It does not make sense for the Municipal Securities Rulemaking Board to invest resources in building a proposed centralized system for the collection and dissemination of critical market information from auction-rate securities because the market is dying, the Regional Bond Dealers Association told the MSRB in a comment letter yesterday.
Though the system is a "reasonable response" to the lack of transparency in the municipal auction-rate securities, and would have been a useful tool before the auction-rate market turmoil began earlier this year, its utility has essentially vanished as issuers and investors have lost interest in the market, the RBDA said, adding, that it is increasingly unlikely they will return. Enhanced transparency will not save the auction-rate sector, the regional dealer group said.
"Given that the [ARS] market is shrinking and will eventually disappear, we believe an investment by the MSRB and market participants in a system to enhance transparency for this product is not warranted," said the letter, which was authored by Michael Decker and Mike Nicholas, the co-chief executive officers of RBDA. "This fundamental weakness in the [ARS] product is not a result of a lack of transparency in the auction process and cannot be cured by enhancing transparency. Rather, the weakness in the product stems from a lack of a hard liquidity facility for [ARS] investors."
The RBDA's letter comes after the board solicited comments on the proposed system.
Auction-rate securities are floating-rate instruments with interest rates set through periodic auctions. The turmoil in the Municipal ARS market was sparked by concerns over the credit ratings of monoline bond insurers, which typically insure auction-rate debt, but it has roots in the overall credit crunch that began last year.
The board proposed establishing the system last month as a way of increasing the amount of auction-rate information available to market participants. Currently, there is no source of comprehensive same-day information about auction-rate securities available to non-market professionals, even information as basic as the clearing rates set through the auction process, the board said.
Specifically, the board has proposed that dealers operating auction-rate programs report auction information to a central system that would be operated by the MSRB. In most cases, auction results would have to be reported no later than 5 p.m. Eastern Standard Time on the day the auction occurs.
The RBDA said that the lack of a "hard put" facility used in other products designed to behave like money-market securities, such as variable-rate demand notes and tender-option bonds, means that investors are dependent on market demand to sell their securities.
"Given the experience of recent months, the lack of a liquidity facility means that the product will no longer be an attractive choice for issuers or investors," the RBDA added.
Another factor contributing to the market's waning interest in auction-rates is the fact that many issuers hedge their floating rate exposure on auction-rate transactions using interest rate swaps based on the Securities Industry and Financial Markets Association Swap Index. But that index is based on the yields of variable rate demand notes, and those yields have diverged significantly from the yields of auction-rate securities over the past several months.
"This divergence makes it difficult for municipal issuers to effectively hedge their [ARS] floating rate exposure," the RBDA said.