• MSRB proposes advisers disclose client bank loan information
  • States, cities aren't required to immediately disclose loans

Banks may not be conducting sufficient investigation and analysis of direct loans offered to state and local and governments and the application of federal securities laws to the transactions, regulators said. 

Firms aren’t conducting adequate due diligence to determine whether the instruments are municipal securities or loans and may not fully understand their role in the deals, such as whether the firm is acting as a dealer or municipal adviser, said the Municipal Securities Rulemaking Board and the Financial Industry Regulatory Authority in a Monday notice.

“The increasing use of direct purchases of municipal securities and bank loans as alternatives to publicly-offered municipal securities gives rise to a number of compliance risks for firms engaging in this activity and may erode market transparency,” the regulators said.

Direct lending by banks has proliferated in the $3.7 trillion market as states, local governments and non-profits find they can borrow at rates comparable to those on bonds, without the fees tied to public-debt offerings. In 2015, Standard & Poor’s evaluated 126 bank loans totaling $5.2 billion.

Fiduciary Duty

A private placement of municipal debt with a single purchaser, including a bank, could be a municipal-securities transaction even if described as a loan, the MSRB and FINRA said. 

FINRA has found instances of financing arrangement that firms concluded are loans even though they contained factors such as documents describing the instruments as bonds or contained language consistent with bond offerings. 

If a firm is advising a municipality, it may be subject to fiduciary duty and to Securities and Exchange Commission and MSRB rules applicable to municipal advisers, the notice said.

Last week, the MSRB proposed that advisers to state and local governments disclose information about their client’s bank loans to its publicly accessible website.

The move highlights the regulator’s concerns about the fast-growing market for bank loans to local governments. Because loans aren’t classified as securities, states and cities aren’t immediately required to disclose them, despite the risk they can pose to bondholders. The loan terms can favor banks over other investors and add to a borrower’s financial risk, credit-rating companies have said.

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