While fintech start-ups are disrupting many financial markets, the US municipal bond market has been largely left behind. As a result, the $3.9-trillion muni market remains largely inefficient, replete with frictions that reduce investor returns and raise costs for issuers. Higher costs for municipal bond issuers translate into a combination of higher taxes and reduced services, so minimizing issuance costs and constraining coupon rates is a matter of public interest, and should attract support throughout the political spectrum.
A 2011 Brookings study estimated that market illiquidity adds 1.12% to municipal bond yields, implying over $40 billion of extra interest costs annually. In a recent UC Berkeley study, I estimated that annual municipal bond issuance costs are upwards of $4 billion. Technology solutions that can take a significant bite out of these costs would add considerable value.
But the stodgy municipal market is resistant to disruptive technologies. Because municipal bonds primarily attract older investors focused on capital preservation and tax-exempt income, the market is largely off the radar screens of millennial founders and Gen-X angels. Two start-ups that have had some traction are Neighborly – which is pioneering small denomination bond issues and the application of blockchain – and 280 CapMarkets – which offers a workstation to screen, evaluate and trade municipal bonds. But for most issuers and investors, market processes remain little changed from previous decades.
A major challenge is a lack of technology standards. Consider, for example, issuer financial reporting. In the corporate world, security issuers have provided their financial statements to EDGAR in text form (with a limited number of HTML-style tags) since the 1990s. In 2008, the SEC began requiring corporate 10-K and 10-Q filers to use eXtensible Business Reporting Language (XBRL), which is based on eXtensible Markup Language (XML). As a result, corporate financial reports are now provided in a standardized, self-documenting, machine-readable format. By contrast, all financial disclosures appearing on the Municipal Securities Rulemaking Board’s EMMA website are in PDF format.
As a result, it is more expensive for data aggregators to compile data sets of municipal financial statistics. Since compiling this data is costlier, it is less widely available. While standardized company financial results are freely available at numerous websites, the same isn’t true for city and county fiscal data.
Municipal finance data sets, potentially combined with socioeconomic data from the US Census, could be used by fintech firms to automatically score municipal bond issuers. Such scores would be a less expensive alternative to credit ratings, which are only available for a fraction of municipal issuers. While automated credit scores for individuals are commonplace and corporate risk scores are readily available to institutional investors, automated municipal scores exist only in prototype form.
The cost of collecting municipal data and of scoring local governments would drop precipitously if the data was reported in a standardized, machine-readable format. The most relevant format is XBRL, which is used for corporate financial reporting not only in the US but in a dozen international markets. The standard has also been applied to municipal reporting in Spain and Brazil.
The idea of extending XBRL to US municipals is nothing new. In 2008, the Association of Government Accountants issued a report describing a pilot implementation for the state of Oregon. The national municipal bond market regulator – the Municipal Securities Rulemaking Board – also discussed the possibility of including XBRL filings on EMMA. But momentum soon stalled.
Earlier this year, US municipal XBRL regained some momentum as the state of Florida passed a law mandating use for local governments in 2022, and XBRL US (the national standards body) formed a working group to propose a state and local government reporting taxonomy (i.e., a standard list of elements that can appear in compliant municipal financial reports). Critical support for the Florida legislation came from St. Petersburg-based Intrinio, a fintech start-up that hosts a financial data marketplace. Application of XBRL to state and local financial reporting would enable Intrinio to add low-cost municipal bond fundamental data to its offerings.
Hopefully, these developments will mark the beginning of a sustained push toward nationwide municipal financial reporting standards. But more regulatory support, more funding and more market participation will be required for this initiative to succeed. Standards like HTML, XML and XBRL are public goods without a clear business model. Yet companies and governments have invested in these standards to create markets and move society forward. In this era of anxiety over public employee retirement benefits, now is the time to propel municipal financial analysis into the 21st century by applying a uniform, open standard to state and local financial reporting.
Marc Joffe is a senior policy analyst at Reason Foundation and Chair of the XBRL US State and Local Disclosure Modernization Working Group. Before becoming a public policy analyst, Marc held a number of technology roles at financial firms including Moody’s Analytics, CIBC, Dresdner and Chase.