Views mixed about more federal involvement in e-trading

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WASHINGTON – Industry officials had mixed views about whether federal regulators should become more involved in electronic trading in municipal bonds and other fixed income securities during a hearing held on Friday by a House Financial Services Committee panel.

The hearing, held by the committee’s panel on capital markets, securities and investments, was held to review fixed income market structure, but included a lot of discussion about electronic trading.

Matthew Andresen, chief executive officer of Chicago-based Headlands Global Markets and Headlands Technologies, which participates on all major muni bond alternative trading system platforms, told the lawmakers that ATSs have been good for the market. But he raised some concerns that he said regulators might want to address.

Randy Snook, executive vice president of the Securities Industry and Financial Markets Association, took a different view, saying electronic trading should be allowed to develop as organically as possible without some external determination of what its structure should be. He also pointed out that the muni market is faced with markup disclosure rules and that it is important to wait and see the results from those. They take effect next May.

The hearing also touched on Securities and Exchange Commission Chair Jay Clayton's proposal to create a fixed income market structure committee, the need to treat municipal bonds as high quality liquid assets, and the importance of tax exemption to the muni market.

Andresen said his firm is a top participant on all major municipal bond alternative trading system (ATS) platforms, executing nearly 700 trades per day and trading with about 400 counterparties.

He said that fixed income electronic trading platforms are “without question” the right direction to go after panel chair Rep. Bill Huizenga, R-Mich., asked about them during the hearing and asked whether there is a consensus about their need.

Andresen explained to the subcommittee that, currently, bonds are sold on ATSs using an auction system where investors and intermediaries request quotes for a “bid price,” the price at which a dealer is willing to buy bonds that an investor wants to sell. After receiving the bids over a set amount of time, the investors can find the highest bid and choose whether to sell.

“The ATSs have brought positive changes to the municipal bond markets through these auctions by increasing price transparency and liquidity and by helping buyers and sellers find each other,” Andresen said.

When panel member Rep. Randy Hultgren, R-Ill., asked how the government could play a role in electronic trading, Andresen said it could encourage the use of electronic trading while emphasizing proper adherence to best practices.

But Snook said the market should be left to develop these systems.

“In each of the markets, we see different degrees of adoption and use of electronic trading,” Snook said. “Let people come in and figure out how to leverage the data and compete.”

Andresen raised some concerns in his written testimony that he said regulators may want to take into consideration.

One is the practice of filtering, which occurs when a dealer handling its own retail customer’s order requests a quote or starts an auction on an ATS but uses automated tools on the system to filter out responses from specified dealers. Current guidance from the Municipal Securities Rulemaking Board says the practice should only be done “for a legitimate purpose consistent with obtaining the most favorable executions for customers.”

Andresen said it is not always apparent that that is the case. “A focus on whether the continued use of filters is ‘for a legitimate purpose’ may be in order,” Andresen said.

He said other concerns involve the competitiveness of auctions.

Some dealers use what is known as a “trade through” and get prices for a customer via a bid wanted auction but then internalize the order by purchasing the bond from its customer for its own account at a lower price than the winning bid in the auction. The practice is harmful to customers because it results in bonds selling at inferior prices, Andresen said.

However, he added that planned MSRB rule changes to have dealers disclose their markups in transactions may help curb that practice.

In addition, dealers sometimes use a “last-look” process where they see the prices submitted to a completed auction and then decide to purchase the bond from the customer at a slightly better price than the winning bid. That is problematic, Andresen said, because dealers could be deterred from bidding if they think their bids will only be used for price discovery.

Hultgren said he finds Clayton’s recently announced plan to create a fixed income markets advisory committee “very encouraging.”

“For this to be an effective committee, it will, of course, need to include the right perspective of market participants, such as small and middle market dealers,” Hultgren said. “It will also need a strong mechanism for making recommendations to the commission, so that its work won’t go overlooked.”

John Vahey, managing director of federal policy for Bond Dealers of America, said the group was pleased to hear Hultgren urge the SEC to take input from regional firms. Vahey said it is “a view we agree with strongly in order to support a well-rounded advisory board.”

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