Buy side confronts dealers over unreliable bond prices

Investors are quantifying the quality of indicative prices and banding together to tackle the issue

Paying too much

When corporate bond prices flash across their screens, buy-side traders know to be sceptical. The price they receive when executing a trade can be far from what was advertised.

Some on the buy side have had enough of this, and they are trying to do something about it.

The trading desk at Pictet Asset Management has been comparing indicative prices sent by dealers to traded prices and confronting them about the discrepancies.

“It was pretty uncomfortable, because it laid bare what they were doing,” says Carl James, global head of fixed income trading at Pictet, recalling one conversation with a dealer some time ago. “[It] wasn’t horrendous, but I just said, ‘that is not what we would expect from you’. Once they realised we were watching and we were showing them this, their data improved rapidly.”

Efforts are also being made to tackle the problem in a co-ordinated way. The issue has been discussed at the UK-based Investment Association in recent months: the trade group’s fixed income committee is said to have considered sending a joint letter to dealers calling for changes.

The Investment Association declined to comment on the matter.

Some buy-side firms are also working with technology firm Neptune to quantify the quality of dealers’ data.

This is not a new problem. Reliable pricing data on corporate bonds is notoriously hard to come by. Some bonds can go days or weeks without trading. When transactions happen, they are executed bilaterally.

The issue is particularly pressing for European asset managers that must comply with the best execution requirements of the second Markets in Financial Instruments Directive. In the US, the Trade Reporting and Compliance Engine provides a history of most bond transactions, which asset managers can use to demonstrate best execution. There is no comparable consolidated tape of bond trades in Europe.

Once [the dealer] realised we were watching and we were showing them this, their data improved rapidly
Carl James, Pictet

As a result, investors use the price information shared by dealers, alongside other inputs, to mark their books and demonstrate best execution.

This data comes in the form of two-way runs and balance sheet axes posted to clients. Runs are indicative prices for bonds at a ‘market size’. These may simply be a salesperson’s best guess of current trading levels. Axes communicate a dealer’s interest in buying or selling a specific bond at a given price.

Dealers also stream executable prices for more liquid bonds in small sizes, though these are of little use to institutional traders looking to transact large blocks.

But asset managers say some of the data being shared by dealers – especially in runs – creates more problems than it solves. “You get a stream of indicative quotes from other providers at the same time [as you execute a trade]. Then compliance is asking, ‘How come you didn’t trade on the best price? We can see on the screen that there are some other quotes from other providers that were better. What the hell did you do?’” says a senior trader at a European asset manager.

“That illustrates the problem – you have pears and apples. You cannot compare indicative to real tradeable quotes. You need to treat that differently.”

Some on the buy side place little trust in indicative pricing. “Often, if you do chuck in a request to somebody who’s showing the indication, it’s rejected, which proves your suspicion that it wasn’t solid,” says Gordon Shannon, a portfolio manager at TwentyFour Asset Management. “I don’t put much faith into anything that isn’t an axe these days.”

Axes are typically the most executable expression of a dealer’s willingness to buy or sell at a given price. But even these can be illusory. Defining an axe remains “an ongoing frustration in the buy-side community”, says Mike Poole, head of fixed income dealing at Jupiter Asset Management.

“Is it inventory, a client seller, the bank wanting to short something on a prop-esque desk, ETF flow?,” he says. “These are things that are good to know and are important. At the moment, an axe is a vague wish by a counterparty to execute in that bond.”

Knowing what lies behind a dealer’s axe can help a buy-side trader determine whether the liquidity is deep enough to meet their needs, or if they should go elsewhere to complete an order, says Poole.

Behind the data

Dealers say they are doing their best to get accurate price information to clients. “We are focused on trying to stream and publish prices and axes as efficiently and accurately as possible,” says a credit head at one large bank. “Our clients have different requirements on how they want to see and access our data and we do our best to meet those needs.”

Many asset managers are willing to give them the benefit of the doubt. They say dealers are in a difficult position, with regulatory constraints preventing them from holding large inventories, and outdated technology systems that may make it difficult to send targeted information to buy-side clients.

“My intuition tells me that banks are trying to do the best job they can to get the right data to the right counterpart,” says Pictet’s James.

TwentyFour Asset Management’s Shannon points out dealers are under no obligation to provide this data and that the information they do share is still useful.

“A lot of customers like us still depend upon those reports for marking our books and for understanding what is happening in the market. Before, they were sending out those runs mainly as an advertisement for business. Now it is almost as a service,” he says.

My intuition tells me that banks are trying to do the best job they can to get the right data to the right counterpart
Carl James, Pictet

Tim Grant, a head trader at PineBridge Investments, says sifting out inaccurate data is an intrinsic part of trading in over-the-counter bond markets. “Sometimes the dealer quote runs are good, and sometimes they’re not so good and not executable,” he says. “I know the traders that typically show executable runs and axes, the traders that are sometimes executable and the guys that are less likely executable or showing stale runs and axes.”

He says most bank salespeople are “trying to create” activity or a “conversation” rather than mislead clients when they share information.

Christoph Hock, head of multi-asset trading at Union Investment, agrees that poor quality pricing data is a problem, but he does not think it inhibits the firm in achieving best execution. “I don’t see a conflict in terms of best execution,” he says. “When you have smart, sophisticated traders, they are aware and know how to cope with it.”

The desk is cognisant of the limitations of dealer-supplied pre-trade pricing and is working on a way to analyse its accuracy more systematically. The buy-side community can still play a role by addressing the issues with dealers, says Hock.

Tech to the rescue

Asset managers are counting on engagement and technology to fix the problem. Jupiter’s Poole says banks need to invest in technology that will allow them to confidently send the right information to the right clients.

“Technology will help in time,” he says. “Banks still tier their pricing when it comes to quoting bonds, so until they have a higher degree of comfort around what the technology is doing for them, it will remain manual in larger sizes and it will remain frustrating for the buy side.”

To some degree, technology has already improved the way corporate bond data is disseminated to the buy side. Financial technology firm Neptune has a platform that is used by dealers to send axes to buy-side clients in real time. Interim chief executive Byron Cooper-Fogarty says the company is talking with buy-side firms about how they can best analyse the quality of the information they receive.

“One of the challenges at the moment is actually capturing those data points and being able to quantify what data quality is,” he says.

He believes the exercise will reveal that the problem of inaccurate pricing, while real, is “sometimes smaller than some [on the] buy side realise”.

At Pictet, James says confronting dealers about the issues has “paid dividends” for the firm. A lot of the “heavy lifting” on data accuracy has already been done following the firm’s initial conversations with dealers, he says, while recent discussions have been more nuanced and focused on “getting more value from the data”.

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