WASHINGTON — A Treasury Department official said Wednesday that she recognizes the proposed issue price rules would be problematic for competitive bond deals and wants to know more about how they would cause problems for negotiated transactions.
"I understand that our proposed definition presents challenges in competitive, but can you elaborate on negotiated?" Vicky Tsilas, Treasury associate tax legislative counsel, asked National Association of Bond Lawyers President Allen Robertson at a public hearing on the proposed rules.
Some of the speakers could not make it to the hearing because of the wintry weather and cancelled flights.
The proposed rules were released in September and have drawn wide-spread criticism from the muni market.
Under the existing rules, issue price for each maturity of bonds publicly offered is the first price at which a substantial amount of the bonds is reasonably expected to be sold to the public, with substantial defined as 10%. The issue price is usually determined based on reasonable expectations when the bonds are priced, before the closing of a bond deal.
However, the proposed rules would eliminate the reasonable expectations standard and instead base the determination of issue price on actual sales of the bonds. The proposed rules include a safe harbor under which the issue price for each maturity would be the price at which the first 25% of the bonds is actually sold to the public.
At Wednesday's hearing and in comments submitted to the Internal Revenue Service in December, market groups explained that the proposed rules would be particularly problematic for competitive sales. Issuers will want to meet the safe harbor on the sale date, which means that they will have to avoid having any unsold maturities. But since underwriters have virtually no ability to pre-market bonds in competitive sales, issuers could have trouble eliminating the possibility of unsold maturities.
In negotiated sales, underwriters are able to sell bonds ahead of the closing. Treasury officials said they had heard that when an underwriter pre-prices bonds, they get conditional commitments for about 80% of the bonds in each maturity, Tsilas said. "The idea of having unsold maturities, while that certainly happens, we were told is a very, very small percentage," she told those at the hearing.
Similarly, Johanna Som de Cerff, senior technical reviewer in the IRS chief counsel's office, asked if unsold maturities "happen really at all in negotiated [transactions]?"
Robertson said that while many bonds sold in negotiated deals could qualify for the safe harbor under the proposed rules, there are some deals where a particular maturity goes unsold.
"We're suggesting this is the minority, this is the exception" but the proposed rules don't have special provisions to deal with the exceptions, he said.
During the financial crisis underwriters were willing to hold certain maturities that they had trouble selling. This was beneficial to issuers, because the alternatives would have been to delay pricing or to raise yields across the bond issue, Robertson said.
Groups have argued that borrowing costs would be higher in negotiated sales under the proposed rules because underwriters will be forced to accept higher yields to sell the bonds to meet the safe harbor. But Tsilas wondered if underwriters now, to some extent, price bonds aggressively in order to get maturities to sell.
IRS officials also had questions about the proposed rules' definition of an underwriter.
In the proposed rules, "the public" would be any person, other an underwriter, "that purchases bonds from the issuer for the purpose of effecting the original distribution of the bonds, or otherwise participates directly or indirectly in the original distribution."
Lewis Bell, a tax attorney in the IRS chief counsel's office, asked Michael Decker, managing director and co-head of munis at the Securities Industry and Financial Markets Association, how he would define the underwriter in a way that would provide better transparency and help with secondary-market trading analysis.
Decker said the IRS and Treasury could use the definition for a broker-dealer provided in the 1934 Securities Exchange Act. The definition of an underwriter in proposed rules could include some non-broker dealer participants like hedge funds and insurance companies, he added.
Syndicate members have to accept orders from non-syndicate dealers as long as they're at the offering price and are in line with order priority rules of the Municipal Securities Rulemaking Board, and there's no way of knowing whether a non-syndicate dealer plans to hold or redistribute the bonds, Decker explained.
