Sifma Issues Muni Bond Due Diligence Standard

Terry Flanagan

The Detroit bankruptcy has brought attention to the state of the U.S. municipal bond market, and to compliance measures needed to help broker-dealers fulfill due-diligence duties when underwriting offerings of municipal securities.

Sifma has issued its proposed execution-with-diligence standard for municipal trading, following its initial proposal in June 2013 that an execution-with-diligence standard be applied to trades in municipal securities. This is a higher standard for dealers to meet than what is currently in place.

“Sifma’s proposal moves the industry forward in a robust way that further enhances standards so that customers receive fair and reasonable prices,” said David Cohen, managing director and associate general counsel. “The proposal recognizes the unique characteristics of the municipal market and would strengthen regulation in a manner consistent with the way the market operates.”

On July 19, the day after Detroit filed, yields on long-dated munis were up 11 basis points, according to Thomson Reuters Municipal Market Data. The market appears to be taking the bankruptcy, which had been anticipated, in stride.

“Despite recent events in Detroit, I believe the famously coined term ‘green shoots’ is an apt descriptor for the municipal bond market at this present time,” said James Colby, portfolio manager and senior municipal strategist for Market Vectors, a brand of ETFs sponsored by Van Eck Global. “Having been scorched by the wildfire correction that engulfed the fixed-income markets since the end of April, as evidenced by the sharp rise in interest rates, there now seems to be indication of a broadening of support for munis from the retail/registered investment advisor community.”

Since municipal bonds are not traded on a central exchange and there is no central aggregator of quotes, the execution standard in the municipal market cannot mirror that for equities.

The municipal securities market also has fundamental differences from other debt markets, including its diverse and fragmented nature, small securities trade sizes and far less frequent trading than corporate bonds. While supporting efforts to improve trade execution standards Sifma noted that due to the unique characteristics of the municipal market, there is not one path for dealers to take for execution with diligence.

Accordingly, it proposed a principles-based rule similar to Finra’s approach to corporate fixed income securities, but with modifications applicable to the municipal market. It would define “market” as encompassing those brokers, dealers, and municipal securities dealers that are known to trade in a particular security and would require periodic review of trading counterparties, which would be a new regulatory requirement.

To enact the recommendation, Sifma is encouraging the Municipal Securities Rulemaking Board (MSRB) to amend its Rule G-18 to reflect an “execution-with-diligence” concept of execution. In conjunction with its proposal, Sifma is also encouraging the MSRB to consider the short term and long term costs and potential benefit of any rule making before formally proposing any changes.

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