The Treasury Market Practices Group at 10
Yesterday, October 5, 2017, the Treasury Market Practices Group (the “TMPG”) invited market participants to the Federal Reserve Bank of New York for a retrospective on its first 10 years and a glimpse into the next decade of work for the TMPG.
The TMPG was formed at the behest of the NY Fed to address a variety of “questionable trading practices” in the Treasury market. The TMPG does not have any regulatory authority, but most market participants, and especially the primary dealers and large asset managers, have codified the TMPG Best Practices into their policies and procedures.
The TMPG’s most famous work is the introduction of a “Treasury fail charge,” which provides an economic incentive for market participants to timely deliver bonds. Today, the group is working on two important initiatives.
First, the TMPG is mapping out of the entire U.S. Treasury clearing and settlement landscape. The bi-furcated clearing ecosystem in U.S. Treasuries is a huge problem for participants and venues (it has even been known to kill off promising startups!). From what I understand, the goal of the project is to lay the groundwork for an eventual central clearing mandate across the entire interdealer market.
The second ongoing initiative for the TMPG is “Best Practice Recommendations on Information Handling.” Basically, it is intended to address how counterparties treat the confidential information that they receive from trading with each other. Confidential information is a tricky subject in the fixed income markets because trades are done on a principal basis. Firms trade for their own account, so any information gained in trading is ultimately beneficial toward that firm’s bottom line.
There was not much to report on from the conference itself, but the six proposed Best Practices are interesting to explore because they would result in significant deviations from current market practices.
1. Market participants should communicate in a manner that is clear and truthful. Market participants also should not omit any material fact or qualification if the omission would cause the communications to be misleading.
Being clear and truthful sounds like a simple rule, but it is actually pretty tricky in practice. Using information strategically, withholding, exaggerating, and slightly misleading are all skills a good salesperson in any industry would employ. These skills are especially valuable to fixed income trader. Take the first example that the TMPG provides:
A money manager is selling a security through a bid wanted and a dealer has the most competitive price, and this bid has met the money manager’s reserve level. The money manager should not imply that the dealer may need to raise its price for its price to be transacted. This communication is misleading since the dealer has already provided the most competitive price.
Think about this outside of finance. If you are buying a car, you might continue to haggle with the salesperson even if the price is acceptable (Give me some floor mats at least!). Asking for a dealer to raise his bid is money that goes directly into the buy side firm’s bottom line, which in turn impacts the performance of a fund that mom and pop own.
The counter argument is that buying a car is not like buying Government debt. You buy a car every few years and there is no expectation of trust between the car dealer and the consumer. But in a financial transaction, you are buying securities day-in and day-out with the same counterparties. Trust is what makes the market as efficient as it is. Without trust, the market would be far less efficient and transaction costs would increase for everyone.
2. Market participants should not share or use confidential information with the intent of adversely affecting the interests of other market participants or the integrity of the markets.
Here’s an illustrative example that the TMPG provides:
A dealer participates in a request-for-quote where there is no execution, or where the dealer did not transact. The dealer is likely still in possession of confidential information and should treat it as such.
This is a tough one. 80% of dealer-to-customer transactions are conducted through the request-for-quote (“RFQ”) process. In an RFQ, customers ask up to N dealers, over the phone or electronically, to provide a bid/offer for securities. Whether the dealer wins the trade or not, it is in possession of valuable information.
It is almost impossible to not use that information. A customer’s trading informs a dealer’s view, whether consciously or not, on the market. If dealers really did not use customer information to price an RFQ, would they price trades as aggressively? Put another way, a customer’s trade information has some value. If dealers cannot use that information, dealers lose that value and will price trades less aggressively to reflect that loss.
3. Market participants should limit the use of confidential information. Market participants should exercise care in disclosing confidential information including own position information and information received from counterparties or third parties, either internally or externally.
I remember traders on the desk who used to rather blatantly discuss a certain asset managers’ positioning using the euphemism of “West Coast” (e.g., “West Coast is short the 5-year sector today”). While “West Coast” could have referred to any number of asset managers in the Pacific time zone, it was most definitely referring to PIMCO, who was one of the few firms whose positioning could move the markets. This information was shared internally, among traders on the desk, and externally, with clients and traders at rival firms.
This type of blatant sharing of customer information is clearly a violation of best practices. But what about more subtle violations? The recommendation further clarifies that “Own trading position information may be shared externally only to the extent necessary to facilitate a transaction.” If your book is positioned a certain way, do you not want the market to follow your lead and move in your favor? No one faults Bill Ackman for talking up his position in ADP on CNBC, but would he be in violation of TMPG Best Practices if he went all in on the 10-year note?
The next two recommendations go together.
4. Market participants should adopt written policies and procedures that identify and address limitations on the sharing and use of confidential information. The policies may vary and should address risks, where they exist, associated with: Sharing of information … and use of information ….
5. All market participants should be aware of their counterparties’ practice for handling confidential information; market participants should make available their practices for handling confidential information to their counterparties.
Basically, write your policies and procedures down and practice them consistently. If you, as a customer, do not disclose the cover price to dealers (second place price) then you should never disclose covers. You should not disclose covers just because you like a certain dealer or want to spare the feelings of the winning dealer because it bid way to aggressively. Consistent policies build trust in the system.
The contra argument is that certain counterparties have earned more trust and thus should be rewarded with more privileged communication. In asset classes where dozens of firms can respond to a bid wanted, even ones with whom you barely have a relationship, is it appropriate to communicate the same information to everyone? That is difficult to answer.
6. Market participants should establish internal controls designed to ensure that confidential information is handled in a manner that complies with the established policies. Such internal controls may include training of employees who have access to confidential information.
This is just common sense. The TMPG is not developing these rules for its own health. A firm cannot just state the Best Practices in their policies and procedures. Firms actually have to monitor and punish violations. There is not really a plausible counter argument that I can come up with.
As I hopefully illustrated, best practices in the U.S. Treasury market often address issues that are not black-and-white. The role of the TMPG, now 10-years old, is more important than ever bringing Best Practices to a largely unregulated asset class.
