SEC Commissioner Gallagher Discusses SEC Supervision of Fixed Income Liquidity, Market Structure and Pension Accounting

SEC Commissioner Daniel Gallagher spoke at the Financial Industry Regulatory Authority conference in New York. He talked about liquidity, market structure and pension accounting risks in the fixed income markets.
According to Commissioner Gallagher, dealer inventory and liquidity in the secondary markets have “dramatically decreased,” despite record issuances of corporate bonds. He explained that, with a record-breaking amount of outstanding corporate debt and dealers unable to commit capital or hold inventories, “there is a real liquidity crisis brewing.”

Commissioner Gallagher explained that the SEC can take steps to address these liquidity concerns, including considering all options for facilitating electronic and on-exchange transitions of these products. Additionally, he stated, the SEC must commit the necessary resources to determine how to incentivize standardized primary offerings in order to facilitate secondary liquidity even more.

Commissioner Gallagher mentioned that a more “discrete and addressable” issue in the fixed income markets is the lack of transparency. He expressed his approval of FINRA and the MSRB’s active engagement with this issue through proposals that require dealers to provide pricing reference information on retail customer confirmations, and applauded the recent SEC approval of the MSRB’s best execution rule.

Commissioner Gallagher also discussed the call to change the bond disclosure regime, particularly in the municipal space. He stated that the SEC has been making better use of its existing authority to improve municipal disclosure practices by testing compliance with Rule 15c2-12 (“Municipal Securities Disclosure”) and actively pursuing municipal issuers and individuals who commit fraud. Additionally, he explained, he is concerned about accounting for municipal pensions and other post-employment benefit liabilities, and recommended a legislative fix to mandate the use of Governmental Accounting Standards Board-approved standards for municipal issuers.

Lofchie Comment: While Commissioner Gallagher and securities market participants warn about liquidity being driven out of the markets, the banking regulators emphasize “safety,” without adequate attention to diminished liquidity. A market without liquidity is extremely fragile (and therefore unsafe) because even the smallest selling pressure will overwhelm the willingness to buy. In other words, push safety too far and you get its opposite.