WASHINGTON — One year after the enactment of a sweeping financial reform law, municipal market participants say the overhaul has created an environment of uncertainty, not dramatic change.
Billed 12 months ago as the most significant overhaul of the market since the Depression, the Dodd-Frank Wall Street Reform and Consumer Protection Act remains a source of anxiety and frustration across the muni securities market — from issuers, who lament the lack of as-yet undefined protections, to dealers and industry groups, who fret about a complex web of regulations, many of which remain unfinished.
Meanwhile, regulators are grappling with the burden of Dodd-Frank rulemaking, budgetary shortfalls and congressional pressure to slow down the pace of reform, adding to confusion about how and when the law will reshape the municipal market.
That lack of clarity, market participants say, is a fundamental by-product of Dodd-Frank to date.
“The impact has been muted at best,” said Matt Fabian, managing director at Municipal Market Advisors.
Enacted in response to the 2008 financial crisis, Dodd-Frank called for far-reaching changes in muni market rules, several of which have been implemented, including one approved last week to boost the Commodity Futures Trading Commission’s anti-fraud enforcement authority over swaps.
But many of Dodd-Frank’s key municipal securities provisions remain unimplemented. They include the creation of a stand-alone municipal securities office at the Securities and Exchange Commission, whose director would report directly to the chairman, and the definition of “municipal adviser” — a new category of regulated entities, established by the statute.
“There are just as many questions a year later, if not more, it seems to me, than at the time Dodd-Frank passed,” said William Daly, senior vice president of government relations for the Bond Dealers of America. “In some ways, things have gotten less clear.”
The SEC’s proposed municipal adviser-registration scheme is just one example.
Dodd-Frank called for a new regulatory regime, administered by the SEC and the Municipal Securities Rulemaking Board, to oversee muni advisers, requiring them to register with both regulators and imposing a fiduciary duty. In general, a fiduciary duty requires an adviser to put the client’s interests ahead of its own.
Late last year, the SEC floated a proposed muni adviser-registration rule, an initial step in subjecting the newly regulated group to federal oversight.
But the proposal sparked a firestorm of controversy, with more than 1,000 comment letters flooding the agency, including several from members of Congress, such as Rep. Spencer Bachus, R-Ala., who chairs the House Financial Services Committee.
Many of the letter writers, including Bachus, criticized a provision that would have required appointed members of state and local governmental boards to register as municipal advisers.
SEC staff are reviewing comment letters on the muni-adviser proposal and the commission is expected to issue a final rule later this year.
But another observer says the flap over the proposed registration scheme raises broader questions.
“I do think it’s a clear warning that everybody in our sector needs to be extremely cautious about the SEC being authorized to impose any regulations because I don’t think they’re a good regulator in our sector,” said Charles Samuels, a partner at Mintz, Levin, Cohn, Ferris, Glovsky and Popeo PC in Washington. “I think they’re trying to learn and catch up.”
Still, the SEC is only one of several regulators straining to meet a Dodd-Frank rulemaking mandate. Observers also cite angst about the MSRB’s expanded role in the municipal securities market and the pace of the board’s efforts.
Dodd-Frank gave the MSRB rulemaking authority over municipal advisers and broadened the board’s mission to include protecting “municipal entities.” It also required the board to transition from a body dominated by broker-dealers to one with a majority-public membership. The MSRB’s newly constituted 21-member board became effective Oct. 1.
Since last fall, the board has floated a series of proposals that would bring muni advisers under its existing regulatory framework, including amendments to Rules G-17, which governs fair dealing, G-20, which governs gifts and gratuities, and G-37, which prohibits pay-to-play transactions.
In May, the SEC also approved amendments to G-23, which prohibits dealers from acting as a financial adviser to a municipal entity on a bond transaction and later as an underwriter on the same issue.
More recently, the MSRB has pivoted to crafting rules for establishing and testing the professional qualifications of muni advisers. A draft supervision rule, G-44, was released for public comment this spring, with additional rule proposals expected this summer.
Still, the MSRB’s efforts — though praised by some, including some independent FAs — have spawned a range of criticism.
Broker-dealers and industry groups worry the board’s regulatory scheme for municipal advisers will not mirror the existing framework for broker-dealers and dealer FAs, thereby creating an unlevel playing field. They also cite concerns that dealers will be held to a fiduciary standard when engaging in what they view as traditional investment banking business, such as the underwriting of municipal securities.
“There shouldn’t be stricter rules for FAs or stricter rules for dealers when they sometimes compete for the same business,” said Michael Decker, managing director and co-head of the municipal securities division at the Securities Industry and Financial Markets Association.
An issuer, by contrast, worries that the MSRB, even with its majority-public membership, may still betray allegiance to the broker-dealer community when crafting regulations about muni advisers’ qualifications.
“It’s one of those things we have to watch,” said Portland, Ore., Treasurer Eric Johansen, who chairs the Government Finance Officers Association’s governmental debt management committee.
An independent financial adviser, meanwhile, urges the board to finalize a test, not expected before next year, for assessing muni advisers’ qualifications.
“We need to do it and let’s go,” said Thomas Johnsen, a principal at Feldman, Rolapp & Associates in Irvine, Calif.
Dodd-Frank also requires the Commodity Futures Trading Commission and the SEC to undertake, for the first time, regulation of the over-the-counter derivatives market. And with derivatives, as with muni advisers, some market participants give the statute — and regulators — less than stellar marks.
A CFTC official acknowledged as much during a public meeting last week, when the commission voted on its first five final Dodd-Frank rules.
“If we were in school, we’d probably get an incomplete on what we’ve done,” said commissioner Bart Chilton, who was nominated by President George W. Bush and renominated in 2009 by President Obama.
The CFTC and the SEC have proposed a host of new regulations for the derivatives industry, including business-conduct standards for swap dealers and major swap participants, which the CFTC released for public comment late last year. The SEC proposed parallel standards for security-based swap dealers late last month.
Both agencies would impose a heightened standard of care, known as a best-interests standards, on swap dealers who enter into swaps with so-called special entities, including state and local governments and public-sector pensions.
“The regulators are kind of starting from a blank page,” said Decker. “It’s just very complex.”
But one swap dealer says regulators have moved far too slowly, and that has market participants spooked.
“What are these rules going to be?” asked Sam Gruer, managing director of Cityview Capital Solutions LLC in Millburn, N.J. “And when are they going to be?”
As a small business owner with two employees, Gruer worries about the cost of compliance with new regulations, whatever form they take.
Such uncertainty could harm muni market liquidity in the long run, Gruer added, because swap dealers will leave the business if it becomes commercially nonviable.
Bachus and three other key congressional Republicans have also created some uncertainty by introducing a bill that would grant the SEC and the CFTC an 18-month reprieve, until as late as December 2012, for issuing derivatives rules.
Democrats counter that Republicans — who control the House but not the Senate and could not muster the votes to repeal Dodd-Frank — are trying to dismantle the law by gutting regulators’ budgets and slowing down rulemaking.
One observer, who said she understands the industry’s concerns about regulatory uncertainty, lamented a shift in the political environment since Dodd-Frank was enacted.
“We’ve done a complete 180 in the time since the legislation was passed,” said Barbara Roper, director of investor protection for the Consumer Federation of America.
Dodd-Frank itself fosters uncertainty by requiring studies that will not be completed for another six months to a year.
The law requires the General Accounting Office to prepare three muni market studies. The first, which the GAO delivered to Congress in January, was a review of the role of the Governmental Accounting Standards Board, including its funding.
Earlier this spring, the SEC directed the Financial Industry Regulatory Authority to establish a reasonable annual fee to fund GASB, which previously relied on contributions from state and local governments.
FINRA is collecting comments on its proposed GASB funding plan, which would allocate fees among members firms based on municipal securities transactions reported to the MSRB. Comments are due Aug. 1. In addition, Dodd-Frank directs the GAO to analyze muni market trading and make recommendations for improving transparency, efficiency, fairness and liquidity.
The statute also requires the GAO to compare muni and corporate disclosure and evaluate the costs and benefits of requiring issuers to improve disclosure, including a repeal of the Tower Amendment, which prohibits the SEC and the MSRB from requiring issuers to file pre-sale disclosure documents.
But the statutory deadline for the GAO’s trading study is January 2012, which will be 18 months after Dodd-Frank’s enactment. And the disclosure study is not due until July 2012, on the statute’s two-year anniversary — further contributing to the muni industry’s Dodd-Frank malaise.
“I have a sense that nobody’s declaring victory,” said Johnsen. “Maybe we’d buy the cake, but we’re not going to light the candle.”
