Remarks at the Bond Market Association Legal and Compliance Conference
Chairman and CEO
Thank you, Peter [Kelly]. And thanks also to Paul Salzman and John Ramsay of The Bond Market Association for inviting me to speak here this morning. John did terrific things in his years at the NASD -- and now he's done a great service in helping pull together this important conference.
In fact, John, I hope you've had time to forgive and forget all those unfortunate things we once said about you abandoning us to go over to the dark side. We were just very upset to see you go.
Seriously, I am pleased to be here. Not least because, in the face of the September 11 atrocities, pressing ahead with this rescheduled conference, in this unstoppable city, is one more sign that the world's greatest markets are back in business and here to stay. And it's been particularly heartening to witness a number of your heroic colleagues first return to their feet and then even return to profitability.
Historically, The Bond Market Association and the NASD did not have all that much to do with one another. Our regulatory focus was overwhelmingly on the equity markets. And I'm pretty certain that was one of life's little disappointments you were able to bear.
But in recent years, the SEC and the self-regulatory organizations have taken a greater interest in the fixed income markets. And while that has increased the burdens on you and us both, I think it's also fair to say that today, our working relationship has never been better.
That's reflected at the personal level, in my ties with Micah Green and Warren Spector as well as our regulatory work with Paul and John. It's also reflected at the institutional level, in the habits of consultation and collaboration we have developed.
That is not to say, of course, that we agree on every single issue. Nor should we expect to. But on the key issues that matter to us both, we have established a strong track record of talking, listening and working with one another. And that is certainly the case with the subjects I'd like to discuss with you today.
A leading example is TRACE. For those of you who've been in seclusion -- or just in denial -- TRACE stands for Trade Reporting and Compliance Engine, and you might call it the little engine that could. All kidding aside, it will be a big step forward in bringing transparency to the fixed income market. Let me give you my sense of where things stand and where we are headed.
TRACE was designed -- and refined, through our extensive consultations with TBMA -- to be useful to investors and workable for the industry.
Under the TRACE Rule, 6230, trades in corporate bonds will be reported in a way that gives dealers flexibility, and largely honors existing methods of Municipal and Corporate Bond reporting.
For certain larger bonds, price and volume information will also be disseminated to the public.
Until September 11, reporting of trade information for all covered bonds was scheduled to begin sometime this quarter, most likely next month. Following the tragedy, the NASD worked hard to reestablish a timetable that everyone could live with. And by postponing the effective date until the beginning of July, I believe we succeeded. Consulting closely with the bond dealer community, the NASD determined that it would be neither fair nor sensible to impose all the technological and training demands of TRACE at a time when the industry is already operationally stressed in the wake of 9/11.
Of course, our collaboration with you on TRACE is far from over. A body comprised equally of representatives chosen by industry and the NASD, the Bond Transaction Reporting Committee, or BTRC, will help us to develop a practical and businesslike approach to such issues such as whether, when and how to publicly disseminate trade information for bonds in addition to the 350 or so already covered. We are adding small firm representatives to the Committee and its first meeting will be later this month.
We both understand that the benefits of liquidity and transparency each come at a cost. The great challenge facing the BTRC will be to find an approach that maximizes transparency while minimizing any possible loss of liquidity.
To do so, the BTRC will tap the expertise of leading academic authorities to study and assess such liquidity impacts. Based on this academic study of liquidity effects, the BTRC will make recommendations to our Board to either expand, contract, or leave the same the bonds subject to dissemination. Our Board will then consider these recommendations and make a final proposal to the SEC.
The manner in which corporate bond trade data is to be distributed has been a subject of widespread interest. The short answer is, the NASD will collect it all, and we will send it to vendors who may then sell it to whomever wants to buy it.
The elements we will disseminate are also clear: price, time of trade, and volume (which for larger trades will be given simply as a range).
Unsurprisingly, the determination of fees and distribution of revenues also has been of considerable interest. Our initial fee proposal has been discussed with our Board. Later this month, it will be the main topic of discussion at our first meeting of the BTRC -- after which we will file it for public comment with the SEC.
We will work with TBMA, members of the industry, interested public commentators and the SEC to put in place a fee structure that allows us to recover our fairly allocated costs of building and operating TRACE and performing the associated regulation of the bond markets. As I told TBMA's Board last July, we are not seeking a commercially profitable rate of return. And we remain committed to sharing with dealers their fair share of the revenues derived from the sale of this data, after we have fully recovered the costs of building TRACE.
For as I said in July, the NASD has no aspirations to be a long-term vendor of the real-time data from TRACE. We inherited our interim role a year ago from Nasdaq -- which did entertain a commercial interest in this data. Our interest in it, by contrast, is purely regulatory.
What we have told both the SEC and the bond dealer community is that as soon as a viable private sector solution emerges, we will be happy to step aside. And we mean what we say.
So let me take a moment to renew our challenge to the industry. Tackle this problem. There is a need and an opportunity here. And I can assure you, we look forward to standing aside the moment it is met.
Looking forward, my long-term vision of bond trade reporting is streamlined and simplified. I want such reporting to be quick, one-stop shopping. I see a world where bond trades of any type -- Munis, Govies, Corporate, High-Yield, you name it -- all will be reported in one uniform format to one central clearinghouse where comparison and clearing can occur and data can then be transmitted real-time to vendors for sale to the public and to self-regulators for use in ensuring market integrity.
That may seem very far over the horizon. But TRACE is a big step in the right direction. It will bring far greater transparency to the bond market for both participants and regulators. That will make this a more rational and efficient market, as investors gain the data they need to monitor performance and make more informed choices. And in those residual areas where investor monitoring of the market is not sufficient, TRACE also will arm regulators with the information we need to protect the priceless asset of market integrity.
And this truly is a priceless asset. For I am convinced -- along with many who know the bond market well -- that yours is a sector with unusual potential for growth as more individual investors and institutions gain the information and understanding they need to participate more fully in the fixed-income market.
Another issue of mutual interest to both the bond dealer community and the NASD is debt mark-ups. As you may know, it's one with a long and somewhat tortured history. In fact, if it were an investment, we'd probably have to call it a long-term bond.
Come to think of it, let's hope it doesn't turn out to be a perpetual bond.
Most members of the industry -- particularly the larger firms -- acknowledge the desirability of greater prospective guidance and certainty in this area. The question, of course, is the substance, form and timing of this guidance.
Two main points bear emphasis. The first is that this issue is closely connected with TRACE. The more information becomes available to customers, the better they will be able to act in their self-interest by monitoring the performance and pricing of intermediaries and giving their business to those bond dealers who deliver solid performance at a fair mark-up. And the more information is available to regulators, the better a job can do, working with the industry, to protect investors in those residual areas where they lack the ability to do so themselves.
The second point is that, at bottom, dealer compensation should bear some relation to dealer risk. This means, first, that the appropriate mark-up depends on the situation, which includes such factors as how long the market maker holds the position, and even more important, the characteristics of the bond.
That being the case, it's reasonable that riskier bonds -- ones that are less liquid, in thinner markets -- may merit greater compensation. And since bonds span an extremely wide range of risk, it's pretty evident that a one-size-fits all rule for bond mark-ups is neither practical nor appropriate.
In reformulating our proposed mark-up rule interpretation, the NASD has been acutely aware that -- as in the TRACE context more broadly -- our focus on investor protection cannot make us lose sight of the need to maintain liquidity, as well. And we believe that our proposed statement strikes the right balance in providing the needed guidance.
Last month, the NASD Board authorized us to file our reformulated debt mark-up interpretation with the SEC. We plan to do so this month. For we are convinced of the value of providing guidance in this area that is more clear and predictable. And we look forward to the Commission publishing it promptly for public comment.
So while we are not in a position to guarantee success, we are also not of a mind to walk away. Because as I have discussed, while TRACE will alter the dynamic in this area, it will not eliminate the need for guidance. And if it makes sense to give investors fuller information, it also makes sense to give bond dealers fuller guidance.
All that explains why the NASD is persisting in its efforts. And why we will continue until investors get all the protection they need, and bond dealers get all the guidance they deserve.
Finally, I come to a topic I am especially eager to discuss with you, because it so clearly reflects and advances my vision of the NASD as a businesslike, private sector self-regulator. I'm talking about our Rule Modernization Project.
This initiative is an outgrowth of our efforts in recent years to streamline specific rules. Last year, we announced and began a systematic, no-holds-barred review of all our rules, to ensure that their benefits fully justify their burdens.
This is not a cost-benefit analysis as such; for in any field, there are rules that are necessary, yet whose benefits cannot be readily quantified. But like business goodwill, such benefits are real and worth preserving.
To help us in this effort, we have enlisted the assistance of a truly distinguished Economic Advisory Board. Working closely with senior NASDR management, these experts are helping us review our existing rules; improve and modernize any we find wanting; and design a template for enacting more streamlined and modern rules in the future.
I won't pretend for a second that our Rule Modernization Project was designed solely with the bond market in mind. But we are aware that our rulebook developed mainly in the equities context. So one of the key things we are looking at in this initiative is whether some of our rules should be changed to work better in the fixed income arena.
The first tranche of rules we are working through includes, for example, looking at whether we can rationalize across regulatory regimes a sound and consistent definition of "institutional investor." Given the economic pressures on the industry and the special challenges posed by 9/11, this entire process is one we are motivated to move along with a real sense of urgency.
In its comments on our Rule Modernization proposal, The Bond Market Association made a number of very fine points. But there are a few things in your comment letter with which we cannot agree. For example, at the same time as you advocate a liberal construction of the costs of our rules, you urge us to consider strictly the "tangible" and "quantifiable" benefits resulting from these rules.
With all respect, counting only those benefits which are clearly quantifiable is not simply less than consistent. It is less than sound policy. Because a number of our rules do not have a single, clearly quantifiable benefit. But they are nonetheless clearly worth preserving.
For example, such rules as our Just and Equitable Principles of Trade Rule, our Advertising Rule, and our Supervision Rule, are not aimed at a narrow specific benefit, but at the broad goal of fostering a marketplace that is fair, trustworthy, and thus attractive to investors. How does one quantify such overarching benefits? And how does one calculate the untold billions lost to our industry if the investor confidence these rules foster is ever undermined?
Let me hasten to add that I am NOT saying that the rules I mentioned -- or any others -- should be considered sacrosanct in our Rule Modernization Project. Nothing in our rulebook has such immunity.
For example, even though the broad aims of our Supervision Rule are clearly sensible, that does not mean that every part of the present rule will necessarily survive in its current form. For instance, we require an annual compliance meeting to ensure that a firm's supervisory responsibilities are met. We are looking at whether firms may be able to meet their supervisory responsibilities without this bit of micromanagement from the NASD.
Similarly, we are looking at the possibility that certain rules providing information or protections to bond investors might sensibly be written so that certain institutional investors would have the freedom to opt out.
Let me be clear. I am not promising or predicting any specific result for this initiative. That's part of what it means to be writing on a clean slate.
But I can say this. The process has already proven to be a healthy one. For you, it will result in rules that are better justified and better crafted. For us as regulators, it will permanently influence our mindset and methods. That sounds to me like a win-win proposition.
For we all realize that trustworthy markets will never be cost-free. But in this new era, I am convinced that the NASD should not spend its authority enforcing rules that could be better crafted or may be out of date. After all, the burden of compliance is on the industry. But the burden of not making compliance needlessly difficult is on us.
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My friends, I hardly need to remind this audience what a despicable assault was wreaked on September 11 -- against our nation, our values, our industry and our markets. For no part of our industry absorbed a heavier blow than you, the bond trading community.
Well, a weaker community would have crumbled. A weaker people would have cowered. A weaker country would have lost heart and hope -- instead of gaining spine and steel.
And any other financial markets in the world, I dare say, would have been thrown into disarray and weakness long after a tragedy of the magnitude of 9/11. Instead, despite recession, war and Anthrax, the world's investors have sent a resounding vote of confidence in our markets -- which have traded in orderly fashion, with robust volumes and striking resiliency, since the day they reopened.
For TBMA and NASD alike, there are many ways to express the same priceless quality of market integrity and investor confidence that has allowed our markets to rebound so strongly from a blow so devastating. For you this is the foundation of your livelihood. For us it is our very reason for being.
And ordinary language reveals an EXTRAordinary amount about how people count on and value this quality.
My colleague Mary Schapiro speaks aptly of the "unwritten contract" of fair dealing that exists between our industry and investors everywhere.
Emphasizing equity, some capture it cleverly with the words, "The world puts its stock in us."
And there is an even more plain and powerful saying that is couched in terms of debt. It conveys the same kind of bedrock confidence that has made our markets the most liquid, transparent and trusted on earth.
For everyone in this room, this common expression should stand as both a compliment -- and a challenge.
For we all know how much it means to say, "Our word is our bond."
And our great shared duty is to keep it so.
Thank you very much.