Settlement and Trading of Municipal Securities

Municipal securities follow specific rules for how trades settle, how transactions are reported, and what suitability obligations dealers owe their customers. These rules are set by the Municipal Securities Rulemaking Board (MSRB).

MSRB Rule G-12: Uniform Practice

Rule G-12 governs settlement timing and good delivery standards for municipal securities.

Settlement types:

Think of it this way: When-issued trading lets investors trade bonds that have been announced but not yet physically delivered. Since the bonds do not exist yet, there is no set settlement date. Once the bonds are delivered, the trades settle.

Good delivery requirements:

• Bonds must be in denominations of $1,000 or $5,000 (or as specified in the official statement)
• Standard municipal bond denomination is $5,000
• Registered bonds must be in multiples of $1,000 par value

Exam Tip: Gotchas

• Municipal bonds settle T+1 regular way, same as equities and corporate bonds. The exam tests whether you know munis follow the same settlement cycle as other securities.
• When-issued trades have no set settlement date. The settlement date is determined only after bonds are physically delivered.
• Cash settlement means same day, not next day. Do not confuse cash settlement with regular-way T+1.

MSRB Rule G-14: Transaction Reporting

Rule G-14 requires trade transparency through real-time reporting.

• Dealers must report municipal securities transactions to the MSRB's Real-Time Transaction Reporting System (RTRS)
• Transactions must be reported within 15 minutes of execution
• RTRS data is disseminated through the Electronic Municipal Market Access (EMMA) website for public transparency
• Applies to both dealer-to-dealer and dealer-to-customer transactions

EMMA is the MSRB's free public website where investors can access:

• Real-time trade prices
• Official statements (new issue disclosure documents)
• Continuing disclosure filings
• Credit ratings and other municipal bond data

Think of it this way: EMMA is for municipal bonds what a stock exchange's website is for equities: the place where the public can see what bonds traded at what prices. But EMMA is only for transparency. You cannot buy or sell bonds through EMMA.

Exam Tip: Gotchas

• Trade reporting to RTRS is within 15 minutes (not 10, not 30). This is a specific number the exam tests.
• EMMA is for transparency only, not trading. Investors view data on EMMA but cannot execute trades there.

MSRB Rule G-19: Suitability

Rule G-19 requires dealers to ensure recommendations are suitable for the customer. It has three components:

• Reasonable-basis suitability: The dealer must understand the risks and rewards of the municipal security being recommended. The recommendation must be suitable for at least some investors.
• Customer-specific suitability: The dealer must consider the customer's investment profile, including:
  • Financial situation and needs
  • Tax status (critical for munis)
  • Investment objectives and time horizon
  • Risk tolerance
  • Liquidity needs
• Quantitative suitability: A series of recommended transactions, even if each is suitable individually, must not be excessive when viewed together.

This aligns with FINRA's Regulation Best Interest (Reg BI) framework for broker-dealers.

Municipal-specific suitability considerations:

• A customer in a low tax bracket may not benefit from tax-exempt municipal bonds (a taxable bond might offer higher after-tax yield)
• A customer subject to the Alternative Minimum Tax (AMT) should avoid private activity bonds (the interest on those bonds is added back for AMT purposes)
• A customer needing liquidity should consider shorter maturities and higher-rated, well-known issuers (these trade more actively in the secondary market)

Think of it this way: Tax-exempt interest sounds great, but the tax exemption is only valuable if you are in a high enough bracket to benefit. A retiree in the 12% bracket gets a small tax savings from munis, while a high-income earner in the 37% bracket saves significantly. This distinction is frequently tested.

Exam Tip: Gotchas

• Suitability for munis depends heavily on the customer's tax bracket. A low-bracket investor may get a better after-tax return from a taxable bond.
• Private activity bonds and AMT are frequently tested together. If the customer is subject to AMT, private activity bond interest loses its tax exemption.
• Rule G-19 has three components, not just one. Reasonable-basis, customer-specific, and quantitative suitability all apply.