I was a corporate-bond reporter for Bloomberg News when the Trade Reporting and Compliance Engine (TRACE) was launched in 2002. As Financial Industry Regulatory Authority explains, Trace was meant to
“…bring transparency to the corporate bond market and create a regulatory database of corporate bond information. Trace enables individual investors to receive real-time information on the actual sale price of virtually all U.S. corporate bonds and to see intra-day transaction data.”
My recollection from interacting with market participants on a daily basis is that the implementation of Trace was a big deal. Information is power, and bond dealers disliked Trace because it meant they no longer wielded all the power. On the other side, investors and traders generally supported Trace, because they could enter into transactions armed with a more accurate read of a bond’s price. For us reporters and editors on the bond team, it meant we could sometimes find prices for some corporate bonds via TRACE, rather than having to ping our bond-trader sources with requests for pricing information.
Yet Trace hardly qualified as a sea change in itself, at least in its early days. It wasn’t like the corporate-bond market went from dark to light at the flip of a switch — trades didn’t have to be reported until 15 or 30 minutes after a transaction took place, and I believe there were some exemptions. I remember Trace being hit-or-miss when we tried to look up bond prices via the Bloomberg terminal — liquid issues of Ford Motor, GE and other big names would typically have dozens of sizable trades from a single day viewable, but smaller names would often have just a trade or two, or maybe nothing for weeks at a time. And some prices looked downright wacky, too wacky for us ‘BNers’ to be confident enough to include in a story.
I take this stroll down memory lane because as fixed income continues to evolve toward a more-electronic market, it turns out that the decade-ago launch of Trace was quite an illuminating development. Not so much illuminating in the sense of fully illuminating the bond market, but illuminating in the sense of showing the limitations of electronic trading and the regulatory aim of full transparency.
As the old adage goes, the more things change, the more they stay the same. This has some applicability to trading in the bond market. Sure, an on-the-run 10-year U.S. Treasury note with deep liquidity can easily be traded electronically. But what about a lonely $150 million bond issued some years back by obscure high-yield debtor XYZ Corp.? For an investor looking to buy or sell say, $10 million of this security, Trace won’t be much help, nor will the fastest, most cutting-edge electronic trading system developed since Trace came on the scene. The process of finding a counterparty and discussing price will have to be done the old-fashioned, high-touch way: over the telephone.
Trace and other developments along the road to a more-electronic bond market represent a redistribution of wealth among market participants, in a sense. Bond dealers lose, because tighter bid-ask spreads brought about by more transparency make for lower profit margins. End-user investors win, because tighter bid-ask spreads mean better trade execution and less friction. Technology providers win, because any change in market structure requires market participants to adjust, creating demand for the products, services and software that manage the change. Granted I’m oversimplifying things, but I believe the gist of my assessment is accurate.
A decade after Trace launched, the bond market is still moving, fitfully and unevenly, toward a more-electronic market. In the estimated $82 trillion global bond market, there is obviously a lot in between my aforementioned polar opposites, the on-the-run Treasury and the dinky bond of an obscure high-yield issuer. More of those non-extreme bonds can be traded electronically now compared with 10 years ago, and it is reasonable to speculate that even more will be low-touch in another 10 years.
What is the ceiling? That is a matter of conjecture, as nobody can know for sure. The bond market’s move toward electronic trading reminds me a bit of the range game on The Price is Right, where the contestant needs to guess the approximate price of a prize item by stopping an ascending rangefinder when its range is over the actual price. For bond-market participants, accurately assessing the ceiling for the market’s ongoing ‘electronification’ is the challenge; the prize is capturing all the efficiencies offered by electronic trading while not wasting resources trying to trade bonds that aren’t suitable for the screen.