Municipal bonds setup has many similarities to corporate bond setup, but there are subtle differences that middle- and back-office operations managers for global investment firms should be aware of.
Municipal bonds are unique because the technology in the space is often old and progresses slowly - it is not uncommon to work with muni traders that still execute orders over the phone.
These securities also have slightly different data requirements, most notably security-specific tax information and more in-depth issuer information.
Mapping fields correctly from muni-specific data providers into portfolio accounting systems and order entry systems can require significant effort up front. When working with over-the-phone traders, it is essential to verify that orders are recorded correctly.
Some of the largest trading systems available today have specific calculations created just for municipal bonds. After all, an incorrect trade calculation will create errors in the next day’s performance and reconciliation reports.
Issuer is a security field provided by most data feeds. For traditional corporate and government bonds, this field indicates which company owns the debt.
However, most data feeds can fall short when it comes to municipal bond setup because the issuer field is typically populated with the company that created the debt – not the government agency that owns the debt. Theoretically, this means a municipal bond for the State of California could have the Issuer field populated by ‘Goldman Sachs,’ the bank helped create the security.
Fortunately, most data fields have a ‘Parent Issuer’ or ‘Ultimate Issuer’ field used to indicate the hierarchy of companies that own the debt. For corporate bonds, this is used to help gain visibility in how much debt an umbrella or holding company may own across all its subsidiaries.
For municipal bonds, the ‘Parent Issuer’ or ‘Ultimate Issuer’ field will have the government entity that owns the debt obligation. It’s important to double check the Issuer field during municipal bond setup to make sure that this field is pointing at a government agency, not a bank.
Many municipal bonds issued by a state are often exempt from federal, state, and local taxes. However, individual muni bonds can have different tax exemption rules from one another, even when issued from the same government entity. Some municipal bonds may be exempt from federal tax but not state tax while others can be exempt from both.
In other words, the tax lot for each muni position needs to be handled individually within portfolio accounting systems.
Fortunately, most security-specific tax information is provided by data feeds. However, the configuring trading systems to handle this security-specific tax lot information may require additional effort.
With the recent 2018 Tax Reforms, it’s essential to realize that the most advantageous tax strategies may have changed.
Municipal bonds are most popular due to their tax breaks, a huge advantage for clients looking to reduce their tax burden.
While the variety of different municipal bonds offerings will create an opportunity for traders, it means more challenges for operations.
Make sure that your middle-and back-office teams are prepared to tackle the different tax structures and issuer-specific information for municipal bonds. Provide additional training, or create documentation around these practices for safe measure.
By ensuring these key data points are set up correctly, you will avoid reporting errors and extra hours associated with trying to fix these securities.