Fear and Loathing of Transparency
In any given market, there are fears that shape and mold the behavior of the participants. Except for red pens on the trading floor, most fears are unwarranted and dissipate over time due to evolving perspectives. The transformation phase can take years or even decades, but in the end there is often a crescendo of debate before a given fear is permanently cast out. For the US corporate bond market, the recent FINRA request for comment regarding a pilot program to delay block trade reporting may be a sign that this market is reaching an apex in the argument about transparency.
Here is a brief synopsis of the current state of trade reporting: Since 2002, the US corporate bond market has had trade reporting via ‘TRACE.‘ Throughout the years, TRACE has matured to provide timely reporting (within 15 minutes) of all dollar-denominated trades for US corporate bonds. If the size of a high-yield corporate bond trade is >= $1MM, TRACE will display a capped +$1MM size indication. If the size of a high-grade corporate bond trade is >=$5MM, TRACE will display a capped +$5MM size indication.
FIMSAC has proposed to increase the transaction reporting caps to $5MM (HY) and $10MM(IG) and delay the reporting of trades that exceed the new caps by a full 48 hours. In the coming weeks, there will be plenty of opinions expressed that support or condemn the proposed delay. However, at the core of this disagreement is a fundamental question that needs greater focus: Why are some corporate bond market participants so afraid of transparency?
We have nothing to fear but transparency itself!
Outside of the bond market, the world appears to benefit from transparency. Knowing the ingredients on a package of food, the calories for a meal, or the cleanliness of a restaurant can save your life, keep you fit or prevent a horrible night of indigestion. Transparency in markets is more complex because of this universally viable concern: Available information about my past behavior, current position, or future intentions will have an adverse impact on my trading activity.
To avoid the negative effects of transparency, market participants adapt by routinely omitting information and distorting the truth. Before rushing to judgment on these deceptive practices it must be acknowledged that this behavior is quite normal and observed in almost every market. For example, if you are selling your house, do you tell the first potential buyer that they are the first and only interested party? No! You tell them that they are one of many people interested in purchasing your home. Doing so masks the true level of demand, which helps to preserve your asking price.
This is exactly the intention of the proposed 48-hour delay for block trades. Mask the true level of supply or demand in the market to prevent pricing from destabilizing when there are large transactions. Unfortunately, removing transaction information from a marketplace will lead to a smaller network for trading because less information will discourage broad participation, undoubtedly hurting liquidity in the long run. Using our real-estate example, you would receive fewer inquiries for purchasing your home if there was no available information regarding the transaction prices of similar properties in your location. Furthermore, the initial act of setting the price would be impeded by the lack of transaction data.
Extracting the benefits of transparency while eliminating its detrimental effects requires techniques that are normally reserved for electronic trading platforms. To get the best out of transparency, we need protocols. Applied properly, the right transparency protocols will increase access to information while protecting the proprietary data that can destabilize a market. Regrettably, mandated transparency initiatives rarely include anything but basic protocols that are universally applied to all market participants. As a result, transparency has historically brought unintended negative consequences that reinforce the fear of information.
Data is the New Oil
As other modernized markets have shown, making basic transaction and pricing information available to all market participants is a fundamental requirement for innovation. Due to the idiosyncratic nature of the institutional US corporate bond market, a standard approach to increasing transparency is sub-optimal. We believe that leveraging the positive benefits of transparency is directly predicated on rules and protocols. BondCliQ generates high-quality institutional pricing information by implementing unique protocols that improve access to data while appropriately socializing proprietary information and limiting the exposure of the dealer. As more market participants use reliable pre-trade information to improve their trading decisions, risk management capabilities and market making performance, data will gradually be accepted as an invaluable commodity.
The institutions that get over their fear of transparency first will be the first to reap its benefits.
-Chris White (CEO – BondCliQ)