NEW ORLEANS – The Municipal Securities Rulemaking Board's proposal to require dealers acting as principals to disclose their markups and markdowns on retail confirmations would add complexity to the market and subject dealers to significant costs, dealers and others said here on Thursday.
The market participants spoke during a panel on markups at The Bond Buyer and Bond Dealers of America 2016 National Municipal Bond Summit.
Michael Marz, vice chairman of Hilltop Securities, Inc., said the "frustration factor" on the markup proposal is "off the charts," citing the difficulty his firm, which clears for 450 broker-dealers, and others would have monitoring and reviewing trades to comply with the proposed changes to Rule G-30 on prices and commissions. "At the end of the day to go back and compare CUSIPS to find out if they were traded within two hours, I'm not sure if the [process] necessarily exists [for that] nor is there existing space on the confirm to add markup disclosure," he said.
Chris Melton, executive vice president of legal and compliance for Coastal Securities, Inc., said the rule's imposed timeframe will have an unintended consequence of "ensur[ing] that all retail clients get stale, expensive bonds."
The proposal also has the potential to be the most costly for dealers to implement out of all the new regulations they face, according to Tom Vales, chairman and chief executive officer of TMC Bonds, an alternative trading system, who moderated the panel.
Under the MSRB's markup proposal, a dealer buying or selling bonds for its own account would be required to, among other things, disclose the markup or markdown on a customer's confirmation when: it executes a transaction on the same side of the market as the customer; the transaction is greater than or equal to the size of the customer's, and: the dealer transaction occurs within two-hours of the customer transaction.
The MSRB would limit the proposed rule changes to the secondary market by excluding transactions in new issue securities executed at the list offering price by members of the underwriting group.
The MSRB first proposed requiring markups on retail confirmations in September 2015, at which time they talked about harmonizing their rule with one being developed by the Financial Industry Regulatory Authority. Both self-regulators have been vocal about their coordination since September, but the rules put out for comment differed from each other, most notably in the window of time covered with FINRA proposing a same-day limit.
The MSRB released its proposal after four of five Securities and Exchange Commission commissioners made a joint statement in August saying they support a markup disclosure rule for retail transactions in the muni market. SEC chair Mary Jo White was not included in the statement but had also expressed support for a markup rule.
Since September, the MSRB has put its markup rule on hold while moving forward with a proposal for determining prevailing market price and markups. FINRA, which already has a prevailing market price procedure, approved its own markup rule for submission to the Securities and Exchange Commission, leading Vales to question how the two self-regulators can say they are still in coordination.
Peg Henry, deputy general counsel for Stifel, said the two self-regulators are likely having conversations with the SEC about the rule and trying to incorporate feedback. She said her personal guess is that FINRA's approval of filing the rules with the SEC will mean the MSRB proposal is going to end up going with a same-day window. She said she's most interested in what the MSRB decides to do with prevailing market price.
As it stands, that proposal would have dealers look at a "waterfall" of factors to determine prevailing market price, modeled on FINRA's standard. The dealers would have to start by looking at their contemporaneous trades of the same muni with other dealers or customers. If they do not have contemporaneous trades of the muni, they would then have to follow a series of steps that includes looking at contemporaneous trades of the muni among other dealers, electronic platforms where trades occur at displayed quotations, and contemporaneous trades of similar securities. If none of those work, they would look at economic models that take into account things like credit quality, interest rates, industry sector maturities, and call provisions.
Dealer groups have already told the MSRB they think the waterfall approach is too prescriptive for the municipal market and would create significant costs for dealers. Representatives from FINRA and the MSRB, speaking at an earlier panel, said the self-regulators plan to emphasize in future communications with the market that municipal securities dealers will not be expected to adhere to one uniform rule, but instead could create their own policies and procedures as long as they adhere to the overall rule.
"It is going to be really important on the muni side of this to get that prevailing market price correct," Henry said.
The panelists also said that different dealers are going to have different policies and procedures that lead them to calculate different markups for retail customers.
"The probability of that occurring is 100%," Marz said.
Henry added that there is a lot of judgment that goes into determining prevailing market price, meaning a customer could see two different markups for the exact same trade from two different dealers and not have a good basis for comparison.
Vales concluded the discussion by asking each panelist what one recommendation they have to change the rule. He said he would shorten the trading window that is covered even further from two hours, where it would still cover a large number of trades.
Marz said that "in a perfect world" he would like to see the rule apply only above a certain markup.
"Call it two points, [above that] you better have an explanation, documentation, contemporaneous prices, or another comparable benchmark," he said. "Beyond that, let the market operate as it is. Liquidity is strained as it is, let's not create more" strain.
Henry suggested the regulators "heavily streamline" the prevailing market price structure for munis to allow firms to jump from contemporaneous trades directly to more suitable methods instead of following a prescribed set of steps.
Melton advised the regulators to avoid trying to find technical violations of the rule because there will never be a way to perfectly define a markup. But he ultimately said he is resigned to the rule coming into effect.
"This is happening and all we can do it try to make it as innocuous as possible," he said.
