U.S. Department of the Treasury

 

NEW YORK - I would like to thank President Dudley and the team at the Federal Reserve Bank of New York for hosting this conference, the other agencies for their participation and leadership on this topic, and the panelists and speakers who have gathered today.  

This conference grew out of a suggestion by Governor Powell, who successfully convened a broad group of stakeholders following the Salomon Brothers bidding scandal in the early 1990s.  We are not here today to respond to a scandal or crisis.  But the issues we will debate over the next two days are no less important, and will benefit from the input of such a broad range of market participants, policymakers and academics.

We will spend the better part of these two days discussing the microstructure of the Treasury market, but I want to first step back and provide some perspective on the importance of these issues.  I will discuss the vital role of the Treasury market and its depth, resiliency, and fundamental health.  I will then describe the analysis that is ongoing following the release of the Joint Staff Report on October 15th, 2014, and then briefly lay out the path ahead.  

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We should begin by recognizing the fundamental role that Treasury markets play in the global financial system.  The Treasury market remains the deepest, most liquid securities market in the world. There are nearly $13 trillion in marketable Treasury securities outstanding, and more than $500 billion in Treasury transactions that are carried out without a hitch every day.  For investors around the world, the Treasury market is a source of safety and liquidity, and a haven in times of turbulence.  Foreign governments choose to invest the majority of their reserves in Treasuries.  Moreover, a deep and liquid Treasury market anchors the role of the U.S. dollar as the global reserve currency and facilitates the effective transmission of monetary policy.  In short, the Treasury market is the benchmark for a well-functioning and trusted financial system.

The Joint Staff Report released in July, and the work that continues in the wake of the Report, including today’s conference, is motivated by our shared commitment to maintaining Treasuries as the global benchmark, not just now but for decades to come.

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I must pause here briefly to discuss matters of great urgency to us all.  If Treasuries are to remain the global benchmark, regular and prolonged debates in Congress over whether to raise the debt limit—whether to pay our bills—must become a thing of the past.  The role that Treasuries play in the global financial system, and the benefits they bring to the U.S. economy, rest on the bedrock foundation of the full faith and credit of the United States.  As we approach the November 3 deadline for Congress to act, we become acutely aware that this foundation cannot be taken for granted.  It is imperative that Congress act now, and avoid gambling with our full faith and credit.

This audience surely appreciates another important aspect of this period.  Short-term treasuries—T-bills—underpin key markets that fund a vast array of businesses and financial transactions in our economy.  As we have noted in recent refunding statements, Treasury intends to increase our bill issuance to meet growing demand in the marketplace.  However, during periods when we're using extraordinary measures, we are forced to reduce our bill issuance, increasing strains in funding markets.  The sooner Congress acts to raise the debt limit the sooner we can return to our planned path of bill issuance.

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To return now to market structure … If our first maxim in addressing the Treasury market is “do no harm,” the second is to keep our eyes on the road ahead.  In order to accomplish this, we must not only analyze today’s market structure, but also understand how the market might develop over the next five or ten years.  We need to anticipate the “new market structure,” and ensure that the rules of the road reflect the path ahead, not the world in the rearview mirror. 

Our current work represents the first fundamental review of the Treasury market since 1998.  We are in the early stages of this review, given how much has changed since that time.  Indeed, a majority of trading in on-the-run Treasury securities and Treasury futures today involves a level of automation that did not exist in 1998.  And large portions of trading activity are conducted by new players, and firms that were not active in Treasury markets at that time.  

Many of the changes underway in the Treasury market, particularly the market for cash Treasury securities, strongly resemble the evolution previously seen in other markets.  Algorithmic trading has been well established in equities and futures since the late 1990s, and now accounts for a majority of trading in most standardized, liquid securities.  This includes more than half of activity on inter-dealer trading platforms for cash Treasuries.

There are many lessons to be drawn from developments in other markets, and in this respect we will benefit from close collaboration with our regulatory partners at the SEC and CFTC.  

One of the key lessons in all of this is that the plumbing matters.  As I noted in recent comments at the Brookings Institution, the growth of algorithmic, high-speed trading has increased operational risk, and heightened the need for comprehensive oversight and risk management practices.  From last October 15 in Treasury markets, to May 6, 2010 or even this past August 24 in equity markets, we have seen how episodes of volatility can be magnified by the interaction at high speeds of automated trading strategies and a complex array of trading rules, venues and products.  The increased prevalence of automated trading strategies and the associated operational challenges will, appropriately, be the subject of several panels over the course of the next two days.

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This conference builds on the analysis that has been underway since the Report was released, and sets the foundation for the path ahead.  

The Joint Staff Report identified four next steps: 

With these objectives in mind, staff from each of the agencies have been working to broaden the scope of our analysis.  For example, staffs from the Federal Reserve Bank of New York, CFTC, and SEC have continued to analyze the events of last October 15th, this time with an additional set of data that was not available at the time of the Report’s release. The first panel today will discuss findings from that analysis.  It shows that, even during the frenetic event window, a meaningful proportion of trading occurred the “old-fashioned” way—directly between dealers and customers.  Decision-making was happening at both human and computer speeds.  This highlights the importance of gaining a more granular perspective, and increasing transparency, across all corners of the Treasury market. 

More broadly, staff has continued to participate in private and public sector forums to discuss the findings of the Report, to solicit feedback, and to promote a better understanding of the evolution of Treasury markets. 

Meanwhile, the Inter Agency Working Group is developing a standing information sharing agreement to expedite the kind of review we did following October 15th. Staff has also been evaluating potential gaps in the regulatory framework governing trading of Treasury securities and the transparency of transactions.

Separately, the Financial Stability Oversight Council, or FSOC, is closely examining potential vulnerabilities related to changes in market structure, which it highlighted in its most recent annual report.  It is critical for regulators to understand how these changes in market structure may impact market functioning.  Accordingly, the FSOC is analyzing potential risks along three dimensions, which dovetail with the themes identified in the October 15th Report: 

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In order to carry this work forward, we will need to draw on the broadest possible range of perspectives, both in precisely identifying areas in need of improvement and in crafting potential reforms.  At every step, it will be essential for us to seek input from all stakeholders as we consider ways to strengthen Treasury market structure and oversight.

To that end, in the coming weeks Treasury intends to work with the other members of the joint task force to develop a request for information (RFI) seeking public comment on the key areas identified for further analysis in the Joint Staff Report.  The RFI will build on the analysis presented in the Report and discussed at this conference.  We will ask specific questions about, among other matters, the sufficiency of data available to the official sector and the appropriate level of transparency to market participants and the public regarding Treasury market activity.  We will also seek information about best practices and lessons learned from other markets that can be applied to the Treasury market.  We expect to provide more information about the RFI in coming weeks.

This conference is a first step in an ongoing dialogue among all of the key stakeholders in Treasury markets.  The views expressed and the ideas exchanged over the coming two days will help to lay the foundation for the work that lies ahead.  It is our hope that market participants here will do the same, and will seek innovative solutions to some of the new challenges posed by an evolving market structure.  In his remarks, Governor Powell cites some efforts already underway that may have promise—efforts to develop central clearing for repo, for example.  

Where private sector solutions fall short, or require reinforcing, policy reforms will be considered.

Proposing changes, even small ones, to the Treasury market is not a straightforward or easy task.  Everyone here has a stake in the success of our collective efforts.  We must be mindful of the complexity and importance of the task, but we cannot afford to stand still as the world changes around us.

We look forward to engaging with all the participants at this conference over the next two days, and well beyond.

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