As 2010 gets underway, the municipal bond market continues to garner attention by policy makers and regulators in Washington. Throughout the year, we can expect Congress and the Securities and Exchange Commission (SEC) to propose and finalize significant legislative and regulatory initiatives that will have a direct impact on municipal bond issuers. This article provides a summary,
REGULATORY REFORM LEGISLATION
Congress is poised to send President Obama the most significant financial services regulatory reforms in more than 80 years. The legislation was created in reaction to the financial market collapse and lack of regulation and appropriate government oversight of financial institutions. The reform efforts would give additional regulatory authority over the financial services sector to various agencies of the federal government, as well as the Federal Reserve and the SEC. The reforms would also apply greater consumer protections to a variety of financial instruments, provide greater guidance and oversight of credit rating agencies, and create a regulatory framework for certain sectors of the market that are currently outside the federal government's control.
The House of Representatives passed its version of the overhaul legislation in December 2009 (H.R. 4173, The Wall Street Reform and Consumer Protection Act), and the Senate is set to consider its bill in early 2010. Both the House-passed bill and discussion drafts of the Senate bill contain numerous provisions that affect the municipal bond market and issuers of municipal securities. These provisions are discussed below.
Creating Uniform Ratings for Municipal and Corporate Securities. Currently, credit rating agencies maintain two separate rating systems for municipal securities and corporate securities. In most cases, the scale used for rating municipal securities is more rigorous than the scale used for corporate securities, even though the rating agencies readily acknowledge that the default rate for municipal securities is far less than what exists in the corporate sector. The two separate scales, and criteria used to determine creditworthiness, cause municipal bonds to be rated lower than their corporate counterparts, which increases the cost of issuing debt for state and local governments. Legislation that mandates the use of uniform ratings (based on the likelihood of default) would create a level playing field for all securities, making it easier for investors to compare types of securities, and significantly assist state and local governments. The House legislation includes such parity language, while early drafts of the Senate version do not. The GFOA and other state and local government organizations are strongly advocating for the inclusion of a provision that would require all securities to be rated in the same manner.
Mandating the Regulation of Financial Advisors, Swap Providers, and Other Professionals Involved in Issuing Municipal Securities. Currently, financial advisors and most other advisory professionals involved in municipal securities are not regulated by the SEC, Financial Industry Regulatory Authority (FINRA), or the Municipal Securities Rulemaking Board (MSRB). Both the House bill and drafts of the Senate bill create a regulatory framework, similar to what exists for broker/dealers, which would ensure that those advising state and local governments meet certain qualifications and adhere to rules that protect their clients from unlawful practices. The GFOA supports such efforts.
Mandating the Regulation of Derivative Products. Currently derivative products, including those associated with municipal securities, are not regulated. A cornerstone of the reform effort is to ensure that an adequate regulatory framework exists for the entire derivatives market. Both the House and Senate versions would affect state and local governments that enter into these contracts. The House legislation would allow a state or local government to enter into a derivatives contract only if the government has more than $50 million in "discretionary investments" or if the counterparty to the transaction is regulated (e. …