I AM NOT a contract lawyer and never wanted to be, but I did in a misguided moment begin to study law at university. I soon discovered that this was not for me and moved to the happier hunting grounds of history and politics. The efforts of my professors were, nevertheless, not entirely in vain. I do fortunately still remember the difference between an invitation to treat and an offer.
For the benefit of those who know little about the law of contract, the former is defined as “an expression of willingness to negotiate” in which “a person making an invitation to treat does not intend to be bound as soon as it is accepted by the person to whom the statement is addressed”. An offer, on the other hand, is intended to be binding and when accepted cannot be revoked without a breach of contract having occurred.
Now I’m sure that platform trading has been turned upside down and inside out by lawyers, but that still leaves me with a horrid sense that something is very wrong when it comes to the electronic trading of bonds.
How many hundreds of times have I seen bids and offers – that’s offers, not invitations to treat – on trading platforms which, when accepted, proved to be nothing of the sort? Egg yolks are more binding than most of the screen prices offered up by dealers.
Why should investors have to phone and ask every time, “Does either side of that two-way screen price actually work?”
Egg yolks are more binding than most of the screen prices offered up by dealers
I HAVE FREQUENTLY commented on my scepticism with respect to the “equitisation” of the bond markets, on how the two markets cannot be compared in terms of liquidity and transparency and on what a load of rubbish it is to even try to apply the rules and standards to one which apply to the other. Yet authorities still seem hell-bent on squeezing the 10-ton gorilla into a skin-tight swimsuit.
But if electronic trading is to take place on transparent platforms (as regulators are pushing for), how about we do the following: let us legislate that, as in equity markets, we use central clearing, which does not require bilateral dealing limits between buyers and sellers, thus opening all prices to all-comers, and let us declare that whatever price is shown on a screen is binding in whatever size it is displayed in.
Let’s refuse the purveyors of prices the option to pick and choose whose dealing request they reject, and let’s prevent them from changing their price when someone tries to deal on it. Let’s make the size they are supposedly prepared to deal in binding and irrevocable.
Then let’s have a look at how much liquidity and transparency there is left in the market.
WHO COULD FORGET Citigroup’s “Doctor Evil” trades of 2004? They aimed to exploit a weakness in the structure of the Italian-based MTS electronic platform in which market-makers were obliged to commit themselves to quote prices for bonds for at least five hours a day for minimum amounts.
On a quiet day in August that year, the US bank’s European guvvie desk placed sell orders worth €11.3bn in 18 seconds, which was equivalent to a full average day’s trading volume on MTS. Together with further sales of €1.5bn on other domestic bond markets, the total sale of no fewer than 200 different issues amounted to nearly €12.9bn. Having hollowed out the bids, it then bought back bonds the same morning at a lower price, earning €18.2m, all at the expense of the competition.
Citigroup proved that day that bonds are best traded over the counter, but in response to having stress-tested the MTS platform and having found it wanting, they were subsequently castigated and fined. All they did was to bring home to the world what any bond market professional could have told you: that one can’t legislate liquidity in a market with too diverse a universe of assets. Hence I would love to see how many prices would be left on screen if they really were binding.
I WAS RECENTLY involved in a bond purchase request for a Swiss private bank. The issue in question was offered on one of the trading platforms by no fewer than six houses in a size that would have suited my order. Rather than trying to lift bonds on screen, I phoned each and every one of them with the simple question as to whether the screen offer would work or whether it was a spoof. In the event, not one of the firms questioned had bonds in position to offer – at least not to me.
Within the ambit of the legal definition, the screen offers are clearly not offers. Nor, would it appear, were they invitations to treat, for the firms in question showed no signs of “an expression of willingness to negotiate”. “No” very clearly meant “No”. So what, I ask, is the legal status of prices displayed on trading platforms?
There are thousands of preservation societies which aim to protect the jungles of the world against planters who want to burn them down and replace them with rows of banana plants and pineapple groves. The bond market is a jungle too – and maybe it too would look best if left in its natural state.