The U.S. Securities and Exchange Commission (SEC) is examining how electronic bond-trading platforms allow dealers to give clients different prices on the same securities in the $40 trillion market, potentially hurting smaller investors.
SEC regulators want to understand why brokers sometimes block their rivals and clients from seeing some of their prices for municipal, corporate, and other bonds, according to a person with direct knowledge of the examination. They're concerned that being able to turn quotes on and off may allow market manipulation, and that smaller buyers may not get the best prices, the person said.
The probe underscores the growing concern that the infrastructure of the U.S. bond market hasn't kept pace with a 23 percent expansion in the past six years, with much of the trading still conducted through telephone conversations and emails. One of the SEC's priorities this year is to evaluate "factors that may impact the quality of execution in the fixed-income market," including market structure and the use of alternative trading systems, it said in a January statement.
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Electronic credit trading "replicates and automates how the market works," reflecting that for years dealers have shown investors different prices depending on how much business they do, said Brad Golding, a managing director at Christofferson Robb & Co., a New York-based asset manager.
The inquiry so far has focused on platforms that cater to retail investors as well as dealers trading among themselves, according to the person, who declined to be identified because the examination isn't public.
The probe is an attempt to get more information, rather than build a case for an enforcement action, and is being conducted by the Office of Compliance Inspections and Examinations wing of the SEC, according to the person familiar with the matter.
The SEC has contacted providers including Tradeweb Markets LLC and TMC Bonds LLC, seeking information about the systems they manage that allow dealers to buy and sell debt to one another and to investors, according to two people with direct knowledge of the matter who asked not to be identified because the conversations were private.
Bloomberg LP, the parent of Bloomberg News, competes with Tradeweb in some businesses, including bond trading with institutional investors. Bloomberg's trading platforms aren't geared toward retail clients.
Banks have increasingly turned to electronic systems to sell bonds on behalf of their clients as a way of aggregating a greater number of bids. That's become more appealing as it's become more expensive for dealers to use their own money to make markets because of higher regulatory capital requirements.
Blocking Rivals
U.S. investment firms predict that 30 percent of corporate-bond trading will occur electronically by 2015, up from 14 percent of investment-grade notes in 2012, according to an August 2013 report by Greenwich Associates and McKinsey & Co. As much as 50 percent of municipal trades already may occur electronically, according to a TMC Bonds comment letter to the SEC last year.
Judith Burns, an SEC spokeswoman, declined to comment, as did Clayton McGratty, a Tradeweb spokesman.
There are reasons some electronic systems enable bond dealers to block rivals from seeing their price quotes, such as if they have found a firm consistently fails to stand by its offers or provides off-market values, said Thomas Vales, chief executive officer of TMC Bonds in New York, who confirmed he'd discussed the issue with the SEC.
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