Draft: June 8, 2003 Developing Efficient Market Infrastructure and Secondary Market of Government Bonds in Developing Countries


Salespeople and Brokers for Liquidity18



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6Salespeople and Brokers for Liquidity18


Regardless of a developed or developing economy, average investors and dealers are likely to find more personal values in manpower-based intermediary services to trade government bonds. Sophistication of salespeople at broker/dealers and utilization of interdealer brokers should be viewed as a liquidity enhancement measure. Under emerging market environments, human intermediation by salespeople and brokers equipped with some electronic devises is expected to remain effective in creating and maintaining liquidity in the secondary markets of government bonds.

6.1Liquidity vs efficiency


We have discussed extensively how to make the market efficient. However, can market efficiency alone create a liquid market? Liquidity is a different concept from efficiency. Efficiency and liquidity compliment each other in most cases. Yet, there are some cases where liquidity can or must be achieved even at the expense of some degree of efficiency. As far as I have observed it, the market needs some human factors in its working for its smooth running. Such factors are represented by salespeople and brokers.

Salespeople are usually employees of broker/dealers, and solicit orders from investors for their in-house traders as counterparty. They are paid out of trading profits that are bid/ask spreads. Brokers in this context are interdealer brokers. They provide their customers with ongoing prices and market information, and broke trades on a “name give-up” or matched principal basis. Normally, interdealer brokers do not broke or trade with end-investors.


6.2Mediocre players


Mediocre investors are an indispensable basis for liquidity. The market consists of a small number of visionary players and, a large number of mediocre ones (see Figure 9). A player may have some visionary elements and some mediocre ones in himself. Players in the marketplace vary in preference. Moreover, they do not have the same level of quality in terms of knowledge, comprehension, reasoning, insight, and foresight. Only the minority of the players is visionary and capable of independently making investment decisions, though this ability does not always guarantee excellent investment skills.

Mediocre institutional investors, or mediocre fund managers at institutional investors, are laden with: uncertainty, accountability, decision-making anxiety, post-decision making anxiety. They are in sharp contrast with so-called “day-traders” who rapidly buy and sell mostly equities on line for their own accounts, and are not required to be accountable to anybody else for their trading. Fund managers and traders at most institutional investors are strictly bound by investment/trading policies and rules under close supervision, and are required to be accountable to their superiors, beneficiaries and regulators for their trading being carried out under a great amount of uncertainty. A failure in accountability risks their job. In this kind of job, they have to live with decision-making anxiety and post-decision making anxiety.

Therefore, the mediocre fund manager needs a routine mechanism that assures him of some confidentiality even from his supervisors, stress control, and, damage acceptability in respect of his trading decisions. At the same time, he is a “price-taker”, but not a “price-giver”, and, nervously needs continuous “price discovery” services and investment advice with human assurance from his “accomplice”. Other players in the industry, even traders at broker/dealers, are in the similar situation. Salespeople and/or brokers are considered to play a critical role in this psychological process of mediocre players.

Thus, routine interactions between mediocre players and salespeople and/or brokers with the psychological implications conceivably generate many orders for trades at random under normal market conditions. This human process of inducing market players to trade significantly contributes to liquidity of government bonds in emerging markets. Therefore, it is advisable that policymakers should incorporate sophistication of salespeople at broker/dealers and utilization of interdealer brokers in their strategy for enhancing secondary market liquidity of government bonds. Policy measures under such a strategy include professional education and certification programs for salespeople, and a licensing category for interdealer brokers.


Figure 9: Mediocre and Visionary Players




6.3Network effects


Capital markets are known for their network effects. This is a reason for the importance of a critical mass for market liquidity. The secondary market or the service rendered in it becomes more valuable as more investors use it. However, the network will not grow large enough unless its owner is allowed to internalize (privately benefit from) network effects. Conversely, a new investor will not join the network for the additional value derived from being able to interact with other market participants if the owner internalizes all network effects. A right balance between the private value and the social value of the network to reach the optimal size of the network is a function of a traded product, characteristics of demand and supply, a level of maturity and sophistication of the market, and so on.

The quality and quantity of public information are generally far imperfect or inadequate in emerging markets. In such markets, an aggregate of personalized information about inventors or dealers collected by salespeople or brokers is likely to have more values for the network owner to internalize than investors or dealers’ trading information mechanically gathered through an electronic trading platform. The aggregate of personalized information about other inventors or dealers will attract new participants to the network. Therefore, the network owner has a better incentive to expand its network.

Personalized collection of information is arguably more expensive than mechanical collection. The number of skillful salespeople or brokers is limited or slow to grow. Consequently, diminishing returns and/or capacity constraints will inevitably bring a manpower-based network to the point where the addition of new participants does no longer make sense to the owner or is no longer possible much sooner than an electronic-based network. The potential size of the former will be smaller than that of the latter. Multiple networks may be able to exist profitably.

This limitation of manpower-base intermediation is unlikely to impede the development of government bonds in most of developing countries at least in the short- or medium-term. This is because their economies may be too small due to heir population size and/or their income level to reach the potential size limit of manpower-based networks. Under such circumstances that are widely common in many developing economies, human intermediation rather than purely electronic intermediation is more practical and effective in driving the owners of intermediary networks to expand their business and generating liquidity in secondary markets of government bonds at least in the initial stage of market development as well as perhaps in the foreseeable future.





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