United States: Regulators Implement Enhanced Oversight And Propose Transparency For The Treasury Market

Introduction

On October 24, 2016, the Federal Reserve Bank of New York (FRBNY) held a conference on "The Evolving Structure of the US Treasury Market" (Conference). The Conference was a sequel to the first annual such event where oversight agencies pledged to work together to better understand and regulate the market for US Treasury securities. The Conference included the Department of the Treasury (Treasury), the Board of Governors of the Federal Reserve System (FRB), the FRBNY, the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) (collectively, Agencies). Presenters included the Honorable Mary Jo White (chair of the SEC), the Honorable Timothy Massad (chair of the CFTC), Antonio Weiss (counselor to the secretary of the Treasury) and the Honorable Jerome H. Powell (governor, FRB). The Conference also included several panels where representatives of the Financial Industry Regulatory Authority (FINRA), the CFTC, the FRB and the industry spoke about the effect of new and potential regulatory initiatives.1

The Conference speakers emphasized the critical role of the Treasury market, and regulators were especially careful to note that there is a collective responsibility to protect the special nature of the market. Speakers reiterated the fact that the Treasury market is the deepest, most liquid securities market in the world. They acknowledged that Treasury securities are the world's risk-free benchmark that facilitate the implementation of US monetary policy, offer a reliable store of value for savers around the world, help businesses manage their risks and finance the federal government. Nevertheless, the volatility of trading on October 15, 2014,2 prompted the Agencies to set up a collaborative working group that reexamined the rules and infrastructure of the Treasury market. The report of the interagency working group (Joint Staff Report), available here, has highlighted several potential sources of risk in the market. This alert summarizes the various proposals to reform the Treasury market over the next 18 to 36 months.

Enhanced Data Collection and Interagency Collaboration

The Conference highlighted the Agencies' commitment to collecting and analyzing information about the Treasury market, but not necessarily to changing the market's operation or structure. Chair White noted the "convergence" of regulatory regimes governing equity markets and the Treasury market. Her priorities now include promoting enhanced oversight and reporting of Treasury market trading, working closely with FINRA as it considers the application of its rules to the Treasury market, and "strengthening the foundational regulatory regime" for platform operators and broker-dealers involved in the Treasury market.3 Counselor Weiss also stated that in response to a request for information published in January, the Treasury received a significant number of public comments expressing support for comprehensive data collection and greater oversight of the Treasury market. The Treasury has therefore started working on a plan (to be completed by the end of the year) for comprehensive collection of trading data for cash Treasuries. He emphasized that the guiding principal of regulatory agencies is to "do no harm" to the market. 4

Data Gathering | FINRA's Efforts

On October 19, 2016, the SEC approved FINRA's new reporting requirements, which require that all Treasury security trades (with the exception of savings bonds) be reported to FINRA through its Trade Reporting and Compliance Engine (TRACE).5 Consequently, trading involving all marketable Treasuries, including Treasury bills, notes, bonds and inflation-protected securities (TIPS), will have to be reported to FINRA by July 10, 2017. Additionally, the new reporting requirement applies to the separate principal and interest components of Separate Trading of Registered Interest and Principal of Securities (Treasury STRIPS).6 Purchases of Treasury securities from the Treasury as part of an auction are not reportable, but "when-issued transactions," which can take place after the Treasury Department's announcement of an auction but before the auction and issuance of the securities, are reportable. The rules now include a new trade indicator for these "when-issued transactions."7

FINRA also announced two new trade modifiers that will be used to indicate Treasury security trades that are priced away from the current market for bona fide reasons. However, FINRA members will not have to implement these modifiers by the current implementation date of July 10, 2017—it is still debating the appropriate implementation timeline for these modifiers.8 Steven Joachim (executive vice president, Transparency Services, FINRA) stated that FINRA recognizes the implementation of the new reporting requirements will take time and technological adaptation, and that participants may make mistakes in implementation or may have interpretive questions. Joachim suggested that FINRA is sensitive to these concerns and is trying to be responsive by implementing real-time filters in reporting tools and by directly answering questions from members. He also stated that the organization understands that different firms have different abilities to adapt to new reporting requirements. Therefore, FINRA is providing machine-to-machine interfaces, setting up phone lines with service bureaus for participants and providing web browser access for small firms, all to facilitate adherence to the new rules. While large member firms with access to sophisticated technology will find it easier to implement these rules, Joachim said that FINRA hopes it can create and effectuate a reporting regime that is relatively fair and equitable to all.

Data Gathering | The Remaining 10%

In his speech, Counselor Weiss noted that FINRA's efforts to collect Treasury trade information through TRACE will capture 90% of Treasury market transactions. He stated that TRACE will cover trades of FINRA members, including the trades of FINRA members with non-FINRA member counterparties, and also capture trading on major platforms, such as BrokerTec and eSpeed. Nevertheless, 10% of Treasury trades occur between banks and other entities that are not FINRA members. To help close this gap, Counselor Weiss said that the FRB plans to collect Treasury market transaction data from banks and use FINRA as its collection agent. He characterized the FRB's plans as consistent with the Agencies' collective desire to ensure that there is "full coverage, no exceptions" of trading data and a level playing field for entities subject to reporting requirements.9

Platform Oversight | Regulation ATS and Regulation SCI

Chair White noted that the equities market has a regime for the registration and oversight of alternative trading systems (ATSs) that does not extend to activities in the Treasury market. When the SEC originally adopted this regulatory structure in 1998, it decided to exclude platforms that solely trade government securities in deference to the joint regulatory responsibilities of the SEC, the Treasury and federal banking regulators regarding the Treasury market. Increases in the trading of Treasury securities, electronic platforms and the exponential growth in high-speed trading have prompted regulators to reconsider their relatively hands-off approach to electronic systems trading these securities. Accordingly, Chair White asked the SEC staff to recommend ways of extending the regulatory regime attendant to the equities market platforms to the Treasury market platforms.10

Chair White mentioned that in the market for on-the-run US Treasury securities, ATSs bring buyers and sellers together for a large portion of daily trading volume. Even so, the operational integrity standards of Regulation SCI—Systems, Compliance and Integrity—do not apply to these ATSs. They are also exempt from Regulation ATS, which requires, among other things, registration as a broker-dealer, regulatory disclosures about operations, and the provision of efficient and fair use of primary trading venues to participants. Chair White expressed her belief that the SEC staff will recommend extending various provisions of Regulation ATS and Regulation SCI to platforms that currently trade government securities.11 Counselor Weiss also emphasized that the Treasury supported the SEC's expansion of its oversight of the Treasury market through the elimination of exceptions in Regulation ATS. Counselor Weiss called the application of Regulation ATS to Treasury platforms "inevitable and necessary."12

Footnotes

1 Industry participants included NASDAQ, ICAP, DTCC, Global Trading Systems, Bank of New York Mellon, UBS, Morgan Stanley, Credit Suisse, BlackRock, Citadel, Hudson River Trading, AQR Capital Management and the Pacific Investment Management Company (PIMCO).

2 On October 15, 2014, the yield on the benchmark 10-year Treasury security, a useful gauge for the price moves in other, related instruments that day, experienced a 37-basis-point trading range, only to close 6 basis points below its opening level.

3 See Mary Jo White, Prioritizing Regulatory Enhancements for the US Treasury Market (October 24, 2016), https://www.sec.gov/news/speech/white-keynote-us-treasury-market-conference-102416.html  (last visited November 10, 2016) (Chair White's Keynote Speech).

4 See Antonio Weiss, Treasury Markets: Data, Oversight and Transparency (October 24, 2016), https://www.treasury.gov/press-center/press-releases/Pages/jl0591.aspx  (last visited November 10, 2016) (Counselor Weiss's Speech).

5 See Notice of Filing of Amendment No. 1 and Order Granting Accelerated Approval of a Proposed Rule Change, as Modified by Amendment No. 1, Relating to the Reporting of Transactions in US Treasury Securities to TRACE, SEC Release No. 34-79116 (October 18, 2016), https://www.sec.gov/rules/sro/finra/2016/34-79116.pdf  (last visited November 10, 2016).

6 Treasury STRIPS are zero-coupon bonds—the coupons are "stripped" from the bond or note. Return is determined by the difference between the purchase price and the bond's trading value, or face value if held to maturity. These bonds and notes offer minimal risk and tax benefits in some states.

7 See FINRA, Reporting Transactions in US Treasury Securities, Regulatory Notice 16-39 (October 2016), https://www.finra.org/sites/default/files/notice_doc_file_ref/Regulatory-Notice-16-39.pdf  (last visited November 10, 2016).

9 See Counselor Weiss's Speech, supra note 4.

10 See Chair White's Keynote Speech, supra note 3.

11 Id.

12 See Counselor Weiss's Speech, supra note 4.

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