Updated: Oct 2, 2018
September 30, 2018
The "stodgy" municipal market is on the verge of a Big Data revolution, driven by rising support for adoption of iXBRL, a machine-readable financial reporting standard, and an increasing need for ESG-related data.
Back when I was running a tax-exempt high yield fund for a major mutual fund complex in Boston, quite a few years ago, a key point we always used to make in our fund marketing pitches is the fact that, as an institutional investor, we had access to credit information that was not normally made available to the individual investor. Issuers and investment bankers also subscribed to this premise, as they routinely scheduled private meetings with large institutional investors, with no intent to make the content of such meetings public.
Obviously, the markets have come a long way since, and it's hard to imagine anyone making the same ciaim in this day and age regarding non-public access to information. With calls for "transparency" pervading every aspect of our society and culture, it's certainly no longer acceptable in modern capital markets to compete on the basis of privileged access to information. In fact, from a regulatory standpoint, such an approach would actually be deemed illegal in most cases. Investors are always welcome to try to generate excess returns on the basis of their perceptive analysis of all available data, of course, but certainly not on the basis of access to material non-public information.
Which brings us to the municipal market, long an object of derision for its perceived disclosure inadequacies, as compared to other asset classes. While socio-economic datasets are freely available from public sources such as the US Census and the Bureau of Labor Statistics, financial audit data has remained wildly inconsistent in quality and difficult to access.
We've all heard the familiar reasons for this apparent disclosure deficiency. First and foremost, this is a fragmented, bespoke market with over 30,000 distinct "obligors" and millions of separate cusips, due primarily to the serial structure of most tax-exempt bond issues and to a multiplicity of security pledges. Secondly, there is no regulatory body, including the Municipal Securities Rulemaking Board or "MSRB" (the industry's own self-regulatory agency), that can directly compel issuers to adopt standardized disclosure practices, all thanks to the so-called Tower Amendment. The result: a hodge podge of disclosure practices, depending on the size of the bond issuer and the frequency of their market access, with the best financial reporting coming only from the very largest state and local entities and quasi-corporate entities such as health care and higher education institutions.
Over the years, market participants have certainly made great progress in trying to to overcome this disclosure hurdle. Industry professional groups such as the National Federation of Municipal Analysts ("NFMA") have been quite successful in forcing major issuers to improve their disclosure practices through "best practices" papers and other lobbying efforts. The MSRB, despite its lack of authority over the issuers themselves, has also tried to improve disclosure standards by going after the only constituency they hold sway over, the broker-dealer community, and holding this group responsible for its clients' disclosure commitments. The creation of the EMMA site itself constituted a major leap forward for municipal disclosure.
While industry players have historically focused on content, i.e. what should be disclosed, in their quest for better disclosure, the delivery mechanism, i.e. how the information should be disclosed, has become an increasing source of frustration for potential data users. Municipal Comprehensive Annual Financial Reports ("CAFRs") continue to be released solely in hard copy and PDF format, forcing all users of such information to spend valuable time and efforts to transfer such information into Excel spreadsheets and other more database-friendly format before they can perform any kind of meaningful analysis. At a recent Volcker Alliance conference on state and local budgets, one of the panelists, a public policy researcher from academia, exclaimed:
" Oh, we just hate these PDF reports!"
This PDF reporting problem has spawned a cottage industry of vendors who see a market opportunity in taking what should be free public sector information and re-distributing it through a more user-friendly interface. Whatever value-added these vendors bring to the table comes about precisely because of the antiquated way the financial data is being reported.
Be that as it may, access to machine-readable financial data for municipal issuers is now concentrated in the hands of two major proprietary fixed-income platforms: one is the Bloomberg Data services, available exclusively through the ubiquitous Bloomberg Terminal; the other is Merritt Data's Creditscope service, available exclusively through portfolio management software vendor Investortools.
Although each of these databases has contributed greatly to improving the industry's credit research process, the relatively high cost of the data licenses effectively limits the potential audience to only the largest institutional investors, leaving a large swath of independent wealth managers, registered investment advisors, academic researchers and public officials without an affordable and non-proprietary source of financial data for their investment and public policy research needs.
This less-than-desirable state of affairs may be about to change. After a few false starts since the financial crisis, there is movement afoot and increasing support from regulators and public officials to encourage state and local governmental entities to report their financials in the machine-readable format called "iXBRL" ("Inline Extensible Business Reporting Language"). This format, already mandated by the SEC for corporate 10-k and 10-Q filings, is expected to facilitate the creation of low cost financial databases for the public finance sector. For details about the current status of this initiative, we refer the reader to a recent article written by our friend Marc Joffe from the Reason Foundation. Marc has long been an ardent advocate of municipal transparency and currently acts as the chair of the new XBRL.US working group, which is hard at work designing the taxonomy for a municipal iXBRL reporting, due to be completed in 2019. The State of Florida, for one, has already signed on to this new reporting format.
Bear in mind we're talking about the municipal market here, so even under the best of circumstances, full adoption of iXBRL, whenever it occurs, will still be at least 5 years away, in our opinion. Nonetheless, it is fair to say the sector is finally moving in the right direction.
The key to securing support from public officials has to go beyond the lofty ideals of bringing transparency to the sector. At the end of the day, this process has to make it easier, and hopefully less costly, for the town clerk in Middle City, USA to do what she has been doing for the last 30 years. It remains to be seen if the reporting software vendor community, which is driving this iXBRL effort, can deliver such a cost-effective reporting platform.
Ironically, we do expect that both Bloomberg and Creditscope will eventually embrace the adoption of iXBRL, instead of viewing as a threat to their business model, for the simple reason that the new reporting format, when adopted, should dramatically reduce their data acquisition costs. Scraping and parsing financial data for up to 30,000 bond issuers is a tremendously expensive proposition, particularly if much of it is still being performed by humans, with some help from technology. Since issuers are unlikely to go back and restate past CAFRs in the new format, the historical data already gathered by both vendors should remain quite valuable, at least for a while.
The municipal market's future data needs will also extend beyond balance sheets and income statements. For instance, there is increasing recognition that climate change impact should be incorporated into any credit analysis framework. Whether or not whole stretches of the Southern Florida coastline will end up under sea level over the next 10 years is as critical a credit risk factor as the condition of the City of Miami's balance sheet. The trick is how to turn this potential environmental threat into a quantifiable risk measure.
In fact, as the municipal market re-asserts its role as the social impact asset class of choice, the need to gather objective data on the so-called ESG factors (as in "Environment, Society & Governance") will only accelerate. Here's an unpopular opinion: despite all the hype from investment bankers, the so-called "Green Bonds" have been something of a dud from the issuers' standpoint, in the sense that they entail more compliance efforts without resulting in significant interest cost savings. The problem, of course, is measurement. The market cannot price what cannot be measured, and how to measure "social impact" will undoubtedly require better, more objective data.
The greater impact of Big Data lies less in the data itself but, rather, in what you can do with it. Off the top of our head, we can think of a few important applications for this potentially improved data flow: (1) semi-automated, algorithmic trading models, particularly for odd lot, retail blocks; (2) credit scoring models, something which we have been very closely associated with; and (3) relative value trading models, when coupled with relevant trade data. And we haven't even mentioned such buzzwords as "Machine Learning" or "Artificial Intelligence"!
"Data is the new oil", as the current popular saying goes. How to capitalize on this newly accessible data will obviously be the next challenge facing all stakeholders in public finance, from state and local officials to software vendors to municipal bond investors. There is no doubt in our mind that a fully transparent municipal market will finally open the floodgate (well, at least the door) to all sorts of advances in credit analytics, public policy research and risk management. This alone should make public finance one of the few remaining pockets of Big Data opportunities across the entire fixed-income landscape.