The Financial Industry Regulatory Authority’s (Finra) proposal to disseminate pricing data for asset-backed securities faces push back from a major industry trade group, which argues that the transparency will reduce liquidity in a market that already faces liquidity challenges.
“We request that [Finra] not implement this proposal, and instead engage in further discussion with the industry as to how best to preserve ABS market liquidity, and re-propose this proposal after such discussions,” wrote Chris Killian, managing director, securitization, at the Securities Industry and Financial Markets Association (Sifma).
Sifma’s was the only comment letter received by the Dec. 20 deadline. However, it is a powerful industry voice that officially represents both the sell-side and the buyside.
More Transparency Tightens Bid-Offer
Increased transparency tends to narrow the difference between bids and offers, a boon to investors but less favored by sell-side brokers who typically take a cut of that spread. Sifma says that both its buy-side and sell-side members “have consistently noted impairment of liquidity in the TBA MBS (to be announced mortgaged-backed securities) market since dissemination was introduced in 2012 ” It adds that liquidity similarly lessened when Finra’s Trade Reporting and Compliance Engine (Trace) began distributing pricing data for high-yield bonds.
“In these markets, we believe that the benefits of improvements to price discovery have been far outweighed by the cost of decreased liquidity, and we continue to strongly urge Finra to revise the dissemination paradigm it has created,” Sifma says, adding that high-yield bonds’ 41.5% decrease in trading activity was the highest among corporate bonds.
Firms began reporting to Trace on most ABS and MBS transactions starting in May 2011, and five months later the self-regulatory agency began releasing certain information, including the volumes of overall trades, institutional customer buys and sells, and inter-dealer activity. A year later, it started disseminating pricing data for the highly liquid TBA securities, and pricing data on specified pools was launched in July.
SIFMA Wants Further Discussion of Proposal
Now the agency is proposing to introduce dissemination of trade prices for ABS ranging from highly liquid credit card and auto ABS to smaller and more esoteric deals in asset classes ranging from time shares, to commercial mortgage-backed securities (CMBS), to highly structured CDOs. Private-label residential mortgage-backed securities and agency real estate mortgage investment conduits (remics) are not covered by the proposal.
The Sifma comment letter refers to a draft research paper published in September called “The Effects of Mandatory Transparency in Financial Market Design: Evidence from the Corporate Bond Market.” The authors, from the MIT Sloan School of Management and the Harvard Business School, found that price dissemination reduced liquidity in the corporate bond market, especially in lower rated, high-yield securities.
The paper states that one reason may be that, prior to Trace dissemination, investment-grade corporate bonds were already more transparent, and so the new pricing data had less effect on them. In addition, the paper notes, high-yield bonds trade less frequently.
“The fact that there is a large reduction of price dispersion for thinly traded high-yield bonds may result in lower spreads and thus cause dealers to hold less inventory,” perhaps resulting in less trading activity, the paper says, adding that its results show transparency has little impact on the trading activity of the most liquid and investment-grade segment of the market.
ABS Already in "Weaker Liquidity Position"
Auto and credit card ABS tend to be very liquid, but outside these major consumer-loan asset classes, ABS tends to be less liquid than corporate bonds, potentially making the impact of price dissemination more severe. “In other words, ABS will be starting from a weaker liquidity position, and there is no reason to believe the impact of dissemination will be any different than it was for high yield corporates—negative for liquidity,” Sifma stated in the comment letter.
When it introduced price transparency for specified pools, Finra sought to assuage dealers concerns by providing information only on the specified characteristics of these pools, rather than their cusips. It’s proposing a different approach with ABS, excluding information about whether a trade was initiated by a customer or dealer. The universe of ABS participants is much smaller than the corporate bond world, with around 70 ABS dealers compared to more than 500 corporate bond dealers.
Sifma also notes that the researchers found price dissemination decreased the daily price standard deviation by 24.7% for high-yield bonds, also more extreme than for other corporates.
“These results indicate that mandated transparency may help some investors and dealers through a decline in price dispersion, while it harms others through a reduction in trading activity,” Sifma says.
The Sifma letter, however, mentions little about the potential benefits for the buyside that result from price dissemination and perhaps even from less liquidity. The research paper notes that tighter price dispersion should enable investors and dealers to base their capital allocation and inventory holding decisions on more stable prices, benefiting investors and “possibly but not necessarily” dealers.
“One consequence may be that [price dissemination] may change the relative bargaining positions of investors and dealers, allowing investors to obtain fairer prices at the expense of dealers,” it states.
The implications of reduced trading activity are less clear, the paper says, and may depend on why market participants trade. “A decrease in trading activity may be beneficial if much of the trading in a bond is unnecessary noise’ trading,” it states. On the other hand, “If most trading is information-based, a decrease in trading activity may slow down how quickly prices reflect new information."