By Kyle Glazier
The Bond Dealers of America will issue a report on municipal bankruptcy in the wake of Detroit’s filing last month, and will also release a best execution proposal for the municipal market, the group’s leaders recently said.
BDA president and chief executive officer Mike Nicholas and board chairman Brad Winges talked about these and other issues on group’s agenda in a wide-ranging interview with The Bond Buyer.
Winges, a managing director and head of fixed income sales, trading and underwriting as well as strategic trading at Piper Jaffray, became BDA board chairman March 1, and will serve through February 2014. He is also president of Piper Jaffray Investment Management.
Winges first became familiar with the world of finance at age 8 as he tagged along after his father, who for 37 years was the owner of a Minneapolis-based brokerage firm that had offices in Houston and California.
“I got to know the muni market inside and out from day one,” he said.
Asked about the implications of Detroit, Winges said the bankruptcy filing “ is going to take a while to play out in the courts and there’s going to be a fair amount of discussion about the priority of pension obligations versus general obligation debt versus senior debt obligations.”
“ I think the market right now is acting like it’s a decision that will come in a week. I don’t think it will,” he said.
Winges added that he does not see GO bonds generally losing their appeal as a result of the effects of Detroit’s action, the largest municipal bankruptcy filing in U.S. history.
“There have been issues in California where similar dynamics have been addressed and there’s still no final clarity. In the end, we believe that general obligation debt is still the primary senior lien and that GO bonds are a wonderful credit, and you’ve got 65,000 issuers out there and not all of those issuers have pension obligations, not all of those issuers have 23% or 24% unemployment.”
Detroit is “a unique situation,” he said.
Nicholas said the BDA’s report on municipal bankruptcy will be released soon, and will focus on this topic generally while also examining some of the issues surrounding Detroit’s filing. The report, he said, will address such questions as, “What actually happened to Detroit? What does it mean for the markets? What does it mean for the industry? What are the next steps? What does it mean for potential bankruptcies going forward?”
Both men also discussed the BDA’s efforts to develop a best execution rule for the muni market. The Financial Industry Regulatory Authority has such a rule for equities and corporate debt, but the Municipal Securities Rulemaking board does not have one for munis. The Securities and Exchange Commission, in its report on the municipal market issued in July 2012, urged the MSRB to consider a best execution rule for munis.
Dealers have warned that the nature of the municipal market, where bonds are typically traded just after issuance and are then held for a long period of time, makes the development of a best execution rule difficult.
Last month, the Securities Industry and Financial Markets Association submitted a letter to the MSRB proposing an “execution with diligence” rule, deliberately not using the term “best execution.” which would require dealers to use “reasonable diligence” to determine the market for a bond so the price it provides to a customer is “fair and reasonable under prevailing market conditions.”
“We have obviously seen the SIFMA response and proposal and I think the vast majority of the BDA membership agrees with the concepts in place there but we will come out with our own view and enhancements to various elements of that,” Winges said. “But in general, I would say we’re supportive.”
“I think you have to frame it that you made a best effort that you can prove to not only your client, but also to the regulator, that you ensured best execution,” Winges continued. “Depending on the market and what that individual bond is, can you show that diligence? It is hard to define, but I think SIFMA did a good job defining that.”
Winges said the industry needs to address a variety of issues relating to best execution.
“How does electronic trading come into play as it relates to best-ex, how does price transparency come into play with that in terms of disclosure?” said Winges. “How do we essentially ensure as an industry that whether you’re a retail investor or an institutional investor, you have open access to not only EMMA data and credit data, but also pricing data in a readily accessible time frame?”
“We had six BDA members on two different panels at the SEC discussing what is the best execution of the muni market,” Nicholas said. “What does that look like? The BDA is actively engaged in a lot of discussion with the SEC with the MSRB, frankly with folks at FINRA as well, about what best execution looks like in the municipal securities industry.”
REGULATION
Nicholas said BDA wants regulators to have specific goals in mind, specific problems that need solving, before they add more regulation to an already heavily-regulated market.
He said BDA, which now has about 55 firms from 14 five years ago, is always asking regulators, “What is the goal here? What are the implications? There are implications to everything that gets implemented regulatory-wise. Some good, some not so good. So, what’s the net result of this to the industry?”
The group’s legislative priority for the remainder of the year and probably next year is tax reform, and in particular defending the tax exemption for munis. BDA was a founder of the Municipal Bonds For America Coalition, a group of dozens of firms and individuals pressuring federal lawmakers not to cap or eliminate the muni tax exemption. The issue also runs deeper, Nicholas explained.
“Obviously when you start peeling back that onion, it’s much more involved than just the tax-exemption. It will involve some form of direct-pay bond and tax-credit bonds and how different aspects of the muni market are treated. Meaning, would everything currently treated as tax-exempt, still qualify as tax-exempt? Or not? How would private-activity bonds be treated? With alternative minimum tax?”
Winges emphasized BDA’s efforts to educate lawmakers about muni issues.
“I think the most important thing, not only as a focus for the BDA, is education about how the municipal market actually works,” Winges said. “That has been really what we’ve been trying to focus on when we’re meeting with congressional leaders on the Senate and the House side and even in meetings with the SEC. There are a lot of preconceived notions and/or misunderstanding about different parts of the business,” he said.
Winges said he is gratified that congressional aides and others have been turning to BDA for information.
“So a lot of the meetings of late, that we’ve had in the last few months, have been very open dialogue, with people asking ‘Why this? What about this? What if we did this? What if we changed that?’ And that’s really refreshing in an environment where change is likely inevitable. We want to make sure the people who are making those decisions have a full understanding of the ramifications of those changes and impacts on the business. They’re not making a decision based on politics or based on agendas being driven by different organizations that maybe don’t have the broader picture.”
The BDA is also continuing to push for an SEC definition of municipal advisor to be released as soon as possible. Dealers want the rule because they are incensed that independent financial advisors continue to operate without the regulations that dealers doing advisory work are already subject to.
Nicholas said the MA definition should have been taken care of immediately at the enactment of the Dodd-Frank Act, but it became complicated early on and has remained so, involving multiple SEC chairs and commissioners. The SEC has denied reports that commissioner Daniel Gallagher wants a further hold on the rule until recently-confirmed commissioners Michael Piwowar and Kara Stein are brought up to date on it.
DISCLOSURE
Winges discussed the industry reaction to a slew of recent enforcement cases, including the SEC’s decision to charge West Clark Community Schools in Indiana as well as its underwriter with falsely claiming in an official statement the district was meeting its disclosure obligations. He said previous enforcement actions and warnings from regulators have spurred underwriters into looking for ways to make sure issuers are meeting their disclosure obligations.
Securities rules suggest underwriters cannot move forward with deals if they do not believe issuers are complying with the terms of their continuing disclosure agreements, such as by not filing annual financial information.
“That started about a year and a half ago, we really started to pay closer attention,” Winges said. “Back when New Jersey had a disclosure issue with pension obligations. I think that immediately raised the antenna for municipal underwriters of how are we assuring of the issuers we are bringing to the market.”
In addition, Winges said, regulators have been telling dealers in meetings, “You are the gatekeeper to the open market, so when you underwrite a transaction, we cannot regulate the issuer, but we are going to regulate you and if you allow that issuer to come in through that gate into the open market …in some fashion we are going to hold you responsible to assure that the issuer is doing its best to abide by what it agreed to in the documents.”
Winges said firms are setting up internal systems or hiring third parties to help them track whether issuers are filing their disclosure documents as promised.
He said that even though the intent of the regulations is right, BDA is concerned that costs for compliance not rise to the point of making it too expensive to do business, noting his own firm’s policies and procedures for checking issuer compliance.
“You essentially have to add resources in order to do follow-ups and track that,” he said. “Piper as an example, every Cusip that we bring to the market, we’ve got an electronic ping if there is an EMMA notice or EMMA event. It shoots into our research team to make sure they are aware of it. If it is something we need to address, we will go back to banking or we will go back to our institutional clients or our retail clients, so that is the cost.”
“We are trying to make sure that we don’t get into an environment where the amount of infrastructure and cost structure becomes so egregious that it is prohibitive to being in the business,” he added.
Winges said he is similarly concerned when it comes to other underwriting regulations.
BOND BALLOT CONTRIBUTIONS
Last month, a group of dealer firms, not including Piper Jaffrey, sent a letter to the MSRB stating that contributions to bond ballot campaigns should be subjected to similar restrictions as political contributions to issuer officials under the MSRB’s Rule G-37. Those firms, some of the largest national underwriting firms, pledged to voluntarily avoid for two years contributing to bond ballot campaigns they would be interested in underwriting for a two-year period and urged the MSRB to consider the G-37 changes.
Some market participants have said such a step would target regional and mid-size dealers, particularly those who do the lion’s share of the underwriting for local school districts in California. Piper Jaffray is the highest ranked underwriter for school district deals in California through June 26 of this year, with 72 issues and $1.4 billion.
Winges said further steps to complicate the underwriting process could have spillover effects that could be negative for the market.
“I think the more complicated you make the underwriting process and the more check boxes and rules and things you put around it, it is going to make it extremely difficult to do the $5 million, $10 million, $20 million, and $30 million dollar deals,” he said. “Before we go out and make all these extra requirements of the dealers, answer the question, why? Who is negatively being impacted? Because that information is not there or because the checkbox is not clicked, who is that to the detriment of?”
“I view capital like water flowing through a stream,” he continued. “On the one end you’ve got the issuer and on the other end you’ve got the buy-side, whether it be retail or institutional. Every time you put another regulation in, you’re putting a boulder in the middle of the river. The water will flow around the boulder, but if we are not careful, depending on where you put those and how many you put in the middle of the stream, the water will end up flowing over the banks left and right and the ramifications of that are unpredictable.”
Winges, however, said the increased use of electronic trading and transparency are something nobody disagrees with, characterizing those issues as an “evolution.” He particularly praised efforts to strengthen the MSRB’s central transparency platform. The MSRB this released a notice seeking comments on how pre- and post-trade transparency can be improved.
“I think EMMA is probably one of the best enhancements that has occurred in the market in the last ten years, I think all the underwriters would agree with that,” he said.
At the end of the day, though, Nicholas and Winges said they are focused on preventing tax reform from radically altering the market. Nicholas has said he does not believe a comprehensive tax reform deal could happen before 2017. The BDA is continuing to lobby lawmakers raise the bank-qualified bond cap back to $30 million from $10 million, an issue that is of particular interest to BDA member firms who do most of that underwriting. While trying to be as politically impartial as possible, Winges said, dealers are trying to stress that they provide an essential service that will remain, regardless of the type of bonds Congress wants to push the market into using.
“We are trying to be as agnostic as we can, but at the end of the day that issuer in Iowa needs to call somebody to raise capital and if we have to do it as a tax-credit bond, if we have to do it as a Build America Bond, if we have to do it as a tax-exempt bond, we are still the underwriter and that issuer still needs to hire us,” he said. “We would like it not to change dramatically, but if it does, we will adapt and issuers will be served. I believe that.”
