Federal Reserve Approves Restrictive Rule on High Quality Liquid Assets
On April 1, the Federal Reserve Board announced that it was adopting a final rule that would classify a very limited number of investment-grade, liquid and readily marketable municipal securities as high quality liquid assets (HQLA). The Federal Reserve’s action follows up on its proposal issued last May to amend the 2014 Liquidity Coverage Ratio (LCR) Rule, which classifies foreign sovereign debt securities as HQLA while excluding investment-grade municipal securities in any of the acceptable investment categories for banks to meet new liquidity standards.
While the GFOA is very appreciative of the Federal Reserve’s efforts to enable some municipal securities to be classified as HQLA, the rule is very restrictive in its approach. For example, the rule would allow investment-grade, liquid and readily marketable general obligation bonds to classified as HQLA, but not revenue bonds. The rule is made more restrictive because it is only being adopted by the Federal Reserve, which has jurisdiction of two of the nine bank holding companies with over $250 billion in assets affected by the 2014 LCR Rule. This means that the other seven banks affected by the 2014 rule, who are larger purchasers of muni securities and fall under the jurisdiction of the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of Currency (OCC), will still not be permitted to classify any municipal securities they are holding as HQLA.
Not classifying municipal securities as HQLA would increase borrowing costs for state and local governments to finance public infrastructure projects, as banks would likely demand higher interest rates on yields on the purchase of municipal bonds during times of national economic stress, or even forgo the purchase of municipal securities. The resulting cost impacts for state and local governments could be significant, with bank holdings of municipal securities and loans having increased by 86% since 2009.
To address GFOA’s concerns with the 2014 rule, our Federal Liaison Center worked with our state and local association partners and a dedicated group of bipartisan House members to secure House approval of HR 2209 on February 1. HR 2209 would require all federal regulators – Federal Reserve, FDIC, and OCC – to classify all investment-grade, liquid, and readily marketable municipal securities as HQLA, and would apply to all nine bank holding companies affected by the 2014 rule.
GFOA is now in the process of working with members of the Senate Banking Committee to introduce legislation like the House-passed HR 2209, and needs your help in reaching out to members of the committee to encourage them to help us. If your Senator sits on the committee, please send him or her a letter requesting his or her support in introducing this important legislation. A list of members of the committee is available here, and a draft letter outlining the need for this legislation is available here.
MSRB Requests Comments on Bank Loan Disclosure Proposal
On March 28, the MSRB announced that it is seeking public comment on a regulatory approach that would require municipal advisors to disclose information about the bank loans and direct purchases of their municipal entity clients to the MSRB’s Electronic Municipal Market Access (EMMA) website. The GFOA has significant concerns with this proposal, which include but are not limited to the following –
- Municipal Advisors (MAs) are the only party in a municipal debt transaction that have a fiduciary responsibility to issuers as outlined in the Securities and Exchange Commission’s 2013 MA Rule. MSRB’s proposed approach to pass along responsibility of issuer disclosure of bank loans and private placements breaches that fiduciary duty, making MA’s also beholden to the investor community. Such a requirement would change the nature of issuers’ relationships with MAs in a manner that is beneficial neither to issuers, or MAs.
- Requiring MAs to assume this responsibility goes way beyond the scope of work that is typical of issuers’ engagement of MAs, and this additional requirement would likely drive up the costs of engaging MAs on debt transactions.
- This MSRB proposal ignores the ongoing and increasing level of activity of GFOA and our municipal market partners (National Association of Bond Lawyers; National Association of State Treasurers; National Association of State Auditors, Comptrollers and Treasurers; Securities Industry and Financial Markets Association; Bond Dealers of America; National Federation of Municipal Analysts; and others) to work collaboratively to improve continuing disclosure from municipal interests. GFOA recognizes and embraces the need for issuers to provide investors with accurate financial information, which is why we have developed best practices to provide guidance to issuers on disclosure.
- This proposal seems to trample on bond counsel’s role to issuers to determine what financial information is material and should be disclosed to investors. MAs currently do not have that responsibility, and it is unclear what expertise they could lend to such a determination.
- Establishing this requirement would further complicate the already unnecessarily confusing matrix of responsibilities assigned to MAs by the 2013 MA Rule and subsequent SEC and MSRB regulations, such as Rule G-42. Some municipal governments and all MAs are still trying to figure out how the new regulatory regime applied to MAs is supposed to function.
GFOA will be submitting comments to the MSRB on this proposal and invites GFOA members to do the same. Comment letters are due on May 27, and can be transmitted to the MSRB through this link. GFOA members can access full text of the short regulatory proposal here.
IRS Proposed Rules to Define "Political Subdivision"
On February 22, 2016, the IRS released proposed rules for determining whether an entity qualifies as a “political subdivision” for purposes of the tax-exempt bond rules (the “Proposed Regulations”). If adopted, the proposed regulations would provide new limitations on the types of entities that qualify as political subdivisions that are permitted to issue tax-exempt bonds. The GFOA needs your feedback on this proposal to help inform any comment letter we organize to send to the IRS. Please take a minute to complete this short survey to share your thoughts on how your jurisdiction may be affected by the proposal.
House Members Launch Municipal Finance Caucus
This week U.S. Representatives Randy Hultgren (IL-14) and Dutch Ruppersberger (MD-02) announced the creation of the Municipal Finance Caucus. This is an exciting development, as the Caucus will consult regularly with the GFOA and our state and local government association partners on federal legislation and regulatory activity affecting state and local government finance functions. According to the press release issued by Congressman Hultgren, “The purpose of the Municipal Finance Caucus is to act as a forum to discuss the opportunities and challenges for states and local governments to independently fund initiatives that will strengthen their communities, and to advocate for bipartisan policies that enhance their access to the capital markets. Key issues that merit strong consideration include: protecting the tax-exempt status of municipal debt, understanding how financial regulations treat such debt, and ensuring there is a robust market for municipal securities.”
Congressmen Hultgren and Ruppersberger are longtime champions of the effort to preserve the tax exemption on municipal bond interest. Over the last three years the duo has sent bipartisan letters to House leadership requesting that leadership reject any proposal to cap or eliminate the tax exemption. Each of these letters collected over 100 signatures.
More information about the new caucus is available here.
Big Win for Marketplace Fairness Act in the Tenth Circuit Court of Appeals
On February 22, 2016, the Tenth Circuit United States Court of Appeals upheld a Colorado law requiring remote sellers to provide Colorado purchasers with an annual summary of their purchases, and to send the same information to the Colorado Department of Revenue. Broadly, this important step taken by the Tenth Circuit upholds the constitutionality of use tax reporting requirements in any state. Reporting requirements are a step in the right direction until Congress acts on legislation that would allow states to enforce the collection of sales taxes on remote online vendors.
Since 2010, the State of Colorado has required remote sellers to provide Colorado purchasers with an annual summary of their purchases and to send the same information to the Colorado Department of Revenue. The Direct Marketing Association (DMA) sued Colorado in federal court, claiming the law was unconstitutional. In Direct Marketing Association v. Brohl, the Tenth Circuit disagreed. The court concluded the Colorado law doesn’t discriminate against interstate commerce because DMA was unable to show that the notice and reporting requirements imposed on out-of-state retailers are more burdensome than the sales tax collection and administration requirements imposed on in-state retailers.
GFOA, along with “Big Seven” members of the State and Local Legal Center (SLLC), have filed amicus briefs in every stage of DMA v. Brohl, citing the devastating impact that the 1992 Quill Corp. v. North Dakota Supreme Courtruling has had on state and local governments in light of the rise of Internet purchases, Congress’s failure to pass the Marketplace Fairness Act, and states’ need to improve use tax collection through statutes like Colorado’s. Justice Anthony Kennedy wrote a concurring opinion, upon considering DMA, which appeared to rely on the SLLC’s brief; it states that the “legal system should find an appropriate case for this court to reexamine Quill.” The Tenth Circuit’s opinion actually cites the SLLC’s amicus brief, which provides an estimate of the very low rate of use tax compliance and also quoted Justice Kennedy’s recent criticism of Quill.
GFOA continues to work with the SLLC to help communicate the necessity of states’ ability to enforce the collection of use taxes already due to the Courts. We will continue to keep members up-to-date on any developments of this case, and we will continue to keep the success of the Marketplace Fairness Act a priority in our legislative activities.