Request for Comment: Plan for Increasing Information Available for Municipal Variable Rate Demand Obligations

The MSRB continues to monitor the market for municipal Auction Rate Securities and remains concerned about the lack of comprehensive information available to market participants.  In a recent notice, the MSRB requested comment on a plan for increasing information available on municipal Auction Rate Securities (“March 2008 Notice”).[1]  Comments received on the March 2008 Notice generally were supportive of the creation of a system to collect and disseminate critical market information about Auction Rate Securities.  However, some commentators noted that, as a result of the extreme volatility in the market for Auction Rate Securities, many Auction Rate Securities have been redeemed by issuers or converted into other types of municipal securities thus reducing the amount of information that would be collected by such a system.  As the MSRB reviews those comments, the question of increased transparency for municipal Variable Rate Demand Obligations (VRDOs) has surfaced.

VRDOs are long-term securities with short-term interest rate periods.  There has been increased interest in the market for VRDOs by both issuers and investors as a result of the volatility in the market for Auction Rate Securities.  Given this increased interest in the market for VRDOs and the likelihood that more individual investors may purchase VRDOs, the MSRB is concerned about the lack of information available to market participants on these securities.  The MSRB is requesting comment on a proposal to collect and disseminate critical market information about VRDOs using the same system proposed in the March 2008 Notice for Auction Rate Securities.

The proposed plan for increasing information available on VRDOs is described below and is the same as the plan proposed for collection and dissemination for Auction Rate Securities described in the March 2008 Notice.  Under the plan, dealers that act as remarketing agents would be required to report information about a VRDO by the end of the day that an interest rate reset occurs.  Comments on the proposed plan should be submitted no later than June 30, 2008 and may be directed to Justin R. Pica, Uniform Practice Policy Advisor.  Written comments will be available for public inspection.

BACKGROUND

VRDOs are long-term securities with short-term interest rates.  Interest rates are reset periodically through programs operated by dealers (“Remarketing Agents”) on behalf of the issuers of the securities.  The interest rate is set to allow the securities to be sold at par.  Interest on a VRDO typically is paid on a monthly or semiannual basis. 

A distinguishing characteristic of VRDOs is the existence of a “put” or “tender” feature that allows holders to liquidate a position in a VRDO, at par, on a periodic basis.  Through the put or tender feature, holders seeking to liquidate a position can put the securities back to the issuer through the Remarketing Agent.  A specified amount of notice is required to be provided to the Remarketing Agent and during that notification period, the Remarketing Agent seeks to find a purchaser for the securities that have been tendered (“Notification Period”).  If the Remarketing Agent is unable to find a purchaser for the securities during the Notification Period, a liquidity facility, such as a letter of credit (LOC) or standby bond purchase agreement (SBPA), provides a guarantee against a failed remarketing to ensure that the holder of a VRDO is able to liquidate its position at a price of par.

Existing Price Transparency Issues

As “short-term” securities under Rule G-14 on transaction reporting, VRDOs are subject to different reporting requirements than other securities.  In 2003, the MSRB proposed rules for a Real-Time Transaction Reporting System (RTRS), including a requirement to report trades no later than fifteen minutes after the time of trade execution, and, for customer transactions, a requirement that the trade report include both a dollar price and yield.[2]  In response, the MSRB received comments from dealers that, because of the special trade processing methodologies for short-term variable rate securities, it would be difficult or impossible to meet these requirements for such securities.  Based on these concerns, the MSRB included special provisions in the final rule that provide dealers with an end-of-day exception from the fifteen-minute reporting deadline and allow dealers to report customer transactions in variable rate securities without yield. 

Since transactions in short-term variable rate securities are executed at a dollar price of par, the lack of yield means that RTRS provides little useful price information on these securities.  The MSRB was aware of this in 2003 when it decided to provide the special provisions, noting:

The MSRB does not currently plan to require reports of yields or reset rates on variable rate and auction rate products, but continues to be interested in price transparency in this area.  Accordingly, the MSRB will explore other ways to provide transparency for short-term rates that are being set…in variable rate and auction products.[3]  

VRDO Market

Most VRDOs have a minimum denomination of $100,000, thus they have primarily been marketed to an institutional customer base, such as tax-exempt money market and bond funds as well as corporations and trust departments.  Information reported to RTRS indicates that most transactions in VRDOs are in large par amounts, reflecting the primarily institutional customer base. 

Given the volatility in the market for Auction Rate Securities, the MSRB is concerned that individual investors may begin to have a greater presence in the market for VRDOs.  The MSRB is not aware of any ready source of information available to retail investors or to the marketplace in general on VRDOs.  Accordingly, many of the concerns the MSRB expressed in the March 2008 Notice with respect to the limited amount of information available to investors on Auction Rate Securities also apply to the market for VRDOs. 

PLAN TO INCREASE VRDO TRANSPARENCY

To improve transparency of VRDOs, the MSRB proposes to require Remarketing Agents to report information about VRDOs to the MSRB by the end of the day that an interest rate is reset.  Information received from Remarketing Agents would be posted to an MSRB web site immediately after receipt. 

The information proposed to be collected on VRDOs would provide an investor with the ability to determine the current interest rate for the security and compare the current interest rate to other VRDOs.  In addition, the MSRB proposes to collect information about the terms of the liquidity facilities attached to VRDOs.  This would allow current and prospective investors to determine whether the VRDO is backed in full or only in part by a LOC or SBPA and inform investors of the expiration dates of the liquidity facilities. 

The specific items of information about VRDOs proposed to be collected and disseminated include:

• CUSIP Number
• Name of Remarketing Agent
• Date of interest rate reset
• Interest rate for the next reset period
• Length of the interest rate reset period
• Length of Notification Period
• Whether interest rate is “set by formula” or “set by Remarketing Agent”
• Minimum and maximum rates, if any
• Minimum denomination
• Type of liquidity facility(ies)
• Expiration date of each liquidity facility

In addition to the specific items of information listed above, the MSRB also proposes to receive notification of interest rate conversions, including the date of the conversion and the new interest rate mode.  The MSRB proposes to require receipt of such information about interest rate conversions by the end of the day on which an interest rate conversion occurs.

Information Collection and Dissemination Methodology

The proposed collection of information about VRDOs would be accomplished through (i) a secure, password-protected Internet web site; and (ii) computer-to-computer data connections.[4]  The MSRB would allow Remarketing Agents to designate third parties, such as information vendors, to provide information to the MSRB on the Remarketing Agent’s behalf.  However, the responsibility to ensure timely and accurate reporting of information to the MSRB would remain with the Remarketing Agent. 

Each Remarketing Agent and submitter would be required to complete and keep current an electronic registration form.[5]  This form would provide the MSRB with contact information for purposes of sending electronic records of submissions and to allow for follow-up by MSRB staff should any submission prove to be incomplete or incorrect.  In addition, Remarketing Agents would identify intended methods of submitting information and identify third-party submitters that would submit information to the MSRB on their behalf.

Information about VRDOs submitted by or on behalf of a Remarketing Agent would be displayed immediately after receipt on an MSRB web site.  In addition to the information submitted, users of the MSRB web site would be able to access any additional documents on file with the MSRB associated with the VRDO, such as the Official Statement, as well as trade reports disseminated from RTRS.

REQUEST FOR COMMENT

Comment is requested on all aspects of the proposed plan for increasing transparency of VRDOs.  Consideration of the following questions may be helpful in providing comments:

• Are the items of information proposed to be collected and disseminated about VRDOs appropriate?  Are there additional items of information that should be added to this list of information?

• What is the current and anticipated volume of VRDOs that are bought by retail customers?

• The MSRB proposes that Remarketing Agents would be required to provide information about VRDOs to the MSRB by the end of the day on which an interest rate is reset.  What time would the information proposed to be collected about VRDOs be available on the day an interest rate is reset?  What deadline would allow for a sufficient amount of time for Remarketing Agents to provide the information to the MSRB?

• Do Remarketing Agents anticipate difficulty in being able to collect such information about VRDOs for purposes of providing it to the MSRB?  Are there technical or operational difficulties associated with providing information about VRDOs to the MSRB?

• Are there documents concerning VRDOs that are not currently required to be filed with the MSRB under Rule G-36, on delivery of official statements, advance refunding documents and Forms G-36(OS) and G-36(ARD), such as the LOC or SBPA for a VRDO, that should be filed with the MSRB and made publicly available?

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Comments should be submitted no later than June 30, 2008, and may be directed to Justin R. Pica, Uniform Practice Policy Advisor.  Written comments will be available for public inspection at the MSRB’s public access facility and also will be posted on the MSRB web site.[6]

May 23, 2008