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In a comment letter filed with the Municipal Securities Rulemaking Board (MSRB), the Securities Industry and Financial Markets Association (SIFMA) notes its appreciation of the MSRB’s efforts to harmonize the manner in which prevailing market prices—which provide the baseline from which the dealer must calculate any mark-up—are determined with that of the method established by the Financial Industry Regulatory Authority (FINRA) for other types of debt securities. However, SIFMA expresses some concerns on the draft guidance offered by the MSRB relating to the unique nature of municipal securities.
SIFMA finds that the hierarchy for determining the prevailing market price in the MSRB’s guidance is unworkable and could lead to inaccurate price determinations because it requires dealers to ignore important pricing information.
SIFMA requests that a number of areas be altered, clarified or expanded. SIFMA respectfully requests that the MSRB:
- allow for a more flexible approach in determining prevailing market price by dismissing the concept of a rigid hierarchy in favor of an approach that recognizes pricing is based on a myriad of factors;
- permit a more flexible approach to documenting transactions;
- expand the exemption from the guidance to include all transactions by dealers with a sophisticated municipal market professional (SMMP);
- expand the discussion of the situations in which a bond dealer may consider itself a market maker; and
- provide dealers with more guidance regarding the definition of “contemporaneous cost”.
“The guidance does not fully reflect the myriad factors that go into pricing determination,” said Leslie Norwood, managing director and associate general counsel at SIFMA. “While the factors specified by the MSRB are important, it would be inappropriate to limit dealers to the factors listed and in a hierarchical manner. We are concerned that asking dealers to ignore relevant information is not only unrealistic, it also exposes them to increased risk and results in increased bid-offer spreads, worse prices for customers, and less liquidity in the market.”
Determining the prevailing market price in a broad over the counter market with taxable and tax-exempt components should be based on a set of factors that may be taken into account, without regard to any hierarchy. Those factors are numerous and include, but are not limited to: contemporaneous cost of dealer and customer trades; changes in interest rates; changes in credit quality; news; size of trade; quotes; and liquidity at that point in the yield curve. Other factors include appropriate reference points in the government bond market or municipal market, depending on taxability of the bonds, and their perceived value relative to prevailing market prices. Changes in the currency, equities and commodities markets are also examples of factors that can be relevant.
Noting the documentation requirements under the draft guidance, SIFMA notes that this will be a sizeable administrative burden as most trades in municipal securities will require documentation at the time of trade due to the sheer breadth of municipal securities municipal securities market and resultant low levels of trading in each security. SIFMA suggests the contemporaneous documentation requirement could be lessened if there was a mere requirement for dealers to have in place policies and procedures setting forth when contemporaneous documentation would be required.
SIFMA strongly supports the carve-out of sophisticated municipal market professionals (SMMPs) from the definition of “customer” for purposes of this draft interpretive guidance, and requests that the MSRB revise the draft guidance to expand the exclusion from the definition of customer to apply to all municipal bond trades with SMMPs. This carve-out is consistent with the well-recognized principle that a dealer’s relationships with institutional customers are qualitatively different from its relationships with retail customers. Currently, the proposed carve-out only applies to trades with SMMPs in “non-investment grade municipal securities.” SIFMA feels a lower threshold may even be appropriate to establish that an institutional investor is a SMMP.
In its letter SIFMA also requests that the MSRB clarify that debt dealers may be market makers, as the market concept is more important in determining prevailing market price other than based on contemporaneous cost. Bond dealers regularly risk their capital to facilitate customer transactions, and regularly provide quotes to customers and in the interdealer market. SIFMA believes that dealers in debt securities may be market makers, and that the MSRB should take into account structural differences between the equity and the bond markets in determining whether a debt dealer may be a market maker.
Finally, SIFMA requests that the MSRB recognize the differences in pricing of different sized transactions, noting that demand is higher for institutional-sized trade and executing a small trade often requires at least as much time and operational resources for a dealer as executing an institutional-size trade. Even if the dealer's mark-up or mark-down is taken out of the equation, the prevailing market price will be different for small trades versus institutional-size trades.
