TRACE at 20: Reflecting on Advances in Transparency in Fixed Income

By Stephanie Dumont and Ola Persson, FINRA

This Friday – July 1, 2022 – will mark the 20th anniversary of FINRA’s Trade Reporting and Compliance Engine, known as TRACE to everyone in the fixed income industry and regulatory community. TRACE is FINRA’s real-time, over-the-counter price dissemination service for the fixed-income market, bringing transparency to the debt markets, including corporate and agency debt as well as asset- and mortgage-backed securities. This milestone provides occasion to reflect on the history, impact and future of this pioneering platform – in fact, there is much on which to reflect:

• TRACE has helped protect investors by providing them with visibility into previously opaque markets. It also has contributed to market stability by giving market participants reliable and timely information about prices and market activity during times of stress.
• The platform has provided regulators with critical data to support policy decisions and for regulatory surveillance and oversight to ensure the integrity of the market.
• TRACE has reduced trade execution costs for investors, reduced bid-ask spreads (generally viewed as a hallmark of efficient markets), and improved valuation precision. TRACE’s unbiased and reliable market information has also helped facilitate market developments such as increased electronic trading.
• The reporting of transactions in Treasury securities (commonly known as “Treasuries”) to TRACE has helped regulators protect investors and ensure market integrity. (The five-year anniversary of the start of this reporting will be in two weeks, on July 15, 2022.)
• FINRA has introduced additional transparency carefully over time to allow for study on the effects of transparency while not harming liquidity. Peer-reviewed academic research on TRACE’s impact is either positive or neutral – there is no evidence of harm to markets.
• Looking ahead, FINRA continues to evolve with the dynamic fixed-income markets, including supporting the Securities and Exchange Commission’s (SEC) transparency initiatives for the markets.

Historical Context

TRACE today is widely viewed as an essential part of the fixed-income market infrastructure, but prior to its introduction in 2002, there was no centralized, public-facing platform to disseminate bond transaction data.

In a 2002 news release announcing the launch of TRACE, Douglas H. Shulman, then-President of Regulatory Services and Operations at the National Association of Securities Dealers (FINRA’s predecessor), said, “In today’s business climate, it is more important than ever for regulators and investors to have access to more information. In developing this system, NASD has worked closely with the SEC, Bond Market Association, and the dealer community to ensure that the TRACE maximizes transparency, while optimizing liquidity.”

That has been a touchstone for FINRA and TRACE ever since: pursuing a balance between enhancing transparency and not negatively impacting liquidity. TRACE has helped level the playing field for all market participants by providing accurate, comprehensive, real-time bond price information to retail and institutional investors alike, as well as market professionals. That data has helped investors gauge the quality of the order execution they are receiving from their broker-dealers. From a regulatory standpoint, it has better enabled regulators to monitor the market, pricing and execution quality.

It all started gradually and deliberately.

FINRA launched TRACE with new rules requiring the reporting of virtually all transaction information in TRACE-eligible securities. Public dissemination of transaction information was implemented in three phases through 2005, starting with large, investment-grade bonds and later expanding to smaller, less active issues. This allowed FINRA to study the impact of transparency on liquidity.

In a parallel effort, the time in which to report a transaction was reduced gradually from 75 minutes at the launch to 15 minutes on July 1, 2005, to allow for more timely data to be disseminated to the public with minimal impact to reporting firms. Since Jan. 9, 2006, all transactions in public TRACE-eligible securities have been disseminated immediately upon receipt.

On March 1, 2010, TRACE began requiring the reporting of transactions in U.S. agency debentures, as well as primary market transactions in TRACE-eligible securities. Primary market transactions are subject to dissemination, with the exception of list or fixed offering price and takedown transactions.

Effective May 16, 2011, TRACE began requiring the reporting of transactions in asset-backed and mortgage-backed securities. Since November 2012, TBA (“To Be Announced”) transactions are disseminated to the public, and since July 22, 2013, mortgage-backed securities (MBS) transactions also became subject to dissemination. Effective June 30, 2014, TRACE began disseminating transactions executed pursuant to SEC Rule 144A. On June 1, 2015, asset-backed securities, as defined in FINRA Rule 6710, became eligible for dissemination.

Since July 10, 2017, TRACE began requiring the reporting of transactions in U.S. Treasury securities – more on that below.

Today, TRACE data are widely available. All major market-data vendors carry real-time TRACE data through data feeds and desktop display applications. Retail investors can see the data free of charge on FINRA’s Market Data Center. FINRA also has created a data set specifically for academic research.

In addition, FINRA publishes daily weekly and monthly aggregate data on market activity in corporate bonds, structured products and Treasury securities. The TRACE Fact Book is updated quarterly and annually with scores of data sets about fixed-income trading activity, issues and market participants, as well as TRACE’s history, a glossary and other information.

TRACE for Treasuries

The market for U.S. Treasury securities is the largest and most liquid in the world. Five years ago, responding to unexplained volatility in the Treasuries market (commonly referred to as the Treasury “flash crash”), FINRA worked quickly with the Interagency Working Group, including the SEC, Federal Reserve and Department of Treasury, to bring Treasuries transaction reporting to TRACE.

This provided regulators with a new source of trusted, reliable data to expand their visibility into this critical trading activity. For example, FINRA used TRACE data in bringing a 2021 disciplinary actionagainst a trader for “spoofing” the market for Treasury securities; that is, placing large, non-bona fide proprietary orders to purchase or sell Treasury securities while simultaneously entering smaller, bona fide proprietary orders on the opposite side of the market. This created a false appearance of market depth and activity so his bona fide proprietary orders would receive a favorable order execution.

At an April 26, 2022 speech at London’s City Week, SEC Chair Gary Gensler called for expanding transparency in the fixed-income market, including Treasuries:

“Five years ago, TRACE was expanded to require broker-dealers to report Treasury transactions, but there isn’t yet any public dissemination. Last fall, the Federal Reserve finalized a rule to use TRACE to require certain banks to report transactions in Treasuries, agency debt, and agency mortgage-backed securities to TRACE. Once more major firms have reporting requirements — the banks and potentially principal trading firms in the future — I think it could make sense to disseminate this information to the public.”

He added, “Public dissemination of Treasury trade data could help enhance counterparty risk management and the evaluation of trade execution quality. It also could expand the provision of liquidity.”

FINRA supports the SEC’s agenda for increasing transparency, and also continues to work with the Treasury, as noted recently by Treasury Under Secretary Nellie Liang. In addition, Under Secretary Liang earlier this month announced a request for public feedback on additional post-trade data transparency in the Treasuries market. And recently, the Federal Reserve Board adopted a rulerequiring banks to report transactions in Treasuries to TRACE.

A Crucial Resource for Regulatory Oversight

TRACE has long been a critical resource in the regulation of trading in corporate and other fixed income securities. Examples include:

• FINRA imposed a $1.9 million fine against a firm (and an order to pay $540,000 in restitution to customers) for violations of fair pricing and supervision requirements;
• A $1 million penalty against a firm (and a requirement to pay customers $353,000 in restitution) for charging unfair prices in bond transactions;
• A $600,000 fine and $648,000 restitution order against a firm for charging excessive markups and markdowns on corporate and agency bond transactions, and supervision violations; and
• Because the reporting of information itself is important to market participants and regulators, FINRA also examines whether firms are reporting timely, accurate and complete information to TRACE, as evidenced by this $1.1 million enforcement action against a firm for reporting and supervision violations.

Research on TRACE’s Impact

A number of independent academic studies have explored the effects of TRACE on the market and found that TRACE has:

• Effectively narrowed bid-ask spreads, widely agreed to be desirable and a hallmark of efficient markets;
• Reduced investor cost significantly (independent studies indicate estimated annual trading cost reductions of nearly $1 billion for the full corporate bond market);
• Contributed to improved valuation precision, reducing the dispersion in valuation between different mutual funds holding the same security; and
• Resulted in no observed loss of liquidity since the launch of TRACE (during the platform’s rollout, one study indicated that the increased post-trade transparency had a neutral or positive effect on liquidity for BBB-rated corporate bonds).

All of this research is posted on FINRA’s website.

An Evolving Platform for an Evolving Marketplace

Looking ahead, in addition to the prospective development in Treasuries market transparency referenced above, as of this writing there are other pending initiatives to enhance the transparency provided by TRACE and ensure that TRACE information reflects evolving market practices. Two are noted below.

• Portfolio trading has seen a steady increase in the last few years. TRACE information will be enhanced to include information on transactions executed as portfolio trades in May 2023.
• A proposed rule change to expand TRACE reporting requirements to trades in U.S. dollar-denominated foreign sovereign debt securities.

Viewed through the lens of its 20-year history, TRACE has been a crucial driver of greater market transparency, investor protection, and the ongoing evolution of fixed-income markets. Perhaps most importantly, the milestone serves as a reminder that the story of TRACE continues to be written. But for now, happy 20th anniversary, TRACE!