Regulators are ready to recommend a boost to municipal market transparency, with the first of five Securities and Exchange Commission hearings on tax-exempt markets to be held this week in California.
SEC hearings could lead to new legislation for municipal markets
Municipal bond analysts, lawyers and investors are scheduled to speak at this week's hearing in San Francisco, where they will be joined by SEC Commissioner Elisse Walter and three of the agency's division heads and will spend a day listening to invited participants discuss borrowers' disclosures to investors and credit ratings in the $2.8 trillion municipal bond market. Similar events in Chicago and Washington are scheduled before the end of the year.
Following the final hearings, to be held in Tallahassee, Fla., in January and Austin, Texas, in February, the SEC said it would draft a report with recommendations for needed changes, which could call for new legislation.
The SEC currently has limited reach over borrowers in the municipal market, where not-for-profit hospitals and health systems routinely issue bonds to finance big-ticket construction, renovation and technology projects.
In 2009, healthcare borrowers sold $45.7 billion in municipal bonds, or about 15% of the $314.2 billion issued. In the first six months of the year, healthcare municipal bond issues accounted for about 12%, or $19.8 billion, of the $161 billion total.
Mary Schapiro, SEC chairwoman, said last fall that the regulator would propose legislation within a year, but the following spring announced the hearings, which she told lawmakers in July would “determine what changes, to laws, to regulation or to private sector best practices, may be needed to better protect municipal securities investors.”
Schapiro and Walter, who was named an SEC commissioner in 2008 from the Financial Industry Regulatory Authority, have repeatedly said the municipal market lacks the transparency found in corporate debt markets, to the detriment of investors.
Walter, in a speech last October speaking personally and not on behalf of the SEC, sharply criticized the market's limited consumer protections as “second-class treatment” for municipal investors. Schapiro, in New York last fall to address the Securities Industry and Financial Markets Association, again said municipal investors see less disclosure than those who buy stocks, but the SEC could do little more with its existing authority. Walter said that laws exempting municipal securities from regulatory oversight should be removed.
In an interview last week, Walter stressed that the SEC has not suggested regulation of municipal markets should be identical to that of corporate markets, but that investors should find necessary information equally transparent. She also said the regulatory agency has not settled on whether legislative changes would be necessary to address the market's transparency.
Securities regulators aren't the only ones calling for more scrutiny of the municipal market. The hearings come as Congress has authorized more oversight over the municipal bond market and inquiries into transparency of the market's trading and disclosure. Walter said that she hoped the hearings would help to inform the inquiries, to be conducted by the Government Accountability Office.
Congress included in the financial overhaul bill signed by President Barack Obama in July reforms and studies of municipal markets, where one $330 billion segment collapsed in early 2008 as the credit crisis unfolded. Investors found they were unable to cash out of municipal bonds they believed to be liquid. Borrowers faced jarring interest-rate hikes, market volatility from bank instability and saw cash unexpectedly tied up in collateral.
Mark Stockwell, chairman of the Board of Governors of the National Federation of Municipal Analysts, said the credit crisis highlighted the need for greater disclosure among borrowers. Analysts found uneven access to information on borrowers' risks from shaky banks or derivative deals as credit markets faltered and continue to do so, he said. “We're hunting and pecking,” said Stockwell, who is also director of municipal research at PNC Capital Advisors. “This is why we're calling for better disclosure.”
Some borrowers were required to post millions of dollars in collateral for derivatives that hedge against interest rate fluctuations when markets soured (Dec. 8, 2008, p. 8).
Borrowers as well as investors would benefit from consistent and more comprehensive disclosure, Stockwell said. Investors can no longer pour assets into deals backed by highly rated bond insurers, many of which saw their credit strength eroded by exposure to risky mortgages. Wary investors may demand higher interest rates from borrowers with limited disclosure or shy from such investments, he said.
Under the financial reform law, the GAO must undertake two studies of the municipal market, which also created an office of municipal securities within the SEC and required municipal financial advisers to register with the agency.
One study will compare how often and how much information municipal borrowers disclose compared with corporations. Findings must be reported to Congress by July 2012.
The SEC has used its authority over underwriters that sell municipal bonds to expand public reporting of financial and other information considered critical for investors. Beginning in December, borrowers with newly issued bonds sold in short-term markets, known as variable-rate demand bonds, must now comply with disclosure rules. The bonds were previously exempt. The rule change also increased the number of major events that must be reported publicly and set a deadline requiring that such events must be disclosed within 10 days of the event.
The second GAO study, which must be completed by December 2011, will examine the market's trade reporting and market transparency.
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