Change is urgently needed in a rule area pertaining to close-outs of failed municipal securities transactions to ensure broker-dealers aren't penalized for settlement outcomes beyond their control, a broker-dealer trade group told the Municipal Securities Rulemaking Board.
The MSRB's 2016 amendments to MSRB Rule G-12(h) "greatly reduced settlement fails," the Securities Industry and Financial Markets Association said in the April 27 letter.
"However, settlement fails continue to occur in the municipal securities market and moreover, there have been recent regulatory enforcement actions with significant fines," SIFMA's letter said. "Many of these remaining fails arise from market structure and clearing system mechanics—rather than dealer inaction or misconduct."
MSRB Rule G-12 sets forth uniform industry practices for the processing, clearance and settlement of transactions between dealers in municipal securities. Rule G-12 (h) requires the close-out of inter-dealer muni transactions that have been compared or otherwise agreed upon by both parties, but which haven't been completed – a fail.
Rule G-12(h) requires failed inter-dealer municipal securities transactions to be either canceled or closed out by the parties no later than 10 calendar days following the settlement date, according to a 2019 "frequently asked questions" document provided by the MSRB. At its discretion, a purchasing dealer can decide to give the selling dealer a one-time extension of 10 calendar days before it completes the close-out.
In all cases, however, inter-dealer fails are required to be closed out within no more than a total of 20 calendar days, the FAQs document said.
Issuer behavior and "pairing dynamics" that occur during the continuous net settlement process at the Depository Trust and Clearing Corporation contribute to settlement fails, SIFMA's letter, signed by Leslie Norwood, managing director, associate general counsel and head of municipal securities at SIFMA, said.
"These operational challenges limit the degree of control broker-dealers can exercise over settlement outcomes and complicate compliance with Rule G-12(h)'s close-out framework," the letter said, adding that dealers demonstrating efforts to comply by acting in a commercially reasonable manner shouldn't be deemed to be violating the rule.
"Regulatory change in this area is needed without further delay," the letter said.
The MSRB should clarify that, despite apparent recent interpretations by the Financial Industry Regulatory Authority as illustrated via
Municipal securities transactions may fail to settle for several reasons, SIFMA's letter said.
"Reasons include operational errors, trading desk errors, issuer action events such as failed deliveries following back-dated calls, partial redemptions, a partial call of the securities in between the trade and settlement dates, or a late notification of a call, all resulting in failure to receive/deliver securities," the letter said.
In such scenarios, broker-dealers are often placed into involuntary short positions in muni securities, SIFMA's letter said.
"Unlike other asset classes, municipal securities are often less liquid, making it difficult or impossible to source replacement securities to affect a buy-in within prescribed timeframes or at all, particularly as securities are partially redeemed over time," the letter said.
In addition to clarifying that Rule G-12(h) doesn't impose strict liability on a purchaser in the situations it described, SIFMA's letter also urged the MSRB to take other actions as well.
The MSRB should make clear in the rule that both the firm failing to receive and the firm failing to deliver securities have responsibilities under the rule, with the firm failing to receive securities operationally obligated to initiate close-out action, the letter said.
SIFMA's letter cited MSRB guidance provided in a 2019 FAQs document, noting that what the letter referred to as "FAQ 7" emphasized that both the purchasing dealer and the selling dealer have responsibility to resolve a failed transaction.
"The requirement under the rule exists even if the parties did not transact together, but were 'paired off' during the Continuous Net Settlement (CNS) process at the Depository Trust Company (DTC)," the MSRB said in its FAQ 7 answer.
While the rule itself addresses the responsibilities of the purchaser in the event of a failure to receive securities, it does not, however, specifically address the responsibilities of a seller who has failed to deliver securities, SIFMA's letter said.
"The only mention of the responsibilities of a seller who has failed to deliver securities is in the above-quoted FAQ 7," the letter said. "MSRB must provide clarity on this issue in the rule itself, or in the supplementary materials thereto."
SIFMA's letter also said the MSRB should require firms to exit transactions that fail to settle from the CNS process at DTCC on T+2 and should issue interpretive guidance relating to the use of DTCC's RECAPS for muni securities.
"Failed municipal securities transactions can become 'masked' after a transaction enters the DTCC's RECAPS processing, which is part of its obligation warehouse," the letter said. "Industry participants have observed that the longer a failed municipal transaction remains in CNS, the greater the risk that allocation lotteries and subsequent pairing activity will obscure the original settlement failure and complicate close-out efforts."
Such dynamics can result in regulatory exposure for a firm unrelated to its "diligence or good-faith efforts to resolve the failed transaction," SIFMA's letter said.
Asked to comment on SIFMA's letter, the MSRB on May 1 issued the following statement:
"MSRB appreciates all comments received from market participants; the municipal market is better served with a robust dialogue about our rules and issues that may arise under them," the statement said.
The board "has been reviewing close out practices, most recently at its January 2026 meeting, and will thoroughly review all feedback and engage in outreach to market participants to better understand whether further guidance, compliance resources or, if appropriate, rulemaking is warranted based on such input and review," the MSRB's statement said.
