Bridging the wholesale – retail market divide

September 9, 2013

One of the most difficult issues related to improving the structure of bond markets for retail investors is that wholesale trading happens entirely apart from retail trading. Retail investors suffer because they pay much higher prices than institutions do. This differs from equities markets where every investor, large or small, can buy a share of Google at the same price at the same time.

In muniland, we have institutional trading platforms like Tradeweb and MarketAxess and retail platforms like Bonddesk and The Municenter that execute “odd-lot” trades or generally those under $100,000. Institutional trading desks and platforms typically execute orders over $1 million and the two pools of trading don’t interact. This structural difference creates two sets of pricing; one with thin spreads for institutional clients and the other with enormous bid/ask spreads for retail clients. 

Two tiered bond pricing differs from the equity market where buyers and sellers of all sizes meet at the same place via the consolidated trade and quote tapes. For equities, institutional and retail size bids and offers flow onto the consolidated tape. These are aggregated by various systems into central order books. You can see all bids and offers at a certain level and their size. This helps pricing for a security remain in lockstep regardless of the trade size. There is no equivalent in muniland or the corporate bond markets. For most of the bond market this would be hard to do because individual securities trade so infrequently. But one part of the bond market is liquid enough to mimic the way equity pricing systems work. This is the $16 trillion U.S. Treasury market, the most liquid bond market in the world.

The Australian government has set up a system, as you can see below, for Australian Government Bonds (AGB) that blends their institutional trading market with their retail market via the Australian Stock Exchange (ASX). The government established a set of regulations for dealers to act as AGB intermediary market-makers between the wholesale AGB over-the-counter market and the ASX. 

In essence an AGB is split into smaller parts, and retail investors buy a “share” or part interest at the wholesale price of the bond. The retail investor receives a prorated share of annual interest and principal when the bond matures. It’s a hybrid solution to the two-tier market problem. 

U.S. retail investors have always lacked any information about spot U.S. Treasury prices in retail size despite the fact that it is one of the biggest securities markets. Since U.S. Treasuries are very liquid I’ve long advocated trading them on the New York Stock Exchange Bonds platform. Maybe the Australian model is worth a try on NYSE Bonds.

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