Kumar Venkataraman

Professor of Finance

Cox School of Business @ SMU

Securities and Exchange Commission

FIMSAC Panel – FINRA’s Block Trade Pilot proposal

June 1, 2020
Comments

• Academic research: Initiation of TRACE trade reports.

• Possible explanations for the decline in block volume in 

corporate bonds between 2007 and 2019.

• FINRA’s Block Trade Pilot proposal

– Intended benefits

– Unintended effects

• Summary
References 

Qualitative discussion

Letter from FIMSAC Members Larry Harris, Kumar Venkataraman, 

and Elisse Walter (Aug. 21, 2018). 

https://www.sec.gov/comments/265-30/26530-4268151-173129.pdf

Survey of related academic research 

H. Bessembinder, C. Spatt and K. Venkataraman. A Survey of the 

Microstructure of Fixed-Income Markets. Journal of Financial and 

Quantitative Analysis 55 (2020), 1-45. 

https://doi.org/10.1017/S0022109019000231
4

TRACE Timeline: Initiation of Transaction Reporting

Corporate Bonds (registered): 07/2002 – 02/2005

Structured Bonds: 11/2012 – 06/2015

Rule 144: 06/2014

Treasury: 07/2017 (data collection only) 

Staggered rollout (in many but not all cases)
Research Design:

– Measure market quality before and a4er TRACE ini:a:on. 

– Compare differences for treatment and control bonds.

Results:

• Large reduc3ons in customer’s trading costs for all trade sizes

• Spill-over benefits due to matrix pricing for non-transparent bonds.

• Ins3tu3ons: 40% to 60% reduc:on of pre-TRACE trading costs.

• Gap in trading cost between small and large ins:tu:ons decline. 

• Greater dealer compe33on: Small dealers gain market share and close 

the trading cost advantage enjoyed by large dealers.

• Post Bond Offerings: dispersion in purchase price declines.

5

How did TRACE reporting affect Trading Costs?
Examine TRACE initiation in Rule 144A Corporate and TBA Agency bonds

• These markets are dominated by institutional traders.

Results

• TRACE initiation led to lower trading costs for institutions.

• Large reductions are observed for blocks exceeding $10 million.

• No decline in block trading volume.

• No reduction in capital commitment by dealers. 

• No reduction in dealer’s propensity to facilitate block trades. 

• Small dealers improve terms for customers. 

6

How did TRACE reporting affect institutional markets? 
v Bessembinder, H.; W. Maxwell, and K. Venkataraman. Market Transparency, 

Liquidity ExternaliCes, and InsCtuConal Trading Costs in Corporate Bonds” 

Journal of Financial Economics 82 (2006), 251–288.

v Edwards, A., L. Harris, and M. Piwowar. Corporate Bond Market TransacCon 

Costs and Transparency. Journal of Finance 62 (2007), 1421–1451.

v Goldstein, M., E. Hotchkiss, and E. Sirri. Transparency and Liquidity: A 

Controlled Experiment on Corporate Bonds. Review of Financial Studies 20 

(2007), 235–273.

v Hendersho^, T., D. Li, D. Livdan, and N. Schürhoff. RelaConship Trading in 

OTC Markets. Journal of Finance 125 (2020), 683-734.

v Jacobsen, S., and K. Venkataraman. Does Trade ReporCng Improve Market 

Quality in an InsCtuConal Market? h^ps://ssrn.com/abstract=3171056.

v O’Hara, M., Y. Wang, and X. Zhou. The ExecuCon Quality of Corporate 

Bonds. Journal of Financial Economics 130 (2018), 308-326.

7

TRACE repor7ng in corporate bonds
v Friewald, N., R. Jankowitsch, and M. G. Subrahmanyam. Transparency and 

Liquidity in the Structured Bond Market. Review of Asset Pricing Studies 7 

(2017), 316-348.

v Gao, P., P. Schultz, and Z. Song. Liquidity in a Market for Unique Assets: 

Specified Pool and To-Be-Announced Trading in the Mortgage-Backed 

Securities Market. Journal of Finance 72 (2017), 1119–1170.

v Hollifield, B., A. Neklyudov, and C. Spatt. Bid-Ask Spreads, Trading Networks, 

and the Pricing of Securitizations. Review of Financial Studies 30 (2017), 

3048–3085.

v Schultz, P., and Z. Song. Transparency and Dealer Networks: Evidence from 

the Initiation of Post-Trade Reporting in the Mortgage Backed Security 

Market. Journal of Financial Economics 133 (2019), 113–133.

8

TRACE repor7ng in structured bonds
v Harris, L. E., and M. S. Piwowar. Secondary Trading Costs in the Municipal 

Bond Market. Journal of Finance 61 (2006), 1361–1397.

v Li, D., and N. Schürhoff. Dealer Networks. Journal of Finance 74 (2019), 91–

144.

v Schultz, P. The Market for New Issues of Municipal Bonds: The Roles of 

Transparency and Limited Access to Retail Investors. Journal of Financial 

Economics 106 (2012), 492–512.

9

MSRB repor7ng in municipal bonds
What explains the block volume decline in 

corporate bonds between 2007 and 2019?

Explanation 1: TRACE trade initiation => Rule it out

– No changes in trade reporting between 2007 and 2019. TRACE 

reporting were initiated between 2002 and 2005. 

Explanation 2: Banking regulation (e.g., Dodd Frank)

– Post-financial crisis bank capital requirements and the Volcker 

Rule reduced dealer inventory and capital commitment.

– See academic studies and reports by Fed economists discussed in 

Bessembinder, Spatt and Venkataraman (2020).

Explanation 3: Growth of Electronic Trading

– New technologies, market structure, and liquidity providers have 

evolved since 2007. New equilibrium.

v Bessembinder, H.; S. Jacobsen; W. Maxwell; and K. Venkataraman. Capital 

Commitment and Illiquidity in Corporate Bonds. Journal of Finance, 73 

(2018), 1615–1661.

v Bao, J.; M. O’Hara; and A. Zhou. The Volcker Rule and Market-Making in 

Times of Stress. Journal of Financial Economics, 130 (2018), 95–113.

v Trebbi, F., and K. Xiao. Regulation and Market Liquidity. Management 

Science, 65 (2019), 1949–1968

v Adrian, T.; M. Fleming; O. Shachar; and E. Vogt. Market Liquidity after the 

Financial Crisis. Annual Review of Financial Economics, 9 (2017), 43–83.

v Schultz, P. Inventory Management by Corporate Bond Dealers. Working 

Paper, University of Notre Dame (2017).

v Choi, J., and Y. Huh. Customer Liquidity Provision: Implications for 

Transaction Costs. Working paper, www.ssrn.com/abstract=2848344 (2017). 

v Anderson, M., and R. Stulz. “Is Post-Crisis Bond Liquidity Lower?” Working 

Paper, www.ssrn.com/abstract=2943020 (2017).

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Impact of bank regula7on on dealer capital
FINRA’s proposed pilot - intended benefits

Possible justification

OK. TRACE is not the cause of block volume decline between 

2007 and 2019. But it is an easy, potential fix to address it.

What to expect with proposed pilot?

• Block trade volume is likely to increase.

• Large Institutions (who trade in blocks) and large dealers (who 

facilitate blocks) will clearly benefit the most. Why?

Transparency represents an information transfer. Proposed pilot

provides information advantages to those trading in block sizes. 

SUPER Blocks?: benefits even smaller set of participants. 
FINRA’s proposed pilot - unintended effects (1)

Who loses?

• Trading is a zero-sum game when measured in trading profits.

• Any cost savings that large institutions and dealers obtain are 

likely borne by their counterparties, grouped below:

– Retail investors (70% of TRACE reports < $100,000).

– Large institutions who trade patiently by splitting orders

• See comment letters from Vanguard, Dimensional Fund

Advisors, AQR Capital, among others.

– Small Institutions & Portfolio Traders (ETF market makers). 

– Small (traditional) dealers.

– Non-traditional liquidity suppliers in electronic platforms.

These counterparties are likely to experience higher trading costs.
FINRA’s proposed pilot - unintended effects (2)

Decline in Data Quality (economically large) 

Proposed pilot delays reporting for over 30% of investment grade bond 

volume and over 40% of high yield bond volume.

Increases information asymmetry, particularly in stress periods.

Dissemination of potentially misleading information

– Block sale is not reported but smaller offsetting buys are reported. 

Trade reports play a critical role in evaluated pricing models. 

– Users include mutual funds, ETFs, and trading desks. 

Hinders technological innovations that rely on availability of 

timely, high quality data.
FINRA’s proposed pilot design

Fully support FINRA’s Randomized Control Design.

Genuine disagreements among both FIMSAC members and 

institutional investors on whether delayed reporting of trades 

helps or hurts markets.

– Concerns about Fairness (creating Winners and Losers) are mute. 

Why? We can’t seem to agree on who will win and who will lose. 

Control Group provides a baseline to measure treatment groups

– “Difference-in-difference” analysis will yield useful evidence under 

a broad range of market conditions (e.g., Covid-19 related stress). 
Reduction in block trades – is this a problem?

• Remarkable growth in the corporate bond market

– Robust New Issuance activity. High secondary market volume. No 

evidence of increase in trading costs.

• Bond Markets are less fragile in 2019 than 2007.

– Less reliance few traditional, bank-affiliated dealers.

– New types of (algorithmic) liquidity providers have emerged.

• Technology and innovation are transforming bond markets.

– New instruments (ETFs) and venues (RFQ-platforms, ATS).

– Heavy reliance on pre- (ATS quotes, RUNs) and post-trade data

New ecosystem

Are old metrics still relevant? Should we measure the health of the 

markets in other ways?
Summary

Agree. Dealers who facilitate blocks need to be protected.

FINRA’s current trade dissemination policy:

– Protects the dealers by capping trade size disclosure. 

– Recognizes that bond markets differ from equity markets.

Agree. Block trade volume has declined between 2007 and 2019. 

– Other factors can help explain these patterns. 

There is not sufficient justification for the proposed pilot.

– Large body of evidence that transparency benefits markets.

– No evidence that TRACE caused reduction in block volume.

– Unintended effects of proposed pilot are large.

– Proposed pilot is likely to hinder technological innovations 

that are transforming bond markets.
Vanguard ($6.2 Trillion AUM)

https://www.finra.org/sites/default/files/2019-06/19-12_Vanguard_Comment.pdf

We believe that the Proposed Pilot will harm investors and markets by 

significantly reducing post-trade transparency for a significant amount of 

trading activity, hindering the evolution and electronification of the corporate 

bond market, and creating an unlevel playing field without compelling 

justification. Although FINRA’s Notice correctly identifies that improved posttrade transparency is associated with lower transaction costs, it fails to 

identify empirical evidence demonstrating that corporate bond liquidity is 

currently constrained by post-trade transparency. As a result, the Proposed 

Pilot is a harmful solution to an unsubstantiated problem.

I. The Proposed Pilot is Unnecessary.

II. The Proposed Pilot’s Delayed Dissemination of Trade Data will harm 

investors and markets.

III. The Proposed Pilot is fundamentally flawed.
T. Rowe Price ($1.11 Trillion AUM)

https://www.finra.org/sites/default/files/2019-06/19-12_TRowePrice_comment.pdf

We do not believe the Pilot will improve market liquidity and we are opposed 

to launching the Pilot in its current form for a variety of reasons. The proposed 

48-hour delay runs counter to our views on enhancing transparency, and as 

discussed below, it would discourage electronic trading and create other 

negaJve impacts.

We urge FIMRA, the SEC, and the Fixed Income Market Structure Advisory 

CommiPee to not pursue as proposed and instead idenJfy opportuniJes to 

expand fixed income transparency in a balanced and measured way. 
AQR Capital ($203 Billion AUM)

https://www.finra.org/sites/default/files/2019-06/19-12_AQR_Comment.pdf

We believe that reduced transacJon costs are but one of the many marketwide benefits of transparency undermined by the proposed Pilot, and as a 

result, we cannot support this iniJaJve. 

..Our views on the proposed pilot are colored both by our belief in the benefits 

of transparency and concerns about its potenJally detrimental impacts....We 

support regulatory efforts aimed at developing a 21st century fixed income 

market structure.....Unfortunately, the Proposed pilot does the opposite, by 

encouraging a revision to the market structure of the past rather than 

preparing our markets for the future. 
Dimensional ($454 Billion AUM)

https://www.finra.org/sites/default/files/2019-06/19-12_Dimensional_Comment.pdf

We strongly disagree with the proposed pilot program..... 

We also believe the pilot program will provide an informaJon advantage to 

certain market parJcipants and investors. This may also increase the trading 

costs for Main Street investors, mutual funds, and ETFs without necessarily 

providing any addiJonal benefits. 

We believe the currently proposed pilot program does not serve the long-term 

interests of investors saving for reJrement or other future consumpJon needs. 

We find the proffered jusJficaJon that the proposed reduced-price 

transparency will improve liquidity unpersuasive.

We are counJng on our regulators to conJnue to strive to keep the markets 

fair for all parJcipants. Please consider rejecJng the flawed proposal for a 48-

hour disseminaJon delay.
Citadel

https://www.finra.org/sites/default/files/2019-06/19-12_Citadel_Comment.pdf

Both FIMSAC and FINRA have been unable to demonstrate that 

(a) block trade liquidity has significantly deteriorated in recent years, and 

(b) any such deterioration is directly attributable to the current post-trade 

transparency framework. 

As a result, there is little evidence to suggest that the Proposed Pilot will 

meaningfully improve liquidity conditions. Instead, the costs and complexity of 

the Proposed Pilot significantly outweigh the asserted benefits, as it will 

negatively impact a wide range of market participants, including retail and 

institutional investors, smaller liquidity providers, new electronic trading 

platforms, and investors in correlated products, such as ETFs. We urge FINRA 

to instead focus on market structure initiatives that are designed to increase 

liquidity by making the corporate bond markets more fair, open, competitive, 

and transparent.