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Speech by SEC Commissioner: Bringing Municipal Bond Trading Into the Light

Commissioner Elisse B. Walter

U.S. Securities and Exchange Commission

The SIFMA Municipal Bond Summit, The Conrad Hotel, New York, New York,

Oct. 1, 2012

Good morning, and thank you very much, Ken, for that lovely introduction. This time last year, my work schedule required me to address you through a video conference from Washington, so I am particularly delighted that I am able to join you in person at this year’s Municipal Bond Summit. Before I begin my remarks, I, of course, must mention that they represent my own views, and not necessarily those of the Commission, my fellow Commissioners, or members of the staff.1

I am extremely pleased that this year I can speak with you about the completed Commission report regarding the municipal securities market, not the work in progress.2 As Ken indicated, this important project has been near and dear to my heart. It was about two years ago that our Chairman, Mary Schapiro, asked me to lead the SEC staff in a concerted effort to study the municipal securities market. We commenced that study with our inaugural field hearing in San Francisco, California to elicit the analyses and opinions of a broad array of participants in the municipal market. We followed up with similar hearings in Washington, D.C. and Birmingham, Alabama, in addition to spending a tremendous amount of time meeting and speaking with interested parties on issues spanning from disclosure to accounting to market dynamics to credit ratings, and beyond.

And, as you know, the information gathering culminated with a comprehensive report that the Commission issued on July 31st of this year with the unanimous support from each of the Commissioners. Let me take this opportunity to repeat my heartfelt thanks to my fellow Commissioners and all of the Commission staff who labored tirelessly on the report. I am honored to have worked closely with the staff on the study and am very proud of their hard work. This was an agency-wide, collaborative endeavor especially by our Division of Trading and Markets including the Office of Municipal Securities, the Division of Corporation Finance, the Division of Risk, Strategy and Financial Innovation, and the Division of Enforcement. Their tireless efforts were undertaken on top of their regular, heavy workloads, which of course included responsibilities under Dodd-Frank and the JOBS Act. I would again like to commend them for their dedication and diligence in preparing this important document.

I also want to take this opportunity to publicly welcome the inaugural Director of the Commission’s new Office of Municipal Securities, John Cross. You will hear directly from him on his new role at the Commission later today in one of the afternoon panels. John has been a leader in the area of municipal finance in a distinguished career that will serve him well in his new position, and I am very excited that he has joined our agency. I am really looking forward to working closely with him to begin moving forward with implementing the recommendations in the report and effecting reforms to help investors in this market, including, of course, the municipal advisor rules.

Turning back to the Commission report, it discusses in depth two broad issues that affect investors in the municipal securities market: disclosure and market structure. The report includes recommendations for changes in legislation, government and SRO regulations, and industry practice. Pleased as I am to have completed the report, more work remains to be done—by the Commission and its staff and the MSRB, and I look forward to what I hope will also be a robust dialog with Congress.

On the issue of disclosure, we have heard consistently that investors need more timely and accurate information from issuers in order to make better informed decisions. The Commission report recommends, among other things, that Congress consider allowing the SEC to set baseline disclosure standards and require municipal issuers to have audited financial statements as appropriate.

Today, however, I want to focus on the structure of the municipal market. Unlike the Commission report recommendations relating to the disclosure arena of the municipal securities market, most of the ideas reflected in the recommendations relating to the market’s structure are new, and are being publicly vetted for the first time by the Commission. In my view, we now have an opportunity to initiate significant improvements in this area to better protect not only today’s investors but tomorrow’s as well. By leveraging the dramatic advances in communications and technology that have occurred in recent years, I believe we can work together to improve the transparency, efficiency and fairness of the municipal securities market, to the benefit of all investors – and particularly the many retail investors for whom municipal securities are such a significant portion of their investment portfolios.

Let me briefly paint a picture of the municipal securities market that exists today. It is substantial by any measure. There are over 1 million different municipal bonds outstanding, totaling approximately $3.7 trillion in principal.3 The average daily trading volume in 2011 was $11.3 billion.4 $3.3 trillion by par amount traded in 2011.5

But, despite the size of the municipal securities market, we know that municipal securities are relatively illiquid. About 99% of outstanding municipal securities do not trade on any given day.6 While trading is most active in newly issued bonds, it declines significantly as time passes. For example, only 15% of municipal securities trade in the second month after issuance.7

As has been the case for many years and despite considerable technological advancements in the trading of securities in general -- including municipal bond trading on alternative trading systems or “ATSs”-- trading in the municipal market remains decentralized and opaque; investors have preferred dealers, and dealers trade selectively with counterparties. Further, the market share among dealers remains heavily concentrated. In 2011, five dealers accounted for approximately 54% of customer trades by par amount,8 and the top ten dealers accounted for approximately 75% of all customer trades by par amount.9

Yet, despite this concentrated dealer market, individual investors play a key role in providing the capital sought by municipal issuers. Fully 50% of the outstanding principal amount of municipal securities is held by individual investors directly.10 Further, an additional 25% of the outstanding principal amount is held on behalf of individual investors by mutual, money market, closed-end, and exchange-traded funds.11

In light of the significant role that individual investors play in the municipal market, we must do much more to protect their interests. As I said in 2009 in my first speech as a Commissioner on this subject, despite its size and obvious importance, the municipal securities market, unfortunately, lacks many of the protections customary in many other sectors of the U.S. capital markets. Investors in municipal securities are, in certain respects, afforded “second-class treatment.”12 In addition to the specific recommendations to improve municipal securities disclosure that are discussed in the Commission report, I believe we need to begin a broad-based initiative to improve the structure of the municipal market so that it is more transparent, efficient, and fair for all investors.

Technology and Transparency

Pre-Trade Transparency

As highlighted in the Commission report as well as the GAO report issued this past January regarding the market structure, pricing, and regulation of the municipal securities market,13 the municipal securities market could benefit from more meaningful price transparency, especially pre-trade price transparency. Quotation information is not prevalent, and, to the extent it exists, it is not widely disseminated. Pre-trade price information is almost never available to individual investors. This lack of market transparency can dilute the protections afforded investors by a competitive market structure. It can inhibit robust competition among market participants to provide the best prices. It can make evaluation of execution quality difficult or impossible. And it can create enforcement and other regulatory challenges that may lower investor protection.

Studies show that it is more expensive for investors to trade municipal securities than to trade corporate bonds or equity securities.14 These studies have attributed the higher transaction costs to the relatively low level of price transparency.15 Further, studies show that transaction costs in the municipal securities markets are generally higher for the market’s primary investor --that is, the retail investor-- than they are for institutional investors.16

There are various reasons identified in the Commission report for this disparity in costs for retail and institutional investors. One reason is that individual investors have less access to price information.17 Because retail investors do not have access to the pricing information that institutional investors obtain, their bargaining power with dealers for a good price is diminished.18 Another reason is that, because the market is decentralized, more levels of intermediation are required for an ultimate buyer and seller to meet, and, with multiple intermediaries extracting multiple compensation charges, transaction costs consequently increase.19 This degree of intermediation appears to be more prevalent in smaller-size trades, making it even more expensive for those investors to transact.20

So why are retail investors in the municipal securities markets at such an informational disadvantage? Many argue that the unique attributes of the municipal bond market – a market with a wide variety of securities and a relatively low volume of secondary market trading – make this market structure inevitable. Perhaps that was the case in the past, when the costs of aggregating liquidity and disseminating trading interest may have been too great to support a different model. But there have been dramatic advances in communications and technology in recent years. I am concerned that market participants are not taking full advantage of these new tools to improve the transparency and efficiency of the municipal securities markets for the benefit of small investors, as they have in other market segments.

Technology has changed how all sorts of products are traded. Consider the real estate market as an interesting comparison. It has attributes that are somewhat analogous to the municipal bond market: there’s a wide variety of homes for sale; each home is unique; and the market is relatively illiquid. Yet technology has revolutionized the transparency of available listings, making it markedly easier for prospective buyers to learn of listings. As you know, a variety of Web-based services today provide consumers with access to property information, including offering prices, that once was available only by contacting brokers directly.

It is my view that we must seek ways to use new technology to help investors in the municipal securities markets. So why couldn’t similar improvements in pricing information - ones that can be made possible by existing developments in technology - be applied in that marketplace?

Certainly, the municipal securities market has experienced important technological advances. Electronic trading in municipal securities is proliferating, as evidenced by the rise of ATSs. Liquidity providers using an ATS can now post available bond inventory and trading interest efficiently. Likewise, they are trading electronically more and more. Indeed, the Commission report estimates that trading in these ATSs could account for as much as 50% of the number of trades in municipal securities.21 Further, the data seems to indicate that such ATS trades represent trading in smaller, retail-size trades.22 All of this suggests that municipal bond dealers have leveraged technology to reduce their distribution costs by using ATSs to more efficiently distribute their inventory of municipal securities. Yet, it is not clear that the benefits of such improvements in efficiency and market transparency have flowed through to retail investors.

In fact, as the report indicates, the trading interest represented on these ATSs is generally available to their participating municipal bond dealers and perhaps even to institutional investors, but is not directly accessible by or transparent to non-participants, such as retail investors.23 We also understand that information about trading interest in an ATS might not even be available to all participating dealers of an ATS.24 While it may be more efficient for dealers to display their trading interest using ATSs, it appears as if the ATSs have been structured generally to mimic the manner in which these liquidity providers have traded in the past. That is, trading interest is still selectively disclosed, and access to that trading interest is selective. In short, the sharing of pricing information remains limited to a select few.

If a primary justification for the existing structure of the municipal securities market and its resulting opacity is the historical inefficiency of dealers in aggregating and disseminating trading interest broadly in a wide variety of securities, then the very same technology being used by these dealers to reduce their own trading costs justifies change. In my view, it certainly provides us with an opportunity to take a significant step in the municipal market towards creating transparency in this area. It presents the industry—all of you—with an opportunity to lead.

As my colleague, Commissioner Dan Gallagher, highlighted in recent remarks regarding market transparency in the bond markets, price transparency is one of the hallmarks of any fair and efficient financial market.25 I wholeheartedly agree with his point, and I have long thought that we should conduct a thorough study of the fixed income markets, as he suggests. To me, it is vital to enable customers to effectively assess whether market professionals are giving them fair prices and best execution. Indeed, the duty of dealers to provide fair and reasonable prices to investors of municipal securities is only as good as the market structure that enables dealers-- including the smaller dealers—to know about and access those prices.

And, in general, we have seen that existing technology can provide the means necessary to enhance market transparency for securities trading. For example, the implementation of Regulation ATS (or Reg ATS) is illustrative. Prior to Reg ATS, there were a number of significant electronic private networks, which enabled market makers to provide better prices than what were made available to public investors. In an effort to promote transparency, the Commission adopted Reg ATS, requiring ATSs with material trading volume to make their best prices publicly available and to provide fair access to that trading interest. This, in turn, made the best prices visible and accessible to everyone.

However, the order display and execution access provisions of Reg ATS, which are themselves imperfect and in need of review, do not apply to ATSs that trade municipal securities. As a result, those ATSs are not required to provide such benefits to investors. In my view, there is no reason why technology cannot be leveraged to enhance pre-trade price transparency in the municipal securities market. Accordingly, the report suggests that the Commission could consider amendments to Reg ATS to require an ATS with material transaction or dollar value in municipal securities to publicly disseminate its best bid and offer prices and, on a delayed and non-attributable basis, responses to “bids wanted” auctions.

I believe this is one of the report’s most significant recommendations for Commission consideration because it acknowledges the efficiencies in the use of ATSs that developed in this market and that such improvements should also be shared, not just among participating dealers, but with the investing public as well. Such a requirement can serve as an important source of pricing information to retail investors and their brokers, enhance the transparency of best prices on these platforms, and help assure that market participants have fair access to them. That is, in requiring transparency of trading interest on significant electronic trading networks, regulation can encourage the use of technology to improve market efficiency and promote competition and fairness in the municipal securities market for the benefit of its investors.

Pre-trade transparency can lay the foundation for positive change in the municipal securities market for its most significant investing constituency, the retail investor. As we know, change is incremental; but change can precipitate more change. Enhanced price transparency can have a cascading impact on the municipal securities market, as market participants become more aware of trading interest and prices that were undisclosed before. This in turn can promote a more efficient and egalitarian aggregation of liquidity available to the market broadly. Ultimate buyers and sellers may find each other more easily and without the need for significant, layered intermediation and its accompanying costs. And competition can be fostered as market participants see the best prices and seek to compete for those prices. As transparency and competition improve, the duties imposed on market professionals can become more meaningful.

Post-Trade Transparency

Fortunately, there have been significant improvements in recent years in post-trade price transparency with the help of advanced technology. Here, once again, I commend the MSRB for its significant first step in improving market transparency by implementing a real-time trade reporting regime. In 2005, the MSRB’s Real-Time Transaction Reporting System was implemented, providing market participants, for the first time, with comprehensive market data concerning transactions in municipal securities. Further, in 2009, the MSRB’s Short-Term Obligation Rate Transparency system was implemented. That system collects and disseminates current interest rates and related information for municipal auction rate securities and variable rate demand obligations. Such transparency initiatives greatly improved the market structure for the benefit of investors. At least one study has shown that price dispersion – where investors buying or selling the same amount of securities at the same time are paying or receiving different prices – has decreased significantly since transactions have been reported in real-time.26

I am pleased that the Commission report aims to promote additional post-trade transparency by recommending further initiatives in this area. To build on the benefits of real-time trade reporting, the report recommends consideration of additional data points for public disclosure, such as yield spreads for each transaction like those expressed by reference to risk-free Treasury securities. Having additional information regarding transactions that allows for greater comparability across the wide variety of municipal securities can provide valuable information to an investor concerning the prices he or she is receiving. And given the recent scrutiny into certain benchmarks that are used in the financial industry, the MSRB has recently published educational materials on its Web site to help investors and state and local governments better understand municipal market indices, yield curves, and other benchmarks and the methodologies used to create them.

I would also strongly encourage the MSRB to move forward in improving its EMMA website, as it has suggested in its recently-issued “Long-Range Plan for Market Transparency,”27 to enhance both the nature of the information made available and the ease with which such information is accessed and used. Such enhancements could include better search functionalities, analytical tools and research, and additional pricing-related market data. The use of technology in these initiatives should bolster post-trade transparency and readily provide retail investors with better pricing and other municipal securities information.

Enhanced Dealer Obligations

Yet, as technology allows for improved market transparency, we must also strive to ensure that the benefits of such transparency are fully appreciated and realized by retail investors. Unlike institutions and market professionals, individual investors generally do not have the experience, expertise or resources to avail themselves of pricing information about municipal securities, even if it can be obtained. In addition to the recommendations aimed at improving market transparency to alleviate this disadvantage, the Commission also made recommendations to harness enhanced price transparency to strengthen existing dealer obligations to customers, reinforcing fair pricing and best execution obligations. This is particularly important given the high level of reliance that individual investors tend to have on their broker-dealers in connection with these transactions.

In my view, some of the recommendations in the Commission report in this area are relatively straightforward and prime for prompt implementation. Because retail investors may not be aware of the variety of options available to buy or sell a municipal bond or their relative advantages and disadvantages, it seems appropriate that municipal bond dealers ought to disclose relevant information about their execution options. Retail investors could also benefit in being provided with relevant pricing reference information from the dealer in order to better assess whether they have received best execution. Such disclosure could also serve to discipline municipal bond dealers in meeting their fair pricing obligations.

The report also highlighted three other important areas intended to bolster the duties owed by dealers. First, it recognizes that there is presently no standardized, consistent manner in which dealers calculate the current market value, or “prevailing market value,” of a particular municipal security in order to meet their obligation to obtain fair and reasonable prices for their customers. This calculation is also important because it is the basis by which dealers assess whether their compensation charges are fair and reasonable under the law. In 2007, the Commission approved detailed interpretative guidance by FINRA that provided the framework for dealers in determining prevailing market price for non-municipal debt securities.28 The MSRB has sought comment on similar interpretative guidance,29 and I would encourage the MSRB to follow through and provide a clear and consistent framework for municipal securities dealers to use in determining prevailing market prices of municipal securities. Consistency in establishing this value should enhance a dealer’s ability to comply with its fair pricing obligations and facilitate the regulator’s ability to enforce those obligations and thus better protect investors.

Second, investors currently do not know what they are paying their dealers for their services. While additional pricing information is helpful for customers, disclosure of the amount of markup or markdown will finally shed light on a long opaque aspect of the municipal securities market, dealer compensation. As a starting point in this effort, the report states that the MSRB should consider requiring municipal securities dealers to disclose to customers any markups and markdowns in riskless principal transactions.

Finally, one last thing I would like to mention, which is certainly not the least important, is the duty of best execution. While best execution of customer orders has been a common law duty for many years, there is no specific best execution rule for dealers in the municipal securities market. Some have argued that best execution is a concept that has no place in a principal trading market. But as I mentioned earlier, times have fortunately changed. As dealers have increasing access to price information and liquidity, consideration should be given to making sure that customers receive the best reasonably available prices. For this reason, the Commission report recommends that the MSRB consider a rule requiring municipal bond dealers to seek “best execution” of customer orders and provide detailed guidance on what that means in this evolving marketplace. And I would encourage the MSRB to move quickly on this recommendation.


The municipal securities market is critical to building and maintaining the infrastructure of our nation, and individual investors are the key participants supporting that market. But this market has lagged other market segments in leveraging advances in communication and technology to enhance the transparency of prices and the efficiency of trading. This failure to evolve expeditiously negatively impacts not only investors, who may obtain worse prices for municipal securities than they would in a more modern market structure, but also municipal issuers, who may not receive as advantageous prices for their securities as they would if there were an efficient and liquid secondary market. I fully support the recommendations in the Commission report, which are designed to push municipal market participants to improve the quality of their market structure, to the benefit of investors, issuers, and ultimately the entire municipal securities market. I look forward to working with you toward this important goal.

1 The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publications or statements by any of its employees. The views expressed herein are those of the author and do not necessarily reflect the views of the Commission, other Commissioners, or the staff.

2 U.S. Securities and Exchange Commission, Report on the Municipal Securities Market (July 31, 2012), available at (“Muni Report).

3 Muni Report at 5.

4 Id at 21.

5 Id.

6 Id at 113.

7 Id at 113 - 114.

8 Id at 20.

9 Id.

10 Id. at 12.

11 Id.

12 Commissioner Elisse B. Walter, U.S. Securities & Exchange Commission, “Regulation of the Municipal Securities Market: Investors Are Not Second-Class Citizens,” (October 28, 2009), available at

13 U.S. Government Accountability Office, Report to Congressional Committees, “Municipal Securities – Overview of Market Structure, Pricing, and Regulation,” (January 2012), available at

14 Muni Report at 123.

15 Id.

16 Id. at 124.

17 Id. at 123 - 124.

18 Id.

19 Id. at 125.

20 Id.

21 Id. at 118.

22 Id.

23 Id. at 119 - 120.

24 Id.

25 Commissioner Daniel M. Gallagher, U.S. Securities & Exchange Commission, “Remarks at the Conference on Financial Markets Quality,” (September 19, 2012), available at

26 Muni Report at 125.

27 See MSRB Long-Range Plan for Market Transparency Products (January 2012), available at

28 See Exchange Act Release No. 55638 (April 16, 2007), 72 FR 20150 (April 23, 2007) (SR–NASD–2003–141).

29 See MSRB Notice 2010-10, “Request for Comments on Draft Interpretive Guidance on Prevailing Market Prices and Mark-Up for Transactions in Municipal Securities” (April 21, 2010).

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