Indexes used by municipal bond participants have proven to be functional for various forms of pricing.
But they’re not ideal for a market that desperately needs an effective hedging tool and a more accurate way to price bonds in an environment where transactions and numbers are limited, panelists said Monday at the Securities Industry and Financial Markets Association’s Municipal Bond Summit.
And though panelists said the various indexes the market uses aren’t generated in a way that could lead to the type of manipulation that is alleged to have taken place with the London Interbank Offered Rate, their limitations increase the market’s opacity and inefficiencies.
Regulators such as the Securities and Exchange Commission and the Municipal Securities Rulemaking Board could help the situation by filling in some of the key blanks regarding price discovery, said Thomas Doe, founder and chief executive officer of the independent research firm Municipal Market Advisors, which provides yield data for the tax-exempt bond market.
“The MSRB and the SEC … can better understand who is providing price discovery,” he said. “And, to the extent that some data is more influential than others, and that price discovery is important in that information flow, then the regulator is in the position to oversee that, to communicate to the individual investor, who is the receiving that daily evaluation that is often misconstrued as price.”
The market could also use more price-related data points and build benchmarks that draw from a broader group of numbers, panelists said. These might produce indexes that help market participants develop a process that allows for the hedging of munis.
Panelists alluded to the short-lived municipal bond futures contract that existed back in the mid-1990s. It was based on 40 bonds in an index that The Bond Buyer constructed and oversaw. Participants in the market provided data to the five brokers’ brokers.
But for more than two years, one participant manipulated the dedicated options that were traded on that futures contract. “Price discovery could be provided to the index provider,” Doe said. “And because there was no real oversight, and because there was a customer relationship involved, our market was vulnerable.”
When the muni futures contracted was discontinued, the municipal market lost an instrument for risk management, he added.
But the market also missed an opportunity, said Robert Nelson, CFA and managing analyst at TM3/Municipal Market Data, which is owned by Thomson Reuters and produces proprietary yield-curve data.
“Instead of improving the process and maintaining a futures contract, an exchange-traded contract, long muni bonds, and finding a way to actually make it work, the response of the muni market was to just pull it,” he said. “Instead of jumping the hurdle, we took a step backwards in response to what happened.”
But regulators may not be the best drivers for any improvements to benchmarks, or for providing a hedging instrument, according to J.R. Rieger, a vice president of fixed-income indexes at Standard & Poor’s. Rather, he added, improvements should be driven by what customers say they need as tools in the market.
The consistency of data is another challenge for indexes in the muni market, Doe said. “Every data set has biases,” he added. “It’s interesting to identify what those biases are.”
The Bond Buyer publishes its own indexes in the market.