By Mark S. Nelson, J.D.
The Municipal Securities Rulemaking Board issued its Q1 markets report and found that multiple bank failures earlier this year apparently had only a muted effect on municipal securities markets, although the bank failures and other factors may yet impact these markets. According to the report, 2023 has been much less volatile than was 2022 at the same time, when higher inflation and a different set of factors pushed investors to flee tax-exempt mutual funds and record trading activity occurred for individual municipal bonds.
The MSRB’s report noted that the impact from the failures of Silicon Valley Bank and Signature Bank, and First Republic Bank’s need for a capital infusion, had been muted in municipal securities markets. That said, the MSRB also noted that new issue volume may have been lower during this same period because volatility in Treasury markets may have discouraged some deals. However, the MSRB cautioned that developments in tax-exempt bond markets may yet have an impact on municipal securities markets.
“For example, if some banks were forced to liquidate their tax-exempt bond portfolios, there could be a corresponding increase in tax-exempt yields and volatility,” said the MSRB report. “Even if banks do not sell the bonds in their current portfolios, it could impact the municipal bond market if they reduce their demand for tax-exempt bonds going forward.”
Other financial markets regulators have commented on issues related to recent bank failures. For example, the CFTC joined the SEC in commenting on the recent FDIC takeovers of Silicon Valley Bank and Signature Bank. In the case of the CFTC, the agency said that qualified financial contracts (QFCs) that are swaps transferred by the FDIC to related bridge banks would not be subject to enforcement under the Commodity Exchange Act and related CFTC regulations for violations that arise solely from the FDIC transfers. The CFTC also said that reporting counterparties should use best efforts to meet their reporting obligations for QFCs that are swaps. Previously, the SEC, via a statement from Chair Gary Gensler, had indicated that it was monitoring the recent bank failures for purposes of market stability and for any possible federal securities law violations.
More recently, SEC Commissioner Caroline A. Crenshaw called on broker-dealers and clearing agencies to help retail investors exercise options in the stocks of Silicon Valley Bank and Signature Bank. Crenshaw cited reports by Forbes and Bloomberg that suggested that some investors were unable to do so. Crenshaw also urged the SEC and FINRA to adopt comprehensive rules for options and other complex products.
Congress has proposed legislation on numerous topics related to this year’s bank failures, including on clawbacks of bank executives’ pay and regarding rollbacks of some provisions enacted several years ago that eased Dodd-Frank Act requirements for community banks.
A Legal Sidebar issued by the Congressional Research Service recommended that federal banking regulators implement the executive compensation provision contained in Dodd-Frank Act Section 956. Joint regulations were proposed twice before but final rules were not issued. The CRS note suggested that Congress could codify the earlier proposals or lawmakers could amend Section 956 to make it effective even without final agency rules.
Dodd-Frank Act Section 956 would bar covered financial institutions from providing their executives with incentive-based pay that could encourage inappropriate risk taking (e.g., excessive compensation, fees, or benefits, or pay schemes that could lead to material financial loss). “Covered financial institutions” would include depository institutions, depository institution holding companies, registered broker-dealers, credit unions, investment advisors, Fannie Mae, and Freddie Mac. Covered financial institutions with less than $1 billion in assets would be exempted from any regulations.