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What’s behind the March Spike in Treasury Fails?

Author(s): Michael Fleming and Frank Keane

From Liberty Street Economics:

U.S. Treasury security settlement fails—whereby market participants are unable to make delivery of securities to complete transactions—spiked in March 2016 to their highest level since the financial crisis. As noted in this post, fails delay the settlement of transactions and can therefore lead to illiquidity, create operational risk, and increase counterparty credit risk. Fails in the Treasury market attract particular attention because of the market’s key role for global investors as a pricing benchmark, hedging instrument, and reserve asset. So what drove the March spike? In this post, we show that much of it reflected sequential fails of benchmark ten-year notes and thirty-year bonds, but that fails in seasoned issues—which have been trending upward for several years—were also elevated.

The Fails Spike
Settlement fails in U.S. Treasury securities rose to their highest level in more than seven years in March. Among the netting membership of the Depository Trust and Clearing Corporation (DTCC), gross fails (the sum of fails to deliver and fails to receive) aggregated across all Treasury issues averaged $95 billion per day over the month, as shown in the chart below. That said, fails remained well below the historic high of $504 billion per day observed in October 2008 at the peak of the financial crisis.

Fails Spike to Post-Crisis Highs in March

The spike in fails is primarily attributable to a jump in fails of benchmark (that is, “on-the-run”) securities but also to a continued rise in fails of seasoned securities, or securities issued more than 180 days prior. Both series reached post-crisis highs in March, with aggregate benchmark fails averaging $36 billion per day and aggregate seasoned fails averaging $50 billion per day. Fails in all other (or “lightly seasoned”) Treasury securities were below post-crisis highs in March, averaging $9 billion per day.

The Rise in Seasoned Fails
In a recent post, we explored fails of seasoned issues in detail, showing that they are widely dispersed over a large number of securities and that they tend to be resolved within a few days (updated versions of that post’s charts are available here ). An earlier post suggested that regulatory initiatives of recent years may have reduced institutions’ willingness to intermediate securities loans and repurchase agreements, which may help explain the rise in seasoned fails. However, the trend in seasoned fails seems to have started before recent regulatory initiatives were binding, suggesting that non-regulatory factors are also at play.

The Surge in Benchmark Fails
The next chart shows that the surge in fails of benchmark issues is entirely attributable to fails in the ten-year note and, to a lesser extent, the thirty-year bond. In fact, fails of the ten-year note are not uncommon and help explain many of the past spikes in benchmark fails. The June 2014 spike in fails—which marked the previous post-crisis peak in fails and which is described in this post—was driven by fails in the five- and ten-year notes, and, to a lesser extent, the two-year note.


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