Markup Rules Dead­line Wor­ries Firms

The Bond Buyer - - Front Page - By Kyle Glazier

PHOENIX – Mu­nic­i­pal mar­ket par­tic­i­pants are be­com­ingly in­creas­ingly con­cerned that they’re not go­ing to be ready in time to im­ple­ment a soon-to-be ef­fec­tive markup dis­clo­sure rule on which reg­u­la­tors place huge im­por­tance.

Amend­ments to Mu­nic­i­pal Se­cu­ri­ties Rule­mak­ing Board Rules G-15 on con­fir­ma­tion and G-30 on prices and com­mis­sions, which are to take ef­fect on May 14, 2018, will re­quire deal­ers to dis­close their markups and mark­downs on cer­tain trans­ac­tions in the con­fir­ma­tions they send re­tail cus­tomers -- a sea change for the mu­nic­i­pal mar­ket. MSRB ex­ec­u­tive di­rec­tor Lyn­nette Kelly has called the rule changes “a game changer” and both the MSRB and the Fi­nan­cial In­dus­try Reg­u­la­tory Au­thor­ity have put sig­nif­i­cant ef­fort into pro­vid­ing firms with ed­u­ca­tion about the rule changes.

But as the clock ticks down to­ward the com­pli­ance date, many in the in­dus­try worry they will not be able to put in place changes that will al­low their au­to­mated sys­tems to com­ply with the new re­quire­ments.

Un­der the rule changes, markup dis­clo­sures will have to be given as a to­tal dol­lar amount and a per­cent­age of the pre­vail­ing mar­ket price.

The amend­ments es­tab­lish a “wa­ter­fall” of fac­tors for de­ter­min­ing the PMP. Deal­ers ini­tially are to look at their con­tem­po­ra­ne­ous

trades of the same muni with other deal­ers or cus­tomers to es­tab­lish a pre­sump­tion of pre­vail­ing mar­ket price. If that data is un­avail­able, they must make a se­ries of other suc­ces­sive con­sid­er­a­tions. They can look at con­tem­po­ra­ne­ous trades of the muni in in­ter­dealer trades, then trades of the muni be­tween other deal­ers and in­sti­tu­tional in­vestors, then trades on al­ter­na­tive trad­ing sys­tems or other elec­tronic plat­forms.

Fur­ther down the wa­ter­fall, firms can look at con­tem­po­ra­ne­ous trades of sim­i­lar se­cu­ri­ties. The MSRB in­cluded a list of “non-ex­clu­sive fac­tors” like credit qual­ity, size of the is­sue, and com­pa­ra­ble yield that can be used to de­ter­mine if se­cu­ri­ties are sim­i­lar. The bot­tom of the wa­ter­fall al­lows deal­ers to use prices or yields de­rived from eco­nomic mod­els.

While com­pli­cated, most deal­ers think that they can com­ply with the rule changes, whether in­ter­nally or through a third-party ven­dor. But many are far less sure they will be pre­pared, by May 14, to au­to­mate the process from trans­ac­tion to de­liv­er­ing the cus­tomer a con­fir­ma­tion with a prop­erly-dis­closed markup or mark­down. A num­ber of dealer rep­re­sen­ta­tives made that point while speak­ing at an MSRB roundtable ear­lier this month.

“The clock is tick­ing on this year, and we don’t have a so­lu­tion in hand to au­to­mate the wa­ter­fall,” Daren Co­la­ia­covo, a di­rec­tor of re­tail trad­ing at RBC Cap­i­tal Mar­kets said at the roundtable. “It’s some­thing we’re tak­ing very se­ri­ously.”

Co­la­ia­covo said that while sev­eral ven­dors are of­fer­ing PMP cal­cu­la­tion so­lu­tions for markup rule com­pli­ance, he is not aware that any firm has their so­lu­tion in hand and is set to go.

Kristin Ma­her, head of fixed in­come ser­vices at Wells Fargo, said Wells has tested so­lu­tions with sev­eral ven­dors but is still work­ing out how to au­to­mate their trades for com­pli­ance. How are we go­ing to do this with a rea­son­able amount of re­sources ded­i­cated to this?” she asked.

Dealer groups are re­flect­ing the con­cerns of in­di­vid­ual firms. They are press­ing the MSRB and the Se­cu­ri­ties and Ex­change Com­mis­sion to ex­tend the com­pli­ance date, pos­si­bly by sev­eral months.

“I think there’s still a long way to go in terms of get­ting ready for this,” said Bond Deal­ers of Amer­ica chief ex­ec­u­tive of­fi­cer Mike Ni­cholas.

BDA has stressed the com­plex­i­ties of au­tomat­ing the wa­ter­fall process in past com­ments to the MSRB and SEC. Ni­cholas is con­cerned that the in­for­ma­tion firms end up pro­vid­ing on con­fir­ma­tions could wind up con­fus­ing cus­tomers. “The last thing BDA mem­bers want is to cre­ate mis­lead­ing in­for­ma­tion for re­tail in­vestors,” he said.

Se­cu­ri­ties In­dus­try and Fi­nan­cial Mar­kets As­so­ci­a­tion man­ag­ing di­rec­tor and co-head of mu­nic­i­pal se­cu­ri­ties Michael Decker said SIFMA is hav­ing dis­cus­sions about these con­cerns with in­di­vid­ual firms and with the reg­u­la­tors.

“The markup and PMP rules are com­plex,” Decker said. “In or­der to au­to­mate com­pli­ance, which is ab­so­lutely nec­es­sary for many firms, deal­ers will need to use so­phis­ti­cated sys­tems. Some firms are con­cerned that they will not have enough time to fully in­te­grate and test their com­pli­ance sys­tems by the dead­line, es­pe­cially if they’re go­ing to de­pend on third-party ven­dors whose time­lines are out of deal­ers’ con­trol. SIFMA wants to en­sure that the cus­tomer ex­pe­ri­ence with the new con­firm dis­clo­sure is a smooth as pos­si­ble and we are ac­tively dis­cussing the ob­sta­cles to full readi­ness with our mem­bers and reg­u­la­tors.”

Ven­dors say they are con­fi­dent in their prod­ucts, but that the real chal­lenge is in in­te­grat­ing their sys­tems with the sys­tems of in­di­vid­ual dealer firms to en­sure a smooth au­to­mated process from start to fin­ish.

Tony Misci­marra, a man­ag­ing di­rec­tor at BondWave, said he is “guard­edly” cer­tain his firm’s prod­uct is set to go be­cause it has done thou­sands of trial runs with data pro­vided by clients and po­ten­tial clients. But only a tiny slice of the in­dus­try is even in the in­te­gra­tion process yet, he said. “Even those that are on the curve or even ahead of the curve now have to face im­ple­men­ta­tion chal­lenges,” Misci­marra said.

TMC Bonds CEO Thomas Vales said that be­cause TMC runs an al­ter­na­tive trad­ing plat­form, the in­fra­struc­ture for pro­vid­ing a PMP so­lu­tion is ba­si­cally al­ready in place, but Vales also ex­pressed that in­te­gra­tion is a heavy lift. “Ev­ery­one is fo­cused on what they need to do at hand, and then the last piece is go­ing to be try­ing to in­te­grate it with ev­ery­one else,” Vales said.

Misci­marra said an ex­ten­sion granted by reg­u­la­tors wouldn’t sur­prise him, but warned that firms can’t sim­ply punt the prob­lem down the road. “That would be a big mis­take,” he said.

“There’s still a long way to go in terms of get­ting ready for this,” said Bond Deal­ers of Amer­ica chief ex­ec­u­tive of­fi­cer Mike Ni­cholas.

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