A Regulatory Upgrade for Electronic Trading
Mark Wetjen | The Wall Street Journal
In the aftermath of the financial crisis, a quiet debate began among market participants and policy makers—has liquidity evaporated in fixed-income markets, or has it simply changed? In either case, why has it and should we be concerned?
The debate has intensified over the past few months. For example, the International Organization of Securities Commissions announced that it would seek to identify needed policy changes to avoid reactions to potential central bank interest-rate increases, such as the “taper-tantrum” in the summer of 2013.
Some observers point to the events on Oct. 15, 2014. On that day there were unusually wide and rapid price swings in the cash market for Treasurys, and in the market for Treasury futures. Yet no single, immediate market event would explain the sudden volatility. Many market participants were left wondering why—and concerned about the future.
Understanding whether and why the financial markets are losing liquidity is a complex and difficult undertaking. Regulations enacted to protect the financial system from another market crisis may be one possible reason for declining liquidity in debt markets.
Concentration among buy-side firms in recent years—significantly reducing the number of price takers—is another. The most recent Financial Stability Oversight Council annual report noted that technology, regulation and competition all contribute to changes in the structure of financial markets.
It may take years to settle the question about the causes of liquidity changes in financial markets. Meanwhile, financial regulators often don’t have immediate access to the information and data they need to identify and respond to disruptions or unwelcome changes to liquidity in the markets they oversee.
The Commodity Futures Trading Commission, where I work, regulates derivatives markets, where Treasury futures and interest-rate swaps are traded. The CFTC hears concerns from participants that there aren’t enough buyers and sellers in some of the derivatives markets. Another concern is that the liquidity is not reliable, e.g., high-frequency traders place orders that they have no intention of executing. But the agency does not have the data to confirm this with any confidence, which complicates its statutory mandate to promote more liquidity in derivatives markets.
Today the CFTC receives post-trade information for executed futures and swap transactions. Trading exchanges and platforms provide order-book data (recording the interest of buyers and sellers in a particular asset class) and traders’ messages to cancel or modify orders when they are asked. Instead, the agency should routinely get order book and message data at some reasonable time after the close of a trading day.
Moreover, understanding liquidity in the derivatives markets requires post- execution data about related markets—including the cash market for Treasury securities—that neither the CFTC, nor any other federal agency, regularly has.
Much of the secondary market for Treasury securities takes place on electronic exchanges and platforms that are not required to routinely report executed trades to any federal agency. The agency can get data on completed trades by requesting it. This too is a clumsy way for policy makers to develop an accurate picture of the liquidity in markets that are, in many cases, fast-moving.
Electronic trading has become increasingly common, and high-frequency and algorithmic trading is now dominant in some markets. Because electronic trading allows money to move around and between markets much more quickly, the nature of trading and price discovery has fundamentally changed. To keep apace with these changes, market oversight and regulation should change too.
Policy makers should think holistically about how best to supervise all financial markets. Individual regulatory agencies must similarly cooperate more closely to share the data they collect.
The CFTC, for one, needs to work with Congress and the trading venues the agency supervises to devise a framework for routinely obtaining relevant order- book data and traders’ messages. Congress also needs to consider how better to provide the CFTC and other relevant supervisory agencies with an appropriate view into the Treasury securities markets, and perhaps other markets related to derivatives.
As markets become interconnected, faster moving and woven together by the same automated traders, agencies including the CFTC need access to data in all relevant markets if they are to properly supervise the specific market they are charged with regulating.
Mr. Wetjen is a commissioner on the U.S. Commodity Futures Trading Commission.
Read the full Wall Street Journal article here.