[House Hearing, 106 Congress]
[From the U.S. Government Publishing Office]
THE BOND PRICE COMPETITION IMPROVEMENT ACT OF 1999
=======================================================================
HEARING
before the
SUBCOMMITTEE ON
FINANCE AND HAZARDOUS MATERIALS
of the
COMMITTEE ON COMMERCE
HOUSE OF REPRESENTATIVES
ONE HUNDRED SIXTH CONGRESS
FIRST SESSION
__________
MARCH 18, 1999
__________
Serial No. 106-8
__________
Printed for the use of the Committee on Commerce
U.S. GOVERNMENT PRINTING OFFICE
55-636CC WASHINGTON : 1999
------------------------------------------------------------------------------
For sale by the U.S. Government Printing Office
Superintendent of Documents, Congressional Sales Office, Washington, DC 20402
COMMITTEE ON COMMERCE
TOM BLILEY, Virginia, Chairman
W.J. ``BILLY'' TAUZIN, Louisiana JOHN D. DINGELL, Michigan
MICHAEL G. OXLEY, Ohio HENRY A. WAXMAN, California
MICHAEL BILIRAKIS, Florida EDWARD J. MARKEY, Massachusetts
JOE BARTON, Texas RALPH M. HALL, Texas
FRED UPTON, Michigan RICK BOUCHER, Virginia
CLIFF STEARNS, Florida EDOLPHUS TOWNS, New York
PAUL E. GILLMOR, Ohio FRANK PALLONE, Jr., New Jersey
Vice Chairman SHERROD BROWN, Ohio
JAMES C. GREENWOOD, Pennsylvania BART GORDON, Tennessee
CHRISTOPHER COX, California PETER DEUTSCH, Florida
NATHAN DEAL, Georgia BOBBY L. RUSH, Illinois
STEVE LARGENT, Oklahoma ANNA G. ESHOO, California
RICHARD BURR, North Carolina RON KLINK, Pennsylvania
BRIAN P. BILBRAY, California BART STUPAK, Michigan
ED WHITFIELD, Kentucky ELIOT L. ENGEL, New York
GREG GANSKE, Iowa THOMAS C. SAWYER, Ohio
CHARLIE NORWOOD, Georgia ALBERT R. WYNN, Maryland
TOM A. COBURN, Oklahoma GENE GREEN, Texas
RICK LAZIO, New York KAREN McCARTHY, Missouri
BARBARA CUBIN, Wyoming TED STRICKLAND, Ohio
JAMES E. ROGAN, California DIANA DeGETTE, Colorado
JOHN SHIMKUS, Illinois THOMAS M. BARRETT, Wisconsin
HEATHER WILSON, New Mexico BILL LUTHER, Minnesota
JOHN B. SHADEGG, Arizona LOIS CAPPS, California
CHARLES W. ``CHIP'' PICKERING,
Mississippi
VITO FOSSELLA, New York
ROY BLUNT, Missouri
ED BRYANT, Tennessee
ROBERT L. EHRLICH, Jr., Maryland
James E. Derderian, Chief of Staff
James D. Barnette, General Counsel
Reid P.F. Stuntz, Minority Staff Director and Chief Counsel
______
Subcommittee on Finance and Hazardous Materials
MICHAEL G. OXLEY, Ohio, Chairman
W.J. ``BILLY'' TAUZIN, Louisiana EDOLPHUS TOWNS, New York
Vice Chairman PETER DEUTSCH, Florida
PAUL E. GILLMOR, Ohio BART STUPAK, Michigan
JAMES C. GREENWOOD, Pennsylvania ELIOT L. ENGEL, New York
CHRISTOPHER COX, California DIANA DeGETTE, Colorado
STEVE LARGENT, Oklahoma THOMAS M. BARRETT, Wisconsin
BRIAN P. BILBRAY, California BILL LUTHER, Minnesota
GREG GANSKE, Iowa LOIS CAPPS, California
RICK LAZIO, New York EDWARD J. MARKEY, Massachusetts
JOHN SHIMKUS, Illinois RALPH M. HALL, Texas
HEATHER WILSON, New Mexico FRANK PALLONE, Jr., New Jersey
JOHN B. SHADEGG, Arizona BOBBY L. RUSH, Illinois
VITO FOSSELLA, New York JOHN D. DINGELL, Michigan,
ROY BLUNT, Missouri (Ex Officio)
ROBERT L. EHRLICH, Jr., Maryland
TOM BLILEY, Virginia,
(Ex Officio)
(ii)
C O N T E N T S
__________
Page
Testimony of:
Campell, J. Patrick, Chief Operating Officer and Executive
Vice President, National Association of Securities Dealers,
Inc........................................................ 21
Green, Micah S., Executive Vice President, the Bond Market
Association................................................ 27
Levitt, Hon. Arthur, Chairman; accompanied by Robert L.D.
Colby, Deputy Director, Division of Market Regulation,
Securities and Exchange Commission......................... 7
(iii)
THE BOND PRICE COMPETITION IMPROVEMENT ACT OF 1999
----------
THURSDAY, MARCH 18, 1999
House of Representatives,
Committee on Commerce,
Subcommittee on Finance and Hazardous Materials,
Washington, DC.
The subcommittee met, pursuant to notice, at 11:07 a.m., in
room 2322, Rayburn House Office Building, Hon. Michael Oxley
(chairman) presiding.
Members present: Representatives Oxley, Ganske, Lazio,
Shimkus, Fossella, Blunt, Bliley (ex officio), Towns, Stupak,
Engel, DeGette, Barrett, Luther, Capps, and Markey.
Staff present: David Cavicke, majority counsel; Linda
Dallas Rich, majority counsel; Brian McCullough, professional
staff member; Robert Simison, legislative clerk; Consulea
Washington, minority counsel.
Mr. Oxley. The subcommittee will come to order. The Chair
would like to recognize the chairman of the full Commerce
Committee, the gentleman from Richmond, Mr. Bliley for an
opening statement.
Chairman Bliley. I thank the chairman, the members of the
committee, and the people who will testify. I'm very happy to
see a good friend, Mr. Levitt, the Chairman of the SEC. I
unfortunately have to be in two places at one time, which is a
difficult thing to do at best. But, we have a hearing on
electricity restructuring at 11 a.m. down in 2123, so I'll have
to shuttle back and forth.
In the 105th Congress, the committee conducted an inquiry
into the U.S. bond markets and we learned three things. First,
the bond market in the United States is huge. The ability of
trading of Government securities exceeds $300 billion; daily
trading of corporate debt, about $15 billion; the daily trading
in municipal bonds about $9 billion. In comparison, the average
daily value of stock traded on the New York Stock Exchange is
about $25 billion.
Second, the bond market offers a way for companies and
cities to raise money with interest rates more favorable than
those offered by banks. To the extent that companies and cities
use the bond market, their cost of capital will be lower. They
will be more competitive and they will save taxpayer's money.
Indeed, today, in the Wall Street Journal, there's an article
that AT&T may be about to raise somewhere between $6 and $8
billion in the bond market by themselves.
Third, the level of transparency in parts of the bond
market is poor. Transparency needs the ability of someone
buying a bond to know the price at which the bond is trading.
When people buy cars or furniture, they often comparison shop
and make decisions based on price. For many investors in bonds,
this comparison shopping is not possible. We heard testimony in
September that two investors buying the same bond at the same
time from the same dealer can be given very different prices,
prices differing by as much 6 percent, a full year's worth of
interest.
I believe this situation is unacceptable. We have received
a study from a professor at Purdue and an economist at the
Federal Reserve that indicates that improved transparency will
reduce spreads and improve prices to investors in the bond
market. I ask unanimous consent that that study be made a part
of today's hearing record.
Mr. Oxley. Without objection.
[The study appears at pg. 42.]
Chairman Bliley. Today, we will consider a committee draft
of legislation designed to improve transparency in the bond
market. It is simple legislation. It directs the SEC to adopt
rules facilitating transparency in these markets with certain
minimum standards in that rulemaking. The SEC will take
comments from the affected parties and will come up with the
best way to improve price competition in these markets.
This is an important goal for our markets and investors.
Anyone using the bond market to save for retirement or
education will benefit from it. Each of the witnesses has
worked cooperatively with the committee to develop this
bipartisan legislation. I commend Chairman Oxley for holding
this hearing and for working with me on this legislation. I
also commend John Dingell, Ed Towns, and Ed Markey for their
cooperation in the project.
I urge all members to consider this important legislation.
After the hearing, it will be revised based on the testimony we
hear today. It will then be introduced. I ask all members to
consider co-sponsoring this legislation with me, and I yield
back to balance my time. And, again, thank you, Mr. Chairman.
Mr. Oxley. I thank the chairman and appreciate his remarks.
The Subcommittee on Finance and Hazardous Materials has
developed a track record of legislative accomplishments in the
last two Congresses, improving our financial markets through
competition. Competition forces change and change produces
efficiency. Our commitment to apply these principles to the
financial markets has translated into tangible results that
benefit investors, as well as businesses.
Of the many accomplishments of which the subcommittee can
be proud, the most notable recent examples include the decimal
pricing initiative, the National Securities Market Improvement
Act, reduction of stock transaction fees, and securities
litigation reform legislation. The decimal pricing effort,
although not fully implemented, had an immediate impact for
investors and business, alike.
When the Exchanges voluntarily moved to reduce the minimum
increment for trading stocks from \1/8\th to \1/16\th,
individual investors and institutional investors began saving
money immediately. And with the addition of twice as many
prices at which to buy or sell a stock, the markets have
experienced greater volume. We obviously don't take credit for
the robust market volume that we've experienced over the last 2
years, but there is sufficient evidence that the move has in no
way harmed market liquidity.
Our current effort to improve the transparency in the
corporate bond market originates with the same philosophy:
improve information, eliminate anti-competitive and regulatory
barriers and greater competition will result to benefit all
aspects of the markets.
When this subcommittee first examined this issue last
September, the consensus was that the corporate bond market was
not as transparent as other segments of the bond market. We
determined that the market for these bonds could become more
transparent. The more that relevant price and yield information
is available, the more competition will improve. This in turn
will improve prices for people buying bonds, their pension
funds, and their mutual funds.
Chairman Bliley challenged the bond market participants to
improve transparency of the bond market. They have responded
well. On their own initiative, the private sector has devoted
its own resources to develop a system to begin to shed more
light on the corporate bond market. I understand that one of
these initiatives is scheduled to be operational within the
next 2 months. I commend them for their efforts.
Today, we are going to examine legislation to buildupon
this work. The SEC has possessed the authority since 1975 to
facilitate price transparency in the bond markets. The
committee draft being considered today instructs the SEC to use
that authority to guarantee transparency in these markets.
Additionally, the committee draft sets certain minimum
standards for transparency in the corporate bond market and
calls for a study of transparency in the municipal market.
I commend Chairman Bliley for his leadership in this
initiative. I also thank the witnesses for their constructive
comments in the drafting process. I recognize Ed Towns, our
ranking member, John Dingell, the ranking member of the full
committee, and my friend from Massachusetts for their help and
support of this legislation. We anticipate that the legislation
will be refined on the basis of today's hearing and then
introduced. I hope we will have the support of all members for
this worthwhile legislation.
That ends the Chair's opening statement and I now turn to
the ranking member, the gentleman from New York, Mr. Towns.
Mr. Towns. Thank you, very much, Mr. Chairman, for holding
this hearing. I appreciate having the opportunity here from our
distinguished witness on bond market transparency and the
committee draft bill, the Bond Price Competition Improvement
Act of 1999.
In 1972, Don Riggins stated in his book, A View From the
Street, that at present, Wall Street is hiding behind a
protective pricing system. While it preaches free competition
and free market, as I mentioned in a public speech, that is
like catching Carrie Nation tickling in the basement.
We say that competition is good for everyone. We base our
investment advice on the competitive stance of economy we are
analyzing. The price of a stock is set by the forces operative
in the marketplace. Yet, we live with this anomaly of a fixed
rate structure. We know there's exceptions to our own rules.
Prices are arrived at by a study of cost and markup for
profits. Prices change as cost rise or fall. And as the demand
for the product of service changes, they react to new
efficiencies, to inflationary or deflationary pressures. That's
the creed. Wall Street must learn to live by it. So, I suggest
that in stock trading, we crown the customer king.
In the 1975 Act Amendment, Congress abolished fixed
commission rates and mandated that the SEC facilitate a
national market system inequities that included implementation
of a composite tape and quotation system. Twenty-five years
later, we have the most transparent, efficient, liquid, fair,
and competitive securities market in the entire world. The
customer is king. But not so in the bond markets. Wall Street
largely still lives as an exception to its own rules.
Mr. Chairman, I'm pleased that we are going to try to shed
a little sunlight on those markets, as well. It is long, long,
long overdue. In June of last year, the hearing on on-line
trading, this subcommittee heard testimony from Mr. Fondren,
that at present, no centralized exchange for bonds, current
price information remains in the hands of a small group of
insiders perpetuating a system that is both inefficient and
unnecessarily costly.
In September, Mr. Chairman, Mr. Levitt gave a speech,
calling for increased price transparency in the corporate debt
market, to help investors make better decisions and increase
confidence in the fairness of the markets. At this
subcommittee's gala September 29, 1998, Chairman Bliley issued
a challenge to the SEC and to the bond market to get going and
clean up this--clean this market up. I look forward to hearing
their reports this morning on what progress has been made. Both
contend, in their written statements, that they are uniquely
qualified to develop the system for public dissemination of
bond transaction information. But, I hope we are not being
asked to anoint any one system at this point. It would seem
that there is room for both, if not others, as well.
I understand that the draft bill was not finished in time
for the witnesses to include detailed comments on the draft in
their testimony, and I understand that. So, I hope that the
chairman will direct them to submit written comments and hold
the record open for that purpose. I look forward to working
with the chairman of the full committee and the chairman of the
subcommittee. I salute you both for leadership. And, at this
time, I would yield back and say to you that I look forward to
working very closely with you in the days and months ahead.
Mr. Oxley. I thank the gentleman for his opening statement.
The gentleman from Iowa, Mr. Ganske.
Mr. Ganske. Thanks, Mr. Chairman. I look forward to the
testimony from Chairman Levitt and I yield back.
Mr. Oxley. The gentlelady from Colorado, Ms. Degette.
Ms. Degette. Thank you, Mr. Chairman, and thank you for
having this hearing today. I, too, look forward to the
introduction of the Bond Price Competition Improvement Act of
1999. I think that there are three broad economic benefits that
price transparency can bring to us.
First of all, it can bolster investor protection by
providing investors with better opportunities to monitor the
behavior of the entities that make markets of secondary
securities. Second, it can improve market liquidity by boosting
investor market maker con-
fidence in the market. Finally, it can enhance market
efficiency by boosting a price discovery process of moving
toward the optimal price for a particular security.
With that, Mr. Chairman, I think there are great benefits.
I would commend Mr. Levitt and others through their work in
this area, as well as you. And I'm so eager to hear my
colleague from Massachusetts comments, which I know are always
wonderful. Usually, I have to follow him when I speak, so I'll
yield back the balance of my time.
Mr. Oxley. The gentlelady bravely yields back her time, and
we now recognize the aforementioned gentleman from the Bay
State.
Mr. Markey. Thank you, Mr. Chairman, very much. And over
the years, I've found that the single most difficult thing to
actually have fun with is the bond market.
By definition, it's dull. I mean, it's really dull. At
least with class, you get a little bit attention. But, in the
bond market, it's really--it's hard, you know. It's a hard
thing to talk about.
I'm so glad that we have our great Chairman of the
Securities and Exchange Commission with us today; he's going to
go down in the annals of the Securities and Exchange
Commissions as one of the greats. If there's a Mount Rushmore,
they'd be carving his picture out right now. He's at the top.
So, we're very glad to have him here with us today, and you, as
well, Mr. Colby. We thank you for coming.
As you know, the Commerce Committee has had a long
tradition of leadership in eliminating obstacles to the
dissemination of market information to investors. It goes back
a long, long way. The goal has always been to ensure that the
public got market information.
At the time that the 1975 Act passed, Congress added
amendments to the Exchange Act, which directed the SEC to
facilitate the creation of a national market system for
qualified securities. When Congress enacted that legislation,
it did not limit its application merely to stocks, but to all
securities, including debt securities. In fact, the only type
of securities that were not included were the so-called exempt
securities, which had defined in the securities laws to include
treasury bonds, government agency securities, and municipal
securities.
At the time this legislation passed, there were many in the
broker-dealer community, who opposed it. But some 24 years
later, the Dow Jones industrial average is pleased to top
10,000 mark and all observers agree that our stock market are
much more efficient and more liquid, in large part due to their
increased transparency.
Over the years the SEC has not made much use of the powers
Congress granted to it in this area to bring transparency to
the corporate bond market. A decade after passage of the
National Market System legislation, this committee also became
concerned about the inadequacy of price transparency in the
government securities market. Those concerns ultimately led the
committee to include in the Government Securities Act of 1986 a
provision mandating a General Accounting Office study of the
matter. The GAO's final report in 1990 called for Federal
regulation of price transparency in the government bond market.
Based upon this recommendation, I crafted legislation, which
would have extended the SEC price transparency authority to the
government market.
But this provision had to be dropped from the final version
of the Government Securities Act Amendments of 1993, due to the
intense opposition of the government bond dealers. Instead, the
committee mandated that the SEC include, in its annual report
to Congress, a requirement that the SEC analyze the report on
the nature and adequacy of price transparency in the government
securities market, and on any remedial legislation needed to
address any future deterioration in investor access to market
information. I look forward to hearing from Chairman Levitt
this morning regarding the SEC's administration of this
reporting provision.
But the principle reason we are meeting here today is to
review new draft legislation, which would direct the SEC to use
the authorities Congress granted it back in 1975, to issue
rules within 12 months to improve price transparency in the
corporate bond market. I support this initiative, because I
believe that bond investors deserve to get full access to the
type of market information that will better enable them to
determine whether they are getting the best price for their buy
and sell orders.
I know that Chairman Levitt has already taken some
preliminary steps to move the industry forward in this area and
that, as a result of his leadership, the NASD is currently
considering rule changes that would create transparency in
audit trail systems for the corporate bond market. In addition,
I understand that the Bond Market Association has also stepped
in with a plan to make certain market information available. I
welcome each of these initiatives and would suggest that the
legislation we are reviewing today should be seen as
complimenting these efforts.
I look forward to the testimony of the Chairman and our
other distinguished witnesses. And Mr. Chairman, I congratulate
you on the vigor with which you are continuing to pursue your
chairmanship, looking into areas in which we can move on a
bipartisan manner, to ensure that the market works in a more
transparent fashion. And I thank you.
Mr. Oxley. I thank the gentleman from Massachusetts. And
try, as he might, to make the bond issue a little more sexy,
you failed just a little bit.
But, that was a good try. It was kind of like Boston
College trying to get into the NCAA tournament, but that's
another story.
The gentleman from Missouri.
Mr. Blunt. Of course, the Southwest Missouri State Bears
play Duke tomorrow in the NCAA and after that 30 point win on
Tennessee, which was harder to predict than anything in the
bond market, I think Mr. Chairman, I'll just listen today.
Mr. Oxley. I thank the gentleman. The gentleman from Long
Island.
Mr. Lazio. Once again, thank you for your interest and
commitment and drive on this. And although we've had some
disagreements in the past, I can say now, I think you were more
right than I was. I look forward to the rest of the hearing.
Welcome, my witnesses.
Mr. Oxley. Did the reporter get that down?
The gentlelady from California.
Ms. Capps. Thank you. Thank you, Mr. Chairman. I'm a new
member to this Subcommittee on Finance and Hazardous Materials
and I can't think of a more fitting introduction to the
committee than to hear the testimony today from the Honorable
Arthur Levitt and from Mr. Robert Colby. So, I look forward to
your presentation. Thank you, very much.
Mr. Oxley. Thank you and welcome to the subcommittee. The
gentleman from the upper peninsula.
Mr. Stupak. Thank you, Mr. Chairman. I'll pass on the
opening statement and look forward to our witnesses. And thanks
for holding this hearing.
Mr. Oxley. I thank the gentleman. We now turn to our
distinguished Chairman of the Securities and Exchange
Commission. We appreciate, as usual, Chairman Levitt, your
participation in this debate; and Mr. Colby, welcome, as well.
We were honored to visit the SEC at your request. I think
speaking from all the members and staff who attended, it was
the most worthwhile opportunity to learn more about what goes
on over there and to understand fully the major
responsibilities that you have and that you've done so well in
carrying out. So, thank you and you're welcome to begin any
time.
STATEMENTS OF HON. ARTHUR LEVITT, CHAIRMAN; AND ROBERT L.D.
COLBY, DEPUTY DIRECTOR, DIVISION OF MARKET REGULATION,
SECURITIES AND EXCHANGE COMMISSION
Mr. Levitt. Thank you, very much. I am accompanied by Bob
Colby, who is the Deputy Director of the Division of Market
Regulation and an absolutely essential component in dealing
with the many complex issues that division deals with, in our
effort to see to it that competition in our markets is both
fierce and fair.
Let me say at the outset that I support the draft bill, the
Bond Price Competition Improvement Act of 1999, which directs
the Commission to use its existing authority to bring
transparency to the corporate debt market. By adding the weight
of congressional action to that of the Commission, I think the
bill sends a strong message throughout the marketplace as to
the importance of this initiative. I know that your intent is
not to constrain prompt Commission action in any way. There is
a provision within the bill that we have some reservations
about, but I know we're working closely with the committee
staff to resolve that issue.
Again, as I said in my speech last fall and previous
testimony before this subcommittee, I think the time has come--
it's probably long overdue--to illuminate this needlessly dark
corner of the Nation's capital markets. Clearly, the technology
now exists to address this issue, to gather transaction prices,
to distribute them, and probably most importantly to interpret
them in a timely, accurate, and efficient fashion.
Today, the bond market touches just about every aspect of
our lives, from the cost of building schools and hospitals to
corporate investments in plant and equipment. It impacts the
assets of public and private pension funds, and it channels
funds to mortgages, to car loans, and a whole universe of
activities important in our day to day lives.
The increase in the significance of the bond market is due,
in part, to its absolutely phenomenal growth. Since 1990,
corporate bond issuance has increased more than fourfold; and,
for high yield bonds, more than tenfold. In effect, movements
in the bond market represent a daily vote on the part of
investors throughout the world, in terms of America's economy.
As you see prices go up and down, it's nothing less than a
reflection of that vote, which takes place minute by minute.
With $2.4 trillion outstanding, the corporate debt market today
is nearly twice the size of the municipal debt market and
almost 70 percent as large as the outstanding treasury market.
Yet, even in the light of this very impressive growth, the
corporate debt market has failed to keep pace with the
transparency improvements that have taken place in our other
markets, including, as Mr. Markey noted, in the government and
municipal bond markets. Some corporate bonds are traded by
interdealer brokers. But transaction prices, even for
interdealer transactions, are certainly not displayed, nor are
they reported in an organized way. Other transactions are not
even reported at all. And without a trading desk and a
sophisticated research department, it's nearly impossible to
gather and to interpret market data.
Investors, who lack the resources at their disposal, are
really left with incomplete information. And as far as I'm
concerned, incomplete information leaves investors vulnerable.
And that, I think, is unacceptable. Guesswork can never be a
substitute for readily available pricing data. Because bond
values are often closely related, the price of one bond can
very often give us important information about other comparable
bonds. And that's why I think comprehensive price transparency
is so absolutely crucial.
Last fall, the Commission asked the NASD to adopt
transaction reporting rules for corporate debt and to develop
systems to collect and redistribute transaction prices on an
immediate basis. We, also, requested that the NASD create a
data base of transactions and a surveillance program to better
detect fraud in the corporate debt market. In response to that,
the NASD has formed a committee of market participants. It's
called the Bond Market Transparency Committee, and their
mission is to develop an industry guided proposal that will
increase price transparency and oversight for the corporate
debt market. We expect to see this proposal before the end of
the summer. It will, I hope, lead to transaction reporting for
corporate debt, improving transparency as pricing data is
distributed to the public. In addition, we expect that the
NASD's efforts will lead to improved surveillance for the
market.
The Bond Market Association is also developing a proposal
for collecting or disseminating transaction information from
interdealer brokers, but only investment grade corporate debt
securities up to now. A lot of the details of that proposal and
its relationship with the NASD's initiative are still unclear.
I absolutely welcome industry support for increased
transparency. And I certainly commit to working closely with
the Bond Market Association, as we look forward with our
initiative.
Today, market information moves at the speed of light. The
availability of accurate information to ensure the long-term
viability of our markets has never been more important.
Transparency is more significant, more effective than almost
any regulatory fix. The corporate debt market is certainly not
immune from these realities. And without reform, I believe that
its current strength cannot guarantee its future prominence in
an increasingly, and fiercely, competitive global market. I'm
encouraged by the progress that we have seen since last fall.
I'm encouraged by a cooperative spirit in both the public and
private sector that appears to characterize this initiative.
A concensus is developing, and I believe that NASD and
industry action will demonstrate that seeking timely and
accurate pricing information is both feasible and practical.
Transparency leads to fair, more efficient, and clearly more
effective markets. That's in the interest of investors. It's in
the interest of our markets, dealers, and our economy as a
whole.
I thank the committee.
[The prepared statement of Hon. Arthur Levitt follows:]
Prepared Statement of Hon. Arthur Levitt, Chairman, Securities and
Exchange Commission
Chairman Oxley, Representative Towns, and Members of the
Subcommittee: Thank you for giving the Securities and Exchange
Commission (``Commission'') the opportunity to present its views on an
issue in which we are actively engaged--enhancing transparency in the
United States debt market. Today, I'd like to focus on three topics:
(1) how transparency promotes fairness and efficiency in the U.S.
capital markets, and how regulatory surveillance bolsters investor
confidence in those markets, (2) why we believe this is the right time
for improved transparency in the corporate bond market, and (3) the
progress that has been made in this area since the Fall of last year,
when I testified before you about the need to improve corporate bond
transparency.
i. regulatory goals of enhanced transparency and market surveillance
Transparency
The Commission has long believed that transparency--the extent to
which prices are visible and understandable to market participants--
plays a fundamental role in promoting the fairness and efficiency of
U.S. capital markets. Despite differences between the debt and equity
markets, the Commission believes that transparency is just as important
for bonds as it is for stocks. Indeed, because the value of a bond is
usually closely related to the value of other bonds, the price paid for
one bond may be important information about the value of many other
bonds.
In order to make informed decisions, investors must know the prices
recently paid for debt instruments generally, as well as for the
specific bonds they hold or that are being offered in the market.
Often, there are no recent market prices for the bonds an investor
holds, and their value must be imputed from the prices of other bonds.
Comprehensive price transparency is therefore critical to informed
investment decisions. Informed investors, armed with accurate
information, ensure that market prices represent fair values. And fair
market prices, in turn, ensure that the markets perform their economic
function of efficiently allocating capital resources.
Because transparency increases the fairness and efficiency of
markets and fosters investor confidence in those markets, it has the
added benefit of encouraging greater participation by investors. This
participation means more trading, more market liquidity, and perhaps
even new business for bond dealers. Thus, we believe that a sound and
sensible approach to bond market transparency will benefit almost
everyone--investors, dealers, and the economy as a whole.
The Commission has a long history of supporting price
transparency. When Congress adopted the 1975 Securities Act Amendments,
it gave the Commission substantially greater authority over quotation
and transaction reporting. Since then, the Commission has pressed
repeatedly for increased transparency in equity markets. Each time
opponents have predicted doom, and each time the results have shown
that more transparency leads only to more liquid and efficient markets.
Recent experience in the debt markets has reinforced the Commission's
belief in the benefits of price transparency.
For example, in 1991, with encouragement from the Commission and
Congress, the industry created GovPX, an electronic reporting system,
to distribute real time quotes and transaction prices for U.S. Treasury
securities. Treasury markets today exhibit an extraordinary combination
of high liquidity and low transaction costs. Trading volume has
increased from $111 billion per day in 1990 to $227 billion per day in
1998, and the spreads for benchmark bonds 1 are near zero.
---------------------------------------------------------------------------
\1\ Benchmark Treasury bonds are generally considered to be the
most recent issues of two, five and 10 year Treasury notes, and the
most recently issued 30 year Treasury bond.
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In 1995, again with the Commission's encouragement, the Municipal
Securities Rulemaking Board (``MSRB'') began collecting the details of
dealer-to-dealer transactions in the municipal bond market and
distributing daily summary reports. In August of last year, with
Commission approval, the daily reports were expanded to include
customer trades as well as interdealer trades. Most recently, just last
November, the Bond Market Association began offering daily summaries on
its Internet Web site, making municipal bond prices for the previous
day available for the first time to the general public. This new Web
page received 17,000 hits in its first three weeks of operation,
suggesting a high level of interest by the public.
Although we view the MSRB transparency program as a successful
effort, the full impact of transparency in the municipal market will
not be clear until trade reporting is done on a real-time basis, which
the MSRB has committed to do and which we continue to support.
In retrospect, we believe the government and municipal securities
market transparency initiatives demonstrate both the benefits of price
transparency in the debt markets, and the wisdom of being sensitive to
the specific qualities of each market. The Commission's corporate bond
transparency initiative will be carried out in the same spirit, seeking
to further transparency goals in a manner uniquely tailored to that
market.
Regulatory Surveillance
Market surveillance, like transparency, is a fundamental means of
promoting fairness and confidence in markets. In fact, the two go hand-
in-hand. Transparency promotes fairness and efficiency by making
essential information available to all market participants, assuring
that market decisions are based on appropriate information.
Surveillance efforts, in turn, are designed to promote fairness and
investor confidence by detecting and preventing fraudulent practices,
such as market manipulation, and other potential abuses. Surveillance
and transparency efforts, in essence, unite to provide a comprehensive
program for protecting investors and promoting the effectiveness of
capital markets.
Effective market surveillance systems require that comprehensive
trade information be reported to regulators. This reported trade
information is subsequently used to produce audit trails and other
sophisticated market surveillance tools. The key to meaningful
surveillance is regulatory access to comprehensive trading information,
essentially the same information that is required for price
transparency.
Today, no regulator has routine access to transaction information
for the broad universe of corporate bonds and preferred stocks.
Consequently, there is no organized system for routine surveillance of
trading in that market. Regulators must depend on examinations of
broker-dealers, or react to complaints brought by investors, which are
cumbersome tools. A system of comprehensive trade reporting will permit
the creation of a regulatory database and appropriate tools for
proactive supervision of the corporate debt markets.
ii. importance of u.s. debt markets
Recent Growth
We encourage this focus on the corporate bond market now, because
in recent years it has grown in importance, but not in openness. In
1985 the corporate bond market, measured by outstanding debt, was
smaller than the municipal bond market. Today, at $2.4 trillion
outstanding, it is about $1 trillion larger than municipal debt. It is
also about 70% as large as the outstanding Treasury debt. Corporate
bond issuance has increased more than four fold since 1990, and for
high yield bonds, more than ten fold.
Corporate Bond Transparency
Despite its unprecedented growth, however, the corporate debt
market has failed to keep pace with transparency improvements in other
markets, including the government and municipal bond markets. Timely
and accurate pricing information on the broad spectrum of corporate
bonds is not available to the public or even to mar-
ket participants. Some corporate bonds are traded by interdealer
brokers, but transaction prices, even for interdealer transactions, are
not displayed or reported in an organized way. As a result, in order to
obtain accurate valuations of corporate debt instruments, corporate
bond market participants must have a trading desk and a research
department with sophisticated analytical tools to gather and interpret
market information. Generally these kinds of resources are available
only to large broker-dealers and institutional investors.
The time has come to illuminate this needlessly dark corner of the
capital markets. The technology now exists to gather transaction
prices, distribute them, and interpret them in a timely, accurate, and
efficient manner. Developing such a mechanism seems the next logical
step.
iii. current initiative
The initiative started last Fall to improve corporate debt
transparency is moving forward. As we testified in September, we have
asked the NASD to adopt transaction reporting rules for corporate debt,
and to develop systems to collect and redistribute transaction prices
on an immediate basis. We also requested that the NASD create a
database of transactions and a surveillance program to better detect
fraud in the corporate debt market.
The NASD subsequently formed a committee of market participants--
the Bond Market Transparency Committee --to work toward an industry-
guided solution that will increase price transparency and oversight for
the corporate debt market.
The NASD was asked to take on this initiative for two reasons.
First, the NASD is the self-regulatory organization for the over-the-
counter market, where almost all corporate debt transactions take
place. While the NASD is already responsible for surveillance of this
market, it generally lacks access to the market information needed to
do so effectively. Second, the NASD already has in place much of the
required infrastructure. For example, the NASD has a national network
that collects transaction reports in Nasdaq and listed securities
traded over-the-counter. It performs on-line comparison and
reconciliation of those transactions, and redistributes the reported
information to vendors and to the NASD's regulatory subsidiary, NASDR.
We believe that much of this technology is adaptable to the corporate
debt market and will obviate the need to ``reinvent the wheel.''
Finally, the NASD will be able to create systems that combine trade
reporting and comparison that will further the industry's goal of T+1
settlement, which is also supported by the Commission.
The NASD, and the industry committee it formed, are working toward
a proposal for market transparency tailored to the unique features of
the corporate bond market. We expect to see such a proposal before the
end of the summer. We expect that the proposal will lead to transaction
reporting for corporate debt that will improve transparency as pricing
information is distributed to the public. Similarly, we expect that the
NASD's efforts will also lead to improvements in its surveillance of
the market.
The Bond Market Association (``TBMA'') is also developing a
proposal for collecting and disseminating transaction information from
interdealer brokers, but only in investment grade corporate debt
securities. While the details of that proposal and its relationship
with the NASD's initiative are still unclear, we welcome industry
support for increased transparency. We believe that TBMA's efforts
will, at a minimum, demonstrate the feasibility of immediate price
reporting in the corporate debt markets.
iv. conclusion
In conclusion, the Commission believes that we are making strides
toward greater transparency for corporate bonds. Transparency is both
feasible and practical, and it will lead to fairer, more efficient and
more effective markets. Almost everyone will benefit--investors,
dealers, and the economy as a whole.
Thank you. I would be happy to respond to any questions you may
have.
Mr. Oxley. I thank the Chairman for his statement and I
recognize myself for 5 minutes for questions.
Let me begin by asking, Chairman Levitt, as you know, the
SEC has had the authority to improve transparency in corporate
debt since the 1975 Act. Why do you think over the years that
that has not been pursued aggressively on the part of the SEC?
Mr. Levitt. Well, it hasn't been for lack of interest. When
I first came to the SEC, our top priority, at that point, was
beginning to look at our debt markets, particularly our
municipal markets, because we felt that, at that point in time,
that market almost totally lacked transparency. But the vast
number--the growing number of retail investors in that market
were absolutely operating in the dark. It was almost like an
oriental bazaar: individuals didn't know what they were buying,
what they were paying, whether the bonds were rated or unrated.
And there was a culture of pay to play, which characterized the
way dealers got that business. So, we spent several years
addressing that issue.
But, it is clear from that time that our debt markets
require additional attention. And I guess the shortest answer
to your question would be in terms of priorities. We never felt
that this was a low priority, but we felt that other issues
really required our attention, at that point. And, frankly, the
initiatives in the municipal market and the way the industry
worked closely with us to attain our goals in that regard have
set the stage for this initiative; I think it makes a concensus
solution much more likely. And, although I share your desire to
have attained this 5 or 6 years ago, I think we will attain it
more comprehensively and more completely, at this time, as a
result of a lot of the work that has been done in the past.
Mr. Oxley. I appreciate that. Of course, 1975 was long
before your tenure began anyway and, obviously, there was, even
going back into the 1970's and into the 1980's, very little
interest in this subject. I think probably other than Ed
Markey, there was very little interest on the Hill, as well. We
appreciate your efforts in working with us toward a better
good.
Mr. Chairman, should investors have to pay for market data
on bonds?
Mr. Levitt. This service is so important, such a
significant benefit to investors, that we simply have to find a
way to fund providing that service. And that means that various
vendors, various dealers are going to have to account for some
of the resources for providing that service. Now, as to whether
investors pay directly, I mean, that's an open question, at
this point. But, I think that it does have to be paid for and
it does have to be provided. Now, I think there are resources
in the community to provide that service.
Mr. Oxley. Do you support giving investors bond prices at
real time? There's some argument that doing so may affect
liquidity.
Mr. Levitt. I think that transparency is good for
liquidity. I reject the notion that it is bad for liquidity. I
think a market that is open, transparent, available to anyone
who wants to access that market is a market that throughout the
history of markets has attracted the greatest amount of
interest. I believe that, while real time is a goal, it's
certainly one that is realizable, and I am supportive of moving
in that direction.
Mr. Oxley. Do you support the increased transparency for
bonds issued by government-sponsored entities, or should they
be, because of very unique nature, be the only ones that
shouldn't be required to provide more transparency?
Mr. Levitt. I think we have to look very carefully at that.
I think clearly what GovPX did for treasuries was something
very important, in terms of public good. And certain aspects of
the government market, I think, are attracting greater and
greater public support and involvement. We have to consider
that area, as we move forward.
Mr. Oxley. Thank you. The gentleman from New York.
Mr. Towns. Thank you, very much, Mr. Chairman. Chairman
Levitt, on the next panel, the Bond Market Association will
testify that an industry-sponsored solution is the best way to
enhance transparency in the bond markets, but this market-based
solution should be assessed before regulatory response is
determined or mandated, and that the Association believes that
legislation mandating regulatory action is unnecessary and
unwanted, at this time. Do you agree or disagree with that?
Mr. Levitt. You know, I think that industry solutions are
always the ones that we try to be mindful of, and, wherever
possible, the Commission works closely with the industry. It's
an industry, after all, that I came out of and spent most of my
life in. And, in general, I think the industry has a
significant contribution to make, particularly in this area.
But, the legislation doesn't obviate that fact. The legislation
asks the Commission to more forward with its rulemaking process
and covers areas that the industry solution does not presently
address.
The industry is dealing in the present iteration of that
solution with highly rated, very liquid bonds. And I think,
with retail investors moving into other aspects of the
corporate debt market, we have to extend beyond that area. It's
terribly important that we cover all areas. And I think it
would be a mistake to hold up our approach in favor of waiting
for the industry or, for that matter, holding up the industry
to wait for us. We're going to move as quickly as we can. I
hope that the industry will move with us. But, I think we both
have the incentive, as a result of this legislation, to move
expeditiously and get this behind us.
Mr. Towns. Thank you. The committee draft includes language
requiring the SEC to take into consideration the effectiveness
of private sector initiatives. In your determination about
whether rules or other actions are necessary, do you agree with
the need for such an assessment?
Mr. Levitt. I don't think that has to be placed in the
legislation. I think if you trace the history of the
Commission, in terms of its dealing with the industry that we
regulate, our history shows that we work closely with them.
We're not operating in a vacuum. I'm concerned that, the way
that language is worded, it could indeed force us to wait for
an industry solution. I think that should be left to our
working with the industry and seeing to it that the two of us
move as expeditiously as possible.
I'm told that the language in its present form might be an
impediment. And why place it there, unless you're fearful that
we wouldn't do that? I would assure you that, as we always do,
we will be consulting with all the parties and all our
constituents that have an interest in this area.
Mr. Towns. Well, I'm happy to know that you indicated you
will be consulting and talking here, because I think that the
chairman raised an issue, in terms of sort of who would pay for
the service. And, of course, I think all these are issues that
really have to be talked about a great deal before anybody can
move forward.
Mr. Levitt. Absolutely.
Mr. Towns. At this time, I yield back, Mr. Chairman.
Mr. Oxley. The gentleman yields back. The gentleman from
Missouri.
Mr. Blunt. Thank you, Mr. Chairman. Let me pursue that just
a little bit more, Chairman Levitt. What about the idea of
paying the market-based solution? Is there any reason that we
should be concerned about the industry making a profit from
market data? Is that going to dramatically impact, in your
opinion, the wide access to that data? Do you think we ought to
be thinking about that, as we craft this legislation? Or do you
think that there likely is competition going to mean that the
data is going to be available in an affordable and easy way? Or
just talk to me a little bit more about that.
Mr. Levitt. Well, this is part of an issue that goes far
beyond this bill. This goes to the whole issue of how market
data is gathered and disseminated, how it should be funded, who
should fund it.
I think we have to take a step back and analyze our whole
regulatory system, which is predicated on the cooperative
efforts of the self-regulatory organizations, the Commission,
and private rights of action. Without all three of those
bodies, I can say to you that we simply would not be able to
protect investors, as effectively as the system has protected
investors for the past 65 years.
The self-regulatory organizations have established a
substantial network of services that include testing,
surveillance, and enforcement efforts. The NASD has built a
very commendable and effective regulatory mechanism. And you
have to ask yourselves what is the best method of paying for
that. Clearly, their membership, through dues and fees and
services, have to pay the bulk of it. And if we take away a
substantial portion of the revenues from any of those entities,
what would happen to them?
When I was the Chairman of the American Stock Exchange,
nearly 60 percent of our revenues came from providing data.
Now, you may say to me, well, that's crazy. Who wants to run a
business based upon that? That's not your mission. And I'd say
I worried about it and worried about it a lot, because I felt
that, if we ever came to the day when that source of revenue
was not there, I didn't know what we could do. So, if you take
away that money from one of the exchanges, clearly somebody,
some institution, some entity is going to have to make up the
difference. They'll have to develop other charges, and some
subsequent SEC chairman will be sitting here answering the
question of why do you allow those charges to be imposed upon
this or that participant in the marketplace.
I don't really know the answer to it. I understand that
we're going to have hearings at some point on this subject. And
I've written a letter to all of the institutions that provide
this service, telling them that we are in the process of
analyzing it and coming back with recommendations. And I'd like
to complete this rather long winded response to your question
by saying that we are addressing the issue, which is complex,
and we look forward to work-
ing closely with this committee, as we try to reach some
reasonable conclusions.
Mr. Blunt. Certainly, your experience at the American Stock
Exchange would indicate that the industry providing data and
providing it at a cost has worked effectively?
Mr. Levitt. Yes.
Mr. Blunt. The only other question I've got, just on the
whole issue of implementation. I know that more than 20 years
ago, the SEC was given authority to work to make corporate debt
more transparent, has decided that wasn't necessary. This is, I
think, a little more directed. But, more importantly, just for
my view on this, you do think this is important and if we pass
this legislation, would move toward the goal of transparency?
Mr. Levitt. I absolutely commit to it. I commend the
sponsors of this initiative. I think it's probably long
overdue. And I commit to working closely with the committee and
being sure that this is reality, as quickly as possible.
Mr. Blunt. Thank you, Mr. Levitt. Thank you, Mr. Chairman.
Mr. Oxley. I thank the gentleman. The gentlelady from
Colorado.
Ms. Degette. Thank you, Mr. Chairman. I'd like to follow
up, Chairman Levitt, on an issue that Mr. Towns talked to you
about, which was the industry's voluntary initiative to collect
price data on certain bonds and they disseminate the data to
the public and regulators. And you talked a little bit about
that. I'd like to hone in a little bit more specifically and
ask you to address two aspects of that.
First of all, how effective do you think the industry can
be, in monitoring itself, in collecting price data on
investment corporate bonds from interdealers?
And then a second and related question is that how do we
know--and this might be a better question for the panel
following it, except I have to leave, so I'll ask you to opine
and then maybe when they testify, they can tell us--tell my
staff or something. But my second question is how can you be
confident that dealers will actually participate, in a
meaningful way, in some kind of voluntary program?
Mr. Levitt. Well, I think the industry is really capable of
doing this. The Bond Market Association, which is coordinating
the industry effort, is the same group that worked closely with
the Commission, in our municipal initiative. And I think the
genius of the creation of this bill, mandating the Commission
to move forward on this, I think will really catalyze the
industry to rapidly bring to closure their part of this and
hopefully carry it beyond their present inclination. So, I
think the combination will work very well.
Ms. Degette. I thank you. I don't have any other questions.
Mr. Oxley. Thank the gentlelady. The chairman of the full
committee is recognized.
Chairman Bliley. Just a couple of questions, Mr. Chairman.
Information is a public good, so why should exchanges or
dealers be able to cross subsidize other parts of their
business to profits from market data?
Mr. Levitt. Well, the providing of market data is something
that has concerned the Commission, and, indeed, about 2 weeks
ago, I sent a letter to all self-regulatory organizations that
were providing that data. As I mentioned earlier in my
testimony, that data represents a substantial part of the
revenues of some of these institutions: 15 percent in the case
of the New York Stock Exchange, a substantial part for the
American Stock Exchange and the Pacific Stock Exchange. And we
are studying this issue and going to come up with
recommendations, as part of a much broader package.
But, because the numbers involved are so considerable, we
have to decide collectively with the self-regulatory
organizations how they can fund themselves. If they don't get
it from this source, where will they go to get those funds to
provide the all important investor protections that they are
providing? I mentioned before that we will work very closely
with the committee, as we work through a study with the
industry to determine what fair pricing would be and how that
pricing is related to the actual cost of providing that
information and what other sources of funding the industry can
develop to see to it that they are viable institutions in doing
their self-regulatory jobs.
Chairman Bliley. Well, that's reassuring that you will have
some guidelines, at least, to somewhat relate the cost of
providing the information with the cost that they charge.
Will improved transparency improve price competition among
bond dealers?
Mr. Levitt. I think it will. I think improved transparency
creates the kinds of markets which will attract more and more
public attention, and more transparency, I think, by virtue of
competitive pressures, will improve pricing, as well.
Chairman Bliley. Thank you, Mr. Chairman. And thank you,
Mr. Chairman. I have no further questions.
Mr. Oxley. I thank the gentleman. The gentleman from
Michigan.
Mr. Stupak. Thank you, Mr. Chairman. Just a question or
two, Mr. Levitt. Maybe you could help us a little bit on the
bill that's been introduced, and I know you said you support
it. In plain English, could you help me out a little bit on
page two? They go in there and they say, ``Action required, the
Commission shall adopt rules and take such other actions.'' It
goes on to say, ``To assure the prompt, accurate, reliable, and
fair collection, processing, distribution, publication,
transaction information, including the last sale data, with
respect to covered debt securities, so that information is
available to all exchange members, brokers, dealers, securities
information processors, and other persons.''
And then they bracket it. And it's my understanding you
have some concerns about the bracketed language in--from the
brackets on line 19 to 24. Are you suggesting some alternative
to the bracketed language? Can you break that down for me?
Mr. Levitt. My concerns about that language are that it
could be interpreted that the Commission would have to defer
addressing this issue for a solution by the private sector. I
mentioned before that, on any of our regulatory initiatives, we
work very closely with the private sector. And I think all of
us feel, judging by the statements that I've heard this
morning, that this is something we should approach
expeditiously. The private sector solutions that have been
recommended thus far, I think, are commendable, move in the
right direction, are not as comprehensive as we would like it,
and are limited to only one part of the market. I believe that
this initiative should carry to other parts of the market.
Now, for instance, the high yield market, is part of the
market that more and more retail investors are getting into.
It's obviously a part of the market that holds greater risks
than the other ends of the market. And, because of that, I
think we've got to look very carefully at that. We can't leave
the high yield market totally out in left field.
So, I guess my feeling is that we will accomplish
everything that is intended to be accomplished by this
paragraph. But by casting it in stone, in a piece of
legislation, I believe it defies our expediting the process.
I'd like to ask Mr. Colby to comment on this, as well, if I
might.
Mr. Colby. Sure. We think the bill would be better without
the paragraph included. If you decide to go forward----
Mr. Stupak. The bracketed part?
Mr. Colby. That's right.
Mr. Stupak. It would be better without the bracketed part?
Mr. Colby. That's right, because it raises ambiguities and
we think that it's something that we don't need in order to do
the job we're planning to do, that we've said we would do. We
have some language, if the committee decides to keep something
similar to the bracheted language, that would reflect that. One
of our goals is not just to create a data base, but it's also
making sure that the market can be monitored. So, we need to
take into account surveillance, and to be able to create a
surveillance data base, as well.
Mr. Stupak. And any suggested language you have, I'm sure,
any member on this committee will be receptive, at least take a
look at it.
Can I ask you, Mr. Levitt, then, on page three, because you
said you didn't want to leave anything out in left field, and
page three, I think line five, starts, ``Covered debt
securities.'' And they say, ``covered debt securities'' and
then they say, ``exempted securities.'' So, what securities are
carved out by the exempted securities and should they be and
what securities might the SEC carve out by its grant of
exempted authority?
Mr. Colby. Exempted securities are treasury securities,
agency securities issued by Fannie Mae, Freddi Mac, and others,
and municipal securities. Municipal securities are covered by a
separate scheme under the Act. Treasuries are typically covered
by a separate scheme also. And agencies are covered, at this
point, by page three of the bill. It's a technical issue--it
may be covered by another provision.
Mr. Stupak. Well, should they be carved out? Should they be
accepted?
Mr. Colby. For agency securities, the straight bonds that
are issued by Fannie Mae and others are already covered very
well by the existing GovPX system. What's left is mortgage pass
through securities and collateralized mortgage obligations,
which are quite complicated, in order to cover everything in
this process.
Mr. Stupak. Could I just ask him to follow up my second
part of the question? Are there any securities that the SEC
might want to see carved out?
Mr. Colby. I believe the reason that this is written the
way it is, is so that if, after consultation with the industry,
there are securities that immediate disclosure creates problems
for, this would give us the authority to carve those out.
Mr. Stupak. Thank you.
Mr. Oxley. The gentleman's time has expired. The gentleman
from Statan Island.
Mr. Fossella. No questions.
Mr. Oxley. The gentleman from New York.
Mr. Engel. Thank you, Mr. Chairman. How come you said
Statan Island for him and you didn't say Bronx and Westchester
for me?
Mr. Oxley. I choked. I couldn't remember.
Mr. Engel. Thank you. Chairman Levitt, first of all, let me
say that--let me thank you for the job that you do and thank
you for your accessibility. There has not been a time when I've
called you that you haven't gotten back immediately, and I know
every on the committee feels the same way. So, I wanted to just
say that publicly, I really appreciate it.
You spoke, in your testimony, you talked about corporate
debt transparency. And I'm just wondering, is that where you
see the most trouble or the most difficulty nowadays? Is it
lack of transparency? Is it the corporate debt problem?
Mr. Levitt. Well, if I began to assess priorities, in terms
of what's going on in the markets, I'd have a pretty long list.
But, almost every issue that would be on that list are issues
that could be enhanced by virtue of increased transparency. And
what this bill proposes to do is really an extension of what
the Commission has embarked upon, in both the corporate and the
municipal market, and is something that was directly and
appropriately mandated in 1975. And the circumstance that more
and more individuals are using our debt markets today than ever
before in history makes this a particularly timely, appropriate
step to take.
Mr. Engel. Thank you. The Bond Market Association, it's
concerned that the premature release of transaction information
might inhibit the trading activity of vital market
participants. Could you respond to those concerns and how this
might affect the implementation of tools to improve market
transparency?
Mr. Levitt. Well, again, I remember from my own days in the
industry, while the industry is enormously progressive, in
terms of new products and new ways of funding our capital
marketplace, the industry sometimes is reluctant to implement
change, in terms of how they deal with the public. I believe
that the industry is extremely progressive and the fact that
they did such a superb job, in terms of our municipal markets,
tells me that they are equally capable of doing the same job,
with respect to our corporates. And I understand the
reservations that they have, because this is bringing light to
a market, which was clearly not as liquid as our equity
markets, cannot be treated overnight in the same way that we
treat our equity markets.
But the goal is the same. The goal is greater
understanding, greater transparency. Congress has appropriately
recognized that goal and is mandating the Commission to come up
with a solution, which I assure you will be sensitive to the
industry, but most sen-
sitive to the public interest. And I think that that sense of
balance, between Congress, the private sector, and the public
sector is exactly the way to go and the time to go there is
now, not 6 months or a year from now.
Mr. Engel. I think it was about 5 years ago, NASD
introduced a fixed income pricing system to improve
transparency in the high yield sector. How well has that
worked?
Mr. Levitt. I think it's worked extremely effectively for
what it was meant to do.
Mr. Engel. And the SEC's recommendations to NASD, how might
that increase the timely dissemination of information?
Mr. Levitt. I think what we've asked the NASD to do,
essentially, is adopt rules, which require dealers to report
all transactions in U.S. corporate bonds and preferred stocks
to the NASD and to develop a system to redistribute that on a
timely basis; and second, to create a data base of
transactions, in both corporate bonds and preferred stock; and
finally, and I think in some ways most importantly, to create a
surveillance program to better detect fraud in this market,
something that you simply can't do in the absence of taking the
steps that you've asked us to take. And I think they are in the
best position to do this. They are already geared up to move
forward on this. I believe they have the resources and the
experience, and I'm very comfortable having this done by a
self-regulatory organization, rather than having government do
it.
Mr. Engel. Thank you, very much.
Mr. Oxley. I thank the gentleman. The time has expired. The
gentleman from Wisconsin, Mr. Barrett.
Mr. Barrett. Thank you, Mr. Chairman. I just have a couple
of quick questions. Is there anything specifically that you
would like to see added to this measure?
Mr. Levitt. Well, I think working together with the
committee, the legislation appears to be thoughtful and
sufficiently comprehensive to do the job I think it's intended
to do.
Mr. Barrett. In the ideal world, would there be any tools
that you would want to have or do you feel that you have the
tools necessary?
Mr. Levitt. I think with respect to this particular
initiative, it gives us the tools necessary to do the job.
Mr. Barrett. I have no further questions.
Mr. Oxley. I thank the gentleman. The gentleman from
Massachusetts.
Mr. Markey. Thank you, Mr. Chairman. Mr. Chairman, you said
earlier that there were limitations to the Bond Market
Association transparency initiative that necessitate SEC and
NASD action. I'd like to explore those limitations further.
First, isn't it true that the scope of the initiative is
limited to investment grade debt?
Mr. Levitt. With respect to the Bond Market Association,
yes, that's correct.
Mr. Markey. So, all the non-investment grade corporate
bonds wouldn't even be covered?
Mr. Levitt. That's correct.
Mr. Markey. Isn't it also true that the industry initiative
relies entirely upon voluntary participation?
Mr. Levitt. That is correct.
Mr. Markey. So, if an interdealer-broker doesn't volunteer
to join the system, its trades wouldn't be displayed; is that
right?
Mr. Levitt. Yes.
Mr. Markey. And a direct dealer to dealer or dealer to
customer trade that doesn't use an interdealer-broker, who
voluntarily joins the system also wouldn't be recorded; is that
true?
Mr. Levitt. That is correct.
Mr. Markey. Now, I, also understand that the voluntary
industry initiative would provide for hourly dissemination of
summary price information. Wouldn't you agree that the value of
price information decreases proportionately in time?
Mr. Levitt. Yes.
Mr. Markey. Wouldn't you, also, agree that in today's fast
moving markets, hour old market data could prove pretty stale?
Mr. Levitt. It would.
Mr. Markey. The SEC has also called for full electronic
audit trails for market surveillance purposes. Can you tell me
why this is needed and how such information could assist the
SEC and the NASD enforcement efforts?
Mr. Levitt. Well, again, to the extent to which information
is available, to the extent to which an audit trail is
implemented, to the extent to which reporting is as broad as
possible, that enables the NASD and the Commission to do their
surveillance job much more comprehensively and accurately. And
without that information--I think it's a question of how soon
we get there. I think getting there overnight in a market,
which is not analogous to our equity markets, for many reasons
may not be possible. But I do believe that to say that we will
take half measures indefinitely would be equally erroneous.
And I'd like to ask Bob Colby to answer that question, as
well.
Mr. Colby. Right now, there is no comprehensive way to
oversee activity in the corporate debt market. And if you
wanted to know what's going on, you'd have to do an individual
examination of each of the hundreds participating in that
market. And this would allow them to look for problem trends
and then focus examinations.
Mr. Markey. Mr. Chairman, in your opening statement, you
expressed some concern about bracketed language in the
Chairman's draft, which would require the SEC to take into
consideration private sector transparency efforts, as it
considers adoption of new rules or other measures to bring more
transparency to the corporate debt market. Should we delete
this provision from the bill?
Mr. Levitt. I would hope so. That would be my preferred
recommendation.
Mr. Markey. Now, I had read this language not as a
limitation on the SEC's authority, but merely as a
congressional suggestion that the SEC consider what was
happening the industry, as it moved forward, but still leaves
you entirely free to take whatever action you deem necessary in
the public interest, all for the protection of investors. You
don't interpret that language that way?
Mr. Levitt. In the staff's analysis of that language, they
felt that it did represent an impediment. And my feeling is,
given the history of this, the fact that, as you pointed out so
correctly, since 1975, the Commission has not taken this
action, and since, as a matter of practice, we work very, very
closely with the industry as we consider these issues, the very
fact that you would give this directive, I think could serve as
an impediment.
On the other hand, by deleting the language, you certainly
create a very strong incentive for all parties to move
expeditiously to attain this goal. And if we're looking for an
optimum solution, why not go for it, rather than taking a
chance of putting anything in its way.
Mr. Markey. Thank you, Mr. Chairman. Thank you, Mr. Colby,
very much.
Mr. Oxley. I thank the gentleman. If I could conclude, Mr.
Chairman, by just asking one question. You had talked about
fraud and obviously the necessity for targeting against fraud.
Is there or do you have any evidence that fraud is any more
prevalent in the bond market than in the equities market?
Mr. Levitt. I think that, with respect to insider trading,
the use of convertible bonds or certain other bond issues has
become more of a factor, in terms of prevalence of fraud. I
think to the extent to which bonds have become more and more
attractive to retail investment, we have to consider that very,
very carefully and seriously. And it's another reason why I
welcome your initiative, at this time.
Mr. Oxley. Has there been some enforcement actions in
regard to those convertibles?
Mr. Colby. I believe there have, but I'd have to check.
Mr. Oxley. Thank you. Mr. Chairman, Mr. Colby, we thank
you, again, for your participation and your leadership on this
very important issue.
Mr. Levitt. Thank you.
Mr. Oxley. The Chair will call the second panel. The chair
would recognize the second panel, Mr. Micah S. Green, the
Executive Vice President for the Bond Market Association; and
Mr. J. Patrick Campbell, Chief Operating Officer and Executive
Vice President of the NASD Stock Market. Gentlemen, welcome to
both of you. And we have no preferred order of appearance, so
if you want to go alphabetically, that's fine with us. Mr.
Campbell, welcome.
STATEMENTS OF J. PATRICK CAMPELL, CHIEF OPERATING OFFICER AND
EXECUTIVE VICE PRESIDENT, NATIONAL ASSOCIATION OF SECURITIES
DEALERS, INC.; AND MICAH S. GREEN, EXECUTIVE VICE PRESIDENT,
THE BOND MARKET ASSOCIATION
Mr. Campbell. Thank you. The NASD supports the
subcommittee's and the SEC's initiative to bring clearer price
transparency, the extent to which timely data on prices is
visible to all market participants to the bond markets, and
wants to express our gratitude to you, Mr. Chairman, and to
Chairman Bliley for your leadership in this area. While
recognizing the contributions of other organizations, we
continue to work with them for greater transparency.
The NASD is uniquely situated to develop the systems and
rules for the public dissemination of bond transaction
information. These benefits stem from the NASD's self-
regulatory status, its proven network, consistent capabilities,
and its potential to provide comparison and settlement
improvements to reduce systemic risk. The NASD is a self-
regulatory organization under the 34 Securities Exchange Act.
It is subject to direct SEC regulation and oversight, to ensure
that it meets its obligations under that Act. Because no
private organization is subject to the full ray of SEC
oversight and review, the NASD is alone in its regulatory
protections it provides among those seeking to improve bond
market transparency.
In addition to its SRO status, the NASD has developed the
NASDAQ Stock Market into the world's premier electronic trading
system, with the larger share volume of any market in the
world. Its trade data are provided through one of the most
extensive private networks in the world, which is being
expanded.
As part of that network, the NASD operates the automated
confirmation transaction service, or ACT, which handles the
post trade process for NASDAQ trade, and in a multi-dealer
market similar to the current bond market structure. Among
other things, ACT provides mandatory 90 second trade reporting,
last sale dissemination, on-line trading comparison and
reconciliation, risk management, real time regulatory
oversight, and forwarding trades for clearing and settlement.
ACT, as we have it today, thus could readily be adapted as a
basis for bond reporting and trade comparison system that could
provide both heightened oversight and reduced systemic risk.
Since the SEC requested us to undertake this initiative in
September of last year, the NASD has conducted extensive
research on the depth and breadth of corporate market, reviewed
reporting, surveillance elements, met with data vendors,
clearing firms, and network display vendors. To pursue the
initiative with all deliberate speed, the NASD has empaneled a
bond market transparency committee, representing investors in
all major segments of the bond market, to ensure that enhanced
bond transparency is implemented appropriately and can be
provided at the earliest possible time. We are proud of the
wide representation that we have been able to obtain on this
extremely important committee. Represented on it are individual
investors, academia, institutional investors, major U.S.
investment banking firms, large discount firms, regional
investment banking firms, foreign-based investment banking
firms, brokers, brokers, the Bond Market Association, the
Securities Industry Association, and our own regulatory fixed
income committee.
Our committee has made substantial progress. The committee
has agreed, in principle, as to the securities that should be
included in the system, which now includes all registered debt
securities in 144(a) securities. The committee will determine
what will be disseminated and within what timeframe, to ensure
maximum transparency, without disrupting markets and,
consequently, harming liquidity. The committee has agreed that
the NASD's automated confirmation transaction system will be an
important tool for the confirmation of reported trades,
especially as settlement cycles ultimately shorten the trade
date plus one for settlement. The committee has also
established that the information that it has collected should
be widely disseminated to all vendors, to the maximum extent
possible.
The NASD is strongly supportive of the objectives and
principles embodied in the Commerce draft of the Bond Price
Competition Im-
provement Act of 1999, and expresses its appreciation, too, Mr.
Chairman, for your efforts in this important area. We
particularly want to stress the importance of the provision in
Section II of that bill, that expressly preserves all of the
Commission's authority under Section 11(a). We believe that
this provision is especially important in making it clear that
the Commission has the authority to approve all the terms on
which market information may be obtained and distribute,
including the power to ensure that fees charged are fair,
reasonable, and non-discriminatory.
The NASD will work, as we have, with the SEC and the
securities industry to make the necessary changes at the
earliest possible time, with the maximum benefit to the
investor and the minimum disruption to the industry. Thank you,
Mr. Chairman.
[The prepared statement of J. Patrick Campell follows:]
Prepared Statement of J. Patrick Campbell, Chief Operating Officer, The
Nasdaq Stock Market
I am J. Patrick Campbell, Chief Operating Officer of the Nasdaq
Stock Market, Inc.
The NASD would like to thank the Subcommittee for this opportunity
to testify again on bond market transparency and the changes needed to
improve that transparency for investors and other market participants.
It was my pleasure to testify before this Subcommittee last September
29 and share with you our thoughts on bond market transparency. Since
that testimony we have made significant progress, which I would like to
describe today. I will also accept the Subcommittee's invitation to
comment on its draft bill, the Bond Price Competition Improvement Act
of 1999.
the nasd
Let me briefly outline the role of the NASD in the regulation and
operation of our securities markets. Established under authority
granted by the 1938 Maloney Act Amendments to the Securities Exchange
Act of 1934, the NASD is the largest self-regulatory organization for
the securities industry in the world. Virtually every broker-dealer in
the U.S. that conducts a securities business with the public is
required by law to be a member of the NASD. The NASD's membership
comprises 5,600 securities firms that operate in excess of 70,000
branch offices and employ more than 590,000 registered securities
professionals.
The NASD is the parent company of The Nasdaq Stock Market, Inc, the
American Stock Exchange, and NASD Regulation, Inc. (NASDR). These
wholly-owned subsidiaries operate under delegated authority from the
parent, which retains overall responsibility for ensuring that the
organization's statutory and self-regulatory functions and obligations
are fulfilled. The NASD is governed by a 27-member Board of Governors,
a majority of whom are non-securities industry affiliated. Board
members are drawn from leaders of industry, academia, and the public.
Among many other responsibilities, the Board, through a series of
standing and select committees, monitor trends in the industry and
promulgate rules, guidelines, and policies to protect investors and
ensure market integrity.
The Nasdaq Stock Market
In keeping with the NASD's mission of facilitating capital
formation for the ultimate benefit of investors, the Nasdaq Stock
Market develops and operates a variety of market systems and services.
The Nasdaq Stock Market is the largest electronic, screen-based
market in the world, capable of handling trading levels of at least one
and a half billion shares a day. Founded in 1971, Nasdaq today accounts
for more than one-half of all equity shares traded in the nation and is
the second largest stock market in the world in terms of the dollar
value of trading. It lists the securities of 5,100 domestic and foreign
companies, more than all other U.S. stock markets combined.
The American Stock Exchange
As the nation's second largest floor-based exchange, the American
Stock Exchange has a significant presence in both listed equities and
equity derivative securities. It lists 770 companies, and is widely
known for its development of successful new investment products.
NASD Regulation
NASD Regulation is responsible for the registration, education,
testing, and examination of member firms and their employees. In
addition, it oversees and regulates our members' market-making
activities and trading practices in securities, including those that
are listed on The Nasdaq Stock Market and those that are not listed on
any exchange.
NASDR carries out its mandate from its Washington headquarters and
14 district offices located in major cities throughout the country.
Through close cooperation with federal and state authorities and other
self-regulators, overlap and duplication is minimized, freeing
governmental resources to focus on other areas of securities
regulation.
NASDR has examination responsibilities for all of its 5,600
members. In addition to special cause investigations that address
customer complaints and terminations of brokers for regulatory reasons,
NASDR conducts a comprehensive routine cycle examination program.
the bond and equity markets are different
The NASD is well aware of the important differences between the
debt and equity markets. These differences include:
Size--The bond markets are many times larger than the equity
markets. For example, the combined equity trading on the Nasdaq
Stock Market and New York Stock Exchange--the two most active
markets in the world, based on dollar volume--totals $44
billion per day. The bond markets' total trading volume is
approximately $350 billion per day, or eight times larger.
Number of bond issues--There are many more bond issues than
stock issues. For example, about 15,000 stocks trade publicly
on US stock markets, but there are more than one million bond
issues outstanding.
Trading activity--Bonds trade most heavily in the first weeks
after they come to market. After that time, they tend to be
placed in portfolios by institutional and various retail
accounts and held longer term. Equities tend to trade more
frequently and are usually held for a shorter period of time.
Yield--In most areas of the debt market, bonds trade on yield
rather than on dollar price and are valued in comparison to
benchmark government securities. Bond trading relies on
interest rates, inflation expectations, economic data, quality
of debt, and the terms of the bond itself, more than on factors
that are unique to the issuer.
Intermediaries--Certain sectors of the bond markets rely
heavily on the role of the ``brokers' brokers.'' These
intermediaries provide anonymity between bond dealers to avoid
divulging their dealers' market positions. The brokers' brokers
also provide dealers with information to give greater insight
into current market situations.
Over the counter--About 90% of all bond trades take place in
the over the counter market rather than on an exchange.
Transparency--As discussed below, corporate bond markets trade
with less price transparency, that is, the extent to which
timely data on prices is visible to all market participants.
Although there are clear differences in the bond and equity
markets, the NASD believes that there are principles that apply equally
to both, such as the need for price transparency and effective
regulation based on modern surveillance systems that examine actual
trade data.
the sec calls for transparency
While public perception of the differences between the debt and
equity markets has been growing slowly, SEC Chairman Levitt's September
9, 1998 statement brought the problem with the lack of transparency in
the bond markets clearly into the public's awareness.
Chairman Levitt identified a clear need for corporate debt market
price transparency, saying:
``Investors have a right to know the prices at which bonds
are being bought and sold. This will help them make better
decisions, and it will increase confidence in the fairness of
the markets. The sad truth is that investors in the corporate
bond market do not enjoy the same access to information as a
car buyer or a homebuyer or even a fruit buyer. And that's
unacceptable. Guesswork can never be a substitute for readily
available price data.''
Noting that the corporate debt market remains one of the last major
US markets to not have some type of electronic price disclosure system,
Chairman Levitt announced the NASD's agreement with the SEC to take
several actions:
Propose rules requiring dealers to report all transactions in
U.S. corporate bonds and preferred stocks to the NASD and
develop systems to receive and redistribute transaction prices
on an immediate basis;
Create a database of transactions in bonds and preferred
stocks that will enable regulators to take a proactive role in
supervising the corporate debt market, rather than only
reacting to complaints brought by investors; and
Create, in conjunction with the development of a database, a
surveillance program to better detect fraud to foster investor
confidence in the fairness of these markets.
We are committed to working with the SEC, the Subcommittee, and
other parties to develop approaches to bring greater transparency to
the bond markets. We believe that transparency is indispensable to
market integrity, and we are confident that our efforts will provide
greater transparency to the corporate bond market.
nasd bond transparency benefits
While recognizing the contributions of other organizations, and
continuing to work with them for greater transparency, the NASD is
uniquely situated to develop the systems and rules for the public
dissemination of bond transaction information. These benefits stem from
the NASD's SRO status, its proven network and systems capabilities, and
its potential to provide comparison and settlement improvements to
reduce systemic risk.
SRO Status
The NASD is a Self Regulatory Organization under the 1934
Securities Exchange Act. It is subject to direct SEC regulation and
oversight to ensure that it meets its obligations under that Act.
These obligations include: protection of investors and the public
interest; promotion of just and equitable principles of trade; fair
representation of members; equitable allocation of dues and fees;
prevention of fraud and manipulation; fostering cooperation with the
clearance and settlement system; facilitation of securities
transactions; discipline of members for rule violations; governing the
form and content of non-exchange quotations; compliance with SEC
requirements on system standards for redundancy, capacity and security;
provision of audit trail capability; and maintenance of market
surveillance systems.
Because these extensive obligations are neither required of or by
any private organization, nor is a non-SRO private organization subject
to the full array of SEC oversight and review, the NASD is alone in the
regulatory protections it provides among those seeking to improve bond
market transparency.
NASD Network and Systems Experience
The NASD has developed the Nasdaq Stock Market into the world's
premier electronic trading system, with the largest share volume of any
market in the world. Its quotes and trade data are provided through its
extensive network to over 300,000 screens worldwide.
The NASD has not rested on its success, however, and is constantly
improving its systems. The NASD is now deploying a new, high capacity,
high reliability, state-of-the-art enterprise wide communications
network to service the more than 7,000 Nasdaq workstations throughout
the country. The new network will initially provide us with four
billion share day network capacity, expandable to more than double that
amount. It uses leading edge communications technology and transparent
back-up capability to provide far greater reliability. This new
network, one of the world's largest, will ensure that NASD capabilities
will be more than adequate to meet any additional capacity required by
a bond transparency initiative.
In addition to its market building success and its systems capacity
improvements, the NASD operates systems that are relevant to providing
additional transparency to the bond markets.
For example, the Automated Confirmation Transaction service (ACT),
handles the post-execution process for Nasdaq issues' trades that were
negotiated over the telephone or executed in the various execution
systems of The Nasdaq Stock Market. Among the critical post-execution
steps that ACT handles are: mandatory 90 second trade reporting, last
sale dissemination, on-line trade comparison and reconciliation, risk
management, forwarding trade data to NASDR Market Regulation for real-
time oversight, and forwarding trade data to the National Securities
Clearing Corporation for clearing and settlement.
ACT could serve as a basis for a bond reporting and trade
comparison system that could provide both heightened oversight and
reduced systemic risk. Risk would be reduced by improving the
comparison rate for bonds, permitting earlier settlement, simplifying
processing, and reducing uncompared trades. In addition, ACT could
accommodate the changes needed when the time for settlement is reduced
from T+3 to T+1.
nasd progress to date
Since the SEC requested us to undertake this initiative in
September of last year, the NASD has conducted extensive research on
the depth and breadth of corporate markets, reviewed reporting and
surveillance elements, and met with data vendors, clearing firms, and
network display vendors.
The Bond Market Transparency Committee
In order to ensure that enhanced bond transparency is implemented
appropriately and can be provided at the earliest possible time, the
NASD has empanelled a Bond Market Transparency Committee representing
investors and all major segments the bond market. These segments and
Committee members include:
Individual Investors--Dr. John Markese of the American
Association for Individual Investors.
Academia--Dr. Ian Domowitz, Pennsylvania State University
Institutional Investors--Ian MacKinnon of the Vanguard Group
and Edward Wiese of T.Rowe Price Investment Services.
Large Discount Firms--John Ladensack of Charles Schwab &
Company.
Regional Investment Banking Firms--Stanley Becchetti of A.G.
Edwards and Sons, and Michael Shea of J.C. Bradford & Company.
London-Based Investment Banking Firm--Mark E. Field of
Schroder & Company.
Major Investment Banking Firms--Jane Carlin of Morgan Stanley
Dean Witter & Company, Kelly Martin of Merrill Lynch & Company,
and Michael Mortara of Goldman, Sachs & Company
Brokers' Brokers--James Jacoby of Asiel & Company, LLC and
Joseph Shea of Cantor Fitzgerald Partners.
Bond Market Association--William H. James of Lazard Freres &
Company.
Securities Industry Association--Jeffrey Theodorou of
Prudential Securities.
NASDR Fixed Income Committee--Zachary Snow, Chairman of the
Fixed Income Committee.
The Committee's Progress
Our Bond Market Transparency Committee has worked diligently from
its first meeting on January 14 and is moving quickly to identify and
solve the issues involved with increasing transparency. The Committee
has made substantial progress.
The Committee has agreed in principle as to the securities that
should be included in the system, which now includes: investment grade
corporate debt; medium term notes issued by U.S. companies; corporate
``Yankees,'' including development banks, and sovereigns; capital trust
securities; convertibles; units; asset-backeds; floating rate notes,
and 144A securities.
The Committee will determine what will be disseminated and within
what time frame in order to ensure maximum transparency without
disrupting markets and consequently harming liquidity.
The Committee has agreed that ACT will be important to the
confirmation of reported trades, especially as the settlement cycle
shortens to T+1.
The Committee has established that the information that is
collected should be widely disseminated to all vendors, to the maximum
extent available.
the bond price competition improvement act of 1999
The invitation letter to this hearing asked us to provide our
comments on the Committee Draft of the Bond Price Competition
Improvement Act of 1999.
The NASD recognizes that the goal of the bill is to ensure that the
momentum started by Chairman Levitt and Chairmen Bliley and Oxley last
Fall continues toward bond market transparency. The bill would require
the SEC to adopt rules on the collection and distribution of
transaction information on covered debt securities. In addition, the
bill would amend the definition of exempted securities in the 1934
Securities Exchange Act to cover government sponsored enterprises under
the bill. Finally, the bill would require studies of inactively traded
securities and municipal securities by the GAO, in consultation with
the SEC and the Municipal Securities Rulemaking Board.
The NASD is strongly supportive of the objectives and principles
embodied in the bill of enhanced bond transparency and remains
committed to work with you and your staff as this bill works its way
through the legislative process. We particularly want to stress the
importance of the provision in Section 2 of the bill that expressly
preserves all of the Commission's authority under Section 11A. We
believe that this provision is especially important in making it clear
that the Commission has the authority to approve all of the terms on
which market information may be obtained and distributed, including the
power to assure that fees charged are fair, reasonable, and
nondiscriminatory.
conclusion
The NASD thanks the Subcommittee for this opportunity to update it
on our progress toward increased bond transparency and our views on the
recently introduced bill.
We strongly support the goals and objectives of the Committee Draft
of the Bond Price Competition Improvement Act, a bill to enhance bond
market transparency. We believe that our experience in developing
systems for both the equity markets and the high yield bond markets
will serve as a strong foundation as we prepare to fulfill our
commitment to the SEC to improve transparency in the bond markets.
Although we would all like to implement important changes like
transparency quickly, we are proud of our efforts to date and pledge
our continued efforts. We will work with the Congress, the SEC and the
securities industry to make the necessary changes a reality at the
earliest possible time, with the maximum benefit to the investor and
minimum disruption to the industry.
Mr. Oxley. Thank you, Mr. Campbell. Mr. Green.
STATEMENT OF MICAH S. GREEN
Mr. Green. Thank you, very much, Mr. Chairman. It's a
pleasure to be before the subcommittee today. If I could ask
that my entire written testimony be submitted for the record
and I will talk more topically about the legislation and the
Bond Market Association's initiative.
Mr. Oxley. Without objection, both statements will be made
part of the record.
Mr. Green. Thank you. Before going into the legislation and
our initiative, I want to first commend you and the members of
the subcommittee and the leadership of the committee and the
staff of the committee for everything they have done since the
hearing last September, in urging the industry and the NASD and
the SEC to get involved in this effort. Since September, we've
taken your guidance and your urging very seriously and we
commend you for your leadership in bringing this issue to the
level of public attention that it surely needed. And I'd also
like to commend the SEC Chairman Levitt, the entire SEC staff
and members, as well as the NASD and our friend Pat Campbell
for everything they have done in reaching out to the industry,
so that we can work cooperatively in this effort. There's not a
competition between a private sector initiative and what the
NASD is working on. Frankly, they are very complementary
efforts. But, we are working very, very closely with the NASD
and look forward to that good working relationship going
forward on this and other issues. So, I commend them for their
leadership.
We represent--the Bond Market Association represents
underwriters and dealers of municipal bonds, corporate bonds,
government securities, and virtually all bonds that are traded
and sold by issuing authorities throughout the country and
throughout the world. And we're very proud of the fact and
several times over the last many, many years, when this
committee has brought to the at-
tention of the industry and the regulators problems that exist
in the marketplace, that we have tried to step up to the plate
and address those issues. And in so doing, we have tried to be
not only responsive to the industry--to the concerns of Members
of Congress and the regulators, but have also tried very
seriously to look very deeply into ourselves and to make sure
we're not missing something. And throughout the consideration
of the Government's Securities Act, as well as the municipal
securities market and now the corporate market, we've tried to
step up and to say what's right and what's wrong about these
markets and work vigorously and objectively to try to address
those issues.
Our written statement, unfortunately, was submitted prior
to the issuance of the final draft of legislation. And I want
to state here today that the latest draft that we saw is a
draft that the Bond Market Association can be supportive of. We
feel very strongly that the legislation reflects the interest
of the free marketplace, by acknowledging that private sector
initiatives should be considered by regulators prior to
finalizing a direction for the regulator to take. And we don't
view this as a delay at all, because as you'll hear in a
moment, our private sector initiative is weeks away from
becoming an absolute reality. But, we do believe that when an
industry acknowledges the criticism that is raised by
policymakers and is willing to take the actions necessary to
address the concerns raised by those policymakers, there should
be absolute consideration of the results of that work, because,
otherwise, would make all this work meaningless and this work
is very important. In a sense, we've become a laboratory for
price transparency in the corporate bond market.
So, we commend the subcommittee for including that
bracketed language that was talked about earlier. Frankly, I
view the brackets more as a highlight, that it's the most
important of the bill. And I know that there will be debate on
it. But, we do view that if this legislation is not intended to
impart new regulatory authority to the SEC, but, in fact, to
impart a congressional desire to employ regulatory authority
that already exists, what you're doing with this bill is laying
out your views, as to how that existing authority should be
utilized. And by simply adding that they shall consider--and
shall consider the private sector initiatives in carrying out
the provisions of this Act, is not an impediment. In fact, it
will make the whole process work that much better and the
Commission and the regulators and the NASD will have the value
of our initiative in moving forward.
Second, the legislation is tremendously improved by
including language in there that requires the consideration of
the effect on liquidity in the marketplace. We don't sit here
today to say that price transparency will hurt liquidity in the
marketplace. Rather, we say that liquidity in the marketplace
is extremely important; that if you lose liquidity, you hurt
the ability of states and corporations and governments to come
to market and get the very best prices on their bonds and get
the very lowest cost of borrowing. So, it should be a
consideration when looking at price transparency in the
corporate bond market. And if it proves that it's not a
problem, carry on. If it proves that it is a problem, it should
influence how the final outcome appears.
And then finally, we are also very appreciative of the fact
that your legislation does not spell out a specific form of
transparency and you leave that up to what the SROs are doing
and what the marketplace is doing, to try to figure out what
the best way to approach that issue is. So, we commend you for
the current version of legislation and we do look forward to
working with you on that.
Now, if I may very briefly talk about where our initiative
is and what the derivation of our initiative. The derivation of
our initiative is this subcommittee. This subcommittee, and I
can hear the words coming out of many of the subcommittee
member's mouths, as if it were yesterday, and it was only a few
months ago, that the industry had to do something. And we came
out of our hearing immediately and met with Arthur Levitt, and
after forming a transparency committee, informed him that we
were prepared to do something very tangible in this area. And
we presented a proposal to him and we sent it, of course, to
the committee, as well. And immediately thereafter, we issued a
request for proposal, an RFP, from various information
providers and information services, to try to implement our
price transparency system. We asked that those proposals be
delivered by December 31. We really thrilled a lot of people
for the Christmas holidays. But by December 31, we received
nine proposals from a wide array of information providers.
During the first 2 weeks of January, we reviewed those
proposals. And at the end of January, we awarded a contract to
GovPX. Why GovPX? Because GovPX is a facilitator of
information. Just as it has provided tremendous market-based
information in the government securities market, as well as, as
Bob Colby said, the agency market, GovPX can be a facilitator
here. And to address Congresswoman's Degette's point, they,
also, have fabulous quality control measures at work right now
in the government securities market, and we wanted them to be
employed here, too. And now, we're about to test. Next week we
have beta testing planned for this, in the hopes that this
system, as designed to try to capture transaction information
on a continuous basis through the day on actively traded
securities, becomes alive at the end of April.
Now, we're not saying it's the end all and be all. What
we're saying is we are doing what we can, as an industry, to
facilitate addressing your concerns as a committee as quickly
as possible. We are working very closely with the NASD in this
whole process, to try to move forward and beyond. But, at this
stage, we are a few weeks away of having something up and
running that would give everyone, the public, market
participants, better information. And it would give regulators
the information they need to survey the market, albeit as was
said, not for all securities in the market, but for those that
we can capture quickly that would give better surveillance and
enforcement information and, more importantly, it would give
regulators and this committee information as to what price
transparency should look like going forward.
So, we believe very strongly that it would be short sighted
to move forward on a specific regulatory approach right now,
until you've seen the results of this, which is, as you can, by
the chart over there are just weeks away. And as soon as it
goes on live, we will start seeing information. And also to
answer several questions that came out about cost, we intend
that this information, on cor-
porate bond transaction information for those actively traded
securities would be available through our onsite
www.investingandbonds.com, free of charge to investors, just
like we do it now for the municipal market. And as Chairman
Levitt's written statement said, that municipal market Website
is hit many, many times throughout the day.
So, we're very proud of this effort, but we, also, realize
that regulators and legislators want more. And we're willing to
work toward the next steps beyond this, but we, also, feel very
strongly that this laboratory that we've set up will have
results from that experiment and they should be allowed to be
analyzed and looked at, as we move forward.
So, with that, I welcome your questions. And Mr. Chairman,
I thank you and the committee.
[The prepared statement of Micah S. Green follows:]
Prepared Statement of Micah S. Green, Executive Vice President, The
Bond Market Association
The Bond Market Association appreciates the opportunity to comment
on price transparency in the bond markets, and to present our views on
associated legislative and regulatory issues. The Bond Market
Association represents securities firms and banks that underwrite,
trade, and sell debt securities both domestically and internationally.
We commend Chairman Bliley, Chairman Oxley, and the subcommittee for
taking the time to examine this important issue.
Last September, this Subcommittee held a hearing that examined the
state of price transparency in the bond markets. At that hearing,
Chairman Bliley and others challenged the industry to improve price
transparency in the bond markets. Securities and Exchange Commission
Chairman Arthur Levitt made a similar call in a New York speech on
September 9th, and again at the hearing. The industry has heeded those
calls.
In September, we pledged our support for the goal of providing
investors with meaningful price information and reaffirmed our
commitment to improve price transparency in the corporate bond markets.
In keeping with that pledge, the Association is sponsoring a private-
sector initiative that will provide price data on inter-dealer broker
trades of investment grade corporate bonds to all market participants
and investors. Beginning next month, the Association expects to
inaugurate a service that makes transaction price data available
directly to regulators and to the public through a wide range of data
vendors and free of charge on our investor website. Under a contractual
arrangement, the transparency product--Corporate Trades I--is being co-
developed by the Association and GovPX Inc. GovPX is a leading provider
of price and volume data in the government securities market and will
operate the system for data collection and dissemination.
This initiative represents our initial attempt to improve the
availability of price data to the public for the corporate bond
markets. In addition, the initiative creates a laboratory in which both
market participants and regulators can obtain important insights into
the interaction between transaction reporting and liquidity. We are
pleased to report at this time that the timeframe for the inauguration
of public reports by the end of April remains realistic and achievable.
At the same time, we acknowledge that this initiative is merely one
part of a longer process through which a variety of different systems
and solutions will evolve.
Historically, industry-based solutions to transparency challenges
in the bond markets have addressed the needs of legislators,
regulators, and market participants alike, and have resulted in
significant improvements in the amount and quality of price data
available to the public without disruption of market liquidity. The
Bond Market Association played a major, proactive role in the design
and implementation of systems to enhance price transparency in the
government and municipal bond markets. We will do the same in the
corporate markets.
In the government securities market, the Association was
instrumental in the creation of the GoxPX system for Treasury
securities. Today, GoxPX is recognized as a leading provider of real-
time price and volume information, and is widely credited with
significantly improving price transparency in the government securities
markets. In the municipal market, we worked closely with the Municipal
Securities Rulemaking Board (MSRB) to develop a transaction reporting
system that provides relevant data to investors. Last November, the
Association, in coordination with Standard & Poor's J.J. Kenny, began
posting the MSRB's price and volume data--enhanced by yield, credit
rating, call dates, and other useful information--on its investor
website, investinginbonds.com. This user-friendly service enables
investors to obtain enhanced end-of-day pricing information--from the
previous trading day--on actual municipal bond transactions free of
charge.
Clearly, this industry has established a tradition of responding
promptly and efficiently to calls for increased price transparency in
the bond markets. The corporate markets are no exception. In less than
six months, the industry has made substantial progress toward
implementing a system that will enhance corporate bond price
transparency. [See the attached timeline that illustrates the progress
of our transparency initiative.] Our commitment to improving
transparency is serious, and we are making it happen. Therefore, we
believe it would be premature at this time, to enact legislation
designed to immediately mandate transparency through regulatory decree.
In this statement, we focus on three themes. First, we will present
our views on the critical relationship between price transparency and
market liquidity in the corporate bond markets. Second, we will discuss
the progress the industry has made toward improving price transparency
since September. Finally, we will discuss why legislation to improve
transparency through regulatory decree is not necessary at this time.
Transparency Policy Issues
The Association fully supports the goal of enhancing price
transparency in the corporate bond markets. However, price transparency
should not be confused with regulatory reporting. Regulatory reporting
involves providing trade information to regulators for audit trail or
other market surveillance purposes. The Association fully supports the
timely transmission of corporate bond transaction information to
regulators and/or Self-regulatory Organizations if such reporting is
necessary to properly surveil the market to prevent and detect market
abuses. However, the appropriate definition of ``timely'' depends on
the regulatory objectives.
The Association encourages regulators to consider the costs and
benefits of implementing a system that would require immediate
reporting of every trade in the corporate bond markets. The differences
between the equity market and the bond markets have long been
recognized by regulators. Chairman Levitt himself is on record stating
he is ``not suggesting that we transpose the national market system
built for equities to the debt markets.'' The Association urges
Congress and regulators to keep this in mind as they move forward with
plans for enhancing regulatory reporting systems to supplement dealer
books and records which have long been available for inspection.
In contrast to regulatory reporting, price transparency is the
timely dissemination of trade information to the public. Here, the
objective is to provide the public--including both large institutional
investors that dominate the corporate bond markets and individuals--
with useful information about the current price levels of bonds they
hold or wish to buy or sell--without jeopardizing their ability to
trade these bonds. Here, we raise the issue of real-time price
dissemination because some have indicated their belief that the public
has a right to know the prices and volumes of all trades
instantaneously.
The nature of the corporate bond markets creates some unique
challenges for the design of systems that would efficiently distribute
meaningful price data to all investors. First, there are many different
bond issues outstanding, and over 95 percent of corporate bonds are
held by institutional investors. In the corporate bond markets alone
there are an estimated 400,000 individual bonds
outstanding.1 Second, the vast majority of outstanding bonds
trade very infrequently, i.e., the bond markets are not continuous
trading markets. Unlike the stock market where most issues trade daily,
it is not unusual for months to pass between trades in a particular
bond issue. For example, in 1996, of the approximately 400,000
corporate bonds outstanding, only 4 percent traded at some point during
the year.2
---------------------------------------------------------------------------
\1\ Source: CUSIP Service Bureau. Estimate includes corporate
bonds, medium-term notes, asset-backed bonds, and non-agency mortgage
securities outstanding as of September 1998.
\2\ Bond Market Association estimate.
---------------------------------------------------------------------------
The Association is also quite concerned about the negative effect
that real-time dissemination could have on liquidity in the corporate
bond markets. Since dealers and institutions trade large blocks of
bonds, revealing prices and trading volumes instantaneously could hurt
market liquidity. If market participants (i.e., potential
counterparties) had access to information about other market
participant's trading strategies, it would be more difficult to conduct
further trades. Given the non-con-
tinuous trading environment of the bond markets, a market participant
attempting to ``unwind'' a large position would definitely not want the
prices of sales posted before the position was fully liquidated. Often,
a small number of institutions or dealers hold very large blocks of a
particular issue, and thus, a liquidation of their position would be
obvious to the market. Additionally, once the bonds are taken into
inventory by a dealer, it could take days, or even weeks to find a
buyer for these less-liquid bonds.
The bond markets depend on the willingness of dealers to take
positions in bonds and carry inventory, thereby shifting market risk to
the financial intermediary and creating liquidity for investors. The
premature release of transaction information could inhibit the trading
activity of these vital market participants. Clearly, a prolonged
reduction in market liquidity would have serious consequences not only
for the bond markets, but for the economy as a whole. Liquidity
disturbances, such as those that occurred in the bond markets last
fall, can lead to a higher cost of capital for bond issuers, and
inhibit capital formation. Higher capital costs for America's
corporations translate into less funding for capital expansion--a
significant factor affecting economic growth. This is why the
Association's initiative is designed to strike an important balance
between transparency and market liquidity.
Regulators have long recognized the differences between highly
liquid markets--such as those for most listed equities, and less liquid
markets--when crafting rules for various markets with respect to the
timeliness and content of public dissemination. In most of the equities
markets, price transparency has been equated with real time last sale
reporting. While real-time transaction price and size dissemination
characterizes the nature of price transparency for liquid equity
securities, transparency for illiquid equities is quite different.
Trade data for liquid equities must be reported to the NASD within 90
seconds of the transaction via the Automated Confirmation System (ACT),
which automatically disseminates trade information to the public.
However, trades in illiquid equity securities are reported to the NASD
for regulatory purposes--but not via ACT--and these trades are not ever
reported to the public. Additionally, odd-lot transactions in National
Market securities and private placements (in reliance on Section 4(2)
of the Securities Act) are not required to be reported through the ACT
system.
Likewise, transparency initiatives for the OTC bond markets need to
take into account the individualistic nature of bonds, differences in
liquidity, and differences across instruments in the various bond
markets. Historically, these differences have been recognized by
Congress and regulatory authorities as evidenced by the differences
between existing bond market transparency systems that have been
developed and have been found to be providing adequate information to
date. The attached table illustrates the characteristics of several
transaction reporting systems currently operating in U.S. financial
markets.
In the government securities market, GovPX is a leading provider of
real-time benchmark pricing for all active and off-the-run Treasuries.
The liquid nature of Treasury securities led to a solution that
provides prompt price dissemination for Treasury securities. In the
municipal market, price transparency has been greatly enhanced by the
Municipal Securities Rulemaking Board's (MSRB) end-of-day trade
reporting, a system that currently includes both dealer and customer
trades. Beginning in November 1998, the Association began posting this
data on its investinginbonds.com website free of charge. Investors can
access CUSIP numbers, security descriptions, number of trades, volume,
and high and low prices for municipal bonds that trade four or more
times on the prior day. Additionally, investors can sort the data
according to State or other criteria. This enhanced user-friendly
format has been well-received by the investing public. The less-liquid
nature of the municipal securities market led to the development of
this time-delayed and synthesized trade reporting system. It is
important to note that individual investor response to this data has
been extremely favorable and liquidity in this market was apparently
unharmed by the implementation of this system.
In the corporate market, a price transparency system for high-yield
bonds has been in place since 1994. The NASD introduced the Fixed
Income Pricing System (FIPS) to enhance transparency in the high-yield
sector. FIPS provides for the collection, processing, and real-time
display of firm quotations and summary transaction data for 50
designated (mandatory) high-yield bonds. Interestingly, actual
transactions are never disseminated to FIPS participants or to the
public. Again, it should be noted that regulators fully recognized the
possible harm that could be brought about by real-time transaction
dissemination and by imposing a system on the entire market. In a 1991
report to Congress, then SEC Chairman Richard Breeden acknowledged that
mandating increased price transparency to the entire high-yield market
could be harmful:
. . . mandating increased transparency for the large segment of
the market that is illiquid could further reduce dealer
participation in that segment of the market, and is therefore
only practical where a ``critical mass'' of market participants
exists.
The foregoing review of transparency systems in the market for
illiquid equities and in the bond markets highlights a critical fact.
Currently, there are no real-time transaction reporting systems in
existence that require or provide immediate public dissemination of
every trade in a given class of illiquid securities. Furthermore,
regulators have recognized the difference between liquid and illiquid
securities when developing regulations for equities and for high-yield
bonds. Therefore, the Association would object to any system that
mandates dissemination of the price and size of every bond trade to the
public on a real-time basis. Given that there is no precedent for
requiring such an extensive system, the negative impact on the markets
would be difficult to quantify since it has not been observed in any
market for relatively illiquid securities. However, academic research
has shown that too much transparency can actually increase market
volatility and lower market liquidity in markets where trading volume
is thin--precisely the type of characterization that applies to a large
number of securities in the corporate bond markets.3
Therefore, the Association is concerned that market liquidity could be
negatively affected by the mandatory real-time disclosure of all
trades.
---------------------------------------------------------------------------
\3\ See Ananth Madhavan, ``Security Prices and Market
Transparency,'' Journal of Financial Intermediation, no. 5, 1996, pp.
255-283.
---------------------------------------------------------------------------
The Association believes the best way to expeditiously achieve
meaningful price transparency in the corporate bond markets is to
embrace a market-oriented approach that is designed to preserve market
liquidity. This approach will also allow for the reassessment of
existing systems and adjustments to the systems over time. This is
consistent with the historical approach to price transparency that has
proven to be successful in the government and municipal bond markets.
The Association's Transparency Initiative
The Association has taken the lead in developing a system that will
enhance price transparency in the investment grade corporate bond
market. In September, the Association organized a Price Transparency
Steering Committee, under the auspices of our Corporate Bond Division,
to examine the issues that must be considered when designing
appropriate systems to improve price transparency without damaging
market liquidity. The Committee is comprised of senior bond officials
from dealer and inter-dealer broker firms. After the Subcommittee
hearing last September, the Committee resolved to implement a system
that would respond directly to the challenge put forth by Congress and
the SEC.
Members of the Steering Committee met with SEC Chairman Levitt in
October to express the industry's desire to design and implement a
first-phase transparency solution within a six-month period.
Recognizing that the industry initiative would likely have to meld with
the longer-term goals envisioned by the SEC, the Steering Committee
proceeded with the plan to design an initial price transparency system
for investment grade corporate bonds.
In November, the Association issued a ``request for proposals''
(RFP) that asked pricing and information vendors, as well as others who
could facilitate this initiative, to submit proposals presenting how
they would implement the Association's initiative by enabling inter-
dealer brokers to submit investment grade corporate bond transaction
data and redistribute such data to the public through electronic means.
The Association also held a bidders conference to answer questions and
discuss other aspects of the plan with prospective bidders.
By the end of December, the Association had received nine proposals
from an impressive group of bidders. Following interviews and
deliberation in January, the Steering Committee selected GovPX as the
vendor that would design and operate the system for the industry's
transparency initiative. GovPX proposed a collection mechanism that is
extremely flexible and can be adapted over time to include a wider
range of reporting entities and/or securities. The ability of the
initial system to expand and adapt to future modifications is a strong-
point of the GovPX system. In addition, from the perspective of the
Association, GovPX is essentially a ``facilitator'' with a strong track
record and financial incentives to redistribute price data through the
broadest range of existing and prospective data vendors. Finally, GovPX
has extensive experience collecting price data from inter-dealer
brokers and disseminating that data for the entire range of government
securities.
Last month, the Steering Committee adopted a set of initial display
parameters for the transparency system, and intends to consider
adjustments to these preliminary parameters after the system has become
operational. The initial parameters were developed in consultation with
a broad range of the Association's membership not only from Wall
Street, but from across the country. Of paramount importance to the
Committee was the intention to protect the confidentiality of
investors' positions, particularly with regard to less-liquid debt
securities. Over the past several months, the Committee collected
valuable input from inter-dealer brokers, dealers, and their customers
before determining the initial parameters for the transparency
initiative.
The Association's Voluntary Price Transparency Initiative product,
called Corporate Trades I, will collect price data on investment grade
corporate bonds from inter-dealer brokers to meet this Subcommittee's
priority to disseminate data to the public, and to meet the SEC's and
the NASD's priority to obtain information for surveillance purposes.
The Association expects that inter-dealer brokers active in the
investment grade corporate bond market will report data on all
transactions to GovPX. To date, seven leading inter-dealer brokers--
which account for approximately 90 percent of investment grade trades
of all inter-dealer brokers--have informed the Association of their
intent to participate in this voluntary initiative. GovPX will then
make the data available to the public consistent with the preliminary
display parameters agreed to by the Steering Committee and the
Corporate Bond Division of the Association.
With respect to dissemination of transaction data to the public,
the initial display parameters will provide for continuous reporting
throughout the day of the prices of all investment grade corporate
bonds that have been traded at least four times and involve individual
transactions of $10 million or less. This information will be
disseminated to GovPX subscribers within one hour of the occurrence of
the fourth trade and within one hour for all trades in the same
security thereafter. At the end of each trading day, the price and size
range of every trade meeting these parameters will be disseminated to
the public and enhanced with descriptive information including credit
ratings and yield-to-Treasury data.
Actual sizes of individual trades will not be revealed publicly in
order to preserve investor anonymity, which is important due to the
concentrated ownership of corporate bonds. The Association's
preliminary view is that these public display parameters strike a fair
balance between our objective of enhancing transparency without
jeopardizing market liquidity. However, for surveillance purposes,
regulators will be provided with a file of all price and volume data
for all trades reported to GovPX.
We expect this new information product to be available to the
public through data vendors before the end of April. In addition, the
Association plans to make the data available in a user-friendly format
on its investinginbonds.com website free of charge at the same time or
shortly thereafter.
Legislation Mandating Regulatory Action is Not Needed
The Association believes that legislation mandating immediate
regulatory action for price transparency is unnecessary and unwarranted
at this time. This industry has responded promptly to calls for
increased transparency. Widespread market abuses have not been
identified in the corporate bond markets, nor have investors clamored
for more protection due to opaque conditions in the corporate markets.
While it is appropriate and commendable for Congress to examine the
issues related to price transparency in the bond markets, the
industry--given our response and action since last September's
hearing--should be given the opportunity to complete development of
appropriate, market-specific solutions.
It is our strong belief that, as in the other bond markets, this
market-based solution should be assessed before a regulatory response
is determined or mandated. In this regard, the Association would be
willing to provide Congress with a report that details our progress on
implementing the system after it has become operational for a
reasonable amount of time. It is our sincere hope that the SEC and
NASD, who have already begun a regulatory review of this matter, will
take into account the results of this important initiative before
decisions are made about a regulatory response. However, if legislation
is deemed to be necessary, legislation embodying a logical and orderly
market-oriented process would be preferable to legislation that
prematurely mandates regulatory action, as the latter would signal
regulators to proceed regardless of the results of the industry's
initiative.
Some have proposed expanding the National Market System for
equities to include the bond markets. In addition, some have advocated
expanding the definition of non-exempt securities under Section 11A of
the Securities Exchange Act to include federally-sponsored agency
securities and securities issued by international financial
organizations, such as the World Bank. The Association opposes such
proposals for several reasons.
First, the legislative history surrounding the 1975 Amendments that
enacted Section 11A reflects the fact that Congress' intended focus in
creating a National Mar-
ket System (NMS) was on the regulation of the equity markets. The NMS
framework and goals were born out of the unique circumstances that
characterized the market structure for corporate equity securities in
the early 1970s. Bond markets were then, and continue be, significantly
different structurally from the equities market.
The SEC and Chairman Levitt have been vocal in their belief that
the National Market System should not be transposed on the debt
markets. In his speech last September, Chairman Levitt said:
I am not suggesting that we transpose the National Market
System built for equities to the debt markets. For many
reasons, that would not work.
Finally, the proposed expansion of the definition of non-exempt
securities to include agencies and issues of international financial
organizations, is not warranted based on the findings of recent
regulatory reports. Last March, the Treasury Department, the SEC, and
the Federal Reserve Board released their ``Joint Study of the
Regulatory System for Government Securities,'' which considered the
state of transparency in the Treasury and agency securities markets.
The report recognized the ``variety of pricing and related
information'' that is available from financial publications and online
vendors. The report concluded that the government securities market--
which by definition includes federally sponsored agencies--is
functioning smoothly:
The market continues to function smoothly, and the three
agencies do not believe it is flawed in any fundamental sense.
As a result, we believe no additional rulemaking authority
under the [Government Securities Act], as amended, is required
at this time.
Additionally, the SEC's Debt Market Review came to a similar
conclusion regarding Treasury and federal agency securities:
The combination of real time data for benchmark Treasuries
and supplementary quotes and other information for the other
securities appears to provide a very good level of pricing
information for all government bonds.
The Review also examined non-agency mortgage and other structured
products and concluded that the ``quality of pricing information and
interpretive tools available to the market is good.'' The SEC has
repeatedly decided not to pursue regulatory changes to the markets for
agency and non-agency mortgage-and asset-backed securities. The Bond
Market Association supports the conclusions of the SEC regarding this
matter.
Conclusions
For over a decade, The Bond Market Association has been at the
forefront of efforts to improve price transparency in the bond markets.
Our most recent initiative will deliver price data on investment grade
corporate bonds to the general public on our investor website--free of
charge--in the coming weeks. While we agree that enhancing price
transparency for liquid securities is a laudable goal, we maintain that
widespread dissemination of trade data for illiquid securities will
likely have a negative impact on market liquidity and on bond market
investors. We will continue to work with the Members of this
Subcommittee, the SEC, the NASD, and others, to ensure that investors
have access to meaningful price information on bonds. However, we do
not believe that legislation mandating immediate regulatory action is
warranted at this time. We believe that policy-makers should consider
the industry's efforts before determining what regulatory actions may
be necessary.
Voluntary Price Transparency Initiative Timeline of Progress
--------------------------------------------------------------------------------------------------------------------------------------------------------
September 1998 October 1998 November 1998 December 1998 January 1999 February 1999 March 1999 April 1999
--------------------------------------------------------------------------------------------------------------------------------------------------------
At transparency hearing, Association Association Association Association Association's Association and Association and
Association pledges to work members meet issues a receives reviews nine Transparency GovPX plan to GovPX plan to
to enhance price with SEC request for proposals from vendor Steering begin testing launch
transparency. Chairman Levitt proposals to bidding vendors. proposals and Committee system to Corporate
and begin to develop selects GovPX adopts transmit and Trades I.
develop transparency as vendor for parameters for disseminate Association
industry product and the industry the prices. plans to post
initiative. hosts bidders. initiative. transparency data on its
Association system--Corpor investingbonds
hosts open ate Trades I. .com website
forum on price
transparency.
--------------------------------------------------------------------------------------------------------------------------------------------------------
Characteristics of Selected Transaction Reporting Systems: Ranked from High to Low Liquidity
--------------------------------------------------------------------------------------------------------------------------------------------------------
Security's General Dissemination Dissemination Release Actual
Security System Liquidity Type Reporting Timeframe Audience Trades to Public
--------------------------------------------------------------------------------------------------------------------------------------------------------
Exchange-listed Equities....... ACT (Nasdaq) DOT Very high......... Within 90 seconds Instantly-price Market participants Yes
and OARS (NYSE). of trade (ACT) and volume. and consolidated
and automatically tape.
in DOT and OARS.
Treasury Securities............ GovPX............. High.............. Instant-built into Instant-price and GovPX participants Yes
system. volume. and subscribing
vendors.
Agency Bonds................... GovPX............. High.............. Instant-built into Instantly-price GovPX participants Yes
system. and volume. and subscribing
vendors.
High Yield Bonds-Mandatory NFIPS (Nasdaq).... Relatively high... Within 5 minutes Every Hour-Price FIPS participants No
Issues \1\. of trade. and Volume and data vendors.
Summary.
Municipal Bonds................ MSRB (NSCC)....... Varies but End of day........ Next Day price and Data vendors and The No
typically low. summary volume Bond Market
data for bonds Association's
that traded 4 or website-
more times. investinginbonds.co
m.
Investment Grade Corporate Corporate Trades I Varies but Within 15 minutes Within 1 hour GovPX subscribers No
Bonds. (The Bond Market typically low. of trade. after 4th trade and investors
Association/ and within 1 hour through
GovPX). for subsequent Association's
trades--prices website-
released for investinginbonds.co
trades of $10 m.
mil. or less.
New York Stock Exchange-Listed ABS (NYSE)........ Varies but Instant-built into Instantly-price market participants Yes \2\
Bonds. typically low. system. and volume. and high speed
quote line; summary
data in newspapers.
High Yield Bonds-Nonmandatory FIPS (Nasdaq)..... Low............... By 5 p.m. on day None.............. None................ No
\3\. of trade.
Non-Nasdaq Equities \4\........ Non-Nasdaq Low............... Price and volume None.............. No.................. No
Reporting System data reported
(NASD). between 4 p.m.
and 6:30 p.m. on
trade date or
between 7:30 a.m.
and 9 a.m. on
next business day.
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ Mandatory FIPS bonds are the 50 most active high-yield bonds as designated by an advisory committee; this committee meets every six months to
reassess the mandatory list.
\2\ The vast majority of NYSE bond trades are retail, odd-lot transactions.
\3\ Non-mandatory FIPS issues are all bonds rated BB+ or lower by Standard & Poor's, excluding those designated as mandatory FIPS issues.
\4\ Non-Nasdaq equities are defined as securities that are neither included in The Nasdaq Stock Market nor traded on any national securities exchange.
Mr. Oxley. I thank both the gentlemen, and we appreciate
your good work in this area. Let me begin by asking Mr. Green:
what should we be looking for in April, when this program is
going to become available? What are you going to be looking for
and what do we need to look for, in terms of the applicability
of this program and its effectiveness?
Mr. Green. Well, in April, and assuming all the beta
testing and everything goes well, but so far, so good,
transaction information on the investment grade corporate bonds
that are traded through interdealer brokers will begin getting
reported on a continued--on a continuous basis throughout the
trading day to GovPX. GovPX will then pipeline that information
out to information vendors, to the Bond Market Association for
use on our Website, and also to regulators. And regulators will
frankly get complete information, so that they can do their
surveillance enforcement activity on those sets of bonds
throughout the trading day. Also at the end of the day, there
will be more complete reports about the total volumes and
buckets of volumes to see what transacted through the trading
day. But, immediately when it's turned on, that reporting
process will begin.
Now, with regard to our Website, we hope it's--we hope the
Website, itself, is ready to take that feed at the end of April
and that's--it may be a few weeks after that, once we see the
information flowing.
Mr. Oxley. Let me ask Mr. Campbell, what role then does
NASDAQ play in this whole process? Take us through the
mechanics of this, if you will. Also, what will you be looking
for in terms of the effectiveness of the GovPX program?
Mr. Campbell. Mr. Chairman, we have, since last September,
had many meetings with our committee on bond transparency. We
have done a fine job in defining and getting in the process of
writing rules. We expect to be delivering those rules to the
Securities and Exchange Commission very early summer, hopefully
in the month of June.
During the period of time that the Bond Market
Association's experiment with collecting and disseminating the
bond transaction information, we should be very sensitive to
what we can learn from them through this initiative and
incorporate that into the rules that we write to follow the
Securities and Exchange Commission, that all broker-dealers
will ultimately have to abide by. And I think the fact that we
have included on our committee a representative of the Bond
Market Association to assist us in the process, we believe that
we should gain some insights that will help us do a better job
in the formulation of those rules.
Mr. Oxley. Let me ask Mr. Campbell, what about junk bonds?
First of all, how would junk bonds be in this mix and how would
they be treated?
Mr. Campbell. At the current time, we have an existing
system that collects information on high yield or junk bonds.
We would expect to include that, as has already been determined
by the committee, that we would collect and disseminate that
information. That is--that decision has already been made. And,
in fact, we can continue to use the FIPS system, as Chairman
Levitt discussed, to continue to collect that information and
dovetail that into the ultimate process.
But at the current time, we have made available in our
architecture of the collection system, every vendor out there,
who has a terminal out there, including the development and
building of a Web-based browser system to those firms, who do
not have the technical expertise or the funding to go on a
computer interface or subscribe to any of those services, we
will allow them to have the input over a Web-based browser
system for timely reporting, too. So, we fully expect and have
already decided that we will include those securities in the
timely reporting, as with the rest of the fixed income
securities.
Mr. Oxley. Thank you. Mr. Green, your plan is basically
dealer to dealer? Do you see, at some point, the expansion of
dealer to customer arrangement?
Mr. Green. Well, within--the voluntary initiative, quite
frankly, there's no question, we are not a regulator. We are
not a self-regulator. The key element that we're trying to do
is to get people, get firms, get market participants to
volunteer to do something. And why we picked, you know,
interdealer brokers and why we picked corporate--investment
great corporate debt, in part, is because the FIPS program
already exists. A lot of odd lot retail transactions are
already covered by the New York Stock Exchange's ABS system.
And we wanted to try to find something that currently wasn't
hit by anything with the universe that we could get to
volunteer, and to go beyond that voluntarily would probably be
more difficult, as an overall industry.
But, I think we need to see what the results of this effort
are, and not a long timeframe for results. But, to see how this
works, to see how useful the information is, to see the
mechanism with which the information is distributed, to see if
it's being used by investors, if it's being interpreted
correctly, if it's being structured properly, and that will
serve as a model for the steps beyond.
Mr. Oxley. Thank you. My time has expired. The gentleman
from New York.
Mr. Towns. Thank you, very much, Mr. Chairman. Mr.
Campbell, do you support the committee draft?
Mr. Campbell. Yes, sir, we support it.
Mr. Towns. Do you think there's anything that's not in
there that should be in there?
Mr. Campbell. No, sir. We believe that the committee draft
encompasses the intent of the committee and the work that
everybody is doing in this area. I think that we would support
the draft document and we have--I had the pleasure of
participating with this committee and the staff in the
assistance and drafting.
Mr. Towns. Mr. Green, same question.
Mr. Green. The way the legislation is currently drafted,
the Bond Market Association can support the current draft.
Mr. Towns. What about any additional information that
should be put in or anything that's left out that should be in?
Mr. Green. Well, we might cross Ts differently or dot Is
differently. But with the provisions that I talked about in my
testimony, it provides a very balanced approach to ensuring
that private sector initiatives and market liquidity are very
much a part of the consideration of anything going forward. And
for that, we would support it.
Mr. Towns. The NASD says that they're uniquely situated to
develop a system that moves for the public dissemination of
bond transaction information. The Bond Market Association
believes that an industry-sponsored solution is the best way to
enhance transparency in the bond market. Who is right?
Mr. Green. Well, we both are. Because if one----
Mr. Shimkus. We're the politicians.
Mr. Green. Because if one could address all the needs of
policymakers through voluntary industry efforts, one would
surely choose to do it that way. But, I think it's incumbent
upon industries to self-analyze and recognize that things that
can be done, should be done. And then if things need to go
further, that's when you may need the next step beyond
voluntary, to a level of self-regulation. And if self-
regulation doesn't work, you have regulation. And if regulation
doesn't work, the Hill will produce legislation that will
provide regulators with the means to do it. So, we're at the
voluntary stage right now.
Mr. Campbell. In last September's testimony, we weren't
given a choice as to whether we wanted to do this or not. We
were challenged by this committee and responded very directly
to the SEC in their call for increased bond market
transparency. We do believe that what we are doing also is a
very industry-led solution. We have the largest to the smallest
underwriters on the committee; we have firms that represent
customers only; we have individuals, who represent specifically
the individual investors; as well as the largest purchasers of
corporate debt securities in the United States.
So, we do believe that, although my friend and I and our
associations differ on very minute, but important issues, that
we have continued to make every effort to work together in a
collegial fashion, to move this forward for the very best
interest of the investor. We continue to gain insights on the
committee from the representation of all the associations that
really have an interest in this, from the Securities Industry
Association, to the Bond Market Association, to the Association
of American Investors. We believe that this effort that we're
undertaking and have been in the process of is not going to be
injurious to the industry. The industry is hard at work in the
process to make this the finest resolution, to provide the
transparency that they know how to provide. So, they are deeply
involved and will continue to work with the Bond Market
Association. And between all of us, we will have a product that
we can be proud of and the investor will benefit from.
Mr. Towns. I think you're saying you can work together? Is
that what you're saying?
Mr. Campbell. We plan to go to lunch very shortly here.
We have been to dinner. We have served on the same panels.
We're proud of our competitive instincts, but recognize that we
have one final goal, and that's to get this to the investor, so
the people benefit from increased information.
Mr. Towns. Thank you, very much. And maybe you two guys
should try breakfast.
Mr. Campbell. We'll try it, thank you.
Mr. Towns. I yield back, Mr. Chairman.
Mr. Oxley. The gentleman's time has expired. The gentleman
from Illinois, Mr. Shimkus.
Mr. Shimkus. Thank you, Mr. Chairman. I apologize for not
being here earlier. I had another subcommittee. You know, I'm
very punctual.
But energy power also is a big issue for Illinois and
that's my other subcommittee.
This question was asked to a previous panel, but I'd like
to address it also to you both. Do you agree that price
information is a public good?
Mr. Campbell. Absolutely. We, in the NASDAQ market today,
trade over a billion shares a day; have an infrastructure that
not only collects and disseminates this information as widely
as any other capital market in the world. We have a Website
that dispenses this information free to the public that has, in
excess, of 20 million hits a day. We spend close to $40 million
a year in Web initiatives that are freely accessible to the
public. There is nobody that is a strong believer, stronger
than NASDAQ, that information and transparency is a positive.
Mr. Shimkus. Mr. Green?
Mr. Green. I would complement the Website, by the way. I
have it book marked and it's really wonderful information. I
guess the--I think prices information should be available to
the public. There's no question about it. But the price
information that the public can get free of charge is either
delayed or paid for by someone else. Because, in a sense,
market information overall is almost a form of intellectual
property. So, where you draw the line between what's
intellectual property and when does it become public domain, I
think is an argument that lawyers can argue over many lunches,
breakfasts, and dinners, and I don't have the answer for that.
But, I think the public policy desire is to get price
information to the public. And where it goes from being
intellectual property that has a value that cost money, to
something that becomes free of charge, is--I don't know where
to draw that line.
Mr. Shimkus. Is it safe to assume that dealers get a better
deal than the public--the consumer?
Mr. Campbell. I think that's probably not true. Today, if I
am a public individual and I'm desirous of receiving real, on
time, instantaneous quotes, I can presently do that for a
maximum amount of only $4 a month, and we have and will have in
front of our Board later on this month a proposal to
essentially reduce that by half. Most of what happens in those
charges are very accessible by any public individual. They can
receive it on their PC at home; they can receive it on their
pager; and there are many different avenues for them to get
that.
Mr. Shimkus. Mr. Green?
Mr. Green. Well, if Pat's talking about cutting the fees
that are paid by members, I have nothing to add.
Mr. Shimkus. But, do you agree? I mean, the question really
was----
Mr. Green. Dealers pay for the data. You know, when instead
of going to nasdaq.com, you get the price through a dealer's
Website, the dealers pay for that data. So----
Mr. Shimkus. There's a pass along charge for just
information.
Mr. Green. Right. Either direct or----
Mr. Shimkus. So, you made the argument, then, that if an
individual consumer is buying direct, with the dealer, it's
going to be an increased cost?
Mr. Green. If the marketplace allows it to be passed along.
It's a very competitive marketplace now driving down the cost
of transactions and it's not always recoupable.
Mr. Shimkus. Let me go to one last question. A lot of
information is provided to regulators. Why can't investors get
what is given to government bureaucrats?
Mr. Campbell. That's an excellent question. We are in the
process of implementing, over the next 12, 18 months, a system
called an order audit trail. That is primarily an SEC driven
initiative for equity securities. There is no reason why that
can't ultimately be transferred to debt securities, whereby
very possibly in the next 18 months, 24 months, you can
actually go on the Website and find your specific order and be
able to track it. And what the public wants more than anything
is they want the price that they paid validated. And the way
they validate it is to see other transactions along with
theirs.
Mr. Shimkus. Mr. Green, do you have anything to add?
Mr. Green. Yeah, I would just say that we don't want to
prejudge whether or not that's doable. But, that's where the
issue of considering the effect of liquidity on the marketplace
is crucial, because the difference between sending information
to a regulator for surveillance and enforcement purposes and
disseminating that same very information to the public, in this
particular market where you're dealing with large wholesale
institutional sized transactions, that can take actually some
time to occur and unwind. The premature dissemination of
information could affect the pricing of that transaction all
along the way.
But, we're not going to prejudge that. We feel that in
designing a system that is going to provide for that price
transparency, the effect on liquidity should be a
consideration, because if it adversely affects liquidity, it
will increase risks in that marketplace, and the dealer
community puts up the capital to create the markets. But more
importantly, the issuing community needs to get the lowest
possible cost of capital. When AT&T comes to market later this
week for $6 to $8 billion worth of bonds, our quarter-point
here or a basis point there makes a lot of difference, and that
happens when liquidity is good or liquidity is bad. So, all
we're saying, in designing and fashioning a final system,
liquidity should be a consideration, as it relates to the
public dissemination, to ensure that the mere dissemination
doesn't hurt the marketplace that you're trying to help.
Mr. Shimkus. Mr. Chairman, my time has expired and I'll
yield back.
Mr. Oxley. I thank the gentleman for participation and we
thank you both for a most enlightening testimony. I think we're
on the right track and we appreciate all the hard work you've
done on your side to make this a reality. Too many times from
our perspective we nod in the right direction and say go to it,
and don't give you a whole lot of encouragement. In this case,
I think, it's a good example of the private sector initiative
working very well at our directive, not necessarily in a
dictatorial way, but in terms of a cooperative way. I think at
the end of the day, that's exactly what's going to happen. It
will benefit ultimately the marketplace and the consumer.
So, thank you all for your testimony. And the subcommittee
stands adjourn.
[Whereupon, at 12:49 p.m., the subcommittee was adjourned.]
[Additional material submitted for the record follows:]
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