This article was published on the TABB Forum on August 15, 2016.

On August 15, the public comment period closed for the Financial Industry Regulatory Authority (FINRA) proposed rule (Proposal) to expand the Trade Reporting and Compliance Engine (TRACE) reporting rules to include most secondary market transactions in marketable US Treasury securities.

The Proposal comes after a May 16, 2016, joint announcement by the US Department of the Treasury (Treasury) and the Securities and Exchange Commission (SEC) that they are requesting FINRA consider a proposal to require its member brokers and dealers to report Treasury cash market transactions to a centralized repository.

The statement was the first public indication that the federal agencies and the self-regulatory organization would take steps in furtherance of the January 22, 2016, Treasury Request for Information on the evolution of the US Treasury Market Structure (RFI). In the RFI, the Treasury cites the July 13, 2015, Joint Staff Report (prepared by Treasury, the Federal Reserve, the Federal Reserve Bank of New York, the SEC, and the US Commodity Futures Trading Commission (CFTC), collectively the “Joint Member Agencies”) on the extraordinary volatility in the Treasury market on the morning of October 15, 2014, as evidence for the “need for more comprehensive official sector access to data, particularly with respect to U.S. Treasury cash market activity.”

Most recently, on August 2, 2016, the Joint Member Agencies issued a statement to highlight “significant actions taken” since the Joint Staff Report’s publication. In this statement, the Joint Member Agencies identify a number of future actions to be taken, including an October 24, 2016, conference on Treasury market issues.

Now that the FINRA Proposal has been published along with the public comments, market participants can begin to see the general long-term framework for comprehensive US Treasury market reform.

Looking forward, we address three of the most pressing questions that remain unanswered:

1. How does the FINRA rule proposal affect market participants who are not FINRA members?

The FINRA Proposal applies solely to its member brokers and dealers. The FINRA Proposal explains that, “Treasuries are traded by broker-dealers as well as commercial bank dealers and principal trading firms (PTFs) that are not registered as broker-dealers with the SEC or members of FINRA.” As SEC Chair Mary Jo White noted: “[R]egulatory reporting by FINRA members could provide important new information about day‑to‑day activity in both inter‑dealer and dealer‑to‑client markets.”

One implication of imposing the TRACE reporting obligation on US Treasury market activity is that some trades will face “two-sided” reporting (i.e., both buyer and seller are FINRA members) and “one-sided” reporting (i.e., only the buyer or the seller is a FINRA member).

Furthermore, because non-FINRA members are not subject to the reporting obligations set forth in the proposal, the information submitted to TRACE will not provide a comprehensive picture of the Treasury market, because non-FINRA members are not subject to the reporting obligations set forth in the proposal. To that end, in the May 16, 2016, statement, Treasury announced that it will “continue working with other agencies and authorities to develop a plan for collecting similar data from institutions who actively trade U.S. Treasury securities but are not FINRA members.”

One interesting dynamic is the evolving nature of FINRA membership. Recently, the SEC proposed rule amendments that would expand the scope of FINRA members “to require that broker-dealers trading in off-exchange venues become members” of FINRA. This is done by refining the current FINRA membership exemption to only capture a subset of off-exchange transactions. These amendments are designed to trigger FINRA membership for “proprietary trading firms, such as high frequency traders.”

As a result, if adopted, proposed changes to SEC Rule 15b9-1 would cause non-FINRA member PTFs to join the self-regulatory organization. In addition to the regulatory burdens associated with FINRA membership, PTFs would face the US Treasury TRACE reporting obligation once adopted by the SEC and implemented by FINRA.

2. Will mandatory TRACE regulatory reporting lead to public dissemination of trade data?

It is too soon to tell whether this initiative will be expanded to include publication of trade information the way TRACE is used in fixed income markets.

FINRA is explicit in the Proposal that, “At this time, FINRA is not proposing to disseminate information on transactions in U.S. Treasury Securities.” FINRA references the responses to the Treasury RFI that resulted in “substantial disagreement as to the potential benefits of public dissemination of information on transactions in U.S. Treasury Securities.”

As a result, the Proposal contemplates end-of-the-day TRACE reporting for US Treasury securities. It does not, as is the case for other TRACE-eligible securities, require reporting within 15 minutes. This clear distinction demonstrates no plan to employ real-time reporting and dissemination in the near future.

It is important for market participants to recognize that the Proposal says “at this time.” And, as discussed in the Treasury RFI notes, in the eyes of the Treasury Department, “[T]he extent of publicly available information for U.S. Treasury markets . . . is substantially more limited than for many other major asset classes.”

The Treasury RFI indicates that:

Making appropriate data available to the public more broadly regarding trading activity in the U.S. Treasury market could support investor confidence and the liquidity of these markets. Greater price transparency could improve efficiency, reduce transaction costs, enhance fairness, improve risk management practices and encourage participation by new entrants, who may otherwise be reluctant to engage in a market where they have less information than their counterparties. Greater operational transparency also may be desirable with respect to the practices governing trading and access at the various trading venues. Visibility into order types, access rules, and rulebooks may encourage greater competition and a more level playing field for market participants.

In the RFI, Treasury commits “to continuing to appropriately enhance the information made public about the U.S. Treasury market.” Any future public dissemination regime would be subject to public comment and, if the responses to the RFI are any indication, heavily debated. But, in the future, any decision about publication of trade data will be informed by the regulatory transparency established by the FINRA regulatory reporting Proposal. And market participants can look back to how public dissemination was implemented in the corporate bond market, through an extended, phased-in process that gave time to measure and analyze public dissemination’s impact on market liquidity.

3. What else have we learned?

To be sure, we are still in the formative stages of any comprehensive Treasury market structure reform. There have been significant changes in the liquidity profile, market participants, market structure, and market dynamics over the past two decades. The Treasury RFI was an appropriate first step to take inventory of the current framework before advancing measures that may change the “deepest and most liquid market in the world.”

In the past seven months, we have learned a few important lessons:

First, there is a lack of centralized market information for regulatory oversight. As the Joint Staff Report revealed, regulators cannot access a centralized repository of US Treasury market activity, nor can they turn to one source for that information and the corresponding information in futures or repo markets. From a systemic risk perspective in a post-financial crisis environment, it is not surprising that the SEC and Treasury urged FINRA to issue the Proposal and that regulatory transparency is the first Treasury market initiative.

Second, reform takes time. As evidenced by the implementation of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), reform of the Treasury market – regulatory reporting, public dissemination, central clearing, PTF oversight, trading venue regulation, among others – will require careful planning, thoughtful organization, and close coordination with market participants and regulatory bodies. Just as some rules remain unfinished or subject to revision six years after passage of landmark legislation (which took several years of Congressional debate), the Treasury market structure debate will not be complete any time soon.

The Treasury RFI and the Joint Staff Report highlight the significant changes to the Treasury markets since the last detailed regulatory review. Since implementation of the Government Securities Act Amendments of 1993, the industry has worked together to increase transparency through the GovPX initiative; market participants are now subject to additional federal regulatory oversight; and both regulation (including bank capital standards) and technology have revamped the way markets operate. These developments need to be analyzed and appreciated before policymakers can proceed with any meaningful reform.

Finally, after reviewing the public comments in response to the Treasury RFI, we find that many of the same arguments offered during the Dodd-Frank Act debate regarding regulation of over-the-counter (OTC) swaps markets seem to be renewed for discussions related to the Treasury market. There are similarities, of course, regarding the institutional nature of the market and varying liquidity profiles, depending on the product. Proponents and opponents seem to be lining up on various sides of the same list of issues, such as pre-trade price transparency, electronification, and central clearing. The debate between exchange-traded and OTC markets appears to be alive and well.

Conclusion

We are rapidly approaching the two-year anniversary of the October 14, 2014, Treasury market volatility. Since then, the Joint Member Agencies have been working in a coordinated fashion to improve the regulatory oversight of the US Treasury market, though their work is far from finished.

The coming months and years will determine the path that this initiative takes, one that will be informed by market events and external events, such as the US presidential election. But as we take stock at the end of the summer of 2016, as evidenced by the FINRA proposal, this is one area that cannot be ignored or taken lightly.