Treasury Securities Market Disruptions and Policy Issues
January 10, 2022
Treasury Securities Market Disruptions and Policy Issues
The U.S. Treasury securities market is considered one of
The enforcement authority for the rules generally resides
the most important financial markets in the world. The
with the Securities and Exchange Commission (SEC),
market provides a low-risk (backed by the full faith and
Financial Industry Regulatory Authority (FINRA), and
credit of the U.S. government) and liquid asset for global
relevant banking regulators.
investors while raising funding to finance U.S. federal
spending. Any event that significantly disrupts Treasury
Trade Reporting and Compliance Engine (TRACE) is
market functions could cause distress in the global financial
the main system for consolidating Treasury securities
system, and recent market events show that the Treasury
transaction data and reporting. FINRA operates TRACE
market is not immune to such disruptions. This In Focus
with the involvement of the Treasury, SEC, Fed, and
describes examples of these market events and related
other official entities.
policy recommendations.
Treasury securities clearing and settlement processes are
Overview
facilitated by some entities operated by or under the
The U.S. Treasury securities outstanding grew in nominal
oversight of the Fed and the SEC. The Fed operates the
dollars to $22 trillion as of October 2021 from $3 trillion in
Fedwire clearing and settlement system. Regulated
2000. They account for around 40% of all U.S. fixed
entities include, for example, the Fixed Income Clearing
income securities outstanding. Market participants use
Corporation and the Bank of New York Mellon.
Treasury securities to hedge portfolio positions, create low-
risk investment strategies, speculate on interest rate
Treasury derivatives markets generally include Treasury
movements, and provide reference rates for pricing and
futures, options, swaps, and futures on indices related to
analyzing other securities. The Federal Reserve (Fed),
Treasuries, among other instruments. The Commodity
foreign central banks, mutual funds, pension funds, banking
Futures Trading Commission (CFTC) oversees Treasury
institutions, and households are common holders of
derivatives markets. In addition to its enforcement
Treasury securities. As the largest individual holder of
authority over manipulative and deceptive activities
Treasury securities, the Fed held $5.6 trillion, or around a
involving derivatives such as Treasury futures, the
quarter of all Treasury securities outstanding as of
CFTC has regulatory oversight of Treasury derivatives
November 2021.
market participants and exchanges.
The Treasury cash market is the market for Treasury
Treasury Market Disruptions
benchmark securities as opposed to Treasury futures and
This section explains three Treasury market events in 2014,
options. In the cash market, the Treasury Department issues
2019, and 2020 and what economists have generally
bills, nominal fixed-rate coupon securities, nominal floating
described as their conditions.
rate securities, and inflation-indexed securities. These
securities are referred to as “benchmark” securities because
“Flash Rally” in October 2014
the yields of these securities are used as references for other
On October 15, 2014, the Treasury market experienced
transactions. The Treasury futures market refers to the
unusually high volatility and a sharp swing of prices
market where Treasury securities buying and selling
without significant news that would normally move
happens at a predetermined price and a set future time.
markets. The event was called a “flash rally” because the
large decline and rebound in prices happened in a short time
Regulatory and Operational Framework
window of minutes, after which markets were calm again.
Multiple authorities are responsible for regulating or
Market observers focused on changes in market structure to
operating various components of the Treasury market:
explain the event. The most fundamental shift in market
structure in the years leading up to the event included the
The Treasury Department is responsible for securities
emergence of high-speed electronic trading. The shift
issuance, while the Fed executes auctions and buybacks
affected the types of market participants and the ways they
(the latter of which are rarely performed).
demand and supply liquidity. For example, principal trading
firms (PTFs), a type of electronic and automated
Trading in Treasury securities is facilitated mainly by
intermediary that includes certain high-frequency trading
brokers and dealers. The Government Securities Act of
firms and nonbank market makers, have become key
1986 (P.L. 99-571) establishes the broker-dealer
players in the Treasury market. At the time of the event,
regulatory framework in the government securities
PFTs accounted for the majority of trading and standing
market. Congress authorized the Treasury Department to
quotes in certain Treasury order books (e.g., futures and the
promulgate rules governing transactions in government
inter-dealer cash market). Because the emerging
securities by government securities brokers and dealers.
intermediaries, such as PTFs, may not have the same
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Treasury Securities Market Disruptions and Policy Issues
balance sheet capacity for market making as the more
Some researchers attribute the reasons for the 2020
traditional bank-affiliated dealers, this change in market
Treasury market disruption to the sale pressure driven by
structure potentially led to weakened market resilience. In
liquidity needs at foreign central banks, mutual funds, and
addition, high-speed trading created incentives for being the
hedge funds. One research paper indicates that sales of
fastest, which could cause slower traders to withdraw from
Treasury securities by foreign investors, mutual funds, and
the market or seek other venues, thus reducing liquidity by
the household sector (which includes hedge funds) were at
reducing the number of traders and separating them into
$287 billion, $266 billion, and $196 billion, respectively, in
different venues. The lack of full information to thoroughly
first quarter of 2020. In contrast, these groups did not sell
analyze the event, some argue, also underscored the need
many Treasury securities during the 2008 financial crisis.
for transparency into some parts of the Treasury market
structure that were not covered by data reporting in 2014
Potential Causes and Policy Options
and are still not covered as of January 2022.
The recent Treasury market events revealed areas of
structural vulnerability. According to a number of
Treasury Repo Market Stress in September 2019
observers, the root cause of the increased Treasury market
A repurchase agreement (repo) is an agreement to sell
disruptions relates to the rapid growth of the market size
securities with a promise to buy them back at a higher price
that outstripped dealers’ intermediation and market-making
and a later time. Repo transactions are similar to
capacity. Specifically, the nominal amount of Treasury
collateralized loans, with the higher price for future
securities held by the public more than tripled between
repurchase playing the role of an interest rate. The repo
2008 and 2020, placing pressure on intermediation. Various
transactions collateralized by Treasury securities represent
government agencies and think tanks have made a number
the largest segment of the repo market. Each day, financial
of recommendations in recent years to address challenges,
institutions generally use repos to borrow more than a
some of which are broadly described below. Critics of these
trillion dollars against Treasury securities.
recommendations may assert some proposals create undue
government intervention or additional costs in the market.
In September 2019, Treasury repo and other money market
Proposed policy options include:
instruments briefly experienced unexpected and severe rate
spikes. The Treasury repo market stress coincided with the
Enhance market-making capacity through the creation of
quarterly corporate tax payment and the settlement of the
a facility at the Fed—which would provide permanent,
mid-month Treasury coupon auction that generated
broad, and direct access to the Fed’s financing—in an effort
transitory shocks (through the decrease in supply of cash
to ensure intermediaries’ confidence in market making. The
and increase in demand for cash). At the time, the reserve
Fed launched a standing repo facility in 2021.
holdings at some banks were low relative to the banks’
desired levels. The reserve levels limited the amount of
Increase safeguards, including potential registration of
cash these intermediaries could lend out to alleviate the rate
PTFs as dealers under securities law and evaluating all
pressure at the repo market, creating a situation where many
exemptions of Treasury securities from U.S. securities laws
lenders did not step in to take advantage of the higher rates.
to see if the exemptions continue to be warranted.
Some large Treasury repo market dealers also experienced
increases in intermediation costs, driving up repo rates. The
Mandate central clearing of more trading activities
temporary reduction in lending from money market mutual
through a central counterparty clearinghouse. Central
funds may have contributed to this cost increase in
clearing could reduce counterparty risk, increase
intermediation. The Fed intervened by lending cash in the
transparency, and expand intermediaries’ balance sheet
repo market and purchasing Treasury securities outright.
capacity (e.g., through “netting”). The specific steps could
include the expansion of central clearing to all Treasury
“Dash for Cash” in March 2020
securities and repos.
In March 2020, the economic and financial uncertainties
surrounding the COVID-19 pandemic induced a “dash for
Increase market transparency and monitoring by
cash” that involved extensive market selloffs for assets
expanding reporting, disclosure, and data collection and
across a wide spectrum, including stocks, bonds, and
tracking. Recommendations along these lines include
Treasury securities. Many market participants—including
potential enhancements to TRACE reporting for Treasury
foreign central banks, mutual funds, and hedge funds—
securities. Among the enhancements under consideration is
started selling Treasury securities. The sales pressure
a shortened trade reporting time frame. Others have
distorted the market and overwhelmed the Treasury market
recommended Treasury securities transactions be publicly
intermediaries, resulting in key market makers (high-
disclosed, like the TRACE reporting on corporate bonds.
volume traders that stand ready to buy or sell a security to
“make a market”), including PTFs and other dealers, being
Enhance trading venue oversight by expanding Treasury
unable to keep up with the demand for intermediation
securities trading regulation (e.g., through changes to the
services. Treasury securities prices briefly experienced
SEC Regulation Alternative Trading Systems).
abnormal volatility, and the financing for Treasuries
through repo became scarce. The Fed took actions to
Evaluate investor positions and trading flows, including
address the market conditions, including establishing
positions at large Treasury securities investors. These could
liquidity facilities and providing large-scale purchases of
include certain hedge funds and mutual funds that pose
Treasury securities and repo lending.
leverage and liquidity considerations.
Eva Su, Analyst in Financial Economics
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Treasury Securities Market Disruptions and Policy Issues
IF12012
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