Shares in Verizon rose. Or they fell. Whichever, the point is that it is easy to keep track. The US telecoms group has one kind of share, whose price zips along the bottom of business news channel screens or pops up when you hover in FT.com stories. Would that it were so simple to keep track in the bond market.
Companies issue such a dizzying number of different bonds that it is impossible to focus the same light on the fixed income market as on equities. In the past, although bond investors grumbled, the opacity did not matter to companies one jot. But the market has changed and it matters now.
There are $7.7tn of corporate bonds outstanding in the US alone, financing business investment and economic growth (as well as, more recently, share buybacks that have plumped up equity markets). Fixing the market’s flaws is vital. It is time for a radical rethink of how companies issue debt.
Verizon, which holds the record for the most money raised on a single day in the bond market, has more than 70 kinds of bond out. When it sold $49bn of debt last year it did so in eight slices, each a different kind of bond paying a different interest rate and maturing on a different date. In the market last week, it raised another $6.5bn with bonds maturing in seven, 10 and 20 years. And Verizon is one of the more restrained issuers.
General Electric, whose shares are among the most widely held in the US, has more than 900 kinds of bond outstanding. Banks have even more: Citigroup had 1,865 separate types when Barclays counted them in April.
The inevitable result is that trading in any one bond issue is very thin, especially in those sold more than a year ago. Finding another investor who wants to buy the exact type of bond you are selling is no easy task at the best of times. If the end of quantitative easing marks the start of rising interest rates, which hurt bond prices, then investors’ 30-year love affair with fixed income may cool, and the market could become dicey indeed. Regulators worry about potential systemic risks in the event that sharp price falls in illiquid bond markets lead to big investor losses.
What is required is for corporate bonds to be standardised so that there are fewer of them trading more frequently. It is the principle adopted by the biggest debt issuer in the world – the US Treasury, which auctions new bonds on a strict timetable and whose 10-year Treasury note is the de facto benchmark for the fixed income market. The derivatives market, often described as the Wild West of the financial markets, is also highly uniform in parts.
Companies ought to increase the size of each individual bond issue to boost secondary market liquidity. They ought to adopt common interest payment dates. And they ought to issue debt on a regular timetable, perhaps quarterly for the biggest issuers, so that all bonds mature on the same dates. The easier it is for investors to make like-for-like comparisons, the more willing they will be to trade.
Corporate treasurers might ask what is in it for them. Right now they dip into the market opportunistically, trying to time it to catch the lowest possible borrowing costs. The trade-off is that standardised bonds that are more readily tradable by investors are likely to attract more demand, which itself will lower companies’ borrowing costs. Reducing complexity should also cut research and administration costs for borrower and bond investor alike.
There is some urgency. Wall Street banks have traditionally bought unwanted bonds and sat on them until a buyer emerges, but post-financial crisis prudence – much of it imposed by regulators – means they are not playing that role to the same extent. US banks’ inventory of corporate bonds has shrunk to 2002 levels, even though the market has doubled in size since then.
Some pine for the days when bonds were the preserve of “buy-and-hold” investors harvesting the annual income, for whom secondary market liquidity was unimportant. But one cannot ignore the fixed income mutual funds, exchange-traded bond funds and other entrants to the market, nor would corporate treasurers wish away these potential sources of funding.
Improving the liquidity of the bond market is now the number one item on the asset management industry’s agenda. Much hope is invested in electronic trading platforms. These should help improve price transparency but cannot do much for liquidity. They cannot create demand out of thin air.
Ultimately, corporate bonds must change, not just the way they are traded.
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