Finra Files Proposal to Disseminate Price Data
December 4, 2013
Would knowing prices on the most recently traded collateralized debt obligations (CDOs) have tempered that market in the run up to financial markets collapsing in 2008, and might some of the more spectacular deal collapses have been averted?
Looking in the rearview mirror is always problematic. Evidence suggests, however, that greater pricing transparency in the U.S. corporate bond market has caused those securities to trade within a more predictable range, and an objective view of prices in the CDO secondary market back then likely would have emitted helpful warning signals. Soon, participants in the asset-backed securities (ABS) market will be privy to that information on a timely basis and they’ll be able to determine for themselves the advantages—and perhaps disadvantages—of greater transparency.
The Financial Industry Regulatory Authority (Finra) filed a proposal Nov. 13 with the Securities and Exchange Commission to disseminate pricing data for ABS, an initiative that could result in the data becoming available within a year. Comments on proposals are typically due 21 days after publication in the Federal Register, which was expected around press time. The proposal would introduce dissemination of trade prices for securities ranging from highly liquid credit card and auto ABS to smaller and more esoteric deals in asset classes such as time shares, to commercial mortgage-backed securities (CMBS) and highly structured CDOs and collateralized loan obligations.
All Finra-regulated firms were obligated to begin reporting to Trace on most ABS and mortgage-backed securities starting in May 2011, and the following October the self-regulatory agency began releasing information on aggregate market activity, including the volumes of overall trades, institutional customer buys and sells, and inter-dealer activity. A year later, it started disseminating transaction-level pricing data for highly liquid “to be announced” (TBA) securities--a forward mortgage-backed securities (MBS) trade typically comprising pass-through securities from a government sponsored entity such as Freddie Mac. Pricing data on specified pools was launched in July.
Now, ABS is in the wings, while private-label residential mortgage-backed securities and agency real estate mortgage investment conduits remain on the backburner.
The general consensus is that increased pricing transparency benefits markets overall and especially investors. “We’ve seen the impact on the corporate-bond side, and [price-data dissemination there] has generally been viewed as positive for pricing comparability and availability,” said Ken Purnell, ABS portfolio manager at Atlanta-headquartered Invesco.
Academics have analyzed the Trace-related data that Finra has collected and generally concluded that increased transparency does stabilize prices, especially for lower rated bonds, although it can have an adverse effect on trading volume.
In a working paper published in September called “The Effects of Mandatory Transparency in Financial Market Design: Evidence from the Corporate Bond Market,” researchers from MIT Sloan School of Management and Harvard Business School found that Trace dissemination of corporate bonds’ secondary-market prices reduced “price dispersion,” in terms of daily standard deviation. The researchers found a similar reduction in the difference between high and low prices over different periods of time.
Starting in 2002, the distribution of corporate bond pricing information was rolled out in four phases over 3.5 years, with the riskiest, most volatile high-yield bond category arriving last. The researchers found that the first three categories of less risky bonds saw reductions in price dispersion between 6.5% and 8.5%, while the reduction for high-yield bonds, with the greatest price dispersion to begin with, was 24.7%.
“The reduction in price dispersion should allow investors and dealers to base their capital allocation and inventory holding decisions on more stable prices,” the paper notes. “Therefore, the reduction of price dispersion likely benefits customers and possibly, but not necessarily, dealers.”
Amy Sze, a senior analyst in securitized products at J.P. Morgan, said it’s generally assumed that dealers prefer volatility because it gives them more opportunity to profit. However she said that an objective source of pricing data would be welcomed by the sell-side. Differences between the corporate and ABS bond markets, she said, could change price dissemination’s impact on price dispersion, especially for the riskier ends of the markets.
“[Pricing transparency] could improve liquidity for plain vanilla ABS that already trade similarly to corporate bonds… credit card and auto ABS have been very liquid with excellent price transparency, and this could help them trade even more like a cash surrogate,” she said. “But dealers may also be less willing to take on large positions with prices disclosed.”
Sze added that off-the-run or esoteric ABS, such as the subordinated tranches of private student loan securitizations, often don’t trade for lengthy periods of time, leading to significant price dispersions between trades. “Even now some of those bonds trade infrequently at best. So I wouldn’t say revealing the price would cause less price dispersion,” she said.