The regulatory environment and its effect on the trading of fixed-income securities are likely to be big talking points at the Bond Market Association's annual general meeting Friday, according to Mark Davies, global head of credit trading at Bear Stearns and vice-chairman of the BMA's executive committee in the corporate markets division. He said certain rules passed by the regulators have harmed liquidity.
The advent of The Trade Reporting and Compliance Engine(TRACE) and its negative impact on liquidity is a topic that is likely to come up, said Davies. TRACE is the online reporting system on which dealers are required to report, within 15 minutes, over-the-counter secondary market transactions in fixed-income securities. Dealers have complained it has reduced trading volumes. "The advent of TRACE has not been an entirely positive development in some regards," said Davies. "We feel liquidity has been hampered because of the TRACE reporting requirement. The market is keen to talk about this, particularly buyside investors."
The increased transparency that TRACE brings to the pricing of securities is offset by the difficulty that dealers have in making large trades without moving the market. TRACE makes it easier for the market to get wind of a large transaction, putting the dealer at risk of taking a position that will move against him. "There is worse execution for investors and volumes are suffering because dealers are less willing to put capital at risk at any given time," said Davies. "The sense is that some regulators don't necessarily prioritize liquidity when considering the impact on the market of new rules and reporting requirements."
Another regulatory requirement that is upsetting players is the 5% mark-up rule. The mark-up rule, governed by the NASD's Rules of Fair Practice, requires that dealers do not make more than a 5% margin when buying and selling securities. The rule is not a problem in the investment-grade bond market, where it is rare for dealers to make a 5% margin. But it is bad for the distressed debt market because of the bigger margins distressed debt traders make on securities. "The regulators have not thought through the implications of the 5% mark-up rule on the distressed market. The sense is that the rules don't necessarily make sense in some cases. People are worried about this."
