Efforts to introduce pre-trade price transparency in the fixed income market could have dangerous repercussions, according UK buy-side body the Investment Management Association (IMA).
Arjun Singh-Muchelle, senior advisor on regulatory affairs for wholesale and capital markets at the IMA, said he is concerned that politicians are trying to emulate regulation imposed on the equity markets in fixed income without properly grasping the unique aspects of that market.
“Regulators really don’t understand the unique features of the fixed income market compared to equities,” he said. “To start with, there is no real secondary market in bonds, it’s primary driven and predominantly traded through a request for quote (RFQ) model.”
Typically, to trade bonds, investors in the illiquid fixed income market will approach a market maker, such as a bank, and make an RFQ and trade against it, but this is done in private with an individual client. European politicians hope to introduce a transparency rule in MiFID II that will require those RFQs to be made public.
However, the IMA said this could be very damaging to liquidity in an already illiquid asset class as banks will be less willing to absorb risk from a client if they are forced to make their pricing offers available to the broader market, potentially resulting in them pulling back from trading fixed income.
Singh-Muchelle said regulators’ thinking stems from what has already happened in the equity market, but is unsuitable to apply to different asset classes.
He explained: “If we look at the equity market, you can already bypass pre-trade transparency by using waivers, so there is some protection for investors available within MiFID. However, the proposals made during the drafting of MiFID II do not include transparency waivers for fixed income trades and this is highly dangerous and could be very damaging to this market.”
It is not yet clear to what extent MiFID II will attempt to force fixed income markets to become more transparent pre-trade, but the European Commission is said to be unhappy with the current state of transparency in non-equity markets and could push for similar transparency rules across a variety of asset classes.