During the worst of the market chaos in March, some credit hedge funds suspended redemptions because they didn’t know what their holdings were worth and the prices of fixed income exchange-traded funds were out of whack with the net asset value of their underlying bonds.
The prices for stocks, which trade on an exchange, are available in real-time. But bonds still trade over-the-counter, meaning a dealer and an investor negotiate a price, whether on a screen of over the phone. As a result, there is no central place to go for bond prices. Bond mutual funds, for example, use what are called evaluated prices from third parties such as ICE Data Services. ICE has analysts and algorithms gathering and assessing multiple sources of information scattered throughout the market to provide evaluated bond prices to investors, asset managers, dealers, and others.
In March and April, as markets cratered and transactions ground to a halt, that information evaporated.
The Securities and Exchange Commission is now looking into what went wrong. While credit markets have stabilized since the U.S. Federal Reserve announced support programs at the end of March, market participants still question the validity of the process of calculating net asset values.
“The whole idea is how we take sparse data — first of all gather as much data as possible — and extrapolate that to 2.8 million securities every day,” said Mark Heckert, chief product officer of ICE Data, speaking during a webcast of a panel discussion held by the SEC’s Fixed Income Market Structure Advisory Committee on Monday.
At the end of March, the Intercontinental Exchange postponed rebalancing of its ICE indexes for a month.
“In a market like we saw in March, there is a phenomenon of distressed transactions. You have to try to ascertain if a transaction occurred orderly or not, and make a determination if that was a fair value or not,” said Heckert. “Our job is trying to represent a good-faith opinion of where a bond would trade in an orderly market. We need to suss out in times of crisis what’s orderly and what’s not.”
Derek Hafer, head of U.S. investment grade trading at Citibank, added, “We find that across various pricing services that there are a lot of discrepancies. We have to kick out the large outliers. As volatility increases, the dispersion in the different third-party marks in the same instrument goes up.”
Ironically, critics have been calling attention to fixed income exchange-traded funds, because many of them were trading at huge discounts to their net asset values — the value of their underlying portfolios. But ETF experts say that counterintuitively, the prices of ETFs, which trade on an exchange, were accurate representations of the value of those ETFs’ entire basket of securities — even if prices couldn’t be determined for the individual bonds.
The larger problem involves mutual funds, which don’t trade on an exchange and whose net asset value is used when investors buy and sell shares in their funds. Asset managers of mutual funds and institutional separate accounts only calculate NAVs once a day based on data from services such as ICE.
Chris White, founder and CEO of BondCliQ, a centralized pricing system that aggregates pre-trade institutional quote data, thinks everyone, including regulators, needs better and more information. One option is getting better pre-trade data about bonds to dealers, so they’ll be more willing to step into volatile markets, make transactions, and keep the flow of information going.
“If pre-trade data were organized in the first place, it would be easier to figure out where a bond should trade. Dealers could then provide liquidity,” said White during the advisory committee meeting. White said he envisions BondCliq providing its source data to pricing services such as ICE, rather than establishing a separate offering.
“In March, [ICE] had ten times the number of questions around the soundness of pricing. It’s because the underlying source data that they rely on to calculate the evaluated prices broke down,” said White. “Without more data points from dealers, it will be very challenging to continue to support a market that is growing in size and risks.”