The Municipal Securities Rulemaking Board (MSRB) Rule G-15

Among the fiduciary rule changes to the financial industry, The Municipal Securities Rulemaking Board (MSRB) Rule G-15 now requires brokerage firms to disclose to individual investors the pricing mark-up or mark-down on corporate, agency, and municipal bond trades. The MSRB rule was approved by the SEC and took effect on May 14th.

While trades in fixed income, or bonds, don’t involve a commission, the price typically includes a premium that is often undisclosed to purchasing investor. The new rule forces brokerage firms to disclose the premium, or mark up. This is good news for investors and bad news for brokerage firms that have been disadvantaging unsuspecting investors.

Fixed Income Disclosure

While costs for individuals trading in small quantities of bonds has declined, the costs remain relatively high when compared to equity trades of similar quantities. This is because, unlike equities, which are traded on a stock exchange that lists a real time price per share, bonds are not traded on an exchange. Therefore, they have remained free from complete pricing transparency. Said differently, if an investor were to by buy stock in the fictitious company Widget (Not on NYSE: WGT), the listed share price on the exchange is what anyone – public pension plan, hedge fund, endowment, or individual – pays for the security. For bonds, however, the price is the ask price from a broker-dealer, which will vary from other broker-dealers based on their inventory. This opaque transaction structure meant that individuals were often ripped off as a result of paying significant mark-ups.

The new rule requiring broker-dealers to detail costs and markups to investors is causing anxiety among banks and securities dealers that were ripping off investors for years. This is likely to cause a shake up in the bond market and we expect to see a renewed push for electronic trading and for investors to continue to shift their money into ETFs and other fee-based options. This environment is a good reason for bond traders, for example, to polish their resumes and make a clean break before their paychecks stop coming.

In examining the bond market, we think it must be noted to investors that our country has reached an all-time high in borrowing by the Federal Government, municipal entities, agencies, and corporations who have refinanced their balanced sheet with cheap debt as a result of the financial crisis. This has us wondering about the short term repercussions for the fixed income market and whether it can support additional dilution, MSRB Rule G-15, less bodies selling, and continue to have investors lined up to buy. Longer term, we hope to see more bonds traded electronically via an exchange like their equity counterparts. This will create broader efficiencies at scale and improve transparency.