MSRB Webinar Draft Rule G-18: Best-Execution March 6, 2014
MSRB Presenters Ritta McLaughlin Chief Education Officer Michael L. Post Deputy General Counsel 2
Webinar Overview I. The Framework The Regulatory Framework Relationship to Current MSRB Rules G-18 and G-30 II. Key Provisions of Draft Rule G-18 Best-Execution Obligation Reasonable Diligence Timing and Scope Policies and Procedures III. Audience Questions 3
The Framework
About the MSRB A self-regulatory organization created by Congress in 1975 Protects investors and issuers of municipal securities Promotes a fair and efficient municipal market 5
Improving the Structure of the Municipal Securities Market Among other obligations, current MSRB Rule G-18 (Execution of Transactions) and Rule G-30 (Prices and Commissions) require dealers to: Trade with customers at fair and reasonable prices Exercise diligence in establishing the market value of municipal securities and the reasonableness of their compensation 6
Improving the Structure of the Municipal Securities Market (continued) The MSRB believes, at this proposal stage, that the addition of a best-execution standard to existing fair pricing requirements could: Bolster obligations Improve execution quality for customers Promote fair competition among dealers resulting in increased market efficiency 7
Evolution of Proposed Best-Execution Standard Discussion of best-execution in SEC filing for MSRB Rule G-43 (Broker s Brokers) rulemaking (March 26, 2012) SEC Report on the Municipal Securities Market (July 31, 2012) MSRB Concept Proposal on Best-Execution (August 6, 2013) Request for Comment Draft Rule on Best-Execution (February 19, 2014) 8
Key Provisions Draft MSRB Rule G-18: Best-Execution
Draft Rule G-18: Best-Execution Overview Dealers must use reasonable diligence to obtain the most favorable terms available to their customers under prevailing market conditions: Guidance on reasonable diligence Provisions specific to broker s brokers and customer instructions Exception for municipal fund securities and transactions for sophisticated municipal market professionals (SMMPs) Requires written policies and procedures and periodic review of these policies and procedures Generally consistent with FINRA Rule 5310 on Best-Execution, but tailored to the characteristics of the municipal securities market 10
Best-Execution Obligation In any municipal security transaction with a customer or a customer of another dealer, dealers must use reasonable diligence to ascertain the best market for the security The dealer must then buy or sell in that market so that the price to the customer is as favorable as possible under prevailing market conditions 11
Market Defined A market encompasses a variety of different venues, including (but not limited to): Broker s brokers Alternative trading systems or platforms Other counterparties, including a dealer itself acting as a principal The term should be construed broadly 12
Reasonable Diligence
Reasonable Diligence Factors used to determine whether a dealer has used reasonable diligence include: character of the market for the security size and type of transaction number of markets checked information reviewed to determine the current market for the security or similar securities accessibility of quotations terms and conditions of the customer s inquiry or order 14
Reasonable Diligence (continued) Factors in draft Rule G-18 generally conform to the factors in FINRA s best execution rule (FINRA Rule 5310) Exception: Information reviewed to determine the current market for the security or similar securities is an additional factor not found in FINRA Rule 5310 Factors in draft Rule G-18 also guide the use of reasonable diligence when there are no available quotations for a security 15
Reasonable Diligence (continued) Failure to obtain the most favorable price does not necessarily mean that a dealer failed to use reasonable diligence A dealer s failure to maintain adequate resources is not an excuse for executing away from the best available market 16
Interpositioning Dealers must not interject a third party, such as a broker s broker, between themselves and the best market for a security if the use of that party would be inconsistent with the dealer s best-execution obligation Unlike FINRA Rule 5310, draft Rule G-18 does not require dealers to show why it was reasonable to use a broker s broker 17
Timing and Scope
Timing Dealers must make every effort to execute customer transactions in a reasonably timely manner, taking into account prevailing market conditions Departure from FINRA Rule 5310 which generally requires transactions to be executed fully and promptly 19
Principal and Agency Transactions Draft Rule G-18 applies to both principal and agency transactions Best-execution obligations are in addition to fair pricing obligations set forth in MSRB Rule G-30 20
Executing Brokers Dealers are only obligated to provide best-execution to customer orders received from other dealers when the order is routed to the dealer for handling and execution The best-execution obligation does not apply to a dealer when another dealer is simply executing a customer transaction against that dealer s quote 21
Customer Instructions Dealers are not required to make a best-execution determination that would supersede a customer s unsolicited specific instruction regarding the execution of the transaction Required to process the transaction in a reasonably timely manner and in accordance with the terms of the customer s bid or offer 22
Municipal Fund Securities and Sophisticated Municipal Market Professionals (SMMPs) Under draft Rule G-18, dealers do not have best-execution obligations for transactions in municipal fund securities, such as 529 plans Draft amendments to proposed Rule G-48 (Transactions with SMMPs) provide that dealers do not have bestexecution obligations with respect to transactions with SMMP customers 23
Policies and Procedures
Policies and Procedures Dealers must have written policies and procedures that address how best-execution determinations will be made for securities with limited pricing information or quotations Dealers must document compliance with their policies and procedures Dealers must conduct periodic reviews of their policies and procedures for determining the best available market for execution of retail customer transactions 25
Periodic Review of Policies and Procedures Dealers should assess whether their policies and procedures are reasonably designed to achieve bestexecution, taking into account: Changes in market structure New entrants Availability of additional pre-trade and post-trade data Availability of new technologies 26
Periodic Review of Policies and Procedures (continued) Dealers should promptly make any necessary modifications to their policies and procedures based on their periodic reviews Dealers that route customer transactions to another dealer for handling as agent or riskless principal may rely on that dealer s periodic reviews if: the results and rationale of the review are fully disclosed to the dealer; and the dealer periodically reviews how the other dealer s review is conducted and the results of the review 27
Economic Analysis
Economic Analysis The request for comment on draft Rule G-18 incorporates the MSRB s preliminary economic analysis Need for the draft rule Relevant baselines against which the likely economic impact of elements of the draft rule can be considered Reasonable alternative regulatory approaches Potential benefits and costs of the draft rule and the main alternative regulatory approaches 29
Economic Analysis Potential benefits of the draft rule may include: Improvement of execution quality for municipal securities investors Reduced effective spreads and reduced transaction costs for market participants Greater dealer certainty about whether and how to apply bestexecution concepts to municipal securities transactions Reduced dealer costs resulting from similar compliance standards across different types of securities transactions 30
Economic Analysis Potential costs of the draft rule may include: Establishment or revision of compliance policies and procedures Adoption of new technology systems The seeking of legal and/or compliance advice to establish a compliance system 31
Specific Questions for Public Comment Could the goal of helping customers obtain the most favorable price possible under prevailing market conditions be better achieved through alternative regulatory measures? Is the desire to have a consistent, explicit best-execution standard applicable to both municipal securities and other types of fixed income securities a worthwhile goal? To what extent can commenters show that the draft rules result in increased or decreased transaction efficiency? 32
Specific Questions for Public Comment What additional compliance and supervision costs would be incurred by dealers to comply with a best-execution requirement? What additional costs would be incurred by dealers to periodically review policies and procedures related to bestexecution? 33
Participating in the Rulemaking Process Identify an Issue Monitor market Engage with market stakeholders Does this issue warrant rulemaking? Economic analysis Reasonable alternatives Draft Rule and/or Amendments Are Published for Comment Rule for stakeholders to evaluate Incorporates preliminary economic analysis May be preceded by concept proposal Comment letters published on MSRB s website Review of Comments All comment letters considered Draft may be amended in response to comments Draft Rule Filed with SEC for Approval All significant issues raised by commenters addressed in filing SEC Publishes Proposed Rule in Federal Register for Comment Additional comment period MSRB responds to comments received SEC Approval Order If approved, rule has the force and effect of federal law Goes into effect on specific date 34
Submitting Comment Letters Public comment period ends March 21, 2014 Submit comments electronically or by mail All comment letters received are published on the MSRB website 35
Audience Questions Submit your questions using GoToWebinar Control Panel
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MSRB Webinar Draft Rule G-18:Best-Execution March 6, 2014