A revolution in muniland

Goldman Sachs

In a speech last week at the Economic Club of New York, SEC Chairman Mary Jo White set out three new initiatives that will reorder the way fixed income markets serve retail investors.

Congress gave the SEC the authority to regulate fixed income markets in 1975. The initiatives that White announced make up the first broad extension of the SEC’s authority over the murky, cost ridden, over-the-counter bond market. The combined firepower of the SEC, FINRA and the MSRB will likely topple any resistance that dealers will use to protect one of the last remaining profit centers.

In her speech, White pointed out that securities markets operate within a “structure” of regulator rules, technology and market practices. Bond trading information for retail-size trades is often locked in trading venues and available only to select market participants. Transparency for investors is mostly an illusion. White said:

It is striking that the dramatic technological advances that have transformed the equity markets over the past decade have had only a modest impact on the trading of fixed income securities. While today there are a number of electronic systems that facilitate trading in fixed income securities, they tend to be ‘inventory-based,’ providing information primarily on the bonds their participating dealers would like to sell.

The vast majority of small trades are executed through alternative trading systems (ATS) like Bonddesk and The MuniCenter.

The SEC’s new municipal adviser rule is not confusing ran a story titled “Why’s the SEC’s New Municipal Advisor Rule So Confusing?” Actually the new rule, although not yet finalized, is not confusing. There are resources for muniland participants to understand how it will be implemented and what responsibilities muni advisors have towards their clients. In fact, I have never seen a better rollout for a new regulatory effort.

Here is a roadmap:

As directed by Congress in the 2010 Dodd Frank legislation, the SEC published the definition of a municipal adviser last September. Over 1,100 municipal advisers have registered with the SEC and MSRB (registrations here including a downloadable list). Reuters detailed what happened last January:

After it was signed in 2010, the Dodd-Frank law ignited a fight over exactly who counts as a municipal adviser. The dispute lasted until the SEC approved a final definition in September, which allowed the MSRB to begin drafting regulations.

The SEC’s role in building better markets

The SEC has just launched a new part of its website dedicated to analyzing the structure of equity markets. Here is how the SEC describes it:

The Securities and Exchange Commission created this website to promote better understanding of our equity markets and equity market structure through the use of data and analytics.

Review current staff market structure research, use interactive data visualization tools to explore a variety of advanced market metrics produced from the Commission’s Market Information Data and Analytics System (MIDAS), download dozens of data sets to perform your own analyses, and further the dialogue through public feedback.

Why SEC adviser rules are desperately needed

Stockton, California is in the early stages of their bankruptcy and a local grand jury polled current city council members about their understanding of public finance. Does the latest round of public servants have any knowledge municipal finance? No, sadly the San Joaquin County Grand Jury discovered that there was little understanding of the city finances that the council oversees and that they could easily repeat prior mistakes. Local ABC affiliate, News10, reports (emphasis mine):

It has been widely reported how Stockton mismanaged its finances into bankruptcy court.  The grand jury also questions the current council and council members’ ability to manage important financial issues.

“The Grand Jury’s concern is the limited grasp of municipal finances.  While a few [council members]) indicated they had taken college-level courses in finance, or attended workshops, none indicated they were proficient in the matter,” read the report.

Memo to Congress: Increase funding for the SEC

The newly confirmed chairman of the Securities and Exchange Commission, Mary Jo White, testified to the House Financial Services Committee on May 16 and requested an increase in funding for her agency. SEC funding does not come from federal government revenues, but from fees assessed on securities transactions. White’s request to increase the agency’s funding does nothing to increase the federal deficit or take funding from other programs. She is merely asking to spend the money the agency collects.

This is the SEC’s Budget Authority (what Congress says the SEC can spend, in the center column) and the Actual Obligations (what was spent, in the right column) for the last several years, in thousands:

There have been increases since the financial crisis in 2008, but the Budget Authority from Congress was frozen between fiscal year 2012 and 2013. Chairman White explains why this will not do:

Should asset backed securities be outlawed?

On Tuesday the SEC is holding a roundtable on credit ratings to address the ongoing question of ratings shopping. Rating shopping is when a bond issuer shops its deal to various credit rating agencies to see who will assign the highest rating. The rating agencies that will assign the best ratings are given the business and the rating fee. Here is how the SEC describes its event:

As previously announced, the roundtable will consist of three panels. The first panel will discuss the potential creation of a credit rating assignment system for asset-backed securities. The second panel will discuss the effectiveness of the SEC’s current system to encourage unsolicited ratings of asset-backed securities. The third panel will discuss other alternatives to the current issuer-pay business model in which the issuer selects and pays the firm it wants to provide credit ratings for its securities.

The possibility of a credit rating assignment system comes from legislation that Minnesota’s senator Al Franken inserted in Dodd-Frank. Franken’s law requires that the SEC study the feasibility of a bureau or panel that would assign a rating agency to rate an offering. Currently issuers choose which firms will rate their offering although for structured finance or asset-backed deals issuers must share the particulars of the new deal with all raters recognized by the SEC in that category. This is equivalent disclosure and something that I have advocated with the SEC since 2007 and Congress since 2008. It has slightly increased competition in rating structured finance securities as seen in the chart above although the size of the market has declined since 2007.

Harrisburg joins Jefferson County with muniland securities fraud charge

The near-bankrupt city of Harrisburg, Pennsylvania was charged this week by the Securities and Exchange Commission with securities fraud. Here is the official language (emphasis mine):

The Securities and Exchange Commission today charged the City of Harrisburg, Pa., with securities fraud for its misleading public statements when its financial condition was deteriorating and financial information available to municipal bond investors was either incomplete or outdated.

An SEC investigation found that the misleading statements were made in the city’s budget report, annual and mid-year financial statements, and a State of the City address. This marks the first time that the SEC has charged a municipality for misleading statements made outside of its securities disclosure documents. Harrisburg has agreed to settle the charges.

A huddle over market transparency

The SEC held a fixed income roundtable on Tuesday to discuss two important issues: market structure and ways to improve it for municipal and corporate bonds. The SEC has as much authority to regulate this market as it does for equity securities, and it appears to be finally flexing its muscles with a little structure for the $18.7 trillion fixed income market.

I tweeted the roundtable all day (you can read the whole thread here), and I’ve posted the best ones here (parentheses are my editorial comments):

SEC must look beyond US borders to reform the fixed income markets

The SEC is holding a Fixed Income Roundtable on April 16 to examine ways to improve the transparency and efficiency of the fixed income markets. This is the first time that I am aware of that the SEC has focused exclusively on the market structure of fixed income. Although fixed income as an asset class is over twice the size of the equity market, and the SEC was given authority in 1975 to oversee this market, almost nothing has been done to regulate it.

All US bond trading is done over the counter or through alternative trading systems (ATS), which are trading platforms registered as dealers. ATS do not have responsibility to oversee the conduct of the other dealers trading on their platform. Think of them as fancy eBay systems for dealers to interact with each other. Rule 300(a) of the SEC’s Regulation ATS provides the following legal definition of an “alternative trading system”:

Any organization, association, person, group of persons, or system:

    That constitutes, maintains, or provides a marketplace or facilities for bringing together purchasers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange within the meaning of Rule 3b-16 of this chapter; and That does not:

1      Set rules governing the conduct of subscribers other than the conduct of such subscribers’ trading on such organization, association, person, group of persons, or system; or

Can fixed income markets be regulated?

The SEC has announced that it will hold a Fixed Income Roundtable on April 16 in Washington to discuss improving the transparency and efficiency of fixed income markets. This news is welcome and long overdue. As I wrote in a comment letter to the SEC in 2008 (emphasis mine):

Former SEC Commissioner Laura S. Unger in a speech to the Bond Market Association in 1999 addressed the [SEC’s] role in facilitating a fair market structure for fixed income investors.

…In adopting the 1975 Amendments to the Securities Laws, Congress gave the Commission the authority to facilitate developing a national market system for securities.

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