Developing a new heartbeat for muniland

July 31, 2013

Trading bonds in muniland is a mess unless you have access to systems that provide information on current market levels for various types of bonds. It’s almost impossible to know, as a retail investor, if your bond purchase is close to a market level or if it is, in fact, marked up excessively. You are basically shooting in the dark and it’s probably best to just stay away from buying these bonds individually.

Institutional systems are very expensive to lease and are usually too pricey for retail investors. The Securities and Exchange Commission recommended in their two recent municipal market reports that investors be provided with more market data by the Municipal Securities Rulemaking Board, which oversees muniland. The MSRB already provides good access to prices for individual bonds that have already been traded. But those are old prices. Most individual bonds don’t trade on a daily basis, so it is hard to guess at current fair value levels. Municipal bond prices are also influenced by the daily rise and fall of the U.S. Treasury market, the same as most fixed income, which is anchored by the yield on the ten-year U.S. Treasury bond.

The MSRB announced last week that it would be publishing several requests for comments asking for more information so investors can make informed investment decisions. The Wall Street Journal ran a story following the MSRB press call that gives a glimpse into the regulatory struggle between the MSRB and the SEC on developing a set of pre- and post-trade pricing tools for retail investors. The SEC is leery of giving retail investors benchmarks that rely on data that is not based on actual trades. From the WSJ:

In the wake of Libor’s problems, the SEC wants to ensure any new guidepost has ‘appropriate safeguards of reliability and absence of manipulation in order to protect investors, municipal issuers and the public,’ said John Cross III, the SEC’s municipal-securities chief.

The SEC has struggled to reach agreement with another agency, the Municipal Securities Rulemaking Board, over how best to structure such a benchmark and ensure it can’t be manipulated, people familiar with the matter said.

The MSRB, a self-regulator overseen by the SEC, wants a third party to develop a benchmark. But SEC officials are concerned such outsourcing could allow for manipulation and result in the MSRB inadvertently giving a regulatory stamp of approval to a faulty benchmark.

According to The Wall Street Journal, the MSRB is working with Thomson Reuters Municipal Market Data as the third-party vendor on this project (disclosure: I often work with MMD on pricing research and municipal credit analysis). The pricing benchmarks distributed by MMD are the industry benchmarks and mostly derived from actual trades that occur, but like all municipal bond pricing and evaluation services, it has some subjective input (also called market color, dealer input, or quantitatively derived data) that goes into the methodology. I wrote previously about MMD’s competitor Municipal Market Advisors, whose pricing system relies entirely on the methodology that underlies Libor, which is polling 38 dealers to get their opinions on current market levels. It appears that the SEC objects to or at least has reservations about MMA’s approach.

I talked to Steve Shaw of BondDesk (the dominant alternative trading system for “odd-lot” municipal trading), and Frank Cicotto of S&P Capital IQ about a new pre-trade pricing evaluation service that they are rolling out together for trades of less than $1 million. This service will be available to dealers, financial advisors, portfolio managers and brokers, but not to the public. Traditionally, pricing on bonds, when done in small sizes (odd lots), is at least 70 basis points, or .7 percent, more than the same bond traded in “round lots” (+$1 million). The BondDesk and Capital IQ system will provide “a unique range around both bid- and ask-prices that indicates a reasonable band to price or trade bonds.”

S&P is proprietary about its methodology in the new system, so it is difficult to know exactly how much it conflicts with the SEC’s desires for benchmarks based only on observable data like trades. This wouldn’t be a concern as a private market vendor, but the dealer’s trade association, SIFMA, has begun floating a proposal for “execution with diligence.” It sounds as if the new BondDesk/S&P Capital IQ system would be used to fulfill that proposed standard. SIFMA would like to substitute its proposal for the current “best execution” standard.

The SIFMA proposal for “execution with diligence” relies entirely on non-public market information and conflicts directly with the SEC’s intent of moving pre-trade information (i.e. aggregated bid/offer data) into the public domain. From the WSJ again:

As part of a sweeping SEC initiative to boost transparency in the muni market, the agency last summer asked the MSRB to ‘promptly’ ensure retail investors have better access to pretrade pricing information, including benchmark information. The MSRB was asked to post the pricing information on an online web portal, which collects and publishes muni disclosures and trade data.

The outcome of this fight will determine if the heartbeat of the municipal bond market will remain buried deep in the systems that control the current market structure. If we’re lucky, the pre-trade data that is currently out of public view will be dragged into the light, just as the derivatives market recently has under the Dodd-Frank reform law. It is kind of crazy to think that municipal bonds can’t make this leap after the over-the-counter derivatives market did it.

Equity markets have long provided depth of book information to market participants and the public. This gives investors a reading on the depth and strength of market participants’ willingness to buy and sell a security. The SEC is pushing in the right direction.

This is an epic muniland fight. Dealers are loath to lose control of the pre-trade information that would expose the massive mark-ups and variations in prices. Muniland’s heartbeat must burst forth.


Bond Buyer: “MSRB To Seek Public Input on Best Execution, Trade Data”

Sifma: Recommendation to the MSRB on “Execution With Diligence” Standard for Municipal Trading

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