Markup disclosure's first birthday

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WASHINGTON — A year-old pair of rules requiring dealers to disclose markups and markdowns to some customers has improved transparency without disrupting trading practices, the industry's primary regulator said.

Tuesday marked the one-year anniversary of the effective date of amendments to Municipal Securities Rulemaking Board rules G-15 on confirmation and G-30 on prices and commissions, which require dealers to disclose their markups and markdowns on certain transactions in the confirmations they send to retail customers. Though this “markup rule” caused technological headache for many dealer firms, the MSRB said it isn’t clear that the rule has changed the sizes of markups or disrupted dealer business practices.

“We heard it was difficult getting there, but we didn’t hear a lot about significant problems or concerns,” said John Bagley, MSRB’s chief market structure officer. “There don’t appear to be unintended consequences.”

Firms have to provide markup disclosures both as a total dollar amount and as a percentage of the prevailing market price, commonly referred to as the “PMP.” The amendments established a “waterfall” of factors for determining the PMP, beginning with contemporaneous trades of the same security and followed by series of other considerations. A dealer must disclose markups or mark downs from a transaction if it also executes one of more offsetting principal transactions on the same trading day in an aggregate size that is the same or exceeds the size of the customer trade.

The calculation of the PMP and the integration of that information into automated confirmation generation processes was a big part of what vexed the industry in the run up to the effective date and in the months after. Many firms hired one of several third-party vendors to provide PMP calculation products for them, while others chose to build solutions in-house.

Michael Ruvo is the CEO of BondWave, one of those companies who developed PMP calculation products. Ruvo told The Bond Buyer that he and representatives of competing PMP product providers were invited to visit the Securities and Exchange Commission and the MSRB to discuss markup disclosure this week. Ruvo said he thinks the industry is in the process of adjusting its markup disclosure procedures based on the first wave of regulator audits over the past year.

Those initial audits focused on whether or not dealers had put compliance systems in place, Ruvo said, but regulators now appear to be getting more detailed in their evaluations.

“They’re starting now to dig deeper down into the process,” said Ruvo.

BondWave data provided to The Bond Buyer showed that 52% of markups were in the 0%-1% range, 36% were in the 1%-2% range, and only 6% were in the 2%-3% range. Markdowns of -% to 0% and markups/markdowns falling outside any of those ranges combined to account for only 6% of all transactions analyzed by BondWave.

Bagley said that the MSRB is working on studies analyzing the impact of the markup disclosure requirements, and that those could be out as soon as late summer. Bagley said he is aware that trading spreads have declined, but it would be difficult to say to what extent the rule might be responsible, because spreads had already been declining before the effective date.

“The intention of the rule was transparency,” Bagley said. “The market really looks the same.”

Nat Singer, senior managing director at Swap Financial Group, was MSRB chair during the board’s 2016 fiscal year. Singer said the challenge the MSRB faced was satisfying the SEC, which wanted fulsome disclosure.

“We got a lot of pushback from the industry at the time, but we knew this was something that had to be done,” Singer said. “It hasn’t been disruptive to the business,” he continued. “It’s providing retail investors with transparency, and that’s important.”

Singer said most large firms have effectively policed their markups in recent years, muting the observable impact of the requirements. They have an incentive to do so because the Financial Industry Regulatory Authority has long had the authority to penalize dealers for markups that are “unreasonable.”

Singer said the next steps are getting retail customers to pay closer attention to their confirmations, and expanding the markup disclosure to more types of transactions. Singer said the SEC was clear about its intent to expand the disclosures.

“Disclosing markups on same-day trades was just the first step,” he said.

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