Jerome H Powell: Treasury markets and the TMPG
Speech by Mr Jerome H Powell, Member of the Board of Governors of the Federal Reserve
System, at TMPG Best Practices @ 10: A Look Back and a Look Ahead, Federal Reserve Bank
of New York, New York City, 5 October 2017.
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I am honored to join you to celebrate the first 10 years of the Treasury Market Practices Group
(TMPG). The TMPG has become an essential forum where industry participants gather under the
auspices of the Federal Reserve Bank of New York to address market practice issues as they
arise in the fast evolving markets for Treasury securities. Outside this room, you are
competitors, and that vigorous competition serves your firms, your customers, and ultimately the
U.S. taxpayer. But when members of the TMPG attend meetings, they bring their long experience
and deep expertise to bear to safeguard the functioning and overall health of these markets. As I
have heard a number of people say, TMPG members check their partisan interests at the door.
The TMPG is the place where market participants recognize and address their responsibilities to
each other. I know that they take that responsibility seriously, and I encourage all of the market
participants here today to take the TMPG's recommendations just as seriously and to adopt them
as best practices that will enhance the market's functioning.
I first encountered Treasury markets in a serious way 25 years ago, when I served as Under
Secretary of the Treasury for Finance under President George H. W. Bush. These markets
made national headlines when we learned that a Salomon Brothers' trader had repeatedly
circumvented Treasury auction rules to corner the market for the on-the-run two-year Treasury.
As it became clear that Salomon's senior management had known about the issue for several
months without alerting regulators, the scandal threatened to bring down one of the largest
financial firms of that time. Over one memorable August weekend, we first prohibited the firm
from dealing in government securities on behalf of customers, and then reduced that sanction as
top Salomon management left the firm and Warren Buffett, then a large Salomon shareholder,
agreed to assume the chairmanship of the board of directors. This event takes up a chapter in
Buffett's biography, The Snowball, and it is a good illustration of why we need the TMPG. I reread
1
that chapter every couple of years, and it still gives me nightmares.
After the dust settled, we had to grapple with the wider implications of the scandal for the market
itself and particularly the role of regulatory oversight. We certainly could have used a TMPG to
help us with this work, but none existed at that time. Our recommendations were summarized in
a joint report to the Congress issued by the Treasury Department, the Securities and Exchange
Commission (SEC), and the Federal Reserve Board. Among the issues we considered were
how to encourage a level playing field for all market participants, and when and where regulators
should respond to the periodic technical difficulties the market sometimes experienced.
As we drew up the report, we were deeply aware of the importance that Treasury markets held
for the American economy. The sale of Treasury bonds, notes, and bills finances the U.S.
government, and those securities are in turn a primary vehicle for savings for a wide range of
U.S. households. Treasury securities are also an important source of collateral within the
financial system. This last role has become all the more critical in recent years as regulations
have required banks to hold larger amounts of high-quality liquid assets so that they can safely
meet their potential liquidity needs.
We also knew that, despite the misconduct by Salomon Brothers, Treasury markets generally
worked quite well. These markets are and have long been among the deepest and most liquid
markets in the world. It was important to make the auction system more robust to potential
manipulation, and we made several recommendations to do so and to open up the process to
greater competition. However, in other areas that already worked well, we chose, for example, to
open up issuance of securities that were in short supply (or "squeezed") when needed rather
than to risk negatively affecting the functioning of Treasury markets by instituting more invasive
regulation.
There is certainly a role for regulation, but regulation should always take into account the impact
that it has on markets-a balance that must be constantly weighed. More regulation is not the
best answer to every problem. There is also a role for a body such as the TMPG to address
market problems.
The TMPG's approach to "fails" in the Treasury and mortgage-backed securities markets
provides a good example. Fails-that is, the failure to deliver collateral in either a cash or
repurchase agreement transaction-impose a cost on the party expecting delivery. If the practice
were to become too frequent, then it could seriously impair market functioning. But at the same
time, it doesn't make sense to simply outlaw the practice, since that limits flexibility in a way that
may not always be called for and would likely reduce market liquidity. The TMPG's
recommendations were carefully calibrated to set financial incentives that would minimize fails
and have been a marked success.
The TMPG also plays an important role in helping to "fill in the cracks" between the competing
regulations that various Treasury market participants face. Many different institutions and
individuals depend on these markets, and the regulatory system reflects that. The Government
Securities Act gave the Treasury Department some rulemaking authority over all government
securities brokers and dealers. But the act also required these firms to register with the SEC. At
the same time, the Federal Reserve regulates many of the banks that are active in these
markets, and the Federal Reserve Bank of New York also plays an essential role, both as fiscal
agent for the U.S. government and, by nature of its frequent activity in these markets, in
conducting monetary policy operations. And of course, the Commodity Futures Trading
Commission regulates Treasury futures markets. The agencies work well together, but there is
real value in having an industry group help to identify issues that cross regulatory boundaries.
I'll give two examples. First, in 2016, the TMPG conducted a study of financial benchmarks and
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uncovered uses of ICAP's federal funds open rate that had not previously been well understood.
As ICAP decided to stop publishing the rate, the TMPG also helped to guide market participants
to an alternative that is aligned with the International Organizations of Securities Commissions
Principles for Financial Benchmarks while steering the market away from the London Interbank
Offered Rate (LIBOR) as a potential alternative-a move that now seems prescient given the
subsequent news around the long-run risks to LIBOR. More recently, the TMPG has been busy
creating a map of clearing and settlement in Treasury markets, work that I am sure all of the
regulatory agencies will find to be of great interest.
All of this is incredibly valuable. In fact, my only regret about the TMPG is that we didn't think of
creating something like it earlier. As regulators, we fully support your work, and will continue to
make sure that our own rules support these markets. The Financial Industry Regulatory
Authority's (FINRA's) new collection of the Treasury transactions of its members through its
Trade Reporting and Compliance Engine, or TRACE system, will do much to improve the
regulatory agencies' understanding of the dynamics of this market. But as in the past, we should
also be concerned about creating a level playing field. For that reason, the Board of Governors is
continuing to negotiate with FINRA for it to act as our agent in collecting similar data from banks.
We do not want to create a regulatory arbitrage where the same activity done within a
brokerdealer is treated differently than when it is done within a bank.
The TMPG and similar groups around the world play an important role by helping both regulators
and industry leaders address market concerns before they threaten market function. I thank the
members for their service and look forward to today's discussions.
1
Alice Schroeder, The Snowball: Warren Buffett and the Business of Life (New York: Bantam, 2009).
2
The ICAP Fed Funds Open rate was a daily indicator published by ICAP, a broker in the federal funds market, as
to where a representative federal fund transaction would be priced at the start of the U.S. trading day. ICAP did
not consider the rate to be International Organizations of Securities Commissions compliant, although it was
nonetheless used as a financial benchmark by some market participants. ICAP ceased publication of the index
in September 2016.