Regulating Debt Research


New York – A lively topic at the recent SIFMA compliance conference was a FINRA concept release creating more regulation of debt research.  The new regulation would create barriers between debt research and sales/trading similar to those that currently exist for equity research and investment banking.  Commentators were concerned about a ‘slippery slope’ which would extend those sales/trading barriers from debt research to equity research.

The Financial Industry Regulatory Authority (FINRA) recently published a concept release to apply objectivity safeguards and disclosure requirements to the publication and distribution of debt research reports. The proposal would require that retail debt research operate under the same regulatory requirements as equity research (NASD 2711).  Institutional debt research would be exempt from these requirements, but would have to add a “health warning” and the communication firewalls imposed between sales/trading and debt research would apply to institutional research also.

In 2005,  the NASD and the NYSE (precursors to FINRA)  surveyed certain firms’ debt research supervisory systems and found many instances where firms failed to adhere to the Guiding Principles of the Bond Market Association (BMA).  More significantly, the SROs found certain cases where firms lacked any policies and procedures to manage debt research conflicts to ensure compliance with applicable SRO ethical and anti-fraud rules.  Hence the desire to introduce an explicit regulatory framework for debt research.

There is a surreal aspect to this proposed regulation.  Publishing debt analysts are a rare breed.  According to sources knowledgeable on debt research, most analysts are desk analysts and do not publish research, providing instead verbal commentary to internal traders and directly with clients.  Retail debt research is rarer still, and if this proposed regulation were to be enacted, can be safely considered extinct.

Attendees of the Securities Industry and Financial Markets Association (SIFMA) Compliance & Legal Society 2011 Annual Seminar were concerned with whether regulators were considering extending the  sales/trading firewalls from debt to equity research, where it would be disastrous to current equity research organization and practices.  Marc Menchel, a FINRA representative who was attending the conference, believes there is a big difference between the interaction of debt analysts with sales/trading and equity analysts with sales/trading.  He indicated that the only reason a debt analyst would agree to cover a particular bond is because s/he checked with sales/trading first to see which bonds are selling/trading.  He felt that equity coverage decisions are not made this way.  He stated that debt analysts interact with sales/trading more than equity analysts.  (Not sure we agree on this.)

If this rule is put into effect, the net effect will be to convert the few remaining publishing debt analysts to desk analysts and to ensure that desk analysts covering debt do not publish research in any form.

For those involved in research, whether debt or equity, the message is very clear that regulators are examining research practices, policies and procedures and potential conflicts.

The concept release can be viewed here.  The comment period expires April 25, 2011.



About Author

Leave A Reply