In this regard, on September 2, 2016, the Municipal Securities Regulatory Board (MSRB) filed a proposed amendment to the Securities and Exchange Commission (SEC) regarding rules G-15, G-30 and FINRA Rule 2232. This change was to increase the transparency of the municipal bond market and to help further clarify the distinction between a bond’s actual price and the markup the broker receives.

The amendment was finally approved and became effective on May 14, 2018, and is expected to raise a lot of discussions in the industry.

Let us go over some of the broader implications of these recently implemented rules.

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The update to these rules is important because, as of the end of 2016, over 75% of all municipal bonds were owned by retail clients.

In the past, every time a retail client would buy or sell a municipal bond, the confirmation of trade would include the final aggregate price for the transaction. This price would include the markup or commission the broker would receive. With the new changes, confirmations are required to show the total dollar amount of the markup and the percentage of the markup in relation to the bond purchase price. In addition to the markup information, the new rule requires the time of the trade and a reference or hyperlink to the Electronic Municipal Market Access (EMMA)’s website.

However, this new ruling is only mandated in two cases. The first is when the dealer has entered into a secondary market on the same side of the market as the client on the same day. The second is when the aggregate amount of the dealer’s other transaction equals or exceeds the amount of the trade with the client.

So, if a dealer has a bond in inventory and then sells it to a client, that markup won’t be disclosed. It will also not be disclosed when a client buys bonds issued on the first day of an initial offering.

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For the retail investor, knowing the difference between the Prevailing Market Price (PMP) and the markup of a bond purchase is very important. For example, if an investor purchased 100 State of New York Municipal Bonds that were trading around $980.09 per bond the total PMP should be $98,090 when excluding accrued interest. In addition, the markup or commission could be $10 per bond, for a total of $1,000. In the past, the confirmation would only show the total trade price of $99,090, including both the PMP and the markup combined. Now, the confirmation will show the PMP amount, the $1,000 markup figure as well as 1.0% for the markup percentage.

One reason why this new ruling could cause controversy is that bond investors never knew how much markup is actually bundled into their purchase price. Unlike stock commissions that have a flat fixed rate, bond markups can be adjusted up or down and have no real guideline. The broker in that same deal could have discounted the trade or even increased the commission.

A key impact for retail investors that this ruling will have is that dealers should be much more inclined to give the best possible pricing for the bond, knowing that clients can easily research it for themselves. This will most likely also limit the amount of markup that dealers add to bond transactions, and eventually, to a much more uniform amount. For example, prior to this ruling, clients had no idea how much markup they were getting on bond deals. Now that the information is transparent, this should provide a more fair and reasonable markup amount.

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In the new rule, the SEC discloses the layout of how a dealer is to determine what the Prevailing Market Price of a particular bond is. This analysis is called the Waterfall method and is described through three steps.

1. Dealers must review other similar trades of the same security to help establish the initial PMP. If there are no similar trades, then the dealer must expand its search to look at interdealer trades, deals done between other dealers and institutions, or trades on electronic trading platforms.
2. If there are no trades of the same security, then the dealer must look at similar securities that are of the same credit quality, issue size or comparable yield.
3. Finally, the last resort for determining the PMP is that the dealer can then rely solely on the prices or yields from economic models. These models would factor in credit quality, current interest rates, sector, time to maturity and several other factors.

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The markup rule is a clear indication that the financial industry is heading toward a more consumer-friendly transparent atmosphere. However, this ruling is only the beginning, as many of the bonds being sold are held in a dealer’s inventory, which would not be required to comply with this new ruling.

Investors who are looking for trade information on a particular bond can research the CUSIP data on the EMMA’s website. This shows the trading history of each bond issue and should help show what the street is pricing the bond at. Or you can use the municipal bond screener on our website to find relevant muni bonds based on yield, price, maturity, insured status, credit rating and the issuing state in the United States.

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