Improving infrastructures for corporate bond market

1
Improving infrastructures for corporate bond
market

• September 27, 2007
• Shanghai, China
• Noritaka Akamatsu
• The World Bank

2
Issues

• Benchmark yield curve (GS market externality)
• Credit rating
• Legal framework
• Trading market and transparency (GS market
  externality)
• Clearance, custody and settlement (GS market
  externality)

3
Benchmark yield curve

• The development of the government bond market has
  created benchmarks in many markets in the region.
• In a varying degree across the countries in the
  region, an yield curve is being established,
  facilitating corporations to tap the market.
  E.g.,
• China, Thailand, Indonesia have established
  benchmarks and yield curves. Vietnam has issued
  an MOF decision to issue benchmark bonds.
• In many markets, however, the reliability of the
  benchmarks / yield curves needs to be improved
  further by enhancing the transparency, liquidity
  and efficiency of the government bond market.
  E.g.,
• Repo market,
• Primary dealers / market makers
• Trading platform and market / price transparency,

4
Credit rating

• The regions rating agencies are only serving
  their home country market. Does the region
  really need its own credit rating agencies
  capable of serving across the region?
• Mandating credit rating for a wide variety of
  issues / issuers (e.g., private placements, local
  government bonds, etc.) may make it a
  commercially viable business. However, it may
  also discourage the market development by
  imposing cost.
• Credit rating agencies could be required to have
  certain qualifications to ensure their
  independence / credibility. E.g.,
• Certain ownership / governance structure to
  promote reputation and independence.
• Diversified revenue base not to rely only on bond
  rating, particularly, revenues linked to services
  for investors.
• Qualified financial analysts and fit-and-proper
  management.
• Minimum capital.
• Etc.

5
Legal framework

• In a varying degree, countries in the region have
  established / improved a basic legal and
  regulatory framework for corporate bond issuance.
  E.g.,
• China Securities law and CSRC Decree 49 on
  corporate bond issuance (i.e., a move toward an
  integration of the exchange market and the
  Inter-Bank Market.).
• Vietnam Securities Law, MOF Decree 52 on
  enterprise bonds
• Yet, significant inadequacies remain regarding
• Securitization,
• Special Purpose Vehicle (SBV),
• Trust
• Etc.

6
Settlement system

• In a varying degree, settlement systems have also
  been improved. E.g.,
• Thailand Bathnet II
• Indonesia BI-SSSS linked to BI-RTGS
• Vietnam SBV IBPS for RTGS money settlement.
  The securities custody and delivery system has
  yet to be integrated and strengthened.
• Issues remaining are
• Consolidation of the securities custody
  arrangements.
• Establishment of online links with the trading /
  market information systems for straight through
  processing (STP).
• Does the region need its own international
  central securities depository (ICSD) like
  Euroclear in Europe?

7
Bond trading market

• Bond market is dominated by large institutional
  investors and dealers, and block trades are
  common. The large institutional seller and the
  buyer need to negotiate the trade directly or
  indirectly through a broker.
• Transaction conventions have been being
  standardized.
• Quoting convention, yield calculation method,
  trading units, trade agreement format, settlement
  cycles, settlement instruction format, master
  repurchase agreement, etc.
• Although advanced ICT is increasingly making it
  possible to better organize the government bond
  market, corporate bond market, which is
  fragmented by nature, remains difficult to
  organize into a common trading platform.
• A vast majority of the trading has been taking
  place in the over-the-counter (OTC) market around
  the world. OTC market transactions are difficult
  to capture, and therefore, the market lacks
  transparency.

8
A Typical Secondary Bond Market Transaction
Dealer E
An investor contacts a dealer to unwind some of
their large positions.
Dealer C
Inter-Dealer Broker
Dealer B
Buy-side Investor 1
Dealer D
Buy-side Investor 2
Inter-Dealer Broker
Dealer A
Instead of risking its own capital, Dealer D
contacts inter-dealer brokers to unload the
investors sell order.
An investor interested in buying bonds contacts a
few dealers to get price quotes for execution.
Dealer F
Source Celent Communications, World Bank
9
Policy objectives formarket transparency

• The issuer wants good market transparency for all
  potential market participants because
• it makes the dealer market competitive and
  reduces bid-ask spread, thus attracts broadest
  participation of investors in the market and
• resulting demand facilitates placement in the
  primary market, lowers the yield and, therefore,
  reduces the financing cost to the issuer.
• The regulator is concerned about transparency
  because
• Transparent market facilitates best execution of
  orders for investors by bond dealers and brokers
  (fairness of the market).
• Reliable benchmark yield facilitates setting of
  coupons in the primary market, pricing of
  instruments in the secondary market and valuation
  of bond portfolios and collaterals and,
  therefore, risk management.

10
Trading platform and market information

• Trading platform can help enhance the
  transparency, but fragmented / illiquid corporate
  bond market alone cannot support its commercial
  viability.
• A trading platform for government bonds, if
  adopted, could be used to trade corporate bonds
  as well, but market participants may prefer to
  trade through a broker in the OTC market.
• Market participants should be required to timely
  report transactions. There should be
  arrangements to centrally gather the reported
  information, consolidate it as market information
  and disseminate back to the market in a timely
  manner. This require a sound market information
  system.

11
Architectural Models

• Many possibilities exist (see www.bondmarkets.com)
  .
• Single dealer systems
• Inter-dealer systems
• eSpeed (Canter Fitzgerald), ETC (Garban
  Intercapital), MTS (which acquired BrokerTec and
  Coredeal), etc.
• Multi-dealer systems
• Market Access, TradeWebb, Bloomberg BondTrader,
  etc.
• Cross matching systems
• Automated Bond System (NYSE, i.e., order-matching
  system)
• Auction systems
• BondVision (for MTS to create a multi-dealer
  system)

12
A typical market structure
Individual
Cooperative
Mutual Fund
Individual
Mutual Fund
SC
Bank
Bank
Dealer
SC
Provident Fund
Dealer
Dealer
Inter-dealer Market
Insurance Company
Bank
Dealer
Foundation
Dealer
SC
Dealer
Bank
Pension Fund
Pension Fund
SC
Mutual Fund
Individual
Insurance Company
13
Competitive Inter-Dealer Market
Mutual Fund
Cooperative
Individual
Mutual Fund
Dealer
Dealer
Dealer
IDB
Pension Fund
IDB
Insurance company
SRO Information Platform
Dealer
Dealer
Foundation
IDB
IDB
Pension Fund
Dealer
Dealer
Dealer
Provident Fund
Individual
Mutual fund
Insurance company
14
Straight through processing from reporting to
settlement

• Settlement system-based information does not
  include price information. Even if the system is
  designed to capture it, it would involve time
  delay or noise unless the settlement cycle is
  standardized and made short. However, short,
  standardized settlement cycle would create a
  liquidity pressure on market participants and may
  be resisted by them.
• Instead, the reporting could be made a separate
  but linked requirement for all transactions to be
  settled.
• To facilitate the compliance, the reporting
  should be supported by a common information
  network linked online to the settlement system,
  achieving STP (although the settlement system
  should offer an option for market participants to
  access directly in case of system failure of the
  reporting system.)

15
However, bear in mind that

• Transparency is not free.
• Gathering, processing and disseminating useful
  information involves implicit as well as explicit
  costs while bond trading is very sensitive to the
  transaction cost.
• User fee may be charged to cover the cost while
  the use is made mandatory (Is this fair?). The
  authority and the market participants should
  explore ways to reduce the cost (e.g.,
  internet-based system) and enhance the
  convenience of reporting (e.g., STP) as much as
  possible.
• The more transparent, not always the better.
• Demanding high transparency of certain market
  information can discourage market activities,
  particularly market making.
• Examine and identify what kind of transparency is
  desirable and what not.

16
Transparency andmarket architecture

• Transparency is not one thing Certain
  information is a public good while some other is
  a private good owned by those who pay for or
  invest in it, implicitly or explicitly.
• Pre-trade price and volume information is a
  partly private good while post-trade price and
  volume information should be a mostly public
  good.
• Anonymity identity of market participants, pre-
  and post-trade is a private good.
• Balancing the public and the private goods is a
  key to designing the secondary market structure.
• Public goods the more, the better,
• Private goods need to reconcile conflicting
  business interests of different groups of market
  participants.

17
Optimal market architecture

• Reconciling different business interests of
  different groups of market participants.
• Market makers / primary dealers
• Non-market maker intermediaries
• Institutional investors
• Retail investors
• Primary market structure influences the optimal
  secondary market structure.
• Primary dealer (PD) system with an exclusive
  privilege to participate in the primary auctions.

18
Legal regulatory issues

• Should an ID platform be authorized as an
  exchange?
• Can it be allowed to offer voice broking without
  a brokerage license?
• Should it be supervised as an exchange as well as
  an SRO by the securities regulator?
• How should IDB be authorized and regulated?
• Is there Regulation ATS to authorize and regulate
  electronic trading platforms and ECNs?
• Whether and how should Bloomberg, Reuters,
  Telerate be regulated if they offer trading
  services?
• How can possible public sector ownership be
  treated under the existing regulatory framework?

19
Thank you.