Conference Agenda

We use TRACE transactions data to assess trading activity and measure dealer markups on riskless principal trades in structured products. Median markups on such transactions with market values in the $5-$10 million range for MBS and ABS are just 0.03%, comparable to the 0.02% observed for Corporate bonds. Corresponding median markups are 0.10% for Agency CMO and 0.20% for Non-Agency CMO. Skewed markup distributions exist in all products, suggesting that customers are short-changed in a significant number of trades by opportunistic (“bandit”) dealers. The top quartile of both Agency and Non-Agency CMO riskless principal trades cross at markups above 1.0%, more than quadruple their median values. The top eighth of these paired trades cross at markups above 2.0%, more than nine times their median values.

The incidence of dealer banditry increased during the Pandemic crisis week beginning March 23, 2020. One bandit dealer made $54.5 million in excessive markups by buying 238 Non Agency CMO worth $1.732 billion from a single seller, while simultaneously splitting sales of these same positions among five counterparty accounts during a 12-minute “fire sale” on March 25, 2020. Benchmarks suggest this dealer also facilitated at least a 20% suppression of the fair value of these trades, benefiting the buying group while disadvantaging the seller by an extra $346 million. One of the buyers realized a $139.4 million capital gain (39% return on investment) after unwinding 35 days later in highly unusual “after hours” trades that also netted the dealer an extra $22.9 million in markup profits.

In sharp contrast to its near immediate dissemination of prices from Corporate bond, MBS, and ABS transactions, FINRA waits more than 18 months after the trade date to release data for CMO trades with transaction quantities equal to or greater than $1 million. We show that the 3/20/2017 rollout of reporting for CMO trades with transaction quantities less than $1 million appears to have reduced both the level and variability of markups in that segment. However, incidences of banditry appear to have increased for Non-Agency CMO trades with sizes of $1 million or more. The March 25, 2020, “crime scene” makes the costs of continuing to withhold reliable and timely information from customers all too real. We recommend that FINRA commence near real-time dissemination of TRACE transactions reports on all riskless principal trades in all structured products, including not only CMO but also Commercial Mortgage Backed Securities (CMBS), Collateralized Loan Obligations (CLO), and Collateralized Debt Obligations (CDO).