SEC Punts on ‘Unreasonable’ Rule That Surprised Bond Traders
(Bloomberg) -- The U.S. Securities and Exchange Commission is giving bond markets at least three more months to prepare for a rule revision that industry insiders say would upend trading for some debt securities.
The amendment to SEC Rule 15c2-1, set to go into effect on Tuesday, is intended to protect investors in over-the-counter trading markets from pump-and-dump schemes often seen with penny stocks. The change mandates that “broker-dealers, in their role as professional gatekeepers to this market, do not publish quotations for an issuer’s security when current issuer information is not publicly available.”
Previously, the rule hadn’t been applied to the trading of fixed-income securities, but the SEC didn’t exempt debt from the new regulation. After a small uproar from bond dealer industry groups, the SEC announced Friday that the rule change won’t be enforced for fixed-income securities until Jan. 3.
Broker dealers weren’t prepared to comply with the rule beginning next week anyway, and hadn’t received guidance on how to do so, according to Michael Decker, senior vice president of federal policy and research at the Bond Dealers of America, an industry group. The BDA called it “unreasonable” for the SEC to expect compliance by next week in a statement.
“We certainly welcome the three-month extension. Without it, you simply would have had a rule with no compliance,” Decker said in an interview. “Trying to squeeze fixed-income into the rule as it exists now would create a lot of problems.”
In a letter announcing the three-month non-enforcement period, SEC Commissioner Hester Peirce said that the rule revision wasn’t intended to go after bonds.
“I acknowledge that I thought of the rule’s application only in the OTC equity context,” Hester wrote in the letter dated Friday. “Nobody seems to have contemplated that this rule would affect the fixed-income markets in a way different from the pre-amendment version of the rule, much less that its requirements potentially would render unviable certain recent technological innovations in trading.”
If enforced, the rule could cause major disruptions in the trading of mortgage backed securities and junk bonds, a market where issuers are often small, private and opaque.
The BDA has joined forces with the Securities Industry and Financial Markets Association, another dealer industry group, to seek a broad-based exemption from the rule for fixed-income. The BDA’s Decker said the groups don’t expect to receive the broad-based exemption at this point. Instead, the SEC needs to create detailed guidance for dealers on how to comply and specific exemptions for situations where the rules don’t make sense, he says, something that’s likely to take longer than three months.
Investors don’t appear too concerend, for now.
John McClain, a high-yield bond portfolio manager at Brandywine, doesn’t expect the SEC to move forward with a rule that could curb bond market liquidity, something regulators and the Federal Reserve have worked hard to improve in recent years. McClain said at least one security in his portfolio could be impacted by the rule.
“Any type of ruling that would run counter to functioning bond markets wouldn’t make a lot of sense to us,” McClain said in an interview. “I don’t see regulators really having a lot of teeth behind the kind of stuff that would gum up bond market liquidity.”
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