U.S. Bond Market Needs Improved Fairness, SEC’s Walter Says
The $38 trillion U.S. bond market needs to be improved to allow better access for all investors, said Securities and Exchange Commission member Elisse Walter.
“The more I look at it the more concerns about fairness I have,” she said today at the start of a series of roundtable discussions the agency is holding in Washington on fixed-income markets.
Walter sought to assure participants that the agency isn’t trying to impose an equity-market structure on bonds with exchange trading and pre-trade price transparency. The challenge, she said, is for regulators to understand the complexity of how debt trades to discover what must be changed. “In this arena, I keep having to reassure people that we get it,” she said.
Dealers have scaled back principal trading in the market amid pressure to increase capital to meet international standards and as they face lower profits from more transparency created by Trace, the bond-price reporting system of the Financial Industry Regulatory Authority, according to a report today by consulting firm Tabb Group LLC.
Corporate bond inventories at primary dealers that trade directly with the Federal Reserve have dropped to $56 billion, below the average of $69.3 billion since the end of 2009 and down from a peak of $235 billion in October 2007, Fed data show.
“Dealers cannot quote in size and wide enough spread to justify the capital deployment” to hold an inventory of bonds, Will Rhode and Henry Chien wrote in the Tabb report. A system for creating instantaneous quotes needs to be developed, they said. “The challenge is simple: how do you price a bond trade in real time?”
One concern for investors is showing large trades to the entire market on bond trading systems, said Robert Auwaerter, head of the fixed-income group at Valley Forge, Pennsylvania-based Vanguard Group Inc.
“You leave a footprint in the market that disadvantages you,” Auwaerter, a panelist on the first roundtable, said. “It’s better to try to go around quietly to dealers” because “if you advertise it to the world you destroy your bid-price execution,” he said.
In the $9.1 trillion U.S. corporate-bond market, about half of trades are larger than $5 million, said Eric Pitt, a managing director at JPMorgan Chase & Co. (JPM) in New York. For those transactions, investors feel they can get better prices by talking directly to dealers, he said.
“Would it work to electronify that part of the market?” he said during a panel discussion on corporate and asset-backed securities. “Is there a problem to be solved?”
The size of new bond deals also has risen as underwriters give more preference to larger offerings than in the past, said Neil Schloss, the treasurer at Ford Motor Co. While $500 million was once considered a large enough bond offering, the company is now told that debt sales under $1 billion won’t be enthusiastically greeted by the market, Schloss said.
“There’s more and more demand but less product,” JPMorgan’s Pitt said.
That’s making it hard for some bond investors to buy the amount of debt they want, said Robert Smith, the chief investment officer at Austin, Texas-based Sage Advisory Services Ltd., which manages about $11 billion. If his firm wants $5 million to $10 million of a certain issue, he’ll tell dealers he wants $100 million in order to be taken seriously. Then he ends up with $1 million of securities, “and that’s on a good day,” Smith said.
“That’s a great risk to my business, because one of those times I’m going to get $100 million and I don’t know how to get around that,” he said.
The solution should be a single place to access all sizes and types of debt, with exchange-like systems alongside specialist dealers, Smith said. “I want a mall,” he said.
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