Don't discriminate against munis, groups tell bank regulators

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WASHINGTON – Three municipal market groups are urging bank regulators to treat tradable, investment grade municipal securities the same as all other Level 2B high quality liquid assets in revisions to Liquidity Coverage Ratio rules that they are to make by Aug. 22.

The groups – the Government Finance Officers Association, the National Association of State Treasurers, and the Securities Industry and Financial Markets Association – made the request sent Tuesday in a letter to officials of the Board of Governors of the Federal Reserve, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corp.

The letter comes after Congress in May passed legislation – the Economic Growth, Regulatory Relief, and Consumer Protection Act (PL 115-174) -- directing the bank regulators to revise their LCR rules by Aug. 22 to ensure tradable, investment grade munis are treated as Level 2B HQLA. The groups urged the regulators to meet that deadline.

The LCR rules, adopted in 2014, require banks with at least $250 billion of total assets or consolidated on-balance sheet foreign exposures of at least $10 billion to have a high enough LCR – the amount of HQLA to total net cash flows – to deal with periods of financial stress.

But bank regulators excluded munis as HQLA believing they were not very liquid. Muni groups told the regulators at that time that they misunderstood munis and that the rules would increase borrowing costs for state and local governments and lead to higher volatility in the muni market.

The concerns prompted the Fed to revise its LRC rules in April 2016 to count some munis as Level 2B HQLA if they met the same liquidity criteria that applies to corporate debt.

But muni market groups felt the rule changes were too restrictive and noted they didn’t apply to any other Level 2B HQLA.
Under the restrictions, only general obligation bonds -- not revenue bonds -- were eligible for HQLA status. The rule changes limited the amount of securities issued by a single issuer that a bank could include as eligible HQLA to two times the average daily trading volume of that issuer. In addition, munis could comprise no more than 5% of a bank’s overall HQLA.

The Fed rule changes were not adopted by the other bank regulators. But the three muni groups appear concerned that the Fed restrictions might now be applied to munis across the board by all of the bank regulators implementing the new law.

“None of these types of restrictions applies to any other eligible HQLA assets,” the groups told the bank regulators.

“Under the prevailing LCR rules, “liquid and readily marketable securities” are defined as having: “more than two committed market makers; a large number of non-market maker participants on both the buying and selling sides of transactions; timely and observable market prices; and a high trading volume,” the groups wrote.

Most investment grade munis meet this definition, they told the regulators.

Congress expects regulatory changes to be made that “provide … a meaningful and workable application of the LCR rule to municipal securities,” the groups said.

“As you all begin to work through your rulemaking response to the Act, our recommendation is to treat municipal securities exactly like other Level 2B assets are treated under the rule,” the groups told the bank regulators, adding, “There is no practical justification for any other approach.”

The letter was signed by Emily Brock, director of the Government Finance Officers Association's federal liaison center, Shaun Snyder, executive director of the National Association of State Treasurers, and Michael Decker, managing director and co-head of the municipal securities division at the Securities Industry and Financial Management Association.

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