MSRB NOTICE 2006-10 (APRIL 21, 2006)

REQUEST FOR COMMENT ON DRAFT PROCEDURES FOR REPORTING SPECIAL CONDITION INDICATORS ON CERTAIN NEW ISSUE TRANSACTIONS

The MSRB is requesting comment on proposed revisions to the transaction reporting procedures used by brokers, dealers and municipal securities dealers ("dealers") on the first day of trading in a new issue.  The proposed revisions would: (i) create a new special condition indicator for certain transactions that are based on pricing commitments made prior to the formal award of a new issue (the "Conditional Trading Commitment" indicator); and (ii) expand usage of the existing special condition indicator for list offering price transactions to include certain inter-dealer "takedown" transactions (the "List Offering Price/Takedown" indicator).  Use of both indicators would be mandatory.  The proposed indicators would be included on transaction reports disseminated by the Real-Time Transaction Reporting System ("RTRS") to improve the price transparency provided by the system.[1] 

The proposed revisions to transaction reporting procedures are described below and include draft amendments to Rule G-14 RTRS Procedures and draft technical specifications.  Comments on this notice should be submitted to the MSRB by June 5, 2006.

BACKGROUND

RTRS serves the dual objectives of price transparency and market surveillance.[2]  Because a comprehensive database of transactions is needed for the surveillance function of the system, MSRB Rule G-14, with minor exceptions, requires dealers to report all of their purchase-sale transactions to RTRS.  All reported transactions are entered into the RTRS surveillance database used by market regulators.  Not all of these reported transactions, however, are equally useful for price transparency.  To address this problem, RTRS was designed so that a dealer can code a specific transaction report to designate the transaction as being subject to a special pricing condition.  Upon receiving a transaction report with one of these special condition indicators, RTRS is programmed to take one of two actions.  Depending on the special condition that is indicated, RTRS either can suppress dissemination of the transparency report to prevent the publication of a misleading price or it can disseminate the transparency report with the indicator, allowing the users of transparency information to see the price as well as the special condition that applied.  The special condition indicators proposed in this notice would follow the second policy, making it possible for transparency users to distinguish primary market transactions and transactions based on pre-award pricing commitments from transactions reflecting the current secondary market activity for a new issue.

Dealers identify transactions that are subject to special pricing conditions by using the "special condition indicator" field in their RTRS transaction reports.[3]  The RTRS Users Manual and Specifications for Real-Time Reporting of Municipal Securities Transactions currently contain instructions on the use of the special condition indicator field and describe several situations in which it is used to identify unusual conditions affecting the price of a specific transaction.[4]  This notice includes a discussion of the procedural and technical requirements for the proposed Conditional Trading Commitment and List Offering Price/Takedown indicators.  Comment is requested on these specific requirements as well as any general improvements that could be made in technical specifications or other procedural aspects relating to the use of special condition indicators.[5]    

NEW SPECIAL CONDITION INDICATOR FOR CTC TRANSACTIONS

A new indicator is proposed for transactions that are priced prior to the formal award of a new issue, but executed after the formal award ("Conditional Trading Commitment" or "CTC" transactions).  Under MSRB rules, a transaction in a new issue cannot be executed, confirmed or reported prior to the formal award of the issue.[6]  Rule G-34 defines "Time of Formal Award" to be, for competitive underwritings, the time that the issuer announces the award and, for negotiated underwritings, the time the contract to purchase the securities from the issuer is executed.[7]  Although trade executions in a new issue are not allowed prior to the Time of Formal Award, it is permissible under MSRB rules for dealers to accept firm orders prior to that time. Dealers generally begin accepting such orders after the pricing for the issue is announced, which sometimes precedes the Time of Formal Award by a day or more.  A dealer’s commitment to execute such a pre-award order customarily is conditioned upon the formal award occurring without material changes in the proposed securities, pricing or estimated quantities.  These pre-award "conditional trading commitments" are executed after the Time of Formal Award, on the first day of trading for a new issue.[8]  Transaction reports to RTRS are made only after transactions are formally executed and include the time of execution.

Underwriters usually begin to make conditional trading commitments immediately after the pricing of a new issue and parties receiving conditional allocations from underwriters sometimes make their own conditional trading commitments starting at this time.  Since this process may continue for a day or more before the formal award occurs, CTC transaction prices frequently can be "stale" when they are executed and reported.  Commentators have noted that mixing stale CTC transactions with current market transactions can create unexplained anomalies in RTRS price data.[9]  The MSRB believes that the requirement to identify CTC transactions with a "CTC indicator" will reduce this problem by allowing transparency users to distinguish potentially stale CTC transactions from current secondary market transactions that are being reported with similar times of trade.

Technical Requirements for Using the CTC Indicator

The draft revisions to Specifications for Real-Time Reporting of Municipal Securities Transactions (the "draft Specifications") show the values that are used in the special condition indicator field to indicate a CTC transaction.  A CTC transaction would be defined in the RTRS Users Manual as "any transaction that is executed based upon a priced trading commitment made prior to the Time of Formal Award for a new issue."  All dealers, including dealers outside the underwriting group, would report their CTC transactions with customers using the CTC transaction indicator.  For inter-dealer transactions, the dealer on the sell side of the transaction would be responsible for using the indicator.  Other transaction reporting requirements would not change as a result of use of the CTC indicator.  For example, CTC transactions would continue to include the time of trade execution (after the formal award) rather than the time the CTC is made[10] and the 15-minute deadline would continue to apply to a CTC transaction unless the transaction qualifies for an exception to the deadline.[11] 

REVISED PROCEDURES FOR REPORTING "LIST OFFERING PRICE/TAKEDOWN TRANSACTIONS"

Under existing transaction reporting procedures, the List Offering Price indicator may be included on reports of primary market transactions that are effected by syndicate managers, syndicate members and selling group members at the List Offering Price on the first day of trading in a new issue.  The "List Offering Price" is defined as the publicly announced initial offering price at which a new issue of municipal securities is to be offered to the public.[12]  Today, the indicator primarily is used by dealers to claim an end-of-day reporting deadline.[13]  The MSRB provided the end-of-day deadline for these transactions because of the substantial operational difficulties underwriters would face in reporting large numbers of List Offering Price transactions within a 15-minute window after the formal award. The MSRB also concluded that real-time dissemination of large numbers of primary market transactions occurring at the same price would not offer a great benefit to RTRS transparency objectives.[14] 

For purposes of RTRS transaction reporting, a "Takedown" transaction is defined as a primary market sale transaction by a sole underwriter or syndicate manager with a syndicate or selling group member at a discount from the published list offering price. In a 2004 Notice, MSRB stated that Takedown transactions should not be submitted using the List Offering Price indicator.[15]  As experience with real-time transaction reporting has increased, however, industry members have pointed out that Takedown transactions share many of the same characteristics as the List Offering Price transactions.  A high volume of Takedown transactions on the first day of trading in a new issue, for example, often presents operational difficulties for underwriters attempting to report all of their takedown transactions within a 15-minute window.  It also has been noted that prices for both Takedown transactions and List Offering Price transactions are set under an offering price agreement for the new issue.

The proposed revisions to RTRS recognize the similarities between List Offering Price and Takedown transactions and the dissimilarities between these transactions and secondary market transactions in a new issue.  Since the secondary market transactions in a new issue are likely to provide the best gauge of the current market value for a new issue and may be reported at the same time as List Offering Price and Takedown transactions, the MSRB believes that transparency reports on the first day of trading for a new issue would be more useful if List Offering Price and Takedown transactions were identified with a special pricing condition indicator.  The proposed revisions to RTRS accordingly would require dealers to use a "List Offering Price/Takedown" ("LOP/TD") indicator when reporting these transactions on the first day of trading.[16]  

Technical Requirements for Using the LOP/TD Indicator

The new LOP/TD indicator would be used by dealers when reporting any primary market sale transaction executed on the first day of trading of a new issue:

•       by a sole underwriter, syndicate manager, syndicate member or selling group member at the published list offering price for the security ("List Offering Price Transaction"); or

•        by a sole underwriter or syndicate manager to a syndicate or selling group member at a discount from the published list offering price for the security ("RTRS Takedown Transaction").

LOP/TD transactions would be designated with the same special condition indicator now used for List Offering Price transactions.  The requirements for use of the LOP/TD indicator generally would be the same as those for the existing List Offering Price indicator, including the definition of “List Offering Price” and the availability of the end-of-day reporting deadline

Use of the CTC indicator and the LOP/TD indicator would be independent of each other.  This means that it will be possible for transactions to be designated both CTC and LOP/TD, CTC-only, or LOP/TD-only, depending upon the actual circumstances of the transaction.

The technical requirements for both the new CTC indicator and the LOP/TD indicator are summarized in the draft Specifications.  Click here to access the draft Specifications

REQUEST FOR COMMENT

Comment is requested on the proposed revisions to transaction reporting procedures and, in general, on the use of the special condition indicator field.  The following questions may be helpful to commentators and would assist the MSRB in considering its action on the proposal.

• Use of the CTC indicator will require dealers to identify transactions in which a conditional trading commitment is formed prior to the Time of Formal Award. Do syndicate/trading systems currently capture both the time that new issue trading commitments are made and the Time of Formal Award?  If so, do those systems pass this information through to the processing systems used for trade reporting?

• Under Rule G-34(a)(2)(c), underwriters currently are required to disseminate Time of Formal Award so that dealers with pending orders in a new issue will know when trade executions can begin.  Is current dissemination of this information adequate to comply with the proposed requirements to identify CTC transactions?

• For competitive underwritings, Rule G-34 defines the Time of Formal Award as the time the issuer official announces the award of a new issue.  This "announcement of the award" means an official announcement confirming the award and including offering prices, coupons and quantities for each security.  Is this definition workable for identifying conditional trading commitments in competitive underwritings?

• In some underwritings, the formal award is made relatively quickly after the pricing of the issue, minimizing the opportunity for the prices reported after the formal award to be "stale"; based on their time of execution.  Should these situations be addressed differently than those where there is opportunity for a significant delay between the time a conditional trading commitment is made and the time the trade is executed?

• The proposal in this notice limits the use of the CTC and LOP/TD indicators to transactions on the "first day of trading"; in a new issue.  The first day of trading is assumed to be the day of the formal award unless the formal award occurs after business hours or so late in the day that the underwriter cannot execute and process its pending transactions.  It is further assumed that, in those latter instances, the underwriter notifies the industry of the time its initial trade executions will begin. Is this assumption accurate?  Is there need for specific rules stating uniform practices for setting the "first day of trading" and disseminating that information?

• The MSRB believes that a period of six months following the publication of final Specifications should be adequate for dealer programming and implementation of the proposal in this notice.  Are there major technical or operational challenges to implementation of the proposal that have not been addressed above and that would require a longer lead time?

• The MSRB has received comment from some transparency users suggesting that a further improvement to transparency could be achieved by adopting procedures requiring dealers to include the time that the CTC is made on trade reports.  This could be done either as an additional field on the trade report or as a substitute for the current “time of trade” (time of execution).  Would the costs and timing for implementation of such a proposal be different than those for the proposal contained in this Notice?

Questions and comments about this notice may be directed to Jay Jackson, Uniform Practice Assistant, or Justin Pica, Uniform Practice Specialist. 

April 21, 2006

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Text of Draft Amendment[17]

Rule G-14. Reports of Sales or Purchases

(a) - (b) No change.

Rule G-14 RTRS Procedures

(a) General Procedures.

(i) No change.

(ii) Transactions effected with a Time of Trade during the hours of the RTRS Business Day shall be reported within 15 minutes of Time of Trade to an RTRS Portal except in the following situations:

(A) A "List Offering Price/Takedown Transaction," as defined in paragraph (d)(vii) of Rule G-14 RTRS Procedures, shall be reported by the end of the day on which the trade is executed. Syndicate managers, syndicate members and selling group members that effect trades in new issues on the first day of trading at the list offering price shall report such trades by the end of the day on which the trades were executed.

(B) A dealer effecting trades in short-term instruments under nine months in effective maturity, including variable rate instruments, auction rate products, and commercial paper shall report such trades by the end of the RTRS Business Day on which the trades were executed.

(C) A dealer shall report a trade within three hours of the Time of Trade if all the following conditions apply:  (1) the CUSIP number and indicative data of the issue traded are not in the securities master file used by the dealer to process trades for confirmations, clearance and settlement; (2) the dealer has not traded the issue in the previous year; and (3) the dealer is not a syndicate manager or syndicate member for the issue.  If fewer than three hours of the RTRS Business Day remain after the Time of Trade, the trade shall be reported no later than 15 minutes after the beginning of the next RTRS Business Day.  This provision (C) will cease to be effective on December 31, 2007 for when, as and if issued transactions and December 29, 2006 for all other transactions.

(iii) - (vi) No change.

(b) Reporting Requirements for Specific Types of Transactions.

(i) - (iii) No change.

(iv) Transactions with Special Conditions.  Reports of transactions affected by the special conditions described in Section 4.3.2 of the Specifications for Real-Time Reporting of Municipal Securities Transactions shall be reported with the “special condition indicators” shown and in the manner specified. Special condition indicators designated as "optional" in these Specifications are required for the Submitter to obtain an extended reporting deadline under paragraphs (a)(ii)(B)-(C) of Rule G-14 RTRS Procedures, but may be omitted if a deadline extension is not claimed.

(c) No Change.

(d) Definitions.

(i) - (vi) No change.

(vii) "List Offering Price/Takedown Transaction" means a primary market sale transaction executed on the first day of trading of a new issue:

(A) by a sole underwriter, syndicate manager, syndicate member or selling group member at the published list offering price for the security ("List Offering Price Transaction"); or

(B) by a sole underwriter or syndicate manager to a syndicate or selling group member at a discount from the published list offering price for the security "RTRS Takedown Transaction").



[1] The documentation for RTRS transparency reports would explain the special condition codes and their significance for users of the transparency reports.

[2] The purposes of real-time transaction reporting and RTRS are described in "Request for Comment: Plan for Real-Time Transaction Reporting," MSRB Notice 2003-23 (June 13, 2003).

[3] See Specifications for Real-Time Reporting of Municipal Securities Transactions, Section 4.3.2 and Appendix B.2.  In Version 1.0 of the Specifications, the special condition indicator field was called the "special price reason code." It has since been renamed the "special condition indicator."

[4] The RTRS Users Manual and Specifications for Real-Time Reporting of Municipal Securities Transactions are available on-line at www.msrb.org.  A summary of existing special condition indicators is included in "Rule G-14 Real-Time Transaction Reporting Update," MSRB Notice 2005-43 (August 17, 2005).  As noted therein, some special condition indicators are used exclusively by dealers to note that a trade qualifies for an exception to the 15-minute reporting deadline (e.g., the Short-Term Instrument Exception and the Three-Hour Exception).  Those indicators do not affect the content of the disseminated trade report. 

[5] The MSRB previously has noted that additional special condition indicators may be required as additional experience is gained with real-time transaction reporting.  See, e.g., "Rule G-14 Real-Time Transaction Reporting Update," MSRB Notice 2005-43 (August 17, 2005) (discussing the possibility of adding a special condition indicator for conditional trading commitment transactions).

[6] See "Confirmation: Mailing of WAII Confirmation," MSRB Rule G-12 Interpretive Letter (April 30, 1982), paragraph 3556.55 MSRB Manual.  Implications for transaction reporting were discussed, among other places, in "Notice Requesting Comment on Draft Amendments to Rule G-34 to Facilitate Real-Time Transaction Reporting and Explaining Time of Trade for Reporting New Issue Trades," MSRB Notice 2004-18 (June 18, 2004).

[7] MSRB Rule G-34 (a)(ii)(C)(2).

[8] The first official day of trading in a new issue typically is the day of the formal award, although it may be delayed to the next day by underwriters in certain circumstances.  This notice includes a request for comment on whether a more formal structure is needed with respect to determining the first official day of trading in a new issue.

[9] See Letter to Jonathan G. Katz, Secretary, Commission, from Leslie M. Norwood, Vice President and Assistant General Counsel, The Bond Market Association (July 20, 2004).  It may be noted that many CTC transactions are effected at list offering prices and are reported only at the end of the first day of trading in the issue.  All transaction reports, however, including end-of-day reports, must include an accurate time of trade execution.  Thus, anomalies continue to exist when comparing transactions with similar execution times. In addition, some CTC transactions are not list offering price transactions and are required to be reported within 15 minutes of execution. Without a CTC indicator, these transactions reports are indistinguishable from reports of transactions occurring in the current secondary market.

[10] The final section of this notice requests comment on technical issues that would have to be addressed in order for dealers to report the time that a conditional trading commitment is made in addition to, or in place of, reporting the time of trade execution.

[11] Under current RTRS requirements, a special condition indicator must be used to claim one of the extended reporting deadlines.  Note that the Three-Hour Exception will expire on December 31, 2007 for when, as and if issued transactions, and December 29, 2006 for all other transactions.  "SEC Approves Proposed Rule Change to MSRB Rule G-14 RTRS Procedures, Paragraph (a)(i)(C) to Extend the Expiration Date of the Three-Hour Exception," MSRB Notice 2005-62 (December 22, 2005).

[12] If the price is not publicly disseminated (e.g., if the security is a "not reoffered" maturity within a serial issue), the price is not a List Offering Price.  See "Reminder Notice on List Offering Price and Three-hour Exception for Real-Time Transaction Reporting: Rule G-14," MSRB Notice 2004-40 (December 10, 2004).

[13] Rule G-14(a)(ii)(A) RTRS Procedures. 

[14] See discussion in "Real-time Transactions Reporting: Revised Schedule and Operational Plan," MSRB Notice 2003-44 (December 11, 2003).

[15] "Reminder Notice on List Offering Price and Three-hour Exception for Real-Time Transaction Reporting: Rule G-14," MSRB Notice 2004-40 (December 10, 2004).

[16] Although most dealers already use the existing List Offering Price indicator to claim the end-of-day reporting deadline, the use of the indicator is optional and is not used by some dealers. RTRS currently disseminates the indicator in its transparency reports; however, most re-distributors of the data do not include the indicator because it is optional or is viewed primarily as the mechanism by which dealers obtain an extended reporting deadline.  If the indicator is made mandatory and extended to takedown transactions, it would suggest the need for all vendors to re-disseminate the indicator. 

[17] Underlining indicates additions; strikethroughs indicate deletions.