Improving Improving infrastructures for infrastructures for corporate bond marketcorporate bond market

September 27, 2007September 27, 2007Shanghai, ChinaShanghai, China

Noritaka AkamatsuNoritaka AkamatsuThe World BankThe World Bank

IssuesIssues

Benchmark yield curve (GS market externality)Benchmark yield curve (GS market externality) Credit ratingCredit rating Legal frameworkLegal framework Trading market and transparency (GS market Trading market and transparency (GS market

externality)externality) Clearance, custody and settlement (GS market Clearance, custody and settlement (GS market

externality)externality)

Benchmark yield curveBenchmark yield curve

The development of the government bond market has The development of the government bond market has created benchmarks in many markets in the region.created benchmarks in many markets in the region.

In a varying degree across the countries in the region, In a varying degree across the countries in the region, an yield curve is being established, facilitating an yield curve is being established, facilitating corporations to tap the market. E.g.,corporations to tap the market. E.g.,– China, Thailand, Indonesia have established China, Thailand, Indonesia have established

benchmarks and yield curves. Vietnam has issued benchmarks and yield curves. Vietnam has issued an MOF decision to issue benchmark bonds. an MOF decision to issue benchmark bonds.

In many markets, however, the reliability of the In many markets, however, the reliability of the benchmarks / yield curves needs to be improved benchmarks / yield curves needs to be improved further by enhancing the transparency, liquidity and further by enhancing the transparency, liquidity and efficiency of the government bond market. E.g.,efficiency of the government bond market. E.g.,– Repo market, Repo market, – Primary dealers / market makersPrimary dealers / market makers– Trading platform and market / price transparency,Trading platform and market / price transparency,

Credit ratingCredit rating

The region’s rating agencies are only serving their home The region’s rating agencies are only serving their home country market. Does the region really need its own country market. Does the region really need its own credit rating agencies capable of serving across the credit rating agencies capable of serving across the region? region?

Mandating credit rating for a wide variety of issues / Mandating credit rating for a wide variety of issues / issuers (e.g., private placements, local government issuers (e.g., private placements, local government bonds, etc.) may make it a commercially viable business. bonds, etc.) may make it a commercially viable business. However, it may also discourage the market However, it may also discourage the market development by imposing cost.development by imposing cost.

Credit rating agencies could be required to have certain Credit rating agencies could be required to have certain qualifications to ensure their independence / credibility. qualifications to ensure their independence / credibility. E.g.,E.g.,– Certain ownership / governance structure to promote Certain ownership / governance structure to promote

reputation and independence.reputation and independence.– Diversified revenue base not to rely only on bond rating, Diversified revenue base not to rely only on bond rating,

particularly, revenues linked to services for investors.particularly, revenues linked to services for investors.– Qualified financial analysts and fit-and-proper management.Qualified financial analysts and fit-and-proper management.– Minimum capital.Minimum capital.– Etc.Etc.

Legal frameworkLegal framework

In a varying degree, countries in the region have In a varying degree, countries in the region have established / improved a basic legal and regulatory established / improved a basic legal and regulatory framework for corporate bond issuance. E.g.,framework for corporate bond issuance. E.g.,– China: Securities law and CSRC Decree 49 on corporate China: Securities law and CSRC Decree 49 on corporate

bond issuance (i.e., a move toward an integration of the bond issuance (i.e., a move toward an integration of the exchange market and the Inter-Bank Market.).exchange market and the Inter-Bank Market.).

– Vietnam: Securities Law, MOF Decree 52 on enterprise Vietnam: Securities Law, MOF Decree 52 on enterprise bondsbonds

Yet, significant inadequacies remain regarding:Yet, significant inadequacies remain regarding:– Securitization, Securitization, – Special Purpose Vehicle (SBV),Special Purpose Vehicle (SBV),– TrustTrust– Etc.Etc.

Settlement systemSettlement system

In a varying degree, settlement systems have also In a varying degree, settlement systems have also been improved. E.g.,been improved. E.g.,– Thailand: Bathnet IIThailand: Bathnet II– Indonesia: BI-SSSS linked to BI-RTGSIndonesia: BI-SSSS linked to BI-RTGS– Vietnam: SBV IBPS for RTGS money settlement. The Vietnam: SBV IBPS for RTGS money settlement. The

securities custody and delivery system has yet to be securities custody and delivery system has yet to be integrated and strengthened.integrated and strengthened.

Issues remaining are:Issues remaining are:– Consolidation of the securities custody arrangements.Consolidation of the securities custody arrangements.– Establishment of online links with the trading / market Establishment of online links with the trading / market

information systems for straight through processing (STP).information systems for straight through processing (STP).

Does the region need its own international central Does the region need its own international central securities depository (ICSD) like Euroclear in Europe?securities depository (ICSD) like Euroclear in Europe?

Bond trading marketBond trading market

Bond market is dominated by large institutional investors Bond market is dominated by large institutional investors and dealers, and block trades are common. The large and dealers, and block trades are common. The large institutional seller and the buyer need to negotiate the institutional seller and the buyer need to negotiate the trade directly or indirectly through a broker.trade directly or indirectly through a broker.

Transaction conventions have been being standardized.Transaction conventions have been being standardized.– Quoting convention, yield calculation method, trading units, Quoting convention, yield calculation method, trading units,

trade agreement format, settlement cycles, settlement trade agreement format, settlement cycles, settlement instruction format, master repurchase agreement, etc.instruction format, master repurchase agreement, etc.

Although advanced ICT is increasingly making it possible Although advanced ICT is increasingly making it possible to better organize the to better organize the governmentgovernment bond market, bond market, corporate bond market, which is fragmented by nature, corporate bond market, which is fragmented by nature, remains difficult to organize into a common trading remains difficult to organize into a common trading platform. platform.

A vast majority of the trading has been taking place in the A vast majority of the trading has been taking place in the over-the-counter (OTC) market around the world. OTC over-the-counter (OTC) market around the world. OTC market transactions are difficult to capture, and therefore, market transactions are difficult to capture, and therefore, the market lacks the market lacks transparencytransparency..

A Typical Secondary Bond Market Transaction

Dealer E

Inter-DealerBroker

Buy-sideInvestor 1

Dealer C

Dealer B

Dealer A

Buy-sideInvestor 2

Inter-DealerBroker

Dealer D

An investor contacts a dealer to unwind some of their large positions.

Instead of risking its own capital, Dealer D contacts inter-dealer brokers to unload the investor’s sell order.

Dealer FAn investor interested in buying bonds contacts a few dealers to get price quotes for execution.

Source: Celent Communications, World Bank

Policy objectives forPolicy objectives formarket transparencymarket transparency The issuerThe issuer wants good market transparency for all wants good market transparency for all

potential market participants because:potential market participants because:– it makes the dealer market competitive and reduces bid-ask it makes the dealer market competitive and reduces bid-ask

spread, thus attracts broadest participation of investors in the spread, thus attracts broadest participation of investors in the market; andmarket; and

– resulting demand facilitates placement in the primary market, resulting demand facilitates placement in the primary market, lowers the yield and, therefore, reduces the financing cost to lowers the yield and, therefore, reduces the financing cost to the issuer.the issuer.

The regulatorThe regulator is concerned about transparency because: is concerned about transparency because:– Transparent market facilitates best execution of orders for Transparent market facilitates best execution of orders for

investors by bond dealers and brokers (fairness of the investors by bond dealers and brokers (fairness of the market).market).

– Reliable benchmark yield facilitates setting of coupons in the Reliable benchmark yield facilitates setting of coupons in the primary market, pricing of instruments in the secondary primary market, pricing of instruments in the secondary market and valuation of bond portfolios and collaterals and, market and valuation of bond portfolios and collaterals and, therefore, risk management.therefore, risk management.

Trading platform and Trading platform and market informationmarket information Trading platform can help enhance the transparency, Trading platform can help enhance the transparency,

but fragmented / illiquid corporate bond market alone but fragmented / illiquid corporate bond market alone cannot support its commercial viability.cannot support its commercial viability.

A trading platform for government bonds, if adopted, A trading platform for government bonds, if adopted, could be used to trade corporate bonds as well, but could be used to trade corporate bonds as well, but market participants may prefer to trade through a market participants may prefer to trade through a broker in the OTC market.broker in the OTC market.

Market participants should be required to timely Market participants should be required to timely report transactions. There should be arrangements to report transactions. There should be arrangements to centrally gather the reported information, consolidate centrally gather the reported information, consolidate it as market information and disseminate back to the it as market information and disseminate back to the market in a timely manner. This require a sound market in a timely manner. This require a sound market information systemmarket information system..

Architectural ModelsArchitectural Models

Many possibilities exist (see www.bondmarkets.com).Many possibilities exist (see www.bondmarkets.com). Single dealer systemsSingle dealer systems Inter-dealer systemsInter-dealer systems

– eSpeed (Canter Fitzgerald), ETC (Garban Intercapital), MTS eSpeed (Canter Fitzgerald), ETC (Garban Intercapital), MTS (which acquired BrokerTec and Coredeal), etc.(which acquired BrokerTec and Coredeal), etc.

Multi-dealer systemsMulti-dealer systems– Market Access, TradeWebb, Bloomberg BondTrader, etc.Market Access, TradeWebb, Bloomberg BondTrader, etc.

Cross matching systemsCross matching systems– Automated Bond System (NYSE, i.e., order-matching system)Automated Bond System (NYSE, i.e., order-matching system)

Auction systemsAuction systems– BondVision (for MTS to create a multi-dealer system)BondVision (for MTS to create a multi-dealer system)

Dealer

Dealer

Dealer

Dealer

Dealer

A typical A typical marketmarket structure structure

Inter-dealerMarket

Dealer

Bank

MutualFund

Bank

Bank

SC

SC

SC

Bank

SC

Insurance Company

PensionFund

Mutual Fund

InsuranceCompany

PensionFund

Foundation

ProvidentFund

MutualFund

CooperativeIndividual

Individual

Individual

Dealer

Dealer

Dealer Dealer

Competitive Inter-Dealer MarketCompetitive Inter-Dealer Market

SRO & Information

Platform

DealerDealer

MutualFund

IDB

Dealer

IDB

IDB

Dealer

Insurance company

PensionFund

Mutual fund

Insurancecompany

Provident Fund

Foundation

PensionFund

MutualFund

Cooperative Individual

Individual

IDB

Straight through Straight through processing from processing from reporting to settlementreporting to settlement

Settlement system-based information does not include Settlement system-based information does not include price information. Even if the system is designed to price information. Even if the system is designed to capture it, it would involve time delay or noise unless capture it, it would involve time delay or noise unless the settlement cycle is standardized and made short. the settlement cycle is standardized and made short. However, short, standardized settlement cycle would However, short, standardized settlement cycle would create a liquidity pressure on market participants and create a liquidity pressure on market participants and may be resisted by them.may be resisted by them.

Instead, the reporting could be made a separate but Instead, the reporting could be made a separate but linked requirement for all transactions to be settled. linked requirement for all transactions to be settled.

To facilitate the compliance, the reporting should be To facilitate the compliance, the reporting should be supported by a common information network linked supported by a common information network linked online to the settlement system, achieving online to the settlement system, achieving STPSTP (although the settlement system should offer an option (although the settlement system should offer an option for market participants to access directly in case of for market participants to access directly in case of system failure of the reporting system.)system failure of the reporting system.)

However, bear in mind However, bear in mind that …that …

Transparency is not free.Transparency is not free.– Gathering, processing and disseminating useful Gathering, processing and disseminating useful

information involves implicit as well as explicit costs information involves implicit as well as explicit costs while bond trading is very sensitive to the transaction while bond trading is very sensitive to the transaction cost.cost.User fee may be charged to cover the cost while the User fee may be charged to cover the cost while the use is made mandatory (Is this fair?). The authority use is made mandatory (Is this fair?). The authority and the market participants should explore ways to and the market participants should explore ways to reduce the cost (e.g., internet-based system) and reduce the cost (e.g., internet-based system) and enhance the convenience of reporting (e.g., STP) as enhance the convenience of reporting (e.g., STP) as much as possible.much as possible.

The more transparent, not always the better.The more transparent, not always the better.– Demanding high transparency of certain market Demanding high transparency of certain market

information can discourage market activities, information can discourage market activities, particularly market making.particularly market making.Examine and identify what kind of transparency is Examine and identify what kind of transparency is desirable and desirable and what notwhat not..

Transparency andTransparency andmarket architecturemarket architecture

Transparency is not one thing: Certain information Transparency is not one thing: Certain information is a public good while some other is a private good is a public good while some other is a private good owned by those who pay for or invest in it, implicitly owned by those who pay for or invest in it, implicitly or explicitly.or explicitly.– Pre-tradePre-trade price and volume information is a partly price and volume information is a partly

private good while private good while post-tradepost-trade price and volume price and volume information should be a mostly public good.information should be a mostly public good.

– AnonymityAnonymity: identity of market participants, pre- and : identity of market participants, pre- and post-trade is a private good.post-trade is a private good.

Balancing the public and the private goods is a key Balancing the public and the private goods is a key to designing the secondary market structure.to designing the secondary market structure.– Public goods: the more, the better,Public goods: the more, the better,– Private goods: need to reconcile conflicting business Private goods: need to reconcile conflicting business

interests of different groups of market participants.interests of different groups of market participants.

Optimal market Optimal market architecturearchitecture

Reconciling different business interests of different Reconciling different business interests of different groups of market participants.groups of market participants.– Market makers / primary dealers Market makers / primary dealers – Non-market maker intermediariesNon-market maker intermediaries– Institutional investorsInstitutional investors– Retail investorsRetail investors

Primary market structure influences the optimal Primary market structure influences the optimal secondary market structure.secondary market structure.– Primary dealer (PD) system with an “exclusive” Primary dealer (PD) system with an “exclusive”

privilege to participate in the primary auctions.privilege to participate in the primary auctions.

Legal & regulatory issuesLegal & regulatory issues

Should an ID platform be authorized as an exchange?Should an ID platform be authorized as an exchange? Can it be allowed to offer voice broking without a Can it be allowed to offer voice broking without a

brokerage license?brokerage license? Should it be supervised as an exchange as well as an Should it be supervised as an exchange as well as an

SRO by the securities regulator?SRO by the securities regulator? How should IDB be authorized and regulated?How should IDB be authorized and regulated? Is there Regulation ATS to authorize and regulate Is there Regulation ATS to authorize and regulate

electronic trading platforms and ECNs?electronic trading platforms and ECNs? Whether and how should Bloomberg, Reuters, Telerate Whether and how should Bloomberg, Reuters, Telerate

be regulated if they offer trading services?be regulated if they offer trading services? How can possible public sector ownership be treated How can possible public sector ownership be treated

under the existing regulatory framework?under the existing regulatory framework?

Thank you.Thank you.