Turning the Magic Eight Ball: FDTA's proposed joint rules tell muni industry to ask again later

Congress passed the Financial Data Transparency Act of 2022 as a means of modernizing and improving the organization, readability and availability of financial information collected by certain federal agencies (i.e., the Securities and Exchange Commission, the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, the Consumer Financial Protection Bureau, the Federal Deposit Insurance Corporation, the Federal Housing Finance Agency and the National Credit Union Administration (collectively, the designated agencies) from various organizations in the public and private sector.

Specifically, the FDTA tasks the SEC with adopting new uniform data reporting standards for financial information filed by issuers of municipal securities with the Municipal Securities Rulemaking Board. Although the FDTA is expected to affect the format used by such municipal issuers in reporting financial information to the MSRB, the Act does not add any new disclosure requirements. Rather, the goal is to present such financial disclosures in a fully machine-readable and searchable structured format using the newly established data standards.

How will the FDTA go into effect?
The FDTA will be implemented through a two-stage rulemaking process conducted by the designated agencies, first, through joint rulemaking where the designated agencies collectively establish uniform data standards to be applied to financial disclosures under their jurisdictions and second, separate agency-specific rulemaking. Under stage one of the rulemaking process, on August 22, the SEC and the other designated agencies published a notice of proposed rulemaking, presenting proposed joint data standards for public comment, which ended Oct. 21. After considering the public comments, the designated agencies are scheduled to jointly publish their final rules establishing the uniform data standards in December. Under stage two of the rulemaking process, the SEC is responsible for publishing agency-specific final rules (currently scheduled for 2026) adapting the uniform data standards to the municipal securities industry. Current indications are that these rules would become effective sometime in 2027.

What is in the Proposed Joint Rules?
The federal agencies establish a broad framework of data standards for the collection of financial information. As such, the Proposed Joint Rules defer many of the specific aspects of the FDTA's implementation to each designated agency as part of its agency-specific rulemaking process. The following is a summary of the proposed data standards set forth in the Proposed Joint Rules.

Legal Entity Identifiers
Under the FDTA, the designated agencies must select a legal entity identifier to be used by their various reporting entities. The Proposed Joint Rules propose using the 20-character alphanumeric International Organization for Standardization (ISO) 17442-1:2020, Financial Services - Legal Entity Identifier (LEI), managed by the Global Legal Entity Identifier Foundation (GLEIF), as the standard. However, the Proposed Joint Rules stop short of requiring reporting entities to obtain an LEI, leaving this decision to each Designated Agency as part of its agency-specific rulemaking authority. Currently, the process for obtaining and renewing an LEI requires the payment of a fee.

Other Common Identifiers
The Proposed Joint Rules also propose establishing several other common identifiers, including: (1) the ISO Unique Product Identifier (UPI) for identifying swaps and security-based swaps; (2) the ISO Classification of Financial Instruments (CFI) codes for identifying financial instruments that are not swaps or security-based swaps; and (3) the Financial Instrument Global Identifier (FIGI) established by the Object Management Group for further identifying financial instruments. For date fields and the identification of States, countries and currencies, the Proposed Joint Rules propose using standards established by the ISO and other standards-setting bodies like the U.S. Postal Service and the Geopolitical Entities, Names, and Code (GENC) standards. Additionally, the designated agencies requested public comment on whether to establish a common identifier for census tract reporting.

Data Transmission and Schema and Taxonomy Format Standards
Rather than identify specific data transmission and schema and taxonomy formats, the Proposed Joint Rules offer a proposed joint standard of required properties to be included in such formats. Any format selected by the designated agencies that includes such properties would be considered consistent with the proposed joint standard.

Regarding data transmission specifically, the Proposed Joint Rules provide examples of formats that generally have such properties, including eXtensible Markup Language (XML) and Java Script Object Notation (JSON). Additionally, data transmission formats like HyperText Markup Language (HTML) and Portable Document Format (PDF) could satisfy these requirements in limited circumstances. For example, HTML or PDF formats would be considered machine-readable (and therefore acceptable) if they included advanced features for tagging fields and allowed for automated data extraction.

Accounting and Reporting Taxonomies
The FDTA does not expressly require the designated agencies to establish specific accounting and reporting taxonomies as part of the joint rulemaking process. Rather, the designated agencies requested public comment on whether to establish either specific taxonomies or a joint standard for such taxonomies.

General Call for Comments
With a view toward producing final joint rules and agency-specific rules, the designated agencies called for public comment on data standards, data transmission formats, and schemas and taxonomies generally. The designated agencies emphasized the importance of receiving backup data and analysis in support of such public comments.

Flexibility
As part of their agency-specific rulemaking, the designated agencies are allowed to consider the framework of uniform data standards established by the Proposed Joint Rules against a number of mitigating factors relative to their regulated industries. Such factors include applicability, feasibility, practicability, scaling and minimizing disruption to the reporting entities.

Public Comments from the Municipal Securities Industry
A number of municipal securities organizations, including the National Association of Bond Lawyers (NABL), the Governmental Finance Officers Association (GFOA), the National Association of State Treasurers (NAST), the National Association of Municipal Advisors (NAMA), the National Association of Municipal Analysts (NFMA), the Bond Dealers of America, the National Association of College, University and Business Officers (NACUBO) and the National Association of Health and Educational Facilities Finance Authorities (NAHEFFA), responded to the designated agencies' call for public comment on the Proposed Joint Rules. The comments provide insight into the potential impact of the FDTA on municipal issuers, from the point of view of these organizations. The following is an overview of the public comments received.

Regulatory Overreach and Unfunded Mandate on Municipal Issuers
Respondents expressed concern that the FDTA's new reporting requirements equated to a regulatory overreach on municipal issuers. With respect to the regulatory overreach argument, respondents reminded the SEC that Subsection (d) of Section 15B(b) of the Securities Exchange Act of 1934 (a.k.a. the Tower Amendment) bars the SEC and the MSRB from imposing document filing requirements on municipal issuers prior to a sale of municipal securities. In fact, the FDTA not only references this protection, but also confirms that the Act's reporting standards are not intended to add any new disclosure requirements.

Respondents also argued that the costs of implementing the FDTA's reporting requirements amounted to an unfunded mandate on municipal issuers. On that point, respondents urged the SEC to conduct a cost/benefit analysis of the FDTA's requirements, emphasizing greater transparency in the quality, as opposed to the quantity, of information that communicates a municipal issuer's credit story. Specifically, the SEC should balance the Act's intended market benefits, in terms of improved quality, accessibility and use of financial information in a machine-readable filing format, against the costs, complexities and regulatory burdens placed on municipal issuers, particularly smaller governmental units.

To illustrate this point, respondents provided examples of the potential implementation costs associated with the new filing format, including installing and maintaining new software, purchasing and maintaining issuer and security identifiers, upgrading and reconfiguring existing systems, hiring outside consultants, utilizing existing staffing capacity, using redundant processes to deal with additional reporting needs and incurring penalties for non-compliance. Such costs, complexities and burdens could drive municipal issuers away from the public market and toward private placement borrowings or other financing vehicles.

Further complicating matters, a recent United States Supreme Court decision may open the door to legal actions claiming that the FDTA is an impermissible federal overreach and/or unfunded mandate. In Loper Bright Enterprises v. Raimondo, the Supreme Court overturned the so-called Chevron (CVX) deference doctrine, where a reviewing court previously deferred to a federal agency's interpretation of an ambiguous statute. Instead, the reviewing court must exercise its independent judgment in determining whether a federal agency has acted within its statutory authority, including situations involving ambiguous statutes. The impact of this decision on future legal challenges to the SEC's rulemaking and enforcement activities, under the FDTA or otherwise, remains an open question. In the wake of Loper Bright, however, comments that describe the FDTA as a federal overreach or an unfunded mandate could be viewed as a warning shot.

Unanswered Questions
By design, the FDTA is intended to change the way in which reporting entities, described in the Act as "financial entities," file information with the MSRB. However, the Proposed Joint Rules leave important questions unanswered, including (1) which entities within the municipal securities industry would constitute "financial entities" and (2) to what degree is the information reported by such financial entities to the MSRB (e.g., official statements, post-issuance disclosure filings and/or other information primarily intended for human consumption) subject to the new data standards? Answers to these questions are likely to come in the form of the SEC's agency-specific rulemaking after the designated agencies release their final joint rule in December. Nevertheless, without specific answers to these questions, respondents could offer only limited feedback on the FDTA's potential impact on the municipal securities industry.

Flexibility as a Mitigating Factor
Under the FDTA, the SEC is permitted to scale and tailor the new data standards in a way that reduces unjustified burdens on smaller entities and minimizes disruptive changes overall. Taking this flexibility into consideration, respondents urged the SEC to execute the new reporting standards in a way that achieved the FDTA's goal of providing adequate information to investors, but at a reasonable cost and with minimal intrusion on operations.

Additionally, due to the wide range of unique characteristics and variances (including the use of multiple accounting standards) that already exist in the municipal securities industry, plus the evolving technology of machine-readable formatting, respondents supported the use of a properties-based joint standard for data transmission, schema and taxonomy formats. However, respondents rejected the establishment of either a joint standard for accounting and reporting taxonomies based on certain properties, or specific taxonomies themselves, in favor of a more flexible, agency-specific approach. If the designated agencies opt for a more standardized approach, however, the SEC should be able to scale or tailor such specific, jointly-issued taxonomies, or use altogether different taxonomies, to address the specific needs and various types of municipal issuers and their credits.

At a minimum, respondents encouraged the SEC to regularly consult with members of the municipal securities industry throughout the rulemaking process in developing the new data standards. Additionally, independent beta-testing and phase-in periods should be incorporated before the new reporting requirements go into effect.

Practicability of Using LEIs and FIGI
Respondents noted that, as presently structured, LEIs are designed to identify only an entity and not the credit involved in the offering of municipal securities. Given that the investing community relies on credit quality in making investing decisions, respondents questioned whether the use of LEIs would serve as a useful identifier for municipal issuers. Respondents likewise questioned the use of FIGI as the shared identifier for financial instruments (in this case, municipal securities), given the market's existing familiarity with, and reliance on, CUSIP numbers. Particularly, respondents asked the SEC to clarify whether the use of FIGI would supplement or replace CUSIPs.

Antifraud Provisions and Other Legal Requirements
The Proposed Joint Rules are silent as to how the antifraud provisions of the federal securities laws and other securities law requirements, including MSRB Rule 15c2-12, would apply to information-gathering under the FDTA's new data reporting standards. For example, would the antifraud provisions apply to misstatements or omissions of material data resulting from a machine-readable file translation process or similar software error, where the source document contained no such errors? Respondents pressed the SEC for clarifications, particularly the role, if any, of underwriters and other municipal market participants in policing municipal issuers' compliance with the new requirements, as well as the use of safe harbors.

Preparing for the FDTA
The Proposed Joint Rules leave many questions unanswered regarding the FDTA's ultimate impact on the municipal securities industry. The answers to these questions are likely to emerge in stages, including through the designated agencies' final joint rules and the SEC's agency-specific rulemaking. Accordingly, municipal issuers should be ready to adapt to a variety of possible outcomes, as they continue to contribute meaningfully to the rulemaking process.