In today’s top story, SEC Chair Mary Jo White is calling for more transparency in the corporate bond market. In fact, many of the recommendations would make the bond market function like our equity markets.
Ironic, isn’t it? For the past few months, since the release of Michael Lewis’ Flash Boys, equity market structure has been the punching bag of the financial sector. This is especially true for liquidity providers and broker dealers, who tend to use the last generation of regulatory structural changes (i.e. maker-taker pricing, payments for order flow and low-latency advantages) to aggressively compete for orders. Now the SEC is calling for pre-trade transparency, technology-based competition for orders, electronic quote streaming, etc., just like the now-vilified equity market.
The concern is that the opacity of the bond market is hurting smaller investors, who do not have access to multiple dealers and thus have no choice but to accept the dealer’s quote and hope it is fair. There has been concern that spreads have gotten more egregiously wide in recent years.
This would seem the ultimate irony – dealer spreads are widening as a likely result of the new regulations, which have put new controls on dealers’ ability to hold positions, as well as placed new capital restrictions and collateral requirements on dealers. Historically, dealers have competitively priced bonds because they kept sizable inventories of the most traded bonds. As the Volcker Rule, Basel III and other dealer rules kick in, dealers must actively work the street to find the other side of an order.
In other words, liquidity has fallen, dealers have become brokers, and the market is in need of a platform that will aggregate liquidity and encourage participation of market makers who can aggressively compete on price. White is calling on the bond market to be more like the stock market, just as many have been calling for the stock market to disincentivize these same basic liquidity functions.
A conundrum indeed.