BlackRock, Inc. (NYSE:BLK)’s September 2014 viewpoint op ed “CORPORATE BOND MARKET STRUCTURE: THE TIME FOR REFORM IS NOW” highlights the deficiencies in the structure and operations of bond markets today, and makes four recommendations that will reform and modernize this outdated market.
The introduction to the BlackRock, Inc. (NYSE:BLK) op ed notes: “We believe the secondary trading environment for corporate bonds today is broken, and the extent of the breakage is masked by the current environment of low interest rates and low volatility, coupled with the positive impact of QE on credit markets. The current environment also breeds complacency—for issuers and investors alike. When any of these factors change, the extent to which today’s fixed income markets are not “fit for purpose” will be exposed.”
Current problems with corporate bond market
Fixed income markets have long been structured as over-the-counter (OTC) “principal” markets where the dealer owns or acquires the bonds and earns money through the bid-offer spread, or the difference between purchase and sale price. In order to function effectively, a principal market requires the dealers to warehouse a significant inventory of bonds to be able to meet investor demand. Moreover, given there is no central exchange, bond markets are highly decentralized, and the pricing information available before a trade is limited to quotations from dealers provided directly to their mainly institutional client base. The BlackRock, Inc. (NYSE:BLK) op ed argues that an “agency” type model is more appropriate for corporate bond markets
Blackrock’s four recommendations for corporate bond market reform
The op ed makes four recommendations to reform the corporate bond market:
- Move to more “all to all” trading venues – BlackRock, Inc. (NYSE:BLK) suggests that one key reform is moving beyond just “dealer-to-customer” or “dealer-to-dealer” transactions. The op ed argues that development and general acceptance of “all-to-all” trading venues, where multiple parties from the buy-side and the sell-side could come together, would be a huge step forward in discovering “latent liquidity”.
- Adoption of multiple electronic trading (e-trading) protocols – Moving to electronic trading platforms — and not just request for quote (RFQ) or central limit order book (CLOB) — is another key step in corporate bond market reform.
- Standardization of selected features of newly-issued corporate bonds — The idea of creating standardized bond products is not new, but BlackRock, Inc. (NYSE:BLK) says the Time is now: “Standardization would reduce the number of individual bonds, via steps such as issuing similar amounts and maturities at regular intervals and re-opening benchmark issues to meet ongoing financing needs. Standardized terms would improve the ability to quote and trade bonds, and would create a liquid curve for individual issuers
- Behavioral changes by market participants recognizing the fundamentally changed landscape — The op ed highlights that these reforms will significantly impact bond market participants. Of note, for investors, accepting the reforms means a willingness to give up new issue gains and various liquidity arbitrage strategies in return for reduced transaction costs, access to broader markets, and for institutional investors, a chance to buy and sell in greater size.