Tabb Group: More is Less When it Comes to European Debt Price Disclosure
Proposed changes to European regulations concerning just how much information is disclosed on fixed-income prices before trades are executed could end up harming rather than helping the European bond market, cautions a new study issued today.
The Economic and Monetary Affairs Committee of the European Parliament is set to vote on changes to the Markets in Financial Instruments Directive on July 9 and the new version of MiFID, coined MiFID II, could be out as early as next year.
When it was launched five years ago, MiFID was intended to make Europe's markets more competitive. Regulators now want to apply the same principle to the otherwise opaque fixed-income markets.
But the new pre-trade transparency proposals for fixed-income securities, according to Tabb Group, will hurt liquidity and raise trading costs making it more expensive for governments and companies to raise capital. "Primary markets funnel cash to issuers and investors raise this capital selling bonds that no longer meet their investment mandate," says Rebecca Healey, senior analyst in London for the research firm and consultancy. "If the secondary market becomes illiquid, it's harder for issuers to place new debt with the primary market."
In her report entitled "MiFID II and Fixed-Income Price Transparency," Healey outlines her rationale as follows: Under MiFID II, market makers in European debt would fall under the category of systematic internalizers (SIs). Doing so, means they have to make any quote given to one investor available to other clients, irrespective of the size or value of the original quote. The SI would be bound by this quote if the volume of the quote is below a yet-to-be defined threshold.
Such a requirement is problematic for market-makers. Why? It's a major difference from current practice which the fixed-income market can't handle. Fixed-income pricing has historically relied on a one-request for quote model. If they know who their customers are and what they are looking for, market makers can provide tight, specific quotes depending on the situation and effectively hedge their subsequent risk. If the dealer doesn't know who will "hit" its bid or lift an offer, the dealer will be forced to either widen its quote or step away from the market.
"Facing full transparency given the current market structure model will increase information leakage and disincentivize market makers to provide liquidity," argues Healey. "There will be little incentive [for favorable spreads] if after the publication of a request for a quote, other dealers can predict hedging strategies and can benefit from taking contrary positions."
Such an outcome, in turn, will increase the cost of hedging and that additional cost will be passed back to investors which, in turn, will increase the borrowing cost incurred by governments and companies.
Written by Chris Kentouris, Editor-in-chief (Chris can be contacted through Chris.Kentouris@hotmail.com).