Wire: Bloomberg News (BN) Date: Sep 22 2006 15:56:03 Bond Traders Lost $1 Billion After Disclosing Prices (Update5) (Adds statement from NASD official in 18th paragraph.) By Mark Pittman Sept. 22 (Bloomberg) -- Wall Street bond traders lost $1 billion in commissions in the first year after regulators required securities prices to be publicly disclosed, according to a study to be published in the Journal of Financial Economics. The difference between bids to buy and offers to sell corporate bonds narrowed by about half, or 8 basis points, in the first year after the July 2002 introduction of Trace, the bond- price reporting system of the NASD, the study said. That represents a loss of about $2,000 per trade. A basis point is 0.01 percentage point. The Securities and Exchange Commission encouraged the NASD, formerly known as the National Association of Securities Dealers, to create Trace as way of bringing transparency to the $5.2 trillion corporate bond market. Beginning with 500 bonds, Trace has since expanded to include almost every trade of more than 29,000 corporate debt securities in real time. ``The real winners are the buy side,'' said one of the authors of the study, Kumar Venkataraman, a professor at Southern Methodist University in Dallas who teaches portfolio management at the Edwin L. Cox School of Business. ``They're giving away less every time they trade in the corporate bond market.'' NASD spokesman Herb Perone declined to comment. Comparable Pricing The study said that institutional investors benefited as much as those who trade smaller lots, according to the study, which compared trading data from before and after the introduction of Trace, which stands for Trade Reporting and Compliance Engine. ``Trace has been a godsend,'' said Marilyn Cohen, who manages $225 million of bonds as president of Envision Capital Management in Los Angeles. The gap between bid and ask prices has ``really tightened up,'' she said. ``All I can say is hallelujah.'' Smaller firms gained market share and larger dealers lost business as all traders were able to share the same prices, the study showed. Trace's influence cut bid margins by 20 percent even on securities whose prices weren't disclosed because traders were able to obtain better comparisons, said Venkataraman, in an interview yesterday. Trading expanded for all bonds after Trace by 29 percent, or $33 billion a year, based on the 2002-2003 data, according to the study. The transparency created by Trace has caused Wall Street firms to cut back on their bond-research departments. In February, Merrill Lynch & Co., the world's third-biggest securities firm, fired three analysts, transferred three others and allowed two to seek different jobs at Merrill. Credit Default Swaps At the same time, income is booming from securities that are derived from corporate bonds. The market for credit default swaps has more than doubled in size in the past year to cover $26 trillion of securities, according to the International Swaps and Derivatives Association. The swaps allow traders to bet on the creditworthiness of companies without actually owning the underlying bonds. Derivatives are financial instruments derived from stocks, bonds, loans, currencies and commodities, or linked to specific events like changes in the weather or interest rates. The New York-based Bond Market Association, which represents bond underwriters and dealers, has opposed the expansion of Trace, saying it reduced trading of corporate debt because dealers aren't being compensated for buying risky bonds. Investors adjust bids and offers after trade prices are disseminated on Trace, the BMA said in November, making it difficult to profit from trading those securities. Exchange Trading The New York Stock Exchange, operator of the world's largest equity market, in March began seeking approval to start electronic trading of 4,000 corporate bonds. John Holman, the NYSE's vice president of fixed income at the exchange, didn't immediately return a telephone message. The most actively traded bond today among institutional investors was Visteon's 8.25 percent note due in 2010, with 44 trades of more than $1 million, according to Trace. The note last traded at 3:25 p.m. in New York at a price of 96.75 cents on the dollar to yield 8.268 percent, or 4.69 percentage point above similar-maturity government debt, Trace data show. Trace yesterday recorded trades of 4,941 issues, with 2,636 rising, 1,729 falling and 170 unchanged. A total of $18 billion worth of bonds changed hands. `Total Daylight' The NASD's president of markets, services and information, Doug Shulman, said in February that corporate bonds are ``a market that has been largely a mystery to retail investors, even though two out of three corporate bond transactions are carried out at the retail level. NASD believes there is no better way to build investor trust than for the markets to operate in total daylight.'' Venkataraman researched and wrote the paper along with Hendrik Bessembinder of the University of Utah and William Maxwell of the University of Arizona. The paper has been accepted by the journal for publication within the next six months, according to Andrea Hugg, director of strategic marketing for the Cox school, and Venkaraman. The Journal of Financial Economics is published by the University of Rochester in Rochester, New York. For the draft of the study, click on: {NSN J60ALR3PWT1D } --Editor: Schoifet. Story illustration: For the Journal of Financial Economics Web site, see http://www.jfe.rochester.edu. For the Edwin L. Cox School of Business, see http://www.coc.smu.edu/home See {TRAC } for NASD's TRACE bond-pricing system. To see today's trading in the bonds that make up Goldman Sachs's iShares InvesTop corporate bond index, click on {BLRV }. Click on edit, and set trade size to >1mm for institutional-only trades. To chart the intraday value of the Goldman Sachs iShares InvesTop corporate bond index, click on {DLLE GIP } To see the NASD-Bloomberg corporate bond indexes, click on {NABI }. To contact the reporter on this story: Mark Pittman in New York at (1) (212) 617-3767 or mpittman@bloomberg.net. To contact the editor responsible for this story: Robert Burgess at (1) (212) 617-2945 or bburgess@bloomberg.net. 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