WASHINGTON — The Municipal Securities Rulemaking Board is urging the Federal Reserve Board, the SEC and other financial regulators to exempt all municipal securities from the Volcker Rule, warning the failure to do so would bifurcate and hurt the municipal market without increasing the soundness of the banking system.
The Volcker Rule, named after former Federal Reserve chief Paul Volcker, was mandated by the Dodd-Frank Act and proposed jointly by four financial regulators. It would prohibit banks from proprietary trading and would restrict their investments in private equity and hedge funds. However, it would exempt short-term trading for market-making or to hedge risks.
In an 11-page letter, the MSRB warned four federal regulators that the failure to adopt a broader exemption for municipal securities from the rule “will have a significant material adverse effect on the primary market pricing and secondary market trading of securities issued by agencies and authorities of states and their political subdivisions.”
“Issuers and investors (primarily retail) will bear the cost,” said the letter, which was signed by MSRB chairman Alan Polsky and sent to the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp., along with the Fed and SEC.
The banking entities covered by the Volcker Rule “represent a very large percentage of the municipal securities market,” the MSRB said. Of the firms that underwrote 98% of the muni securities issued in fiscal 2011 by principal amount, almost 76% were covered bank entities, it said. Of the firms that reported 98% of the trades executed during fiscal year 2011 by principal amount, 75% were covered banking entities.
The joint proposal would currently exempt from the Volcker Rule muni securities issued by states, counties and cities. It would not exempt housing or turnpike authorities, water and sewer districts, school districts or other such entities, some of which were established because their governments did not have the authority to issue revenue bonds.
About 41.4% of the muni securities issued in fiscal 2011 were issued by such agencies, authorities and districts, based on data from Thomson Reuters, the MSRB said.
“Most of the debt issued by agencies and authorities is clearly public purpose in nature,” the board said. “It finances schools, roads, bridges, water systems and other major infrastructure projects. There is no indication that Congress meant to bifurcate the municipal securities market by means of the Volcker Rule simply because a state or political subdivision has chosen to finance its key infrastructure needs through the issuances of bonds by its agencies [or] authorities ... rather than directly through the issuance of identical bonds by the state or political subdivision.”
The MSRB recommended the federal regulators adopt the definition of municipal securities that appears in the Securities Exchange Act of 1934, which covers all munis.
The joint proposal by federal regulators also would exempt market making from the Volcker Rule. But the MSRB said the exemption would be of little use to the muni market, where many bonds are infrequently traded.
On a typical given day, about 39,000 trades in 14,000 different securities occur, according to the board. “This means that over 99% of municipal securities do not trade on a given day,” it said. “In fact, over 90% typically do not trade in a given month.”
“Dealers in municipal securities do not typically post bid-ask prices for a significant number of municipal securities on a regular basis,” the MSRB added, “Most municipal market participants consider a primary function of market making to be the generation of liquidity in the market by taking securities into inventory.”
Lynn Hume writes for The Bond Buyer.