BDA’s Taxable Fixed Income Focus August 2020

GSE Reform:

The BDA continues to advocate for reform of the Government Sponsored Enterprises (GSE)  Fannie Mae and Freddie Mac. Recently, as part of the BDA’s effort to grow political intelligence for membership, a GSE policy brief was developed that covers the history of GSE’s and discusses current happenings and BDA actions, while handicapping potential future possibilities.

Following the proposals laid out in the 2019 BDA GSE White Paper which included the call for “Capital Building,” the FHFA, led by Director Mark Calabria, has taken steps to reform the two mortgage agencies.  On June 2, 2020, the agency proposed a capital rule, which is viewed as a crucial first step of reform, and an idea that has been advocated for by the BDA. While at this time it seems reform will remain narrow and non-legislative, with the most likely change being the capital rule, prospects for further action in 2021 seem even less likely. House Financial Services, led by Committee Chairwoman Maxine Waters (D-CA), a long time opponent of reform, will almost certainly retain the position for next Congress and GSE would remain a non-priority for the Committee.  It’s also worth noting that the current financial distress our country is navigating may further delay administrative reform.  While the mortgage market has yet to hit severe turbulence, the long-term prospectus on the industry varies.

Fannie Mae and Freddie Mac have recently announced that they will begin to plan charging a 50-basis point up-front fee on all mortgage refinancing originations. The fee is designed to compensate the agencies for heightened credit risk during the virus crisis and to generate revenue for building up capital and is scheduled to take effect on September 1. However, the White House, key members of Congress, and mortgage industry stakeholders have all come out recently against the initiative, and press reports indicate imposition of the fee may be delayed.
The BDA GSE political intelligence document can be viewed here.

Moving Forward Act

As part of the ongoing infrastructure discussions on Capitol Hill the House recently passed H.R. 2 the Moving Forward Act, a broad-based infrastructure package as park of the Surface Transportation Reauthorization which runs out of current funding on September 30th.

Part of the package includes a new direct pay bonds program known as Qualified Infrastructure Bonds. While Qualified Infrastructure Bonds were based off the prior Build America Bonds program,  they would be exempt from sequestration, a key change from BABs, and would initially have a deeper subsidy for issuers than BABs. 

QIBs would be taxable bonds similar to Build America Bonds where a cash credit accrues to the issuer for a portion of the interest expense. The reimbursement percentages for issuers are proposed to be (by year of issuance):

  • 2020 through 2024: 42%
  • 2025: 38%
  • 2026: 34%
  • 2027 and thereafter: 30%

The bill defines Qualified Infrastructure Bond as “100 percent of the available project proceeds of such issue are to be used for capital expenditures or operations and maintenance expenditures in connection with property the acquisition, construction, or improvement of which would be a capital expenditure.” The bond must also qualify for tax exemption and meet arbitrage issue price requirements. Current refundings of QIBs would be permitted.

H.R. 2 also includes many BDA municipal priorities, these include:

  • The restoration of municipal advance refundings;
  • Expansion of PABs; and
  • Raising the limit on BQ debt.

The bill also would authorize a new category of School Infrastructure Bonds (SIBs) where the proceeds are used for capital construction and repair of public school facilities as described in the bill. Similar to Qualified School Construction Bonds authorized in 2009 and 2010, SIBs would be taxable bonds where the issuer receives a 100% reimbursement for interest costs. The bill would authorize $10 billion of SIB issuance per year for three years. Allocations would be on a formula basis.

At  this time, passage of the full package in 2020 seems unlikely.  Congress is poised to pass a short-term extension of the Surface Transportation Reauthorization by September 30th, punting the policy debate until 2021.

The BDA has developed an Infrastructure policy brief that takes a deep dive into BABs, as well other municipal provisions that are BDA priorities.

The BDA infrastructure political intelligence document can be viewed here.

Corporate Syndicate Rule

In late 2019, the BDA wrote FINRA calling to amend FINRA Uniform Practice Code Rule 11880 (“Rule 11880”) to reduce the maximum time to settle syndicate accounts from the current 90 days.  The BDA believes reducing the time to settle syndicate accounts would streamline the corporate bond and equity issuance process and reduce counter-party credit risk.

The current version of this provision of the rule was put in place in 1987. Rule 15c3-1, which specifies that dealers may count certain receivables towards regulatory capital, but only receivables 30 days old or younger. Underwriting receivables due to co-managers in underwriting syndicate do not count as regulatory capital after 30 days.

For co-managers in a corporate new-issue underwriting syndicate, capital is tied up for the last 60 days of the FINRA 90-day period and cannot be counted towards compliance with capital rules. Additionally, the MSRB amended its Rule G-11 governing underwriting syndicates in 2009, reducing the time to settle a syndicate from 90 days after closing to 30.

Since our letter to FINRA, we have had continuing conversations with FINRA and SEC staff on this issue. FINRA has expressed concern that shortening the syndicate settlement deadline may not be feasible for all types of transactions. However, SEC staff have expressed some initial willingness to revisit capital regulations that prohibit dealers from counting receivables longer than 30 days—such as deal proceeds held by a senior manager for up to 90 days—from counting towards compliance with regulatory capital rules. We will continue the dialog with SEC staff on the issue.

TRACE Pilot 

Earlier this year, FINRA halted a plan, known as the TRACE Pilot, to test whether delayed disclosure of corporate bond trades would boost market liquidity. The TRACE pilot, as proposed, was to review the effect of withholding dissemination of certain block trade transactions for 48 hours. The proposal also would have raised the trade size caps for disseminating actual block trade sizes.

In a major advocacy win for the BDA, the move comes after widespread market opposition, while the BDA was the only sell-side trade group to join the opposition.  

BDA opposed the pilot program as BDA member firms believe the proposed 48-hour delay in disseminating trade information would introduce significant and damaging opacity to the market, disadvantage retail investors, and include no incentive for middle-market firms to increase their capital commitment or provision of liquidity.
Rumors have emerged that FINRA and the SEC may reconsider an amended version of the TRACE Pilot proposal in the future. BDA will continue to closely monitor regulator actions on this issue and respond as appropriate.

FINRA 4210

As a longstanding priority for the Taxable Committee, the BDA continues to press FINRA to reassess Rule 4210.

In a big advocacy win for the BDA, in October 2019, FINRA filed with the SEC a proposed rule change to extend to March 25, 2021,the implementation date of the amendments to FINRA Rue 4210 (margin requirements).

The delay, as well as certain changes to the amendments are in line with the BDA advocacy efforts, but the BDA continues to press FINRA for further postponement or for FINRA to withdraw the amendments entirely.

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