Comments Widget

At least three firms now host trades for auction-rate securities - MuniCenter LLC, Restricted Securities Trading Network, and Hartfield, Titus & Donnelly LLC's online system. Tradeweb and BondDesk Trading, two other popular platforms, do not offer ARS on their systems.

"There are many issues involved in trying to facilitate a marketplace that is currently dysfunctional," said Tony Miscimarra, president of BondDesk Trading. "Thus far, providing [solutions] has been challenging considering some of the obstacles to creating a secondary market within an uncertain market for the future of ARS."

This is the first I have heard of MuniCenterLLC and Gartfield, Titus & Donnelly.  According to Barry Silbert of RSTN:

Since March, about 170 ARS have been listed on the platform, with about five to seven transactions occurring each day, Silbert said. He charges a 1% fee for each side and handles the entire closing and settlement agreements for the transaction.

5 to 7 transactions per day isn’t very impressive.  The list of reasons is what you would guess, but also a lot more.  First, the initial bid/ask spreads were too wide, with sellers wanting close to par.  Legal liability in disclosing information and other compliance issues is another.  But there’s more:

Chief among the issues is the bidding rights attached to the securities. These rights essentially ensure that the holder of the ARS has a right to participate in the next auction. However, since ARS were never intended to change hands, the concept of transferring the bidding rights was never considered, Silbert said.

In addition, it has proven difficult to get comprehensive information for the securities. The short-term nature of the long-term maturities of ARS makes the life of the loan difficult to determine and maximum rates are often complex calculations, making appropriate disclosure a necessity. However, trustee banks have balked at requests to disclose the information they hold for each issuer.

In a recent conference call hosted by the Securities Industry and Financial Markets Association, representatives of some of the banks said they worried about the legal liability in disclosing that information, according to a person on the call.

A third risk involves the possibility that municipal issuers may refinance outstanding auction rates. In one example, Hartfield Titus had an offering on its platform of 92 for a $20 million block of ARS from a Mississippi issuer. A couple of days after the bonds were offered on the system, the issuer refinanced them. Though the trade never went through, a seller could unnecessarily lose money if he were to sell at a discount prior to a refunding.

"It is a treacherous market for the sell side," Caldas said. "You don't want to be on that side."

The ‘bidding rights’ issue never occurred to me, although I have tried to read the fine print in the prospectuses.  Also their automated trading platforms aren’t set up to disclose rates like the higher of libor + 125bp or libor x 125%.  What’s the yield to maturity on a floating rate perpetual bond?  If you read Tyler Cowan’s blog, Marginal Revolution, he frequently runs a piece called ‘Markets in Everything.  So how can a $300 billion bond market not have an efficient market?  I guess now we know.

Final comment -- If other solutions are slow to develop, I would expect these types of secondary markets to become more efficient and the prices of vanilla CEF’s to move closer to par.