Blackrock Report Calls for Reforms to Market Structure (with Lofchie Comment)

Blackrock issued a report, titled "Corporate Bond Structure: The Time for Reform Is Now," that calls for changes in the secondary trading markets for corporate bonds.

The report explains that the system for trading corporate bonds on a secondary market is "masked" by low interest rates and low volatility, coupled with the positive impact of quantitative easing (QE) on credit markets. This environment, according to the report, "breeds complacency" for both issuers and investors.

The paper lays out, among other things, four recommendations for reform:

• more "all to all" trading venues – not just "dealer-to-customer" or "dealer-to-dealer";
• adoption of multiple electronic trading (e-trading) protocols – not just request for quote or central limit order book protocols;
• standardization of selected features of newly issued corporate bonds; and
• behavioral changes by market participants recognizing the fundamentally changed landscape.

These reforms, according to Blackrock, would "hasten the evolution" of the current market structure into a "fit for purpose" corporate bond market.

Lofchie Comment: Blackrock's comments call for change in the current operation of the fixed income markets as a result of the negative impact of recent regulatory developments. The Blackrock report offers the following description of recent regulatory changes and their impact: "Liquidity has been impacted by regulatory changes after the global financial crisis and diminished risk appetite by market intermediaries. Contributing factors to decreased liquidity include regulatory reforms such as Basel III and regulations under the Dodd-Frank Wall Street Financial Reform and Consumer Protection Act of 2010 (Dodd-Frank Act). Reforms have resulted in greater capital and liquidity requirements for banks, which in turn diminished banks' ability to maintain large inventories of corporate bonds, while reducing the return on capital of market-making activity. The Volcker Rule proscribing proprietary trading has had a noticeable impact on OTC trading desks, given intermingled activity. As a result, dealer inventories have declined, as has the ability for dealers to act as effective market-makers."The Blackrock report treats these regulatory developments as a done deal, and moves on to the question of whether it is possible in some way to restore liquidity in the financial markets. The solutions proposed by Blackrock are essentially: (i) try to reduce the role of financial intermediaries by encouraging customer-to-customer trading; and (ii) standardize financial products. These might very well be sensible responses to the current markets, but both solutions have negative implications: i.e., there is no entity that is in the business of providing liquidity to customers, and issuers of financial products would be less able to tailor their debt offerings to their individual situations.

See: "Corporate Bond Structure: The Time for Reform Is Now."