WASHINGTON — Federal regulators would spend months, if not years, implementing the sweeping changes to the municipal market that were outlined in the financial regulatory reform legislation finalized by House and Senate negotiators late last week.
Congressional leaders had hoped both chambers would sign off on the 2,300-page bill this week, but the death of Sen. Robert Byrd, D-W.Va., cast an element of doubt over whether Democrats would be able to get the 60 votes needed to overcome an expected filibuster attempt in the Senate. West Virginia Gov. Joe Manchin 3d, a Democrat, has authority to appoint someone to finish Byrd’s term, which ends in 2013.
However, even if Congress approves the measure and President Obama signs it into law as planned before July 4, it will still take months before regulators can fully implement many of the muni-market related changes.
The Commodity Futures Trading Commission, for example, would have one year to write rules for the registration of, and business conduct standards for, swap dealers and major swap participants in the municipal and other markets.
In addition, the CFTC would have a year to formulate a code of conduct for dealers that enter into swaps with “special entities,” which include states, localities, and pension funds. The code of conduct was added to the bill during the final negotiations that concluded early Friday morning, replacing a proposed fiduciary duty on swap dealers. Both dealers and issuers warned the fiduciary language would have been legally unworkable.
In contrast to the year-long transition for many rules related to swaps, the Municipal Securities Rulemaking Board would have to act much more quickly. Officially, the board would have until Oct. 1 to ensure that a majority of its members consist of representatives of the public — individuals who generally are not employed or directly tied to dealers or advisers — including at least one representative of issuers, one representative of retail or institutional investors, and one muni expert. It also would have until Oct. 1 to draft requirements to ensure the independence of its public members.
In reality, however, the board only has a few weeks to ensure that a majority of its new board is independent, since it typically votes to elect new members during its summer meeting, which is to be held July 21-22 near Cape Cod. The new members would not begin their three-year terms until Oct. 1, the start of the MSRB’s fiscal year.
The timing for some of the other muni-related provisions is less clear. Though the Securities and Exchange Commission would register financial advisers and the MSRB would write business conduct standards, professional qualifications, and a “fiduciary duty” rule for them, it is unclear when these would be implemented.
And while the bill would authorize, but not require, the SEC to direct the Financial Industry Regulatory Authority to collect assessments from dealers to fund the Governmental Accounting Standards Board, it does not set any deadline.
GASB currently is funded through voluntary contributions from state and local governments, as well as by revenue from the sales of its publications. But it is constantly short of funds and its dependence on issuers is seen as a conflict.
GASB reported a $3.83 million budget shortfall for 2009 and projects a shortfall of $4.46 million in 2010, according to estimates on the group’s website. Neal McGarity, a spokesman, said GASB would not comment on the reform bill.
Though dealer groups have warned it would be inappropriate to collect fees for GASB from their members, market participants speculated that regulators are hoping to tap dealers because they currently have no regulatory authority over issuers. Were Congress to direct a regulator to collect the fee from issuers, “they’d be playing with Tower and it gets very sensitive,” said one market participant, referring to an amendment to the Securities and Exchange Act of 1934 that prohibits the SEC or the MSRB from collecting documents from issuers prior to bond sales.
The compromise bill would require the congressional watchdog, the Government Accountability Office, to evaluate the role and importance of GASB within 180 days of the bill’s enactment.
In addition, it would require the GAO to report to Congress within 18 months of enactment on the municipal market in general, including an analysis of trading, and to send Congress another report within two years on whether legislative changes are needed to improve muni disclosure.
Though many market participants are generally supportive of the muni provisions in the bill, the U.S. Chamber of Commerce yesterday warned it poses a “regulatory tsunami” that includes at least 355 potential new rulemakings, 47 studies, and 74 reports. In opposing the bill, the chamber compared it unfavorably to the Sarbanes-Oxley Act of 2002, which in comparison had only 16 rulemakings and six studies.
However, dealer groups like the Securities Industry and Financial Markets Association said they are pleased that the conferees approved the proposal to bring unregulated financial advisers under SEC and MSRB authority, which it contends will level the playing field for dealer and non-dealer advisers and help protect investors.
MSRB executive director Lynnette Hotchkiss said the board is “pleased that Congress is establishing oversight of municipal financial advisers.”
“We believe this is necessary to prohibit fraudulent and manipulative practices, require fair treatment of municipal securities issuers and investors, ensure rigorous standards of professional qualifications, and promote market efficiencies,” she said in a statement. “If the financial reform bill is signed into law, the MSRB will begin immediately to develop the necessary regulatory framework and professional standards for financial advisers.”
The board also would be able to assist other regulators in the enforcement of its rules and could impose charges on dealers or FAs for late submission of data or other information required by board rules, as well as collect a portion of the fines the SEC and FINRA charge for violations of board rules.
Peter Shapiro of Swap Financial Group in South Orange, N.J., said the regulations for advisers, including the fiduciary duty, represent a “big step forward to a cleaner muni market,” adding that while some key details will have to await the adoption of final regulations from the CFTC and SEC, “so far so good.”
“Swaps will be subject to regulation, but municipal issuers and nonprofit borrowers should be able to continue to enter into swaps on an over-the-counter basis, without the burdensome collateral requirements and less effective hedges that they would have to settle for if they were forced into using only exchange-traded derivatives,” he said.
Sam Gruer, managing director at Cityview Capital Solutions LLC in Millburn, N.J., said he generally agrees with the municipal adviser section of the bill but has some concerns about the actual implementation of some provisions, including an apparent requirement for written representations by the adviser about both the fair pricing and the appropriateness of a transaction.
“Some of our clients have hired us solely for pricing-execution and others solely for analysis,” he said. “Will this continue to be allowed or will all special entities be required to hire an adviser for the full spectrum of representation?”
Gruer noted that the bill would require a dealer to conclude whether an adviser is qualified to evaluate a particular transaction, but said the provisions should be implemented in a way that does not create a conflict of interest between the adviser and the dealer.
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