How The Market Works MSRB

Municipal Securities Rulemaking Board (MSRB) www.msrb.org

How the Market Works Municipal Securities Issuers and Their Bonds Issuers of municipal securities include states, counties, cities, and special tax districts, along with special agencies of state and local governments. Transportation, housing and healthcare authorities of state and local governments, for example, frequently issue municipal securities for their specific missions. In all, there are estimated to be more than 55,000 different issuers of municipal securities in the United States, including the District of Columbia, U.S. Territories and Puerto Rico.

Some municipal bonds represent the general obligation of the governmental issuer with taxing authority; others will pay principal and interest only from a specified source of revenue. The issuer's promise to pay interest and principal on a bond may be backed by various types of pledges and sources of security, depending on the type of bond and the purpose of issuance. It is important for the municipal bond investor to clearly understand the nature of the credit and security for the promise to pay principal and interest.

The Underwriting Process Municipal bonds typically are brought to market through an underwriting process. As part of this process, one or more municipal securities dealers – also known as underwriters – purchase newly issued securities from the issuer and sell the securities to investors. The underwriter has an "arm's-length relationship" with the issuer. In some cases, one municipal securities dealer acts as the sole underwriter for a new issue. In other cases, a group of municipal securities dealers work together in an underwriting syndicate. Syndicates are led by a municipal securities dealer known as the managing, or lead, underwriter, which typically works with the issuer on behalf of the syndicate.

Read more about the underwriting process.

Role of Municipal Advisors Municipal advisors act in a fiduciary capacity for issuers. The strategic services offered by municipal advisors may include development of comprehensive financing plans; analysis and monitoring of client portfolios; advice on potential financing solutions and new financial products; and recommendations for tracking and achieving on-budget performance. Municipal advisors also provide advice on conditions of a new issue, such as structure, timing, marketing, fairness of pricing, terms and bond ratings. During the transaction, municipal advisors represent the interests of state and local governments in negotiations with underwriters, rating agencies, banks and others involved. Municipal advisors also assist state and local governments with preparing disclosure documents, including official statements and continuing disclosure documents.

Read more about the roles and responsibilities of the financing team.

Sale of New Issue Bonds to Customers New issue municipal securities typically become available to customers during the issues' order period.

Persons and institutions seeking to invest in a new issue may place orders with members of the syndicate. In some new issues, issuers will establish a retail order period during which individual investors may be given the opportunity to place orders prior to institutional investors or other dealers.

Read more about investor transactions in municipal securities.

Transaction Disclosure A municipal security trade, or transaction, is the purchase or sale of a bond. Dealers are required to report these transactions to the MSRB for dissemination to the market. The MSRB’s EMMA website provides free access to municipal bond transaction prices.

Read more about trade data.

New-Issue Disclosure At the time of issuance, an issuer normally prepares a disclosure document called the official statement.

This document is intended specifically for purchasers of the new issue, serving as the primary and official source of information about the issuer and the securities in the transaction. The MSRB’s EMMA website provides free access to official statements for new issues.

Read more about new-issue disclosures.

Continuing Disclosure Continuing disclosure consists of important information about a municipal bond that arises after the initial issuance of the bond. This information generally would reflect the financial or operating condition of the issuer as it changes over time, as well as specific events occurring after issuance that can have an impact on the ability of the issuer to pay amounts owing on the bond, the value of the bond if it is bought or sold prior to its maturity, the timing of repayment of principal, and any number of other key features of the bond. Each bond will have its own unique set of continuing disclosures, and not all types of continuing disclosures will apply to every bond. EMMA also provides free access to municipal bond continuing disclosures.

Read more about continuing disclosures.

Secondary Market Trading After the initial sales of a new issue have been completed in the underwriting process, trading in the issue may continue throughout the life of the security in what is generally called the secondary market. There is no central exchange for municipal securities. Instead, the secondary market for municipal securities historically has been an over-the-counter, dealer market.

Read more about secondary market trading.

Regulation of Municipal Securities Dealers Municipal securities dealers serve as intermediaries in the market, buying, selling and brokering transactions in municipal securities and underwriting the sale of municipal securities by issuers. A municipal securities dealer acting in this capacity must be registered with the Securities and Exchange Commission and with the MSRB. Approximately 2,000 municipal securities dealers are registered with the MSRB for this purpose. Municipal securities dealers must follow the rules of the SEC relating to municipal securities and the rules of the MSRB. Read more about how the municipal market is regulated.

Regulation of Municipal Advisors Municipal advisors include a variety of different types of firms and individuals that provide advice to state

and local governments and other municipal entities, as well as to certain private beneficiaries of municipal bond issues (such as hospitals, colleges and other obligated persons), on a range of municipal securities or investment-related matters. Municipal advisors include financial advisors that provide advice to issuers and obligated persons regarding municipal bond offerings, swap advisors that provide municipal entities with advice in connection with derivatives transactions, and brokers and other advisors that provide advice or assistance to issuers regarding guaranteed investment contracts or the investment of municipal bond proceeds.

Municipal advisors also include firms and individuals that solicit business from municipal entities on behalf of broker-dealers, banks, other municipal advisors or investment advisers to secure certain types of investment banking, financial advisory or investment advisory work with municipal entities, such as public pension funds, 529 plans, local government investment pools and other state and local governmental entities or funds. These municipal advisors are sometimes referred as consultants, third-party marketers, placement agents, solicitors or finders.

As of October 1, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act broadened the mission of the MSRB to include regulation of municipal advisors, which are required to register with the Securities and Exchange Commission and with the MSRB. Read more about municipal advisors.

Certain Types of Municipal Securities Municipal bonds are generally used by governmental issuers for long-term financing of capital projects.

Maturity dates are typically between one and 30 years from issuance. Interest may be paid either at a

stated fixed rate, or at a variable interest rate that is determined from time to time based on a stated process or formula.

Payment of principal and interest on a municipal security may be backed by various types of pledges and forms of security. Below is a general description of some of the more common sources of security for payment of principal and interest. For detailed information about a specific bond, refer to its official statement which will typically be available on the MSRB's EMMA website.

General Obligation Bonds The term “general obligation” typically refers to a bond issued by a state or local government that is payable from general funds of the issuer, although the precise source and priority of payment for general obligation bonds may vary considerably from issuer to issuer depending on applicable state or local law.

Most general obligation bonds are said to entail the "full faith and credit" (and in many cases the taxing power) of the issuer, depending on applicable state or local law. General obligation bonds issued by local units of government often are payable from (and in some cases solely from) the issuer’s ad valorem taxes, while general obligation bonds issued by states often are payable from appropriations made by the state legislature.

Revenue Bonds “Revenue bond” is the term used generally to describe a bond that is payable from a specific source of revenue and to which the full faith and credit of an issuer with taxing power is not pledged. The issuer of a revenue bond is not obligated to pay principal and interest on its bonds using any source other than the source(s) specifically pledged to the bond. Revenue bonds are payable from identified sources of revenue and do not permit the bondholders to compel taxation or legislative appropriation of funds not pledged for payment of debt service. Pledged revenues may be derived from operation of the financed project, grants or excise or other specified non-ad-valorem taxes. Generally, no voter approval is required prior to issuance of such obligations. If the specified source(s) of revenue become inadequate, a default in payment of principal or interest may occur. Various types of pledges of revenue may be used to secure interest and principal payments on revenue bonds. The nature of these pledges may differ widely based on the type of issuer, type of revenue stream, and other factors.

Some revenue bonds are issued by governmental agencies to fund facilities for essential public services.

A bond issued by a municipal water and sewer authority, for example, typically would involve revenues obtained through local water and sewer assessments. The pledge of revenue would identify specific assessments that can be used to pay principal and interest on the bonds, the authority’s responsibility and ability (if any) to raise water and sewer assessments, and any superior claim on the assessments, for example.

Another type of revenue bond may be issued by a governmental issuer acting as conduit for the benefit of a private sector entity or a 501(c)(3) organization. In these cases, the governmental issuer is seeking to advance specific public purposes within its mission, with such conduit bonds commonly issued for not-forprofit hospitals, single and multi-family housing, airports, industrial or economic development, student loan programs, and redevelopment programs. Principal and interest on such bonds normally are paid exclusively from revenues pledged by the entity receiving financing (the obligor). Unless otherwise specified under the terms of the bonds, the issuer is not required to make payments of principal or interest if the obligor defaults.

Double-Barreled Bonds The term “double-barreled bond” is used to describe bonds secured by a defined revenue source as well as the full faith and credit of an issuer that has taxing power. It has both general obligation and revenue pledges.

Moral Obligation Bonds The term “moral obligation bond” refers to a bond, usually issued by a state or agency, that is secured by a non-binding covenant that any amount necessary to make up any deficiency in pledged revenues available for debt service will be included in the budget recommendation made to the state legislature or other legislative body, which may appropriate moneys to make up the shortfall. The legislature or other legislative body, however, is not legally obligated to make such an appropriation. Unlike a general obligation pledge, the moral obligation bond does not require voter approval and does not have the state’s official pledge of its full faith and credit.

Glossary of Municipal Securities Terms

BOND (1) The written evidence of debt, which upon presentation entitles the bondholder or owner to a fixed sum of money plus interest. The debt bears a stated rate(s) of interest or states a formula for

determining that rate and matures on a date certain. (2) For purposes of computations made on a “per bond� basis, a $1,000 increment of a security (no matter what the actual denominations are) (e.g. 10 bonds refers to a $10,000 investment). (3) Generally refers to debt securities with a maturity of greater than the short-term range.