WASHINGTON — The Municipal Securities Rulemaking Board is urging Congress to “develop a regulatory structure that governs municipal market participants that provide certain key services” to state and local issuers and has asked that it be given authority to regulate independent financial advisers and investment brokers.
In a wide-ranging letter to key lawmakers, a copy of which was released by the board this morning, the MSRB is also calling for the creation of a federal muni czar or inter-agency group that would coordinate muni finance issues, improved federal, state, and self regulatory agency coordination of muni enforcement activities, and a consideration of federal or federal/state regulatory oversight of bond insurers.
While the issue of whether and how to regulate credit default swaps and other derivatives “remains controversial,” all regulation of derivatives based on municipal debt should be subject to the same comprehensive framework that may be developed for swaps and other types of derivatives products, the MSRB said, adding that if the government chooses to require disclosures on derivatives, the muni-related disclosures should be made to the board’s EMMA system.
Though the MSRB urged the lawmakers to develop a regulatory structure governing certain key muni market participants, it makes it clear that it doesn’t see the need for federal regulations of municipal issuers.
“We note the extensive improvements in municipal disclosure over the years primarily due to industry cooperation and coordination, and the influence of the buyside community to demand additional disclosures for certain sectors and in certain markets,” the board wrote in the letter, which was sent late last week and signed by MSRB chairman Ron Stack, managing director and head of public finance at Barclays Capital. “We believe that these ongoing industry efforts and market influences will continue to enhance the quality and timeliness of disclosures in our industry.”
The MSRB’s letter comes as President Obama and Congress plan to reshape the financial regulatory system. The board says it believes that there is an important role for “market-specific, self-regulatory organizations” in any new framework, because SROs “are uniquely situated to work with the industry to develop effective rules and information systems, and can be vital links between the industry and the broader regulatory community.”
The letter also comes after the board released a statement Jan. 9 asking that specific consideration be given to placing financial advisors, investment brokers and other unregulated market participants in the municipal market under federal regulation.
Expanding on the points it made in the statement, the board told the lawmakers that it is taking the action because multiple ongoing federal investigations of investment advisers and other muni market participants -- as well as “the ensuing media coverage and the resulting negative impact on investor confidence and market integrity” — have highlighted the need for broader regulation of muni market participants.
“We believe that as Congress and the administration review the regulation of financial advisors, investment brokers and related intermediaries in the municipal market, the MSRB (a creature of the Congress and the SEC), as the agency charged already with municipal market rulemaking ... would be the appropriate candidate to be the agency to regulate these unregulated entities,” said the letter, which was sent to the chairman and ranking minority members of the House Financial Services and Senate Banking committees.
Though independent FAs and investment advisers provide “necessary investment and other services” on complex financial transactions, the MSRB said, these participants “have significant influence with issuers, earn significant fees and many times, are not constrained by any prohibitions on political contributions, either participating in pay-to-play, or giving the appearance of a quid pro quo for attaining business.”
“Unfortunately, the regulatory structure over the municipal market has not kept up with the evolving marketplace and nearly all of these participants are unregulated,” the letter adds. “At a minimum, financial advisors and investment brokers should be held to standards of conduct that protect municipal issuers, taxpayers and investors in this market.”
Additionally, the board would like them to be subject to MSRB rules that prohibit fraudulent and manipulative practices; require the fair treatment of investors, issuers and other market participants; mandate full transparency; restrict real and perceived conflicts of interest; ensure rigorous standards of professional qualifications; and promote market efficiencies.
While many states and localities have laws that prohibit pay-to-play activities and that require disclosures of political contributions for market professionals other than dealers — in some cases modeled on the MSRB’s Rule G-37 — “the limited patchwork nature of these state and local laws has not been effective in stopping the possibility and appearance of pay-to-play activities in the unregulated portions of our market” the board said, adding. “A comprehensive federal approach is required.”
Turning to the creation of a federal muni czar or inter-agency group that would coordinate muni finance issues, the board said that such an office would be vital as part of any new “multi-layered regulatory framework,” which in turn would feature: a market stability regulator to address overall conditions of financial market stability that could impact the general economy; a prudential financial regulator to address issues of limited market discipline; and a business conduct regulator to address standards for business practices.
“This approach, or in fact any scenario, requires that these regulatory entities have deep and extensive knowledge of all financial markets,” the board said. “The lack of municipal finance expertise at the federal level became apparent during the past year and resulted in a very late and limited recognition of the impact of the credit crisis on state and local municipal finances, and the failure of federal programs intended to alleviate the economic impact of the credit crisis to address the needs of state and local governments.”
Meanwhile, the board said that enforcement activities have traditionally been spread across numerous federal and state governmental entities and SROs, “creating a patchwork of overlapping jurisdiction and inconsistent and uncoordinated enforcement activities.”
“While some coordination of enforcement activities currently exists, the MSRB strongly recommends that each of the entities that are charged with the enforcement of securities laws —regardless of the genesis of those laws — develop a more formal process to coordinate their regulatory and enforcement activities,” the board said. “Coordinated actions could avoid regulatory gaps, provide clearer statutory authority and promote an efficient and consistent enforcement mechanism for the industry.”
On financial guaranty insurance companies, the MSRB noted that insurance is currently regulated at the state level, but said that because of the systemic risk implications of a failure of the bond insurance industry, Congress should consider “the potential for federal oversight for financial guaranty insurance companies or a dual federal/state regulatory structure.”
The board also said it believes that the possibility of federal, or a combination of federal and state credit enhancement, and a national and/or state financial guaranty insurer, “provides an interesting opportunity worthy of further exploration.”
The MSRB said it is not advocating any particular position on the regulation of derivatives, but that derivative instruments based on municipal securities “should be subject to the same comprehensive regulatory framework that may be developed for swaps and other types of derivative financial products in other markets,” adding that “such development should be done in consultation with experts in the municipal and other markets.”
“Should enhanced disclosures in derivative instruments be a part of any regulatory scheme, the MSRB is well poised with its EMMA system to provide disclosures of municipal derivative contracts and provide the necessary transparency for our market,” the board said.