Still lots of room to improve fixed income markets, research finds

Markets overall, and retail investors in the fixed income space in particular, would benefit if over-the-counter (OTC) trading shifted to a centralized electronic platform, says new research.

The Bank of Canada published a new staff working paper that examines the potential payoff of moving OTC fixed income trading to an electronic platform by examining the workings of the existing government bond market.

While Canada’s government bond market is considered relatively efficient — “because it is highly liquid and features low price uncertainty,” the paper said —the researchers found that it may not be nearly as efficient as believed, and that investors still pay “sizeable” dealer markups.

They also said that “large [institutional] investors pay consistently lower prices than small [retail] investors” in the government bond market.

This disparity is, in part, due to the fact that “institutional investors have access to the electronic platform CanDeal, while retail investors do not,” the paper said.

In a model that allows retail access to a centralized platform rather than just OTC markets, the researchers estimated that the gap between retail and institutional prices would drop 32% to 47%.

“When we allow retail investors to trade on the platform, most do — and prices fall,” the paper said.

While prices would improve significantly with increased platform trading, the researchers also concluded that using a centralized platform is not a perfect solution, as it imposes costs too. As a result, not all retail trading would migrate there.

Nevertheless, they estimated that overall market welfare would improve, adding, “This suggests that policies aimed at promoting platform access can lead to better prices for Canadian investors.”

James Langton

James is a senior reporter for Advisor.ca and its sister publication, Investment Executive. He has been reporting on regulation, securities law, industry news and more since 1994.