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munibonds.md

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Muni bonds

  • How can you pass along the interest payments to bondholders?
  • Can you issue a bond without interest payments or no

According to the Securities and Exchange Commission (SEC), one-third of municipal bonds trade once after initial issuance; the remaining bonds trade two or three times during their lifetimes, and 5% of all municipal bonds may trade once every 12 years. (CRS IF11969)

Muni bond secondaries are intermediated by muni B-Ds

Additionally, dealer markups, the commission paid to broker-dealers to facilitate municipal trades, may be excessive if retail investors have information disadvantages. Unlike broker-dealers, retail investors are less likely to have access to electronic pricing information about past transactions. Efforts to increase market transparency, therefore, may enhance liquidity and increase the overall willingness to hold (and trade) municipal bonds.

more stats

3.8m txns were <$25k. Daily averages: $11.3b ADTV, 41.2k trades, 15.2k unique securities Corporate bonds: $20.6b ADTV on 11.5tn in issuance and 50k bonds. "Flow of funds" data, Federal Reserve

Regulatory structure

  • MSRB is an SRO made up of all muni B-Ds as well as muni advisors, who earn fees for advisory services.
  • Its rules are approved by the SEC
  • It has no enforcement authority; supervision and enforcement of non-bank muni B-Ds is done by FINRA. All muni B-Ds (1800) are FINRA members (FINRA has 4400 members).
  • No unified market: The MSRB Rule G-14 requires dealers to submit transaction data 15 minutes after execution of a municipal securities trade, with limited exceptions.
  • Issuers still subject to antifraud securities rules, i.e., you have to tell the truth.
  • Disclosure currently placed on the underwriter, who either buys securities from the issuer directly or solicits the sale of the bond to others. Underwriters must review an official statement 'deemed final' in order to fulfill their antifraud obligtaions. Underwriters are also prohibited from underwriting a bond issuance where the issuer has not committed to making continuing disclosures. The issuer itself has no regulatory obligations other than not lying.
  • the MSRB only regulated muni B-Ds, Ds, and municipal advisors. "Municipal advisors" includes people giving advice to a municipality but excludes lawyers giving traditional legal advice, RIAs.
  • "Municipal advisor" = "solicitation of a municipal entity or obligated person" and must include fact that advisor is receiving "direct or indirect compensation."
  • Munis can voluntarily submit disclosures to EMMA

the issues

  • Disclosure: while you want disclosure, are you accusing Gary, Indiana of defrauding retail investors? SEC 2012: "Historically, municipal securities have had significantly lower rates of default than corporate and foreign government bonds."
  • Muni dealer "fair and reasonable price" -- "Rule G-30(a) requires both that the (1) total transaction price to the customer be reasonably related to the market value of the security and (2) mark-up or mark-down not exceed a fair and reasonable amount." Not the "best execution" standard of equity and corporate debt markets.

the opportunity

  • Very large market: $3.2 tn in debt outstanding as of June 2021.
  • Very fragmented, long-tail market: In 2011, $3.7tn issuance, >1m bonds outstanding, 44k state and local issuers, $3.3tn in trading value in 10.4m transactions.
  • Infrequent secondary market trading + poor liquidity: "The municipal securities market is characterized by relatively low liquidity and, following the initial distribution period, municipal securities trade only infrequently. For example, in 2011, about 99% of outstanding municipal securities did not trade on any given day" (SEC 2012).
  • Poor investor protections: legacy, intermediated, fragmented system means investors may not have accurate prices > need to trust the dealer to provide a fair, competitive price (dealer earns money on commission)
  • HIGH FEES: 0.98% on trades of $20k, 1.98% on trades of $20k, compared to 1.24% for corporate bonds and 0.4% for equities (see Lawrence E. Harris and Michael S. Piwowar, Secondary Trading Costs in the Municipal Bond Market, J.FIN., at 1379). Estimated average dealer markup for trades is 1.77%-2.0%. (“Li and Schürhoff, Dealer Networks”), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2023201.
  • High retail ownership: retail owned 75% of all muni bond issuance (SEC 2012).
  • New audiences for municipal debt: Young people, people living outside of a city or state -- there is probably a lot of interest in investing in safe, purposeful municipal debt... give people access and it will reduce the cost of issuance, zero doubt.

The market structure

  • "Broker's brokers" (BBs) = people who connect dealers via electronic and voice means. (SEC 2012, p. 129). Do not typically take securities into inventory.
  • There are ATSs which make up a large percentage of trades (30-50%) but a very small percentage of volume (5%) (SEC 2012, at 118).
  • ATSs include themunicenter.com and BondDesk Trading LLC. TradeWeb LLC, Knight BondPoint, Schwab Bond Source, Bonds.Com, Inc., and HTDonline. Broker’s brokers that provide such electronic access to other municipal bond dealers include Wolfe & Hurst Bond Brokers, Inc. and Regional Brokers, Inc.
  • ATSs and BBs tend to be offer-side only. For bids, they support RFQs.
  • On pricing: trading interest on muni ATS is only available to members, sometimes large institutions. Not available to non-participants.
  • "True price" is inferred by a yield curve published by a credit rating agency: the Municipal Market Advisors AAA Median Municipal Benchmark or the Thomson Reuters’ Municipal Market Data Group AAA-rated General Obligation Municipal Yield Curve.
  • Because there is no market price, investors will pay a pricing service (S&P, Interactive Data, Bloomberg, Markit) to value a portfolio or a trade.
  • Retail is on an '(inequal) information footing with municipal bond dealers' (SEC 2012, fn. 731)
  • Pricing is important to retail because they may get one valuation on their monthly statement but that value will not reflect the value they would obtain when selling
  • Retail can technically access pricing information, yield curves, estimated prices, prior trades, but retail investors may not (1) have the expertise to use it effectively, (2) may not want to pay the fees to access the information. It may be very hard to assemble accurate information because of outdated systems: (1) can't do attribute search in EMMA to find similar securities, (2) results returned as PDFs not searchable text (SEC 2012, at 137-138).
  • Addition of post-trade transparency reduced price dispersion (but not spreads). See SEC 2012, fn. 752.
  • "In the decentralized municipal securities market, extensive intermediation by multiple dealers may be required to find a willing counterparty, with each intermediary extracting compensation for its efforts" (SEC 2012, at 140). See Li and Schürhoff, Dealer Networks at 10.

Components of rollout

  • The issuer should voluntarily, or to fulfill its antifraud obligations, make initial and continuing disclosures that are not fraudulent.
  • Support from a state government + Senators and Representatives in Congress
  • Document describing regulatory changes that would be helpful
  • Support from academics who have studied issues in the municipal securities market
  • Support from an SEC commissioner, with a focus on investor and market benefit
  • identification of new areas of business for muni B-Ds, underwriters, and advisors? briefings for muni advisors?