Pimco’s ‘Worst’ Market Needs a Transparency Push: Canada Credit

Jul 07, 2014 9:52 am ET

July 7 (Bloomberg) -- In the 20 years that Ed Devlin has traded bonds across three continents, the market of his native Canada has earned a dubious distinction in his eyes.

“It’s among the worst,” said Devlin, who’s worked in New York, London, Tokyo and Toronto and oversees $17 billion for Pacific Investment Management Co., manager of the world’s biggest bond fund. “It’s the worst in terms of transparency, it’s the worst in terms of liquidity.”

The sentiment has been echoed by others, including the Canadian Bond Investors Association, who say Canada is lagging behind other jurisdictions in ensuring equal access to information in the bond market. Amid a global push to make bond trading more transparent, Canadian regulators are taking action.

The Canadian Securities Administrators, a coalition of the country’s provincial and territorial securities regulators, announced last month it’s starting a review of transparency in the C$390 billion ($366 billion) corporate bond market. The CSA questioned whether the private sector-led transparency model currently in place is working, and if more active regulation is needed.

The move comes as bond trading falls under closer scrutiny worldwide with the top regulator in the U.S. calling for more public information on private trading, and the European Union seeking to build a system to publicly disclose prices in real time.

Unlike stocks, bonds aren’t traded on public exchanges but as private transactions with securities dealers acting as middlemen, giving the brokerages -- many of whom are owned by banks -- an informational advantage.

It’s historically been more profitable for firms to trade bonds than stocks because the debt markets are less transparent, making it easier for brokers to take a bigger fee for each exchange.

‘Oligopolistic’ System

“We have a sort of oligopolistic banking system where the banks kind of set their own rules, and there’s been a lack of transparency in the bond market forever,” said Ed Waitzer, chairman of the Ontario Securities Commission from 1993 to 1997 and a senior partner at Toronto-based law firm Stikeman Elliot LLP. “It sounds like the commission is feeling a little bit of heat again because the rest of the world is kind of shining a light on dark markets.”

In 2012, bond trading, including in government bonds, represented C$10 trillion of value, according to the Investment Industry Regulatory Organization of Canada. In comparison, equity trading was only C$1.9 trillion in value, the organization said in a notice last year.

The Canadian corporate bond market has about C$390 billion worth of high yield and investment grade notes outstanding, according to Bank of America Merrill Lynch data.

Information Processor

In 2003, a service called CanPX, a for-profit joint venture between major dealers and interdealer brokers, was appointed by the CSA as the corporate bond market’s information processor. The service was charged with bringing more transparency to the market by collecting trade information from all the dealers and making it available to investors. The dealers include the securities units of the major banks such as Toronto-Dominion Bank and Royal Bank of Canada, while the interdealers include Shorcan Brokers Ltd., according to the CanPX website.

Interim Mandate

On June 27, the CSA extended CanPX’s mandate for 18 months rather than five years as in previous extensions, while the regulator conducts its review of the market. The CSA’s statement criticized CanPX for slowness in adding to the list of securities it covers and for not doing enough to make the availability of that information known, particularly to smaller investors.

“This calls into question whether CanPX’s contribution to corporate fixed-income transparency has been meaningful,” said the CSA in its statement, posted on the Ontario Securities Commission’s website. “We will determine whether it is appropriate to continue with an industry-led solution to corporate debt transparency or whether additional regulatory intervention is required.”

CanPX provides information and pricing on about 340 bonds, less than half the number of investment grade and high-yield Canadian issues tracked by the Bank of America Merrill Lynch indexes. By contrast, the U.S. Trade Reporting and Compliance Engine, or Trace, which was created around the same time as CanPX with similar goals, and says it offers data on all publicly traded U.S. corporate bonds.

Trace Reports

“It makes it harder to be an active investor,” said Pimco’s Devlin, in a July 2 phone interview from New York. “It is a very small market and it’s very hard to trade and it’s got very poor liquidity and very poor transparency.”

The European Union released rules in May that would create a transparency system even more open than Trace, giving investors access to market information in real time. Trace mandates trades be reported within 15 minutes, while CanPX is required to report within an hour.

The U.S. is also seeing a renewed push to increase bond market transparency. Mary Jo White, head of the Securities and Exchange Commission, said in a speech last month she wanted to level the playing field for smaller investors by making more information public.

Securities dealers caution that too much transparency will compromise their ability to provide the liquidity that keeps the debt market running smoothly.

Reduced Incentive

When an investor looking to sell bonds can’t immediately find a buyer, a dealer will sometimes purchase the bonds and hold them on the firm’s balance sheet until a buyer emerges.

If that purchase is public knowledge, it could allow someone else to bet against the dealer, opening it to losses and reducing the incentive for dealers to put liquidity in the market, said Ian Russell, chief executive officer of the Investment Industry Association of Canada, which represents securities firms.

“There is a risk that a dealer’s position, be it long or short, would be exposed to say, the buy side, or other dealers,” he said in a July 3 phone interview. “That could precipitate some kind of predatory activity.”

Russell says a balance must be struck between transparency and liquidity, and his organization supports the CSA’s efforts to fine-tune that balance.

Transparency Objectives

“Given its experience and knowledge of Canadian fixed income markets, CanPX is well positioned to continue assisting the CSA in meeting its bond market transparency objectives,” Richard Van Nest, president of CanPX, said in an e-mailed statement. “CanPX is committed to providing the optimal level of debt market transparency for Canada, one which balances investor needs for increasing price discovery with the liquidity and efficient functioning that investors have come to expect from our market.”

Increased transparency may also mean reduced profits for the largest dealers.

Wall Street bond traders lost $1 billion in commissions in the first year after Trace was implemented when the difference between bids to buy and offers to sell corporate bonds narrowed, according to a study published in the Journal of Financial Economics in 2006.

Another effect was smaller dealers gained market share at the expense of larger ones as all traders were able to share the same prices, according to the study.

“We’ve fallen way behind,” said Waitzer. There’s “no reason why the OSC can’t be doing real-time monitoring and analytics on trading data.”