Regulating the Fixed Income Market in the United States Felice B. Friedman OECD-World Bank Bond Market Forum 2-3 June 2003

2 Introduction and Background The SEC and Debt Markets –Two Myths to Debunk Debt markets as unregulated US as case study for “Developing an Efficient Regulatory Framework for Debt Markets”

3 Snapshot of US Fixed Income Market $20.2 trillion outstanding debt securities, year-end 2002 $11.7 trillion in equities, slightly more than half the debt market $ trillions

4 Snapshot of US Fixed Income Market Treasury Securities: $3.2 trillion Federal Agency Debt: $2.4 trillion Municipal Securities: $1.8 trillion Corporate Debt: $4.1 trillion Mortgage-backed: $4.7 trillion Asset-backed: $1.5 trillion Money Market: $2.6 trillion Source: Bond Market Association

5 Framework of US Debt Market Regulation Multiple Gov’t Agencies/ Regulators –US Department of the Treasury –Federal Reserve System –US Securities and Exchange Commission –Self-Regulatory Organizations NYSE, NASD, MSRB –Office of Federal Housing Enterprise Oversight

6 Framework of US Debt Market Regulation Multiple Governing Laws – Crisis-driven rather than “designed” –Securities Act of 1933 and Securities Exchange Act of Established disclosure framework for regulation. All securities offered to public must be registered with the SEC, unless exempt –Government and municipal securities exempted from registration and reporting requirements No exemption from antifraud provisions

7 Regulation of Municipal Securities Securities Acts Amendments of 1975 –Response to New York City financial crisis Regulated broker-dealers; established the MSRB Rule 15c2-12, adopted in 1989 –Response to default of Washington Public Power Supply System (WHOOPS) in 1983 First bond disclosure rule

8 Regulation of Government Securities Government Securities Act of 1986 –Response to failure of several key government securities dealers Regulated broker-dealers Government Securities Act Amendments of 1993 –Response to Salomon Brothers “cornering” incident Improvements in auction process Development of sales practices rules for government securities markets Large position record-keeping and reporting requirements

9 Regulation of Corporate Securities Corporate Debt Securities –Sarbanes-Oxley Act of 2002 Response to failures of Enron, WorldCom Focus was equity and not debt, but disclosure remedies of Sarbanes-Oxley apply equally to issuers of debt as well as to issuers of equity –Regulatory framework for equity applied without independent consideration of debt market

10 What Lessons Can We Draw? Hodgepodge of Regulators Hodgepodge of Laws and Rules Why does it work? What’s key?

11 A Closer Look at the Municipal Securities Market Why the municipal securities market? –Financed the growth of the US –Has both public and private aspects –Highlights key regulatory elements –Demonstrates creativity in regulation

12 Snapshot of the Municipal Securities Market Approx. $1.8 trillion sub-sovereign debt outstanding at year end 2002 Approx. $430 billion in municipal debt issued in 2002, about 75% long term. About 25% due to refinancing/ refunding Over 50,000 issuers and 1.5 million different issues

13 Overview of Municipal Securities Regulation Historically –Exempt from registration and reporting requirements of Securities Act and Exchange Act Reasons unique to United States Low-risk investment Institutional investor base

14 Overview of Municipal Securities Regulation What changed? –Financial crisis in major municipalities –Changes in bankruptcy law in 1979 –Cutbacks on federal aid to municipalities –Proliferation of new, untested financing techniques –Change in investor base

15 Regulation of Municipal Securities Broker-Dealer Regulation –Securities Acts Amendments of 1975 established regulatory scheme for municipal securities broker-dealers Added Section 15B to Exchange Act –Authorized SEC to set up an SRO All MSRB rules approved by SEC Inspection and enforcement authority with SEC, NASD, and FRBNY

16 Regulation of Municipal Securities Disclosure Regulation –Rule 15c Imposes both primary and secondary market disclosure Requires underwriter to obtain, file and distribute Official Statement Underwriter must obtain from issuer a written agreement to make financial and operating information available on ongoing basis Transparency Requirements –MSRB rules require transaction reporting for each security traded at least two times the previous day Antifraud Regulation – and Enforcement –City of Miami, 2003

17 Issues to Consider Who should be the regulator? –Consider US example, or non-example Functional regulation – How best to look after investor concerns? –Should the safety and soundness regulator be charged with disclosure requirements for public offerings? Coordination among regulators – and self-regulators

18 Issues to Consider Should there be a self-regulatory organization involved? –Sufficient government oversight Balance between SRO and regulator: consider powers of MSRB vs. powers of NASD

19 Issues to Consider Should offerings of debt securities be registered? –What is being offered? Is it backed by full faith and credit of the government? –Who is the investor base? Registration and oversight more important for retail investors and when material information is similar to that as would be required for equity offers

20 Issues to Consider May not be necessary to have a registration scheme for offerings –Broker-dealer conduct regulation with strong market integrity provisions may substitute –Can impose disclosure obligations on intermediaries instead of issuers Rule 15c2-12, as example

21 Issues to Consider What information should be disclosed? –Material information, both financial and non- financial Importance of high quality accounting and auditing principles/ standards (also to the rating agencies) Importance of non-financial statement disclosure –MD & A: picture of company through management’s eyes –Role of market participants in demanding better and more timely information

22 Issues to Consider Is enforcement regime effective? –Importance of strong, well-resourced, independent, regulator Complemented by individual private right of action –Need effective judicial system with an impartial judiciary that will enforce regulatory action, where needed

23 Conclusion Regulatory goal: Increase investor confidence and provide readily accessible source of capital –Comprehensive regulatory scheme not necessary –Key elements of regulation critical, but may vary depending on the legal structure, the market and the investor base Oversight of intermediaries, including capital adequacy Mandatory centralized disclosure and price transparency for investors Prohibition of fraud and effective enforcement Market development and regulation is evolutionary process