Secondary Market Transparency and Corporate Bond Issuing Costs

January 23, 2022

Secondary Market Transparency and Corporate Bond Issuing Costs
James Brugler, Carole Comerton-Forde, J Spencer Martin
Review of Finance, Volume 26, Issue 1, February 2022, Pages 43 – 77, https://doi.org/10.1093/rof/rfab017

We examine the impact of increased secondary market transparency following the introduction of mandated post-trade transparency (TRACE) in the US corporate bond market. We answer two questions: (1) does enhanced secondary market transparency impact the cost of issuing bonds? and (2) if costs change, what is the economic mechanism through which this reform impacts costs?

We find that secondary market transparency is associated with a fall of 14 bps in the yield spread of a typical issue, from a sample mean of 144 bps. This corresponds to a 1.1% increase in price. We causally identify these reductions in costs by exploiting the staggered roll-out of TRACE, which allows us to estimate the magnitude of transparency-related changes via difference-in-differences regressions both pooled across all bonds and split by roll-out phase. Our results split by phase show that TRACE mainly affects issuing costs for smaller, lower rated bonds.

There are at least three ways secondary market transparency might influence bond issuing costs: through transactions costs in the secondary market; changes in information asymmetry in the primary market; and changes in information asymmetry in the secondary market.

While these mechanisms are not mutually exclusive – all could simultaneously affect bond issuing costs – our analysis points to reduced information asymmetry in the primary market issuance process as the most important driver of lower issuance costs in the bond market. Intuitively, prices paid in the secondary market for other, related bonds provide useful information for investors trying to price a new bond issue. Prior to TRACE, agents responsible for more trading activity, such as large dealers or fund managers with high turnover, have an information advantage when a new issue comes to market as they observe more information about the trading process of related bonds than smaller dealers or less active fund managers. After TRACE, everyone observes the complete trading history, reducing this important source of information asymmetry.

Our results provide new evidence that the economic consequences of increased transparency in secondary markets for corporate bonds extends to primary markets and the cost of raising debt capital. Reducing information asymmetry in the issuing process is an important driver of lower issuing costs. This should provide further impetus for European regulators to move ahead with the creation of a post-trade consolidated tape for the European bond markets. For regulators in other countries that wish to develop their bond markets, our results suggest that a post-trade transparent secondary market can help this process.