“The Impact of Dodd–Frank on True Interest Cost of Municipal Bonds: Evidence From California”

A forthcoming article in Public Budgeting & Finance by Mikhail Ivonchyk evaluates the impact of Dodd-Frank on the nature of financial advise in the municipal debt market—both as a disciplining factor and as a mechanism of weeding out bad advice from the market–, and as a result, lower cost of borrowing for California local governments. Central features of the Dodd–Frank Wall Street and Consumer Protection 2010 Act (Dodd-Frank Act) and directly relevant to municipal borrowing in the US are the governance provisions for municipal advisers (MA). Ivonchyk (page 2) writes that:

“The Dodd–Frank Act charged the U.S. Securities and Exchange Commission (SEC) with defining “municipal advisor” and the Municipal Securities Rulemaking Board (MSRB) with creating rules governing MA activities. The initiative was intended to increase fairness and transparency in the municipal debt market. The implementation of the MA registration requirement was postponed several times to allow market participants more time to analyze and prepare for the new rule. It finally took effect on November 1, 2014, implementing the Dodd–Frank requirement that all individuals and legal entities providing debt-related advice to municipal issuers register separately with both the SEC and MSRB. Under the law, MAs now have a fiduciary duty to place issuers’ interests ahead of their own. The SEC was granted certain enforcement tools to sanction violators. As of the rule’s effective date, financial advisors can no longer serve as underwriters in the same transaction, due to the conflict of interest. The Dodd–Frank Act will likely bear significant ramifications for the municipal securities market and fundamentally change market participants’ behavior.”

The author reasons that new requirements that MA’s keep records of their books and all written communications and agreements with municipalities, as well as details and contacts for all persons they have worked with within the past five years—and that these files are made available to the SEC at a known address—will ensure discipline among MAs. Moreover, to practice financial advisory functions, MAs must register with the SEC and become subject to fiduciary duties. Therefore, a process of weeding out the “charlatans” from the municipal market, paired with disciplining pressures from the regulators, may lower borrowing costs for municipal governments.

The findings appear to suggest that Dodd-Frank may have worked as expected, at least as it applies to governance of financial advisors. Ivonchyk (page 18) concludes that:

“The Dodd–Frank Act introduced substantial changes to the municipal securities market. Previously unregulated (but essential to municipal borrowers) financial services are now governed by the federal law. The new registration requirement and increased transparency and accountability of advisory activities were intended to weed out unqualified advisors, improve the quality of financial advice, and help municipal debt issuers raise capital more efficiently (Luby and Hildreth 2014, 96; White 2014).”

The table below presents estimates for cost savings for an average notional term bond due to Dodd-Frank.

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