Panellists spar over transparency in ABS secondary
Since bringing transparency to the asset-backed securities secondary market three years ago, the Trade Reporting and Compliance Engine (Trace) from Finra continues to spark debate among ABS traders on whether the service enhances liquidity, or if it is more disruptive than helpful. Panellists speaking on the second day of ABS East were divided on the value of the reporting engine, particularly due to the unintended consequences on more illiquid asset classes.
Trace is a network facilitating the mandatory reporting of over-the-counter secondary market transactions in fixed income securities, including ABS. With the establishment of Trace data for securitization, the ABS market has been able to gather useful data to paint a better picture of liquidity and pricing.
The average number of trades increased by 20% from 2016 to 2018, a positive data point aggregated through Trace, said Alie Diagne, director at the Financial Industry Regulatory Authority (Finra). Although some differences exist among asset classes, with auto or credit card ABS trading more, and small business administration loans or student loan ABS trading less, the differences overall are relatively small, Diagne added.
However, some traders say that increased transparency is bringing with it unforeseen challenges. The dissemination of prices may have “more of a cost than benefits” for less liquid parts of the market that require more sophisticated investors, traders on the panel said.
“Dissemination for illiquid products is a bit more controversial,” said Scott Levy, senior managing director and co-head of fixed income at Guggenheim Securities. “We’ve all benefited over the last 10 years or so from rising price and a tightening yield environment. To the extent that the market goes in the other direction, that’s when we would identify significant issues with dissemination on the illiquid side of the market.”
When a market participant decides to trade in a less liquid part of the market and that price gets disseminated, that may “reset the price for the whole market”, Levy added. To avoid such risks, Finra should differentiate between asset classes that benefit from price dissemination and those that do not and exclude the latter from Trace reporting requirements, Levy suggested.
For example, participants active in buying class ‘E’ certificates of aircraft ABS may not want price dissemination, particularly if the sector runs into trouble, given that the sector is relatively illiquid to begin with.
It’s also unclear what the impact of Trace would be in a downward cycle, said Kyle Pietila, director and senior trader and Société Générale. In years before Trace data became available for ABS, market participants that wanted to sell a transaction could do so quietly without worrying about potentially sparking a wave of broader volatility in secondary markets.
“Executing that is now much more painful because [traders] see a print, they see another print, and another print, and the price goes wider and wider,” said Pietila. “That’s an example where it actually hurts [rather than helps].”
Nonetheless, for many market participants in the more illiquid parts of the industry the transparency provided by Trace is integral to trading, said Diagne, particularly because they find it difficult to obtain information otherwise. With triple-A, plain vanilla asset classes, most people know where the market is trading.
On the other hand, information on more niche sectors is harder to come by. Many also believe having the current level of transparency may have mitigated damage caused during the financial crisis if it had been available for MBS. For these reasons, several investors involved in less liquid markets have actively requested Finra to mandate transparency, Diagne said.
Moreover, simply seeing another name in an illiquid sector may encourage new players to enter that space, said Brian Kustrup, ABS trader at Credit Agricole CIB. All information has the potential to be of use.
“Information begets trade, trade begets more trade,” said Kustrup. “Illiquid or liquid, it’s just one more tool to get feedback.”