Better Data, New Tools Make Municipal Bond Market More Transparent

Traders Magazine Online News, March 1, 2018

Madhura Katre

Despite numerous regulatory efforts for greater transparency, the nature of the municipal bond market remains opaque due to its fragmented nature. While some of the attempts at increasing transparency such as municipal issuer continuing disclosure requirements or near-real time trade data reporting have been effective, even with 30,000+ trades reported daily, publicly available trade data fails to provide meaningful context for price discovery of municipal securities without extensive manipulation. And even though they may appear to be alike, no two municipal bonds are directly comparable due to the innate diversity of municipal issuers. For many investment professionals, it is difficult to establish the relative value of securities in which they wish to invest. The problem is magnified for the end investor.

Existing solutions fall into two broad categories: benchmarks (i.e. yield curves) and indices. Between the two they provide some framework, but do not necessarily equip the investors with a transparent or complete engine to ease their search for value. For example, popular municipal yield curves use polling techniques to establish an opinion of value (rather than observable market data) and do so over a very small slice of the municipal market. One such curve is limited to bonds rated AAA with a 5% coupon, which represent less than 2% of daily trading in municipal bonds. Another uses a single state (Maryland) and bond characteristic (general obligation) as a general guide. While these simplifications are appealing in that they remove complications from the calculations, they do not make for a more comprehensive depiction of the actual market. With today’s large, detailed databases, improved hardware and software techniques for dealing with masses of data, it is time to revisit the need for simplifications that remove available data from calculations.

Indices represent a greater portion of the municipal market and are designed to be broadly inclusive. This inclusive nature means that they will include securities which are not available for purchase. As such, they wholly depend on third party evaluations. And unlike yield curves, indices are primarily used as benchmarks for portfolio total returns rather than facilitating daily trading or investment related decisions by allowing comparisons across bonds at a point in time.

In either case, with current yield curves or indices there is an inherent bias and lack of transparency because neither of the benchmarks are based on actual market observations. What then does the market need?

Emerging technology tools can enable traders and investors to address this problem through a transparent, quantitative and flexible approach utilizing newly publicly available trade data. These state-of-the-art solutions include the fixed coupon investment grade segment of the tax exempt municipal market (representing 80-85% of daily municipal trading activity), and provides what BondWave believes is just the right amount of context to municipal price discovery.

Municipal Benchmarks 

In the contemporary municipal market, predominantly two types of benchmarks influence the determination of general level of interest rates:

• Yield Curves – the term structure of interest rates, representing the relation between yield levels and maturities at a point in time; and
• Bond Indices – a broad rules-based composite used to determine value of a certain bond market segment over time, regardless of the underlying constituent maturities.

For more information on related topics, visit the following channels:

• Fixed Income