Policy on the Use of Economic Analysis in MSRB Rulemaking

Purpose
The purpose of this Policy is to provide for the integration of economic analysis into Municipal Securities Rulemaking Board (MSRB) rulemaking to strengthen the effectiveness and efficiency of the MSRB’s statutory rulemaking function, to meet the rule change approval standards of the Securities and Exchange Commission (SEC), including that a rule change not be designed to impose any burden on competition not necessary or appropriate in furtherance of the purposes of the Securities Exchange Act of 1934 (the “Exchange Act”), and to help the SEC meet its statutory obligations to consider whether its approval of an MSRB proposed rule change will promote efficiency, competition and capital formation.

Scope
This Policy addresses rulemaking activities of the MSRB that culminate, or are expected to culminate, in a filing of a proposed rule change with the SEC under Section 19(b) of the Exchange Act, other than a proposed rule change that the MSRB reasonably believes would qualify for immediate effectiveness under Section 19(b)(3)(A) of the Exchange Act if filed as such (e.g., Board administrative filing, fee filing or facility filing) or as otherwise provided under the exception process of this Policy (see “Exceptions”). A proposed rule change for purposes of this Policy encompasses proposed MSRB rule additions, amendments and deletions. This Policy also informs the process by which the MSRB reviews its rules retrospectively.

Policy
This Policy establishes guidance that the MSRB is to follow in conducting economic analysis when engaged in the rulemaking process. Economic analysis should inform, as opposed to determine, the regulatory approach to addressing a market problem or other identified needs for rulemaking and serves as part of what the MSRB considers in its deliberations regarding a rule change. Economic analysis is to be included at the earliest stage of the rulemaking process to influence the choice, design, and development of policy options before a specific regulatory course has been determined. However, economic analysis is not a substitute for the decision-making authority vested in the MSRB Board of Directors (“Board”) by the Exchange Act.

Key Elements of Economic Analysis
This guidance incorporates the principles of the SEC’s guidance on economic analysis in rulemakings dated March 16, 2012 (the “SEC Guidance”).¹ The SEC Guidance broadly outlines best practices, while recognizing that flexibility is required in order to determine the appropriate approach for individual rulemakings. Consistent with the SEC Guidance, this Policy establishes four key elements of regulatory economic analysis:

1. Identifying the need for a proposed rule change and explaining how the rule change will meet that need.

2. Articulating a baseline against which to measure the likely economic impact of the proposed rule change.

3. Identifying and evaluating alternative regulatory approaches.

4. Assessing the benefits and costs, both quantitative and qualitative, of the proposed rule change and the main reasonable alternative regulatory approaches.

Guidance for implementing each of these elements and for integrating these elements into MSRB rulemaking is set forth below. The guidance below should be read in conjunction with the SEC Guidance in connection with applying this Policy to any applicable rulemaking initiative.

1. Identify the need for a proposed rule change and explain how the rule change will meet that need.

A starting point in the initiation of any MSRB rulemaking action should be a justification for the rule change that includes a description of the intended purpose and the motivation of the proposed rulemaking. Staff should explain the problem that is being addressed, describe the policy and economic rationale for the proposed rule change, and describe the anticipated consequences of the change in addressing the problem. This description should also address, when applicable, how the rule change would work within the existing regulatory framework or alter that framework, and how inconsistent or duplicative regulation would be avoided.

As the SEC Guidance notes, there may be more than one purpose or justification for a rule change. In some instances, the justification may be that Congress has directed a rulemaking in a statute. Other justifications may include the general category of improving processes. Often, a rule may be proposed to address what is perceived to be a market failure. The SEC lists “traditional” market failures to include market power, externalities, principal-agent problems involving conflicts of interest, and asymmetric information. Other market failures may include public goods problems. In some cases, what may appear to be a market failure may instead, or alternatively, be characterized in another manner, and recognizing that alleged market failures can be characterized in different ways may lead to alternative regulatory responses. For example, characterizing an issue as a market failure may suggest the need for a proscriptive rule, but characterizing the same issue as the existence of barriers to market participants engaging in the desired activity may mean that the regulatory response is better aimed at reducing the cost of engaging in such activity or at other market-based alternatives to regulation in addressing the issue.

2. Articulate a baseline against which to measure the likely economic impact of the proposed rule change.

To analyze the economic consequences of a rule change, a baseline should be defined as a point of reference. The baseline reflects an assessment of the status of the markets and participants potentially affected directly or indirectly by a proposed rule change (collectively, the “affected parties”) in the absence of the proposed rule change being implemented. An important feature of articulating this baseline state is to identify and describe these affected parties. An economic analysis of a proposed rule change compares the expected status of affected parties with the proposed rule change in effect to the baseline status of such affected parties prior to the rule change taking effect. The economic impact of a proposed rule change is measured as the difference between these two states.

The SEC Guidance addresses the issue of selecting baselines when Congress has mandated rulemaking. While the fact that a rule proposal is undertaken under Congressional mandate should be a factor in the economic analysis, such mandate should not be viewed as obviating the need to adequately consider the economic consequences of the particular rule change intended to meet the mandate. Consistent with the SEC Guidance, the MSRB should consider both the economic impacts attributable to Congressional mandates and those within the discretion of the MSRB as the entity charged by Congress to implement such mandates. In addition, when a proposed rule change is being compared to alternative approaches, staff should consider evaluating the economic impact of the alternatives against the expected state under the proposed rule change as a baseline in order to see if the alternatives are better or worse than the proposed rule in terms of addressing the problem.

3. Identify and evaluate alternative regulatory approaches.

Reasonable potential alternatives to the proposed rule change should be identified and discussed. This element applies primarily to the policy formation process that is performed internally at the MSRB prior to a decision about a specific recommendation for rulemaking. This element is associated with the first element above on identifying the need for a proposed rule change and how the change will meet that need. Alternative approaches could include different rule specifications, different compliance dates, differing requirements for different market participants, or the issuance of interpretive guidance that may not require a filing with the SEC under Section 19(b) of the Exchange Act. The SEC Guidance recommends that the public comment process be used to solicit comments to help assess and inform the analysis of alternative regulatory approaches. The public comment process, for example, is likely to produce suggestions on alternative regulatory approaches that will then trigger the MSRB’s obligation to reasonably consider these alternatives. Only reasonable, not every conceivable, alternatives need be considered.

4. Assess the benefits and costs, both quantitative and qualitative, of the proposed rule change and the main reasonable alternative regulatory approaches.

It is critical that the MSRB evaluate costs and benefits in a neutral and consistent manner and transparently acknowledge any limitations in the data used to undertake the analysis. It may not be feasible to quantify many of the costs and benefits of a proposed rule change or its alternatives. Nonetheless, consistent with the SEC Guidance, the relevant benefits and costs of the proposed rule change and its main reasonable regulatory alternatives should be identified. In addition to benefits that correspond to the identified justifications for the rulemaking, the SEC Guidance outlines general economic benefits that may enhance economic efficiency, including but not limited to:

a. reduced incentive misalignment or reduced monitoring costs;

b. lower cost of capital;

c. better information sharing which can lead to lower risk premiums and a better allocation of capital;

d. enhanced competition, which can lead to reduced prices or higher quality;

e. overcoming collective action problems;

f. the avoidance of harmful transactions by reducing principal-agent problems;

g. reduced transaction costs; and

h. more efficient enforcement of rules.

As for costs, the MSRB should consider compliance costs, direct costs and indirect costs. Indirect costs can include:

a. the distributional and competitive effects of the rule change,

b. negative collateral consequences, such as the potential misuse of newly created rights; and

c. a misallocation of resources resulting from regulatory arbitrage.

The SEC Guidance stresses the need to attempt to quantify anticipated costs and benefits even where the available data are imperfect. In order to attempt to quantify costs and benefits, data are necessary. At an early stage in the rulemaking process, staff should identify data sources that would potentially assist in quantification and should attempt to obtain the necessary data. When quantifying costs and benefits, the MSRB should describe the measurement approach used, include references and descriptions of data used and specify the timeframe analyzed. The MSRB should generally ask for relevant data as well as academic and industry research literature from the public during the request-for-comment process, including the instances where data cannot otherwise be obtained by the MSRB. If costs and benefits cannot reasonably be quantified or quantification is impracticable, an explanation of that determination should be offered. Whether or not a quantitative analysis can be provided, a qualitative analysis of the economic consequences of the proposed rule change and main reasonable regulatory alternatives should be provided. This qualitative analysis should be clear as to the strengths and limitations of the analysis.

In considering the economic impact of a proposed rule change, academic and industry studies may be available that can be added to the public record to help inform the process. In evaluating competing studies or evidence, MSRB rulemaking proposals and filings should clearly state the reasons for giving greater weight to some studies over others and should explain why, with supporting evidence where applicable, a study should be discounted. It is important that the MSRB provide a neutral, consistent and credible evaluation of competing studies.

Integration of Economic Analysis into the Rulemaking Process
Prior to the initial release to the public of a specific rulemaking proposal, whether through a request for comment or a filing with the SEC, economic analysis may be used to assist the Board in the evaluation of potential policy options. This pre-proposal stage may include a high-level discussion of the major economic consequences resulting from the regulatory alternatives. This high-level discussion may also provide a roadmap on how a formal economic analysis will be conducted. This discussion may also identify the types of data required to evaluate the market impacts of regulatory alternatives. Including a high-level discussion of the requirements for economic analysis helps communicate to staff the tasks, resources, and timetable necessary to conduct an appropriate economic analysis during the rulemaking process. In some cases, the MSRB may choose to publish a concept release or a request for comment without a specific rulemaking proposal during this concept proposal stage to gather relevant qualitative and quantitative information from the public on the merits of undertaking rulemaking with regard to a particular issue and on potential alternative approaches to addressing the issue. Such information should be considered in staff’s preparation of the rulemaking and economic analysis activities.

In conjunction with the filing of a proposed rule change with the SEC following the publication of a request for comment, the economic analysis included in the SEC filing should be revised, as appropriate, to address any new information obtained during the public comment period with respect to reasonable alternatives to the rule, economic arguments about the economic effects of the proposed rule, additional relevant studies, and any new data provided or identified and obtained by the MSRB. The economic analysis drafted for the SEC filing should capture the analysis provided in the request for comment but may need to be more complete as it should also capture relevant economic information and arguments made during the public comment period and take into account any alterations to the proposed rule change. In addition, the MSRB may need to address any new information obtained during the public comment period conducted by the SEC for the filed proposal with respect to any additional reasonable alternatives to the proposed rule change, new economic arguments about the economic effects of the change, additional relevant studies, and any new data identified to the SEC and the MSRB by commenters.

The publication of a request for comment provides an opportunity for the MSRB to solicit public comment on how to improve the economic analysis of the proposed rule change and to ask commenters to identify or provide empirical evidence that may inform the MSRB about the economic consequences of the rule change it is considering. It is important that the questions posed to the public be carefully framed in order to prompt the most useful type of response. It is also important that the staff carefully consider economic arguments, data or relevant studies included or cited in comment letters.

Roles and Responsibilities

Chief Executive Officer and President
- Policy owner responsible for overseeing work of the Chief Regulatory Officer and Chief Economist or economic consultant

Chief Economist or economic consultant
- Undertake or direct all data gathering, literature review and economic analysis activities
- In coordination with the Chief Regulatory Officer, prepare the economic analysis portions of rule proposals and SEC filings

Chief Regulatory Officer
- In coordination with the Chief Economist or economic consultant, prepare the preliminary rulemaking description
- Prepare rule proposals and SEC filings

Board of Directors
- Evaluate and comment on economic analysis undertaken by the Chief Economist or economic consultant

Exceptions

By vote of the Board, a proposed rule change otherwise subject to this Policy may be adopted without undertaking an economic analysis consistent with this Policy so long as the Board states its reasons for not undertaking such analysis and includes in its filing with the SEC a qualitative statement of the proposed rule change’s potential burdens and benefits based on the Board’s expertise.
If the MSRB undertakes a rulemaking initiative without publishing a request for comment, the MSRB may omit the actions that this Policy anticipates would be taken in conjunction with such request for comment or may incorporate such actions into other phases of the rulemaking initiative.
Although proposed rule changes that are filed for immediate effectiveness are not subject to this Policy, they will include the required discussion of the burden on competition. Such proposed rule changes may also include any additional economic analysis that the MSRB believes may inform the rulemaking process based on the facts and circumstances. A proposed fee change, for example, may include analysis of the potential effects across firms of different sizes or other demographic characteristics.