SAN ANTONIO — State and local governments are facing more scrutiny from municipal market participants, including rating agencies and underwriters, market experts warned this week.
The comments came Monday at the Government Finance Officers Association’s annual conference here, during a panel discussion devoted to what issuers need to know about the Dodd-Frank Wall Street Reform and Consumer Protection Act.
Dodd-Frank and the lingering economic downturn have prompted rating agencies to reassess their relationships with issuers of municipal securities, causing them to probe state and local governments more closely about new issues, one analyst noted.
“I think all the way along the road, there are going to be more questions,” said Amy Laskey, a managing director at Fitch Ratings in New York.
If the economy improves, she said, the level of questioning may subside to a certain extent.
But a wave of regulatory reform, including Dodd-Frank, has prompted the rating agencies to step up their surveillance and investigation of muni issuers on an ongoing basis.
According to Laskey, this is a positive outgrowth of the financial crisis, since it’s important for investors and the Securities and Exchange Commission to have more confidence in the rating process.
“That’s really the goal here,” she said.
One of the biggest changes under Dodd-Frank, Laskey said, is that rating agencies are required to perform a “reasonable investigation” of certain aspects of their relationships with issuers, and document the steps they have taken.
For example, she said, agencies must now verify that an issuer’s auditor has the appropriate credentials, including by checking the auditor’s website.
While rating agencies might have performed this in the past, now they must document their efforts, Laskey said.
“Again, I think that’s a positive thing, even though it’s more paperwork,” she added.
In addition, she said, Fitch is conducting regular surveillance of its ratings, to make sure they are still accurate.
“If we call and say we’re doing surveillance, please call back,” Laskey added.
Overall, she said, these changes may lead to a more arms-length relationship between issuers — a trend observed by several members of the GFOA’s debt committee, which met here Saturday.
“But it’s sort of by necessity and it’s the world we live in,” Laskey said.
Another member of the panel, who confined his remarks to Dodd-Frank’s treatment of swaps and derivatives, expressed concerns that the expense of complying with the legislation will force broker-dealers from the municipal derivatives market.
“All of this compliance burden will have a cost to them,” said Mitchell Rapaport, a partner at Nixon Peabody LLP in Washington, D.C.
One possibility, he said, is that broker-dealers will pass that cost along to state and local governments.
Another, he added, was that broker-dealers would exit the swap business altogether, further increasing the cost of swap transactions to state and local governments.
During a question and answer session, Ritta McLaughlin, director of market leadership at the Municipal Securities Rulemaking Board, fielded several questions about proposed amendments to the MSRB’s Rule G-23.
The proposed rule amendments would prohibit dealer-financial advisers from switching roles and becoming underwriters in the same municipal securities transactions.
Under the existing Rule G-23, dealer financial advisers can become underwriters in negotiated muni transactions if they terminate their FA role, disclose to the issuer possible conflicts of interest stemming from the role switch, disclose their expected compensation, and obtain the issuer’s consent.
In February, the MSRB proposed amendments to Rule G-23 and filed them with the SEC, which then released the proposal for a second round of public comments.
The MSRB’s proposal contained interpretive guidance that said a dealer would not be considered an FA for purposes of the role-switching ban if it clearly identified itself as an underwriter from “the earliest stages of its relationship with the issuer.”
On Monday, MSRB chairman Michael Bartolotta said the board is continuing to discuss changes to Rule G-23.
When asked for clarification about Rule G-23, McLaughlin said: “If you’re an underwriter and cross the line and become a financial adviser, you can disclose that, but a financial adviser cannot become an underwriter.”
One issuer official, who moderated the panel, expressed concerns that the proposed G-23 amendments would not go far enough.
“It seems to me that’s a bit troublesome,” said Timothy Firestine, the chief administrative officer of Montgomery County, Md. “I’m a strong believer that if you underwrite the transaction, you shouldn’t be the FA.”