posted on 18 January 2017
from Liberty Street Economics
-- this post authored by Michael Fleming
Greater transparency is coming to the U.S. Treasury securities market. Members of the Financial Industry Regulatory Authority (FINRA) will be required to report their trades in Treasuries using FINRA’s Trade Reporting and Compliance Engine (TRACE) starting July 10, 2017.
Although initial collection efforts are focused on providing such data to the official sector, the public will likely have access in the future. In this post, I discuss the motivation for such reporting, how it came to be decided on, and the evidence from the corporate bond market on how public access to such data affects trading costs.
Impetus for Trade Reporting
On October 15, 2014, the U.S. Treasury market was unusually volatile, experiencing a rapid “round-trip" in prices without a clear cause, as discussed in this post. The Joint Staff Report investigating that episode highlighted the limited data available for cash market transactions and recommended further assessment of the data available to the public and to the official sector. Support for additional data collection and reporting arose at the Conference on the Evolving Structure of the Treasury Marketheld at the New York Fed in October 2015.
Road to Reporting for the Official Sector
On January 19, 2016, the Treasury issued a Request for Information (RFI) on the evolving structure of the Treasury market. The RFI sought views in four areas including the best way of providing additional information on Treasury market activity to the official sector and whether additional reporting of transaction data to the public would be beneficial.
Following the RFI comment period, and pointing to “broad support for more comprehensive reporting to regulators," the Treasury and the Securities and Exchange Commission (SEC) announced on May 16 that they were “working together to explore efficient and effective means of collecting U.S. Treasury cash market transaction information." As part of that effort, they asked FINRA to consider requiring its broker-dealer members to report such transactions to a centralized depository.
On July 18, FINRA proposed a rule change that would require its members to report transactions in Treasury securities to TRACE. After consulting and considering the views of the Treasury, the SEC approved the proposal on October 18, calling it “an important first step in providing regulators with more comprehensive information concerning activity in the U.S. Treasury market." The next day, FINRA announced that the first day for reporting transactions would be July 10, 2017.
On October 21, the Federal Reserve Board announced that it planned to collect data from banks for secondary market transactions in Treasuries and that it would negotiate with FINRA to possibly collect such data. The data from banks would complement that collected from broker-dealers covered by the FINRA rule and provide a more complete view of secondary market trading. Requiring principal trading firms (PTFs) that act as dealers to register as such, as discussed in a recent speech by SEC Chair Mary Jo White, would subject PTFs to the FINRA reporting requirements, making the data collection even more comprehensive.
Eventual Reporting for the Public?
While near-term efforts are centered on supplying the data to the official sector, availability of such data to the public seems likely in time. Several officials spoke in favor of public reporting at the Second Annual Conference on the Evolving Structure of the U.S. Treasury Market held at the New York Fed in October 2016. Mary Jo White stated, “I continue to think that this is a question of ‘how best’ to deliver public transparency, not ‘whether’ to do so." Along those lines, in remarks prepared for the conference, counselor to the Treasury Secretary Antonio Weiss said, “we believe the debate should shift from whether to seek increased transparency to how, when, and on what basis."
By providing market participants with timely trade prices, public reporting could promote competition and efficiency, leading to lower transaction costs and improved risk management. Conversely, public reporting could have the opposite effect by making it costlier for dealers to unwind positions, especially after large trades, reducing their incentive to take positions in the first place. As discussed by Antonio Weiss, those potential risks associated with greater transparency can be mitigated through time delays in reporting, limits on disclosure of size for large trades, and a phased-in approach.
Evidence on the Impact of Trade Reporting
Members of FINRA have been required to report prices and quantities for their secondary market trades in corporate bonds to TRACE since July 1, 2002. Public dissemination of trade information was initially limited to investment-grade bonds with issues sizes greater than $1 billion, with dissemination of trade information for other bonds phased in later.
A number of studies have assessed the effects of the additional trade information on corporate bond transaction costs. This study describes a controlled experiment under which trade data was publicly disseminated for some bonds, but not others. It finds that increased transparency is associated with narrower bid-ask spreads for all but the largest trades, and attributes the decrease in trading costs to investors’ enhanced ability to negotiate better terms of trade with dealers due to investors’ access to better bond-pricing data.
Another study examines a broader cross section of transactions and bond issuers, and finds that bonds for which there is public reporting have lower transaction costs than non-transparent bonds, and that transaction costs decrease when bonds’ prices become more transparent. Although the absolute cost differences between transparent and non-transparent bonds are greater for smaller trades, which are more costly in general, the relative cost differences are greater for larger trades.
Lastly, still another study examines the effects of transparency using a sample of institutional (insurance company) trades, before and after the TRACE reporting system was initiated. It finds that trade execution costs fell roughly 50 percent for bonds eligible for public reporting and 20 percent for ineligible bonds. The latter finding suggests a possible “liquidity externality," whereby better pricing information for some bonds improves valuation and execution cost monitoring for related bonds.
Implications for the Treasury Market and Other Markets
If post-trade public reporting comes to the Treasury market, might the effects differ from those seen in the corporate market? On the one hand, the Treasury market is more transparent than the corporate market was in 2002 in some respects, with institutional investors having access to real-time transactions data from the interdealer market. This suggests that the benefits of greater transparency may be more modest in the Treasury market. On the other hand, given the Treasury market’s widespread role as a benchmark, even slight improvements in efficiency and liquidity could produce sizeable positive liquidity externalities for related markets. Moreover, the benefits of transparency could be greater with respect to dealer-to-client transactions, for which there is little widespread price information available today.
The views expressed in this post are those of the author and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the author.
About the Authors
Michael Fleming is a vice president in the Federal Reserve Bank of New York’s Research and Statistics Group.
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