The Governmental Accounting Standards Board is set to issue new financial reporting guidelines requiring municipalities to disclose the risks of their derivative investments.
The guidelines require municipalities to reveal in financial statements any exposure to credit risk, market risk, and legal risk associated with derivatives and other similar investments, such as structured financial instruments like mortgage-backed securities.
Such disclosures should give investors a better sense of the risks of a government's investments, said David Bean, the board's director of research.
A draft of the proposed guidelines was distributed in October, and is scheduled to be discussed today as part of a three-day public meeting in Norwalk, Conn., which began Tuesday. The five members of the standards board are expected to approve the guidelines later this week, Bean said.
Once approved, the guidelines would become effective immediately, applying to financial statements for periods ending after Dec. 15.
The board sets standards intended to keep state and local governments in compliance with government accounting standards, or generally accepted accounting principles.
However, the board cannot compel compliance with its guidelines. If a municipality fails to comply, then the accounting firm that audits its financial statement would note an "exception," explaining in what instances the statement does not follow standard accounting procedures.
Officials with the board amended the draft guidelines following the disclosure of huge losses by Orange County, Calif.'s investment pool and the county's subsequent bankruptcy filing.
The amendment states that the same reporting requirements apply for municipalities indirectly exposed to the risk of derivative investments due to participation in a mutual fund or an investment pool.
The change requires municipalities to disclose any risks associated with "indirectly using, holding, or writing derivatives, such as through participation in a mutual fund or investment pool that holds derivatives."
"If the government has information available involving an entity's exposure risk, these disclosures are required to be made," Bean said.
If information on the risks is not available, this also must be disclosed.
Municipalities' problems with derivative and other structured investments prompted the board to create the guidelines, Bean said, although he added that such disclosures may not necessarily have prevented the crisis facing Orange County.
In crafting the document amendment, the board reviewed Orange County's June 30, 1993, financial statement, which was in compliance with current guidelines. Bean said the board does not have a copy of the county's financial statement for June 30 of this year. However, under current guidelines, this year's document should have shown that the county had engaged in reverse repurchase agreements. The market value of the transactions and any liability also should have been disclosed, he said.
Under the new guidelines, the county also would be required to disclose "the potential risks associated with those types of investments, especially the market risk," Bean said.
