A montage of the US Treasury building and the logo of the Department of the Treasury
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A new system for trading Treasury bonds could reduce reliance on banks and may help avert future market meltdowns, according to asset managers and experts.

Efforts to improve the structure of the $22tn Treasury market have been accelerated since March 2020, when trading seized up at the onset of the Covid-19 pandemic — forcing the US Federal Reserve to step in to enable transactions to continue. And one of the suggestions under consideration by regulators is “all-to-all” trading — a system that would make the bond market look much more like the stock market.

Currently, banks act as intermediaries in many Treasury bond transactions. But an all-to-all trading system would allow traders to transact directly with one another.

Banks have, in some ways, already stepped back from this traditional role. New regulations put in place after the global financial crisis of 2008 mean it is more expensive for them to hold debt securities, including Treasuries. Also, since then, the size of the Treasury market has more than quadrupled. As a result, bank holdings of Treasuries, relative to the total size of the market, have plummeted, with hedge funds and high-speed traders becoming bigger players.  

This ballooning of the market and changing make-up of its participants has seen liquidity — the ease with which traders can buy and sell a Treasury bond — evaporate at crucial moments. Previously, liquidity had been a hallmark, and attraction, of the US Treasuries market. Now, research from market watchers, including the Fed and the Financial Stability Board, suggests that hedge funds and high-speed traders are not providing the kind of liquidity in times of stress that banks once did — exacerbating crises, such as the 2020 market meltdown.

Line chart of Bloomberg US government debt liquidity index  showing Treasury liquidity dried up as volatility rose

Some hedge funds and high-speed traders have become bigger participants in certain segments of the bond market. Access has been limited, however, and some other participants, such as large asset managers and institutional investors, have been excluded.

Moving to an all-to-all market would therefore expand the number of investors who could provide liquidity in the market — filling in for the banks that are hamstrung by regulation, and for the hedge funds and high-speed traders that have little incentive to trade in times of stress.

Suggestions for how the market could work have come from all corners, with the Inter-Agency Working Group — which includes representatives from the Fed, Treasury, Securities and Exchange Commission, and Commodity Futures Trading Commission — helping to lead the charge.

In its annual report on Treasury market stability in November, the IAWG said that, among other measures, it was studying the benefits and costs of all-to-all trading in Treasuries. A New York Fed paper published a few weeks before that outlined the idea in more detail.

“In theory, all-to-all trading may improve market liquidity by increasing the number and diversity of potential counterparties to a trade or reshaping the competition among them,” the IAWG report said, recommending further study of the issue.

Large asset managers — which would benefit significantly from a move to all-to-all trading — have been among the biggest advocates for the switch. In a widely read note published in November, Pimco argued that policymakers should hasten the transition to all-to-all trading, “pushing the bond market into the modern age, with deeper liquidity and greater resilience to financial shocks”.

Rick Chan, one of the authors of Pimco’s paper, says the firm continues to hold this view — even though the current method of trading Treasuries proved relatively resilient during the recent banking crisis.

“Nothing has changed since last fall,” says Chan. “The Treasury market stood up pretty well but it’s because there was a lot of cash in the system.”

However, Darrell Duffie, a professor at Stanford University who was an adviser to the G30 working group on Treasury market stability, says all-to-all trading does not necessarily have to be bad for banks. The transition to the new system would mean that banks intermediate fewer trades and lose market share. But that’s only bad for them if the market stays the same size.

“It is not yet clear whether [all-to-all] is a cost or benefit to [dealers],” he says. “If the market doesn’t increase in size, the dealers lose. But there’s every reason to think the market would grow exponentially, because that is what happens when you get all-to-all traders. When all-to-all trade was introduced in the equity market in the 1970s, the market expanded dramatically.”

Banks’ willingness to step up and enable more deals in the market may depend on an easing of the crisis-era regulation that initially prompted them to step back. Many have argued that exempting Treasuries from the leverage ratio requirements imposed on banks after the financial crisis would improve market liquidity and allow banks to bolster their market-making. The Fed’s vice-chair for supervision, Michael Barr, is conducting a wide-ranging review of the banking system’s capital rules this year. But, even before the banking sector turmoil of 2023, experts were not expecting any rule changes that would favour banks.

Banks are expected to fight any all-to-all trading proposal vociferously. Without any change to the system, though, the troubled Treasury market dynamics are likely to persist.

Duffie believes the priority must be to ensure that “as the Treasury market gets bigger and bigger, we are not relying on dealer balance sheets that are not getting bigger”. He sees all-to-all trading as a solution — and one that “would significantly benefit Treasury liquidity”.

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