoofing-traders-dupe-markets-1424662202.

[51] Federal Reserve Bank of New York, Treasury Market Practices Group, Automated Trading in Treasury Markets, 6 (June 2015), available at http://www.newyorkfed.org/tmpg/TPMG_June%202015_automated%20trading_white%20paper.pdf.

[52] International Monetary Fund, Global Financial Stability Report, 33 (Apr. 2015), available at http://www.imf.org/external/pubs/ft/gfsr/2015/01/pdf/c1.pdf.

[53] Id.

[54] Regulation ATS provides an exclusion for trading platforms that limit their activities to government securities, including Treasuries. See 17 CFR 242.301(a)(4)(ii), available at https://www.law.cornell.edu/cfr/text/17/242.301.

[55] Michael Mackenzie, Dealerweb launch shakes up Treasuries trading, Financial Times (June 5, 2014) (noting that, “[f]or more than a decade, the electronic trading of Treasuries has been dominated by BrokerTec, which is run by ICAP, and eSpeed, which Nasdaq OMX acquired for $750m from BGC Partners last year.”), available at http://www.ft.com/intl/cms/s/0/168da448-ec16-11e3-ab1b-00144feabdc0.html.

[56] Alternative Trading Systems with Form ATS on File with the SEC as of July 1, 2015, available at http://www.sec.gov/foia/ats/atslist0715.pdf.

[57] Currently, Regulation SCI applies only to ATSs that trade NMS stocks, municipal securities, and corporate debt securities. 17 CFR 242.300(a).

[58] Joint Staff Report: The U.S. Treasury Market on October 15, 2014, 2 (July 13, 2015) (noting that “[b]ecause analysis is ongoing and the data are an incomplete snapshot of the U.S. interest rate complex, the findings presented are necessarily preliminary and limited in scope.”), available at http://www.treasury.gov/press-center/press-releases/Documents/Joint_Staff_Report_Treasury_10-15-2015.pdf; see also Simon Potter, Executive Vice President, Federal Reserve Bank of New York, Remarks at the 2015 Primary Dealer Meeting, Challenges Posed by the Evolution of the Treasury Market (Apr. 13, 2015) (noting that “comprehensive data on the universe of secondary trading in the Treasury market is somewhat lacking . . . .”), available at http://www.newyorkfed.org/newsevents/speeches/2015/pot150413.html.

[59] Yogi Berra, The Yogi Book, 30 (1998) (describing Mickey Mantle and Roger Maris repeatedly hitting back-to-back home runs in the early 1960s).

[60] The consolidated audit trail (CAT) will be a comprehensive audit trail that will allow regulators to more efficiently and accurately track activity in NMS securities throughout the U.S. markets. The CAT is being created by a joint plan of the eighteen national securities exchanges and the Financial Industry Regulatory Authority (FINRA) pursuant to SEC Rule 613. See SEC Rule 613: Consolidated Audit Trail (CAT), Frequently Asked Questions, available at http://catnmsplan.com/CAT_FAQ/#q_0.

[61] Katy Burne, U.S. Government Bond-Market Volatility Sparks Talk of Circuit Breakers, The Wall Street Journal (June 2, 2015), available at http://www.wsj.com/articles/icap-weighs-treasurys-trading-collars-1433285708.

[62] International Monetary Fund, Global Financial Stability Report, 33 (Apr. 2015), available at http://www.imf.org/external/pubs/ft/gfsr/2015/01/pdf/c1.pdf.

[63] Id.

[64] Regulation of Exchanges and Alternative Trading Systems, Securities Exchange Act No. 40760 (Dec. 8, 1998) (noting that “[u]nlike surveillance of trading in equities and other instruments traded primarily on registered exchanges, surveillance of trading in government securities is coordinated among the Treasury, the Commission, and the Board of Governors of the Federal Reserve System.”), available at https://www.sec.gov/rules/final/34-40760.txt.

[65] Government securities broker-dealers are currently regulated jointly by the Commission, the U.S. Department of the Treasury, and federal banking regulators, under the Exchange Act and the federal banking laws. Id.

[66] Chair Mary Jo White, Enhancing Our Equity Market Structure, (June 5, 2014) (“I have asked the SEC staff to prepare two recommendations for the Commission: the first, a rule to clarify the status of unregistered active proprietary traders to subject them to our rules as dealers; and second, a rule eliminating an exception from FINRA membership requirements for dealers that trade in off-exchange venues. Dealer registration and FINRA membership should significantly strengthen regulatory oversight over active proprietary trading firms and the strategies they use.”), available at http://www.sec.gov/News/Speech/Detail/Speech/1370542004312.

[67] Katy Burne and Aaron Kurlikoff, Regulators Want Data on Bond-Trade Fees, The Wall Street Journal (Jan. 13, 2015) (noting that “most investors only see prices after trades are complete, either through Finra’s Trade Reporting and Compliance Engine known as ‘Trace’ for corporate debt or the MSRB’s Electronic Municipal Market Access website called ‘Emma’ for municipal bonds.”), available at http://www.wsj.com/articles/regulators-want-data-on-bond-trade-fees-1421193311. I have noted in the past that the MSRB’s EMMA system, though extremely helpful, could be improved still further. See Commissioner Luis A. Aguilar, Statement on Making the Municipal Securities Market More Transparent, Liquid, and Fair (Feb. 13, 2015), available at http://www.sec.gov/news/statement/making-municipal-securities-market-more-transparent-liquid-fair.html#_ednref46.

[68] Commissioner Luis A. Aguilar, Statement on Making the Municipal Securities Market More Transparent, Liquid, and Fair (Feb. 13, 2015), available at http://www.sec.gov/news/statement/making-municipal-securities-market-more-transparent-liquid-fair.html#_ednref46.

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Modified: July 14, 2015