There is great debate about the CSA's plans to improve transparency in the notoriously opaque fixed-income market

By James Langton | December 2015

THE BUY AND SELL SIDES represent opposite ends of the Street, but rarely are their interests as diametrically opposed as they are on the issue of regulators' efforts to shed more light on the murky world of bond trading.

In September, the Canadian Securities Administrators (CSA) laid out its plans to improve transparency in the notoriously opaque fixed-income market. On the heels of stepped-up regulatory oversight, the CSA is looking to provide the public with trading data, too. (Major bond dealers had to begin reporting their trades to the Investment Industry Regulatory Organization of Canada [IIROC] as of Nov. 1, and all dealers will have to report their trades to IIROC starting in November 2016.)

Under the CSA's proposal, IIROC will utilize the data that it is collecting in the service of market surveillance, and IIROC will release some of these data to the public - starting with specific bonds by mid-2016 and extending public reporting to all debt securities by the end of 2017.

With IIROC acting as the "information processor" for the bond market, the CSA is considering whether to extend reporting requirements to exempt-market dealers, which don't ordinarily fall into IIROC's regulatory orbit, to capture a more complete picture of trading activity.

If the regulator goes ahead with these plans, that will represent a major shift for the Canadian fixed-income market, which has long suffered from a lack of comprehensive trading data, which, in turn, translates into a severe shortage of market power for investors, particularly retail investors.

According to an Ontario Securities Commission report released in April, the data that currently are available on fixed-income trading in Canada are "limited and fragmented"; and the bond market itself "is a decentralized, over-the-counter market where large investors have significantly more bargaining power than small investors."

That said, even large investors see themselves as being at a disadvantage when dealing in the Canadian fixed-income market. For example, Invesco Canada Ltd.'s comment on the CSA's proposals notes that fixed-income dealers can generate "excess profits due to information asymmetry" in the fixed-income market; and these excess profits are made solely at the expense of the buy side.

Thus, buy-side firms are emerging as some of the most vocal supporters of the CSA's efforts to improve market transparency in the hope that this will reduce the dealers' advantage and ultimately bring down costs for investors.

Conversely, the dealers have significant concerns with the regulator's plans. However, the probable negative impact on their bond trading margins is not one of their stated objections. Instead, they suggest increased transparency will hamper liquidity, as dealers may pull back from the market for fear that increased transparency will reveal too much about their holdings and enable other traders to take advantage of that information. This could reduce liquidity, the dealers warn, in a market that is already liquidity-challenged.

But while these dealers' concerns might be taken with a grain of salt, they may not be wholly unfounded. According to research published by a trio of U.S. academics in 2013, the effort to bring transparency to U.S. bond markets did significantly improve prices for all bonds, but also led to a significant decrease in trading activity for some types of bonds, particularly high-yield bonds, which were relatively illiquid to start with.

The CSA is well aware of concerns about the possible impact on liquidity by improved bond market transparency, so the regulator's proposal includes a couple of measures designed to mitigate the negative consequences for liquidity. There will be a delay in disseminating the data, and volume caps will prevent the actual size of large trades from being reported.

Despite these measures, a comment from Investment Industry Association of Canada (IIAC) warns that the CSA's proposed approach still could lead to loss of liquidity. In particular, the IIAC comment warns, dealers will be "less likely to engage in transactions of highly illiquid corporate bonds for clients" if regulators go ahead with a model that treats all corporate bonds the same.

Alternatively, the IIAC comment suggests the CSA could exclude certain illiquid securities from the transparency requirements altogether; or the regulators could consider mandating a longer delay before trades in these sorts of securities are reported publicly.

This idea of allowing a longer delay between a transaction and when it is reported publicly - which the CSA proposal indicates is likely to be two days after a trade takes place - does not sit well with players on the buy side, several of whom argue that a two-day delay is too long and will undermine the goal of improving market transparency.

"The time delay perpetuates the uneven playing field regarding transparency in Canada," says a comment from the Canadian Bond Investors' Association, a group of large institutional investors. That comment suggests that the delay should be no more than one day after a trade.

Others would shorten the delay further. The Canadian Advocacy Council for Canadian CFA Institute Societies' comment argues that trade reports "can and should be required to be filed within 15 minutes of a trade," which is the requirement in the U.S. The comment also recommends that trade information be circulated publicly soon thereafter.

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