Can fixed income markets be regulated?

February 28, 2013

The SEC has announced that it will hold a Fixed Income Roundtable on April 16 in Washington to discuss improving the transparency and efficiency of fixed income markets. This news is welcome and long overdue. As I wrote in a comment letter to the SEC in 2008 (emphasis mine):

Former SEC Commissioner Laura S. Unger in a speech to the Bond Market Association in 1999 addressed the [SEC’s] role in facilitating a fair market structure for fixed income investors.

…In adopting the 1975 Amendments to the Securities Laws, Congress gave the Commission the authority to facilitate developing a national market system for securities.

Not just equities, mind you, but all types, including fixed income securities.

Congress recognized that many of the goals of a national market system were universal ones, such as transparency of quote and trade information, giving investors the opportunity for best execution, self-regulatory coordination, and strengthening Commission oversight of the markets.

At the same time, Congress made clear that it didn’t intend for the Commission to force all securities markets into a single mold. The Commission was to classify markets and take into account the differences among them in achieving the goals of a national market system…

No, fixed income markets will never have the same market structure as equities. Commissioner Unger identified the key areas of the fixed income markets that needed improvement:

  • Transparent quote and trade information
  • Best execution
  • Self-regulatory coordination
  • Strengthened Commission oversight of the markets

We have had tremendous gains in trade transparency since Unger made her 1999 speech. For municipal bonds we have the RTRS system that publicly reports trade prices on the MSRB’s EMMA system. In the corporate bond space, TRACE collects and disseminates trade prices for corporate bond, agency and MBS securities (TRACE only publicly reports corporate bond trades). All trades from both systems are reported on a 15-minute delay. To reach more of a national market system, these reporting times will need to be improved so that market participants have adequate market signals to do new trades.

Unger went on in her 1999 speech to promote the value of electronic trading for fixed income:

First, electronic trading technology is cost-efficient, both in the sense that it lowers start-up costs for new systems and reduces continuing operating costs substantially.

Second, electronic trading technology changes the dynamics of the marketplace by removing physical constraints such as geography and the number of participants in a market.

Third, electronic trading technology has a great potential for disintermediating the markets, allowing buyers and sellers to meet directly.

Finally, electronic trading technology has blurred the distinction between broker-dealers and exchanges.

Electronic trading for fixed income is already widely adopted at all levels: inter-dealer, dealer to client and retail platforms. The SEC’s focus must be on defining and overseeing this emerging market structure. Regulating the over-the-counter fixed income market would be fighting the last war.

FIX Protocol, which oversees the industry-wide language for electronic trading of securities, recently released its latest specifications for fixed income. This is a useful primer for regulators to see the bones of the growing electronic fixed income market. The protocol doesn’t dictate how traders would seek best execution, but it does explain the language that traders use to speak across platforms.

SEC Chairman Elisse Walter has already laid down some markers for increasing pre-trade transparency, and I laud her for these far-reaching efforts. Retail bond investors need protections, and there are very few in place. The SEC had been aware of these issues in the bond markets since Congress gave it authority to oversee these markets in 1975. It’s time now to begin the process of better protecting investors.

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