Wall Street’s Bond Transparency Letters Are Revealing

(Bloomberg Opinion) -- In most bond-market battles, if BlackRock Inc. and Pacific Investment Management Co. are on the same side, it’s a safe bet to assume they’ll come out victorious. After all, the two behemoths oversee about $9 trillion in assets combined and loom large in both actively managed fixed-income mutual funds and exchanged-traded funds.

However, their push to delay reporting of large corporate-bond trades was so audacious — and against the grain of just about every other move toward transparency across markets — that it seems to have left the Financial Industry Regulatory Authority with little choice but to side against them, at least for the moment.

As a reminder, Finra in April proposed a pilot program that would give bond traders 48 hours to disclose large block trades to other investors instead of the 15 minutes required under current rules. The initiative, as I wrote at the time, would serve to provide some empirical evidence in the debate about the trade-offs between bond-market liquidity and transparency. The regulator held an open comment period for a few months, during which it received 31 letters. I inquired about the status of its proposal in late October and was told there was no update.

Well, there is now. Bloomberg News’s Ben Bain, citing two people familiar with the matter, reported Wednesday that Finra informed the Securities Industry and Financial Markets Association that the study had been put on the back burner, pending further discussions with the Securities and Exchange Commission and a bond advisory panel called the Fixed Income Market Structure Advisory Committee. Finra spokesman Ray Pellecchia told Bain, “we’re continuing to review the comments received and consider potential next steps.” But at the very least, it seems the plan has hit a wall.

It takes only a quick glance at the comment letters to Finra to understand why. There’s real concern that this proposal was an attempt by the biggest investing firms to tilt the playing field to their advantage and that of large dealers.

This passage from Federated Investors, for example, summarizes the general sentiment:

The 48 hour delay appears to be intended to accommodate the circumstances of the largest buy-side participants in executing large trades. This may simply reflect the possibility that these institutions have reached their capacity limit in managing fixed income funds. The 48 hour delay would therefore improve liquidity for these institutions while impairing market efficiency for other market participants. This is per se contrary to the SEC’s statutory missions of promoting competition and market efficiency.

The purpose of reapportioning this transactional cost is not to significantly improve liquidity, but rather to provide a relief valve for the largest asset managers in the U.S. corporate bond market… market structure should not favor large traders to the detriment of smaller traders.

As far as Finra comment letters go, that’s quite spicy. For some context, Federated manages about $527 billion of assets overall. BlackRock has $565 billion in just its fixed-income iShares ETFs, to say nothing of its actively managed bond funds and other investment options. BlackRock expects that number will reach $1 trillion within the next five years, Chief Executive Officer Larry Fink said last week in an earnings conference call, calling the bond ETFs “a modernizing force in financial markets.”

The backlash doesn’t stop there, though. T. Rowe Price Group Inc., which has twice as many assets as Federated at $1.12 trillion, also cautioned against carrying out the pilot program:

The 48-hour delay would create an unlevel playing field in the fixed income markets because it would only apply to the most sizeable trades. As a result, the largest investment advisers and broker-dealers would have an information advantage over other market participants when negotiating trades, effectively creating a two-tier system of haves and have-nots.

Let that sink in for a moment. A trillion-dollar investment firm is concerned about “have-nots.” T. Rowe either believes that a two-tier system would be bad for the corporate-bond market as a whole or that it would be at risk of becoming a “have-not” itself.

Still, the biggest dagger to the heart of the pilot program might have been from Vanguard Group Inc. and its $5.6 trillion in assets under management. “The Proposed Pilot is a harmful solution to an unsubstantiated problem,” the letter signed by Chief Investment Officer Gregory Davis said. “We routinely trade corporate bond blocks much larger than the current dissemination caps and... have observed that liquidity for corporate bond block trades has generally improved over time.”

Citadel LLC and AQR Capital Management also voiced opposition. Citadel faulted some members of the SEC’s advisory committed for simply asserting that bond trading would improve despite “little evidence to suggest that the Proposed Pilot will meaningfully improve liquidity conditions.” That’s similar to how AQR put it:

While we are strong supporters of making policy decisions based on the type of data-driven analysis afforded by pilot programs, the reality is that all pilots are disruptive to the workflow of market participants and thus have inherent costs. In order to justify imposing such costs on the marketplace as a whole there should be clear evidence that the changes being tested have at least a reasonable likelihood of achieving the desired outcome. We do not believe that the Proposed Pilot meets this basic standard.

Of course, this argument presents something of a Catch-22. The reason there’s no evidence that delayed disclosure of large corporate-bond trades improves overall liquidity is because it hasn’t been tested. And without trying it out, there will never be the empirical data needed to get a program like this off the ground. 

For this reason, I’m not sure I’d entirely rule out the possibility of some sort of corporate-bond experiment, even if the details aren’t quite the same as the earlier proposal. A person familiar with the matter told Bain that Finra could still make changes and go forward after consulting with the SEC.

Overall, though, the comment letters reveal real concern — and borderline fear — about what might happen to the bond market if big investment managers are afforded even more power when they’re already gobbling up ever-larger shares of just about every asset class. One firm even went so far as to say that hiding block trades creates “the potential for many victims.” That alone should be enough to give Finra pause.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.

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