Treasury Market Structure

Recent events highlighted longer-term structural questions in the Treasury markets, particularly the growing mismatch between the volume of Treasury issuance and the capacity of the system to intermediate the trading of those instruments.

How Treasury market liquidity can be maintained, even during periods of stress, is the subject of significant study and debate.

U.S. Treasuries are debt instruments issued by the U.S. government to finance its activities. Owing to the United States’ creditworthiness and status as the world’s leading economy, the U.S. Treasury market (comprised of the cash market as well as the repurchase agreement (“repo”) and futures markets) has been described as the “biggest, deepest and most essential bond market on the planet.” Investors view Treasuries historically as risk-free or near-cash assets i.e., assets that retain their value and can be easily sold during both normal and stressed market periods. Unsurprisingly then, Treasuries have tended to be viewed as safe havens for investors during market crises. Owing to their stability, U.S. Treasuries also often serve as benchmarks for other fixed-income securities and hedging positions; as a result, U.S. Treasury yields have an impact on the rates that consumers, businesses, and governments across the globe pay to borrow money. In addition, the U.S. Treasury repo market is a key transmission mechanism for U.S. monetary policy, and vital to the liquidity of the cash Treasury market. Put simply, the U.S. Treasury market is a bedrock of the global financial system.

The resiliency of the Treasury markets has been called into question by a series of market disruption events in which market price volatility increased dramatically and/or where the depth of the market (i.e., the amount of liquidity available) decreased precipitously. These include the “Flash Rally” in October 2014, stresses in the Treasury-backed repo markets in September 2019, and the “Dash-for-Cash” in March 2020. While these events have differed in their scope and magnitude, collectively they have highlighted a variety of underlying structural problems in the Treasury markets. This has led to calls for reforms.

Emerging Policy Proposals

Although by no means exhaustive of the ideas circulating in public debate around Treasury market reform, it does seem that there are four broad categories of reform currently being debated. These are:

  1. Greater use of centralized clearing and “all-to-all” trading platforms;
  2. Expanded access to the Federal Reserve’s recently created standing repurchase (“repo” facility (“SRF”);
  3. Changes to banking regulation (such as reform of the SLR requirement); and
  4. Improved data and disclosure by market participants.

While each of these approaches has been discussed on a standalone basis and most had been suggested prior to the market events in March and April 2020, some have argued that these reforms ought to be considered holistically as a single package.

Some of the reforms appear more feasible to implement than others; for example, modifications to the Supplemental Leverage Ratio (SLR) would be relatively straightforward. In regard to central clearing, it appears that the relative benefits in the repo market are greater than in the dealer-to-customer cash market. Mandating central clearing in the cash market could impede market functioning and diversity while simultaneously failing to provide the same capacity benefits that are seen in the repo market.

Twin Goals for Reforms

What is certain is that more study is needed to determine the impact of many of these proposals, both individually and collectively, on the Treasury markets. Moreover, we are likely to see other reform ideas emerge over the coming months as the FSB, U.S. Treasury, and others continue to study recent events and collect data on the markets.

The goals of any reforms in the Treasury market should be to enhance the liquidity resiliency in the market and to increase the market-making capacity of market participants in order to meet the growing demand for, and supply of, Treasury securities. These twin goals must be top-of-mind as policymakers and market participants assess the costs and benefits of any reforms.

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