On June 7, 2017, the Final Issue Price Regulations (the “Final Regulations”) become effective. More specifically, the Final Regulations apply to bonds sold on or after June 7, 2017 and without regard to the bonds’ issuance date. Suffice it to say, if you have read our blog or been practicing in the area of municipal finance for any period of time, you know that June 7, 2017 is a date that is YEARS in the making.
Unlike other guidance from the IRS and Treasury that is phased-in over a period of time, June 7, 2017 is a metaphorical Rubicon that separates the existing issue price regulations from the Final Regulations. For bonds sold on or after June 7, 2017, issuers will no longer be able to establish issue price using the existing issue price regulations. There is no phase-in period to apply the Final Regulations, and issuers are unable to elect to apply the existing issue price regulations following that date. Accordingly, June 7, 2017 officially marks the end of an era for the “reasonable expectations” test that we all know and love (discussed here).
It remains to be seen how the Final Regulations will impact the pricing of bonds, though there will surely be some effect. Replacing the reasonable expectations test with the hold-the-offering-price rule may depress prices paid by underwriters because it prohibits underwriters from reselling the bonds at prices in excess of the initial offering price for a period that begins on the sale date and that ends on the earlier of five (5) business days thereafter or the date on which at least 10 percent of each maturity is sold to the public at a price that does not exceed the initial offering price of the given maturity. To offset the risk that the market will move away from them, underwriters likely will be incentivized to offer comparable bonds at a lower price in the hold-the-offering-price context than they would have under the existing regulations. This practice is common, for example, when underwriters purchase large tracts of bonds before breaking them up for sale to smaller retail customers. In any event, the hold-the-offering-price rule is more restrictive than the reasonable expectations rule and underwriters will need to consider the restriction when pricing bonds.
How public finance professionals will implement the Final Regulations is another matter that remains to be seen. Although the model issue price certificates released last week by NABL (click here for the certificates and here for our discussion) will undoubtedly grease the wheels, for regulations as significant as these, the model certificates may be “tweaked” by public finance professionals based on their (our) interpretation of the Final Regulations.
Finally, it will be interesting to see how issuers choose between (or combine) methods to determine issue price. If the first price at which a substantial amount of bonds is sold to the public is something other than the bonds’ initial offering prices, the resulting issue price would differ from the issue price of the bonds under the hold-the-offering-price rule. The Final Regulations make clear that the issuer can choose the method to determine issue price at any time on or before the closing date; therefore, for bonds for which the hold-the-offering-price restriction has been built into the bond purchase agreement and that are sold at prices below the initial offering price, the issue will be able to choose the lower issue price with the effect of increasing the arbitrage yield.
 The hold-the-offering-price rule was introduced in response to the outcry against the “alternative method” which was proffered in the 2015 proposed issue price regulations. Under the alternative method, bonds could be sold at prices in excess of the initial offering prices at any time between the sale date and the issuance date provided the lead underwriter (or sole underwriter) provided a certification (along with supporting documentation) that the higher price was a result of a market change for those particular bonds. The alternative method was universally lambasted by commenters out of concern that it would be difficult to determine whether or not a price increase was attributable to market fluctuations. However, arguably, the alternative method was the middle ground between the eminently flexible reasonable expectations rule and the inflexible hold-the-offering-price rule.