WASHINGTON – The Municipal Securities Rulemaking Board has proposed guidance on how municipal securities dealers should price bonds and calculate their compensation.
The guidance, in the form of proposed amendments to Rule G-30 on prices and commissions, would tell broker-dealers how to establish the prevailing market prices of munis and how to calculate mark-ups and mark-downs (compensation) for principal transactions, in which they are buying munis for, or selling munis from, their own account.
The board has asked for public comments to be submitted on the proposed rule changes by March 31. It also plans to host an educational webinar on the guidance on Thursday, March 10, at 3:00 pm.
"Today's draft pricing guidance is a major step in the MSRB's effort to ensure investors are getting a fair price when buying and selling municipal bonds, and ultimately, that they better understand the cost of their transactions," said MSRB executive director Lynnette Kelly. "We are eager to continue our momentum on advancing these important issues in coordination with other regulators."
The draft is designed to harmonize the MSRB guidance with that established by the Financial Industry Regulatory Authority for other fixed income securities to the extent appropriate giving the differences between the markets, the board said.
The FINRA guidance has been in effect since 2007 for corporate debt and currently applies to agency debt as well as Treasury securities, sources said. It took 10 years for FINRA to get it approved by the SEC, they said. This is why the MSRB used the guidance as a starting point. But the board stressed it wants to tailor the guidance to take into account the differences between the muni market and these other markets.
The board's Rule G-30 generally requires a dealer to buy munis for its own account from customers, or sell municipal securities from its own account to customers, at an aggregate price that is "fair and reasonable." The transaction price to the customer must bear a reasonable relationship to the prevailing market price of the security. In a principal trade with a customer, the dealer's compensation must be computed from the interdealer market price prevailing at the time of the transaction.
Rule G-30 also obligates dealers to exercise reasonable diligence in establishing the market value of muni securities and the reasonableness of their compensation. Therefore, it is possible that a dealer could charge reasonable compensation but violate G-30 because it has not paid attention to the market value of the security.
The MSRB's Rule G-15 on confirmation, clearance, settlement and other uniform practices requires dealers to disclose on customer confirmations the amount to be received from the customer when the dealer acts as an agent, someone who acts on behalf of the customer. But there is no requirement on the disclosure of markups or markdowns when the dealer acts as a principal, buying or selling for its own account.
Like FINRA, the MSRB proposes a "waterfall" of factors that dealers should look at to determine the prevailing market price of a muni security.
First, dealers should look at their contemporaneous trades of the same muni security with other dealers or customers to establish a presumption of prevailing market price. The prevailing market price should not differ if the dealer trade is with another dealer or a customer.
If the dealer believes contemporaneous trades are not representative of market value, they can rebut the presumption of that the trades determine the prevailing market price by showing changes in interest rates, the credit quality of the debt, or news that has changed the market's perception of the market value of the security.
If the dealer does not have any contemporaneous trades of the muni security, it can look at contemporaneous trades of the muni security among other dealers. If it fines none, it can look at trades of that muni security between other dealers and institutional investors with which the dealers regularly trade that same security. If there are none, the dealer can look at alternative trading systems, or other electronic platforms, where trades occur at displayed quotations.
If there are no contemporaneous trades in the muni security or quotes for it, the dealer can look at contemporaneous trades of similar securities. A muni security would be similar if it has a comparable yield. To see if a security is similar, the dealer would look at features, provisions, or technical factors that could affect the yield in the same way such as credit quality, spreads, maturities, call dates of tax treatment.
The MSRB cautions dealers against relying on isolated transactions or quotations, saying they should be given little or no weight in determining the prevailing market price.
As a last resort, dealers could base determinations on economic models that apply the "waterfall" concept and take into account such things as credit quality, interest rates, industry sector, maturities and call provisions.
For principal transactions, the dealer's compensation would be the amount it charges over the prevailing market price when selling bonds and the difference between what it pays and the prevailing market price when buying bonds.
