MSRB Potential Rule Changes

By Tedra DeSue

Two key efforts by the Municipal Securities Rulemaking Board (MSRB) could bring significant changes to how much information and access individual investors can have to the municipal bond market.

One of these efforts addresses investors being informed of any bank loans state and local governments have taken out. The other deals with loosening the constraints placed on individuals that can prevent them from being able to invest in larger and/or complex deals.

The MSRB wants state and local governments that issue municipal securities to make information about any bank loan financings more accessible to investors. The MSRB wants the information to be available its Electronic Municipal Market Access (EMMA®) website. This website already provides free municipal documents and data, such as official statements, continuing disclosure documents, interest rate resets and daily market statistics.

Adding information about bank loan financings would further enhance the ability of bondholders, potential investors and other market participants to access key information about bond deals they need to make informed investment decisions.

The MSRB notes that bondholders currently do not have easy access to certain terms and conditions of bank loans that could negatively affect them if an issuer’s loan goes south. For example, the loan may require the acceleration of debt repayment if the issuer encounters financial stress. Also, the terms of the bank loan may create parity or a senior position with the issuer’s other outstanding debt.

The need for this type of measure is even more important now as more issuers are taking out bank loans to finance their capital needs instead of selling bonds. For many issuers, their credit has deteriorated, making it difficult to attract buyers to their deals without having to pay higher interest rates.  Typically, bondholders and investors have not been privy to information about an issuer’s  bank loans. If the issuer runs into paying off their bank loan, bondholders may not readily learn about it. This is problematic because such failures can be warning signs about the issuer’s solvency.

While observers agree that the move is admirable, there are concerns about how effective it will be considering issuers won’t be required to submit the information. The MSRB is requesting issuers to submit the information on a voluntary basis.  A gripe about the MSRB’s move is that unless timely disclosure is mandatory, it is useless, especially when it comes to leveling the playing field for all investors. Observers also point to other types of financings that can fly below the investment radar screen, such as private placements. This kind of information may be included in the issuers’ comprehensive annual financial report, but it is usually dated by then.  Also, some investors believe that issuers should disclose bank loans prior to taking them out, not afterwards.

The second effort recently embarked upon by the MSRB involves those who are referred to as “sophisticated municipal market professionals” or SMMP. The MSRB has requested approval from the Securities and Exchange Commission (SEC) to redefine who is considered to be a savvy enough investor to independently evaluate the investment risks and the market value of municipal securities.

According to the MSRB, the definition needs to be changed because investors have access to more information to make informed decisions, such as through databases like EMMA than they did 10 years ago when SMMPs were first defined.  “The quality and availability of information concerning municipal securities has improved substantially in recent years and sophisticated municipal market professionals have a greater ability to make investment decisions on their own,” said MSRB Executive Director Lynnette Kelly in a statement released last week.  She added that the proposed revision would provide important regulatory consistency with a new Financial Industry Regulatory Authority (FINRA) rule on suitability for institutional customers.

If approved, an SMMP would be defined as an institutional customer of a dealer that the dealer believes is capable of evaluating investment risks and market value independently. Also, the investor must affirm that they are exercising independent judgment in evaluating the recommendations of their dealer.

The MSRB is requesting that the change become effective in July if it is approved.

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