What’s Prevailing with Prevailing Market Price (PMP)
In 2014, when Malcolm Northam, then the head of Market Regulation for FINRA, spoke in front of the St. Louis Municipal Bond Club Outing and asked the question “Has everyone here read the SEC’s “Report on the Municipal Securities Market?”(July 31, 2012), very few hands were raised. But there’s no doubt that there’s been a lot more attention paid to the report since “Mac” challenged the room; many of the recommendations made by the SEC in their report have since been answered by the MSRB in the form of both new rules, and changes to existing rules. Outing members would have had to read no further than the Executive Summary (the first ten pages) to understand the changes that were to come.
This article is my take on various sections of rule changes that Dealers should keep in mind when developing their WSPs as regards to “mark-up”. While the rule has already gone into effect (May 14 2018), there are still many details that Dealers are working on in order to make sure that they have correctly interpreted the Rule.
Municipal Continuing Disclosure Co-0peration (MCDC), Time of Trade Disclosure (MSRB Rule G-47), and Best Execution (MSRB Rule G-18) have all been instituted in the time since the report was issued. Most recently, the MSRB responded to another recommendation from the report: “The MSRB should consider requiring municipal bond dealers to disclose to customers, on confirmations for riskless principal transactions, the amount of any markup or markdown”. (SEC Report Page xx)
By a series of changes to existing rules, mandating that mark-ups be included on confirmations for certain municipal trades, the MSRB has fulfilled the SEC recommendation. The MSRB set a hard start date of May 14 of this year for implementation, and Cindy Friedlander, current Director of Fixed Income at FINRA, has said that FINRA will immediately start including mark-up in their cycle exams.
The amendments to MSRB Rules G-15 and G-30 were a couple of years in development- the first notice of Proposed Rule Change was issued in November 2014, the Prevailing Market Price (PMP) Proposal went out in February of 2016, and the SEC approved the changes in November of 2016. Implementation, as previously stated, was May 14, 2018.
On its face, the requirements of the rule seem fairly simple. Rule 15, having to do with confirmations, now states under (F) that the confirmation shall include a mark-up or mark-down for the transaction expressed both as a total dollar amount and as a percentage of the prevailing market price IF the trade is done with a non-institutional customer AND if the dealer had an offsetting transaction of the same or larger amount in that same bond on that same day. (Readers are encouraged to check the MSRB Rule for the exact wording).
Simply put, if a Dealer buys a bond from the street and sells it to a non-institutional account on the same day, it is required to show the mark-up (or mark-down, if the trade is going the other way) on the confirmation.
Where “fairly simple” becomes “a bit more complicated” is the requirement for Dealers to establish a “Prevailing Market Price”. The PMP determines what price Dealers must use as the starting point from which they have marked up the bond.
The MSRB, in their guidance, recommends that Dealers modify their WSPs to describe the ways in which they will arrive at PMPs. As stated by MSRB guidelines, “dealers would be expected to have reasonable policies and procedures in place to determine prevailing market price in a manner consistent with Rule G–30, and that such policies and procedures would be applied consistently across customers”.
MSRB Rule G-30 describes PMP as primarily the price (referred to as “contemporaneous price”) that a Dealer paid for the bonds before selling them to the customer. “Presumptively for purposes of this Supplementary Material .06, the prevailing market price for a municipal security is established by referring to the dealer’s contemporaneous cost as incurred, or contemporaneous proceeds as obtained, consistent with applicable MSRB rules.” (MSRB Rule G-30, Supplementary Material .06)
The process of developing a Dealer’s cost and marking from that level seems simple, but the MSRB guidance adds another factor that a Dealer must consider: timing. “A dealer’s cost is (or proceeds are) considered contemporaneous if the transaction occurs close enough in time to the subject transaction that it would reasonably be expected to reflect the current market price for the municipal security”. (MSRB Rule G-15 Interpretive Guidance FAQ 3/19/18)
Therefore, a Dealer should develop policies and procedures that specify time limits that would be used in order to define contemporaneous trades.
Another complication is the question of whether or not trades done on the same bond, at different prices, by other Dealers, can affect a Dealer’s PMP. In its publication “Confirmation Disclosure and Prevailing Market Price Guidance FAQ Section 3.9” (3.19.18) the MSRB states “Dealers could also define criteria to consider other relevant factors, such as whether intervening trades by other firms occurred at prices sufficiently different than the dealer’s trade to suggest that the dealer’s trade no longer reasonably reflects the current market price for the security, or whether changes in interest rates or the credit quality of the security, or news reports were significant enough to reasonably change the PMP of the security.”
A Dealer should consider developing policies that address the range in which a bond could trade before it affects the determination of that Dealer’s PMP.
Finally, Dealers should also note that MSRB is takes into consideration the timing of a firm’s information input as regards to their development of PMP. Again, from MSRB Guidance, “ This means that a dealer that systematically inputs the information at the time of trade may determine the PMP—and therefore, the mark-up—at the same time (even if the confirmation itself is not printed until the end of day). On the other hand, if a dealer systematically inputs such information at the end of the day, the dealer must use the information available to the dealer at that time to determine the price prevailing at the time of the customer transaction—and, therefore, the mark-up.” (Confirmation Disclosure and Prevailing Market Price Guidance FAQ Section 3.4)
For example, a firm buys a 100m piece at 10:00 A.M. at par and immediately sells 50m at 101.5, intending to show a 1 ½ point markup on the confirm (which would be expressed both as total actual money and percentage of price). Then, a trade on matching bonds occurs at 2:00 P.M. in the street at 99. The PMP determined by a firm inputting information at the time of trade could develop a different PMP than a firm using an end of day method of inputting information. (A Dealer that chooses to use an end of day determination would have to take into account both trades in establishing its PMP).
Dealers should pay close attention to how their information input is prescribed.
In this article, I have dealt with just a few of the considerations that a firm should consider in reviewing its WSPs in order to make sure that the firm is compliant in dealing with mark-up and PMP. I would be happy to receive comments or questions regarding this topic.