6.3.4 Transactions with Credit or Liquidity Support
If credit for the securities is enhanced by a bond insurance policy, a letter of credit, or another credit facility, or if a third party is providing liquidity support, a separate security is being offered, and the OS must include a description of the terms of that credit or liquidity support and disclosure regarding the credit or liquidity provider (See Section 2.3.2, Credit Enhancement and Liquidity Support). Liquidity providers ensure market execution by providing capital to an illiquid market. A form of any bond insurance policy or letter of credit securing the securities is generally included as an appendix to the OS.
For fixed rate municipal securities secured by bond insurance or other credit support, the financial condition of the issuer is nonetheless material because, no matter the financial strength of the credit provider, an issuer’s financial failure could lead to an early par redemption when interest rates would otherwise result in the securities being valued at a premium. The financial condition of the issuer is also material for variable rate securities with liquidity but not credit support because the issuer’s financial failure could excuse the liquidity provider from performance. In both of these cases, an OS with full disclosure of the issuer’s financial position (plus disclosure concerning the credit or liquidity provider) is necessary.
There is a range of market accepted approaches to disclosure for variable rate debt with both credit and liquidity support (e.g., variable rate demand bonds secured by a letter of credit or by a standby purchase commitment and bond insurance).114 Sometimes full financial disclosure about the issuer or other obligor is included in the OS for variable rate securities, and representatives of the SEC have expressed a preference for full financial disclosure, regardless of the credit or liquidity support provided. Sometimes, however, when there is a “full credit substitution” letter of credit, where investors are protected against financial consequences of a default by the issuer or obligor, virtually no financial information about the issuer is included, in which case the investor is explicitly instructed to make its investment decision on the basis of the credit and liquidity support provider and not based on the condition or circumstances of the issuer.