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Thank you, Jay. I would like to thank Bill Dudley and the team at the Federal Reserve Bank of New York for hosting this conference, the other agencies for their participation, and the panelists and speakers who are participating today and tomorrow.
I should acknowledge at the outset that 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 discuss 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, so I want to begin today by stepping back and providing 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 (the Report), and briefly lay out the path ahead. In doing so, I hope to place this conference in appropriate context.
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We should begin by recognizing the fundamental role Treasury markets play in the global financial system. The Treasury market remains the deepest, most liquid securities market in the World. There is nearly 13 trillion in marketable Treasury securities outstanding, and approximately $500 billion in Treasury transactions—by primary dealers alone—that are carried out without a hitch every day. For investors all over 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. It also facilitates the effective transmission of monetary policy. In short, the Treasury market is the benchmark for a well-functioning and trusted financial market.
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 collective commitment to maintaining Treasuries as the gold standard, not just now but for decades to come.
I am compelled to pause here to dwell briefly on matters of the moment. If Treasuries are to remain the gold standard, 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 Treasuries play in the global economy, and the benefits they have for the U.S. economy, rest on the bedrock foundation of the full faith and credit of the United States. As we approach the deadline for Congress to raise the debt limit, we become acutely aware that this foundation cannot be taken for granted. It is imperative that Congress act soon, and avoid gambling with our full faith and credit.
This audience surely appreciates another important aspect of the period we’re in. Short-term treasuries—T-bills—are, in essence, lubrication that keeps the wheels turning in markets that fund a vast array of businesses and financial transactions in our economy. Demand for treasury bills has increased in recent years, and as we saw in 2013, this demand can become particularly acute during a period when we're using extraordinary measures and have to reduce our bill issuance. The strain this creates is a real, and unnecessary, cost. The sooner Congress acts to raise the debt limit the sooner we can return to our normal bill issuance.
If our first maxim in addressing the Treasury market is “do no harm,” the second is surely to “ensure that the Treasury market of tomorrow is as deep and liquid as the Treasury market today.” In order to accomplish this, we must not only understand today’s market structure, but also anticipate how the market might develop over five or ten years from now. We need to anticipate the “new market structure,” and ensure that the rules of the road address the path ahead, not the world in the rearview mirror.
Our current work represents the first fundamental review of the Treasury market since 1998, and even that review did not focus on secondary markets. Much has changed since then. Indeed, a significant proportion of trading in on-the-run Treasury securities or 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, or firms that were not active in Treasury markets at that time.
Here it is worth noting that many of the changes underway in the Treasury market, particularly the market for cash Treasury securities, strongly resemble the evolution of other markets over time. 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, including more than half of activity on inter-dealer trading platforms for cash Treasuries.
There are many lessons to be drawn from the developments in other markets, and in this respect we will benefit greatly from close collaboration with our regulatory partners at the SEC and CFTC.
One of the key lessons 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 this August 24 in equity markets, we have seen how episodes of volatility can be magnified or accelerated 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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Next, I will put this conference in the context of the analysis that has been underway since the Report was released, and the path ahead.
The Joint Staff Report identified four areas for further work: first, to continue to study the evolution of U.S. Treasury market and the implications for market structure and liquidity; second, to continue monitoring trading and risk management practices of market participants; third, to assess the sufficiency of data available to the official sector as well as to the public; and fourth, to continue to strengthen monitoring and surveillance while promoting interagency coordination.
With these objectives in mind, staff at each institution has been working to broaden the scope of our analysis and to think critically about ensuring the stability of Treasury markets going forward. For example, staffs from the Federal Reserve Bank of New York, CFTC, and SEC have continued to analyze the events of last October 15th. The first panel today will discuss preliminary findings from that analysis. It shows that even during the event window a meaningful portion of trading still occurs between dealers and customers, and this activity is tightly linked to activity in the interdealer markets. 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 engage with private and public sector forums to share the findings of the Report, to solicit feedback, and to promote further engagement on understanding the evolution of Treasury markets.
Meanwhile, the Inter Agency Working Group plans to develop a standing information sharing agreement to expedite the kind of review we did following October 15th. Staff has also been evaluating the regulatory framework governing trading of Treasury securities and the transparency of those 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 important for regulators to understand how these changes in market structure may impact the provision of liquidity and market functioning, particularly in a stressed market environment. Accordingly, the FSOC is analyzing potential risks along three dimensions, which dovetail with the themes identified in the October 15th Report:
- First, risks related to operational resiliency and preparedness arising from the increase in electronification across several markets.
- Second, the need to coordinate, to the extent possible, prudential and supervisory standards across different venues for products that share similar risk characteristics.
- Third, ways to improve data collection and sharing in certain markets.
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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 the areas in need of improvement and in crafting potential reforms. This conference recognizes the important role that market participants, policy makers, and academics will all need to play in enhancing the functioning of the Treasury market— at every step, it will be important for us to seek input from all stakeholders as we consider changes in oversight.
To that end, in the coming weeks all five institutions will issue a request for information seeking public comment on several of the areas identified for further analysis in the Joint Staff Report. The RFI will build on the Joint Staff Report and this conference, and will ask specific questions about, among other things, the sufficiency of data available to public authorities 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 between all of the key stakeholders in Treasury markets. The views expressed and ideas exchanged over the coming two days will help to lay the foundation for the work that lies ahead. It is our hope that the 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 simple or easy task, and everyone here has a stake in the success of our collective efforts. We must proceed with eyes wide open, 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.
