Canadian Dealers Say More Regulation May Stifle Bond Trading

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A push by regulators to reform bond markets may worsen selloffs by hindering the role of the market’s middle men to facilitate trades, the Canadian bond dealers’ association said.

Rules put in place since the credit crisis have already limited the ability of investment dealers to absorb bonds in a downturn, Ian Russell, chief executive officer of the Investment Industry Association of Canada said in the group’s annual letter. Regulations now being proposed to a market that’s still largely conducted by e-mail and over the phone could make it harder still, causing more dramatic price swings when a shock hits, according to the IIAC.

“These forthcoming regulatory initiatives have the potential to reduce market-making and further erode already thin liquidity in traded debt markets,” Russell wrote. “The consequences for credit markets could be severe.”

Efforts by regulators in Canada and around the world to increase transparency in the bond market, create standard trading practices in the wake of recent instances of market manipulation, and remove service charges embedded in the prices dealers offer to buy and sell securities, could further hamper liquidity, according to the letter.

Barclays Study

Kristen Rose, a spokeswoman for the Ontario Securities Commission, which is considering how to regulate the fixed-income market to improve transparency and fairness, declined to comment on the IIAC’s letter.

Investment dealers are now holding a smaller percentage of the total amount of U.S. Treasury notes on their books for trading purposes than at any point in nearly three decades as new rules come into effect making it more expensive for banks to hold securities, according to data from Deutsche Bank AG cited in the IIAC’s letter.

Another study this month from Barclays Plc shows liquidity has been draining from the U.S. corporate bond market too, with turnover falling to the lowest in at least a decade, and the gulf between prices offered to buy securities versus those to sell them widening.

The trend is raising alarm among investors as well with Montreal-based Addenda Capital asking in a note on liquidity this month, “Are we closer to the day of reckoning?”

“New rules to supposedly insulate the public from a financial crisis have been put in place but little has been done to fill the space left somewhat empty by investment dealers,” Jean-Francois Pepin, co-chief investment officer of the firm wrote. “It is when bond prices start to decline that we will be able to fully appreciate the damage done by regulators to the financial system.”

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