One Monday morning in October 2014, the United States Treasury securities and futures markets started behaving very, very strangely. In a six-minute stretch, the interest payment on 10-year Treasury notes plummeted 16 basis points—hundredths of a percent—and then, just as quickly, rebounded to the original yield level. Even more strangely, there was no obvious trigger for this chaotic market movement.
This event, quickly branded the “flash rally,” thoroughly spooked the financial world. The New York Times called it “unnerving” and “bizarre,” comparing the swing to the drop in bond yields that occurred when Lehman Brothers collapsed in 2008. Bankers quickly began pointing fingers: some blamed regulators for limiting the inventories of bonds that banks could hold, which causes more volatility in the market; others accused trading algorithms.
In order to help prevent such dramatic, unexpected Treasury market movement in the future, the Financial Industry Regulatory Authority (FINRA)—a government-sponsored private regulatory authority, responsible for regulating brokerages and stock exchanges and maintaining market fairness—recently adopted a proposed rule that will mandate new reporting requirements for transactions in Treasury securities. The new reporting requirements mandate that each party to a transaction involving most kinds of Treasury securities must report the transaction. Market participants could then access and view some, but not all, reported information.
The rationale behind the new rule is simple: the stability of the Treasury market is essential to the global economy. Antonio Weiss, the former Lazard investment banker turned Counselor to the U.S. Secretary of the Treasury, called the Treasury market the “deepest, most liquid securities market in the world” and heralded it as “unique and critical…in the global economy.” The Treasury market provides a risk-free benchmark for the rest of the global economy, allows the Federal Reserve to implement monetary policy, and serves as a primary financing source for the United States government.
To proponents of the new reporting requirement, increased transparency will allow traders to better understand market structure and will encourage new entrants into the market, increasing liquidity—the measure of how easy it is to buy or sell an asset. Maintaining high market liquidity serves to ensure that sellers receive full value for their assets. Nasdaq, in a comment in favor of the new rule, argued that market transparency allowed investors to react quickly and with accurate information. Another commenter lamented that the Treasury market lags well behind other securities markets in transparency, calling it “the largest dark pool in the U.S.”
In opposition to the rule, Credit Suisse argued that more comprehensive reporting requirements would actually make the market less liquid. Effectively, instantaneous reporting will sometimes have the side effect of letting the market know that there is only one buyer or one seller for a given security, allowing other market participants to offer a price that is too low to that buyer or seller.
Fretting about bond market liquidity has in recent years become a common occurrence among market participants. Liquidity worries have become so common that Bloomberg columnist Matt Levine has started to include a daily subsection titled “People are worried about bond market liquidity” in his newsletter.
Despite the controversy, the U.S. Department of the Treasury stated that there was “little compelling evidence” of a decline in liquidity, a position backed up by the Federal Reserve. Even so, a managing director at New Oak Capital, a financial consulting firm, noted that what regulators were saying about liquidity directly conflicted with what market participants believed.
The flash rally, and the market uncertainty it represented, prompted the primary regulators of the Treasury market—the Board of Governors of the Federal Reserve System, the Federal Reserve Bank of New York, the Securities and Exchange Commission (SEC), the Department of the Treasury, and the Commodities Futures Trading Commission— to release a joint report on this bizarre Treasury market behavior. The report concluded with four “next steps,” including an assessment of the data regarding the Treasury market available to regulators and the public. The Treasury Department then published a Request for Information seeking comment on the current structure of the U.S. Treasury market. After the receipt of public comments, FINRA adopted the new reporting requirements.
The new rule will go into effect July 10, 2017.
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Elizabeth Warren is the senior United States Senator from Massachusetts. Senator Warren has served in the Senate since 2012, and she is the ranking member on the Economic Policy Subcommittee of the Committee on Banking, Housing, and Urban Affairs. She was the driving force behind the Consumer Financial Protection Bureau, and in 2008, she headed the Congressional Oversight Panel for the Troubled Asset Relief Program.
Jason Furman is the 28th Chairman of the Council of Economic Advisers, a role in which he serves as President Obama’s Chief Economist and as a Member of the President’s Cabinet. A member of President Obama’s Administration since the start of his presidency, Chairman Furman previously served as Principal Deputy Director of the National Economic Council and as Assistant to the President.
Jed S. Rakoff
Jed S. Rakoff is a United States District Court Judge for the Southern District of New York. He ascended to the bench in 1996 after being nominated by President Bill Clinton, and he assumed senior status on December 31, 2010. He is a leading authority in securities law and white-collar crime as well as a prolific writer, having authored four books, 100 published articles, over 220 speeches, and over 425 judicial opinions.
Susan Dudley is the Director of the GW Regulatory Studies Center and distinguished professor of practice at GW’s Trachtenberg School of Public Policy and Public Administration. She serves as president of the Society for Benefit-Cost Analysis, and as a senior fellow of the Administrative Conference of the United States. She served from 2007 to 2009 as the Administrator of the Office of Information and Regulatory Affairs within the Office of Management and Budget.
Richard L. Hasen
Richard L. Hasen is the Chancellor’s Professor of Law and Political Science at the University of California, Irvine. A leading expert in campaign finance regulation and election law, he is the author of the book, Plutocrats United: Campaign Money, the Supreme Court, and the Distortion of American Elections, as well as the writer of the widely regarded Election Law Blog.
Wendell Pritchett is the Presidential Professor of Law and Education at the University of Pennsylvania Law School, and he is a recognized leader in the field of higher education. He was Deputy Chief of Staff and Director of Policy under Philadelphia Mayor Michael Nutter, who later appointed him to the School Reform Commission, where he served from 2011 to 2014. He also served as Chancellor of Rutgers-Camden from 2009 to 2014.
Mike Lee is the junior United States Senator from Utah. He is the Chairman of the Senate Steering Committee; the Judiciary Subcommittee on Antitrust, Competition Policy and Consumer Rights; and the Water and Power Subcommittee of the Energy and Natural Resources Committee. He was previously General Counsel to Utah Governor Jon Hunstman, and law clerk to Supreme Court Justice Samuel Alito.
Patricia L. Bellia
Patricia L. Bellia is Notre Dame Law School’s William J. and Dorothy K. O’Neill Professor of Law. A teacher and researcher in multiple areas including constitutional law, administrative law, and cyberlaw, Professor Bellia is co-author of a leading cyberlaw casebook and has published articles on internet law and separation of powers. She previously served as an attorney-adviser in the Justice Department’s Office of Legal Counsel.
Donald C. Langevoort
Donald C. Langevoort is the Thomas Aquinas Professor of Law at Georgetown University. He was previously Vanderbilt University School of Law’s Lee S. and Charles A. Speir Professor, and the U.S. Securities & Exchange Commission’s Special Counsel in the Office of the General Counsel. An authority in the area of securities regulation, he is the co-author of a securities regulation casebook and author of a treatise on insider trading.
Rena Steinzor is a professor at the University of Maryland Carey Law School. She is a founder, former president, and member scholar of the Center for Progressive Reform. She teaches and has authored and co-authored books on administrative law, consumer safety, public health, and environmental law. She has testified before Congress multiple times, addressing such issues as the impact of health, safety, and environmental regulations on the economy.
Richard L. Revesz
Richard L. Revesz is New York University School of Law’s Director of the Institute for Policy Integrity and the Lawrence King Professor of Law. From 2002 to 2013, Professor Revesz was the Dean of NYU School of Law. He is a nationally recognized expert in the fields of environmental and regulatory law and policy, with a focus on issues including the use of cost-benefit analysis in administrative regulation.
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