Municipal bond issues remain popular in Washington: throughout the year, we can expect Congress and the SEC to propose and finalize significant legislative and regulatory initiatives that will have a direct impact on municipal bond issuers.
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.g., a bank). The Senate draft, would only allow governments with more than "$50 million in discretionary investments" to enter into these contracts.
Requiring Studies to Review the Need for Federal Intervention in Municipal Securities Issuance, Governmental Accounting Rules, and GASB Funding. Senate drafts have included two studies that would affect state and local governments significantly The first study would have the Government Accountability Office (GAO) examine the effectiveness of the Tower Amendment on municipal securities. In a nutshell, the Tower Amendment, passed in 1975 and named after then-Senator John Tower (R-Texas), reiterates language in the 1933 Securities Act that prohibits the SEC from regulating issuers of municipal securities. The GFOA strongly supports the prohibition of federal government involvement in the issuance of bonds by state and local governments, and remains vigilant in opposing efforts to change or eliminate this ban. The second study calls on the SEC to review a stable funding source for the Governmental Accounting Standards Board (GASB). The GFOA continues to oppose any efforts to involve the federal government in the funding or oversight of the GASB and has expressed concern that such a study, especially if conducted by the SEC, would not provide a well-rounded assessment of the potential options for funding the GASB or adequately address the concerns about having the federal government involved in the management of the GASB.
The American Recovery and Reinvestment Act (ARRA), enacted in early 2009, has provided much-needed relief to state and local governments during the economic downturn (see "The 2010 Municipal Market: Looking for the Calm after the Storm," in this issue of Government Financial Review, and the GFOA's online ARRA Resource Center at http://gfoa.org/index.php? option=com_content&task=view&id=1 133). However, Congress is likely to act in order to ensure that the new and expanded bond programs it created remain in place, as most of them expire at the end of 2010.
Bank-qualified bonds top the GFOA's list of importance. The ARRA increased the bank-qualified debt limit to $30 million from $10 million--the first increase since the limit was set in 1986. The GFOA is strongly urging Congress to extend--or better yet, make permanent--the $30 million bank-qualified debt limit. Banks have historically been major purchasers of municipal bonds, and prior to 1986, they were permitted to deduct all or a major portion of the interest costs they incurred to invest in these bonds. The 1986 Tax Reform Act eliminated this deduction, except for certain very small issuers that do not issue more than $10 million in bonds annually. With an increased threshold of $30 million in 2009, many small governments have been able to take advantage of placing their debt with community banks rather having to sell their debt in the open market and face higher issuance costs. The changes in the law have been extremely helpful to small borrowers, and the GFOA is strongly pushing for the $30 million level to be maintained.
Build America Bonds. A new type of tax credit bond created under the ARRA--Build America Bonds (BABs)--give a direct subsidy payment from the federal government to the state or local government entity equal to 35 percent of the interest costs of the bonds. Members of Congress and Obama Administration officials have touted the program as one of their most successful efforts to help state and local governments. Their commitment and nod to the amount of BABs that have thus far been issued make it likely that Congress will look to continue the program, although it is unclear if Congress will continue the program as-is, place new limits or requirements on BABs, decrease the 35 percent subsidy rate, or expand the types of projects for which BABs may be used (currently, they can be issued only for governmental bonds).
Recovery Zone Economic Development Bonds. Congress will also need to determine if a companion program, Recovery Zone Economic Development Bonds (RZEDBs), will continue or be woven into the BABs program. RZEDBs give issuers a 45 percent reimbursement of interest costs for bonds issued to promote economic development in designated recovery zones.
Tax Credit Bond Programs, Reauthorization of certain traditional tax credit bond programs that are set to expire in 2010--including Qualified Zone Academy Bonds (QZABs), Qualified School Construction Bonds (QSCBs), and Recovery Zone Facility Bonds--is also on Congress's to-do list. Interestingly, the House of Representatives passed legislation in December 2009 (H.R. 2847, the Jobs for Main Street Act of 2010) that would turn the QZAB and QSCB programs from traditional tax credit bond programs, where the investor receives the tax credit, to something that is similar to a BABs structure. The legislation would allow the issuer to receive a direct subsidy payment equal to the full interest cost of the bonds (unlike BABs, which only allows for a 35 percent subsidy). The Senate has not yet considered comparable legislation, but such an initiative might take hold as calls for a complete overhaul of tax credit bond programs increase. Issuers and investors alike continue to be concerned with these programs, as the bonds are difficult to structure and lack a strong appetite from investors.
OTHER LEGISLATIVE INITIATIVES
FHLB Letters of Credit. The Housing and Economic Recovery Act of 2008 included a provision amending Section 149(b) of the Internal Revenue Code, adding Federal Home Loan Banks (FHLBs) to the list of government-sponsored enterprises permitted to provide credit enhancement for all types of tax-exempt bonds. (Previously, the FHLB had only the authority to provide credit enhancement to housing bonds.) The authority expires on December 31, 2010, and the state and local government community is seeking to have the authority extended or made permanent. This is necessary because the lack of bond insurance available limits credit enhancement alternatives.
SEC Efforts to Further Regulate the Municipal Market and State and Local Governments. While the Senate calls for studies on these matters, SEC Commissioner Mary Schapiro and other SEC commissioners, most notably Elisse B. Walter, commented throughout 2009 that Congress needs to give the SEC more authority to regulate issuers of municipal securities through the repeal of the Tower Amendment, which would allow the SEC to place direct regulations on state and local governments that issue bonds. Some members of Congress have expressed their support for such efforts, although House Financial Services Chairman Barney Frank (D-Mass.) does not support the SEC's ambitions. The SEC has also spoken about the need to have a direct relationship with the GASB by possibly providing a funding source to the organization, mandating the use of GASB standards by all governments, and having oversight authority over the GASB. The GFOA and the state and local government community strongly oppose any such intrusion by the SEC in these areas. While it is unclear if such barking will end up with any bites, the GFOA's Washington office will continue its work to educate members of Congress about the perils of federal involvement in the business of state and local governments, and will work closely with other state and local government organizations, including the National Governors Association, the National League of Cities, and the National Association of Counties, to defeat any efforts that would give the SEC authority to regulate issuers of municipal securities or oversee the GASB.
In addition to its repeated comments that it will focus on the need for additional regulatory authority over issuers of municipal bonds, the SEC is working to implement further rules on municipal securities within the context of its current authority.
In July 2009, the SEC proposed additional requirements to SEC Rule 15c2-12, which sets forth obligations on underwriters for ensuring that issuers of municipal bonds have prepared official statements for primary offerings and have agreed to provide continuing disclosure information for the lifetime of the bond, including material event disclosures and annual financial information. The proposed changes would apply continuing disclosure obligations to variable rate demand obligations, increase the number of material events that must be submitted to the MSRB's Electronic Municipal Market Access system (EMMA), and require disclosure of certain events even if they are not deemed material. One of the most significant proposals would require material event notices to be submitted within 10 business days after the event, which the GFOA opposes. Currently, Rule 15c2-12 calls for submissions to be made "in a timely manner: In a formal comment letter submitted in September 2009, the GFOA cautioned the SEC against a uniform standard and noted that in some instances, an issuer may be made aware of a material event much later than within 10 days of its occurrence (e.g., in the case of a downgrade of insurance or letter of credit provider).The GFOA has also expressed concern about eliminating the need to determine materiality for some events, especially a new requirement to disclose IRS audits. The SEC is expected to finalize these rules in early 2010 and will possibly propose additional changes to Rule 15c2-12 in an effort to push its current authority over municipal securities as far as it can, short of securing new statutory authority.
TREASURY AND THEIRS
The U.S. Department of the Treasury is responsible for writing regulations for all the new bond programs. While it has released many of these rules, including the forms for receiving BABs subsidy payments and allocation authorities, and rules for issuing QSCBs and RZEDBs, the industry is anxiously awaiting the Treasury's guidance on allowing investors to strip the tax credit off these bonds so they may be sold to other investors. Such guidance will make the tax credit bonds more attractive to investors.
In recognition of current credit market constraints, the Treasury in December extended by a year the temporary rules allowing state and local governments to buy and temporarily hold their tax-exempt bonds without their being considered reissued for tax purposes. The rules allow issuers to buy and hold tax-exempt auction-rate securities, variable-rate bonds, and commercial paper without penalty until December 31,2010.
The Internal Revenue Service (IRS) will continue its focus on post-issuance compliance matters. In 2008 and 2009, both governmental and 501(c)3 bond issuers have received surveys from the IRS that ask detailed questions about the standards the entity has in place to ensure compliance with the tax code after the bonds are issued. The IRS is also expected to take a close look at issuers' compliance efforts under the BABs program. The surveys and focus on post-issuance compliance practices may result in additional IRS guidance and procedures.
MSRB AND EMMA
The MSRB's proposed new voluntary fields for the EMMA system are awaiting final approval by the SEC (see "Issuer's Continuing Disclosure Responsibilities and Using EMMA; in this issue of Government Financial Review).The new fields would allow issuers to indicate whether they submit a URL link to budgetary and other financial information located on the government's Web site; follow generally accepted accounting standards as pronounced by the GASB or the Financial Accounting Standards Board (depending on type of issuer); intend to file annual financial information within 120 days of the end of the government's fiscal year; or intend to file annual financial information within 150 days of the end of the government's fiscal year.
The GFOA continues to support efforts to allow issuers to submit their Web links to EMMA so investors and the public can view a plethora of information that is available about their government. However, the GFOA opposes efforts to place voluntary fields within EMMA indicating that a government is able to submit its annual financial information within 150 or 120 days of the end of their fiscal year. Such a timeframe does not reflect the time necessary to produce this information--and have it audited. Governments might feel pressured to meet these deadlines, which would lower the quality of the information provided and compromise the audit itself. In letters to the MSRB and the SEC, the GFOA has stated that its own Certificate of Achievement in Financial Reporting program gives governments 180 days to complete their annual financial information, and timeframes that are shorter than this would be impossible for most governments to meet. Furthermore, the GFOA continues to recommend that the EMMA system create a field for the issuer to indicate if it has submitted annual financial information in accordance with the bond's continuing disclosure agreement (CDA). The CDA is the legal, binding document that issuers enter into with the underwriter at the time the bonds are sold, indicating when they will submit annual financial information to EMMA for the lifetime of the bonds.
While the municipal bond issues described above outline the most urgent Washington activities that state and local governments should monitor in 2010, other, more technical, regulatory initiatives are also being addressed. Issuers of municipal bonds should continue to ask their financial advisors and bond counsel about any regulatory or legislative changes that might affect their outstanding--or new--bond issuances. Additionally, GFOA members and the entire state and local government community should closely monitor these actions, continue their efforts to educate leaders in Washington about the importance of the municipal bond market, and identify those proposals that might either cause harm or be helpful to your communities.
Please visit the GFOA's Web site at www.gfoa.org for more up to date information on these issues. Click the "Federal Governmental Relations" tab on the left side of the home page, or go directly to http://www.gfoa.org/indexohp?Opti0n=com_content&task=view&id--93& Itemid=105.
SUSAN GAFFNEY is director of the GFOA's Federal Liaison Center in Washington, D.C.
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|Title Annotation:||Federal Focus|
|Publication:||Government Finance Review|
|Date:||Feb 1, 2010|
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