REFILE-UPDATE 2-U.S. SEC's White calls for reforms in fixed income markets

Fri Jun 20, 2014 3:43pm EDT

(Refiles to fix capitalization in name of SIFMA trade group in paragraph 11)

By Sarah N. Lynch and Lisa Lambert

WASHINGTON, June 20 (Reuters) - The top U.S. securities regulator on Friday called for hefty reforms of the less transparent multi-trillion dollar bond market - putting traders and brokers on notice that they cannot use technology to hide pricing and cost information from investors.

In a speech in New York, Securities and Exchange Commission Chair Mary Jo White for the first time laid out her regulatory vision for fixed income - a huge slice of the capital markets that has in recent years taken a back seat to the equity markets, as regulators turned their sights toward high-speed trading and trading in unlit "dark pools."

"Trading in these massive fixed income markets ... remains highly decentralized, occurring primarily through dealers where costs of intermediation are much more difficult to measure," said White in prepared remarks at the Economic Club of New York.

"I am therefore concerned that in the fixed income markets, technology is being leveraged simply to make the old, decentralized method of trading more efficient for market intermediaries."

White's speech shows the SEC is finally stepping up efforts to implement some recommendations from its 2012 sweeping report on the $3.7 trillion municipal securities market, which was spearheaded by former commissioner Elisse Walter, who also temporarily served as chair of the SEC.

Most notably, White announced the agency is launching an initiative to start requiring electronic dealer networks such as alternative trading systems to publicly disseminate their best prices for corporate and municipal bonds. The initiative would focus on providing pre-trade pricing information especially to smaller retail investors.

"This potentially transformative change would broaden access to pricing information that today is available only to select parties," she said.

In addition, White threw her support behind several other reforms in the works that she said will be handled by the two industry-funded regulators for the municipal and corporate bond markets.

One measure, being drafted by the Municipal Securities Rulemaking Board, will require municipal bond dealers to comply with best execution rules.

Best execution is well-established in equities markets, but is not required in the municipal market. It essentially requires brokerages to execute customer orders at the best price in the shortest possible time.

The best execution rule was also recommended in the 2012 report, although some critics are wary of trying to create the standard in a highly illiquid market. The market's lead trade group, the Securities Industry and Financial Markets Association, has said that since municipal bonds are not traded on a central exchange and they are very diverse any standard "cannot mirror that for equities."

White said the MSRB and the Financial Industry Regulatory Authority, which oversees brokers and corporate bond trading, will also work on guidance for achieving best execution.

"The development of a workable best execution rule for both the corporate and municipal bond markets is vital for the protection of investors and enhancing price competition," White said.

Any rules by FINRA and the MSRB will need to go through a public comment process and be approved by the SEC.

RISKLESS PRINCIPAL TRADES

White said she also supports a pair of rules that the MSRB and FINRA are currently completing that will force dealers to disclose more about their compensation for a type of trade known as a "riskless principal transaction."

Such trades involve dealers purchasing securities from their customers and immediately reselling them to other dealers.

Dealers often charge a mark-up to customers for these trades, but are not required to disclose it.

"This information should help customers assess the reasonableness of their dealer's compensation and should deter overcharging," White said.

White's support of a rule to require disclosure of mark-ups for riskless principal trades now virtually guarantees it will come to fruition.

Earlier this year, two other SEC commissioners - Republicans Michael Piwowar and Daniel Gallagher - called for similar reforms.

"Her speech today highlights important reforms that could dramatically improve retail investor protection by enhancing the manner in which fixed income securities trade," Piwowar said.

Additionally, Virginia Democratic Senator Mark Warner and Oklahoma Republican Senator Tom Coburn earlier this year also introduced legislation to address the issue. (Reporting by Sarah N. Lynch and Lisa Lambert in Washington; additional reporting by John McCrank in New York; Editing by Chizu Nomiyama and Nick Zieminski)

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