Commentary: 2014 Regs in the Muni Securities Market: What's in Store?

FAYFOTO/Boston

We are only a few months into 2014, and The Bond Buyer's forecast for key muni regulations in 2014 appears relatively sound. With much of the angst around the debt ceiling silenced until 2015, Congress is unlikely to focus much on the municipal securities market, which means that the tax exempt status of municipal debt is unlikely to be threatened in the near term. With that said, regulator cross hairs remained trained on the municipal market. Municipal advisor rule guidance from the SEC was the first shoe to drop in 2014; it surely won't be the last. Here are a few other areas where regulators are likely to impact the municipal securities market this year:

• MUNI RESIDUE FROM THE VOLCKER RULE FRYING PAN - Municipal bond participants breathed a big sigh of relief at the end of 2013 when the finalized Volcker Rule permitted banks to invest in securities issued by states, localities and government agencies. However, when the Volcker rule goes into effect in July 2015, it will prohibit banks from owning tender option bonds (TOBs), which institutions can utilize to invest in high-quality municipal bonds, among other long-term investments. While it is unlikely that regulators will amend the rule to exclude TOBs, market participants are likely to use the interim period to determine how best to meet the regulatory and business requirements involved with TOBs.

• OUT OF THE FRYING PAN BUT INTO FIRE? While munis were largely spared from inclusion in the Volcker Rule, banking regulators (the OCC, the Fed, and the FDIC) are advancing liquidity coverage ratio requirements in conjunction with Basel III and this requirement currently excludes municipal securities from the definition of high quality liquid assets (HQLAs). As detailed by Bond Buyer, by excluding munis, banks may become reluctant to participate in and support the municipal securities market. The industry has marshalled its forces as industry groups (SIFMA, the Bond Dealers of America, etc.), banks, and municipal issuers nationwide call for regulators to treat municipal bonds as a higher quality asset.

• READY, AIM, FIRE: BEST EXECUTION - In July 2012, the SEC issued its report on the municipal securities market in which the agency recommended that the MSRB should consider a rule that would require municipal bond dealers to seek 'best execution' of customer orders for municipal securities. In the late summer / early fall of 2013, MSRB tested the waters with a request for comment on whether to require dealers to adopt a "Best Execution" standard. In mid-February 2014, the MSRB requested comment on a Draft Best Execution Rule. The proposed rule seeks to harmonize with key elements of FINRA's Rule 5310 for equities and corporate debt while also attempting to tailor certain principles to address the unique characteristics of the municipal securities market.

• BANKING ON FEDERAL SUPPORT: President Obama's State of the Union address in late January called for Congress to approve measures that expand funding for infrastructure improvements. Industry insiders view this as a push for the establishment of a federal infrastructure bank, which could provide tens of billions of dollars in loan guarantees to finance the expansion of ports and repair and construct major roads and bridges. Currently, legislation is pending in both the House and Senate which would mirror many of the White House proposals for a federal infrastructure bank. However, none of this legislation has yet advanced past the introductory stage so it will likely take time for this to progress further.

• BLINDED BY THE LIGHT: INCREASING TRANSPARENCY - In early February 2014, the SEC published for public comment its Draft Strategic Plan that outlines the agency's strategic goals for fiscal years 2014 to 2018. The agency outlined more than six dozen initiatives intended to improve its efficiency and effectiveness. Included within this framework is an initiative to enhance the market structure for fixed income securities by pursuing many of the recommendations highlighted in the above mentioned July 2012 report. This effort will include initiatives aimed at promoting transparency and the development of new mechanisms to facilitate the provision of liquidity, as well as initiatives to improve the execution quality of investor orders. Related to this, the MSRB continues to advance its long-range transparency plan. Last year, the municipal securities regulator published a concept release on pre-trade and post-trade pricing data dissemination. As the MSRB evolves its Real-Time Reporting System and Electronic Municipal Market Access (EMMA) website, individual and institutional investors alike should stay tuned for new content, features and functionality that can help them better understand the key drivers behind trading activity in the municipal securities market.

As regulators make more progress on these and other muni mandates in 2014, investors will need to adjust to keep pace as these initiatives are likely to impact the municipal securities market participants not only this year but for many years to come.