Making the Treasuries market safe at speed

One of the greatest responsibilities of US financial regulators is to preserve confidence in the market for our federal debt, the world’s deepest and most liquid financial market.
There are $19.8 trillion dollars of federal debt outstanding today, of which the public holds $14.4 trillion. This debt finances the federal government, and it plays an irreplaceable role in financial markets—facilitating the transmission of monetary policy, providing the world’s risk-free benchmark, helping businesses to manage their risks, and providing a reliable store of value to savers around the world, from sovereigns to retirees. In short, everyone you know relies on well-functioning Treasury markets.
How could confidence in this market be shaken? One obvious way is through reckless brinkmanship over the debt limit, which must be raised by the end of September to avoid the perils of default. A more insidious, if less cataclysmic, route would be a failure to modernize the oversight of the secondary market for US Treasuries, in which investors and intermediaries trade already issued securities.
The market for Treasuries has undergone radical technological change. High-frequency trading, which started in equity markets in the 1990s, has expanded to all standardized securities, including foreign exchange contracts, futures, and, over the last decade, the most liquid cash treasuries. It now accounts for a majority of trading in inter-dealer Treasury markets, which in turn represent about half of all trading in Treasuries. (The other half consists of traditional dealer-to-customer orders.) High-frequency trading allows for fully-automated transactions, carried out in nanoseconds, and is widely deployed by banks, broker-dealers, and independent trading firms called “PTFs” (principal trading firms).
High-frequency trading has also been associated with a number of so-called “flash events,” from the infamous flash crash in US equities in 2010 to the sudden 9 percent drop of the British pound on Oct. 7, 2016. Certainly few observers of US Treasuries will soon forget the “flash rally” of Oct. 15, 2014. The yield on the benchmark 10-year US Treasury traded in a 37-basis-point range (0.37 percent), only to close six basis points below its opening level. Moreover, between 9:33 a.m and 9:45 a.m, yields dropped 16 basis points and then fully recovered, without any apparent catalyst. Treasury markets had experienced similar moves just three times in the preceding 20 years, and always as a result of a clearly identifiable economic event.
In the absence of an explanation, theories abounded. “The machines turned off,” traditional brokers reported. “A single, mammoth volatility trade was unwound,” others said. In fact, it took five federal agencies nine months to analyze the data and issue a Joint Staff Report that concluded there was no single cause of the volatility. The agencies found that, during the flash rally, PTFs accounted for more than 70 percent of trading in inter-dealer markets, and there was a higher incidence of order-stuffing at the open (whereby multiple orders are placed and then canceled). There was also more self-trading than usual (whereby one firm trades with itself). Notably, the machines never turned off. Many kept making money.
Perhaps more troubling than the events described was the better part of a year that federal agencies needed to gather and analyze the data. Following the Joint Staff Report, the Treasury Department initiated its first exhaustive review of Treasury markets in decades and issued a request for information to the public.
— Bloomberg