The fixed-income market has improved its transparency in recent years. And a number of industry players say it should be left alone to evolve further. Others argue, however, that more is needed to protect retail investors from being left in the dark about the quality of execution and price competition.

As it stands, theCanadian Securities Administrators has proposed amendments to its marketplace rules that would, among other things, impose added transparency and reporting requirements on the bond market.

Pressure for improved transparency has been around for some time. In 2002, the CSA published a survey in conjunction with the Investment Dealers Association of Canada that recommended better regulation and increased transparency for the retail side of the fixed-income market.

The report recommended that the IDA introduce rules regarding debt pricing and markups for retail investors (which it did earlier this year) and that the CSA and IDA address the need to improve transparency in the retail debt market.

The survey found that many market players think retail markups are excessive. But the lack of market transparency makes it impossible for investors and retail brokers to assess the fairness of prices.

The importance of fairer and more transparent debt markets is only expected to grow as the population ages and investors’ portfolios shift away from equities toward more fixed-income allocations.

Transparency standards were established in the last revision to the CSA’s rules in this area in 2003. But bond-market players were given an exemption from certain reporting requirements, a pass that terminates at the end of the year. Comments submitted on the proposed amendments show most industry players would like to see the exemption extended for another five years. The move was considered by the CSA, but initially rejected.

In general, the industry comments argue there is no need to impose increased transparency requirements on the institutional side of the market because it is self-policing. They say transparency is increasing naturally due to market forces and, while they concede that there may be a need to impose some requirements on behalf of retail investors, there’s not yet enough hard evidence to justify regulatory intervention.

Indeed, earlier this year, an IDA paper by Paul Bourque, senior vice president of market regulation, stated that there are two important questions to be answered to determine whether regulatory intervention is justified: the extent of retail participation in the debt market; and whether market-based solutions can deliver the appropriate level of retail transparency.

In its comment to the CSA, the IDA notes it is conducting a survey of debt-market participants that will look at “best execution” and pricing issues in both the retail and institutional markets. “Although this survey is an important first step, it will not provide the complete picture required to assess the transparency requirements of the retail fixed-income market,” it says. “The IDA will use the information gathered from the debt market survey to provide the framework for further research it will be conducting into retail debt market transparency.”

Another survey of the quality of retail transparency is being conducted by Toronto-based financial data vendor Gmarkets Inc. , in co-operation with the industry’s new trade association, the Investment Industry Association of Canada.

Gmarkets president and CEO Robin Hanlon says the survey is being circulated among a random sample of retail brokers at both bank-owned and independent dealers, and the IIAC has distributed it to its members’ chief compliance officers and retail sales committee members.

The survey aims to use advisors to provide the retail investors’ perspective on the availability and pricing of fixed-income products, to assess investors’ level of knowledge and determine the sources of information both clients and advisors use for pricing.

Hanlon concedes that there may be a gap between advisors’ interpretation of their clients’ knowledge and views on market transparency, and what the clients might say themselves if they were asked directly. She notes, however, that it’s hard to reach investors and it’s also important to get advisors’ feedback on the quality of transparency, given their role in retail markets. The survey is expected to continue for a few weeks, with the results available around mid-November.

Retail brokers have long complained that their firms’ bond desks gouge them and their clients on pricing, that they have a hard time verifying the fairness of prices and that there’s a lack of competition in the fixed-income market. Brokers at some of the independent firms may be able to shop among several dealers’ bond desks, but many brokers are simply captive to their in-house desks.

@page_break@Such comments are frequently expressed in Investment Executive’s annual Brokerage Report Cards. As one broker noted in this year’s survey: “There is a fundamental structure problem. The bond desk is run as a profit centre. They compete against us. We can never find out if it is a good price or not.”

Another advisor complained: “There’s no comparison to tell you if the pricing is fair.”

Another broker joked: “I’m told it’s good pricing.”

Some advisors have simply resigned themselves to the fact that their firms profit mightily from their bond desks, at the expense of the advisors’ businesses and clients.

Fixed-income pricing is “important to me, but you have no control over it. You pay what you have to pay,” said a broker with a big dealer.

Not surprising, the dealers have a more upbeat view of their role in the market and the progression of retail transparency in the past few years. Several firms commenting on the proposed amendments argue that bond market transparency for retail investors has improved in a variety of ways.

“In the past five years, industry-driven initiatives, as well as specific firm-driven initiatives, have led to increased transparency for investment advisors and retail investors in the fixed-income market,” states Bank of Montrealin its comment. “Apart from the quotes provided by CBID Markets Inc. in the financial press daily, a rudimentary yield curve, provided voluntarily by CanDeal Inc. , is available at the Toronto Stock Exchange public Web site. And BMO’s retail bond desk provides extensive historical data and market colour to its sales force.”

On top of the increased sources of market information, retail investor protection has been improved by a policy recently adopted by the IDA that sets standards for the treatment of retail clients in the bond market.

One comment notes the availability of competitively priced fixed-income products through sources such as discount brokers, although it is doubtful that many dealers are encouraging their brokers to send clients online to get well-priced bonds.

The industry appears virtually unanimous in the conclusion that retail transparency has improved and that regulators should refrain from imposing new transparency requirements — at least, until more research has been carried out. Moreover, they fret that imposing prescriptive requirements to improve transparency may, in turn, hurt liquidity.

This last view, common among dealers, is echoed by institutional investors. It is repeated in a joint comment from the Bank of Canada and the federal Finance Department, which warns that added transparency requirements won’t resolve retail investor concerns and may have unintended consequences for the wholesale market.

However, the opinion isn’t entirely universal. Indeed, one of the firms that has been credited with improving transparency — Perimeter Financial Corp. , operator of the CBID online multi-dealer market — stands out as a dissenting voice among the comments to the CSA.

“There has been insufficient progress in delivering transparency to retail customer channels.” Perimeter states. “Single provider markets dominate the retail landscape. Notwithstanding the goals of [the IDA’s policy on the treatment of retail investors] to place a burden of fair dealing on market providers, it is left to the provider, not the customer or regulator, to make the determination of value to the investor. Faced with an offer from a single dealer to which a retail customer is typically captive, the customer has limited ability to judge the fair value.

“In addition,” Perimeter’s submission continues, “without a credible external benchmark price against which to measure executions, there is little basis for ascertaining the quality of the execution achieved. [Without that benchmark], there will be undetected abuses and market inefficiencies, and the retail investor will have no basis to complain of suspected misdealing.”

While the CSA will be reviewing all of the comments before making a final decision, it seems to share those concerns. After all, it decided to introduce transparency requirements after considering the possibility of extending the exemption for five years, or even offering a permanent exemption.

“We have concluded that, while transparency has generally increased, issues regarding pricing for retail customers still exist, and that it is difficult to monitor compliance with other requirements applicable to the fixed-income markets (for example, best execution or fair pricing) without a single source of reported and disseminated information for government fixed-income securities,” the CSA notes in its proposed amendments.

Finally, there is some fear that if regulators back off from their push for greater transparency, the industry may, too. Perimeter reports: “We have not seen a meaningful change in the industry’s willingness to provide an increased level of transparency. Based on the evolution to date, it would, therefore, appear that without a regulatory mandate we will continue with the current piecemeal solution at best.”

Perimeter warns that if the current exemption is extended or granted permanently: “There could be a regression from the current, inadequate levels of transparency. Market participants could infer that the CSA no longer agreed with the policy arguments in favour of increased transparency, thereby removing this incentive to comply with the existing voluntary regimes.”

Despite much improved transparency in the Canadian bond market, there may still be a need for more sun to shine into the still murky world of debt trading. IE