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“New rules set to come into force on January 1 2022, following publication of the Bond Market Equitisation Project conducted under the auspices of the Financial Stability Board, will restrict frequent borrowers in the bond market to a maximum of two fixed-rate issues per year.
Category I Borrowers – a dynamic biennially updated group of the 5% of issuers responsible for over half of the annual notional primary debt stock – will be required to opt for pre-set five and 10-year maturity buckets. They will have to apply for regulatory approval to get into the formal eight-week visible supply window and will be granted formal issue dates within 10 days of their applications being lodged. Issue sizes will be set at a minimum of US$3bn with no upper limit.
Investors will be obliged to bid a minimum premium over theoretical composite benchmarks managed and maintained by ICMA and approved by US, European and Asian regulators for each rating class – 50bp minimum for issues of US$5bn to US$10bn; and 100bp for issues in excess of US$10bn. Bids will only be permitted via liquidity-R-us™, the single regulated multi-dealer and investor-owned not-for-profit electronic dealing platform.
“The Liquidity Premium Quote will benefit benchmark issuers in terms of smoothing and optimising target funding levels per rating class. Borrowers will in effect be compensated for the issuance straitjacket by investors, who, on the flip side, will be guaranteed the liquidity they crave and will therefore happily pay up for,” said an industry spokesperson.
Pricing will be conducted via modified Dutch auction, and buy-side allocations will be carried out on the basis of amount of securities bid for. Investor bait-and-switch demand-inflation tactics will be neutralised under the new rules as investors will be unable to scale back and will get what they bid for prior to the deal printing if that print falls within their pricing parameters.
They will be able; however, to get to optimal hold levels by participating in trading sessions conducted at set advertised times during the week. Each session will permit only one rating class to be traded during anonymous 90-minute electronic click-to-trade sessions. Eligible Category I investors (yet to be determined) will be permitted to access the discrete block-crossing segment for minimum US$5m lots.
FRNs, zero-coupon bonds, structured offerings, subordinated debt, hybrid capital instruments, other non-standard formats, and event-driven financing (as-yet undefined in the draft being drawn up by the FSB ahead of the next formal G20 gathering) will initially be exempt from the rules.
Outside of the five and 10-year formats, ICMA will advertise specimen interpolated points along the maturity curve off the five and 10-year synthetic benchmarks. Issuers will be permitted to bid anonymously for access to funding at those non-standard maturity points; pricing will depend on the extent and elasticity of formal investor demand lodged on the platform.
The industry spokesperson said the new rules will reduce fragmentation, create optimal issuing and trading conditions and lead to industry-wide and systemically safe solutions. In the wake of the new rules, leading bond dealers are expected to shutter large swathes of their voice-broking and trading capacity, leading to large-scale redundancies.”
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And then I woke up…
So is the narrative above the answer to the corporate bond illiquidity woes that have become the subject of such intense debate – transforming the bond market into some sort of ersatz equity market? I’ve seen some remarkable and inventive ideas put forward to create workable solutions to create liquidity for investors.
Part of the problem is that they all seem to come at it from the investor perspective; none seem to put themselves into the shoes of issuers. So is equitising bond markets a flawed concept? Probably. Issuers need funding for a variety of reasons so notions such as issuing windows or standard maturity buckets just don’t work; not least from a diversification perspective. Debt and equity are different animals; they exist for different reasons and serve different purposes. Homogenising the bond market won’t work.
I’ve written a lot about liquidity as the debate has taken on gargantuan proportions, at all points, though, I’ve felt a little uncomfortable about one basic underlying fact: the corporate bond market has always been illiquid. Lower dealer inventory, new capital, liquidity and leverage rules, bans on prop trading etc may have rendered the situation slightly worse but we’re not talking paradigm shift here.
In all fairness the issue is over-engineered and inflated. It’s long been the case that there’s a whole universe of bonds out there that never trade. It’s not necessarily that these are buy-and-hold securities and locked away in buyside vaults; or that there’s anything intrinsically wrong with them; it’s just that they don’t trade.
The corporate bond market is driven by issuer and investor opportunism, diversification and choice. It’s the ultimate window venue where opportunities to maximise spread wax and wane. Issuers and their underwriters go to great lengths to hit target cost of funds at optimal parts of the curves in different markets depending on elasticity of investor demand and a host of other factors.
Large corporates with out-size funding requirements can only really achieve size via multi-tranche offerings and multiple offerings where tranche sizes and terms respond to investor demand, and issuers print to demand and with an eye to making sure they don’t over-issue at any single point and at the same time reach diversified pools of capital.
Here’s another basic truth: for all of their clamouring for liquidity, imagine if an issuer went out with a US$20bn bond at a single maturity. How do you think investors would react? By offering a huge discount for that much-vaunted liquidity? Yeah, like hell. They’d demand a punitive premium to take the size down. They want their cake and eat it.
To meet diverse funding requirements and idiosyncratic timing issues, borrowers need the flexibility to play the cycles and work the windows to get the optimal print to maximise business benefits. I don’t see that changing.
