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Regulating the Fixed Income Market in the United States

Regulating the Fixed Income Market in the United States. Felice B. Friedman OECD-World Bank Bond Market Forum 2-3 June 2003. Introduction and Background. The SEC and Debt Markets Two Myths to Debunk Debt markets as unregulated

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Regulating the Fixed Income Market in the United States

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  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 Gov’t 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? What’s 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 management’s 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

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