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Reg Reform Bill May Not Cover Ratings

Senate Banking Committee chairman Christopher Dodd, D-Conn., is expected to unveil a revised financial regulatory reform bill by the end of the week, but it is not expected to include any changes to the municipal market-related provisions floated in the original version in November.

As a result, market participants said they will press the committee to add a “uniform rating” provision that was included in separate legislation passed by the House in December but not in the initial draft bill in the Senate.

A number of issuer organizations — including the Government Finance Officers Association, the National League of Cities and the National Governors Association — are pushing for the uniform-rating language, which generally would require rating agencies to rate municipal and other types of debt on the same scale. The groups also are getting support from large labor unions, like the Service Employees International Union.

Currently, munis are generally rated on a more rigorous scale than corporate debt, even though historically they have a much lower probability of default.

Though Moody’s Investors Service and Fitch Ratings have committed to migrating to a uniform scale, they halted those efforts at the height of the financial crisis. Moody’s has said that it plans to update the market on the status of its migration sometime during the first quarter.

However, sources said Moody’s historically has opposed any legislation that would mandate such a change. A Moody’s spokesman declined to comment and would only say, “We are committed to achieving comparability of our ratings to all other sectors including, corporate, sovereign, sub-sovereign and structured finance.”

Some critics of such a provision point out that Congress historically has refrained from mandating the content of rating methodology.

Standard & Poor’s says it has always used a single global scale for its ratings, though it has upgraded hundreds of credits as a result of an updated default study that revealed munis defaulted less than originally expected.

Lars Etzkorn, program director of the National League of Cities’ Center for Federal Relations, said that his group will continue to work the issue until the Senate votes on the bill and — barring its inclusion in a Senate bill — would hope to have the provision added during the conference between House and Senate negotiators.

Some dealer groups have also made the measure a priority. Michael Nicholas, chief executive officer of the Regional Bond Dealers Association, said his group plans to write a letter to key members of the Senate this week to urge that their bill include uniform ratings.

In addition, the RBDA plans to express strong support for other provisions in the November draft bill that would for the first time regulate independent financial advisers.

Under the provisions, all currently unregulated muni market intermediaries — including non-dealer financial advisers and guaranteed investment contract brokers — would have to register with the Securities and Exchange Commission and would be subject to Municipal Securities Rulemaking Board rules. The rules would be enforced by the SEC.

Industry groups like the Securities Industry and Financial Markets Association have long supported such regulation on the grounds that it would establish a level regulatory playing field between dealer and non-dealer FAs. They say non-dealer FAs are not subject to any professional conduct and qualification standards or pay-to-play restrictions.

Market participants said they also do not expect any changes to Dodd’s proposed regulations of over-the-counter derivatives, which would prohibit states and localities with less than $50 million in “discretionary investments” from serving as an eligible contract participant in derivatives transactions like interest-rate swap agreements.

The measure would likely shut down the muni derivatives market, several market participants have said, but it is unclear if that is the intent of lawmakers working on the bill.

A related measure in the House bill is much less restrictive. While it includes a similar $50 million threshold, it would not apply if a state or locality’s counterparty is a bank or securities dealer, which virtually all muni swap counterparties are.

Both bills also would make the MSRB a majority public self-regulatory organization, requiring that at least eight of its 15 members consist of “public” officials. By statute, the board currently is dominated by 10 dealer officials.

Meanwhile, though Dodd suggested in a comment letter filed with the Securities and Exchange Commission this month that he may seek to give the MSRB oversight over pension fund placement agents, market participants have said that he is not expected to include this in the bill.

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