A Step Closer to a Fixed-Income NBBO

Will a new FINRA pre-trade transparency proposal lay the ground work for establishing a consolidated tape for the corporate bond market?

A modestproposal made by the Financial Industry Regulatory Authority (FINRA) aims to have fixed-income alternative trading system(ATS) operators to submita weekly reportthat containsall of their quotation data for TRACE-eligible corporate and agency debt-securities to the regulator.

Such data would help FINRA better surveil the growing electronicfixed-income market, especiallyretail trades, according Robert Colby, the chief legal officer at FINRA.

We would love to have this information, he said when speaking the Investment Company Institutes capital markets conference.We do not get them now, so we are not super familiar with it. Weve gotten it in batches at times but are not familiar with it enough to know how to work it into our surveillance system, which is our primary line of interest.

FINRA officials declined to comment on the proposal further citing that it was still out for comment at press time.

According to the proposals text, FINRA would notdisseminate the ATS-provided data publicly and useit solely for regulatory and surveillance purposes. However the text also states that FINRA may analyze the data for the potential value and feasibility of publicdisseminationin the future.”

When a fellow panelist pressed Colby whether this proposal might lead to a nationalbest bid and offer (NBBO), he responded coyly with his personal opinion: You tell me.”

Retail Cornerstone

Changing a markets structure to protect retail investors is far from a new for US regulators. As the cash equities markets adopted automation, regulators made sure that retail investors reaped the same benefits as professional investors of tightened spreads and increased competition.

However, retail investors are experiencing the opposite in the corporate-bond market in the past year.

According todata fromBank of America Merrill Lynch the composite spread for AA-AAA and BBB-A industrial bonds increased lastyear.At the end of 2014, the spreads ofinvestment-grade corporatebonds increased 15.1 percent, to 61 basis points (bps) from 53 bps, since the end of 2013.Thespread on high-yield corporate bonds similarly increased 13.6 percent, to 142 bps from 125 bps, over the same period.

Imconcernedthat in the fixed-income market, technology is being leveraged simply to make the old, decentralized method of trading and moreefficient for market intermediaries, and its potential to achieve more widespread benefits for the broad availability of pre-trade pricing information, lower search costs, and greater price competition, especially for retail investors is not being realized, stated Securities and Exchange Commission (SEC) Chair Mary Jo White, in a speech to the Economic Club of New York on June 20, 2014.

Prior to heraddress, Chair White instructed SEC staff to focus on a regulatory initiative that would enhance the public availability of pre-trade pricing information for the fixed-income marketthat would require public dissemination of best prices generated by ATS platforms and other electronic dealer networks in the corporate and municipal bondmarkets.

This potentially transformative change would broaden access to pricinginformation that is available only to select parties, she added.

Under FINRAs proposal,which it published in February, the regulator would require ATS operators to submit all real-time and delayed quotation data and updates that are displayed to a platforms general subscriber or a subset of subscribers.

Such data would include: the identity of the party submitting the quote; whether the party is actings an agent or a principal; the instruments CUSIP identifieror FINRA symbol;whetherthe quote is to buy or sell the instrument; the quotes time, data, and, if applicable, duration; if there is an actual on minimum associated with the quote; the quotes yield or spread to benchmark and relevant benchmark information; the quote as it was submitted to the ATS and displayed to ATS subscribers; where the quote is subject or firm and whether it has been modified or canceledas well as the date and time it was modified or canceled if itis applicable.

After gathering thisweekly information, affected ATS operators would need to submit it to FINRA by the end of the following week.

This might not be as much data as one thinks as the proposal covers ATS platforms that display resting quoteslike Tradeweb DirectandMTS BondsPro (nee Bonds.com).Electronic fixed-income markets that use a request for quote(RFQ) methodology, such as Bloomberg, MarketAxess,and Tradeweb Direct, which acquired BondDesk in 2013.

A Cracked Foundation

Industry insiders like Thomas Urano, principal and managing directorat Sage Advisory, see FINRAs desire to better surveil the corporate-bond market as the right thing to do, but questions how useful the data that regulator proposes to collect will be.

Im not sure it will provide meaningful information for how corporate bonds are priced and traded, he explained.

By collecting only resting electronic orders, FINRA proposal omits the vast volume of corporate-bond trading volumes, Urano added. The vast amount of our corporate-bond trading is done through dealers or electronic-RFQ platforms. Less than 1 percent of our corporate-bond notional volume trade on odd-lot platforms.

Sages execution strategy falls in line with the rest of the market.

Anthony Perrotta, principal, head of fixed income research at Tabb Group, estimates that only 16 to 18 percent of the notional turnover in the institutional corporate bond market could be attributed to some form of electronic trading. Of that minority volume, he believes close to 95 percent of it represents electronic RFQs while the remaining 5 percent are resting orders.

According to rival industry analyst firm Greenwich Associates’ 2014 annual fixed-income survey of institutional investors, 80 percent of the respondents execute trades for investment-grade corporate bonds electronically and 43 percent of them say they execute trades for high-yield corporate bonds electronically. However, these trades only represent notional volumes of these trades represent 16 percent and 4 percent of their overall notional volume respectively.

To be fair, retail orders are traded much more electronically than theinstitutionalside, said Kevin McPartland, principal, market structure and technology at Greenwich Associates.

Not only would the relatively small notional amount of corporate bonds trading on order-driven ATS platforms compared to RFQ platforms skew potential results, but Sages Urano also questions the quality of the quotes.

Retail-sized trades are notoriously off-market on one-side or the other for a couple reason, Urano adds.

One reason is that traders typically post much wider spreads for retail orders.

If someone wants to transact at one-side of the spread, that is perfect for the party posting the quote since there is a huge spread built into the quote, Urano explained. It is more likely, however, that they would negotiate directly with the quotes poster to negotiate what the correct price should be.

Secondly, platforms that allow subject quotes along with firm quotes only muddy the water when parties seek a consensus price.

If you put up a subject quote and know that youll never have to stand behind it then can paint the market one way or another, Urano added. If you go to the odd-lot market to tell you what a price is, you will be way off base.

It would be too much of a stretch for FINRA to use this data to set up a NBBO, agreed McPartland. Itdoesnt include RFQs, which is most of the institutional market, and the reporting is a week delayed. In principal, what FINRA proposes makes sense, but I dont see it being majorly impactful.

Yet, he argues that there is need for a protocol on determining the current price of corporate bonds. In some ways, a bonds price is in the eye of its buyer or seller. There needs to be a feedback loop when it come to e-trading corporate bonds.

Urano believes that FINRA already has the necessary tools and data to observe and price corporate bonds.

“Looking at the history of execution data in TRACE data, you can garner a lot of things like the liquidity of individual bonds,the spread of individual bondsand you should be able to get a sense on how individual bonds trade on institutional basisfor the retail level by parsing prices and sizes in that TRACE history.