OSC wants a more transparent fixed-income market

When he started in the bond business nearly 20 years ago, James Price used to clip out the Monday markets page of the Globe & Mail and keep it at his desk. “I didn’t do it to see the prices,” says Price, director of Capital Markets Products at Richardson GMP in Toronto. “But I wanted to know what our clients were going to be saying when they phoned in to trade bonds.”

While technology has since improved information flow, the OSC urges faster progress in its recent report on the state of the Canadian fixed-income market and in OSC Staff Notice 21-708—OSC Staff Report on the Canadian Fixed Income Market and Next Steps to Enhance Regulation and Transparency of Fixed Income Markets.

“With this report, we have compiled research that confirms our focus on enhanced post-trade transparency and regulation of the fixed-income markets in Canada,” Howard Wetston, chair and CEO of the OSC, said in a statement.

“Our priority is to develop regulation that will promote more informed decision-making for market participants regardless of size, improve market integrity and ensure the market is fair and equitable to all investors.”

The report notes the fixed-income market is dominated by large issuers and institutions, with little direct participation from retail investors. Even electronic trading, the OSC admits, hasn’t changed this situation.

Benjamin Bathgate, a partner in McMillan LLP’s commercial litigation group, says the regulator needs to find more robust technological solutions to empower retail investors. “That’s still obviously what’s missing.”

So, what’s the holdup? “The structure of an equity market is pretty simple,” says Price. “Everybody comes to the same place to trade on an exchange.”

It’s much different with bonds. When a retail investor knows what bonds she wants to buy, she can get them online through one of the bank trading sites. “That’s really what an over-the-counter network is,” says Price. “Rather than selling to another investor through a medium like a stock exchange, you’re actually going to be selling your bonds to or buying your bonds from the dealers you deal with.”

In this inter-dealer broker system, the bank can sell an investor a bond from its inventory or through its network of dealers. “Over the years,” says Price, “that’s caused a lot of angst for investors, because between that and the lack of transparency, where there’s no exchange with listed prices, a lot of investors have come to say, ‘Well, we’re relying on the good graces of the dealer to make sure pricing is fair, because in theory, they could charge anything they wanted.’ ” Investors also don’t know what commissions they’re paying.

Says Bathgate: “There’s very limited data on retail bond holdings in Ontario. We just don’t have the pre- and post-trade information we have on the equities market. Regulators need to resolve information problems before they can regulate them.” That’s why the OSC’s next step is to gather information to better define the issue.

Without a TRACE

There’s a growing consensus that Canada’s falling behind the U.S. and Europe, says Bathgate, echoing the OSC’s concerns. For example, since 2002, the U.S. has been using the Trade Reporting and Compliance Engine (TRACE), which posts information on over-the-counter transactions. Price says the OSC wants a similar system, where the big dealers report their bond transactions, and post-trade reports get published on services such as Bloomberg. “You might not be able to see a live price you can purchase or sell at, but what you should see is a recently traded price so that you can determine whether the price you’re being offered by your broker is in line.”

There have been attempts to create such systems in Canada—CBID, for example. It’s a kind of bond exchange, where dealers can view live fixed-income price and yield information. It facilitates transactions between these dealers, but stops short of offering a platform where retail investors can buy and sell. It’s unlikely a new system will get any traction unless the OSC steps in, says Price, since the major bond dealers—the big banks—have no apparent incentive to change.

Bathgate notes it’s cheaper to sell to institutional investors, who purchase more bonds than retail clients. Research costs are lower, and institutional investors hold their bonds for longer. And launching a reporting or trading system would be a huge project. “There’s all kinds of reporting technology that would need to be in place to build that [trading] system,” warns Price.

Tech is key?

Price is still confident Canada will get a TRACE-style system. “What I’m unclear on is whether that ultimate trade system will be something retail clients have immediate access to.” Say the data needs to be accessed through a Bloomberg terminal: “Most retail clients aren’t going to spend the [US]$2,000 a month.”

And few retail traders are sophisticated when it comes to bonds, which can have highly complex terms. “If you’re looking at the wrong one [because of a] remote detail—say a strip bond that matures in December 2018 instead of June 2018—the price doesn’t help you. The retail client must know exactly what they’re looking at.”

Bathgate is optimistic that technology can level the playing field for retail investors. “You need to empower the retail investor and give them the tools they need to be more active, informed and sophisticated,” he says. “I think there is potential.”

He adds the OSC is already overseeing the implementation of IIROC rule 2800C, which calls for all over-the-counter debt securities or inter-dealer bond broker transactions to be reported on a post-trade basis, starting November 1. “That’s going to give surveillance-type information to the OSC and will inform the next step they take.”

Price agrees technology has and will continue to give retail investors more transparency with bonds. What hasn’t changed, he says, is the general lack of interest among retail clients in paying close attention to the bond market.

by Allan Tong, a Toronto-based financial journalist.