AI is set to change the game in the muni market

While many have traditionally viewed the municipal bond market as a technological innovation left behind in other markets, Artificial Intelligence appears poised to change the game.

“I think artificial intelligence is going to completely transform this market in every way, shape or form, everything from credit to trading,” said Barnet Sherman, professor, finance and multinational trade, Boston University. “It will completely overturn everything.”

The comments came during a webinar produced by the Council of Development Finance Agencies on Tuesday.

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Instead of applying the writing capabilities of ChatGPT, an online tool that uses machine learning to research and produce written content from spoken requests, some broadcasters and large trading houses are using AI capabilities for aggregating of data.

“We are seeing a shift in the concentrated landscape of institutional bond buyers,” Sherman said. “An increasing amount of money is moving into separately managed accounts, particularly indexing Exchange Traded Funds, in the muni market. This will have an impact on where the bond buyers are, how they will buy your bonds and the price at which your bonds will be redeemed.”

Sherman believes money managers are under pressure from tighter fees and tighter margins, and are looking to automated help to make transactions happen faster, more accurately and be more traceable.

The notion of improved tracking data in munis and the transparency that comes with it hit home for the industry in 2022 with the passage of the Financial Data Transparency Act. The FDTA requires municipal securities disclosures to be converted to a machine-readable format, which will also enable AI to function. The Securities and Exchange Commission is currently struggling with the details for putting the plan into action.

Trading strategies are also leaning on the numbers that AI is crunching. “Many firms are turning to algorithmic trading,” Sherman said. “We have a huge technology war going on and if you’re not in algorithmic trading and if you’re not using AI, you’re going to be left behind.”

Credit rating agencies are also looking closely at how AI-managed infrastructure systems are being used by municipalities and attaching ESG scores.

Greg Sobel, assistant vice president, analyst, Moody’s Investors Service referred to an AI vendor that supplies budgeting software to local governments. “They use ChatGPT technology and three years of data to build budgets with accompanying narratives to explain unique scenarios,” Sobel said.

“Their clients have reported up to a 25% reduction in the time it takes to produce budgets and narratives increase transparency and disclosure, which is a positive credit from Moody’s perspective in terms of governance considerations.”

The city of San Francisco and Pittsburgh International Airport are using sensors to improve sanitation operations by sending data about how full containers are to truck dispatchers.

Los Angeles and Miami are both using AI to monitor air pollution levels. “If it can help a city like Miami minimize the effects of pollution, it will show that technology can be used to address these risks, which would be beneficial from Moody’s perspective,” Sobel said.

Akron, Ohio, Newark, New Jersey, and Tucson, Arizona have all used AI-enabled technologies in their water and sewer departments. Akron was able to reduce chemical costs by 25% or $1.2 million in 2022.

Despite all the promises, AI also comes with an inherently increased risk of hacking. “The use of AI brings significant exposure to cyber risk, and this is largely due to the massive amounts of data that AI needs to succeed,” said Sobel. “Data represents a veritable treasure trove for criminals.”