The Securities and Exchange Commission's (SEC) Fixed Income Market Structure Advisory Committee (FIMSAC) held its latest meeting on February 10, 2020.1 The SEC formed FIMSAC to provide advice to the SEC on the efficiency and resiliency of the fixed income markets and identify opportunities for regulatory improvement. During the February meeting, FIMSAC considered and voted to approve:
- a recommendation from the Technology and Electronic Trading Subcommittee regarding reporting additional indicators for corporate bond trades to the Financial Industry Regulatory Authority's (FINRA) Trade Reporting and Compliance Engine (TRACE); and
- a recommendation from the Municipal Securities Transparency Subcommittee involving the timeliness of financial disclosures in the municipal securities markets.
FIMSAC also convened a panel to consider internal fund crosses.2
On November 13, 2019, the SEC renewed the charter for FIMSAC for another year.3 With its newly renewed charter, FIMSAC will continue discussions regarding potential enhancements to the fixed income markets during the coming year. FIMSAC's next meetings for this year are currently scheduled for April 27, 2020 and August 3, 2020 (although the dates are subject to change). In addition to considering issues discussed in the February meeting, FIMSAC is considering a request from SEC Chairman Jay Clayton to analyze and comment on various structural and macroeconomic factors in the fixed income markets, including, without limitation:
- developments in monetary policy and corresponding financial conditions as they relate to the fixed income markets;
- the transition away from LIBOR;
- developments in the sub-investment grade and leveraged finance markets, including covenant packages; and
- developments in the municipal finance markets, including issuer disclosure.
In his introductory remarks for the February meeting, FIMSAC Chairman Michael Heaney summarized the work performed by FIMSAC over the past two years, including having provided the SEC with 10 recommendations on nine topics.4 Chairman Heaney also described the progress to date in implementing two of the recommendations. On April 9, 2018, FIMSAC introduced a recommendation for a pilot program to study the market implications of changing the reporting regime for block-size trades in corporate bonds.5 To implement this recommendation, FINRA requested comment on a proposed pilot program to study the recommended changes to corporate bond block trade dissemination.6 FINRA received over 30 comment letters, which expressed divided views on the proposal. FINRA continues to evaluate next steps for such a pilot program.
In addition, on October 29, 2018, FIMSAC recommended that the SEC, in conjunction with FINRA, establish a reference data service for corporate bonds which would contain specified data elements on TRACE-eligible corporate bond new issues.7 On December 4, 2019, the SEC, pursuant to delegated authority, approved FINRA's proposal to establish a central depository for public dissemination of new-issue corporate bond reference data that was in line with FIMSAC's recommendation.8 On December 12, 2019, however, the SEC stayed approval of the service in response to a petition to review the delegated approval, until it orders otherwise.9
Recommendation to Enhance Data Reported to TRACE for Corporate Bond Trades
One panel of the FIMSAC meeting discussed the Technology and Electronic Trading Subcommittee's preliminary recommendation to improve price transparency for certain types of fixed income transactions reported to TRACE. The recommendation addressed two particular types of trades for which the TRACE reported price may not be reflective of the current market price, namely completed spread trades awaiting a Treasury spot and portfolio trades. After discussing issues raised by the proposal, FIMSAC voted to approve the subcommittee's recommendation, with 17 votes in favor and no votes in opposition or abstentions.10
Completed spread trades awaiting a Treasury spot11 are reported to TRACE following the completion of the spotting process, even if the parties agreed to the spread much earlier in the day. As corporate bond spreads and Treasury prices can move throughout a day, the delayed spot process allows for a potential mismatch between the assumed value of the trade when the spread is agreed on and the price reported to TRACE following the Treasury spot later in the day. To address this issue, FIMSAC recommends that the SEC, in conjunction with FINRA, require that reporting parties include a flag or modifier for delayed spot trades that will alert market participants that the spread-based economics of the trade had been agreed on earlier in the day, and that the reporting party on a delayed spot trade be required to report the time at which the spread was agreed on.
In addition, with respect to portfolio trades, FIMSAC recommends that the SEC, in conjunction with FINRA, require that reporting firms use a TRACE modifier to identify whether a particular trade was executed as part of a portfolio trade. For purposes of this recommendation, a "portfolio trade" is defined to mean a trade that is executed between only two parties involving a basket of securities of at least 30 unique issuers for a single agreed price for the entire basket and that was executed on an all-or-none or most-or-none basis. FIMSAC believes that requiring a modifier for the TRACE report of a bond that is part of a portfolio trade would allow market participants to know with certainty that the price was agreed on as part of a portfolio and therefore may not reflect the independent market price for the particular bond.
FIMSAC also believes that market participants would benefit from a complete and accurate picture of the number and volume of fixed income trades that are executed electronically in order to track e-trading trends and to better inform transaction cost analysis. FIMSAC, however, did not provide a recommendation that FINRA and the Municipal Securities Rulemaking Board (MSRB) incorporate an "electronic trade" modifier for the fixed income markets due to the issues raised by the varying regulatory treatment afforded electronic trading platforms (i.e., regulated as broker-dealers, alternative trading systems or not at all). Once there is a unifying regulatory framework for all fixed income electronic trading platforms, FIMSAC believes that FINRA and MSRB should establish an appropriate definition of an "electronic trade" that could form the basis for a comprehensive electronic trading flag.
Recommendation Regarding Timeliness of Municipal Issuer Disclosure
Another panel discussed the Municipal Securities Transparency Subcommittee's preliminary recommendation regarding timeliness of municipal issuer disclosure. After discussion of the proposal, FIMSAC voted in favor of the recommendation, with 14 votes in favor, two votes in opposition and no abstentions.12
FIMSAC recommends that the SEC be given additional statutory authority to (1) provide a mechanism for the SEC to enforce compliance with continuing disclosure agreements and other obligations of municipal issuers to protect municipal securities bondholders, and (2) provide a safe harbor from private liability for forward-looking statements for municipal issuers that satisfy certain conditions, including, but not limited to, appropriate risk disclosure relating to such forward-looking statements, and if projections are provided, disclosure of significant assumptions underlying such projections and that the financials are provided in good faith.
FIMSAC also recommends that the SEC explore ways in which it could make disclosure deadlines for annual financial information and audited financial statements more certain and predictable. This recommendation is intended to give investors more certainty regarding when a municipal issuer has agreed to provide annual financials. FIMSAC further recommends that the SEC seek wide-ranging public comment about the concerns raised by market participants about disclosures in the municipal markets and the potential need for the SEC to establish a disclosure framework, including time frame obligations for municipal issuers. After reviewing comments, the SEC can determine whether it would be appropriate for the SEC to seek legislation to give the SEC additional (but still limited) authority over municipal disclosures. Finally, FIMSAC recommends that the SEC explore ways in which it can raise municipal issuers' awareness of the potential consequences of providing less timely and less robust disclosure information, such as the potential for the market to demand higher yields from such municipal issuers.
Internal Fund Crosses Panel
The final panel of the FIMSAC meeting discussed the risks and benefits of internal fund crosses, and the potential advantages and disadvantages of providing relief from certain regulatory requirements related to such crosses. Certain panelists noted that such crosses can be beneficial to both the buyer and seller, and may assist funds with liquidity risk management. Certain panelists also noted the practical difficulty of obtaining and using bids and quotes for purposes of complying with Rule 17a-7 under the Investment Company Act of 1940, and the improved coverage and quality of pricing services that are now available. The discussion also recognized the need to prevent inappropriate self-dealing in cross trades.
1. For information about FIMSAC, including a transcript of the February 2020 meeting, see Spotlight on Fixed Income Market Structure Advisory Committee (available at https://www.sec.gov/spotlight/fixed-income-advisory-committee).
2. FIMSAC also convened a credit ratings panel to discuss the issuer-pay model for credit ratings.
3. FIMSAC Charter (Nov. 13, 2019) (available at https://www.sec.gov/spotlight/fixed-income-advisory-committee/fimsac-charter-nov-2019.pdf).
4. On March 2, 2020, the SEC staff released its report summarizing FIMSAC activities since the 2018 FIMSAC Annual Report. SEC Staff Report on the Second Year of the Fixed Income Market Structure Advisory Committee (Mar. 2, 2020) (available at https://www.sec.gov/spotlight/fixed-income-advisory-committee/fimsac-report-2019.pdf).
5. See Recommendation for a Pilot Program to Study the Market Implications of Changing the Reporting Regime for Block-Size Trades in Corporate Bonds, FIMSAC (Apr. 9, 2018) (available at www.sec.gov/spotlight/fixed-income-advisory-committee/fimsac-block-trade-recommendation.pdf).
6. FINRA Requests Comment on a Proposed Pilot Program to Study Recommended Changes to Corporate Bond Block Trade Dissemination, FINRA Regulatory Notice 19-12 (Apr. 12, 2019) (available at https://www.finra.org/rules-guidance/notices/19-12).
7. See Recommendation for the SEC to Establish a New Issue Reference Data Service for Corporate Bonds, FIMSAC (Oct. 29, 2018) (available at https://www.sec.gov/spotlight/fixed-income-advisory-committee/fimsac-corporate-bond-new-issue-reference-data-recommendation.pdf).
8. Securities Exchange Act Rel. No. 87656 (Dec. 4, 2019), 84 Fed. Reg. 67491 (Dec. 10, 2019).
9. Letter from J. Matthew DesLesDernier, Assistant Secretary, SEC, to Stephanie Dumont, Senior Vice President and Director of Capital Markets Policy, FINRA re: Order Granting Approval of a Proposed Rule Change, as Modified by Amendment No. 2, to Establish a Corporate Bond New Issue Reference Data Service, Securities Exchange Act of 1934, Release No. 87656 (Dec. 4, 2019) (Dec. 12, 2019) (available at https://www.sec.gov/rules/sro/finra/2019/34-87656-acknowledgement-letter.pdf). See also Andre E. Owens, Bruce H. Newman, Cherie Weldon and Mahlet Ayalew, WilmerHale, FINRA Introduces Two Fixed Income Initiatives (Feb. 20, 2020) (available at https://www.wilmerhale.com/en/insights/client-alerts/20200220-recent-finra-fixed-income-initiatives).
10. Recommendation Regarding Additional TRACE Reporting Indicators for Corporate Bond Trades, FIMSAC (Feb. 20, 2020) (available at https://www.sec.gov/spotlight/fixed-income-advisory-committee/fimsac-additional-trace-flags-recommendation.pdf).
11. Most investment grade bonds trade on the basis of a spread to the applicable benchmark government bond yield. These trades are then converted to a dollar price by "spotting" the benchmark Treasury security. The spotting process can occur either at the time of the spread trade or on a delayed basis (often at a set time in the afternoon, such as 3 p.m.). When a trade is spotted on a delayed basis, FINRA Rule 6710(d) provides that the time of execution shall be the time when the parties have agreed on all the terms of the transaction that are sufficient to calculate the dollar price of the trade (i.e., the time of the delayed Treasury spot).
12. Recommendation Regarding Timeliness of Financial Disclosures in the Municipal Securities Market, FIMSAC (Feb. 10, 2020) (available at https://www.sec.gov/spotlight/fixed-income-advisory-committee/fimsac-muni-financial-disclosures-recommendation.pdf).
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