WASHINGTON — Certain municipal bonds will qualify as high-quality liquid assets within days following action by federal banking regulators Wednesday, a victory for muni issuers and bankers who pushed for HQLA recognition for years.
The Federal Reserve, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corp. announced Wednesday afternoon that they were issuing an “interim final rule” to allow investment-grade munis that are “liquid and readily marketable” to qualify as level 2B HQLA.
The rule becomes effective upon publication in the Federal Register, which typically takes about three business days.
The rule change was required by the Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018, which President Donald Trump signed into law in May.
The issue is important to the muni market because without being able to qualify as HQLA, banks have less incentive to hold muni debt.
The rule change followed a struggle that began in 2014, when the regulators adopted Liquidity Coverage Ratio rules to 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 liquidity coverage ratio — the amount of HQLA to total net cash outflows — to deal with periods of financial stress.
All of the bank regulators initially excluded munis as HQLA in the LCR rules because they believed they were not liquid. Muni market groups protested.
The Fed later revised its rules, but its muni HQLA provisions were seen by many in the market as too restrictive. Specifically, they allowed only general obligation bonds to count as HQLA and 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.
Muni groups had been concerned that the Fed’s rule would be applied by the other regulators following the passage of the law, but the rule as amended and released on Wednesday contains no such restrictions and overwrites the Fed’s previous rule.
The rule will now allow many revenue bonds, including private activity bonds in some cases, to qualify as Level 2B HQLA. These munis will be treated the same level as mortgage-backed securities.
Emily Brock, director of the Government Finance Officers Association’s Federal Liaison Center, said that the GFOA is happy to see a rule change that treats munis the same as other assets.
“We are definitely pleased,” said Brock.
Michael Decker, a managing director and co-head of munis at the Securities Industry and Financial Markets Association, also hailed the rule change.
“It is especially important that the agencies determined that municipal securities, including revenue bonds, will be treated like other level 2B HQLA as long as they are investment grade and liquid and readily marketable,” Decker said.
Bond Dealers of America Chief Executive Officer Mike Nicholas thanked the regulators and said the BDA would be commenting on the final rule, particularly the definition of “liquid and readily marketable.”
“While the BDA believes municipal bonds deserve the classification of level 2A liquid assets due to the long track record of safe investment, treatment of eligible municipal securities as level 2B is a step in the right direction to continue leveling the playing field and making municipal bonds a more attractive investment,” Nicholas said.
The National Association of State Treasurers released a statement touting the importance of the change for the muni market.
“The National Association of State Treasurers is pleased that the past four years of advocacy and education have paid off," NAST said. "We are very grateful to the Federal Reserve, FDIC, and OCC for taking the actions necessary to strengthen the municipal bond market, which will lead to lower borrowing costs for public infrastructure projects and result in savings for state and local governments and taxpayers. This could not have been achieved without our partners in Congress, leadership in the regulatory agencies, and our other allied associations working for our taxpayers.”
