Bond Analytics: Taking an Open Souce Approach
Much has been written about what’s wrong with the rating agencies: structural conflicts-of-interest; intellectually over-matched; lacking in creativity and orthogonal thinking. Some believe the rating agency industry as we know it is on death row. To be honest, I tend to agree. Attempts at resuscitation are unlikely to yield the material changes required. The biggest problem: lack of transparency and insight into the multi-trillion dollar debt market. Much as the OTC derivatives market needs an overhaul, the opaque corners of the debt market need to move out of the shadows as well.
One of the unique aspects of the debt market is its mind-numbing diversity and dimensionality: maturity, amortization, optionality, collateral, seniority, etc. A “one size fits all” approach simply does not work for the bond market, and it is questionable as to whether a single entity has the intellectual horsepower and access to the resources necessary to effectively and efficiently analyze its range of securities. Large, seemingly intractable software problems have benefited from the massive collaboration available through the open source movement. This has been an effective method for not only addressing a core problem, but for keeping up-to-date and relevant as technology evolves. It has also been a vehicle for value-added service providers to build on top of these solutions (e.g. Red Hat/Linux, Lucid Imagination/Lucene, etc.) for specific use cases, providing needed service levels and documentation, etc. While not a panacea, the open source movement has effectively harnessed the world’s intellectual capital and applied it to big problems relevant to a broad array of constituencies.
If an open source approach has worked so well in software, why not apply it to the ratings problem? Whether or not ratings should be required for institutional investors to buy certain securities is not the issue; the essential point is getting better transparency into and analysis of instruments constituting the investable universe. Imagine a university or a large institutional investor seeding the open source initiative by putting their own debt ratings models into the public domain and allowing others to contribute to its development. I can see a suite of open source libraries by type of instrument, with a new industry emerging to deliver additional analytics, data and recommendations on top of these libraries. There would need to be a Wikipedia-type board of curators, ensuring that additions to the libraries are sensible and increase the stock of intellectual capital. But I can’t see why such an approach wouldn’t address the biggest problems facing the ratings industry today.
Combining bond analysis and the open source movement could deliver:
- Transparency;
- Unbiased input;
- Access to a global talent pool;
- Opportunities for specialized applications to be delivered in tandem; and
- Institutional-grade analytics and research available to all.
I haven’t seen or heard of a better solution to the problem, and the problem certainly isn’t going away. If we as a financial community are committed to such an approach, it is bound to be successful. Let’s give it a shot.
