(Bloomberg) -- The world’s biggest money managers are mapping out proposals intended to grease trading in debt markets that regulators warn are at risk of seizing up in the event of a sudden rush by investors to pull cash.
Pimco, BlackRock and Vanguard are among firms that have met in recent months to discuss potential fixes that they want to present to the U.S. Securities and Exchange Commission, according to Paul Jakubowski, Vanguard’s head of global credit.
The talks are in early stages and will include whether the industry should focus trading on one or two electronic venues where investors can buy and sell with each other without having to rely solely on a broker, he said.
The money managers are seeking to address what BlackRock last year called a “broken” market after post-crisis financial regulations prompted the biggest debt dealers to scale back their bond inventories, making it more difficult to trade. That’s prompting concern that the market’s primed for failure when the Federal Reserve starts raising interest rates, sapping demand from investors who poured almost $1 trillion into U.S. debt funds during the past six years.
“It’s a global issue, everyone’s focused on it,” Jakubowski said in an interview at Vanguard’s offices in Valley Forge, Penn. “We’re making incremental progress in terms of ideas and at least there’s that joint focus, which I don’t think has ever existed.”
The firms have met as part of the Securities Industry & Financial Markets Association’s asset managers group. They convened after a call by SEC Commissioner Daniel M. Gallagher in September to create standard terms for corporate bonds that would make them easier to exchange on automated venues.
“We’ve got a lot of due diligence going on right now,” Tim Cameron, a managing director for Sifma’s asset managers group, said in an interview. Wall Street’s largest lobbying group is in the process of gathering data about how regulation has changed behavior and the ability to trade. “We’re working on it, it’s a big issue.”
BlackRock, the world’s largest money manager, has made three attempts in as many years to draw attention to the market’s liquidity issues. The New York-based firm, which oversees $4.65 trillion, created a trading system in 2012 that would allow investors to trade among themselves. As it stands, a buyer or seller typically needs dealers such as JPMorgan and Bank of America to act as middlemen, matching up the trades with other investors.
Tara McDonnell, a BlackRock spokeswoman, declined to comment. Mark Porterfield, a spokesman for Newport Beach, California-based Pimco, didn’t immediately respond to telephone and e-mail messages.
The concerns about investors’ ability to get in and out of assets have intensified as more and more money shifts into the least liquid debt. That includes the high-yield, high-risk corporate loan market, where trades can take weeks to settle.
By contrast, mutual funds and exchange-traded funds settle investors’ redemption requests within three to seven days, according to Moody’s Investors Service.
Federal Reserve Governor Jerome Powell warned in a Feb. 18 speech in New York that such a mismatch creates a “liquidity illusion” that can quickly evaporate amid market shocks.
Both the SEC and the Financial Industry Regulatory Authority have made trading in fixed-income markets a priority in the past year.
“They’ve done a bunch of work on the equities side, now they’re saying, hey we’ve done nothing on fixed income,’” Jakubowski said. “They are concerned about rates going higher and what does that trigger.”
The SEC’s Gallagher said he attended a meeting of bond-fund managers, broker-dealers and electronic-trading firms organized by Sifma in December that focused on ways to increase liquidity.
“I’m sure it will be of interest to me and my colleagues on the commission, all of whom have expressed an interest in fixed-income market reform,” he said in an interview Wednesday.
Eighteen electronic trading systems are currently competing for orders, according to a report last month from Greenwich Associates. Success for the platforms will hinge on including the dealers, Greenwich analyst Kevin McPartland said.
When BlackRock’s Aladdin Trading Network was met with tepid support from those dealers, the firm instead partnered with MarketAxess Holding Inc. Part of that effort involves the so-called Open Trading system, where investors have the ability to execute trades directly with each other, without the involvement of a dealer.
Seven percent of MarketAxess trades are now done on Open Trading, up from 2 % at the beginning of 2014, the company said earlier this month. Dealer banks are also included among the users and MarketAxess doesn’t provide a percentage of the trading that is purely between investors.
Bloomberg, the parent company of Bloomberg News, competes with MarketAxess and others in facilitating bond trades between investors and banks.
Money managers have been taking their own steps to ensure they have enough cash and liquid assets to meet redemptions. At Vanguard, which oversees $800 billion in fixed-income assets, managers are increasing the use of derivatives that allows the company to wager on debt while being able to unwind them more easily, Jakubowski said. In the past 18 months, the firm has boosted allocations to liquid assets in its actively managed credit funds to 10 % to 15 %, from 5 % to 10 %, he said.
Barclays analysts led by Jeffrey Meli warned that measures such as using derivatives or exchange-traded funds to boost liquidity may not be enough to protect against the effects of mass redemptions.
They said there could be a chain reaction in which asset managers would have to raise money to meet redemptions by selling their bonds, putting pressure on the market and leading investors to withdraw more funds.
“In the event of a market disruption, these tools may no longer be effective if outflows exceed the extent to which fund managers have built in flexibility to meet them, they would have no choice but to turn to the underlying markets to meet their liquidity needs,” the analysts said in a Feb. 24 note to clients.