Municipal bonds are used to finance everything from parking lots to airports, but buying a bond isn’t as simple as looking up a quote and clicking a ‘buy’ button.
Unlike equities, most muni bonds don’t trade very frequently and, when they do, many trades still take place over the phone rather than via an electronic trading platform. These dynamics make it difficult to research bonds and determine a fair price for buyers and sellers.
In this article, we will look at how electronic trading platforms are changing the muni bond market and what it means to investors.
How Do Muni Bonds Trade?
The municipal bond market transacts over-the-counter – or OTC – which means that most trades occur outside of any centralized exchange (like the NYSE for equities). Instead, investors trading in the secondary market must buy or sell exclusively through dealers that execute nearly all transactions in a principal capacity with significant advantages. This makes it nearly impossible to know prices in advance or shop for competitive quotes from multiple dealers.
These issues are exacerbated by the market’s lack of standardization, making it difficult for investors to research and identify suitable bonds to purchase. While the U.S. muni bond market is less than half the size of the corporate bond market, there are more than 1.5 million different types of muni bonds – 20 times the number of corporate bond types. The sheer number of unique bonds makes it difficult for a secondary market to exist at all.
These problems have created many issues for individual investors, including:
- Increased cost: One study estimated that, between 2005 and 2013, the muni bond market’s pricing inefficiencies likely cost investors ‘substantially’ more than $10 billion. Without access to reliable pricing data, many retail investors end up overpaying and many issuers end up losing out on value that could go toward public works.
- Reduced liquidity: Many muni bonds go days or weeks without a single trade compared to high-volume trading in the equity markets. This lack of liquidity makes it difficult to determine a fair market price for buying or selling. As a result, liquidity risk for a given position or portfolio of bonds could increase significantly.
These challenges can make it difficult for investors to conduct due diligence on muni bonds and make informed investment decisions.
A Better Solution for Investors
The good news is that the municipal bond market has been making improvements over the years. The Municipal Securities Rules Board’s (MSRB) Electronic Municipal Market Access – or EMMA – website enables investors to compare trade histories of bonds with comparable features while requiring all dealers to report trades within 15 minutes. This trading data and filtering toolset enable investors to more easily find appropriate bonds.
Many electronic trading platforms are also opening the door to financial advisors and smaller investors rather than just dealers. For instance, consider the following platforms:
- Bloomberg: Bloomberg Professional Service launched its new electronic trading platform in December 2016, featuring a muni bids wanted tool among other things.
- The Muni Center: TMC is a hybrid fixed income marketplace that combines electronic trading and expert voice support.
- KCG Bond point: KCG delivers centralized liquidity and automated, cost-efficient trade execution services for fixed income securities.
- Tradeweb: Tradeweb is a leading electronic fixed income marketplace for financial advisors, RIAs, traders and buy-side investors.
- MarketAxess: MarketAxess provides a single platform for easy access to multi-dealer competitive pricing on a wide array of credit products.
These electronic platforms provide many advantages for investors, including:
- Enhanced price discovery: Streaming prices on popular muni bond issues makes it easier to determine the real-time price of a bond rather than having to solicit quote directly from dealers. This could help dramatically reduce the incidents of investors being overcharged due to a single information disadvantage.
- Improved liquidity: Real-time order matching helps improve liquidity by identifying multiple potential buyers and sellers rather than trying to arrange each transaction one at a time. Buyers and sellers can also use Dutch Auctions to transact over a period rather than in a single transaction where limited buyers or sellers may exist.
- Lower costs: Electronic platforms keep costs down by making the entire transaction more efficient and reducing the amount of manpower needed to execute trades.
- Better compliance: Electronic platforms make audit trails a lot easier by keeping track of every trade that’s processed through the system.
Issuers can also benefit from the use of electronic trading platforms to more efficiently price their offerings. For example, Ohio issued a variable rate muni bond last year using ClarityBidRate’s electronic trading platform to reset the rates.
The downside of these systems is that it’s easier to make mistakes when entering trades electronically rather than over the phone. Frequent traders should also keep in mind that there are trading costs incurred with these trades.
The Bottom Line
The municipal bond market may be worth nearly $4 trillion, but trading hasn’t evolved much over the decades it has existed. Fortunately, the introduction of new electronic trading platforms has helped address many of these problems and is creating a more even playing field for retail investors and smaller advisors in the space. Investors may want to consider these platforms to reduce costs, increase efficiencies and ultimately make more profitable trades.