New bond trading rules target disclosure on pricing

Boyd Erman,  From Tuesday's Globe and Mail

Toronto — Canada's securities industry watchdog is set to propose new rules for bond trading to address investor concerns that brokerages may be inflating prices and hiding big commissions.

The proposed regulations, which will be published Friday for public comment by the Investment Industry Regulatory Organization of Canada, are designed to increase transparency and drive down costs for investors.

Many investors would for the first time find out exactly how much commission they are paying to buy and sell bonds. Industry convention is to hide the commission in the purchase or sale price of the bond, but the new rules would force it to be broken out.

The rules would also require better disclosure of the bond's yield – the real interest rate based on the price.

Perhaps most importantly, and contentiously, IIROC plans a “fair pricing rule” to enable regulators to punish dealers who trade bonds at prices far from the true market price.

That practice is all too common because it's tough to shop around for bonds, some investment industry members say. There's no central exchange and limited access to prices from competing dealers, so investors don't know whether they're getting a fair deal.

“I'm a big believer in ‘sunlight is the best disinfectant,'” Susan Wolburgh Jenah, chief executive officer of IIROC, said in an interview. The moves are “a good first step” and the regulator is just “catching up to where we should be,” she said.

The planned regulations are likely to be unpopular in the inner sanctums of the country's securities dealers.

The flip side of better prices and lower commissions for investors is less profit for brokers, who keep the difference between the price at which they buy a bond and the price at which they later sell it.

The rules “will be stoutly resisted” by some big bond-dealing firms, predicted Hank Cunningham, fixed-income strategist at independent brokerage firm Odlum Brown Ltd.

He is also the author of In Your Best Interest: The Ultimate Guide to the Canadian Bond Market.

A fair price rule has merit, so long as it's not structured in a way that creates a “bureaucratic nightmare” of paperwork for brokerages that have to justify their pricing, he said.

As for disclosing commissions, that's a “no-brainer,” Mr. Cunningham noted. “I don't think people are getting overcharged but they don't know, and when you don't know, you think you're getting ripped off.”

Ms. Wolburgh Jenah said the changes are designed to force an evolution of bond trading that mirrors what has happened in recent years in stocks – to the benefit of investors big and small.

In the stock market, pricing information is now available in real time for almost every stock, so investors know when a broker is giving them a raw deal.

Additionally, regulators require that share trades get done at the best possible price for investors.

The result is better returns for investors because they get more when they sell and pay less when they buy.

“There's been less movement on the bond side and it's something we really need to focus on,” Ms. Wolburgh Jenah said.

Once IIROC has a “fair pricing” rule in place, she said the regulator may look to build a computer system to watch over the bond market, just as it tracks the stock market looking for signs of manipulation.

The proposed system would look for trades that take place at prices that are far from where other trades are taking place – what she called “outliers.”

While the rules are aimed mainly at bonds, they are also expected to apply to other so-called over-the-counter investment products, like derivatives, that don't trade on exchanges.

The new rules are needed because the securities industry has been slow to move on its own to give out more information on bond pricing and commissions, Ms. Wolburgh Jenah said.

“Sometimes they need a little help,” she said of the bond dealers. “The challenge [for regulators] is to figure out what kind of help and how much.”