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Securities Law

Sirri: Investors Benefitting From RTRS

AUG 3, 2012 6:16pm ET
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WALTHAM, Mass. — Regulatory efforts to improve municipal bond pricing transparency have resulted in lower prices paid by retail buyers of munis, according to preliminary results of a study on muni pricing and trading being conducted by former Securities and Exchange Commission official Erik Sirri.

Sirri, a finance professor at Babson College and former director of the SEC's trading and markets division, was among roughly 15 academics and muni market professionals who spoke Friday at Brandeis International Business School's 2012 Municipal Finance Conference.

Speakers discussed a range of topics, including competition at credit rating agencies, the relationship between disclosure and market efficiency, and a new analytical tool to predict issuers' defaults.

"It's pretty clear that trading costs fell when transparency came to the bond markets," Sirri told the roughly 200 attendees at the conference. "There is every evidence that transparency is beneficial to trading in this market."

Sirri, who was commissioned by the Municipal Securities Rulemaking Board in April 2011 to conduct the study, said he has examined 47 million municipal bond trades in an effort to understand the impact on muni bond prices from improved municipal market transparency.

He said he examined changes in bond prices during chains of secondary-market transactions, starting with when a bond was sold from a customer to a dealer, and ending when another dealer sold the bond back to a customer.

The research showed that prices paid by retail investors declined after Jan. 31, 2005, the day the MSRB began requiring municipal bond dealers to report most trades to its Real-Time Transaction Reporting System within 15 minutes of execution.

After the 15-minute rule took effect, the cost of bonds fell about 50 cents per $100, a "fairly robust" decline, he said.

The median amount of the trades examined was $25,000, and the bonds traded an average of two-and-a-half times per year, he said.

Sirri said his research also indicates that a typical muni transaction now involves fewer dealers than in the past.

For instance, in 2003 and 2004, muni bonds passed through an average two-and-a-half dealers between when they were bought and sold by retail customers. Today, bonds pass through an average of 1.7 dealers, he said.

"It's as if a bond is more efficient at finding its way from customer to customer," he said.

Sirri said some market participants attribute the change to falling rates.

"When rates are low …you may just see dealers stepping back from participating in market," he said.

Sirri declined to comment further on the study, noting that his work is still underway. MSRB executive director Lynnette Kelly said she expects the study will be complete in about a month.

Another speaker Friday, Marc Joffe, a consultant at San Francisco-based Public Sector Credit Solutions, discussed a new, open-source analytic tool that he said can better predict defaults on general obligation bonds.

Joffe gathered muni bond default data from as far back as the 1920s and developed software that can analyze issuers' health. The "open-source" software, which can be downloaded at www.publicsectorcredit.org, works by analyzing a range of demographic and economic data, such as a state's birth rate forecast and home price depreciations. It then calculates financial ratios, such as interest-to-revenue ratios, which can help predict defaults.

The data must be manually entered, which Joffe admits is time-consuming. But he said his system takes a more scientific approach than rating agencies.

"It appears that what rating agencies do is largely qualitative. [They] don't put numbers together in a model," Joffe said.

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