July 16, 2018

Securities and Exchange Commission Meeting of the Fixed Income Market Structure Advisory Committee (FIMSAC)

Key Topics & Takeaways

  • Panel 2: Current State of Pre-Trade Transparency in the US Corporate Bond Market
    • This panel discussed ways to improve liquidity and build a better functioning market by looking at the current state of pre-trade transparency.
    • Some panelists recommended providing symmetric information to dealers, so they will be more confident in their quote and better support the market.
    • Providing immediate and accurate data to asset managers, particularly on market depth, will improve pre-trade transparency.
    • Pre-trade transparency is not a problem for the institutional market and it should be considered separately from the retail market.
  • Panel 3: Current State of Pre-Trade Transparency in the US Municipal Securities Market
    • The third panel discussed transparency in the municipal securities market and it began with the SEC Staff presenting a DERA paper on pre-trade information in the municipal bond market.
    • The Panelists stated that pre-trade information is available to all market participants but there is no consistency in the method of delivering the information.
    • There are a number of solutions to help with price transparency, but the key is obtaining more dealer input from dealer trading desks doing most of the pricing.
  • Panel 4: Electronic Trading Venue Regulation
    • The FIMSAC Committee approved the FIMSAC Technology and Electronic Trading Subcommittee’s recommendation for the SEC to form a joint working group with FINRA and the MSRB.
    • The panelists supported ways to right-size the rules for fixed income electronic trading and create a level playing field for market participants offering similar services that are regulated differently.
    • Regulations need to allow room for innovation and focus on the decision-making process of algorithmic and auto trading.

FIMSAC Committee Discussion

Please note that SIFMA’s summary of the event does not cover the first panel discussion on pre-trade transparency under MiFID II. 

Current State of Pre-Trade Transparency in the US Corporate Bond Market

Mihir Worah of PIMCO moderated the panel and began by introducing the panelists who represent the buy and sell sides, institutional and retail businesses, and technology providers. Worah outlined the goal of this panel to discuss ways to improve liquidity and build a better functioning market by looking at the current state of pre-trade transparency.

The panel participating in this portion of the meeting consisted of:

  • Jon Klein, Bank of America Merrill Lynch
  • Ben Macdonald, Bloomberg
  • Tim Morbelli, Alliance Bernstein
  • Steve Shaw, BondSavvy
  • Thomas Urano, Sage Advisory Services
  • Chris White, Viable Markets and BondCliq

White discussed the modern bond market and its reliance on market data. As outlaid in his presentation, White characterizes the U.S. corporate bond market as having fragmented, non-standard, institutional pricing data and asymmetric price information. White stated that providing sell side with similar reliable pricing information will improve the liquidity of the bond market as broker-dealers can support the market with less capital. A consolidated quote system, that displays non-executable up-to-date quotes with size details to the buy-side and up-to-date anonymous quote prices to the sell side, will enhance pre-trade transparency and create market efficiencies.

Urano stated that pre-trade transparency relies on high quality data, and he considers the price, trade size and market impact when deciding how to best execute a trade. Urano said he has found less price transparency in the size of the market and its impact, especially for illiquid securities, as dealers are reluctant to engage in transactions larger than $5-10million and it has taken him two weeks to unwind a $15 million position of illiquid securities. Urano believes providing immediate and accurate data, particularly on market depth, will improve pre-trade transparency.

Morbelli helped develop Automated Liquidity Filtering and Analytics (ALFA) to help provide pre-trade transparency. Rather than directly addressing liquidity, ALFA solved for trading efficiency by providing traders with a holistic view of the market based on comparable bond attributes, which inadvertently addressed liquidity.

Klein stated that liquidity is different but related to pre-trade transparency. Transparency improvements have resulted from investments in technology and delivering what customers want to see to help their execution process. Additionally, information delivery to clients improves with the technology improvements.

Macdonald discussed how clients use Bloomberg for data and transparency. Bloomberg’s mission was to improve the market’s transparency, and this started with a person putting in a spread to see if it was an accurate price. Eventually, this goal lead to more market makers making prices available on one page for reference.

Shaw discussed his recommendations to enhance pre-trade transparency for retail investors which are also outlined in this letter. Shaw stated that investors can adequately assess corporate bonds because the corporate disclosures are the same for equity investors, and individual bonds should be included in a retail investor’s portfolio because the market is fair for large and small investors. Shaw recommended improving transparency for retail investors by providing credit spread, educating the investors on the advantages of selling bonds prior to maturity and modify the bond prices on client statements to better reflect the bond’s market value.

FIMSAC Member Larry Harris discussed the advantages and disadvantages of providing pre-trade disclosure of mark-ups for riskless trades, pre-trade dissemination and customer recommendation of limit orders. For mark-ups and commissions, providing this transparency will promote competition by allowing customers to compare prices but also disincentives firms to disclose mark-ups.

FIMSAC Members Brian Archer and Larry Tabb explained the importance of separating the transparency issues for institutional and retail firms. Archer stated pre-trade transparency is not a problem for the institutional market as information is immense and continually improves. Archer stated that providing certain pre-trade information would not have helped certain illiquid bonds, but it could help in the retail space. Tabb also recommended separating retail from institutional rather than pursuing a one-size fits all solution. Shaw emphasized there is a competitive market with live and liquid quotes for retail investors but there is a challenge in getting the information to the investors.

Several FIMSAC Committee members asked the panelists to discuss ways to improve execution between buyers and sellers if there is sufficient pre-trade transparency information and whether regulators should consider a requiring a firm quote rule to incentivize broker-dealers to honor their quote. White stated that market-makers, who do not know the other quotes, may lack the confidence to stand with its quote when the buy side has more information. White stated that providing dealers with more information will to make them confident in their quote and market incentives and competition will reduce the need for regulation. Klein added that each dealers quote is affected differently by the same factors, such as inventory and expected client demand, so dealers have difficulty determining the appropriate price in isolation.

Current State of Pre-Trade Transparency in the US Municipal Securities Market

After lunch, the FIMSAC resumed meeting and the third panel discussed ransparency in the municipal securities market. FIMSAC Member Lynn Martin of ICE Data Services moderated the discussion and the participants were:

  • Bernard Costello, Morgan Stanley
  • Ric Edelman, Edelman Financial Services
  • Chris Ferreri, Hartfield, Titus and Donnelly
  • Ben Smelser, Breckinridge Capital Advisors
  • David Umeda, Charles Schwab
  • Ron Valinoti, Triangle Park Capital Markets Data

Before the discussion, SEC Staff Abby Kim presented the SEC DERA paper on pre-trade information in the municipal bond market. The paper found that a small fraction of bonds trade on a given day but quotes are available on days when the bonds do not trade. The paper found that more than 90% of bonds have one sided quotes, the average number of days quoted for bonds is 16 days, the average issue size is 1.5 larger than traded bonds, and large dealers who trade large number of bonds are four times more likely to provide quotes on ATSs. The paper found that transaction costs – quoted spread, effective spread, price improve, and mark ups – vary across bonds but are larger for customer trades than inter-dealer trades. The paper found that 75% of customer trades are executed outside best quoted, most inter-dealer trades are typically executed close to best quotes. Costello raised concerns with the results of the study because the data was based on information in 2014, which gives a misleading interpretation of the current market place after sweeping regulatory changes in best execution requirements.

Martin asked Smelser, Costello and Edelman to describe the tools available, and whether those tools are technology enabled, to help find reference data. Smelser begins by determining the bonds available and aggregating internally to develop a view of the market by talking to different broker dealers and reviewing bid-wanteds. Then, if there is no price based on CUSIP, Smelser stated he begins looking at comparable bonds based on the issuer, maturity, bond terms and tax status. Costello stated that a trader can easily evaluate the price of a large, liquid and highly-rated CUSIP based on post-trade data. Costello further stated that the information is available to all market participants but there is no consistency in the method of delivering the information. Edelman stated that because prices for the same bonds can vary by firms at the same time, he does his best to pull data from bondview.com to determine a fairer price but typically just makes a best estimate. Edelman emphasized that he typically refers retail investors into ETFs rather than individual municipal bonds due to the lack of diversification, larger spread and fees, and lack of confidence in an effective price.

Martin asked Ferreri and Umeda to describe the process their firm employs to make information on potential investments and pricing to customers. Ferreri stated that as a brokers-broker, his firm has moved from disseminating information through green screens to now licensing technology that allows traders to see live, indicative and aged prices and around 5,600 bids-wanted daily based on about 15 brokers’ quotes on web-based screens. Umeda stated that clients provide the best quotes to everyone equally and clients can interact online or with professionals.

Martin then asked Valinoti what information vendors provide to the market on reference data and value of securities. Valinoti stated that his firm aggregates quotes from brokers’ brokers and ATS partners to provide almost 400,000 quotes daily. Valinoti emphasized that the municipal bond market is geographically diverse, and most regional firms don’t have the technology to take in this data. Valinoti stated that there are many solutions to help with price transparency, but the key is obtaining more dealer input from dealer trading desks doing most of the pricing.

FIMSAC Member John Bagley asked the panelists to describe what they consider pre-trade information and what information is provided to the buy-side and retail firms. Smelser stated that he considers CUSIP, new issues, market offerings, bid-wanted items and tax status to be relevant pre-trade information. Ferreri stated that all relevant pre-trade information is provided via different sources, and there may be some duplicity and it should be the brokers’ role to manage that information. Edelman stated that he would like retail investors to be provided with a standardized tax equivalent yield, so the client understands that buying an out of state bonds does not have the same tax impact as in-state bond.

Electronic Trading Venue Regulation

The final panel focused on the FIMSAC Technology and Electronic Trading Subcommittee’s preliminary recommendation for the SEC to form a joint working group with FINRA and the MSRB to consider the increased use of electronic trading platforms on the liquidity, efficiency and resiliency of the corporate and municipal bond markets. The Panelists were:

  • Horace Carter, Raymond James
  • Doug Friedman, Tradeweb
  • Ben Macdonald, Bloomberg
  • Rick McVey, MarketAxess
  • Alex Sedgwick, T. Rowe Price
  • Bill Vulpis, ICE BondPoint

SEC Division of Trading and Markets Director, Brett Redfearn, and FIMSAC Member Rick McVey of MarketAxess began by describing the recommendation. Redfearn explained the long-standing challenge in categorizing various trading platforms and broker dealers and requested panelists to comment on whether the current conditions for exemption from ATS and Exchange regulation are appropriate in the fixed income market. McVey further elaborated on the current fragmented regulatory framework for the fixed income markets and that different regulatory statuses are arbitrarily based on revenue models. This FIMSAC Subcommittee recommended a joint working group to improve competition and avoid regulatory redundancy.

Each panelist discussed the benefits of the proposal. Carter stated he would not be in favor of a large regulatory framework but supports restricting or narrowing protocols that continue to allow innovations to improve liquidity. Friedman was supportive of principle-based regulation that meets the policy objectives of providing transparency and reducing risks. Friedman stated that the working group should work closely with market participants to ensure any regulations apply consistency across similar platforms and conduct a cost benefit analysis. Macdonald emphasized that any regulatory recommendations need to understand the nuances of the marketplace and be forward-looking. Sedgwick stated that well-designed regulation could create a fair playing field, and the working group should consider transparency, fee structures, auto-executions, and data protection. Vulpis supported the recommendation as a step towards defining a set of rules for fixed income electronic trading.

Redfearn asked the panelists to discuss how the trading protocols in fixed income platforms have evolved to become more electronic and how each panelist would design the regulations for a fixed income trading platform if starting from a clean slate. Carter stated that electronic trading will continue to grow, and regulations need to provide enough room for innovation. Additionally, Carter recommended trades be reported net of fees, for regulators to look at potentially duplicative volume reporting, and consider market structure changes to improve bond liquidity. Friedman recommended defining the objectives, markets and products to ensure rules are applicable across various trading platforms.  Macdonald stated that regulations need to address the shift towards automated decision-making and trade messaging with direct connectivity. Sedgwick recommend regulations ensure platforms have strong internal controls and promote confidence in users making a right routing choice. Vulpis stated that regulations need to bring post-trade transparency to pre-trade markets and ensure regulations apply to all market participants based on how and where they are transacting.

Redfearn asked the panelists to address the impact of the various regulatory regimes on each of their firms’ business models and to provide any recommendations for regulatory change. Macdonald stated that Bloomberg is an aggregated trade messaging service – that does not match orders, settle or clear trades, and does not conduct trading – and its that’s resiliency will be measured by its usage. Macdonald emphasized the importance of regulators paying attention to technology evolvement and how algorithmic or auto traders make decisions. Friedman stated that there are definitional issues with the ATS regime which also resulted in issues with the market access rule. Vulpis agreed with the issues with the market access rule and stated that Reg. ATS does not cover various protocols in the market place today. Carter stated that clients don’t fully understand the differences between ATS and other trading platforms, and he does not prefer one venue over another based on their regulation. Carter stated that clients favor venues with better record-keeping and the regulatory environment does not benefit one participant over the others. Sedgwick agreed that he does not see the benefits of a trading platform being regulated as an ATS and most market participants do not understand the reasoning in different regulations.

The Subcommittee’s recommendation was approved with 16 voting in favor and 6 voting in opposition.

For more information on this meeting, please click here.