MINNEAPOLIS -- The federal government should take tough new steps, possibly including legislation or regulation, to protect states and localities from losses in derivatives trading, the executive board of the Government Finance Officers Association said Sunday.
"The GFOA believes that greater federal government involvement in the regulation of derivative products is warranted to avoid market disruption and the loss of scarce taxpayer funds," the board said Sunday as it approved a two-page policy statement drafted by the GFOA's cash management committee.
The GFOA membership is scheduled to vote today whether to adopt the policy.
The executive board, meeting here as part of the GFOA's annual convention, said possible steps include new legislation or regulations, better enforcement of existing rules, improved oversight, and education.
The executive board also adopted a set of recommended practices proposed by the cash management committee on Saturday that urge finance officers to "exercise extreme caution" when using derivatives. Officials should only venture into derivatives transactions if they sufficiently understand the products and have the expertise to manage them, the board said.
"The GFOA is concerned about the increasing complexity of new derivative products used for debt, cash, and pension management purposes," the board said in its policy statement. "Indeed, some public jurisdictions have already experienced losses."
The panel supported closing gaps in the regulation of securities firms and insurance companies that are dealers in derivative products. Banks are subject to periodic regulatory examinations of their derivatives use, but there is no federal regulation of the derivative activities of securities and insurance firm affiliates. And there is little or no state oversight of derivatives activities of insurance company affiliates, the cash management panel said.
The committee also urged federal regulators to clarify existing suitability rules and craft new ones for derivatives brokers, dealers, and investment managers if necessary.
"State and local governments must be assured that the product recommended for their use is appropriate and that the broker or dealer has disclosed his or her own position," the board said.
The Financial Accounting Standards Board also should move more quickly to set accounting standards for derivative products and for disclosure by derivatives brokers and dealers, the draft policy said.
Regulators also should set reasonable capital requirements for derivative brokers and dealers, the draft said. "Currently, only banks have capital requirements," the draft said. "There are no capital requirements for securities firms or insurance companies affiliate derivative dealers."
The draft set of recommended practices urges state and local governments to consider eight factors before using derivatives. For instance, governments should be aware if the broker or dealer with whom they are dealing is merely acting as an agent or intermediary in a derivative transaction or is taking a proprietary position.
Finance officers also should be aware that there may be little or no pricing information or standardization for some derivatives, the draft said. "Competitive price comparisons are recommended before entering into a transaction."
Officials should not only get a written acknowledgment from brokers that they have read the locality's investment policies; brokers must also show that they have determined that the product is suitable, the draft recommended practice said.