Steven Mnuchin, President-elect Donald Trump’s nominee for Secretary Treasury, will face a confirmation hearing in front of the Senate Finance Committee on Thursday, January 19. Ahead of that hearing, Jim Greco, the CEO and a cofounder of US treasury trading platform Direct Match, has written an open letter to Mnuchin.
Dear Mr. Mnuchin:
I would like to congratulate you on your nomination as the next Secretary of the Treasury. Your experience running FICC and as CIO of Goldman Sachs put you in a unique position to grasp the complexity of the challenges facing the Treasury Department and the market and technological forces that are driving them. Following your nomination, you indicated an openness to extending the duration of the federal debt by issuing bonds beyond 30 years of maturity, a new solution to a long standing and complex problem. Your experience and your openness to new ideas will both be extremely useful as you address one of the most pressing challenges: reform of Treasury market structure.
You arrive at Treasury at a very unique time for the Government debt market. The unwind of quantitative easing and the fiscal plans of the incoming administration require a strong and stable secondary market for government securities. Over the past few years however, the market structure has been anything but stable. On the surface, the Treasury market is the largest and most liquid fixed income market in the world. However, beneath the surface regulation and technological change have profoundly recast the market in recent years. Dodd-Frank, the Volcker Rule, Basel III, and MiFID II have successfully de-leveraged and de-risked the banking system, but have resulted in raising the cost of risk capital and thus reduced the amount banks devote to market making. As bank participation has declined, proprietary trading firms have leveraged technology to become the dominant liquidity providers in the inter-dealer market, similar to the evolution of the equities market 15 years ago. The customer facing part of the bond market has remained separate from the inter-dealer market and continues to function largely as it did when you were a trainee at Salomon Brothers in the 1980s.
The challenges of this new market structure were made apparent on October 15, 2014 when the yield on the ten year note rose and fell 37 basis points
in 15 minutes for no apparent reason whatsoever. The “flash crash” undermined the confidence of market participants and challenged the official sector’s assumptions about the resilience of the market. If this kind of market shock was possible during the calm period of Fall 2014, imagine what might be possible during the unwind of QE or during a major fiscal expansion. After the crash, regulators collaborated on an investigation into its causes and solicited feedback from market participants who largely shared the concerns of the official sector about the evolution of the market structure. Subsequently, regulators began by focusing on three areas where the market needs official sector involvement: market data, market practice standards, and central clearing.
The scarcity of market data was the primary impediment to the investigation of the flash crash. Regulators have moved swiftly to correct this by requiring trade reporting to the official sector using the TRACE system used in the corporate bond market. This is a good start, but we would encourage you to go further. Market participants cannot make informed decisions about their execution quality if they cannot access the data they need to measure it. Commissioner Piwowar’s paper on TRACE has shown the great public benefits such information canprovide, including deeper liquidity and a substantial reduction in transaction costs. Market data should be made available to the public in a timely fashion as it is in all other fixed income markets today.
The Treasury market has historically been exempt from many FINRA rules. The SEC is working with FINRA to determine whether those exemptions have outlived their usefulness. We hope you will carry on this work. The US Treasury market is, by far, the most lightly regulated market in the US. Historically, the sophistication of the participants and the preponderance of dealers justified this. Today, while investors remain sophisticated from a financial perspective, their capacity to adapt to technological change varies widely. The role of the dealers has also been diminished, and the ways in which customers source liquidity are rapidly changing. Market forces can solve most of these problems but uniform, enforceable market practice standards woul channel those forces more efficiently.
With respect to central clearing, there is a strong preference for it from most market participants, but there is little agreement as to how to bring it about. This is an issue of particular concern to Direct Match as a last-minute withdrawal of a bi-lateral clearing relationship caused a near-death experience of the firm. The absence of central clearing in the Treasury market serves as a moat between the end investors and the majority of liquidity providers, and hamstrings the efforts of innovators to solve market structure problems. The Treasury Department should work together with market participants and encourage them to work out a solution that balances the need for certainty with the economics of all participants.
In closing, I hope that once you take office that you will make the continuance of Treasury market structure reform one of your top priorities. The departures of Mary Jo White from the SEC and Antonio Weiss from the Treasury leave much unfinished work. The fiscal plans of the Trump Administration and the end of extraordinary monetary policy during your tenure will present great challenges to the Treasury market on top of the existing structural issues. The more robust the secondary market for Treasuries, the easier it will be to navigate the challenges that lie ahead. These issues are not partisan. Capital constraints and electronic trading will proceed regardless of the party in power and its regulatory philosophy. Direct Match is hard at work on these problems, delivering a market-based solution that will welcome all participants to a single venue. Direct Match would like to welcome you back to the fixed income world, and we hope that you share our concerns for the market structure for US Treasury securities. We and other Treasury market participants look forward to working with you to improve it.
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