WASHINGTON, Sept 13 The federal government is
taking up proposals it first introduced six years ago to change
how it evaluates U.S. municipal bond prices and potential
A notice published by the Internal Revenue Service on Friday
with the Treasury Department said they "are concerned that
certain aspects of the existing regulations for determining the
issue price of tax-exempt bonds are no longer appropriate in
light of market developments."
Representatives from the IRS were not immediately available
Arbitrage restrictions in the U.S. municipal bond market
have existed for decades. The concern is that the proceeds of
tax-exempt bond sales, used to finance long-term infrastructure
needs, will instead be invested in higher-yielding securities
for a profit. Municipal bond issuers must make investments with
In September 2007, the federal government began updating the
restrictions. But then came a pause that spanned the financial
crisis, the meltdown of auction-rate securities and bond
insurance, and turbulence in the variable-rate market, as well
as creation of new regulations on providing greater information
on municipal bonds.
Now, the federal government is revising the proposals, with
a hearing scheduled for February.
The advent of the centralized trading and information
website known as EMMA "has led to heightened scrutiny of issue
price standards," the notice said.
"The reported data has shown, in certain instances, actual
sales to the public at prices that differed significantly from
the issue price used by the issuer," it said.
EMMA, which stands for Electronic Municipal Market Access,
is run by the Municipal Securities Rulemaking Board.
The issue price is key in determining refunding prices and
also in ensuring investments do not have overly high yields that
would lead to arbitrage.
The IRS and Treasury are proposing issuers base the issue
price on what the public paid for 25 percent of the bonds in an
offering - as opposed to the current standard of the "reasonably
expected" price for 10 percent of the bonds sold to the public.
At the same time, they would like to remove a restriction on
creating working capital reserves, saying it penalizes issuers
who may have bona fide needs for a reserve to cover expenses.
The proposals also encompass hedges that issuers use against
possible interest rate increases. Specifically, terminating a
hedge can create a profit that regulators may deem arbitrage.
"Issues have arisen in this area as a result of market
conditions during the last several years. State and local
governments have faced a number of circumstances that have put
pressure on issuers to modify or terminate their existing
qualified hedges," according to the notice.
The federal government is proposing that the amount of a
termination payment on a hedge be equal to the fair market value
of that hedge on the termination date. It is also looking into
allowing issuers to keep hedges on bonds when they refinance.
Currently, when bonds are refunded, their hedges must be
terminated. Under the proposals, the hedges could continue with
the refunding bonds.