WASHINGTON – The Municipal Securities Rulemaking Board on Wednesday released guidance in a question-and-answer format on rule changes that next year will require dealers to disclose their markup and markdowns on certain transactions.
The requirements, which stem from changes to MSRB Rules G-15 on confirmation and G-30 on prices and commissions, are set to take effect on May 14, 2018. They received Securities and Exchange Commission approval on Nov. 29, 2016 even though dealers were concerned that the proposed markup disclosures would be more complicated and harder to comply with than realized by regulators.
The MSRB’s 24-page guidance document may be updated over time as the MSRB interfaces more with dealers. The self-regulator also plans to hold a half-day seminar here on Nov. 2 to give dealers the opportunity for an in-depth discussion of the markup disclosure and prevailing market price requirements. It may host another half-day session after that if the need is there, according to the board.
“By offering additional guidance with nearly a year remaining for firms to prepare, the MSRB aims to facilitate the industry’s adoption of this historic new level of price transparency for retail investors,” said MSRB executive director Lynnette Kelly. “Today’s guidance is one example of the MSRB’s renewed commitment to supporting regulated entities’ compliance with new and existing standards of conduct.”
She added that firms can expect to see additions to the FAQs as more questions on the markup rule arise, as well as best practices and other compliance resources on a variety of topics in the months ahead.”
The changes to Rules G-15 and G-30 will require a dealer, which buys or sells munis for or from its own account to a retail customer and engages in one or more offsetting transactions on the same trading day in the same security in an amount that in aggregate equals or exceed the size of the customer trade, to disclose its markups and markdowns in the confirmation it sends the customer. Markup disclosures will have to be given as a total dollar amount and a percentage of the prevailing market price.
There are three exceptions to the rule under which markup disclosure will not be required: an offsetting trade done by a functionally separate trading desk; primary market trades at the list offering price; and trades of municipal fund securities.
The amendments also establish a waterfall of factors for determining prevailing market price, which dealers are to use to calculate their compensation. Dealers initially are to look at their contemporaneous trades of the same muni with other dealers or customers to establish a presumption of prevailing market price. They will then make a series of other successive considerations if that data is not available. They can look at contemporaneous trades of the muni in interdealer trades, then trades of the muni between other dealers and institutional investors, then trades on alternative trading systems or other electronic platforms.
Further down the waterfall, firms could look at contemporaneous trades of similar securities. The MSRB included a list of "non-exclusive factors" like credit quality, size of the issue, and comparable yield that can be used to determine if securities are similar.
The bottom of the waterfall allows dealers to use prices or yields derived from economic models.
The FAQ guidance document is broken down into four sections: when markup disclosure is required; the content and format of markup disclosure; determining the prevailing market price; and the time of execution and security-specific URL disclosures.
The section on when disclosure is required explains the need for markups when the transaction is with a non-institutional customer and reminds dealers that markups are only required to be disclosed when a customer trade offsets a same-day principal trade in whole or in part. However, the self-regulator told dealers that they can voluntarily disclose markups more often than required if they wish.
The section also clarifies that if a dealer’s offsetting principal trade is executed with one of the dealer’s affiliates and does not occur at “arm’s length,” the dealer is required to “look through” to the time and terms of the affiliate’s trade with a third party to determine whether the markup disclosure requirements would be triggered. If the transaction is at arm’s length, then the dealer would treat the transaction as if it were any other offsetting transaction. Arm’s length is defined as a transaction conducted through a competitive process in which non-affiliate firms could also participate, and where the affiliate relationship did not influence the price paid or proceeds received by the dealer.
The guidance makes clear to dealers that they are, among other things, allowed to give context about things like their methodology when providing a markup as long as the statements are accurate and not misleading. However, dealers will not be able to label the markups as “estimated” or “approximate.”
Dealers designing a method to comply with the prevailing market price determination requirements should do so while ensuring they are following reasonable policies and procedures that are align with Rule G-30 and consistently applied, the MSRB stressed in the guidance.
The MSRB also said that it understands that dealers may use different processes for generating customer confirmations and also may conduct the analysis to make the prevailing price determination at different times.
“Dealers may base their markup calculations for confirmation disclosure purposes on the information they have available to them (based on the exercise of reasonable diligence) at the time they systematically input relevant transaction information into the systems they use to generate confirmations,” the MSRB said. That means that a dealer could determine prevailing market price at the time of trade or at the end of the day, but must ensure that the timing is applied consistently.
Dealers also won't be required to cancel or correct a confirmation if events occur after the prevailing market price has been determined that might contribute to a different determination.
“Once the dealer has input the information into its confirmation generation systems, the MSRB does not expect dealers to send revised confirmations solely based on the occurrence of a subsequent transaction or event that would otherwise be relevant,” the board said.
The last section of the guidance explains that the time of execution and a security-specific URL will be required for all transactions. It also details how and where that information should be disclosed.