Securities and Exchange Commission FIMSAC Meeting
Securities and Exchange Commission
Fixed Income Market Structure Advisory Committee (FIMSAC) Meeting
Monday, October 5, 2020
Opening Statements & Introduction
In their opening remarks, Commissioners Clayton, Peirce, Lee and Crenshaw all outlined their support for continuing the charter of the FIMSAC and emphasized that the work of the committee is extremely valuable. Lee specifically noted the need to incorporate lessons gleaned from recent COVID-related events and Crenshaw highlighted the need for consistent standards as it relates to the reporting of electronic trading. Brett Redfearn, Director, SEC Division of Trading and Markets, added that the fixed income market structure faced strain due to COVID-19 but has recovered well from the peak stress periods in March.
Presentation and Discussion: Recommendation Regarding Defining Electronic Trading
Rick McVey, MarketAxess, provided an executive summary of the recommendation stating that this proposal should be viewed as a follow-up complimentary effort to the Committee’s E-Trading Oversight Recommendation that was unanimously approved in July 2018. He continued that the Technology and Electronic Trading Subcommittee of the FIMSAC believes that a consistent, cohesive definition of “electronic trading,” and an industry standard for reporting “electronic trading volumes,” are necessary to facilitate regulatory harmonization as well as to allow regulators, investors, dealers, analysts, and the public to better understand the liquidity, market share and transaction cost trends across the wide variety of electronic trading venues currently in existence. McVey also outlined the factors that influence the reporting of “electronic trading” volumes to, and away from, TRACE, which include: ATS vs. non-ATS, Fully Electronic Trades vs Processed Trades, Single-Dealer vs. Multi-Dealer, as well as inconsistencies with double-counting. He emphasized that market participants require reliable and consistent data on electronic trading volumes to best understand where they can find liquidity and that the above factors ensure that the ATS volumes captured and disclosed by TRACE do not accurately reflect aggregate electronic trading volumes. McVey concluded the presentation by reiterating that the market would benefit from one common regulatory framework for all fixed income electronic trading venues.
Sonali Theisen, Bank of American Merrill Lynch, and Larry Tabb, Bloomberg Intelligence, both agreed that there is a fundamental need for some type of consistency as it relates to categorizing and measuring electronic trades. Tabb outlined his concerns regarding the need to not loop in platforms that have no role in providing capital or matching buyers and sellers.
The FIMSAC voted in favor of approving the recommendation for the Commission’s consideration.
Corporate Bond Market Observations and Lessons Learned
Gilbert Garcia, Garcia Hamilton & Associates, said that while COVID-19 has caused significant volatility, overall the markets worked very well, noting that there was unprecedented monetary and fiscal stimulus. He added that the mere existence of the commercial paper backstop and Municipal Liquidity Facility helped.
Kumar Venkataraman, SMU Cox School of Business, noted that in the midst of economic uncertainty and a sharp decline in economic activity, the BBB market has fared well and improved dramatically from an initial decline at the beginning of the crisis, crediting this improvement to the establishment of the Federal Reserve (Fed) facilities and improved stress conditions. He noted that the investment grade and high yield indexes saw a steep decline coinciding with the Fed’s announcement of its liquidity facilities, resulting in a sharp reduction in BBB spread and a significant boost in BBB bond issuance, saying that the Fed’s interventions have calmed the market.
Theisen noted that through this fluid and quickly escalating situation, adaptability, particularly of the public sector, has made for the best outcomes. She explained that at the beginning of the pandemic the capital markets seized and global uncertainty led to a selloff, but once the Fed intervened, markets opened up constructively and reliably. Theisen said that markets have seen two waves of issuance, first in March-May and the second in August-September, marked by the repayment of debt and turning out of commercial paper. Offering observations on overall activity, Theisen noted that risk transfer continued throughout the volatility, banks and broker-dealers had robust liquidity, and regulators stepped in to provide appropriate relief to allow a transition to work from home while keeping the markets open.
McVey said that credit markets never anticipated an event that would impact every sector of the economy in every region of the world at the same time, calling this a significant shock to the market. He said that maintaining connectivity to liquidity providers through electronic venues was fundamental. McVey added that through this credit event, new market makers have emerged and the pool of liquidity now available on many electronic trading venues is more diverse. He also said that investors and dealers have been able to electronically find natural matches in the market through times of stress in the system and TRACE volumes were up substantially.
Lee Olesky, Tradeweb Markets, agreed that systems worked incredibly well and that the evolution of electronic trading allowed investors to access real-time data, saying that the work from home environment underscores the importance of this. He said the electronic trading infrastructure “held up” and allowed for price discovery and execution under extreme conditions. Olesky stressed the systemic integrity of this technology that allowed firms to transition seamlessly at a time of incredible market stress.
Tabb highlighted the importance of getting the real economy back on track, saying the Fed ultimately cannot support credit quality and it is important to explore and incentivize where else the markets can find liquidity. He noted that spreads on electronic venues rose substantially, topping out at 18 basis points for investment grade securities.
Municipal Securities Market Observations and Lessons Learned
Lynn Martin, ICE Data Services, highlighted the resiliency of the ecosystem that helped the muni markets recover quicker despite unparalleled spikes in volatility fueled by short-term panic and a desire to exit positions and keep cash on hand. She stressed that this volatility was not due to a lack of confidence in the muni market but rather due to general macro uncertainty, which calmed down once regulators stepped in. Martin said that market structure enhancements made since 2008 and federal stimulus helped support a quick recovery.
Olesky said that algorithmic firms were well prepared to handle trading volume increases in March and performed well, as did the overall system. He noted an increase in buy-side activity of more than twice normal volume, saying that since March volumes have been at record highs for institutional investors. He added that electronic trading platforms were resilient, reliable, and allowed market participants to transition to work from home.
Winges agreed that the market was more nimble than it was during the 2008 crisis. He noted that all ratio categories widened, saying it was surprising how quickly the markets “snapped back” after the Fed stepped in. Winges said that had the Fed not stepped in to provide liquidity and stability, there would likely have been dramatically different outcomes and possibly a more significant, longer lasting event.
Horace Carter, Raymond James, added that electronic trading platforms held up remarkably well throughout this crisis and that without access to electronic trading, the economic and financial impact could have been much worse. He continued that electronic trading is critical in facilitating more efficient information flow, thereby reducing the costs to investors and market participants.
Mark Kim, Municipal Securities Rulemaking Board, provided an update on disclosures throughout the pandemic. He said that as part of the response to the pandemic, the MSRB has focused on bringing greater transparency to the market to better allow insight as to the economic dislocation as a result of this public health crisis.
Darryl Street, Government of the District of Columbia, provided the perspective of an issuer grappling with the impact of COVID-19. He cited the significant decrease in sales taxes, specifically from the hospitality sector, as a challenge for all state and local issuers. He added that the District of Columbia entered this crisis in a position of strength, allowing it to better weather the impact compared to less fortunate entities. Various committee members noted that there will be a continued divergence between the “haves” and the “have-nots” when it comes to issuers, underscoring that certain entities will continue to struggle.
The Committee then turned to a discussion on new issuance. Suzanne Shank, Siebert Cisneros Shank, stated that 2020 total issuance has been high through September, ranking 1st in total issuance volume over the past 35 years. She then compared issuance volume in 2008 vs. 2020, highlighted that: 1) total 2020 tax-exempt volume is projected to be approximately $2 billion lower than in 2008 despite new money issuance being down due to the COVID-10 pandemic; 2) total 2020 taxable volume is projected to be over $118 billion higher than in 2008; and 3) total 2020 issuance is projected to be about $482 billion, approximately $116 billion higher than in 2008.
Regarding the Municipal Liquidity Facility (MLF), committee members outlined that this facility was structured as a last resort and that is exactly how it has been utilized. They did note that some issuers would like to see this facility extended into next year as well as some reconsideration of key terms and procedures. Amy McGarrity, Colorado Public Employees’ Retirement Association, noted that the Credit Ratings Subcommittee believes that a more market-based measure should be incorporated when evaluating the credit risk of an issuer.
Elisse Walter, fmr. SEC Chairman, concluded the conversation by encouraging the Committee to examine whether further action is needed as it relates to pre-trade transparency.
Bond Fund and ETF Market Observations and Lessons Learned
Ananth Madhavan, BlackRock, provided perspectives on the performance of fixed income ETFs throughout the COVID-19 crisis. He stated that fixed income ETFs generally performed as expected and provided an alternate source of liquidity for challenges bond markets and noted that market participants turned to fixed income ETFs for price discovery throughout this period. Further, in addition to serving as a vehicle for efficient price discovery, Madhavan added that BlackRock’s analysis demonstrated that Bond ETFs were more efficient to trade than the underlying bonds and that there was no evidence found supporting claims of “wrong way” arbitrage.
Venkataraman presented a survey of academic research on Bond Funds during the COVID-19 pandemic. In sum, Venkataraman stated that observations gleaned throughout the COVID-19 pandemic demonstrate that fund illiquidity amplifies fragility. He continued that the Fed’s announcement of corporate bond purchases stopped the outflows by calming the markets. Venkataraman concluded by highlighting the need to implement swing pricing as he views it as an effective tool to mitigate run dynamics and reduce redemptions during stress periods.
FIMSAC Member Observations
Dan Allen, Anchorage Capital Group, said that financial markets were tested in many ways and though there were pockets of dislocation, for the most part markets continued to function and risk continued to transfer.
Larry Harris, USC Marshall School of Business, noted that how bonds are traded is changing but FIMSAC has not yet addressed many of the current issues associated with secondary trading in the bond markets. He encouraged the committee to consider how to encourage municipalities to deliver timely financials, and encourage issuers to issue fewer securities, saying that the number of bonds complicates how they are traded and all issues would trade better if they were larger.
Kim noted that the pandemic caused a significant dislocation in the municipal securities market as many state and local government issuers did not have access to the primary market and liquidity was scarce. He explained that this dislocation was short, and the muni market displayed its resilience, though one significant risk is that of credit quality in the municipal securities market. He highlighted that as the pandemic continues to dampen economic activity, state and local governments are facing increasing economic pressure and low revenues, which support the repayment of most muni bonds. He said in this current low interest environment, it remains challenging for investors to fully evaluate and price credit risk in the muni market.
Martin emphasized the need for a fixed income market structure that supports liquidity provision in times of stress and preferences a transparent and competitive landscape. She said this is increasingly important and challenging in today’s fixed income marketplace where electronic venues are not always subject to the same regulatory regime as other venues, adding that it is essential that the committee ground future policy in lessons learned from 2020.
Theisen noted that it is important to remember that market conditions do and will change over time, and those changes can either be episodic or structural. She encouraged the committee and the SEC to be flexible enough to be responsive to episodic issues, ensure that decisions are supported by data, and work to make the market easier to understand for everyone.
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