Treasury Flash Crash – Lessons Learned
Summary
The Federal Reserve Bank (the Board) has proposed a new report to collect detailed data on an institution’s daily trading transactions of markable U.S. Treasury securities, debt and mortgage backed securities (MBS) issued by U.S. federal government agencies and government sponsored agencies (FR 2956). Every national bank, state member bank, state non-member bank, saving association or U.S. branch and agency of a foreign bank with an average daily transaction volume of over $100 million for U.S Treasury debt or over $50 million for agency issued debt and MBS during the prior fiscal year would be subject to the proposed FR 2956 reporting requirements and would electronically report transactions through the Board’s data collection vendor, Financial Industry Regulatory Authority (FINRA), utilizing its Trade Reporting and Compliance Engine (TRACE). The report would have two parts. Part 1 would collect transactions in U.S. Treasury securities and Part 2 would collect transactions in debt and MBS issued by agencies.
Background and justification for data collection
The U.S. Treasury securities market is one of the most expansive and liquid government securities markets in the world. It has an integral role in the global economy, serving as the primary means of financing the U.S. Government and as a significant investment and hedging instrument for global investors, a risk-free benchmark for other financial instruments and an important market for implementing the Board’s monetary policy. Market participants in the trading of U.S. Treasury securities are typically U.S. Securities and Exchange Commission (SEC) registered broker-dealers and members of FINRA as well as commercial bank dealers and principal trading firms.
On October 15th, 2014 the U.S. Treasury market experienced its most volatile day on record, after the 10- year U.S. Treasury yield dropped 20 basis points in a matter of 30 minutes at the opening of the U.S. equity market. The yield recovered most of the losses by the end of day closing at 6 basis points lower, but was considered a major event, especially when the U.S. Treasury securities market is considered a benchmark for risk-free assets with a high degree of stability. Events such these are referred to as flash crashes and are defined as a rapid decline in security price followed by a significant price recovery shortly after. In response to this unanticipated event, an interagency working group comprised of staff from the U.S. Treasury Department, The Board, the SEC and the U.S. Commodity Futures Trading Commission (referred to as the “Joint Staffs”) analyzed both the conditions contributing to the events on October 15th and the structure of the Treasury security market. The Joint Staffs issued a report on July 13, 2015 (JSR), that detailed its finding regarding the October 15th volatility and the significant characteristics of the Treasury securities market structure. In addition, the Joint Staffs included a proposed series of four next steps in understanding the progression of the Treasury securities market. One such step was to assess the data available to the public and to the official sector on the U.S. Treasury securities market.
Following the publication of the JSR the Treasury department issued a request for information seeking public comment on structural changes in the U.S. Treasury market. One remarkable item in this request was to develop a holistic view of the trading and risk management practices across U.S. Treasury futures and cash markets. The Treasury Department further noted that it is most interested in an efficient and effective way to have access to timely and comprehensive data across markets and announced it had requested FINRA consider a proposal to collect relevant transactional data in a central repository.
The proposed new report, FR 2956 is a product of the joint efforts by the Treasury Department and the Board. In conjunction with these efforts, the Board has assessed whether it should also require depository institutions to report data for market transactions for debt and MBS issued by U.S. government agencies. The Board has determined that along with Treasury securities, debt and MBS are also considered high-quality liquid assets and play a significant role in housing finance and an important channel for monetary policy execution. This information is not currently available from other sources.
Conclusion
The Treasury Flash Crash in 2014 has brought to light the complexity, interconnectedness and vulnerability of the U.S. Treasury securities markets, once perceived as a stable and risk-free instrument is and can be subject to volatility when the market behaves abnormally. As a result, it has come to the Board’s attention its lack of understanding of the current market structure and data availability limit its ability to provide adequate oversight to ensure safety and soundness to the financial sector when such events occur. In response, a joint committee of regulators have proposed a new daily reporting requirement to collect transaction data on U.S. Treasury securities and debt and MBS issued by government sponsored agencies. Comment period for this proposal ends March 22, 2021.
Katherine TORNARITES -Regulatory Product Analyst