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December 14, 2016

The Changing Nature of Municipal Bond Markets

by Mike Demas.

From default to market reform, the U.S. municipal bond market now demands a greater focus from investors.

When the Government Development Bank (GDB) of Puerto Rico failed to make its full debt service payment on May 1, the municipal market took note. While anticipated, the default of a major issuer still raises concerns among investors.

This is just one reason why they are paying closer attention to their muni bond holdings.

Due to its triple tax-exempt status (exempt from federal, state and local income taxes), Puerto Rico bonds are found in a number of state-specific and high-yield funds. Recent research showed that a small but significant number (29 out of 562) of U.S. muni bond funds carried an exposure to Puerto Rican bonds greater than 5%, with some estimated exposure approaching 50%.


Structural shifts for muni bonds

Puerto Rico is unique due to its Commonwealth (Territorial) status. It isn’t eligible to file for Chapter 9 bankruptcy protections – unlike Detroit, Michigan and Jefferson County, Alabama – which have done so in recent years.

The economic and social changes that impacted those States could also affect a multitude of States in the future. Ongoing structural developments in the U.S. muni bond marketplace are further changing the nature of trading in this vast market segment.

Regulation, the introduction of new technologies, and merger & acquisition activity are all emphasizing the need for investors to scrutinize direct and indirect muni bond holdings. Reliable market information is the key to doing this effectively.

New market execution rules

On the regulatory front, the most visible development has been the Municipal Securities Rule Making Board’s (MSRB) release taking effect on March 21 2016 of new guidance around best execution for the muni marketplace.

At the heart of MSRB’s best execution rule is the requirement for dealers to use “reasonable diligence” to determine the best market for a client order to ensure the price for the customer is “as favorable as possible under prevailing market conditions.” This should offer investors some level of comfort. Despite a lack of detail of exactly what reasonable diligence entails, the MSRB does provide a list of factors that dealers need to take into account. These include:

  • Character of the market for the security
  • Size and type of transaction
  • Information reviewed to determine the current market for the security or similar securities
  • Accessibility of quotations
  • Terms and conditions of the customer’s inquiry or order
  • Number of markets checked

The MSRB isn’t mandating any minimum number of markets or dealers a dealer should check to meet its requirements, but it does recommend checking more than one market, or exposing client orders to multiple bids/offers.

Similarly, it doesn’t require the use of broker’s brokers or Alternative Trading Systems (ATSs) to fulfill diligence requirements, but points out that electronic systems are more readily available and recommends that dealers consider their use.

Need for robust pricing data

Perhaps more significantly, recent consolidation in the evaluated pricing data business leaves many practitioners with pricing sourced from a single supplier. The fact that best-practice encourages market participants to refer to a second pricing provider will undoubtedly push investors to pay closer attention to the levels of insight vendors can provide into the muni bond market.


Market events so far underscore the importance of maintaining access to reliable muni bond data, especially for less transparent aspects of the marketplace, with more developments on the horizon. Some have suggested the ongoing changes may spark the development of derivative markets in these instruments, creating a further need for trusted sources of muni bond pricing.

Our award-winning evaluated pricing service, Pricing Service (TRPS), covers investment grade, taxable, high yield and distressed issues, across a range of bond types.

TRPS employs a credit curve driven attribute model, providing accurate evaluations for the municipal universe. Credit curves incorporate information from primary and secondary market sources.

Additional adjustments are made on an issuer and issue basis for the following attributes: bond type, use of proceeds, state of issuance, tax status (tax exempt, taxable, alternative minimum tax), coupon rate and redemption features. This attribute based approach provides the flexibility to make adjustments from a macro scale to the granularity of a single security.

TRPS supports thousands of investors by providing them with the information they need to manage market transition and regulatory change.

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