MSRB Keeps Watchful Eye on Retail Investor Risks

Some market participants may not realize that American households hold $1.63 trillion in municipal securities, representing over 42 percent of outstanding U.S. municipal bond debt. This extensive household ownership of municipal securities requires close monitoring by the MSRB of market practices that may pose a potential risk to retail investors.

Recently, the MSRB identified products and practices within the municipal securities market that could adversely impact retail investors. Presented below is a high-level list of the self-regulator’s top concerns.

The Macroeconomic Environment

The MSRB is concerned with potential risks to retail investors that may arise from the convergence of a rising interest rate environment and the potential for financial distress among some municipalities. With the rise in interest rates over the last several months, the MSRB is urging retail investors to consider reviewing their portfolios with their financial professionals to ensure that they continue to have the appropriate credit exposure and maturity range in their municipal bond holdings. They are recommending investors also keep in mind that all else being equal, the price of a bond with a longer maturity is typically subject to more volatility due to changes in interest rates than a bond with a shorter maturity.

Municipal Fiscal Health

Another area of focus for the MSRB from an investor-risk perspective, is how and when retail investors learn of important developments within a municipality, including those that may indicate fiscal distress. The MSRB supports the decision by the SEC to amend SEC Rule 15c2-12 to include additional event notices that will result in issuers of municipal securities and obligated persons publicly disclosing additional information about bank loans and other financial obligations. The MSRB is in the process of updating the EMMA disclosure submission process and public website to accept and display the new event disclosures upon the effective date of the changes to Rule 15c2-12. These changes were made in light of the new disclosure requirements for issuers with the ultimate goal of providing additional useful information to investors and the market.

Market Practices

The MSRB in April 2018 published a notice for dealers regarding their role in transactions in distressed municipality securities, and the investor protection rules applicable to dealers when effecting customer transactions in securities of distressed municipalities. The MSRB continues to be concerned that investors may seek yield by transacting in securities of distressed municipalities that may not fit well given their risk tolerance and investment objectives. MSRB Rule G-47 requires dealers to disclose to their customers all material information known about a transaction, including material information on the security that is reasonably accessible to the market. This might include credit risks and changes to ratings, or whether the issuer has failed to make filings required under its continuing disclosure agreements. The MSRB reminds dealers that they also should be conscious of their suitability obligations and that, depending on a customer’s investment profile, it may not be suitable to recommend the purchase of the municipal securities of a distressed municipality in light of the potential risks of the investment.

The MSRB continues to be concerned with certain market practices that may negatively impact prices received by retail investors in municipal bonds. The MSRB believes that widespread “pennying” may be harmful to retail investors by disincentivizing participation of other dealers in the bidwanted process. The MSRB is also concerned that pennying may harm municipal market liquidity by discouraging quotations by market participants. The MSRB is currently seeking comment on this topic.

In light of a few new regulatory developments affecting this market, the MSRB, SEC and FINRA plan to hold a compliance outreach program for municipal advisors this February. To register for that conference, click here. If you’re an MSRB-registered firm and still have yet to complete your 2018 continuing education program, click here to browse our course catalog.