Investment Strategies and Proceeds of Municipal Securities Presenter: Maria Altomare, Managing Director PFM Asset Management, LLC

Discussion Topics The Municipal Advisor Rule –What are the key areas to understand when investing bond proceeds Bond Proceeds – How are they defined? Bond Proceeds – Risks and procedures when Investing? © 2014 PFM Asset Management LLC

The Municipal Advisor Rule – What are the key areas to understand when investing bond proceeds? © 2014 PFM Asset Management LLC 3

New MA Rule Implemented on July 1, 2014 by the Securities and Exchange Commission (SEC). The MA Rule requirements were originally developed as part of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act in order to establish a high standard of care for those who provide financial and investment advice to municipal entities. Before the 2010 Dodd-Frank Act, the activities of municipal advisors were largely unregulated and the 2008-2009 credit crisis showed that many municipal entities were engaged in complex derivative products that caused significant losses. This caused the enactment of the 2010 Dodd-Frank Act as well as the SEC’s MA Rule. The goal of the two are to protect municipal entities from unscrupulous activities. © 2014 PFM Asset Management LLC

What is a Municipal Advisor? “Municipal Advisor” defined to include a person (who is not a municipal entity or an employee of a municipal entity) who provides advice to a municipal entity or obligated person with respect to municipal financial products or the issuance of municipal securities Municipal Advisors are required to register with the SEC and the MSRB Every Municipal Advisor has a Statutory Fiduciary Duty For municipal entity clients, not obligated person clients Each Municipal Advisor is subject to MSRB rules (e.g., record-keeping, professional qualifications) MSRB G-42 as proposed would have prohibited a municipal advisor and its affiliates from doing principal trades if municipal entity or obligated person were the counterparty © 2014 PFM Asset Management LLC

Who is excluded or exempt from registering as a Municipal Advisor? Underwriter Exclusion Only applies for underwriting activities, and SEC has stated that “advice on investment strategies” is outside the scope of the underwriter exclusion Investment Adviser Exclusion – for “any investment adviser registered under the Investment Advisers Act of 1940” (RIA) Banks are exempt, if providing advice with respect to: “any investments that are held in a deposit account, savings account, certificate of deposit, or other deposit instrument issued by a bank” “any extension of credit . . . including the issuance of a letter of credit, the making of a direct loan, or the purchase of a municipal security by the bank for its own account” “any funds held in a sweep account” “any investment made by a bank acting in the capacity of an indenture trustee or similar capacity” © 2014 PFM Asset Management LLC

Who is excluded or exempt from registering as a Municipal Advisor? Independent Registered Municipal Advisor (“IRMA”) Commonly used in context of the “issuance of municipal securities” part of the municipal advisor definition Rules establish elements to qualify for IRMA exemption Independent – measured at firm and individual level Person seeking to use IRMA exemption “receives a representation in writing that it is represented by, and will rely on the advice of, an independent registered municipal advisor” RFP/RFQ Exemption for any person “providing a response in writing or orally to a request for proposals or qualifications from a municipal entity or obligated person for services in connection with a municipal financial product or the issuance of municipal securities.” © 2014 PFM Asset Management LLC

What defines “Advice”? “Advice” is generally described as a specific recommendation related to a security or financial product SEC Rules provide that “advice excludes . . . the provision of general information that does not involve a recommendation regarding municipal financial products.” Brokerage distinguished: “purchase and sale of escrow investments upon the direction of an obligated person or its financial advisor without rendering advice is merely a provision of brokerage services and does not render such person a municipal advisor.” [SEC Rule Release] © 2014 PFM Asset Management LLC

What information is NOT considered “Advice”? Examples of the General Information Exclusion from Advice… (c) information regarding a financial institution’s currently-available investments (e.g., the terms, maturities, and interest rates at which the financial institution offers these investments) or price quotes for investments available for purchase or sale in the market that meet criteria specified by a municipal entity or obligated person; (SEC FAQ page 3) © 2014 PFM Asset Management LLC

Bond Proceeds – How are they defined? © 2014 PFM Asset Management LLC

How does the SEC define bond proceeds? “monies derived by a municipal entity from the sale of municipal securities” “investment income derived from the investment or reinvestment of such monies” “monies of a municipal entity or obligated person held in funds under legal documents for the municipal securities that are reasonably expected to be used as security or a source of payment of the debt service” “investment income derived from the investment or reinvestment of monies in such funds” © 2014 PFM Asset Management LLC

When are funds considered “proceeds”? SEC did not agree that once proceeds of a municipal offering are commingled with other funds, they lose their character as proceeds But did provide that once the proceeds “are spent to carry out the authorized purposes of municipal securities, they cease to be proceeds of municipal securities.” Pension Bonds – “proceeds of pension obligation bonds lose their character as proceeds of municipal securities . . . upon their contribution to the public pension plan.” © 2014 PFM Asset Management LLC

Bond proceed tracking Municipal entitles should develop policies and procedures to help determine whether or not the advice they receive involves their bond proceeds investments This means tracking all bond proceeds going forward Establish different rules depending on whether proceeds held in existing accounts or investments are from before July 1, 2014 “unless a market participant actually knows or reasonably should have known that an existing account or existing investment contains proceeds of municipal securities, a market participant may determine that such existing accounts or existing investments do not contain proceeds of municipal securities” FAQ 11.1 © 2014 PFM Asset Management LLC

Post July 1, 2014 bond proceed tracking Municipal entities might consider segregating bond proceeds from other funds so that the other funds are not “contaminated” by the bond proceeds for purposes of aiding compliance with the MA Rule. Municipal investors may consider working with an SEC-registered investment advisor (RIA) that can provide a full range of bond proceeds investment strategies. Hiring an RIA to professionally manage bond proceeds investments essentially eliminates the municipal investor’s additional administrative responsibilities related to the MA Rule, since the responsibility of investment management shifts to the RIA. © 2014 PFM Asset Management LLC

What is an IRMA? Some broker/dealers are now requiring certification that public entities have an established Independent Registered Municipal Advisor (IRMA) There have been instances where broker/dealer refuse to further communicate with public entities until an IRMA has been designated. After certification that an entity has an IRMA, a broker/dealer is free to continue to provide the public entity with advice via unsolicited proposals. © 2014 PFM Asset Management LLC

What can a municipal entity do? Entities can choose not to sign certification, and instead state they will not rely on broker for advice Entities can choose not to sign certification, and instead state they will not rely on broker for advice as they have an RIA (however the RIA does not have a statutory safe harbor) - this relies upon the instruction to the broker not to provide direct advice Entities can choose to sign the certification, and instruct that they have an IRMA (the IRMA must have competency with bond proceed investing within scope of services) On a daily basis (or whenever seeking to trade), issue a mini-RFP by means of circulating a bid/offer sheet for brokers to respond to by providing information for entities to consider/execute Do nothing - there is no regulatory driver behind brokers not being able to do business after July 1st – the service provider’s corporate policy (compliance & legal) may still say otherwise but do not carry weight beyond their walls © 2014 PFM Asset Management LLC

What should a municipal entity do? It may depend upon the size of the entity, staffing, investment portfolio, and volume of trading Be aware that broker/deals cannot provide unsolicited proposals to public entitles unless they register as a Municipal Advisor or otherwise meet an exemption What if an entity is accustomed to taking broker ‘recommendations’ for trades? What role can a service provider play as a broker / dealer? as a registered investment adviser? © 2014 PFM Asset Management LLC

Bond Proceeds – Risks and Investing? © 2014 PFM Asset Management LLC

Understanding the risks of investing bond proceeds Credit (Safety) The risk of investing in instruments that may degrade in credit quality or default Market (Liquidity) The risk of selling an investment prior to maturity at less than book value Opportunity (yield/return) The risk of investing long-term and having interest rates rise or investing short-term and having interest rates fall and needing to reinvest the bond proceeds © 2014 PFM Asset Management LLC

How to reduce Risk of investing bond proceeds? Commitment to principles of Safety, Liquidity and Yield (in that order) Credit Risk (Safety) Understanding State Statutes for permitted investments and Developing good cash flow estimates Market Risk (Liquidity) Periodically updating those cash flow estimates to reduce credit risk Opportunity Risk (Yield/Return) Integrating knowledge of expected future market conditions with cash flow requirements to reduce opportunity risk. © 2014 PFM Asset Management LLC

Developing Policies and Procedures for Investing Bond Proceeds Ensure that you have policies and procedures for: Legal and regulatory – State Statutes, IRS, other Investment Policy – Does your school follow MSBA’s or do you have your own written investment policy? Introduction and statement of purpose Duties, responsibilities and procedures Investment objectives, constraints and guidelines Evaluation and review Ensure your objectives for various uses of bond proceeds are identified Procedures of when you will engage the use of an Investment Advisor (RIA) or Municipal Advisor (IRMA) © 2014 PFM Asset Management LLC

Considerations when Investing Bond Proceeds Official statement should include investment of bond proceeds or describes a referral to other documents that outline the parameters for investing bond proceeds Coordinate debt management and investment of bond proceeds activities with different offices or staff Be aware that different types of bond proceeds may have varied investment goals and procedures Construction fund Debt service fund Capitalized interest fund Debt service reserve Escrow fund (in case of a refunding) © 2014 PFM Asset Management LLC

Considerations when Investing Bond Proceeds Understand interactions with broker-dealers regarding the investment of bond proceeds and escrow as a result of the new MA Rule Some broker-dealers may not want to provide advice as it may subject them to a fiduciary duty Some broker-deals may clarify that they will not provide advice absent in exception from MA Rule but will show full inventory, quote prices and respond to RFP Some broker-dealers may refuse to accept accounts with bond proceeds or escrows. If the investments are longer than one year, mark to market accounting requirements should be in place and verified by auditors. © 2014 PFM Asset Management LLC

Considerations when Investing Bond Proceeds Require that Registered Investment Advisor (RIA) and Independent Registered Municipal Advisor (IRMA) report finder’s fees or fee-sharing arrangements in advance Seek a minimum of 3 competitive bids and request fee arrangements be fully disclosed If you want a broker/dealer to bid that has no fiduciary duty to your school, consider issuing an RFP and records should be kept to show: Investment issuer purchased at fair market price Bids are date stamped and arrive at the same time Minimum of 3 bids © 2014 PFM Asset Management LLC

Questions ? © 2014 PFM Asset Management LLC

Disclaimer This presentation is only intended to provide you with an overview of the Municipal Advisor Rule at this particular time. As the Rule evolves, so will the corresponding regulatory interpretation and guidance relating to the Rule. This material is based on information obtained from sources generally believed to be reliable and available to the public, however PFM Asset Management LLC (“PFMAM”) cannot guarantee the accuracy, completeness or suitability of this content. This material is for general information purposes only and is not intended to provide specific advice or a specific recommendation regarding the application of the SEC Municipal Advisor Rule. All statements as to what may happen under certain circumstances are based on assumptions, some but not all of which are noted in this presentation. Assumptions may or may not be proven correct as actual events occur, and results may depend on events outside of your or our control. Changes in assumptions may have a material effect on the outcome. Please note that the information provided herein does not constitute legal advice and you must be sure to consult your attorney regarding your institution's specific circumstances. Any investment advice in this document is provided solely by PFMAM. PFMAM is an investment advisor registered under the Investment Advisers Act of 1940. © 2014 PFM Asset Management LLC