Corporate-bond brokers may face a squeeze on profits as regulators start publishing prices for almost $1 trillion of privately sold debt, if the past is any guide.
The Financial Industry Regulatory Authority, seeking to “foster more competitive pricing,” plans to start disseminating trading levels for securities issued under a rule known as 144a on its 11-year-old Trace system within the next year. That means the notes, sold only to institutional investors, will face the same price transparency as publicly registered corporate bonds for which buyers demand half a percentage point less in yield spreads. Brokers typically are paid larger fees from higher-yielding debt.
By selling bonds under Securities Act Rule 144a, corporate borrowers can avoid filing financial disclosures as long as they sell the notes only to qualified institutional buyers, saving them money otherwise spent on regulatory compliance. That often leads to higher yields to compensate investors for the reduced transparency and liquidity that can make it tougher to sell the bonds.
The indexes typically fall as investor confidence improves and rise as it deteriorates. Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
Finra’s plan to publish trade information for 144a bonds, the first expansion of Trace’s corporate-debt offerings since 2006, drew a dissenting opinion from the Securities Industry and Financial Markets Association. Disseminating the privately sold debt’s pricing “is not appropriate or necessary at this time,” Sifma’s Chris Killian wrote in a Nov. 16 comment letter, citing “concerns around changes in market liquidity and the impact of many regulatory changes.”
The difference between prices at which brokers will buy and sell bonds typically widens as yields increase and tighten as they decline. The MarketAxess High-Grade Bid-Ask Spread Index, which gauges liquidity in U.S. corporate bonds, plunged to 8.18 on Sept. 23 from 42.6 on Nov. 3, 2008. In that period, yields on the debt dropped to 4.09 percent from 10.96 percent, according to the Bank of America Merrill Lynch U.S. Corporate & High Yield Index.