Make way for new muniland disclosure and market structure

By Cate Long
August 1, 2012

The SEC released its long-awaited report on muniland disclosure and price transparency yesterday. Ten years from now, every retail investor will want to say a word of thanks to Commissioner Elisse Walter, even if only half her recommendations on transparency and investor protection are implemented. Unfortunately, her term as SEC commissioner expires June 5, 2013, which leaves her less than a year to get the ball rolling on her proposals.

The report is composed of two primary areas: The first part concerns better disclosures by municipal bond issuers about their finances, and the second addresses the market structure for trading municipal bonds. It’s the second part that contains the really game-changing parts of the report.

On disclosure, the report recommends institutional changes, such as the requirement that muniland participants adopt the standards of the Government Accounting Standards Board and make timely and audited financial disclosures. The report recommends that conduit borrowers (think non-public entities like non-profit hospitals and private colleges) be subject to the same registration and disclosure standards as corporate securities and barred from using exemptions that municipal issuers rely on. Conduit issuers happen to have the highest incidence of defaults, and investors need the greatest level of disclosure for these securities.

On market structure, Walter’s proposals attempt to fill a void, as there is almost no regulation in the muniland secondary market. Dealers usually push retail-size orders to alternative trading systems like Bonddesk, the MuniCenter or Tradeweb Retail. The report recommends that the rules be changed to require these systems to publicly disseminate the bid-offer prices for securities they have on their platforms. Furthermore, the report proposes that the MSRB could compile the bid-offer prices across these alternative trading systems into a quote feed, making the systems more like equity markets. That would be a giant step forward for the municipal markets. Here is the regulatory version:

Although there have been improvements in the availability of pricing information about completed trades (i.e., post-trade information), the secondary market for municipal securities remains opaque. Investors have very limited access to information regarding which market participants would be interested in buying or selling a municipal security, and at what prices (i.e., pre-trade information).

Firm bid and ask quotations are generally unavailable and municipal bond dealers typically do not widely display firm quotations electronically. To the extent there is pre-trade price transparency, it tends to be provided through electronic networks operated by broker’s brokers, ATSs, or similar trading systems. This information, however, is not broadly accessible by the public, but rather is generally available only to participating municipal bond dealers.

This report is a roadmap for an entirely new market. Expect the dealers, through their industry association Sifma, to fight this tooth and nail. The current rules allow brokers to mark up bonds by 5 percent (the Finra markup rule), but more recent market surveys suggest that a 2 percent markup is the industry norm. This means that for every $1,000 in par for a bond, a dealer could make between $20 and $50. An investor would have very little information with which to compare the price received versus market indicators. The dealer’s profits in municipal bonds can be very lucrative, especially in contrast to equities that trade in penny increments. Dealers aren’t likely to favor any transparency on bond pricing for retail investors.

Using current laws and resources, the SEC report rationalizes muniland by focusing on increased transparency in issuer disclosure and pre- and post-trade pricing. Reading about the proposals may make your eyes glaze over, but these recommendations are fundamental to creating a stable, open municipal bond market. Kudos to all involved.

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