A deconstructed view of a consolidated tape
By Neil Ryan, FINBOURNE Technology
Published: 21 March 2022
The mood music around the introduction of a consolidated tape (CT) in the UK and the EU has been growing louder over the past six months, with the recent crescendo replaying some of the basic use cases and policy challenges - again!
However, against a background of rapidly changing market structures, innovative and accessible products and rapidly developing technologies and solutions, a CT can make a significant contribution to standardising transparency, improving market pricing and investment strategy, and delivering key public policy goals.
Transparency drives trust
The relationship between transparency of information and market outcomes can be separated into two fundamental elements - information asymmetry and predatory trading.1 The former addresses the relationship between transparency and market outcomes, in the context of market participants possessing differing degrees or levels of information, based on whether or not information access is costly. The latter is subject to considerable regulatory attention, in terms of ensuring fairness and best execution for retail clients.
Asymmetric information discourages market participation, where people feel it is difficult or costly to access basic data to inform investment decision-making. It also leads to a degree of caution on the part of investors in terms of engaging with financial markets that they feel they don’t trust or understand.2 If we take the example of seemingly transparent markets - such as the US corporate bond markets, where the Financial Industry Regulatory Authority (FINRA) operates the Trade Reporting and Compliance Engine (TRACE) CT – even this system does not provide a total, global view of all US corporate bonds traded.
While the issue of data quality has been highlighted as central to the CT debate, it is also wrapped up in a broader point about accessibility. This concern also features in the European Securities and Markets Authority’s (ESMA) MiFID II/MiFIR Review Report (September 2020), where, in relation to changes to the regime, the sell side ‘group’ noted that “priority should be given to working on accessibility, readability and quality of market data”. Similarly echoed by a section of the larger buy-side ‘group’ who cite “the need to improve the standardisation, the accessibility, and the quality of MiFIR market data”.
The current MiFID II rule requires access to 15-minute delayed data that must be made public by the various venues and data providers. However, as we highlighted in the first of our series of whitepapers, while access is available, it requires a degree of technical knowledge that would overwhelm most retail investors (and even some asset managers). This is because the array of file formats presented makes aggregation of the data from those different providers, almost impossible.
What are the market benefits of a CT?
Transparency is a key benefit of a CT and there are more concrete examples of how the mechanism can benefit the market, when we look at the implementation of TRACE in the US:
- Reduction in trading costs: Research at the University of Chicago’s Booth School of Business3 estimated that the introduction of mandatory dissemination of price and volume information for corporate bond trades (via TRACE) reduced overall market trading costs, across all types of bonds, by some US$605m per annum.
- Cost of capital savings for issuers: Recent research4 on behalf of the European Finance Association, has focused on the relative importance of potential economic mechanisms that link secondary market transparency and primary market costs. The analysis identified how regulatory reform impacts cost of capital and highlighted that improved post-trade market transparency (via TRACE) is associated with a fall of 14 bps in the yield spread of a typical issue - corresponding in their sample to a 1.1% cost of capital ‘saving’ for issuers.
- A complete view of liquidity: Fragmented reporting limits the visibility that the market has in terms of a complete view of liquidity. In TRACE’s case, while it provides a comprehensive view of corporate bonds traded on US venues, research has shown that when data from EU venues for those same US corporate bonds, is included, the actual total weekly volume and number of trades were respectively 15% and 17% higher, than those reported in TRACE alone.5 Similarly, in the UK and the EU, a single source of comparable data should allow a more complete view of total liquidity to emerge.
- Understanding inter-connectivity of securities: Where there are connections between different parts of the markets - for example, a high yield bond ETF – it is often useful to be able to observe the prices of the underlying components. Recent research6 has shown that including a bond in an ETF has a favourable impact on the bond’s liquidity and this can impact investors’ assessments of those bonds, as well as ensuring a better understanding of the bond price dynamics.
- Buffering market volatility: An area of focus from some global regulatory bodies has been how to stabilise prices during periods of financial markets turmoil – to encourage institutional investors to reprice securities, rather than exit markets. Recent analysis7 examined whether retail investors had a stabilising effect on stock prices, using the COVID-19 pandemic as an exogenous shock. It found that shares likely held by retail investors have 17% higher liquidity and at least, 24% lower ‘crash’ risk. This indicates that retail investors are rational, according to their trading patterns and do not necessarily follow institutional investors.
Long standing policies
Since 2015, the EU has been pursuing an ambition to complete its Capital Markets Union (CMU) Programme as a core pillar of the EU itself. At the end of November 2021, the European Commission adopted a package of measures to ensure that investors have better access to market trading data, to deliver on several key commitments in the 2020 CMU action plan.
In 2022, they want to help connect EU companies with investors, improve their access to funding, broaden investment opportunities for retail investors and better integrate capital markets.
A CT is seen as a key mechanism from the review of the Markets in Financial Instruments Regulation (MiFIR), with a series of proposals published to help deliver part of that action plan.
Meanwhile in post-Brexit UK, the HM Treasury outlined an initial policy perspective through its Wholesale Markets Review in mid-2021 and the recent WMR response has confirmed the focus on delivering fixed income CT.
The detail is in the data
In both the EU and UK, the issue of data quality will need to be addressed as part of any CT process. While there are detailed regulatory technical standards (RTS 1’ and RTS 2) defined by ESMA, when we looked at the MiFID transaction records’ data, we found inconsistencies in the transaction records published. In our analysis, we break the data quality issues down into three categories: consolidation and aggregation, consistency and coherence.
Both the UK and the EU have launched or plan to launch consultation processes on these standards. However, a better solution might be to ensure that there is a uniform approach and standardised practices by market participants and venues around the common application of the existing RTS standards – an ‘instructions manual’, if you will.
Most market participants hope that, while the CT process may take different paths in the UK and the EU, the basic infrastructure, data standards and transparency rules will be the same, to ensure an effective implementation of CT initiatives across markets.
FINBOURNE agrees with industry bodies, regulators, and market participants that a CT is both necessary and beneficial. There are a myriad of issues still to be decided but the sense of direction is clear, while the need for market participants to contribute to the debate and start to get ready for a CT is equally obvious.
We believe that the time for engagement is now and we’re inviting market participants to keep in touch with developments in our Design Council, as we take the first steps to address the data challenges and build a technology-led market focused CT.
To learn more and for details on how to join the Design Council or to speak to us about CT, get in touch at [email protected].
1 FCA Occasional Paper No. 6 Transparency in the UK Bond Markets: An overview January 2015.
2 They still haven’t told you Knuteson SSRN-id3998202
3 The Effects of Mandatory Transparency in Financial Market Design: Evidence from the Corporate Bond Market, Asquith, Covert and Pathak April 2019
4 Secondary Market Transparency and Corporate Bond Issuing Costs Brugler, Comerton-Forde and Martin (on behalf of the European Finance Association), Oxford Review of Finance July 2021
5 Bond liquidity and dealer inventories: Insights from US and European regulatory data, Ivanov, Orlov and Schihl, FCA Occasional Paper SEC DERA Working Paper February 2020
6 The Impact of the HYG ETF on the Liquidity of the Markets for the Underlying High-Yield Bonds, Finnerty and Reisel, Gabelli Business School Fordham University July 2021
7 The Impact of Retail Investors on Stock Liquidity and Crash Risk, Hüfner and Strych Karlsruhe, Institute of Technology December 2021