Over the month, investment grade (IG) markets were impacted by a sell-off of European bonds, political tensions in Italy and emerging market concerns stemming from higher U.S. Treasury rates and a strong U.S. dollar.
The 2016 Municipal Securities Rulemaking Board (MSRB) rule requiring broker-dealers to disclose markups on municipal bond transactions becomes effective May 14. In this piece, we provide a Q&A about the rule and its importance.
For more detail on how markups work and why they matter for investor returns, see Watching Every Dollar – Understanding Markups in Muni Trading.
Q: What are the new requirements for broker-dealers?
A: In November 2016, the MSRB received approval for a new version of MSRB Rule G-15. Among other requirements, the amended rule requires broker-dealers to include the following information on municipal bond transactions with retail clients:
- The markup or markdown for the transaction, expressed as a total dollar amount and as a percentage of the prevailing market price
- A hyperlink to the EMMA1 page that includes publicly available trade data for the specific security traded
The latest version of the rule requires broker-dealers to disclose transactions in which they buy or sell securities with retail customers and have an offsetting principal trade on the same day. As an example, a broker-dealer may purchase $100 of bonds for his principal account; then, the same day, he sells those bonds into client accounts. The broker-dealer is now required to disclose the markups and markdowns on those trades.
If the broker-dealer in this case purchased the bond at $105, but is selling it into client accounts for a higher price than that, he has “marked up” the price of the bond. That markup must now be reflected in trade confirmations.2
Q: Why is the new version of the rule important?
A: The new disclosure allows retail investors more insight into how efficiently trades are being executed and quantifies the client’s costs from markups. While municipal yields have risen year-to-date, we remain in a low-yield environment globally in fixed income and markups can meaningfully reduce a client’s potential yield from a municipal bond transaction. For context, for retail trades ($25,000-$500,000 par amount), the average full spread of bonds, which includes the markup and bid/ask spread3 for bonds purchased from customer and sold to customer, is $8.50 per bond.
Q: What portion of the municipal market is impacted by the new rule?
A: The markup rule applies to non-institutional retail clients and does not apply to broker-dealer transactions with registered investment advisors or mutual funds. As of 4Q17, about 41 percent of U.S. municipal holdings belonged to individual investors (Figure 1). However, the requirements will only impact 8,000 retail investor transactions per day,4 per MSRB estimates; this is a small portion of the roughly 42,000 municipal trades occurring each day in aggregate.5 Note that the markup reported is based on the broker purchase and sale. As noted in our recent blog post, there can be interdealer markups as well, which can impact the price of the bond substantially.
Most investors do not think the market will be significantly impacted by the new version of the rule. In addition, many broker-dealers have already gone down the path of being transparent with pricing.
However, the rule sheds light on the issue of markups, which can affect an investor’s overall yield and return. This increased transparency may encourage some retail investors to steer away from financial advisors who charge markups or commissions on individual bonds, in favor of separate account managers or mutual funds.
Q: What are the key takeaways for investors?
- The rule was approved in November 2016 and the details behind the disclosures have been well-communicated.
- We do not expect a significant impact to pricing in the municipal market.
- We recognize that the markup disclosures may galvanize some retail investors to more-adamantly seek investment managers that do not charge markups or commissions on municipal transactions.
- At Breckinridge, our experience in municipal market trading, our proprietary technology and our broad dealer network of over 150 dealers can provide our clients improved market access and trade execution.
 The Electronic Municipal Market Access system, or EMMA®, is a service of the Municipal Securities Rulemaking Board. Portions of EMMA data are provided by Standard & Poor’s Securities Evaluations, Inc.; CUSIP Service Bureau; and American Bankers Association.
 Example assumes that the price paid by the broker-dealer is considered the “contemporaneous cost” incurred for the bond, per MSRB rules.
 As discussed in our earlier blog post, the bid/ask spread is an unavoidable spread between the buy and sell price that every market participant pays when trading a bond.
 “Municipal Securities Investors to Gain Access to Dealer Compensation Information,” MSRB, November 18, 2016.
 MSRB, EMMA, 30-day average trade summary, March 28, 2018 to May 9, 2018.
DISCLAIMER: The opinions and views expressed are those of Breckinridge Capital Advisors, Inc. They are current as of the date(s) indicated but are subject to change without notice. Any estimates, targets, and projections are based on Breckinridge research, analysis and assumptions. No assurances can be made that any such estimate, target or projection will be accurate; actual results may differ substantially.
Nothing contained herein should be construed or relied upon as financial, legal or tax advice. All investments involve risks, including the loss of principal. An investor should consult with their financial professional before making any investment decisions.
Some information has been taken directly from unaffiliated third party sources. Breckinridge believes such information is reliable, but does not guarantee its accuracy or completeness.
Any specific securities mentioned are for illustrative and example only. They do not necessarily represent actual investments in any client portfolio.