Beyond Bond Markets 2000: The Electronic Frontier and Regulation of the Capital Markets for Debt Securities

Abstract

STEPHEN WALLENSTEIN [*] I INTRODUCTION On October 18-19, 1999, more than fifty securities lawyers, representatives of ratings agencies, regulators, and academics gathered in Washington, D.C., for a conference on the regulation of capital markets for debt securities. The conference, generously cosponsored by the Bond Market Foundation and the Duke University Global Capital Markets Center, was organized by Executive Director Stephen Wallenstein of the Duke University School of Law and the Fuqua School of Business. The purposes were to examine the characteristics of debt capital markets and to assess the role of government policy and self-regulation on the operation of these markets. The program was organized around the following three topics: 1. Distinctive Features of Debt Markets; 2. Regulatory Issues Driven by Risk and Liquidity Considerations; and 3. Technology and the Regulation of Debt Markets This article summarizes some of the recurrent themes and conclusions arising from deliberations by conference participants, and applies those themes and conclusions in an examination of issues concerning electronic markets that have emerged since the conference took place. We hope to move the debate beyond the existing regulatory framework, to consider how recent technological developments necessitate a new approach to the regulation of corporate debt transactions. In the process, we relied on a complete transcript of the proceedings, which omits the names of all participants in accordance with our agreement that remarks would go unattributed. This article represents a synthesis of the stimulating and thoughtful ideas offered at the conference, and their application to the ever-dynamic debt capital markets of today. II CORPORATE DEBT MARKETS AND SELF-REGULATION Empirically, corporate bond markets have been one of the most understudied areas of the economy, especially relative to other assets prevalent in American capital markets. This theme was prominent in the discussions, as participants repeatedly noted the paucity of data that would be the building blocks for research in this area. Reasons for this absence of information include lack of centralized reporting of trades, lack of transparency, and the relatively small size of the markets for exchange-traded bonds--a small fraction of the total market--which predominantly trade over the counter. Many conference participants echoed regulators' concern about the lack of information available to anyone other than dealers and their institutional clients. The institutional nature of corporate debt markets complicates attempts to apply broad regulatory principles to this segment of the capital markets. Because institutions have substantial access to high-end advisory services, as well as the recommendations of ratings agencies, they are far more sophisticated and less vulnerable to misinformation than are retail investors. Because more than four million individual debt securities are currently outstanding in the United States, including government, corporate, municipal, mortgage, and asset-backed debt (versus approximately ten thousand equity securities), bond advisory and information services face a daunting task. This task is more difficult because trading in the vast majority of these debt securities is quite infrequent. Moreover, administrative and information services must account for a greater number of variables, such as time to maturity, coupon rate, and benchmark treasury rates. In addition, external factors--such as dealer inventory and the size of a purchase or sale in relation to the amount of that security outstanding--can have a serious impact on bond prices in ways that are incompatible with regulatory paradigms based on an equity-style approach. Furthermore, institutions enjoy a superior pricing power with respect to their dealers, which allows them to purchase securities at lower bid/ask spreads. …