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Carl James   00:00:00

Hello, everyone. Welcome to the Capital Markets podcast. This is the inaugural podcast that Chris and myself, Carl are going to be talking about all things concerned in capital markets. Chris, would you like to just give a couple of minutes of your background?

Chris Fenske   00:00:22

Okay. So for starters, thank you, Carl. I lead capital markets research for our primary markets group. So that covers ECM, DCM, public finance. Prior to this, I was managing a portfolio of asset-backed securities, distressed ABS. Prior to that also, I was also in the research role as well as a trading role of ABS, ABS and CBS many, many years ago. And everything we're involved in capital markets intrigues me. And it's something that I really enjoy talking about and sharing thoughts on and talking to our clients about all the time.

Carl James   00:00:56

My background is I've been trading capital markets since I was 19. I started on the floor of the London Stock Exchange and has seen the trajectory of implementing both regulation and electronification across all asset classes. My current responsibility is I'm responsible for fixed income and municipals for S&P. So in this inaugural podcast, we thought what we should do is talk about something that's dear to the heart of lots of traders and I guess, portfolio managers as well. It's liquidity and how do they navigate through markets, getting that risk on and off their portfolios, potentially also off their principal books if they're a market maker. Chris, since you've covered both equity and fixed income, I wondered if you'd sort of touch on the equity market and how that's evolved in terms of transparency and liquidity.

Chris Fenske   00:02:01

I mean equity market is light years ahead of fixed income market. Fixed income market is gradually catching up. But I mean, it boils down to just the concept of an order book. I mean the equity market, you have full transparency on different order books. You could see where the highest bid is, the lowest offer is on almost real-time nature, especially for the more liquid type issues. The ETF market is extremely developed there as well as it is in fixed income, too, which has actually been one of the revolutionary changes in fixed income over the past 25 years that I've seen. But that level of transparency, it would actually definitely help the fixed income markets. It may not be possible, but I always view more transparency as improving liquidity. I think the less friction you have for analyzing a security, the more price transparency you have, the easier it is to make a trade decision, which actually expands the audience of people willing to buy that particular security. It shortens the amount of time to actually make the decision or formulate a price. Many will disagree with that. Too much transparency could impact market makers where you're not going to get as wide of a bid-ask. So it's harder to make money if you are a market maker and harder to sell securities. But I think at the end of the day, it's benefiting both the issuer and the investor, which are probably the 2 most parties in the 2 most important parties in that transaction.

Carl James   00:03:23

Yes, it's interesting. I mean if we think about equities, there's a much smaller number of equities that are traded versus the number of bonds that are available. I mean, generally, you have a single equity or you might have voting A, voting B shares, but essentially, it's equity. And you might have 100 different bonds of that particular company, different durations, different covenants built into that. The other thing I think is interesting is the average size of the trade. I remember I read a white paper, and it was talking about the average trade size in equities is 500 shares. and the average trade size in fixed income is far larger by nominal, but the turnover is much smaller. So you're getting much higher turnover in equity markets and much lower turnover in fixed income. And for example, if you look at the rates, how much they trade versus a high-yield bond, a high-yield bond might trade once every 3 months. So again, they all have impacts upon transparency and therefore, liquidity. Have you observed anything particular on those 2 bits of the turnover versus the transparency between fixed income and fixed and equity?

Chris Fenske   00:04:54

So I touched on ETFs before. So we have to talk of an indexation. Indexation, -- so if a bond is in a major tradable index, one that's tracking one or more major ETFs, -- that's as good a transparency as you could possibly get. You're getting a lot of price points. You're having people look at the valuations every single day, even intraday. There's actually economic decisions at the end of each day based on those valuations. And those bonds themselves become benchmarks for comparable bonds from that issuer from that sector because there's so many price points. There's so much transparency in that particular area. To your point, too, bonds are not as fungible as equities. There's, of course, different rates, duration, maturity structures. IR started off in securitized products. there is no fungibility there at all, where even from the same issuer, the collateral pool could be significantly different, which involved a lot more work, a lot more credit analysis, more detailed work to actually get to that price determination. In addition, to your point earlier, some of these bonds trade every few months. Some of these bonds trade every few years. So you're not going to ever get a golden truth price for the broader sector unless it's a very highly traded liquid bond or potentially bond in a major index.

Carl James   00:06:13

Doesn't that beg the question of -- I mean, fixed income, if you go back far enough, was essentially a buy and hold to maturity investment. With the emergence of different methodologies, ETFs is one of those. You've got portfolio trading, you have dark pools now. You're seeing a higher velocity within the bond market. And on top of that, the synthetic nature of some of the trades, CDS, IRS, et cetera. So I wonder if that's actually changed the nature, and this is why we need to have that transparency because that velocity of trading is higher.

Chris Fenske   00:07:01

In addition, I mean, I look at it as almost the bond market over the past 20 years ETFs has been democratized, where 20, 30 years ago, the amount of effort for a retail buyer to invest in a bond was significant. And the bid-ask spread was significant also for the size of bonds that they would buy. But now you could take broad high-yield exposure or investment-grade exposure, get in and out the same day if you really want to. and actually have exposure to that market without doing credit work on all these bonds, without having to take a wide bid-ask spread. In addition, you're getting real-time prices throughout the day. So that democratization increased liquidity. But to your point, it's also increasing turnover, too. But even turnover is producing price points, right? Even if a trade is happening, you have more price points going on through the day, you're seeing the direction that's driving the broader market. And a big part of this, too, I mean, the ETF market, one of the foundations of it is significant advances in bond pricing. S&P Market Intelligence has a group that's pricing a large portion of the universe real time. And those advances enable the ability to actually have a functioning ETF market for fixed income. And it's significant, no matter the type of data they use, the algorithms they use to price these bonds, it's come a long way in the past 20 years.

Carl James   00:08:21

I do actually quite like what you're saying there. The idea of having accurate pricing and particularly on timing-wise is really important. When I was trading and you had a bond that hadn't traded for a while, you're just trying to figure out actually where it is that you need to be offering or bidding for. So I think that at a holistic level, the way that the fixed income markets have evolved, it's going in the right direction. I think that most market participants would accept that. In your experience, do you think there's anyone that would say, no, we want less liquidity -- sorry, not less liquidity, excuse me, less transparency.

Chris Fenske   00:09:11

If you're a market maker in something very distressed, where a very opaque market where one slight difference in a credit assumption could be 3 or 4 points in the bond. It's a bond that really trades. Your value add or your value proposition is to basically determine the value of where that bond would trade if you would purchase at a particular price. And that wider bid-ask spread is revenue. That's going to translate into revenue, that opaque market. So I would say someone in the seat in that area or that sector would not necessarily want additional transparency. -- wouldn't necessarily want real-time prices going through a trace print, a trace tape or something like that. There is some detriment to them from a revenue perspective. And that's well known. There's no secret there.

Carl James   00:09:58

Yes. And I think if we think about it, the the banks used to be in the storage business because they would take that risk onto their books. Realistically now, they're in the moving business. The time that the risk sits on their book has much reduced. And the amount of risk they are taking on their books has reduced dramatically, somewhere up to 90% it's reduced by. So in terms of the benefits of that transparency, one of the things I was thinking about was different methodologies, portfolio trading, for example. If you're a client that has given some of your capital to an asset manager and the asset manager instead of having to cherrypick particular bonds, they can now take a slice of the whole portfolio and have it very keenly priced and accurately traded each of the individual bonds because of the heightened level of transparency and to a degree, that pushes the velocity. So actually, from my perspective, I see that the end client gets the benefit of these different methodologies that have emerged over time.

Chris Fenske   00:11:18

One thing I want to -- I didn't touch on before, and I do want to mention that one of the downsides of transparency, and we saw this probably more in the securitized product space, probably particularly Agency MBS like pass-throughs, too much transparency on actual CUSIPs trading or pools trading. it becomes a little bit too easy to reverse engineer someone's trade. So if someone who's trying to do a trade from a buy-side perspective, there's such complex instruments, these are such complex trades, MBS pass-through is the strategy. You don't necessarily want someone reverse engineer trade. So I didn't mention it before, but there is potentially some negative attributes of too much transparency for the buy side, too. And that could hold true for any type of sector. It doesn't have to be MBS pass-throughs. It could be distressed securities as well.

Carl James   00:12:06

Okay. So I think broadly, we're in agreement that more transparency does help most parts of the e-trading ecosystem, and it probably leads to better outcomes for the end client. It's predicated upon data, and that data is really a manifestation of the electronification of capital markets, which has seen an accelerated trajectory for. So therefore, I would suggest that one of the bits that people should be thinking about is how do they make sure that they're electronifying their trading process so that they capture those data points that I think you were talking about earlier. And then you can analyze those data points, aggregate them up and you basically are able to make better informed decisions. I think that's what the conclusion we're saying here, Chris.

Chris Fenske   00:13:06

100% capturing those data points, connecting with other data points, maybe even beyond your own sector and trying to see where they're moving in parallel. And it's also -- it's providing fuel for a lot of these pricing services and pricing technology where they're producing more accurate prices for their end clients for striking NAVs, for pricing ETFs. So that increased transparency, it benefits the broader market in general from an accuracy perspective. So one thing I looked at, this is back in March 2020, I looked at 13F filings. So when you look at 13F filings for equities, on March 31, 2020, every single price for every single fund, for every single equity is the same for that particular equity. So it's -- exchange closes, you have a price -- a closing price, and that's the same no matter what fund you are. You do the same thing for bonds, there's sometimes a very wide disparity. You very rarely get everybody price a bond at the same exact price, give or take, 3 decimal points in a given month, which it's a fundamental difference between the equity market and we were talking about that before. And the closer you get the spread of prices through more transparency, the more it's improving that's just a functioning of the overall markets versus an overvalued position, an undervalued position. I mean it varies. And a lot of -- these -- the difference is most extreme during times like March 2020 during extreme market events. Generally, it's a relatively tight range. A lot of people are using the same data sources, same same logic, same models to try to get to these end prices. But it's something that one day, maybe you'll have the same closing price rebound. It might take a while, and that actually could be very good for the market overall.

Carl James   00:14:54

Well, if we think there's a definite trajectory that this market is on. And I think it could be that one of the points that we end up in is that pricing. So I think we sort of talked through certain bits of the transparency and the liquidity element. What we're going to do is look to our listeners and see tell us what you think, what do you think about transparency? Tell us what you think about liquidity. Also tell us what you'd like us to talk about future podcast. Thank you, Chris. Appreciate your time doing this.

Chris Fenske   00:15:34

Thank you as well, Carl. It's a pleasure. Looking forward to doing this again soon.