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
• US as case study for “Developing an Efficient
Regulatory Framework for Debt Markets”
2
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
$25.00
$20.00
$15.00
Debt
Equity
$10.00
$5.00
$0.00
$ trillions
2002
3
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
Treasury Debt
Fed. Agency Debt
Municipal Debt
Corporate Debt
Mtg.-Backed
Asset-Backed
Money Market
4
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
5
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
6
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
7
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
8
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
9
What Lessons Can We Draw?
• Hodgepodge of Regulators
• Hodgepodge of Laws and Rules
• Why does it work? What’s key?
10
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
11
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
12
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
13
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
14
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
15
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
16
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
17
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
18
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
19
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
20
Issues to Consider
• What information should be disclosed?
– Material information, both financial and nonfinancial
• 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
21
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
22
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
23