US Treasury market in need of reform after shocks, policymakers warn

US policymakers and other financial experts have escalated calls for reforms to the $22tn market for US Treasury securities to protect it from future shocks after recent episodes of chaotic trading.

The world’s most important government bond market was thrown into disarray in March last year when investors spooked by the start of the coronavirus pandemic tried to sell off chunks of their Treasury holdings.

Speakers at an annual Treasury market conference on Wednesday said recent policy improvements did not go far enough to guard against future trouble.

John Williams, president of the Federal Reserve Bank of New York, joined with senior Biden administration officials in saying changes were needed to the way that Treasuries were traded and regulated.

“Severe disruptions to critical financial markets like we saw last spring should be rare. But just as a town ravaged by flooding will seek to rebuild in ways that help it withstand the next big storm, so, too, must we think about how to shore up the Treasury market so it can better endure the next big shock,” Williams told the conference hosted by the New York Fed.

The US Federal Reserve has already taken steps to bolster how the Treasury market is backstopped in times of stress, making permanent in July two programmes that allow eligible market participants to swap securities for cash at a set rate.

But conference participants stressed that much more needs to be done.

Gary Gensler, chair of the US Securities and Exchange Commission, suggested that proprietary trading firms register with his agency, which could shed more light on their activities.

These groups include high-frequency trading firms that have become big players in the Treasury market, but are not necessarily subject to the same levels of oversight as the group of 24 banks known as primary dealers.

Banks were long the main providers of Treasury market liquidity, but they have stepped back after regulations passed after the 2008 financial crisis constrained the amount of debt they can hold on their balance sheets. This created an opportunity for trading firms to step in.

Gensler also spoke forcefully about the need for central clearing. Clearing houses are utilities that stand between buyers and sellers to guarantee the terms of transactions. Central clearing limits default risk and can therefore enable smoother functioning in markets.

Nellie Liang, an economist serving as under-secretary for domestic finance at the US Treasury department, acknowledged that central clearing was “promising”, but she also told the conference of its possible drawbacks.

“Consideration has to be paid to potential higher costs of participation in the market and potential risks of expanded central clearing from concentration of risk at a central counterparty,” she said.

Sandie O’Connor, a former chief regulatory affairs officer at JPMorgan Chase who serves on the expert Task Force on Financial Stability, recommended changes to rules guiding how much capital the biggest financial institutions need to hold.

Large banks must have capital equal to at least 3 per cent of their assets, or 5 per cent for the largest institutions. Lenders were allowed to temporarily exclude holdings of Treasuries and cash kept in reserve at the Fed from their assets when they calculated the ratio after March 2020, but the requirement was reinstituted this year.

“Broker dealers aren’t able to flex their balance sheets to deal with dislocations when they have occurred. And that’s exactly when we want our primary dealers to be flexing their balance sheets,” O’Connor said.