In the wake of the Libor-rigging scandal, U.S. regulators are looking at how a key benchmark rate in the $3 trillion U.S. municipal bond market is determined. Maybe regulators read the RiskMatters blog?
Ok, maybe not. But in a blog post a couple of weeks ago, I suggested that municipal bonds and other financial products with opaque rate-setting process were likely to
be questioned as a result of the Libor scandal. Yesterday, Thomson Reuters released a brief statement saying it “has been in discussion with regulators” regarding its Municipal Market Data (MMD) service, which is widely used to determine prices in the municipal bond market.
The process for determining MMD appears to share many of the same flaws as Libor. It is based voluntary rate submissions from a small group of dealers, and it is administered by Thomson Reuters, the financial data behemoth. Unlike the Libor process however, MMD’s rate setting is more mysterious. According to a news report:
The rates are compiled and issued each afternoon by Thomson Reuters using a proprietary method that includes input from banks that buy and sell municipal bonds, industry participants said, though Thomson Reuters does not publicly explain its method.
That’s a recipe for problems. When details of the rate-setting process are not disclosed, it leaves ample room for shenanigans and speculation. (It will be interesting to see whether Thomson has any liability arising from these shortcomings.)
The municipal bond market has seen more than its share of scandal in recent years. Just this week, three former UBS bankers went on trial for allegedly accepting kickbacks for steering municipal business to favored firms.
The market also has been whipsawed in the past year over fears about possible bankruptcies among local governments. With regulators now digging into rate-setting, it seems the municipal market is on the cusp of another rocky period, which will further shake investor confidence in the sector.
So if ever there was a time for dealers and other market participants to voluntarily take steps to improve transparency in the market, this is it. They will need to move quickly, before regulatory enforcements and private litigation freeze everyone in place. I’d like to be optimistic, but the banks have a poor track record on voluntary reform, and they’ve got a long list of problems to handle already.