A solution in search of a problem

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The SEC in the last week of September released the first numbers on the use of their June Temporary Conditional Exemption related to the role of Municipal Advisors in certain bank placements. The results are underwhelming to say the least.

The SEC’s June exemption permits Municipal Advisors to solicit investors in bank placement transactions of $20 million or less subject to certain conditions. For more than 80 years, soliciting investors has been recognized by federal securities regulators as broker-dealer activity, so the SEC’s action breaks significant new ground. It also sets a dangerous precedent because it removes private placements executed under the Exemption from all the investor protection regulations that apply to broker-dealers.

The terms of the Exemption require MAs that use it to report deal details to the SEC. Last week we learned that a grand total of three transactions totaling around $2 million par closed using the Exemption between June 16 and July 31 out of maybe $75 billion of total issuance during that period. To call the exemption a flop is an understatement.

The SEC sold the Temporary Conditional Exemption to Congress and the market as a response to the COVID crisis, stating that the purpose of the Exemption is “to facilitate more timely and efficient access to bank financing alternatives by municipal issuers during this historic COVID-19-related market disruption.” Never mind that by June 19 when the Order granting the Exemption was issued, municipals were trading through levels from before the crisis. Issuers are getting such great primary market execution that we may see record issuance volume this year.

There is a history behind the Temporary Conditional Exemption. The SEC began looking into issues related to the role of MAs in private placements in 2018 at the request of a prominent Municipal Advisor firm. In December 2019 the SEC proposed a far-reaching exemption for Municipal Advisors on private placements that would have allowed Advisors to effectively serve as placement agents—but without all the dealer regulation—on nearly any municipal private placement transaction placed with nearly any institutional investor.

The SEC has gratefully backed off from the egregious December proposal, at least for now, but the Temporary Conditional Exemption remains on the books until the end of the year, longer if the SEC chooses to extend it as they have hinted. The SEC has characterized the temporary relief as “very narrow” despite that it covers more than 70% of the new-issue market.

Allowing Municipal Advisors to serve many of the roles of placement agent in new issuance transactions is rife with problems. Perhaps most important is that in two years of conversation over the role of MAs in private placements, never did the SEC provide a justification for why that kind of relief is necessary or who, apart from non-dealer Municipal Advisors, would benefit. Nobody talked about lack of market access or excessive transaction costs or poor execution or any benefits accruing to issuers. The virus seems to have given the SEC a “reason” for the change when none existed before.

Of course we know the market has more than recovered since March and April. Every month since March has marked an increase in municipal issuance versus last year. Levels are at near historic lows. Mutual fund outflows have reversed. We are experiencing some of the most issuer-friendly market conditions of our lives. Even the Fed has recognized the market’s recovery. All this emphasizes the important question of what is the connection among the virus crisis, issuer market access, and new issue activity that motivated the SEC to act in June to provide the Temporary Exemption. We still do not know.

If last week’s data are any indication, issuers do not need the relief the SEC provided in June. Underwriters certainly do not want it, and there is no evidence that bank investors sought this change. An exemption for Municipal Advisors to solicit investors in private placements remains a solution in search of a problem.

Hopefully, the thin use of the exemption by MAs will convince the SEC once and for all that this is misguided, unnecessary policy.

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