Deal­ers Cau­tioned By MSRB

The Bond Buyer - - Front Page - By lynn hume

WASHINGTON – The Mu­nic­i­pal Se­cu­ri­ties Rule­mak­ing Board is cau­tion­ing bro­ker-deal­ers trad­ing through al­ter­na­tive trad­ing sys­tems or bro­ker’s bro­kers against “fil­ter­ing” or screen­ing out bids and of­fers in a way that ad­versely im­pacts re­tail in­vestors and mar­ket ef­fi­ciency.

“The MSRB re­minds firms that fil­ters are to be used only for le­git­i­mate pur­poses and that deal­ers should have in place, and pe­ri­od­i­cally re­view, poli­cies and pro­ce­dures to gov­ern when and how the firm uses fil­ters,” the board said in a no­tice pub­lished Wed­nes­day.

The no­tice comes al­most a week be­fore the Se­cu­ri­ties and Ex­change Com­mis­sion holds its first Fixed In­come Mar­ket Struc­ture Ad­vi­sory Com­mit­tee meet­ing, which is sched­uled to be held on Jan. 11 and to fo­cus on liq­uid­ity is­sues. The ad­vi­sory com­mit­tee in­cludes sev­eral muni mar­ket par­tic­i­pants, in­clud­ing MSRB chief mar­ket struc­ture of­fi­cer John Ba­gley.

The no­tice urged bro­ker-deal­ers

to de­ter­mine what pro­cesses and what cri­te­ria or fac­tors should be used when es­tab­lish­ing, mod­i­fy­ing, and re­mov­ing fil­ters.

Firms also should de­cide whether au­tho­riza­tion must be re­quired to es­tab­lish fil­ters and, if so, who should give it, the board said. In ad­di­tion, bro­ker-deal­ers should de­cide how of­ten fil­ters are re­viewed, who should do the re­views, and what those re­views should en­tail.

The MSRB stressed that the no­tice “does not cre­ate new le­gal or reg­u­la­tory re­quire­ments” but rather sum­ma­rizes ex­ist­ing guid­ance on fil­ter­ing or screen­ing in Rule-43 for bro­ker’s bro­kers, Rule G-20 on prices and com­mis­sions, as well as guid­ance is­sued in 2015 on Rule G-18 on best ex­e­cu­tion.

“Deal­ers have had al­most two years to im­ple­ment and com­ply with the best ex­e­cu­tion rules, which has been an ex­am­i­na­tion pri­or­ity for en­force­ment agen­cies,” said MSRB Ex­ec­u­tive Direc­tor Lyn­nette Kelly. “Given the de­vel­op­ments in the use of ATSs, it makes sense to re­mind deal­ers of the guid­ance about the ap­pro­pri­ate use of fil­ters to help sup­port their com­pli­ance with the best-ex rule.”

Fil­ter­ing oc­curs when a dealer han­dling a cus­tomer’s or­der uses au­to­mated tools on an ATS to screen out bids re­ceived from and of­fers made avail­able by cer­tain deal­ers. It also oc­curs when a sell­ing dealer di­rects a bro­ker’s bro­ker to limit the par­tic­i­pants for a bid-wanted.

In its no­tice, the MSRB said it “rec­og­nizes that there are le­git­i­mate pur­poses that jus­tify the use of fil­ters.” How­ever, the board said it’s “con­cerned that their use oth­er­wise may limit ac­cess to and com­pe­ti­tion in the mar­ket, which could re­duce liq­uid­ity and have a neg­a­tive im­pact on the qual­ity of ex­e­cu­tions and, ul­ti­mately, the prices paid or re­ceived by cus­tomers.”

One im­pe­tus for the no­tice was the in­creased use of ATSs and the role of bro­ker’s bro­kers.

The MSRB re­leased sta­tis­tics in Novem­ber 2017 show­ing that for the 12 months from Septem­ber 2016 to 2017, an av­er­age of about 59% of trades be­tween deal­ers, and 29% of the par vol­ume traded, were ex­e­cuted on an ATS.

About 90% of the ATS trades in­volved trans­ac­tions of $100,000 or less – typ­i­cally the size of trades as­so­ci­ated with re­tail in­vestors.

The MSRB found that 25% of all re­tail-sized trades in the muni mar­ket were con­ducted on ATSs.

The data in­di­cated that 7% of in­ter­dealer trades oc­curred through a bro­ker’s bro­ker, the board said.

The MSRB raised con­cerns about fil­ter­ing last year in an Oct. 17 let­ter to SEC In­vestor Ad­vo­cate Rick Flem­ing.

Flem­ing had asked the board to iden­tify prod­ucts and prac­tices in the mu­nic­i­pal se­cu­ri­ties mar­ket that may have an ad­verse im­pact on re­tail in­vestors.

In Jan­uary of last year, the Fi­nan­cial In­dus­try Reg­u­la­tory Au­thor­ity listed best ex­e­cu­tion among its reg­u­la­tory and ex­am­i­na­tion pri­or­i­ties for the year in a let­ter to mar­ket par­tic­i­pants.

It said firms should con­sider how “re­cent ad­vances in trad­ing tech­nol­ogy and com­mu­ni­ca­tions in the fixed in­come mar­kets af­fect their or­der han­dling de­ci­sions and fac­tor those changes into the re­view of the ex­e­cu­tion qual­ity they pro­vide cus­tomers.” ◽

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