PMP Lessons Learned

Traders Magazine Online News, December 6, 2017

Paul Daley

Introduction:

On September 1 and August 12, 2016, respectively, the MSRB and FINRA formally applied to the SEC to make mark-up disclosure on retail confirms the law of the land. In the 14 months since, BondWave has been actively engaged in providing a real-time Prevailing Market Price (PMP) solution to automate the required mark-up calculation and reporting function. BondWave has been in regular and on-going dialogue with all three regulators to ensure our understanding and interpretation of the complex set of steps required to calculate a PMP value.

We have also had many meetings with clients and prospects to discuss their needs and the applicability of our solution. As a part of this dialogue we always offer to perform “Proof of Concept” calculations. As a result, we have been engaged by a number of firms and have performed tens of thousands of these PMP calculations.

All of that practice and all of those discussions in advance of the May 14, 2018 implementation deadline has led to a number of important lessons learned.

1. Negative Numbers Are Not Just Possible, They Are Probable.

In performing these calculations over 50,000 times BondWave has found that there is a possibility of deriving a mark-up that suggests a firm has lost money on a trade even when they have not. A typical example involves a firm with no prior position that first buys a bond from one retail client before selling to another retail client. The first trade’s mark-up is calculated by traversing down the waterfall and can lead to negative numbers even in the case where the firm later sold the bond at a profit.

2. The Clearing Firms’ Solutions Are Not Really Solutions, But They Will “Accommodate” Your Solution

Most clearing firms’ trade processing capabilities are not engineered to accommodate a third-party modification of a trade record and most have decided not to perform the calculation themselves. Instead they will permit their clients to manually input a PMP/mark-up, or insist that the proper value is delivered at the time the trade record is delivered. This can be problematic for firms that either wish to, or are required by the rule to, perform full-day PMP calculations.

3. Even Riskless Principal Brokers Will Need a Barrell (i.e. Go Down the Waterfall)

Many firms that mostly trade on a riskless principal basis believe all their PMP determinations will occur at level one of the waterfall. However, as mentioned in the original MSRB filing with the SEC and in the subsequently published FAQs, if both sides of the riskless principal trade, or both sides of a bond that goes into and out of inventory in the same day, involve retail clients then the first trade will require a calculation at a lower level of the waterfall.

4. Time is Not Your Friend (Systems Integration Takes Time)

While solution providers like BondWave may have completed the work necessary to provide PMP/Mark-up calculations, the work of integrating the solutions with front and back office systems is a daunting one. The IT staffs at regulated firms have no open cycles and with year-end technology freezes right around the corner hard decisions to re-prioritize projects cannot be put off much longer.

5. An Extension Will Not Come at the 11^th Hour

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

• Fixed Income
• Regulations