US Treasury market structure could pose systemic risk — report

The current structure of the US Treasury market could pose a risk to financial stability, an industry advisory group to the Federal Reserve Bank of New York has concluded.

The $14tn US government bond market — the world’s biggest and arguably most important — has evolved in recent years, with trading increasingly conducted using high-speed algorithms on electronic platforms.

New proprietary trading firms (PTFs) have taken on a more significant role at the same time as traditional dealers have increased their reliance on technology, prompting warnings that the old structure of the market may be ill-suited to the new type of trading taking place.

The new report, published by the Treasury Market Practices Group (TMPG) on Thursday and seeking public comments until September 28, said that market participants lack a common understanding on the risks associated with trading Treasuries via complex channels that link asset managers and hedge funds through trading platforms to big dealer banks, PTFs and clearing houses.

The TMPG represents all the main participants in the Treasury market, including banks such as Morgan Stanley and Citigroup, PTFs including Citadel and Global Trading Systems and investment managers led by BlackRock.

Its focus on market structure has sharpened now that the Federal Reserve is embarking on a reduction in the size of its balance sheet and raising interest rates, prompting predictions from analysts and investors that volatility is set to increase.

Among a litany of other causes for concern, the TMPG warns that the practice of holding collateral to guard against potential losses on a trade has not kept pace with other markets and that the increase in the use of technology in Treasury markets opens it up to cyber threats and coding errors that “may have systemic implications” if they go awry.

Wednesday, 9 May, 2018

The paper also noted that large trading platforms could be left on the hook to cover transactions if one of their members, such as a PTF that builds up large exposures through the day, defaults. CME Group recently acquired Nex’s BrokerTec which has roughly 80 per cent market share in Treasury trading on platforms that cater to bank dealers and PTFs.

“Given the Treasury market’s global importance and benchmark status, any disruption has the potential to create systemic risk that may be transmitted to other domestic and international capital markets,” says the report. “While the likelihood of such a disruption in the Treasury market is remote, the TMPG believes a discussion of the clearing and settlement processes and practices now is prudent and could help improve the Treasury market’s resiliency to stress events.”