Issuers Ask if Issue Price Rules Will Limit Competitive Bond Sales

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WASHINGTON – Issuer officials who said Treasury's final issue price rules are a vast improvement over earlier proposals nevertheless raised concern that they might discourage competitive sales of bonds or create problems for issuers if underwriters run afoul of the rules.

Members of the Government Finance Officers Association's debt committee both praised the rules and asked about potential impacts during a meeting with John Cross, Treasury's associate tax legislative counsel, on Friday.

The final issue price rules were released on Thursday and published in the Federal Register the morning on Friday. Cross told committee members that issue price has been controversial in the tax-exempt bond market for a decade.

Under existing rules, which have been in place for years, the issue price of each maturity of bonds that is publicly offered is generally the first price at which a substantial amount, defined as 10%, is reasonably expected to be sold to the public.

But tax regulators became concerned that some dealers were "flipping" bonds -- selling them to another dealer or institutional investors who then sold them again almost simultaneously -- with the prices continually rising before the bonds were eventually sold to retail investors. The regulators worried that the "reasonably expected" issue prices for bonds were not representative of the prices at which the bonds were actually sold.

These final issue price rules, which would apply to bonds sold on or after June 7, 2017, contain several requirements to address the regulators' concerns.

First, they contain a general rule under which the issue price is the price at which the first 10% of a maturity of bonds is actually sold to the public.

Then there is a special rule, under which the issue price is the initial offering price (IOP) as long as the underwriter sticks with the IOP for bond sales during the five business days after the sale date (or a shorter period if 10% of a maturity of bonds is sold to the public at a price that does not exceed the IOP). The five-day, "hold-the-offering-price" provision is an anti-flipping or an anti-abuse provision. The lead underwriter must certify the IOP to the issuer, as well as provide documentation, such as the pricing wire. Each underwriter in a syndicate must agree in writing that it will not offer or sell the bonds at a price higher than the IOP for five business days after the sale date.

There is also a special rule for competitive sales, something that had been sought for by market participants. Under this special rule, an issuer in a competitive sale may treat as the issue price the reasonably expected IOP of the bonds to be sold to the public, as long as the issuer obtains bids for the bonds from at least underwriters. The issuer must also: disseminate the notice of sale in a manner reasonably designed to reach potential underwriters; give all bidders must have an equal opportunity to bid; and award the bonds to the bidder who offers the highest price or lower interest cost.

During the meeting, Eric Johansen, debt manager in Portland, Ore.'s Office of Management and Finance, asked if the special rule might discourage issuers from doing competitive sales for bonds out of fear they will not get the required three bids for advance refunding bonds. This would mean issuers would not immediately know the issue price, complicating efforts to buy yield-restricted state and local government series securities or Treasuries for the refunding escrows. Otherwise, he had no problems with the final issue price rules.

Cross said the three-bid rule as "a policy call" that Treasury and the IRS thought was necessary to ensure "the integrity of the competitive bidding process."

He said issuers can use any of these issue price rules. If the issuer doing a competitive sale doesn't get three bids, it can base the issue price on the sale of first 10% of the bonds. It can also treat as the issue price the IOP if the underwriters meet the five-day, hold-the-offering-price requirement.

Some debt committee members said, however, that if an issuer starts out with the special rule for competitive sales, doesn't get three bids, and then switches to another issue price rule, the underwriter will probably want more money.

Cross said that at past meetings, issuer officials had told him it wouldn't be hard to get three bids. "If I were in your shoes, I would continue to do competitive deals," he said.

Interviewed about the rules on Thursday, Cross had said, "As a policymaker, we think that competitive sales promote competition and price transparency and we wanted to provide a workable rule to accommodate this important market sector."

Issuers at the debt committee meeting also raised concerns that they would be the ones on the hook with regulators if a rogue underwriter that agreed to meet the five-day, hold-the-offering-price requirement but failed to do so and sold bonds at a higher price within the five days.

Cross said the Securities Industry and Financial Markets Association will have to incorporate the five-day, hold-the-offering-price rule into its model agreement (AUU) among underwriters to ensure syndicate members using that requirement will be bound by it.

But one of GFOA's advisors noted that issuers are not parties to the AAU. That led some committee members to suggest that the issuer could obligate the underwriter to meet the five-day requirement in the bond purchase agreement it signs with the lead underwriter to buy the bonds.

Mark Kim, chief financial officer of the District of Columbia Water and Sewer Authority, thanked Cross for taking debt committee concerns and comments into account in writing the final rules. Several other committee members agreed with Kim.

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