The purpose of this policy is to provide for the integration of economic analysis into MSRB rulemaking to strengthen the effectiveness of the MSRB’s statutory rulemaking function, to meet the rule approval standards of the Securities and Exchange Commission (SEC), and to help the SEC meet its statutory obligations to consider whether its approval of an MSRB proposed rule will promote efficiency, competition and capital formation.
This policy addresses rulemaking activities of the MSRB that culminate, or are expected to culminate, in a filing of a proposed rule change with the SEC under Section 19(b) of the Securities Exchange Act of 1934 (the “Securities Exchange Act”), other than a proposed rule change that the MSRB reasonably believes would qualify for immediate effectiveness under Section 19(b)(3)(A) if filed as such or as otherwise provided under the exception process of this policy.
This policy establishes guidance that the MSRB is to follow in conducting economic analysis when engaged in the rulemaking process. Economic analysis should inform, as opposed to determine, the regulatory approach to addressing a market problem or other identified needs for rulemaking and serves as part of what the MSRB considers in its deliberations regarding a rule. Economic analysis is to be included at the earliest stage of the rulemaking process to influence the choice, design, and development of policy options before a specific regulatory course has been determined. However, economic analysis is not a substitute for the decision-making authority vested in the MSRB Board by the Securities Exchange Act.
Key Elements of Economic Analysis This guidance incorporates the principles of the SEC’s guidance on economic analysis in rulemakings dated March 16, 2012 (the “SEC Guidance”). The SEC Guidance broadly outlines best practices, while recognizing that flexibility is required in order to determine the appropriate approach for individual rulemakings. Consistent with the SEC Guidance, this policy establishes four elements of a good regulatory economic analysis:
- Identifying the need for a proposed rule and explaining how the rule will meet that need
- Articulating a baseline against which to measure the likely economic impact of the proposed rule
- Identifying and evaluating alternative regulatory approaches
- Assessing the benefits and costs, both quantitative and qualitative, of the proposed rule and the main reasonable alternative regulatory approaches
Guidance for implementing each of these elements and for integrating these elements into MSRB rulemaking is set forth below. The guidance below should be read in conjunction with the SEC Guidance in connection with applying this policy to any particular rulemaking initiative.
1. Identify the need for a proposed rule and explain how the rule will meet that need.
A starting point in the initiation of any MSRB rulemaking action should be a justification for the rule that includes a description of the intended purpose and the motivation of the proposed rulemaking. The rulemaking team should explain the problem that is being addressed, describe the policy and economic rationale for the proposed rule, and describe the anticipated consequences of the rule in addressing the problem. This description should also address how the rule would work within the existing regulatory framework, or how the rule would change that framework.
As the SEC Guidance notes, there may be more than one purpose or justification for a rule. In some instances, the justification may be that Congress has directed a rulemaking in a statute. Other justifications may include the general category of improving processes. Often, a rule may be proposed to address what is perceived to be a market failure. The SEC lists “traditional” market failures to include market power, externalities, principal-agent problems involving conflicts of interest, and asymmetric information. Other market failures may include public goods problems. In some cases, what may appear to be a market failure may instead, or alternatively, be characterized in another manner, and recognizing that alleged market failures can be characterized in different ways may lead to alternative regulatory responses. For example, characterizing an issue as a market failure may suggest the need for a proscriptive rule, but characterizing the same issue as the existence of barriers to market participants engaging in the desired activity may mean that the regulatory response is better aimed at reducing the cost of engaging in such activity or at other market-based alternatives to regulation in addressing the issue.
2. Articulate a baseline against which to measure the likely economic impact of the proposed rule.
To analyze the economic consequences of a rule, a baseline should be defined as a point of reference. The baseline reflects an assessment of the status of the markets and participants potentially affected directly or indirectly by a proposed rule (collectively, the “affected parties”) in the absence of the proposed rule being implemented. An important feature of articulating this baseline state is to identify and describe these affected parties. An economic analysis of a proposed rule compares the expected status of affected parties with the proposed rule in effect to the baseline status of such affected parties prior to the rule taking effect. The economic impact of a proposed rule is measured as the difference between these two states.
The SEC Guidance addresses the issue of selecting baselines when Congress has mandated rulemaking. While the fact that a proposal is undertaken under Congressional mandate should be a factor in the economic analysis, such mandate should not be viewed as obviating the need to adequately consider the economic consequences of the particular rule proposal intended to meet the mandate. As recommended in the SEC Guidance, rulemaking staff should include both the economic impacts attributable to Congressional mandates and those within the discretion of the MSRB as the entity charged by Congress to implement such mandates. In addition, when a proposed rule is being compared to alternative approaches, staff should consider evaluating the economic impact of the alternatives against the expected state under the proposed rule as a baseline in order to see if the alternatives are better or worse than the proposed rule in terms of addressing the problem.
3. Identify and evaluate alternative regulatory approaches.
Reasonable potential alternatives to the proposed rule should be identified and discussed. This element applies primarily to the policy formation process that is performed internally at the MSRB prior to a decision about a specific policy recommendation. This element goes hand-in-glove with the first element above on identifying the need for a proposed rule and how a proposed rule will meet that need. The SEC Guidance suggests alternative approaches could include different rule specifications, different compliance dates, or differing requirements for different market participants. The SEC Guidance recommends that the public comment process be used to solicit comments to help assess and inform the analysis of alternative regulatory approaches. The public comment process is likely to produce suggestions on alternative regulatory approaches that will then trigger the MSRB’s obligation to responsibly consider these alternatives. Only reasonable, not every conceivable, alternative need be considered.
4. Assess the benefits and costs, both quantitative and qualitative, of the proposed rule and the main reasonable alternative regulatory approaches.
It is critical that the MSRB evaluate costs and benefits in a neutral and consistent manner and transparently acknowledge any limitations in the data used to undertake the analysis. It may not be feasible to quantify many of the costs and benefits of a proposed rule or its alternatives. Nonetheless, consistent with the SEC Guidance, the relevant benefits and costs of the proposed rule and its main reasonable regulatory alternatives should be identified. In addition to benefits that correspond to the identified justifications for the rulemaking, the SEC Guidance outlines general economic benefits that may enhance economic efficiency, which should be considered, including but not limited to:
a. Reduced incentive misalignment/reduced monitoring costs
b. Lower cost of capital
c. Better information sharing which can lead to lower risk premiums and a better allocation of capital
d. Enhanced competition, which can lead to reduced prices or higher quality
e. Overcoming collective action problems
f. The avoidance of harmful transactions by reducing principal-agent problems
g. Reduced transaction costs
h. More efficient enforcement of rules
As for costs, the MSRB should consider compliance costs, direct costs, and indirect costs. Indirect costs can include:
a. The distributional and competitive effects of the rule
b. Negative collateral consequences, such as the potential misuse of newly created rights
c. A misallocation of resources resulting from regulatory arbitrage
The SEC Guidance stresses the need to attempt to quantify anticipated costs and benefits even where the available data is imperfect. In order to attempt to quantify costs and benefits, data is necessary. At an early stage in the rulemaking process, the rulemaking staff should identify data sources that would potentially assist in quantification and should attempt to obtain the necessary data. In its public comment process, the MSRB should describe the measurement approach used, include references and descriptions of data used and specify the timeframe analyzed.
If costs and benefits cannot reasonably be quantified or quantification is impracticable, an explanation of that determination should be offered. Whether or not a quantitative analysis can be provided, a qualitative analysis of the economic consequences of the proposed rule and reasonable regulatory alternatives should be provided. This qualitative analysis should be clear as to the strengths and limitations of the analysis.
In considering the economic impact of a proposed rule, academic studies may be available that can be added to the public record to help inform the process. In evaluating competing studies or evidence, MSRB rule proposals and filings should clearly state the reasons for giving greater weight to some studies over others and should explain why, with supporting evidence where applicable, a study should be discounted. It is important that the MSRB provide a neutral, consistent, and credible evaluation of competing studies.
Integration of Economic Analysis Into Rulemaking Process. Prior to the initial release to the public of a specific rulemaking proposal, whether through a request for comment or a filing with the SEC, economic analysis should be used to assist in the evaluation of potential policy options. This pre-proposal stage should include a high-level discussion of the major economic consequences resulting from the regulatory alternatives. This high-level discussion should also provide a roadmap on how a formal economic analysis will be conducted. This discussion should also identify the type of data required to evaluate the market impacts of regulatory alternatives. This high-level discussion could be provided in an “economic analysis term sheet” that would complement staff’s preliminary rulemaking description or term sheet describing the rule proposal itself. Including a high-level discussion of the requirements for economic analysis helps communicate to the entire rulemaking team the tasks, resources, and timetable necessary to conduct an appropriate economic analysis during the rulemaking process. In some cases, the MSRB may choose to publish a concept release during this pre-proposal stage to gather relevant qualitative and quantitative information from the public on the merits of undertaking rulemaking with regard to a particular issue and on potential alternative approaches to addressing the issue. Such information should be considered in staff’s preparation of the rulemaking and economic analysis term sheets.
In conjunction with the initial release to the public of a specific rulemaking proposal, whether through a request for comment or in those cases where a proposal is filed directly with the SEC without an MSRB comment period, a more substantial analysis of the rule’s likely economic consequences should be included. This analysis should capture potential tradeoffs, a comparison to alternative rule formulations, and a cost-benefit analysis that includes relevant academic or industry studies as well as any relevant empirical evidence available to the MSRB. If empirical evidence is not available to provide a quantitative analysis, a qualitative analysis should be conducted along with an explanation as to why empirical evidence is not available or useful.
The publication of a request for comment provides an opportunity for the MSRB to solicit public comment on how to improve the economic analysis of the proposed rule and to ask commentators to identify or provide empirical evidence that may inform the MSRB about the economic consequences of the rule it is considering. It is important that the questions posed to the public be carefully framed in order to prompt the most useful type of response. It is also important that the rulemaking team carefully consider economic arguments, data, or relevant studies included or cited in comment letters.
In conjunction with the adoption of a rule proposal by the MSRB and its filing with the SEC following the publication of a request for comment, the economic analysis included in the rule filing should be revised, as appropriate, to address any new information obtained during the public comment period with respect to reasonable alternatives to the rule, economic arguments about the economic effects of the proposed rule, additional relevant studies, and any new data provided or identified and obtained by the MSRB. The economic analysis drafted for the SEC rule filing should capture the analysis provided in the request for comment but should be more complete as it should also capture relevant information and arguments made during the public comment period and take into account any alterations to the proposed rule made during the rulemaking process. In addition, the MSRB may need to address any new information obtained during the public comment period for the filed proposal conducted by the SEC with respect to any additional reasonable alternatives to the rule, new economic arguments about the economic effects of the proposed rule, additional relevant studies, and any new data identified to the SEC and the MSRB by commenters.
— this policy shall not apply to any rulemaking proposal initially presented by staff to the Board prior to the beginning of the transition period, unless the Board, by vote, elects to apply this policy to such proposal, in which case the MSRB may omit actions that this policy anticipates would occur during any rulemaking stage of such proposal occurring prior to or during such transition period or undertake such actions in an alternative manner
— for any rulemaking proposal initially presented by staff to the Board during the transition period, the MSRB may omit actions that this policy anticipates would occur during any rulemaking stage of such proposal occurring during such transition period or undertake such actions in an alternative manner
By vote of the Board, a proposed rule change otherwise subject to this policy may be adopted without undertaking an economic analysis consistent with this policy so long as the Board states its reasons for not undertaking such analysis and includes in its filing with the SEC a qualitative statement of the proposed rule change’s potential burdens and benefits based on the Board’s expertise.
If the MSRB undertakes a rulemaking initiative without publishing a request for comment, the MSRB may omit the actions that this policy anticipates would be taken in conjunction with such request for comment or may incorporate such actions into other phases of the rulemaking initiative.