WASHINGTON – An economist and a financial advisor said Monday that pre-trade price transparency is sorely lacking in the municipal and that retail investors are getting hurt as a result.
But industry officials refuted their claims, saying this has not been the case in recent years since Municipal Securities Rulemaking Board has adopted rules on best execution, markup disclosure and brokers’ brokers that have taken effect.
The back-and-forth took place at the Securities and Exchange Commission’s Fixed Income Market Structure Advisory Committee meeting at a session called “Current State of Pre-Trade Transparency in the U.S. Municipal Securities Market.”
Abby Kim, a financial economist in the SEC’s Division of Economic and Risk Analysis, presented a paper that concluded retail investors in the municipal market receive muni prices that are worse than the best available quotes from dealers.
Retail investors would benefit the most if pre-trade prices were transparent and publicly available, according to the economists, which also included Louis Craig and Seung Won Woo.
The paper stressed in a footnote that these are the economists’ personal views and that they do not necessarily reflect opinions of the SEC or its staff.
The economists said that while the Municipal Securities Rulemaking Board’s Real-Time Transaction Reporting System provides post-trade prices and size of trades, because most munis trade infrequently, “the last trade information is often stale by the time of the next trade, providing less useful information to customers.”
Retail investors rely on dealer quotes to obtain information from the market to trading, but have less knowledge about the market and the quotes than dealers and institutional investors, they wrote in the paper.
“Academic studies have indicated that the lack of transparency and resulting information asymmetry between dealers and customers is one of the main drivers for high transaction costs for retail investors and lower market quality in this market,” the economists wrote.
Transaction costs vary across different types of bonds, but are consistently larger for customer trades than interdealer trades, the paper found.
Ric Edelman, founder of independent financial advisory firm Edelman Financial Services, said his firm stopped buying individual municipal bonds years ago because of the lack of transparency and now only buys mutual funds.
“It simply isn’t a level playing field,” he said, referring to the disparity in the pricing information obtained by dealers and institutional investors compared to retail investors.
Edelman says he’s found it “rather shocking” that the municipal market, which is huge with more than a million Cusips, “has such a poor level of pre-trade transparency” compared to every other security.
Retail investors, he said, “are outclassed, out-gunned, and out-sophisticated by the industry.”
Edelman also said retail investors don’t realize that muni bond prices can be negotiated.
But Bernie Costello, head of municipal trading at Morgan Stanley, took umbrage at the remarks by Kim and Edelman. He said things have changed since 2014, the date of the data in the economists’ paper data, and long after Edelman bailed from the muni market.
“We’ve had ground-breaking, sweeping” regulatory changes, Costello said, referring primarily to the SEC’s best execution rules, which took effect in March 2016 and require dealers to use reasonable diligence to seek the most favorable price available for their retail customers’ muni trades.
Other industry panelists agreed, also pointing to MSRB rules for broker’s brokers and more recently, its markup disclosure rules. The latter rules require dealers, which buy or sell munis for or from their own accounts and engage in one or more offsetting transactions on the same day in the same security, to disclose their markups or markdowns in the confirmations they send retail customers.
It was somewhat ironic that firms, which have fought against the MSRB on many of these rules, were touting them and lauding the board for approving them.
Costello also said he relies on historical trade data to see what a muni has been doing over time.
Chris Ferreri, chief operating officer of Hartfield Titus & Donnelly, said the industry has found solutions to the lack of widely available pre-trade price information.
He described Jersey City-based MuniBrokers, an online service that aggregates bond offerings and bid-wanted lists from 15 muni broker’s brokers and their customers. Subscriptions are available for $200 per month, he said.
Ron Valinotti, founder of Triangle Park Capital Markets Data, said that in the past, regional firms didn’t have the price and other trade data that the big Wall Street firms had.
“That’s changing,” he said. “We’ve seen it in pricing,” he said, adding that spreads are narrower now.
TPCMD has created the Municipal Bond Information Service (MBIS), which describes itself as a supplier of the largest set of muni pre-trade bids wanted and offering data available today. By including data from interdealer brokers and alternative trading systems, he said MBIS captures an average of more than 400,000 market quotes daily. And it also has an extensive historical data base.
MBIS recently partnered with The Bond Buyer to provide The Bond Buyer Data Workstation, which provides a wealth of trade and other information about the municipal market to subscribers.
Panelists were asked what they would like to see to improve pre-trade transparency.
Edelman said, “We concerned about the ability of some of these bonds, on the revenue side, to … deliver.”
He also said he would like to see some sort of tax equivalent yield, so that investors realize that it may make more sense for them to hold munis from their own state from a tax standpoint. States often make the tax-exempt bonds that they issue tax-free from the state’s standpoint. That makes the bonds doubly tax-exempt, since they are already tax-free to the federal government.