Finding Off-the-Run Liquidity


The U.S. Treasury market is in a transparency tug-of-war between ultra-liquid on-the-run issues and the less liquid off-the-run issues, and market regulators are pulling hard for greater transparency.

Ever since the five market regulators that oversee the US Treasury market issued their 2015 Joint Staff Report on the October 14, 2014 ‘flash crash’ in the Treasury market, they have concluded that public reporting of Treasury trades would benefit the market.

Since then, the Financial Industry Regulatory Authority has received the U.S. Security and Exchange Commission’s approval to require its members to submit their Treasury trades to the regulator’s TRACE reporting engine beginning on July 10. The reported data will not be disseminated publicly but will be used to gather a better understanding of the market’s health, according to the regulator.

However, some in the industry fear that too much transparency will harm the $13.7 trillion market.

Susan Estes,
OpenDoor Trading

“I find it disingenuous that the Treasury used data for the most liquid, electronically traded, on-the-run segment—six issues that comprise under 2% of outstanding nominal issuance—and then used an obscure measure known as the ‘G-Curve’ to extrapolate the off-the-run curve to conclude that 100% of the market was healthy,” said Susan Estes, CEO of OpenDoor Trading. “I can’t imagine any similar leap of faith receiving a passing grade in any academic setting.”

Although transparency would benefit professional trading groups trading liquid on-the-run Treasurys — those most recently issued in a particular maturity — it would not help pension funds, mutual funds, and foreign central banks price their off-the-run issues, she added.

OpenDoor Trading plans to address the need for pricing of off-the-run Treasuries and Treasuries Inflation-Protected Securities with the pending launch of its electronic all-to-all trading platform.

The platform initially will support trades in the fifth most recent auctioned security into the most recent auctioned securities, Estes explained.

“Off-the-runs that are deliverable against the 2-year, 5-year, 10-year or 30-year futures contracts will also be included in each auction,” she added. “In addition, if there is an off-the-run not displayed that a participant would like included in the next auction, OpenDoor provides an ‘opt-in’ feature. The participant indicates which security she or he would like added, and if enough participants choose the same bond, it will be included in the next auction.”

The platform will provide five pricing auctions throughout the day, which will consist of a pricing phase, a “breathing phase,” and a matching phase.

During the pricing phase, the web-based platform will publish streaming prices from participating dealers, which contractually obligated to provide a two-sided market, end users that wish to provide prices as well as an aggregated third-party feed of additional dealer prices.

There is some overlap among the price providers, but there are ten dealers represented in the pricing feeds, according to Estes.

“At the end of the pricing phase, OpenDoor will display the derived mid-market levels for each off-the-run in the auction, as a yield spread to the benchmark,” she explained. “By trading yield spreads, market pricing moves to decimalization.”

During the breathing phase end users, which could include mutual funds, hedge funds, and bank portfolios, will review their prices and upload their orders over the next several minutes.

End users then can trade through the level or bid above or below the mid-price. If an end user decides to trade away from the mid-price, they are required to trade $10 million at the mid-price to validate the mid-price.

“In other words, we’re happy for traders to place bids below and offers above the displayed mid-market levels, but there was our concern we would have what we refer to as a ‘junior high school dance’ event where boys are on one side and girls on the other, with no one asking anybody to dance,” said Estes. “We want to have a mechanism that helps validate the mid, one of many factors that will contribute to the valuation in the next auction.”

Once and end user completes a trade, municipal bond broker Hartflield, Titus & Donnelly clears all of the trades made on the platform.

OpenDoor Trading is a trading platform and not a dealer, she noted.

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