The average investor does not get very far when trying to buy a bond in today’s municipal and corporate fixed income markets. Some may find it difficult to find the exact bond they want to purchase, while many grow frustrated with the lack of transparency in bond pricing. Contrasted with the equity markets, where information seems to be at anyone’s fingertips at any given moment, bond markets continue to operate under a decentralized model, where dealers seem to control the flow of information and, ultimately, the market participants. The U.S. Securities and Exchange Commission (SEC) wants to change how bond trading works, and Wall Street should take notice.
On June 20, 2014, in a speech entitled “Intermediation in the Modern Securities Markets: Putting Technology and Competition to Work for Investors,” SEC Chair Mary Jo White focused on the issues of technology and competition, and particularly on how they influence “intermediation” in the securities markets. Ms. White defined intermediation as simply the services provided by brokers, dealers, and exchanges to execute buy and sell orders of investors. Her overall message was clear: The SEC’s efforts to improve efficiencies in intermediation in the equities markets have led to widespread benefits for all investors, and it’s time for those same efficiencies and benefits to be realized in the municipal and corporate bond markets.
Ms. White explained that bond markets today operate essentially the same as they did several years ago. She expressed concern that technology seemingly has been used to increase efficiencies for market intermediaries in the “old, decentralized method of trading” and not leveraged to benefit retail investors. Efforts to change that could provide everyday bond investors with increased availability of pre-trade pricing information, decreased search costs and greater price competition.
To help address her concerns, Ms. White announced the following new initiatives the SEC will undertake:
- Assist the Financial Industry Regulatory Authority (FINRA) and Municipal Securities Rulemaking Board (MSRB) to finalize a “best execution” rule for the municipal securities market and develop practical guidance for brokers to achieve best execution;
- Work with FINRA and MSRB to develop rules by the end of the year to require disclosure of markups (i.e., dealers’ compensation) in “riskless principal” transactions for both municipal and corporate bonds, which should help investors better understand the cost of bond transactions; and
- Focus on a regulatory initiative to increase the public availability of pre-trade pricing information and require the dissemination of best prices by electronic dealer trading networks in the municipal and corporate bond markets.
These announcements come only two weeks after Ms. White announced the SEC’s intention to strengthen equity markets by reviewing the fairness of trading in high-speed markets, enhancing trading venue regulation, and mitigating broker conflicts.
The move by the SEC to strengthen competition in the bond markets could significantly impact the advantages enjoyed by many large dealers. It’s certainly easy to imagine how more information related to the supply and demand of certain bonds could lead to increased interest in bond securities by smaller investors and, ultimately, more competition in a profitable dealer business. But these regulatory initiatives target only a portion of the overall bond market, and any regulation may stifle trading and leave the normal bond market players to enjoy an effectively unchanged environment. Time will tell how the SEC’s moves impact an important segment of the bond markets.