The SEC is holding a Fixed Income Roundtable on April 16 to examine ways to improve the transparency and efficiency of the fixed income markets. This is the first time that I am aware of that the SEC has focused exclusively on the market structure of fixed income. Although fixed income as an asset class is over twice the size of the equity market, and the SEC was given authority in 1975 to oversee this market, almost nothing has been done to regulate it.
All US bond trading is done over the counter or through alternative trading systems (ATS), which are trading platforms registered as dealers. ATS do not have responsibility to oversee the conduct of the other dealers trading on their platform. Think of them as fancy eBay systems for dealers to interact with each other. Rule 300(a) of the SEC’s Regulation ATS provides the following legal definition of an “alternative trading system”:
Any organization, association, person, group of persons, or system:
That constitutes, maintains, or provides a marketplace or facilities for bringing together purchasers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange within the meaning of Rule 3b-16 of this chapter; and That does not:
1 Set rules governing the conduct of subscribers other than the conduct of such subscribers’ trading on such organization, association, person, group of persons, or system; or
2 Discipline subscribers other than by exclusion from trading.
Retail investors have access to a number of fixed income ATS like Bonddesk and Municenter through online brokers like eTrade. But the rules regulating ATS do nothing to protect a retail investor who uses an introducing broker via the ATS. Since the retail investor is “self directed,” the introducing broker has no responsibility for “fair dealing” to them either.
As it is set up now, retail-directed bond trading either goes through an ATS where prices are pooled, or the investor must choose a specific bond and call a number a dealers to request a price. They then need to establish an account to purchase the security. Efforts aimed at improving pre-trade transparency might give the retail investor some reference data to make price comparisons, but (page ix) they would require the investor to visit EMMA or rely on their broker to have comparative prices. Having pre-trade data in a different location from an execution venue will likely prove a hurdle for direct investors and make comparison shopping more difficult. The best solution for retail investors is to have pooled trading where real time pricing and investor protections are a part of the structure.