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March 30, 2020

A Buy-Side View—What’s Wrong With Primary Markets?

By Chetna Mistry

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For as long as we can remember, primary markets for European investment-grade securities have never had a standardised process. This has often led to anguish regarding information dissemination on book size, security set ups, obtaining a prospectus, identifying ISINs and other issues. The list is endless.

One of the biggest hurdles the buy side faces when it comes to primary deals is the setting up of new securities within their respective Order Management Systems (OMS). This can be time-consuming, especially when multiple deals hit the market at the same time. We, as the buy-side professionals, fast came to realise that information is not standardised between deals and can lack consistency. The investment desk can spend a lot of time and effort tracking down information to complete security set-ups. There are also regulatory checks that need to be carried out based on where the underlying investor client is domiciled. All of these take valuable time and can be a distraction. Obtaining pre-trade compliance approval before a book closes can be a tall order as well, especially when there are approximately 10 to 15 deals a day at certain times of the year.

A book update is always sought-after information and can indicate how much momentum any given deal has. Fortunately, we have come a long way in Europe with regards to how book updates are communicated. There was a time when you called up your sales contact or the syndicate desk and got the book size, while your peers did not necessarily have that same information. All of this changed quite a few years ago and now there are book updates whereby all participants are given the same information at the same time. However, this does not always mean that a book update is provided. We have seen deals, especially in sterling, where no book update is released prior to the deal being closed. Communicating book size prior to a deal closing has always been a bone of contention between the syndicate desks and the buy side. This may be one point that we will never be able to agree on. As a potential buyer of bonds, the buy side views this as critical information.

In discussions with investors, one of the popular topics is the initial price talk (IPT). As syndicate desks are aligned with the issuers, the initial pricing is set mindful of the preferred level for the issuer. More often than not, a hefty premium (typically 20 to 25 bps) is then taken out of the IPT, resulting in a deal launching with little or close to zero premium. We have seen this happen more frequently, especially over the last year. This has an effect on the book size when certain investors pull their orders if the spread goes below their target. That being said, we are all familiar with the counterargument that investors indicate that they will pull their order if it goes below a certain spread, but sometimes this never materialises—so how can the syndicate desk view us, the buy side, as credible in these cases? I concede that there will be a small percentage of the investor base that may engage in this type of behaviour. However, what would help stabilise book sizes is not to show an IPT that is too far from reality. It is like being shown a diamond ring and ending up with a cubic zirconia! This is very evident in how some bonds trade in the secondary market after aggressive tightening in the primary market. It would also save a lot of time for investors when setting up a security for which an order is pulled after the IPT is squeezed too tight.

Book statistics that are released after the fact are another source of information that investors like to focus on. Although the information given is very generic, as investors we value understanding how the bonds were distributed, both geographically and by investor type. We even acknowledge that no two analyses of book statistics have the same groupings. This may be acceptable, but what is unclear is why suitably aggregated book statistics are not released for each and every deal, even if the release is a week later.

The easy part is pointing out critical inefficiencies in the primary market, but let us also outline some possible solutions that we as an industry can work towards. In 2018, the International Capital Market Association (ICMA) created a Primary Markets Forum, whereby all parties could come together—the buy side, syndicate and issuers—to talk about the challenges we all face and how we can work towards a common solution. While this initiative has taken some time to gather traction, we believe the changes we have implemented so far do make a difference. By no means should we be complacent about the challenge. This is going to be a long, uphill struggle and all parties will require different things.

In January of this year we saw the standardisation of information for the announcement of fixed-income primary deals in European investment-grade, where 24 set fields now must be populated. This was a huge step for the industry. All deal information now includes a Legal Entity Identifier (LEI), which will determine the hierarchy of the issuing entity in their respective capital structure. With changes being introduced to the prospectus regime we now see either a link to a prospectus or a preliminary prospectus attached. This has significantly reduced the time it takes the investment desk to get specific answers it needs, either during the security set-up or even during the compliance pre-clearance process.

We have also seen the emergence of electronic platforms for the primary market. Some are established, whilst others are in the testing phase. The information provided on these platforms is gradually aligning with the 24 fields mentioned earlier, but are not yet fully there. From what we have seen to date, there is an option to consume a machine-readable security set-up on some of these platforms. This would obviously require a fixed link between the platform and the OMS. As a result, however, it poses a new issue given the increase in costs due to new regulations being introduced: are investors going to spend money to build this link and if so, how much of a priority is this for an off-the-shelf OMS? We may see other technological entrants coming to the market in the future and they may be sufficiently innovative to provide the solutions the industry has been searching for.

Compromises will have to be made on all sides if we are to create a more standardised framework for the primary market. All parties readily acknowledge that we may have different priorities, but what we can all agree on is that we need to improve the process. Perhaps the two biggest negotiations we face will be the communication of book updates and a realistic IPT. These are both sensitive topics and the room for manoeuvre is limited from all sides. The good news is that we have made a great start. There is hope that by working together, through the representative forum that ICMA has established, we can eventually introduce a framework in Europe that one day may be replicated in other primary markets across the world.

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