Evaluated Security Pricing Service Offerings Have Increased Recently Mar 23, 2007 URL: http://www.advancedtrading.com/showArticle.jhtml?articleID=198500315
Evaluated security pricing services, which provide computer-driven or manually calculated marks for illiquid and over-the-counter (OTC) securities, have been a staple of the market-data business for nearly 30 years. In the early 2000s, though, market-leading supplier FT Interactive Data changed the competitive landscape when it acquired rivals Muller Data and Merrill Lynch Securities Pricing Service.
These acquisitions gave the supplier a strong lead in the market, which remains virtually unchallenged today. However, other vendors invested actively in their own services in 2006, focusing on emerging market opportunities (including Europe and Asia) and new, complex products such as structured debt and derivatives. Where once there were few choices, now there are many.
How Are Evaluated Prices Generated?
The vast majority of bonds and derivatives do not trade on exchanges. Therefore, data vendors have developed and refined complex computer models to generate artificial best estimates, or fair values, of bond prices. These are commonly referred to as evaluated prices.
Vendors' techniques vary depending on the type of security being priced. More-commoditized evaluated pricing data, including investment-grade corporate and municipal as well as government bond prices, generally is calculated through use of a computer model with little or no manual intervention. These models are affected by macroeconomic-, sector- and issuer-level data as well as the specific terms and conditions of the individual bonds in the model.
Complex and illiquid issues, such as high-yield bonds, typically are hand-priced, whereby an evaluator calls the desk of a broker-dealer that makes a market in the security (ideally the primary dealer) to get a current valuation. Mortgage-related products generally are model-priced with analytic data and dealer quotes, among other data, as inputs. Vendors typically will incorporate actual trade data into the models and/or adjust the model prices to remain in line with any visible trades in the market.
Another type of evaluated price is what has been labeled a "fair value" for foreign equities. FT Interactive Data pioneered fair-value services in early 2002 in response to the mutual fund market-timing scandals that roiled the industry. Fair-value services aim to eliminate the Europe-to-U.S. time gap by applying a statistical model-driven adjustment to foreign equity prices to account for the activity that occurs after their official close. Reuters launched a competing product through a partnership with agency-broker Investment Technology Group (ITG) in early 2006.
Why the Renewed Interest?
A host of drivers are generating a new interest in evaluated pricing and are pushing vendors to increase their capabilities and coverage. Among these are investors' search for alpha, growth in derivatives, global regulation and the need for information transparency.
As investors -- both retail and institutional -- have become disillusioned with the moderate returns from traditional asset classes, they've begun to shift assets to alternative investments and portfolio strategies. These may be retail products like "go-anywhere" and hedge-like mutual funds, or institutional products like portable alpha and liability-driven investment (LDI) strategies. Many of these products rely heavily on the use of derivatives, which will require evaluated prices for portfolio valuation.
Another key driver influencing spending on evaluated pricing is regulation. Specific regulations -- such as Sarbanes-Oxley and Regulation NMS in the United States, the Markets in Financial Instruments Directive (MiFID) in Europe, and anti-money laundering (AML)/Know Your Customer (KYC) regulations globally -- place a high degree of importance on information transparency, reference data content and data-management processes. More directly, several examples have driven and will continue to drive the use of evaluated pricing, including IAS 39 fair value option, UCITS III and FAS 157, which provides guidance for fair valuing securities.
Future regulations also are likely to address the valuation of derivatives by hedge funds and hedge fund administrators. The current practices of self-valuation by fund managers and broker-quoting by administrators are likely to come under scrutiny because of their inherent conflict of interest, and the industry should expect to see a mandate requiring independent valuations of all OTC derivative positions either from an industry body such as the AIMA or from a government regulator.
Who's Buying Evaluated Prices?
The primary consumer of evaluated pricing data is the buy side, particularly fund companies and fund administrators. To these firms, receiving accurate evaluations shortly after market close to value their funds and calculate net asset values is critical.
Although the United States historically has been the primary consumer of evaluated pricing data, demand should grow at a faster pace elsewhere as regulation challenges the status quo, and emerging markets look to establish and open themselves. Firms in Europe have long relied on contributed prices rather than evaluated prices because of the region's looser regulatory environment, which has allowed the practice. However, new accounting standards are likely to gradually change that practice in favor of more independent and transparent evaluated prices. Emerging markets such as China also should serve as strong centers of demand for evaluated pricing as new financial institutions seek out foreign investments and build global portfolios.
FT Interactive Data leads the market for evaluated pricing by a large margin. Its nearest competitor on a global basis is Standard & Poor's Security Evaluation Services. Other players include Reuters Enterprise Information, Bear Stearns PricingDirect and Telekurs Financial. Of the specialist providers to specific asset classes, the most notable are derivatives specialist Markit Group and Canadian debt specialists SVC Corp. and FRI Corp. Each vendor offers a variety of fixed and flexible data file formats and supports a range of transmission methods.
Vendor Agility Is Key
The market data industry is notorious for its lethargy with respect to product management and for its long development cycles, which result in a lengthy gap between clients' demands and new product launches. As the evaluated pricing industry becomes more crowded, data vendors' success will depend in part on the agility of their product management and development teams. Vendors that become more responsive and shorten development cycles will find themselves in a much more favorable position with their clients and will earn first rights to new business opportunities.
In response to the market conditions discussed above, the evaluated pricing market will be highly competitive. Not only are new niche vendors likely to enter, but the large, existing vendors are likely to expand their services into emerging asset classes in an effort to garner new revenues. We also expect large vendors to form additional partnerships with niche providers, and perhaps even acquire them, as they eye traditional and nontraditional growth opportunities. Incumbent vendors will need to be on top of their game in 2007 to fight off competitive threats and must focus on improving their agility in product development and their speed to market with new offerings.