Democratizing finance: The primary bond market is next

The history stretches as far back as the late 1970s and 80s, an era when the democratization of finance really started to take off, due to the lifting of post-war regulations trapping capital within national borders, and an increase in the institutional management of capital and the global integration of financial market clearing and settlement infrastructure.

This was a game changing period, ultimately enabling the masses, not just the privileged few, access to international capital markets for the first time.

Fast forward to today, and access to global markets has never been greater. Technological advancement and digitization are enabling this transformation, with the rise of cryptoassets even seen by some as symbolic of a 21^st century financial revolution.

In the traditional asset classes of equities and bonds, technology has already brought revolutionary change, but the extent of that change differs between these markets. Equities trading and investing has, for instance, undergone greater democratization than bond trading and investing, which is today still dominated by large institutional investment funds. Retail investors barely get a look in.

Another side to this is the primary market, where companies raise capital through the sale of shares and bonds almost always with the help of investment banks. Yet, in both the primary equity and bond markets, institutional investors and company issuers are pushing for change in the practices and processes of capital raising.

This is particularly the case in the primary corporate bond market, where the electronic connectivity between the investment banks and institutional investors, together with some of the workflows around the selling and buying of bonds, has not advanced with technology. Seen another way, some of the practices and processes are outdated, overly manual and need to be modernized.

For instance, banks market an offering through direct negotiations with investors, usually over the telephone or by electronic message. As a result, the information conveyed is often inconsistent. What’s more, banks generally seek to get the best terms for the issuer and provide deal certainty, but they have discretion in deciding with which investors they wish to place the bonds.

This issue is such that financial regulators have been taking an interest, including the International Organisation of Securities Commissions – the regulator's regulator – European regulators, Hong Kong’s Securities and Futures Commission and the US Securities and Exchange Commission (SEC).

In a report last year, the SEC’s Office of the Investor Advocate (OIA), which looks after investor interests, wrote that while the new issue corporate bond enables issuers to raise capital efficiently, “on closer inspection, the market does not function as seamlessly as might be presumed.”

“In recent years, many institutional investors have raised concerns that the marketing process for new issues does not provide buy-side participants an adequate opportunity to make informed investment decisions,” the report said.

A bond offering can be announced and priced within a day. Yet, the amount of time between a deal’s announcement and the deadline given for submitting orders is sometimes as short as 15 minutes.

The Credit Roundtable, an investor trade association composing 39 members managing over $4 trillion of fixed income assets between them, has been speaking out on the issue, and wants some of the practices in the process of marketing, pricing, and distributing new bonds to be reformed. This includes pushing for standardized offering protocols and reference data, which they say would improve investors’ ability to assimilate offering information more quickly.

Several trading technology platforms have emerged in recent years to help address some of these issues, including one called DirectBooks, which is owned by some of the biggest investment banks in the bond market.

This shows there is a willingness by the banks to address these issues, but there has been a reluctance to change, says Christopher Sztam, managing director and head of the global markets group at IHS Markit, which also offers a suite of platform solutions for the new issue bond market.

The most recent is InvestorAccess, which brings together investors and banks on a single platform, enabling them to participate in new issuance and all the workflows relating to the distribution of deal terms and communication of orders and allocations. The platform was essentially built to address the issues – highlighted by the CRT – that investors face.

“One of our areas of focus is around interoperability between execution or order management platforms and the primary bond market through InvestorAccess,” says Sztam, adding that the buy-side is "really excited by that and is eager to have it.”

However, not all participants are so keen. Opposition by some banks – particularly those promoting their own system – to InvestorAccess or any other platform vendor, may be understandable. But the risk is that “multiple systems will fragment the market for both sell-side and buy-side participants,” says Nick Hall, managing director and global head of fixed income at IHS Markit.

He adds that there is going to have to be some kind of compromise, where there is collaboration. “I don’t think the market wants two separate systems, that don’t talk to each other, doing the same thing,” he says. “The buy-side don’t want that. And the banks won’t want to have to pick which system they’re going to use depending on whether they’re running a deal in the US, Europe or Asia. They want either one platform or at least multiple platforms that can interact with each other.”

For Sztam, there is room in the market for a few different platforms, but in the end, and for the benefit of all market participants, “they have got to work together – interoperability is fundamentally important.”

He adds that market participants including both providers and consumers of capital want collaboration in the capital formation process and are demanding cooperation.

And if there is no movement on this, the risk is that financial market regulators may need to get involved, as indicated by the SEC.

Transforming the bond issue process in the way that is needed will take time, but it is critically important to “provide more efficient access for all market participants,” says Sztam. “The bond market has seen some automation on the sell-side, but further market integration is required in order to bring greater transparency and efficiency.”