Bond Market Association (BMA) Swap: Definition, Function, and Practical Applications

A bond market association (BMA) swap, also referred to as a municipal interest rate swap, is a financial contract enabling two parties to exchange interest rates on debt obligations. Typically, this involves swapping a fixed interest rate for a floating rate, or vice versa. The distinguishing factor of a BMA swap lies in its linkage to the U.S. SIFMA Municipal Swap Index, dictating the floating rate.

The bond market association (BMA) once served as a trade association uniting brokers, dealers, underwriters, and banks dealing with debt securities. However, in 2006, it merged with the Securities Industry Association, giving rise to the Securities Industry and Financial Markets Association (SIFMA). The SIFMA Municipal Swap Index, formerly known as The Bond Market Association/PSA Municipal Swap Index, stands as a vital benchmark for municipal swap transactions, comprising numerous tax-exempt variable-rate demand obligations (VRDOs).

SIFMA, or the Securities Industry and Financial Markets Association, represents a significant securities trading group in the U.S., advocating for the interests of securities firms, banks, and asset management companies. Although the BMA has dissolved, its legacy endures through the SIFMA Municipal Swap Index, which plays a crucial role in municipal swap transactions.

Comparable to how LIBOR (London InterBank Offered Rate) functions as a standard measure for short-term taxable rates, SIFMA operates as an indicator for short-term tax-exempt rates. The SIFMA rate often trades as a fraction of LIBOR, reflecting the tax advantages associated with municipal bonds. Nevertheless, it’s imperative to note that the Intercontinental Exchange, responsible for LIBOR, will cease publishing certain LIBOR rates after specific deadlines.

In a municipal interest rate swap scenario, an issuer may opt to convert existing fixed-rate debt into floating-rate debt, or vice versa, without necessarily refinancing or refunding the existing debt issue. For instance, if an issuer anticipates a decline in prevailing interest rates, it may choose to introduce variable exposure through a BMA swap. Here, the issuer pays the counterparty the prevailing SIFMA rate while receiving an agreed-upon fixed interest rate. This arrangement helps mitigate interest rate risk and potentially reduces overall interest costs.

The bond market association (BMA) was instrumental as a trade association, representing brokers, dealers, underwriters, and banks engaged in debt securities. It played a pivotal role in shaping industry standards and advocating for the interests of market participants.

A BMA swap specifically involves the exchange of interest rates on debt obligations, with the floating rate tied to the U.S. SIFMA Municipal Swap Index. This sets it apart from other interest rate swaps, which may utilize different reference rates or indices.

While BMA swaps offer benefits in managing interest rate risk, they also entail complexities and risks. These include exposure to basis risk, where the swap index and actual funding rates may diverge, as well as the requirement for expertise to accurately assess and mitigate risks.

Issuers can potentially benefit from BMA swaps by managing their interest rate exposure more effectively. By swapping fixed-rate debt for floating-rate debt or vice versa, issuers can align their debt structure with prevailing market conditions and potentially reduce overall interest costs.