Why is everyone worried about the bond market?
All of a sudden, people are freaking out about the bond market. Blackstone’s Stephen Schwarzman, JPMorgan’s Jamie Dimon and economist Nouriel Roubini are all on record wringing their hands about the terrible state of things, and making dark predictions about another financial crisis. Today the Financial Industry Regulatory Authority, or Finra, anon fed its plan to call a number of meetings to discuss the difficult bond trading environment.
The issue is liquidity. Traders, bankers and investors are all worried that’s its becoming increasingly difficult to trade bonds.
Here’s the line from the FT, which originally reported the story (paywall):
The financial industry has raised concerns that tougher regulations intended to prevent another global credit crunch have made traders more reluctant to buy and sell large blocks of bonds, the newspaper said, citing people familiar with the matter.
Traders reluctant to sell large blocks of bonds, eh? What’s that about? You’d think traders would be champing at the bit to sell large blocks of anything, right? Well, yes, but there are some issues.
Firstly, if you want to sell ones, you have to buy ’em first, and if you buy bonds, you then have to hold a lot more capital on your books, so it’s getting expensive. Second, the strangling of proprietary trading desks at banks – where banks bet their own money on the mattes – haas diminished those operations, so there are now fewer players in the game. Next, there’s a worry that EU regulations, aimed at making the bond market more transparent, could force banks to trade bonds on exchanges, and those new rules could make it hard to trade certain bonds. Finally there are complaints about Finra’s Trade Reporting and Compliance Engine, which requires traders to report their trades within 15 minutes, which bankers say is making it hard to make money trading bonds.
In short, bankers say that a bunch of changes in the system designed to make the banks safer and the bond market more transparent is making it harder for traders to actually make money. As a result, they’re doing less business. The most important part of this is the biggest banks, who act as market-makers, essentially making sure that if anyone needs to trade, they have a counterparty. The tightening of regulations is killing the incentive for being a market-maker, so fewer banks are taking on that role, which means it’s becoming harder for anyone to trade.
Top of the list in the Finra discussions: the Trace regulations. Traders note that sometimes when you sell a big block of something, it a) forces you to sell it cheaper and b) makes it harder to sell more of that thing, if you happen to need to. It makes things a lot harder, they say, if you have to tell everyone you’ve just traded something; so they would like to extend the reporting time to a day.
That would make the market less transparent, but it might help banks make money and keep them in the system.
On the other hand, it’s worth noting that all these concerns relate to the secondary market in bonds: trading bonds that have already been issued. The primary market, where companies borrow from the public by selling bonds, is very healthy indeed. That said, one of the reasons the primary market is so healthy is because investors know they can sell their bonds in a liquid secondary, if they need to. And that’s really why the regulators will want to be sure to find some middle ground with the banks.
