The Investment Industry Regulatory Or-ga-n-ization of Canada has proposed new rules designed to make bond trading more transparent and less expensive. But critics charge that reforming the bond market is not so cut and dried.

On April 17, IIROC, which enforces rules for trading activity on all Canadian debt and equities markets, published its proposals for comment that would, for the first time, enable investors to find out how much they are paying in terms of commissions when they buy and sell bonds.

Currently, bond trading costs are buried in dealers’ prices; under the new proposals, they would be shown as explicit charges.

Additionally, instead of the current system, in which investors must call dealers to find bonds the investors wish to buy or sell, then compare the prices, investors could get a few quotes from the dealers, see the trading charges explicitly stated, then make the choice.

But reforming the rules of the bond market will be a challenge. There are far more bonds in existence than stocks, and each bond issue has variations in interest, term, call features and covenants, says Jeff Eby, head of Perimeter Markets Inc. , a bond data trading service in Toronto.

Also, bond spreads should quite properly vary with the difficulty of finding inventory, the cost of carrying the issue and the cost efficiency of trading it, suggests Randy LeClair, senior vice president and global bond portfolio manager with AIC Ltd. in Burlington, Ont.

The least problematic issue is pricing of new federal and provincial bonds.

These issues are highly liquid, so competitive quotes can easily be found. Corporate bonds, on the other hand, present some problems.

“Retail investors only trade in bonds they are offered by their dealers’ retail desks,” says John Carswell, president of Richmond Hill, Ont.-based bond manager Canso Investment Counsel. “But the retail desk buys from the institutional desk and adds a spread to what the institutional dealer has imposed. The client’s broker may then add his or her own spread or fee.”

However, in spite of all these hurdles to reform, Carswell says, changes in the bond market are vital: “The improvements contained in the IIROC proposals are needed. The bond market is the least efficient and the least transparent in the country.”

The existing system favours dealers and, not surprising, they have their own reform proposals. The eight biggest bond dealers — mainly the bond desks at the bank-owned brokerages — are teaming up to build a system that will be called CanMarketData.

Parts of the system would be in operation in 2009, says Jayson Horner, president and CEO of CanDeal Inc. , which would help create the new system. “It is likely to help satisfy some of the regulatory requirements that IIROC wants.”

The fact that most bonds seldom trade makes pricing problematic, says Edward Jong, senior vice president with MAK Allen & Day Capital Partners Inc.and portfolio manager of frontierAlt Opportunistic Bond Fund.

“To be listed, a bond should have an issue of at least $100 million and have 10 or more holders,” Carswell suggests. “But some large issuers, such as General Motors Acceptance Corp., have thousands of issues below the $100-million hurdle.” These types of issues, he says, would be part of the invisible majority.

The best outcome, he continues, will be the reporting of all trades rather than of all bond bids and offer prices.

This amounts to a bias for frequently traded or large issue bonds, he adds. IIROC’s proposals don’t solve the problem of finding a price for an obscure bond.

In the end, the fact that the bond market has both a few huge institutional players and a great many small players won’t change the fact that charges vary with order size, Jong says.

“Most of the benefit will be in the secondary or resale bond market, in which there is active bond trading,” Carswell points out. “Yet, for all the transparency, there is doubt that retail margins will tighten. Small investors will continue to pay higher markups than big institutions. That is just the economics of the market.” IE