U.S. House Financial Services Committee to Hold Hearings on Credit Rating Agency Regulation, Municipal Finance
May 19, 2009
The U.S. House Financial Services Committee has scheduled the following hearings this week related to credit rating agencies and municipal bond financing (the latter being accomplished specifically through a federal reinsurance proposal):
- Tuesday, May 19, 2009 (today at 2:00 p.m.): Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises “Approaches to Improving Credit Rating Agency Regulation”
- Thursday, May 21, 2009: House Financial Services Committee (full Committee) “Legislative Proposals to Improve the Efficiency and Oversight of Municipal Finance”
Additional details on each hearing are outlined below.
Should you have any questions or comments, please contact Colodny Fass.
Tuesday, May 19 (today)
U.S. House Financial Services Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises hearing “Approaches to Improving Credit Rating Agency Regulation” at 2 p.m. A live Webcast of this hearing can be accessed by clicking here.
Witness List and Prepared Testimony (click on the witness name to view corresponding written testimony):
- Mr. Robert Auwaerter, Principal & Head of the Fixed Income Group, Vanguard
- Mr. Robert Dobilas, President and Chief Executive Officer, Realpoint LLC
- Mr. Eugene Volokh, Gary T. Schwartz Professor of Law, UCLA School of Law
- Mr. Stephen W. Joynt, President and Chief Executive Officer, Fitch, Inc.
- Mr. Alex J. Pollock, Resident Fellow, American Enterprise Institute
- Mr. Gregory Smith, General Counsel, Colorado Public Employees’ Retirement Association
Thursday, May 21
The U.S. House Financial Services Committee will hold a hearing entitled “Legislative Proposals to Improve the Efficiency and Oversight of Municipal Finance” on Thursday, May 21 at 9:30 a.m.. The Committee also circulated draft legislation – none of which has been formally introduced – that witnesses will be asked to discuss during the upcoming hearing. A summary of the draft legislation is below, as well as links to their full texts. To access a live Webcast of this hearing, click here.
SUMMARY OF MUNICIPAL MARKET DRAFT LEGISLATION
The downgrades of most bond insurance companies over the past 18 months have made it more difficult and costly for municipalities to issue bonds. The legislation would aid municipal issuers by providing federal reinsurance for municipal-only primary bond insurance. Treasury-provided reinsurance would make it easier for smaller, lesser known issuers to borrow in the capital markets by increasing capacity of municipal bond insurers to insure new risks. The bill does the following:
- Creates the Office of Public Finance within the Treasury Department specifically to provide reinsurance for municipal-only bond insurers in the most cost effective manner. Eligible insurers are those that are licensed in one or more of the 50 states.
- The Office of Public Finance will set risk-based premium rates at a level that is sufficient to maintain a negative credit subsidy under the Credit Reform Act as well as cover administrative costs of the program.
- The Office of Public Finance shall set other program terms consistent with providing additional capacity in the market for municipal bond insurance.
- The reinsurance program is limited to reinsurance of a par amount of no more than $50 billion annually for fiscal years 2011 through 2015.
- Treasury is directed to submit to divest the reinsurance program after no more than five years.
- Sec. 149 of the Internal Revenue Code is amended so reinsured bonds can remain tax-exempt.
Variable rate municipal bonds are long-dated securities for with the interest rate resets on a short-term basis. Investors that purchase the bonds at short-term rates as short-term investments have the right to redeem the bond at set periods that can range from daily to several weeks. This function is supported by a liquidity facility, or standby bond purchase agreement provided by banks for a fee. As bank balance sheets have become constrained over the past 2 years, the availability of new liquidity facilities has decreased as their cost has increased. The legislation would provide the Federal Reserve with the authority to fund new liquidity facilities for certain securities. The bill does the following:
- Amend the Federal Reserve Act to permit the Federal Reserve to lend money to a special purpose vehicle or designated corporation to finance standby bond purchase agreements, or liquidity puts. The loans would be secured by municipal variable rate demand notes and short-term cash management notes for which the liquidity put is being provided.
- Amend the Emergency Economic Stabilization Act to authorize the Treasury Department to use TARP funds to in connection with a Federal Reserve facility. The TARP funds would be used as credit protection for the Fed facility similar to the structure of the TALF.
- The use of the funds would be restricted to funding the purchase of variable rate demand notes (already issued at the time of enactment), variable rate demand notes issued to refund municipal auction rate securities or short-term cash management notes.
- The bill clarifies that the Federal Reserve may cooperate with the Treasury Department and other federal agencies in providing such financing.
- Sec. 149 of the Internal Revenue Code is amended so any bonds backed by Federal Reserve-financed liquidity would remain tax exempt.
This legislation is intended to regulate financial advisors to municipalities that are not currently regulated under existing securities laws. The bill does the following:
- Establishes a requirement and set out the terms under which municipal financial advisors register with the SEC.
- Sets out specific prohibited transactions for municipal financial advisors, such as engaging in fraudulent or deceptive practices.
- Creates a fiduciary responsibility for municipal financial advisors toward their clients.
- Defines a municipal financial advisor (MFA) as one who
- 1.) provides advice to municipalities on bond issuance, the investment of bond proceeds and financial contracts, such as interest rate swaps;
- 2.) brokers investment products for municipalities;
- 3.) serves as a placement agent for municipal securities.
- Legal advisors and certain other professionals that interact with municipalities would be exempted from the new registration requirement.
- Creates authority for the SEC to write rules governing the conduct of MFAs, conduct regular exams and impose sanctions.
The legislation is intended to address the apparently unequal treatment by National Recognized Statistical Rating Organizations (“NRSRO”) of municipal and corporate bonds. Tables comparing default rate and credit ratings of the two types of securities by NRSROs consistently show that municipal bonds with equal or lower default rates that corporate bonds nonetheless have lower credit ratings. The bill does the following:
- Requires NRSROs to design and maintain credit rating for debt securities based on the risk that an investor will not be repaid according to the terms of the security.
- Requires NRSROs to clearly define rating symbols and use them consistently.
- Provides that NRSROs can use additional credit factors in developing their credit ratings so long as they are documented and disclosed and demonstrably related to the risk an investor will not receive repayment.
- Provides that NRSROs can develop complementary ratings such as those designed to measure volatility or other risks.
- Requires that the SEC establish performance measures that it is to consider when deciding whether to initiate a review concerning whether an NRSRO is in compliance with its stated policies and procedures.
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