New NASD System Could Alter Bond Trading
November 8, 1999
An electronic system proposed by the National Association of Securities Dealers that would quickly make public most corporate bond trades could have far-reaching effects on the fixed-income trading strategies of institutional investors.
Market impact - the tendency of prices to rise or fall significantly in advance of large block trades - has long been the nemesis of institutional investors in the equities market. Because the market is so efficient in detecting any large appetite to buy or sell shares, institutions often are forced to break up large orders into smaller transactions to mask their true intentions. If trade data were rapidly made public in the corporate bond market - where the number of buyers and sellers is a fraction of that in the public stock market - broker-dealers warn that the effects of market impact would be greatly magnified.
"Compared to the stock market, there are only a handful of investors," said one corporate bond trader. "If people have to report trades within 15 minutes, it's going to affect prices immediately."
The NASD last week submitted a proposal to the Securities and Exchange Commission asking for permission to implement the system, which will ultimately require broker-dealers to report most investment-grade and high-yield corporate bond trades within 15 minutes of completion. If approved by the SEC, the system would be put in place by the spring of 2000, with reporting and dissemination phased in over the next nine months. Trade data including bond description, quantity, price and date and time of execution will then be disseminated to the public via an NASD Web site and third-party vendors.
Corporate bond market sources point out that unlike the stock market, where shares from any company are in the hands of hundreds, or even thousands of investors, issues in the bond market are often held by just a few institutions. In some cases, a single investor holds the vast majority of any given issue.
With that in mind, the rapid dissemination of sizable trades would make it relatively easy for the rest of the market to determine who was buying or selling and adjust their own bids and offers accordingly.
"I'm not sure how you get around that," said one trader. "Even if you break up your trades, it would still be tough to preserve your anonymity."
Of course, the NASD proposal is far from a finished product, with the SEC's review process and the public comment period still ahead. And even in the current version of the plan, the NASD intends to assess the system's impact on market liquidity in the months following implementation.
Beyond Simple Reporting
NASD officials could not be reached for comment before press time last week, but other bond market players note there is more to the proposed system than simple trade reporting. Broker-dealers will enter trades into the NASD system via the Trade Reporting and Comparison Entry Service (TRACE), a new facility of the Nasdaq Stock Market. (TRACE and the new system will replace the current Fixed Income Pricing System, which collects trade reports on some high-yield securities.)
In a letter to members of the Bond Market Association, that group's chairman, Nelson Civello, describes TRACE as "a mandatory electronic facility that would allow reporting firms to enter executed trades in corporate bonds and have these trades available for trade reporting, matching and clearing." Civello goes on to write, "In many respects, TRACE is apparently designed to facilitate anticipated industry efforts to achieve next day (T+1) settlement."
The Bond Market Association, in response to SEC Chairman Arthur Levitt's call for increased price transparency in the corporate bond market, launched its own trade reporting system, Corporate Trades I (www.investinginbonds.com), earlier this year. Working with GovPx, the system provides anonymous price information and other data relating to investment-grade corporate bond transactions provided by leading inter-dealer brokers.