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Regulation and Compliance > Federal Regulation > SEC

To Meet SEC’s N-Port Rule, Overbond Marks Bond Prices, Liquidity Levels

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The best technology startups deliver a way for established firms to more efficiently compete or comply with regulatory requirements. Overbond meets that startup definition. A private company based in Toronto and New York, Overbond calls itself “the first end-to-end fixed income markets fintech platform for AI predictive analytics.”

This month it launched COBI Pricing, a proprietary bond pricing and liquidity risk management automation platform which should also be of interest to advisors and must be of interest to large and small asset management firms. That’s because those fund firms must comply with an SEC mandate on the liquidity and pricing of their mutual fund and ETF holdings this calendar year under the final SEC Rule 22 e-4.

Let’s put this platform and the mandate into context. Many investing vehicles have provided greater transparency to investors on their holdings and their philosophies, especially since the Great Recession. However, one investing segment remains quite opaque—fixed income. That is so despite the fact that the value of both the U.S. and worldwide bond markets is significantly larger than that of the equities market.

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Moreover, in times of market volatility, such as was the case with equities over the past year, investors seek safety in bonds. On Jan. 28, Cerulli reported that mutual funds posted “staggering” net negative flows of $157 billion in 2018; ETFs also lost 1% of their assets during the year.  But perhaps not surprisingly, Cerulli cited Morningstar data showing that a majority of the top-10 mutual funds and ETFs that had net-positive inflows for 2019 were in fixed income, notably ultrashort bonds, intermediate-term taxable bonds and intermediate national munis.

Partly in response to the financial crisis of 2007-2009, in which illiquidity of some assets (e.g., real estate) played a large part along with counterparty risk, and to modernize its systems of monitoring the capital markets, the SEC in 2017 ruled that registered investment companies (RICs) of all sizes must file Form N-PORT monthly beginning in 2019. The compliance deadline for large RICs, those with more than $1 billion in assets, is now April 30, 2019; for smaller funds, the deadline to begin filing Form N-PORT is now April 30, 2020, according to the SEC’s Division of Investment Management.

Among other requirements, the SEC mandates that all mutual funds and ETFs (not money market funds) must report each fund’s holdings as either highly liquid (HLI); moderately liquid MLI); less liquid (LLI), or illiquid (II), based on how quickly those individual holdings could be converted to cash.

That’s an issue for bond funds due to the illiquid nature of the fixed income market. Form N-Port also requires RICs to provide data to the SEC related to the pricing of each fund’s holdings, a challenge due to the imprecision of bond pricing in both the primary (first issued) and secondary bond markets.

But this is the business opportunity for Overbond and its CEO, Vuk Magdelinic, a former bond trader and regulator. He says that the company’s Corporate and Government Bond Intelligence (COBI) suite of products can efficiently and with confidence assign all of a fund’s bonds to one of those four levels of liquidity mentioned above, and “pass that reporting to regulators and, ultimately, to clients.”

Overbond accomplishes the task by building an algorithm that looks at current and historical data on the trading activity of bonds in the second market, gaining insights into liquidity and pricing. The algorithm also looks at the data for those bonds’ peers in the same sector.

Should there not be enough data available for a thinly traded bond, the algorithm looks at another set of data, which Magdelinic says an investment banker would use to measure the value of a The final data parsed by the algorithm, Magdelinic reports, comes from how a “large universe” of corporate bond issuers going back 20-30 years priced their bonds. That sell-side data is then combined with buy-side data that Overbond has gathered for the past two years from fund managers. That provides insights into what kinds of bonds fund managers like and dislike.

The COBI platform’s use of both buy- and sell-side data is, Magdelinic says, the “machine-learning component” of the tool. Using those current and historical datasets—one proprietary—yields an accurate “mark-to-market price for a bond and the liquidity metric for a single bond or a basket of bonds,” that Overbond can then use to export the findings to a regulator and to clients.

What’s the value to advisors? For one, bond funds using tools like Overbond’s can allow advisors to construct portfolios with clearer risk profiles and more accurate pricing, suggests Magdelinic. Secondly, regulations fostering and competitive forces leading to better risk management and greater disclosure is a benefit to end clients, especially, says Magdelinic, when “commercial solutions go above and beyond what regulators require.”

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