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Remarks at FINRA’s 2016 Fixed Income Conference

Commissioner Michael S. Piwowar

Sept. 7, 2016

It is a pleasure to join you all today at this excellent conference.[1] I thank the Financial Industry Regulatory Authority (“FINRA”) for the invitation, and Chris [Stone] for that kind introduction.

Before I begin my remarks, I want to take this opportunity to thank Rick Ketchum for his years of excellent leadership as FINRA’s Chairman and CEO. I also want to congratulate Jack Brennan on becoming FINRA’s new Chairman and Robert Cook on becoming FINRA’s new President and CEO. I have known all three of them for several years; I wish Rick all the best and I look forward to working with Jack and Robert in their new roles.

The title of this conference is “Transparency. Technology. Transition.” FINRA made a wise choice in selecting this title, because it not only identifies some of the key issues facing the fixed income markets, but does so with the use of alliteration, which must be mandated somewhere in the strict code of conduct for conference planners. Well done.

Of course based on the dialogue surrounding fixed income market developments over the past couple of years, FINRA could just as appropriately have titled the conference “Liquidity. Liquidity. Liquidity.”

In thinking about this ongoing dialogue regarding whether sufficient liquidity exists in the fixed income markets, I cannot recall another markets issue that has generated so much debate with so little certainty about the extent of the problem or how to resolve it. It is not uncommon for me to have two meetings in the same week where one market participant warns the liquidity sky is falling, and then another market participant questions why everyone acts so concerned about what appears to be a fairly well-functioning market.

It reminds me of the annual struggle of meteorologists in Washington, D.C. trying to predict the summer weather. Every day we wake up to wildly different predictions: “Sixty percent chance of rain.” “Ten percent change of rain.” “Eighty-five percent chance of rain.” And yet most days end up being the same hot and humid weather we had the day before. What I have come to realize is that at the end of the day, what truly matters to me is not the predictions, but whether it starts pouring when I walk outside.

Current predictions about bond market liquidity seem no more precise than Washington, D.C. weather forecasts. And what primarily matters to market participants is not whether it is generally true that “people are worried about bond market liquidity,”[2] but that actual liquidity exists in the market at the moment they seek to trade. As the primary federal regulator of the U.S. corporate and municipal bond markets, we at the Securities and Exchange Commission (“SEC” or “Commission”) are striving to ensure that when the next liquidity shock inevitably occurs, everyone has access to a steady flow of timely, comprehensive, and accurate information so that investors and market participants can make informed decisions about when to deploy their proverbial umbrellas.

In the remainder of my time with you today I would like to share a few thoughts on the current bond market liquidity discussion, as well as recent regulatory developments aimed at addressing some of the other challenges in the corporate and municipal bond markets.

Recent Regulatory Efforts

On the regulatory front, a number of improvements have been made to the fixed income market structure over the past year. One key development was bolstering the best execution requirements applicable to both municipal and corporate bonds. In late 2015, FINRA and the Municipal Securities Rulemaking Board (“MSRB”) each published coordinated guidance on how best execution requirements applied to their markets.[3] This guidance followed on the heels of the MSRB adopting a rule implementing best execution requirements in a manner consistent with FINRA’s existing rule.[4] These actions ensure that investors in both the municipal and corporate bond markets will receive consistent protections covering the execution of their transactions. They also give dealers the guidance they need to comply with best execution obligations for these thinly-traded securities.

I am sure that many of you in this room have spent countless hours working through the guidance and attempting to apply it to real-world scenarios. I also recognize that ensuring best execution for fixed income securities can be challenging given the breadth of unique products and the manner in which they are traded. However, since the guidance came out I have yet to hear a chorus of complaints that it is either misconceived or unworkable. Maybe that will change after this speech and you all with flood my office with objections. But right now I believe the lack of criticism is a testament to the thoughtful, inclusive process that FINRA and the MSRB followed in developing the guidance. I commend the staff of those two organizations for the way they worked together, with our staff at the Commission, and with industry to develop workable guidance in this area.

A second area of recent regulatory focus is the disclosure of markups on riskless principal transactions, a topic that has been a focus of mine for some time. I am pleased to say that today the Commission has two proposed rule changes before us, one from FINRA[5] and one from the MSRB,[6] that would make this common sense disclosure a reality. One of the fundamental tenets of how we approach regulation at the Commission is that investors must be provided with meaningful disclosure in order to make their own investment decisions. For many years now there have been discussions about the use of riskless principal transactions, which are economically equivalent to agency trades, but lack similar disclosure on markups. While there is nothing wrong with these transactions in and of themselves, I believe that disclosure of markups for riskless principal trades will be a giant step forward in giving investors the type of meaningful disclosure they deserve.

However, I also recognize that implementing this type of disclosure is not an easy change for dealers, and that a number of questions have arisen throughout this process regarding how to identify a reference price upon which to base the disclosure, among others. Once again, I believe that FINRA and the MSRB have gone out of their way to work with industry on these difficult issues and I know that they have dedicated themselves to addressing the concerns of market participants throughout the process.

At the same time many of us were debating these detailed issues of municipal and corporate bond market structure, another sector of the fixed income markets grabbed the headlines when the U.S. Treasury market experienced a flash crash in October 2014. That event led many to realize for the first time that — while the SEC, FINRA, and the MSRB could enhance the municipal and corporate bond market structures through incremental improvements — the U.S. Treasury market had very little regulatory structure at all. This fact became even more apparent upon completion of an excellent joint report undertaken by a group of financial agencies in response to the events of October 2014.[7] One of the key takeaways from that report was that the regulatory community had an immediate need for transaction-level post-trade information on secondary trading in the U.S. Treasury cash market.

All too often as regulators we are reminded of the early childhood lesson that what we think we need, and what we actually get, are often entirely different things. However, I am pleased that in this case we seem to be moving in a very positive direction. In fact, the comment period recently closed on a FINRA proposal to require its member brokers and dealers to report U.S. Treasury cash market transactions to the Trade Reporting and Compliance Engine (“TRACE”).[8] This proposal generated a number of helpful comments, and my sense is that it has generally been well received throughout the industry. I look forward to Commission action on the proposal in the near future.

Commission staff is also engaged in an ongoing review of the regulatory framework for U.S. Treasuries. As part of this study, the SEC’s Division of Trading and Markets recently sent FINRA a letter requesting that it undertake a comprehensive review of its rulebook to determine whether existing exemptions for U.S. Treasury market securities are appropriate, and/or whether clarification of the application of such rules to these products is warranted.[9] I commend this effort, and believe it is an important step towards ensuring that the most liquid bond market in the world is being appropriately regulated.

Issues for Future Study

In addition to these recent achievements in fixed income regulation, there remain other topics in this area that merit further study. One natural area for focus is the lack of pre-trade price transparency in the fixed income markets.

Any discussion about transparency in the financial markets is sure to raise vigorous debate, and the current discussion concerning pre-trade price transparency in the bond markets is no different. For a number of years, the issue has been under consideration in the regulatory community.[10] Several prominent academic economists, including three former SEC Chief Economists, have also recently pushed for greater pre-trade transparency in these markets.[11]

When I evaluate any discretionary regulatory action, certain key questions come to mind. First, what market failure are we trying to solve? Second, what are the respective roles of the government and industry in solving the market failure? Third, if government intervention is warranted, how can the government most effectively and efficiently address the market failure?

These three questions are instructive for the current debate over pre-trade price transparency. I have heard serious concerns that the lack of pre-trade transparency is resulting in sub-optimal executions for a variety of market participants. For example, some market participants have complained that, despite posting competitive bids on alternative trading systems that they believe should execute, often no trade occurs. Then, later, these participants see trades in the same bonds printed on TRACE at inferior prices. Similarly, academic research suggests that the lack of pre-trade transparency may be a factor in trade-throughs occurring in the fixed income markets.[12]

This market failure has not gone unnoticed by innovators. In fact, a number of market participants are already seeking their own solutions to the problem, as new startups continually emerge promising unique methods for increasing the electronic trading of bonds. As trading moves from phones to platforms we can expect that pre-trade pricing information will increase. However, it still may be the case that retail investors lack access to these venues that would allow them to take advantage of this naturally evolving transparency. If that is the case, it may be up to the Commission to step in and encourage more broad-based price dissemination.

Recognizing the potential disparities in pricing information available to different market participants, a team of people at the Commission have been analyzing how best to approach any new government efforts to improve fixed income pre-trade transparency. These efforts must answer a variety of questions regarding the scope of securities that would be impacted, the type of transactions (e.g., retail vs. institutional) included, the entities that would be required to provide information, and whether there is a role for encouraging increased display of orders. As we seek to answer these and many other questions about pre-trade transparency in the bond markets, I hope that you all will join with our staff in moving the conversation forward.

Another topic that I believe merits further study is the so-called Tower Amendment.[13] The Tower Amendment, which prohibits the Commission from regulating issuers of municipal debt, hovers in the background of all regulatory efforts in the municipal space. This prohibition has long generated strong views amongst industry, regulators, and legislators alike. Some have gone as far as calling for a full repeal of the Tower Amendment.[14] Not surprisingly, the issue was addressed in the Commission’s 2012 report on the municipal securities market, which recommended legislative changes that would give the Commission authority over certain areas of the municipal market previously prohibited under the Tower Amendment.[15] Despite the steady debate over the merits of the Tower Amendment, calls for its repeal typically die quickly as municipalities recoil from the notion of federal regulation, and, frankly, as some of us at the SEC shudder at the thought of adding over 50,000 new registrants.

Recent conversations, however, have led me to consider whether it is time to revisit the reach of the Tower Amendment. Often, the debate over the Tower Amendment presents a binary choice between either repealing it in its entirety or maintaining all of its strict prohibitions. This simplistic view fails to account for the incredibly diverse landscape of municipal borrowers, which includes large state governments, local school districts, and a wide range of conduit borrowers. It is worth considering whether each of these entities should be treated the same. For example, many conduit borrowers arguably resemble corporate issuers of debt more than they do municipalities themselves. Would it be appropriate to regulate certain conduit borrowers under the federal securities laws even if traditional municipal issuers continue to be shielded by the Tower Amendment? This approach was recommended in the 2012 Muni Report, and I believe it is the type of middle ground discussion that we should have as our municipal securities markets continue to evolve.

Bond Market Liquidity

I will end today with a few thoughts on the topic that I mentioned at the beginning of my remarks, bond market liquidity. I am still not quite sure how this issue became such a media sensation. Maybe it just looks good in a headline, or maybe it has staying power because it is so hard to nail down exactly what liquidity in the bond market looks like, how to measure it, or whether the problem is increasing, decreasing, or nonexistent. Whatever the reason, it seems that each day you can find another commenter joining the debate.

Some commenters are convinced that the reduction of dealer inventories and the high cost of capital resulting from post-crisis bank regulation mean that a single, large shock could cause the whole market to freeze up. Others see the way that fixed income markets have evolved over the past few years with large buy-side firms taking on some of the traditional roles of dealers, as well as fund managers stockpiling cash for the purpose of entering the market should there be a large sell off, and are persuaded that existing market dynamics are creating sufficient liquidity to withstand a large shock. With neither side able to provide conclusive evidence that a liquidity catastrophe either is, or is not, on the horizon, I am left with one conclusion: we all have more work to do.

There is a role for everyone engaged in the fixed income markets to do their part to ensure that these markets remain fair, orderly, and efficient even under stressed market conditions.

For market participants, that means dedicating resources to planning for future liquidity shocks and continuing to focus on innovations that may promote greater liquidity. For example, much has been made of the promise held by numerous fixed income alternative trading systems that could increase liquidity in the markets by matching buyers and sellers in creative new ways. However, I have heard from a variety of sources that many in the industry are not participating in these new endeavors. Instead, they seem content to rely on traditional methods of transacting in bonds, while depending on others to make the advancements necessary to solve for future problems. Of course, this response may indicate that these market participants believe that liquidity concerns are overblown. But to the extent that the issue continues to raise alarms, I encourage both buy-side and sell-side alike to seek out and support industry-led solutions to bolster bond market liquidity.

There is also a natural role in this discussion for academics, and more research is needed in the area of fixed income market structure. To be sure, we are starting to see rigorous research come forward on some aspects of the liquidity debate, such as the decline of dealer inventories.[16] However, there are other topics that could benefit from further academic research, such as the impact of bond exchange-traded funds on liquidity in the underlying securities, the evolving role of the buy-side in the provision of liquidity, and the impact of regulatory and monetary policy decisions on the liquidity of fixed income markets.

And, of course, we in the regulatory community have important roles to play. At the Commission, we must continue to analyze possible changes to the current fixed income market structure that might ensure our markets function properly even under stressed conditions. We must also make sure that our own regulations do not get in the way of innovators seeking new ways to enhance liquidity in these markets. Other regulators have obligations to engage in this discussion as well. For example, the self-regulatory organizations — specifically, FINRA and the MSRB — must not lose the momentum they have gained from their recent regulatory actions. In addition, prudential regulators owe the market an honest assessment of the cumulative impact of their post-crisis reforms, as well as a fair analysis of whether these regulations themselves may be creating or exacerbating market problems.

Finally, the regulatory community, and particularly the Commission, must maintain a steady focus on our core missions and not become distracted by the special interest groups that continually seek to promote their private agendas through public regulation. The issues of bond market liquidity and well-functioning fixed income markets are squarely within the mission of the Commission. We cannot allow our time, effort, and resources to be hijacked by special interest groups if we are to sufficiently confront the complex challenges of the fixed income markets.

I look forward to continuing the dialogue on these important issues during the rest of this excellent conference and beyond.

Thank you.

[1] The views I express today are my own and do not necessarily reflect those of the Commission or my fellow Commissioners.

[2] See Matt Levine, People Are Worried About Bond Market Liquidity, BloombergView (June 3, 2015), available at

[3] See Implementation Guidance on MSRB Rule G-18, on Best Execution (Nov. 20, 2015), available at; FINRA Regulatory Notice 15-46, Guidance on Best Execution Obligations in Equity, Options and Fixed Income Markets (Nov. 2015), available at

[4] See Press Release, MSRB Adopts Best-Execution Rule to Enhance Fairness and Efficiency in the Municipal Securities Market (Dec. 8, 2014), available at

[5] See Securities Exchange Act Release No. 78573 (Aug. 15, 2016), available at

[6] See Securities Exchange Act Release No. 78777 (Sept. 7, 2016), available at

[7] See Joint Staff Report: The U.S. Treasury Market on October 15, 2014 (July 15, 2015), available at

[8] See Notice of Filing of a Proposed Rule Change Relating to the Reporting of U.S. Treasury Securities to the Trade Reporting and Compliance Engine, Securities Exchange Act Release No. 78359 (July 19, 2016), 81 FR 48465 (July 25, 2016), available at

[9] See Letter from Stephen Luparello to Robert Cook (Aug. 19, 2016), available at

[10] See, e.g., MSRB Notice 2013-14, Concept Release on pre-trade and post-trade pricing data dissemination through a new central transparency platform (July 31, 2013), available at

[11] See, e.g., Financial Economists Roundtable, The Structure of Trading in Bond Markets (May 11, 2015), available at

[12] See, e.g., Larry Harris, Transaction Costs, Trade Throughs, and Riskless Principal Trading in Corporate Bond Markets (Oct. 22, 2015), available at

[13] Securities Exchange Act of 1934 § 15B(d)(1).

[14] See, e.g., Commissioner Luis A. Aguilar, Statement on Making the Municipal Securities Market More Transparent, Liquid, and Fair (Feb. 13, 2015), available at

[15] See Report on the Municipal Securities Market (July 31, 2012) (“2012 Muni Report”), available at

[16] See, e.g., Hendrik Bessembinder, Stacey Jacobsen, William Maxwell, and Kumar Venkataraman, Capital Commitment and Illiquidity in Corporate Bonds (July 20, 2016), available at

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