«Dettes et mensonges sont ordinairement réunis.» - Rabelais Likviditet i obligationsmarkedet en myte? CBS Brett S. Chappell, 7 January 2016
We are awash in debt, not in equity The corporate bond market continues to grow overall. Total par bond trading volume in the secondary market reported to TRACE in the US has already reached $7.7 trillion in the first three quarters of 2015. It is on pace to be the most active year ever. One share, many bonds. Volkswagen AG has 178 outstanding bonds. BBVA has over 250 outstanding bonds. Dong Energy has nine outstanding bonds And, in this low rate environment, issuers are whacking the print button: Source: Citbank Dealogic 2 CBS
Acronym Soup
MIFID II - Non-Equity Classification - LIQUIDITY Base definition of liquid requiring pre-trade transparency average nominal trade value of at least 100,000 an average of 2 trades/day trades on 80% of available trading days Post-trade transparency: liquid bonds Within 15 minutes of the initial transaction first three years (five min.thereafter) T+2 deferral time if a waiver is met (national competent authorities allowed to extend this time in certain cases) SIs (Systematic Internalizers) and market makers must modify their behavior and price quoting according to the liquidity status of the bond at hand 4 CBS
MIFID II - Non-Equity Classification - LIQUIDITY Waivers LIS (Large in Scale) in contrast to SSTI (Size Specific to the Instrument) Orders in an Order Management facility IOIs (Indications of Interest) in RFQ (Request For Quote) above SSTIs Bonds defined as Illiquid Calibration IBIA (Instrument by Instrument Approach) over COFIA (Classes of Financial Instruments Approach) : Bonds will be determined liquid on a case-by-case basis ESMA will carry out this analysis during 2016. A determining liquidity factor will be how seasoned the bond is. 5 CBS
Life cycle of the bond it s better in the first three months The average annual percentage of bonds among the most active 1,000 that were issued within the last 90 days on a rolling basis. Between 2003 and 2007, the percentage of newly issued bonds remained below 20%. Since 2011, newly issued bonds represent an average of 45% of the most actively traded portion of the secondary market. Source: https://www.finra.org/sites/default/files/oce_researchnote_liquidity_2015_12.pdf 6 CBS
Life cycle of the bond it s better in the first three months The decline in the par value of trading volume among active issues after they have been in the secondary market for 90 days. After their first 90 days in the secondary market, par trading volume in corporate bonds fell by 38% in 2015. This reduction in trading volume is 250% faster than occurred in 2007 (14.5% decline in trading volume). Source: https://www.finra.org/sites/default/files/oce_researchnote_liquidity_2015_12.pdf 7 CBS
What s missing from MiFID II? PAYING FOR RESEARCH - Bundling/Unbundling payment for investment research from trade execution. Pay as you play or simply stay away? YOU CAN T GO SHORT - No final decision has been made yet of the forced buy-in proposal of the CSDR (Central Securities Depositories Regulation). Market-makers ability to quote two-ways will be seriously hampered especially with a dysfunctional repo market. IS THE PENDULUM SWINGING BACK? Jean-Claude Juncker s wish for a capital markets union is a political decision. ESMA s long consultation period demonstrates the desire to get it right. Too much regulation may well impede reaching this goal. 8 CBS
EQUITY versus DEBT The Case Study of the Brazilian Supermodel THE EQUITY ANALYST SAYS Put all your money on her. She ll be on the cover of Vogue within three months THE DEBT ANALYST SAYS Don t get near her. She ll either die of anorexia or a drug overdose within three years... 9 CBS
How equity-like are some non-equity instruments? Corporate hybrid bonds can have equity or debt weightings according to Standard & Poors and Moody s methodologies. Unfortunately, this classification is subject to change according to the whims of the agency analysis team. As for banks, the FSB (Financial Stability Board) issued minimum TLAC (Total Loss Absorbing Capacity) standards for the 30 G-SIBS (Global Systemically Important Banks) according to BCBS (Basel Committee on Banking Supervision) last November. This must be in place for 2019. Insurers will issue Tier I capital with principal loss absorption to meet Solvency II ratios. Investors need to know what exactly they are buying with these instruments. More so, they need to know how to sell if everyone is heading towards the door at the same time. Caveat venditor! 10 CBS
Relationship with the sell-side DOWNSIZING Tier I clients will receive the best service from the global investment banks whereas Tier II and Tier III clients will be pushed on to platforms. NICHE PLAYERS Will take up the slack where the global investment banks are lacking. Local knowledge is the key. More counterparty lines are required, but on-boarding them can take time. MORE GRANULARITY Buy-side must liaise not only with the sales, but the syndication desks and the material risk takers at the banks directly. It s still a relationship business. AGENCY NOT PRINCIPAL It s a brave new world. We must adapt to the market conditions. 11 CBS
E-Trading REGULATORY REPORTING OF TRADES engaging the market via a trading facility allows for an electronic trail to prove best price execution and pushes a good deal of the reporting into the lap of the platforms like MarketAxess, Tradeweb, and Bloomberg. FINDING THE OTHER SIDE many new entrants are aiming to streamline the process with dark pools (Bloomberg s BBX, TradingScreen s TradeCross, Liquidnet, etc.) They are only now coming to market. PRIMARY ISSUANCE new initiatives, such as Ipreo s buy-side service, will come on line in 2016 allowing for a more efficient process in the new issue market DATA-MINING More time and effort is used now in the pre-trade process than ever before. The bulk of this is done electronically (B2San, Neptune, Algomi, Bloomberg, etc.) 12 CBS
Thank you! Brett S. Chappell brett.chappell@nordea.com