The European Commission is reviewing pre-trade and post-trade transparency in the bond market. Frances Maguire asks if the bond market’s self regulation could prevent mandatory transparency requirements, similar to the equities market.
Currently, the Markets in Financial Instruments Directive (MiFID) applies to all asset classes, including bonds, except in the price transparency area where it only applies to equities, although EU regulators do have the flexibility to extend those provisions to bonds.
As required under MiFID, the European Commission has begun to consider whether to recommend a similar regulatory approach to pre-trade and post-trade transparency for bonds and derivatives. It will issue a draft report by June 30, followed by a public hearing in July. Consultation will close in September and the commission’s final report will be published on October 31, 2007.
A senior industry source says: “It is generally accepted that any further pre-trade transparency in the bond market could be counter-productive and could even decrease the market liquidity. It is not clear-cut if there is a need for more post-trade transparency and, if so, to what extent it can be achieved without damaging the market.”
Detrimental transparency
The numerous trade associations representing the banks and brokers in the bond and capital markets that have responded to the commission’s Call for Evidence are arguing that, although the investment advice and best execution provisions of MiFID are applicable to the bond markets, mandatory price transparency would be detrimental.
Bertrand Huet-Delaherse, executive director and European legal and regulatory counsel at the Securities Industry & Financial Markets Association (Sifma), says: “Based on the existing levels of transparency in the bond market at the moment, which we think are fairly high – based on how transparency has developed over the years through an increase of electronic trading and industry initiatives – we believe the case is not strong enough to bring in price transparency regulations.”
He also points to the findings of two independent academic studies commissioned from the Centre for Economic Policy Research jointly by a number of trade associations. Professor Bruno Biais of the University of Toulouse led the research on corporate bond markets and concludes that imposing pre-trade transparency via regulation would be risky because it would require significant changes to the microstructure of the market, and that greater post-trade transparency would benefit some market participants but should be designed and implemented carefully and be market-led if possible. Professor Richard Portes of the London Business School led the research on government bond markets and concludes that the regulatory imposition of greater transparency could adversely affect liquidity in the government bond markets.
Mr Huet-Delaherse says: “In certain countries, such as Italy, there is a lot of retail involvement in the bond market. But, overall, the European bond market is an overwhelmingly institutional market and institutional investors have a significant amount of price transparency already available to them.
“We recognise the fact that access to price information for retail investors is more difficult, which is really the only valid argument that has been put forward for the need for greater transparency. We and other associations are looking into industry-led ways to improve this, perhaps along the lines of the US retail investor service – www.investinginbonds.com – that Sifma runs in the US. We are in favour of transparency but not at the expense of liquidity.”
Co-ordinating efforts
Much of the bond industry’s efforts are being co-ordinated by the International Capital Market Association (ICMA), a trade association for capital market users as well as being an international securities self-regulatory organisation and a designated investment exchange.
According to ICMA, which has joined forces with several other trade associations, there is already a high degree of pre-trade transparency and it does not see the need to extend the MiFID provisions for transparency in equity markets to bonds. In its submission to the Committee of European Securities Regulators, it argues: “Mandated post-trade transparency is unlikely to be an effective regulatory protection for ‘buy and hold’ execution-only retail investors.”
Kevin Milne, managing director of ICMA Ltd, says that the bond market, especially Eurobonds, is still predominantly a voice-traded, over-the-counter (OTC) market.
He says: “Most of the equity and FX markets are electronic and, as a result, where an electronic trade confirmation system used to be the last part of the trading process, it is now becoming the first part of the settlement process. But in an OTC market, where it is predominantly a principle-based market, most of the trading is voice so the matching is still an incredibly important part of the trade because it is the first time that both counterparties have a shared electronic version of the trade.”
TRAX2 is ICMA’s post-trade, pre-settlement, trade matching and regulatory confirmation system. It is designed to assist financial institutions in meeting their regulatory reporting requirements under MiFID, in addition to allowing them access to new repo matching capabilities for the first time.
New rules afoot
ICMA’s rulebook already requires market makers to report end-of-day prices and to report their trades to ICMA within 30 minutes. This trade information is not currently published but ICMA is in consultation with its members over wholly new levels of self-regulatory, post-trade transparency for the bond market, such as publishing end-of-day trades in large, liquid bonds and a web-based service for retail investors. The latter could include educational material about investing in the bond market and give users access to a near real-time tape of retail sized trades. Such proposals would enhance the current daily end-of-day data on prices and volume available through ICMA and would also significantly increase the level of information available to retail investors.
Initially, MiFID made no distinction between equities and bonds but it is obvious that they are markedly different from a trading, settlement, risk and market structure perspective.
Mr Milne says: “MiFID is about reducing risk and providing market integrity. There is no evidence of systemic failure or risk in bond markets where there is in equity markets. The problems that MiFID is driving out of the equity markets are all about harmonisation of practice and process because equity markets grew up as national markets.
“The way the bond market works today is immeasurably more consistent with MiFID than the equity market. The bond market already has a common standard. MiFID will have a less profound effect on the bond market.”
It is difficult to know if the directive would look different if it had been designed for the bond market first, and applied to the equities second, but the directive was probably applied in this order because of the higher levels of direct retail participation in the equities market.
Opening up market
Bonds are not only priced differently, but they are also traded less frequently than equities, with much of the retail participation from indirect investment, through funds. It could be argued that as much as providing best execution, the focus has shifted to opening up the bond market to higher levels of direct retail investment – which is a different issue.
However, Mr Huet-Delaherse states that all have the same goal in sight, but that the intrinsic differences in the two markets are very relevant. “There is a desire to reach a pan-European solution but it is complex because the bond market is decentralised, with no one pool of liquidity, and mainly over-the-counter, so there are many different sources of information,” he says.
