On-The-Run Treasury Notes: The Benefits of a Tiered Market Structure

In trading terms, US Treasuries has been a sizable market for at least the last decade. While issuance hit a trough of $312 billion in 2000, the annual average daily notional of Treasury trading among dealers alone has exceeded that of the entire US equities market since 1997. But competition in the Treasury space has been sparse. The number of primary dealers has been on the decline since the mid-1980s; only recently have new entrants emerged. There has also been a lack of new competition among the execution venues. BrokerTec and eSpeed own the interdealer broker business, while Bloomberg and Tradeweb dominate the institutional dealer-to-client trading. However, the combination of record issuance, expected rate hikes, and a weakened competitive landscape make US Treasuries a ripe opportunity for mid-tier dealers, independent trading firms and hedge funds, alternative trading venues and the supporting technologies.

It is ironic that the Treasury market’s tiered system sounds exactly like the kind of system that the SEC objects to in the equity markets. The existence of high-frequency traders, block-crossing networks, dark pools, proprietary data feeds and co-location creates the fear that some traders have an unfair advantage over others. There are no Cassandras in the Treasury market because regulators have a deeper understanding of liquidity formation, the market has appropriately segmented itself into separate venues, and the mechanisms exist to balance the needs of all participants. The FRBNY and Treasury understand that not all traders play the same role in the market, and that it is perfectly okay for dealers, institutions and retail to have different rules and access mechanisms. The fact that some market-making function in the secondary markets has shifted to less regulated firms is not seen as a danger to other investors as long as the dealers interacting with clients still have fiduciary obligations.

Ultimately, what is going to fuel change to US Treasury market structure is the massive expansion of the Fed’s balance sheet. While this has happened before without changing the underlying market structure, current levels of competitive and economic pressures are unprecedented. Many members of the dealer market are in a weakened position, having lost or shed critical fixed-income personnel. Lower volumes have put economic pressures on interdealer brokers and exchanges. High-frequency trading strategies are running out of capacity as volatility returns to historic norms. The odds are against the status quo.

The type of change that will occur is not a wholesale restructuring of the way government debt is distributed; there is no smoking gun, dramatic inefficiency or regulatory reform to act as a catalyst. (But if the Volcker rule gains momentum again, the entire fixed-income market could be in for a shock.) Rather, opportunities to capture a piece of this growth in an otherwise anemic capital markets period, coupled with advancements in trading technology, will change details within the distribution’s workflow.

The TABB Group Vision Note On-The-Run Treasury Notes: The Benefits of a Tiered Market Structure gives a detailed description of US Treasury market structure for on-the-run notes, from the distribution of primary issuance to the dealer-to-client platforms. The report drills down into the interdealer platforms: We detail who is accessing those markets, how they access the market, and how changes in matching logic are making platforms look less like auctions and more like order-driven price/time markets. The report also examines how automation in banks’ liquidity provisioning functions is impacting the liquidity discovery process on the dealer-to-client platforms.