Pers Sjoberg and Susan Hinko of TriOptima argued in Financial Times this week that OTC derivative markets aren’t liquid enough to be subject to real-time transparency requirements. But what does liquidity have to do with the social benefits of price transparency?
The correct comparison is not futures or option markets, but other illiquid markets like the corporate bond market. And it’s far from clear that real-time transparency has been detrimental to the corporate bond market — in fact, the most recent news has been that the corporate bond market is thriving.
The authors argue:
[In] highly-liquid, standardised markets, real-time reporting and price transparency are meaningful concepts. When these concepts are applied to the OTC markets, adjustments should be made, especially given the fact that many of these low-frequency transactions have large notionals and need to be hedged discreetly to minimise hedging costs.
The whole goal of price transparency is that it should be impossible for anybody to “hedge discreetly.” That’s the point. Every transaction shows up in the market price. If I do a bond transaction sequentially for two different accounts, I’m likely to see a price movement from one transaction to the next — and I trade in very small quantities. But this is simply the inherent nature of trading on a functional market where my earlier purchase (which was completely unpredictable before I sent it in) shows up as having a price effect after it has been made public. Price movements, like this, are the very purpose of transparent markets.
The authors continue:
However it is important for the new rules to reflect the realities of the market so regulators and the public have access to meaningful information. Intra-day reporting will place systems and cost burdens on institutions already restructuring to meet the demands of new legislation and regulation, and will not yield significant results to the public.
I don’t understand why purchases like my first purchase of an illiquid bond are classified by the authors as not “meaningful information.” That’s a decision that the dealers on the market make when they post their bids and offers. If a transaction is not meaningful to them, it will not shift the price, and, if it is meaningful to them, it will.
We can all understand that it is more beneficial to financial institutions for them to be able to trade with more information than the rest of us, but it is far from clear that protecting their intra-day information is in the public’s interests. If the only costs are structural, because financial institutions will have to set up real-time reporting systems, it seems to me to be in the public’s interest to create a standard that says that such systems should be set up for just about everything that financial institutions trade. Thus, when regulators want real-time reporting of a new product, it should take the financial institutions days, not weeks, months or years to provide.
We live in a society where every pack of gum is bar-coded and consumers can do cross-store price checks on their phones. Why has the financial industry chosen to maintain back office procedures that are practically medieval — even as they trade in multi-million dollar products?