WASHINGTON - State and local finance officials meeting in Minneapolis this weekend and early next week will consider a policy statement that says derivatives should be used with caution and only by those who can understand and manage their risks.
"We plan to talk about some recommended practices on the use of derivatives for state and local governments," Betsy Dotson, an assistant director of the Government Finance Officers Association's federal liaison center in Washington, said in a recent interview.
"We want to discuss what people need to look out for and what kinds of things they need to keep in mind in, considering the use of derivatives," she said.
Dotson declined to discuss the specifics of the proposed policy statement until GFOA members have had a chance to consider it.
Sources familiar with the statement say that it indicates that the most appropriate use of derivatives is for hedging.
Derivatives may not be appropriate if they are highly leveraged or difficult to value, the statement says.
Derivatives also may not be appropriate if they have not been market-tested or if they would have a high price volatility in an illiquid market or require a high level of sophistication to manage, the statement says.
The association's debt, cash management and pension committees are expected to consider the derivatives policy statement at the meeting in Minneapolis on Saturday, June 4, after being briefed on the General Accounting Office's recent report on derivatives, Dotson said.
The GAO report finds that derivatives pose risks for dealers, end-users, and the global financial system. Legislation is needed, the report says, to ensure that derivatives are federally-regulated in a comprehensive and consistent manner.
If adopted, the policy statement still would have to be approved next Tuesday by the GFOA's board and full membership, Dotson said.
The definition of derivatives in the policy statement includes currency and interest rate swaps, options, forwards, futures floaters and inverse floaters, caps, floors, collars and collateralized mortgage obligations, sources said.
The statement makes clear that derivatives, when used prudently, can be useful economic and financial tool.
Finance officials would be urged by the policy statement to make sure they have the authority to enter into derivatives contracts and that the contracts are not in violation of municipal debt limits or other restrictions.
The policy statement also advises state and local officials to set up internal controls to manage the risks associated with their derivatives activities. These The officials are urged to develop written objectives and procedures for using derivatives and to make sure that management has expertise in these complex products.
The policy statement urges government finance officers to ensure that their broker-dealers are knowledgeable about derivative products and know whether the products fall with-in the state or local government's debt and investment policies.
