Regulating the Fixed Income Market in the United States

1
Regulating the Fixed Income Market in the United
States

• Felice B. Friedman
• OECD-World Bank Bond Market Forum
• 2-3 June 2003

2
Introduction and Background

• The SEC and Debt Markets
• Two Myths to Debunk
• Debt markets as unregulated
• US as case study for Developing an Efficient
  Regulatory Framework for Debt Markets

3
Snapshot of US Fixed Income Market

• 20.2 trillion outstanding debt securities,
  year-end 2002
• 11.7 trillion in equities, slightly more than
  half the debt market

trillions
4
Snapshot of US Fixed Income Market

• Treasury Securities 3.2 trillion
• Federal Agency Debt 2.4 trillion
• Municipal Securities 1.8 trillion
• Corporate Debt 4.1 trillion
• Mortgage-backed 4.7 trillion
• Asset-backed 1.5 trillion
• Money Market 2.6 trillion

Source Bond Market Association
5
Framework of US Debt Market Regulation

• Multiple Govt Agencies/ Regulators
• US Department of the Treasury
• Federal Reserve System
• US Securities and Exchange Commission
• Self-Regulatory Organizations
• NYSE, NASD, MSRB
• Office of Federal Housing Enterprise Oversight

6
Framework of US Debt Market Regulation

• Multiple Governing Laws Crisis-driven rather
  than designed
• Securities Act of 1933 and Securities Exchange
  Act of 1934. Established disclosure framework
  for regulation.
• All securities offered to public must be
  registered with the SEC, unless exempt
• Government and municipal securities exempted from
  registration and reporting requirements
• No exemption from antifraud provisions

7
Regulation of Municipal Securities

• Securities Acts Amendments of 1975
• Response to New York City financial crisis
• Regulated broker-dealers established the MSRB
• Rule 15c2-12, adopted in 1989
• Response to default of Washington Public Power
  Supply System (WHOOPS) in 1983
• First bond disclosure rule

8
Regulation of Government Securities

• Government Securities Act of 1986
• Response to failure of several key government
  securities dealers
• Regulated broker-dealers
• Government Securities Act Amendments of 1993
• Response to Salomon Brothers cornering incident
  
• Improvements in auction process
• Development of sales practices rules for
  government securities markets
• Large position record-keeping and reporting
  requirements

9
Regulation of Corporate Securities

• Corporate Debt Securities
• Sarbanes-Oxley Act of 2002
• Response to failures of Enron, WorldCom
• Focus was equity and not debt, but disclosure
  remedies of Sarbanes-Oxley apply equally to
  issuers of debt as well as to issuers of equity
• Regulatory framework for equity applied without
  independent consideration of debt market

10
What Lessons Can We Draw?

• Hodgepodge of Regulators
• Hodgepodge of Laws and Rules
• Why does it work? Whats key?

11
A Closer Look at the Municipal Securities Market

• Why the municipal securities market?
• Financed the growth of the US
• Has both public and private aspects
• Highlights key regulatory elements
• Demonstrates creativity in regulation

12
Snapshot of the Municipal Securities Market

• Approx. 1.8 trillion sub-sovereign debt
  outstanding at year end 2002
• Approx. 430 billion in municipal debt issued in
  2002, about 75 long term. About 25 due to
  refinancing/ refunding
• Over 50,000 issuers and 1.5 million different
  issues

13
Overview of Municipal Securities Regulation

• Historically
• Exempt from registration and reporting
  requirements of Securities Act and Exchange Act
• Reasons unique to United States
• Low-risk investment
• Institutional investor base

14
Overview of Municipal Securities Regulation

• What changed?
• Financial crisis in major municipalities
• Changes in bankruptcy law in 1979
• Cutbacks on federal aid to municipalities
• Proliferation of new, untested financing
  techniques
• Change in investor base

15
Regulation of Municipal Securities

• Broker-Dealer Regulation
• Securities Acts Amendments of 1975 established
  regulatory scheme for municipal securities
  broker-dealers
• Added Section 15B to Exchange Act
• Authorized SEC to set up an SRO
• All MSRB rules approved by SEC
• Inspection and enforcement authority with SEC,
  NASD, and FRBNY

16
Regulation of Municipal Securities

• Disclosure Regulation
• Rule 15c2-12 -- Imposes both primary and
  secondary market disclosure
• Requires underwriter to obtain, file and
  distribute Official Statement
• Underwriter must obtain from issuer a written
  agreement to make financial and operating
  information available on ongoing basis
• Transparency Requirements
• MSRB rules require transaction reporting for each
  security traded at least two times the previous
  day
• Antifraud Regulation and Enforcement
• City of Miami, 2003

17
Issues to Consider

• Who should be the regulator?
• Consider US example, or non-example
• Functional regulation How best to look after
  investor concerns?
• Should the safety and soundness regulator be
  charged with disclosure requirements for public
  offerings?
• Coordination among regulators and
  self-regulators

18
Issues to Consider

• Should there be a self-regulatory organization
  involved?
• Sufficient government oversight
• Balance between SRO and regulator consider
  powers of MSRB vs. powers of NASD

19
Issues to Consider

• Should offerings of debt securities be
  registered?
• What is being offered?
• Is it backed by full faith and credit of the
  government?
• Who is the investor base?
• Registration and oversight more important for
  retail investors and when material information is
  similar to that as would be required for equity
  offers

20
Issues to Consider

• May not be necessary to have a registration
  scheme for offerings
• Broker-dealer conduct regulation with strong
  market integrity provisions may substitute
• Can impose disclosure obligations on
  intermediaries instead of issuers
• Rule 15c2-12, as example

21
Issues to Consider

• What information should be disclosed?
• Material information, both financial and
  non-financial
• Importance of high quality accounting and
  auditing principles/ standards (also to the
  rating agencies)
• Importance of non-financial statement disclosure
• MD A picture of company through managements
  eyes
• Role of market participants in demanding better
  and more timely information

22
Issues to Consider

• Is enforcement regime effective?
• Importance of strong, well-resourced,
  independent, regulator
• Complemented by individual private right of
  action
• Need effective judicial system with an impartial
  judiciary that will enforce regulatory action,
  where needed

23
Conclusion

• Regulatory goal Increase investor confidence
  and provide readily accessible source of capital
• Comprehensive regulatory scheme not necessary
• Key elements of regulation critical, but may
  vary depending on the legal structure, the market
  and the investor base
• Oversight of intermediaries, including capital
  adequacy
• Mandatory centralized disclosure and price
  transparency for investors
• Prohibition of fraud and effective enforcement
• Market development and regulation is evolutionary
  process