The Evolving Role of Issuers and the Financing Team
Teams can change players, coaches and rules that can affect how they react to certain situations. Municipal Issuers such as cities and counties can face a constantly changing landscape as they issue debt to help their infrastructure and quality of life needs. Rule changes can affect how municipal issuers and the financing team can move forward to perform their duties. These team players are all in tune with the regulatory rules under which they have to perform under and can assist municipal issuers through the ever-changing regulatory environment.
Some of the key players for municipal issuers include, but are not limited to municipal advisors, underwriters and rating agencies all of whom have been affected by rule changes in the last several years. According to GFOA Best Practices, a key part to issuing debt is to assemble a finance team to help the municipal issuer.
Once a municipal issuer decides to finance a project, it should consider hiring finance professionals to assist in tasks such as creating a plan of finance, setting up a timetable, advising on a method of sale, developing bond documents and closing the transaction. If a public sale is chosen as the method of sale, preparing for rating agency presentations and marketing the bond offering to investors are added to the list. A municipal issuer can benefit from understanding the roles for those that are part of their finance team.
In light of the changing regulatory landscape brought about by the financial crisis and ensuing congressional actions such as the Dodd-Frank Wall Street Reform and Consumer Protection Act passed in 2010, rating agencies, investment banks, municipal advisory firms and other financial intermediaries are under significant regulatory scrutiny causing them to heighten their level of questioning and due diligence of municipal issuers as well as having to adhere to new regulatory rules.
The Municipal Advisor
When the Securities and Exchange Commission (“SEC”) enacted the Municipal Advisor Rule on July 1, 2014, it defined the term, “municipal advisor,” and created a requirement that both municipal advisors and broker-dealers who provide municipal advisory services register as municipal advisors. In addition, as of September 17, 2017, in order to be able to provide advice as a municipal advisor, professionals must take and pass Municipal Securities Rulemaking Board’s (MSRB) Municipal Advisor Representative Qualification Examination (Series 50) before engaging in municipal advisory activities on behalf of a municipal advisory firm. The new rules are coupled with MSRB rule G-42 that dictates that a municipal advisor in the conduct of all municipal advisory activities for a client, be subject to a fiduciary duty that includes a duty of loyalty and a duty of care.
The role the municipal advisor performs for municipal clients has not changed dramatically with the implementation of the Municipal Advisor Rule. One of the new items that municipal issuers need to be aware of is that a municipal advisor must disclose to a municipal issuer that it will be acting in the role of a municipal advisor at the outset of a relationship, even if a formal contract has not been signed yet. This rule is in place to make it clear to the issuer what role the professional is playing. A municipal advisor cannot act in the capacity of an underwriter for a Negotiated transaction (which has been true for many years) but now it cannot bid even on a Competitive transaction.
The municipal advisor assists the issuer with identifying and analyzing financing solutions and alternatives for funding its capital improvement plan, preparing a plan of finance, selecting a method of sale and preparing a timetable amongst other roles. Once the issuer is ready to move forward with a financing the municipal advisor will advise on the method of sale taking into account market conditions and other key considerations. On a competitive bond sale, the municipal advisor will help the municipal issuer with preparation of the notice of sale, preliminary official statement, verification of bids and calculation of the True Interest Cost. If the method of sale is a negotiated sale, the municipal advisor can advise on the selection of underwriter, negotiate compensation with the underwriter, and advise on the allocation rules for the sale and on the interest rates offered.
The MSRB rule G-17 known as the fair dealing rule sets out specific requirements that an underwriter must follow when communicating to and working with municipal issuers throughout the issuance process for municipal securities, particularly for negotiated offerings. Unlike a municipal advisor, an underwriter does not have a fiduciary duty to the municipal issuer and, therefore, is not required to act in the issuer’s best interests without regard to its own financial or other interests. An underwriter’s primary role is to purchase bonds from an issuer for distribution in an arm’s-length transaction and resell those bonds to the public. In a negotiated sale, an underwriter has a duty to purchase the bonds from the issuer at a fair and reasonable price but must balance that with selling municipal bonds to investors at prices that are fair and reasonable. Other duties it performs include holding a due diligence call with the issuer; pre-sale marketing and solicitation of preliminary pricing ideas from any co-managing underwriters. In a competitive sale underwriters bid against one another for the right to sell the issue. Under this type of sale, the underwriter reviews the Notice of Sale and Bid Form, submits an electronic bid after evaluating comparable issues in the market, discussions with potential investors and weighing possible competition from other firms. In a completive sale a limited due diligence call takes place with the issuer and its legal counsel, however, the underwriters are still required, under the new rules, to review the issuer’s continuing disclosure to make sure the requirements have been met.
The new tax rule establishing the issue price of publicly offered tax-exempt bonds is different from prior regulations. The new rule became effective June 7, 2017. The rule is intended to provide a baseline that establishes an issue price based on substantial amount; 10% of the bonds actually sold to the public. For a competitive sale, the issue price is the initial offering price for the bonds providing the municipal issuer receives at least three bids for the bonds from competitive bidders. In the case of a Negotiated Sale process, the underwriter agrees in writing that it will not sell the bonds to any person at a price higher than the initial offering for five business days after the sale date or until 10% percent are sold.
The Rating Agencies
The Dodd-Frank Act also affected the regulation of the internal process regarding record keeping and conflict of interest for national rating agencies. Dodd-Frank Act adopted new rules pertaining to how a national rating agency would conduct themselves. The following are some of those new practices that have been enacted, such as annual reports on internal controls, updated rules regarding conflicts of interest with respect to sales and marketing practices and better transparency with regard to rating outcomes. The main reason each of the three traditional municipal bond rating firms have all updated their rating methodologies in the last several years was because of the Dodd-Frank Act. These new methodologies have lead the agencies to disclose additional data and assumptions with regard to how credit ratings are assigned.
The SEC’s Rule 15c2-12, requires a continuing disclosure undertaking regarding: (i) a security, (ii) the issuer and its financial data and operations, and (iii) the occurrence of certain material events, also required in the final official statement prepared in connection with the offering of securities. In addition, the passage in 2014 of the Municipal Continuing Disclosure Cooperative (known as “MCDC”) addressed violations of compliance in the final offering statement. If such a violation occurred, the SEC may file enforcement actions against the issuer under Section 17(a) of the Securities Act of 1933 (the “Securities Act”) or Section 10(b) of the Exchange Act. The SEC may also charge underwriters with violating anti-fraud provisions if they failed to exercise adequate due diligence in determining whether issuers have complied with the disclosure requirement in the final official statement.
The municipal issuer, in order to sell most types of bonds, must enter into a written agreement to make certain annual financial information about the issuer publicly available for as long as any bonds remain outstanding. The contractual obligation by the municipal issuer to make information available on an annual basis is referred to as “continuing disclosure,” and the written document the issuer signs is usually called the “Continuing Disclosure Agreement.” Municipal issuers are required to post this continuing disclosure information on the MSRB’s Electronic Municipal Market Access website known as EMMA. The exact type of information required to be updated annually and publicly disclosed through EMMA differs depending on the type of bond issue, but generally consists of the annual financial statements of the issuer and certain specific operating data.
GFOA provides some best practices for the municipal issuer to follow:
• Understand and discuss the municipal issuer’s policies and procedures on disclosure.
• Know who within the municipal issuer is filing what, when and where.
• Know what the issuer has promised to do in its continuing disclosure agreement.
• Be aware of what the municipal issuer has posted on EMMA.
• Recognize that each official statement must include a statement about whether the issuer failed to materially comply with previous commitments within the past five years.
The MCDC Initiative intended to address potential violations of the federal securities laws by municipal issuers and underwriters of municipal securities in connection with certain representations about continuing disclosures in bond offering documents. The obligation for accurate disclosure in the preliminary official statement and official statement ultimately resides with the Issuer.
More than likely, the municipal bond industry will have more and not less regulations to adhere to in the future. One of GFOA’s Best Practices is to hire outside professionals if the issuer does not have sufficient resources on its staff. These outside professionals can help municipal issuers through the new regulatory framework in which we now work within.
This material was prepared by public finance for information purposes only and is not a solicitation of any offer to buy or sell any security/instrument or to participate in any trading strategy. Unless otherwise indicated, these views (if any) are the author’s and may differ from those of the Davenport fixed income or research department or others in the firm.
Article provided by: Ricardo Cornejo, First Vice President Public Finance
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