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For Better Pricing & Distribution, Issuers Should Go Electronic – Part I
April 26, 2016
According to the MSRB fact book, there were nearly 37,000 trades made in 2015 in the municipal bond market involving over 13,000 unique securities. Many of those trades were handled through electronic trading platforms, also known as Alternative Trading Systems (ATSs), like TMC Bonds and TradeWeb. In 2016, new entrants to the muni ATS market will inject even more technology emphasis on electronic trading. Last month, MarketAxess announced it was expanding its business to include the $3.6 trillion municipal bond market. And the owner of the New York Stock Exchange, Intercontinental Exchange, recently purchased two bond evaluation services used by investors that may lay the groundwork for yet another electronic trading platform.
This infusion of technology by well-capitalized and established exchanges are a very good thing for the bond market, which has been criticized by the SEC as being opaque and inefficient when compared to other capital markets. More electronic trading should improve trading execution, reduce fees, and enhance pricing transparency. This all contributes to greater liquidity for investors, which should help attract additional capital to the market. A more efficient and liquid secondary market is also a very good thing for municipal issuers.
What all of these platforms currently have in common is that they are set up to handle the municipal bond market’s secondary market trading. However, municipal issuers should also think of the opportunities that electronic trading may hold for them in the primary market, where their bonds are initially sold to a dealer and then reoffered to the public. It’s in the primary market where an issuer selling fixed-rate bonds locks in bond prices/yields for the issuer and its taxpayers over the life of the bonds. There are opportunities for large, frequent issuers to benefit from electronic platforms, benefits that overcompensate for the time and resources it takes to issue bonds through such an alternative method. This is particularly true for issuers seeking to attract additional retail investors.
Bond issuers in other markets certainly take advantage of technology to raise capital and distribute bonds more efficiently. For example, the US government sells bonds electronically to retail investors through its TreasuryDirect program. And there are a number of blue-chip companies that issue bonds to retail investors through electronic trading platforms like InCapital. InCapital has been incredibly successful selling corporate bonds through its platform. Last year it announced that it had crossed the $350 billion threshold in terms of new-issue bonds sold to retail investors.
So if issuers in other markets have had success using electronic trading platforms to sell bonds to a wider network of investors, why can’t they also be used in the municipal market? The answer, of course, is that they can be used by certain issuers. Large and frequent issuers – like states, big cities or counties, universities or hospital systems, or public utilities – could sell bonds more efficiently through electronic trading platforms and benefit from their enormous distribution channels.
In March 2014, the Commonwealth of Massachusetts launched MassDirect Notes, a first-of-its-kind program in which bonds were offered to retail investors through the open-architecture platform of TMC Bonds. Over the program’s 9 weeks of selling, the Commonwealth sold about $6 million in bonds per day to retail investors. Over 1,000 individuals orders for MassDirect Notes were placed from 44 different firms, with the average order size being under $250,000. And the bonds were sold at spreads that were tighter than where the state had sold similar bonds in the past.
The decision to develop and launch the MassDirect Notes program – which ended up being named The Bond Buyer’s National Deal of the Year – was rooted in the state’s desire to harness innovation in order to benefit its taxpayers in both the short-term and long-term. I think there are opportunities for more issuers in the municipal bond market to realize significant savings – or avoided interest costs – by using electronic trading systems to sell bonds. The potential benefits fall into three buckets: better pricing, less market risk, and better investor distribution.
I’ll go into detail on each of these potential benefits in my next post.