Over the seven or so months since last October’s Treasury flash crash, the world has gradually woken up to what we’ve been saying for years. Namely, that between the Fed sucking up all the high quality collateral and HFT algos’ tendency to chase down the same rabbit holes, what was once the most liquid market on the planet now has the potential to trade like a penny stock on any given day depending on the machines’ interpretation of the headlines.
Now, bond market liquidity is all the rage with everyone from sellside credit strategists to prominent buysiders to JP Morgan’s billion-dollar man [9] warning that illiquidity will likely lead to further instances of extreme volatility in bond markets. Indeed, even the ECB’s Mario Draghi said Wednesday that investors should prepare for “more volatility” going forward.
In a sign of the times, ICAP, which handles nearly two-thirds of Treasury trading activity between HFTs and banks is considering the implementation of circuit breakers in the Treasury market to halt trading in the event of an ‘accident.’
WSJ has more [10]:
ICAP PLC is studying the possibility of temporarily halting Treasurys trading following large price moves, according to people familiar with the matter.
Such a program would mark the first use of such safeguards in the $12.5 trillion U.S. Treasury market.
Circuit breakers are routinely used to halt trading in stocks when price fluctuations exceed predetermined ranges.
London-based ICAP is raising the idea with some of its customers, one of the people said, and weighing the pros and cons of adopting such controls, which already are commonplace in equity markets in the U.S. and elsewhere. According to Sandler O’Neill + Partners estimates, ICAP’s BrokerTec unit handles about 60% of Treasurys trading activity between banks and high-speed trading firms, which account for a large share of overall trading.
Not everyone is thrilled with the idea, as some traders suggest curtailing investors’ ability to take refuge in traditional safe-haven assets could play havoc with other markets:
Some traders worry that timeout periods in the world’s most liquid securities market would reduce investors’ access to the perceived safety of Treasurys when other markets are declining, and could raise the possibility of distorted prices in related markets like derivatives that are closely tied to government bonds.
Of course, the VaR shock [11] that took hold in German bunds last month has served to heighten concerns...
ICAP’s discussions come on the heels of large one-day price swings in Treasurys and German bunds, two of the largest, most liquid markets in the world, over a period of months. The events touched off a debate about whether electronic bond venues need heightened risk controls.
Such procedures would be vastly more difficult to apply to bonds, observers say. While much of the bond markets are traded electronically today, trading doesn’t take place on exchanges and the handful of platforms catering to bonds don’t coordinate with each other on how to handle extreme price moves.“In a world where liquidity can move so quickly from one venue to the next, the absence of an industrywide agreement on when to halt trading poses a risk to the bond market,” said Adam Sussman, head of market structure at institutional equities-trading platform Liquidnet.


