There’s ample reason for concern that “broken” bond markets are the new norm. The Securities Industry and Financial Markets Association tallies $38 trillion globally in U.S. fixed income/bond debt outstanding of which American markets account for roughly 40%. Bond market volumes initially shrank after the 2007-08 credit crisis (see “Not back yet,” below). The Federal Reserve took on responsibilities as key buyer of both U.S. Treasury and residential mortgage-backed instruments (RMBS).
As the Fed steps back from its extraordinary intervention addressing the liquidity drought, it is not yet clear that a liquid market for U.S. Treasuries, seasoned corporates, or RMBS will recur. Insurer and pension fund investment portfolios are primarily invested in these securities. Thus, illiquid markets (e.g., an inability to clear these credit risks) pose threats to the insurance and pension fund sectors and could trigger systemic financial risk among and beyond systemically important financial institutions.
At the end of September, industry leader BlackRock ($337 billion under management for an estimated 200 insurers in 28 countries) published a white paper contending that corporate bond markets are broken (see “Time to reform corporate bond structure,” here).
BlackRock proposes new structures and executions for corporate bonds, including:
- An “all to all” market structure, modifying the incumbent bilateral dealer model,
- Multiple electronic trading protocols, moving beyond request for quote or central limit order book standards,
- Standardization of newly issued corporate bond features, and
- New participant behavior.
BlackRock Vice Chairman Barbara Novick and her colleagues are sounding a clarion call drawing attention to corporate bond markets in the context of zero lower bound FED debt management should corporate bond markets continue to atrophy or, in fact, deteriorate catastrophically.
Within a week of the white paper, the Financial Times cautioned, “Start getting ready for the corporate bond crash.”
Separately, Securities and Exchange Commission Chair Mary Jo White wants results on best executions in corporate and municipal bonds and disclosure of markups in “riskless principal” corporate and municipal bond transactions.
“[In] the fixed income markets, technology is being leveraged simply to make the old, decentralized method of trading more efficient for market intermediaries, and its potential to achieve more widespread benefits for investors, including the broad availability of pre-trade pricing information, lower search costs, and greater price competition—especially for retail investors—is not being realized,” says White.
She is tasking the Financial Industry Regulatory Authority (Finra) and the Municipal Securities Rulemaking Board (MSRB) to reach solutions.
Fortunately, an innovative technology is at hand for all these and many more elements to transform finance.