New rules coming to the municipal bond market are likely to turn one of the less-transparent U.S. markets into a truly real-time trading environment. But first, dealers need to get past a key December deadline. As the Municipal Securities Rulemaking Board (MSRB) prepares for its New Year's resolution to shift from end-of-day batch reporting to real-time transaction reporting, the board is requiring all municipal dealers to test their real-time transaction reporting systems (RTRS) and gain certification from the MSRB by Dec. 15.
The shift isn't a surprise to anyone in the municipal securities market; the MSRB has been pushing for more price transparency in the municipal bond market since at least 2003. What is surprising, however, is the delay by some dealers to sign up for testing.
Harrell Smith, a senior analyst at Celent Communications, offers a two-prong theory: a general opposition to transparency in a market where dealers and broker-dealers have had an informational advantage, and a lack of infrastructure to automatically submit trades. "Given the fact that munis and corporates were traditionally the most opaque part of the bond industry, it was high time for some increased regulation, and I think there's going to be some resistance to it," he says.
As of October, more than one thousand municipal dealers - representing about 80 percent of trading volume by number of trades - had signed up to test their real-time transaction reporting systems or were already in the testing process. Another 215 dealers - representing about 11.5 percent of trading volume - already have been certified.
Just weeks from the deadline, however, 150 high-volume municipal dealers have yet to sign up for testing. "It would be hard to speculate why [some dealers] haven't signed up," says Hal Johnson, deputy general counsel, MSRB. "All I can say is that we have sent a number of communications requesting it, and we're anxious to hear from them."
In June 2003, the MSRB published two documents to prepare municipal bond dealers for the system switch from end-of-day batch processing to real-time reporting. More than a year later, in August, the Securities and Exchange Commission approved a proposed rule change relating to the MSRB's implementation of real-time transaction reporting, and the MSRB amended two rules: Rule G-14, effective in January 2005, requires dealers to report transactions in municipal securities within 15 minutes of the time of trade execution, instead of by midnight on trade date, as is currently required; and Rule G-12(f), also effective January 2005, requires dealers to submit inter-dealer transactions to the central comparison system within the same time frame.
Making the Shift
When New York-based Lehman Brothers first learned of the regulatory changes, it immediately began to examine its infrastructure to see what would need to be done to comply with the 15-minute real-time reporting rule. Early this year, the firm's municipal technology arm began looking at different solutions that could support the shift for its customer trades.
After considering vendors related to some of its existing trading initiatives, Lehman Brothers finally selected a system from Plainsboro, N.J.-based Wizcom Corp. Lehman Brothers picked Wizcom foremost for its experience with RTRS technology and its strategic alliance with New York-based straight-through processing software provider Volante Technologies, says Anthony Licciardi, Lehman's VP of municipal and auction rate technology. (The MSRB chose Volante's product suite to build its RTRS in October 2003.) "We felt that Wizcom [offered] a particular technology that no one else had," Licciardi says.
Essentially, Wizcom's technology is an end-to-end RTRS system. It incorporates a Volante "black box"-an ISO-compliant communication software layer that speaks a language the MSRB's RTRS can understand. Wizcom integrated the Volante appliance with Lehman Brothers' trading system so that Lehman's system would be capable of reporting transactions directly to the MSRB. "The box is like a translator," explains Licciardi. "It takes a trade message that is proprietary to Lehman and translates it through the black box, then it actually does another translation into the MSRB-formatted message."
Lehman Brothers' solution was certified in mid-October, and as of press time, the firm was still in parallel testing with the MSRB. "In our testing environment right now, we've built an internal tool that lets us track [in] real-time what the outcome is," says Licciardi.
Every time trade messages come out of Lehman's front office, they go directly to MSRB. According to Licciardi, MSRB then responds with various messages, telling Lehman if everything is OK, if there's an error and the 15 minutes have passed, or if something appears problematic. An operations group examines the responses and addresses each accordingly.
Lehman Brothers is scheduled to go live with its RTRS at the end of November. "The nice thing about [parallel testing] is that it puts us in a very good position," says Licciardi. "We still don't have to commit to having the trades within 15 minutes until [January]. So, even when we're in production, if things go wrong, we'll still have until the end of the day to fix it."
Tips for the RTRS Test
Lehman Brothers' Anthony Licciardi offers peers some words of advice for preparing their real-time transaction reporting systems for certification by the Municipal Securities Rulemaking Board.
1. Don't underestimate this project. There are little snags that you'll encounter, especially when you're dealing with different trading systems or different back-office systems. It's not a cookie-cutter solution, so don't treat it like one.
2. Review all the products. We're dealing with many different products - from syndicates to short-term bonds - with different reporting times. Make sure that you understand all of the MSRB requirements upfront, because the number of scenarios that can occur is mind-boggling.
3. Synchronize your clock. To ensure accurate reporting times, check that your clock is set to the same time as the MSRB's clock.
4. Have a back-up plan. Unlike the traditional days of MSRB, when you had eight hours to fix an error, now you only have minutes before you're in danger of reporting late. If something goes wrong, you have to make sure all these systems are able to recover very quickly.