TRACE and Reg ATS: the changing face of US Treasuries regulation

Author: Nichola Hunter
06 April 2017

Regulatory changes are afoot in the US Treasuries market. While reporting transaction data to regulators has been the norm in the equities market for decades, in October last year the SEC approved FINRA’s new reporting rule requiring UST trades to be reported by the end of the day on which they were executed.

Starting in July this year, all broker-dealers registered with the SEC that are FINRA members must report transactions through the Trade Reporting and Compliance Engine (TRACE) system. This is a major development for the UST market and one that will cause no small number of headaches amongst participants. The cost and resourcing implications of such a major change to regulatory reporting cannot be underestimated.

Nevertheless, the UST market plays a unique role within global wholesale financial markets, and there is a collective responsibility amongst regulators, participants and infrastructure providers to ensure it functions in an efficient and orderly manner. Treasury securities are considered a risk-free benchmark that perform several important functions, including helping institutions manage risk, facilitating US monetary policy and financing the federal government.

The introduction of TRACE reporting is a direct response to the volatility the UST market experienced on 15 October 2014, labelled a “flash crash” by both market participants and the media. Reporting trades via TRACE will undoubtedly enhance the ability of FINRA and other regulators to gain a deeper understanding of trading activity in Treasury securities, with a view to preventing similar events in the future. However, there is fear amongst certain participants that this move is the thin end of the wedge, and proposed further extensions of the requirements could put the health of the market at risk.

A Treasury Department request for information (RFI) issued last year sought public comment on structural changes in the UST market, including a request for specific feedback on whether “dissemination of transaction data to the public would be beneficial.” This as-yet unactioned proposal would move beyond regulatory oversight and into a new realm of transparency, the effects of which on the market could be significant.

Broadly speaking there are two camps that argue for and against more transparency. While it would be difficult to find anyone willing to argue that increased transparency shouldn’t be encouraged for the purposes of improved regulatory oversight, less certain is the path to real time public dissemination.

Typically, professional trading firms will argue that transparency is required to enhance liquidity, improve best execution processes while reducing overall transaction costs. However, many of the dealers will argue the exact opposite, citing experiences in other markets that attest to a reduction in overall liquidity, widening of the bid/ask spread and the negative impact of transparency on their hedging strategies.

That said, with these divergent views regulators must think seriously about any potential unintended consequences of extending TRACE proposals. The market has made significant steps forward in recent years in fostering a healthier trading ecosystem, in which liquidity providers and consumers can work through large orders efficiently without fear of falling victim to disruptive trading strategies. Regulations should serve to enhance this positive evolution, not endanger it.

Trade reporting is not the only regulatory burden on the horizon for UST market participants. While the SEC has traditionally exempted platforms that solely trade government securities from its regulatory regime for alternative trading systems, known as Reg ATS, changes in market structure have recently prompted it to change its stance.

Reg ATS was introduced in 1998 to enhance regulatory oversight of off-exchange equities trading and improve the transparency of operations and protections for investors, with the aim of promoting a fair and competitive market. It requires platform operators to register as a broker-dealer and disclose significant details about operations, as well as committing to providing market participants with fair access to the its services and liquidity pool.

UST platforms were excluded from the rules at the time due to the unique regulatory framework for government securities in the US, which involves the SEC, Department of the Treasury and federal banking regulators. However, the SEC now believes that market conditions and the broader regulatory environment have evolved to a point where it is appropriate to extend Reg ATS to the UST market. It remains to be seen if the acting or any new SEC chair will pick up the baton and move forward with this change.

The decision to exempt UST platforms from Reg ATS back in 1998 is now viewed by many as an anomaly – one of a number of by-products of a highly fragmented regulatory landscape. In today’s market there are few who would disagree that standardised controls, access requirements and reporting requirements across all trading venues, regardless of asset class, would improve efficiency, transparency and ease of compliance.

At LiquidityEdge we are well positioned to adapt to a potential extension of Reg ATS to UST venues. Our platform is built on tried and tested technology, widely used in the FX market to ensure robust performance and efficient market access. Thus, the technology need to meet many of the requirements of Reg ATS is already built into the fabric of the platform.

LiquidityEdge was designed to meet the evolving needs of US Treasury market participants and facilitate a more orderly and efficient trading environment. Transparency and fair market access play crucial roles in achieving this end goal, and if regulators consult closely with both platform operators and all types of market participants before putting pen to paper, they will help build an appropriate legislative framework for today’s complex US Treasury Market.

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