Monday, June 12, 2017

Disrupting our Antiquated Fixed-Income Markets

“A talent for following the ways of yesterday,” declared King Wu-ling of Zhao in northeastern China, in 307 BC, “is not sufficient to improve the world of today.”

Much is being written about bringing our debt markets into the electronic age.  (The FX and swap markets too, but that's a story for another day.)

The Economist recently called the corporate debt markets "astonishingly archaic" and also "shockingly archaic," for additional emphasis.  Despite the US debt markets dwarfing the equity markets (by a factor of about 7-to-1 in 2016) the magazine notes that basic price data are sometimes hard to come by, and the trading of bonds often requires a call to a bank's trading desk.  

The criticism is not ill-founded.  In the bond market, even to the degree some of the trading goes through electronic platforms, the dealers still hold the cards ... which is great if you're a dealer, and frustrating if you're not.  

There are some downsides, to the economy, of dealers commanding such a presence in the market.  One issue is price uncertainty, with investors only really knowing what the dealers (often their counterparties) tell them about pricing, supply and demand.  And with uncertainty, comes the potential for panic, warranted or not.  (For our European readers, some of this may be mitigated under MiFID II.)   

Another concern is that when dealers play the role of intermediary or market-maker, and investors get accustomed to this framework, the market can seize up quickly when the dealers suddenly withdraw.  When they stop supporting trading, or putting principal at risk, the market dries up... and with less liquidity, prices can drop suddenly, and we all know what that's like.

There are advantages to this system, too .... if you're a Silicon Valley-style "disrupter."  For disrupters, an antiquated system is a prime target for your energies.  Not that it's easy, but the recent flurry of news stories about the antiquated model being gamed, won't make it any more difficult to get some backers motivated to influence change.  (The FinTech revolution was arguably fueled by the financial crisis, and the diminished faith in the financial institutions.)   

We have pulled together some of the recent stories circulating about "bogus" dealer quotes and investor reliance (sometimes over-reliance) on dealer marks and representations.  Meanwhile, traders from Nomura are currently on trial (jury is deliberating) and a Jefferies trader has been convicted for misrepresenting prices.  We don't see that in the market for Apple stocks.  There's an agreed-upon price. 

The problem, to a degree, is that there's a financial motivation to lie and it's just so easy to get away with lying or fibbing or bluffing: the market is opaque, and there is a high degree of subjectivity brought to the pricing/trading process, making it ever more difficult to separate true from false, without the evergreen trader chats, that is.    

Click here to read about the (endless) ongoing investigations into pricing/valuation issues (and broker quotes).

Click here to read about a dude at JPMorgan who is enticing Silicon Valley and Silicon Beach to get a move-on in disrupting this market, or else he'll do it faster himself.  That's his job, and he has a sizable budget to work with.  The red flag has been raised, but this time by the bull.


The Economist's articles can be found here and here (subscription required on your second click).

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