WASHINGTON -- Swap dealers are raising strong objections to a policy adopted by the GFOA this week that urges the federal movement to take steps, possibly including legislation or regulation, to protect local governments against losses from derivatives.

"The policies ... contain statements which are at odds with the recent congressional testimony of industry experts and present and past financial regulators," Gay H. Evans, chairwoman of the International Swaps and Derivatives Association, said Tuesday in a letter to Jeffrey L. Esser, executive director of the Government Finance Officers Association.

Evans was referring to recent testimony by both Federal Reserve Board Chairman Alan Greenspan and Securities and Exchange Commission Chairman Arthur Levitt Jr. Both officials testified that a new federal regulatory scheme would not make sense for the rapidly evolving derivatives market because it would not be flexible enough to adjust to changes in the markets.

Derivatives markets and firms are already heavily regulated by private counterparties who, for self-protection, insist that dealers maintain adequate capital and liquidity, Greenspan said.

The SEC is already pursing many of the goals identified by a recent General Accounting Office report that called for legislation to authorize federal regulation of securities firms and insurance company derivatives affiliates, Levitt said. He outlined the commission's efforts to devise capital, accounting, and disclosure standards that are tailored to derivatives.

Both officials made their remarks at a hearing May 25 on derivatives before the House Energy and Commerce Committee's subcommittee on telecommunications and finance.

But in a voice vote Tuesday at their annual meeting in Minneapolis, GFOA members approved a two-page policy statement calling for "greater federal involvement in the regulation of derivatives products." Such involvement "is warranted to avoid market disruption and the loss of scarce taxpayer funds," the association said in adopting the statement, which was drafted by the GFOA's cash management committee.

The GFOA said possible steps include legislation, regulation, better enforcement of existing rules, improved oversight, and educational initiatives. For instance, "federal action" is needed to close gaps in the regulation of securities firms and insurance companies that deal in derivatives, the association said.

GFOA members also adopted a set of recommended practices on Tuesday that urge finance officers to "exercise extreme caution" when using derivatives. Officials should not venture into derivatives transactions unless they sufficiently understand the products and have the expertise to manage them, the association said.

Evans told Esser that she shares the association's concerns that state and local governments "attain the objectives of sound asset and liability management.

"Derivatives are an integral part of that process," she said. "As Chairman Greenspan noted in his testomony, 'the board believes that the array of derivative products that has developed in recent years has enhanced economic efficiency.'"

Evans said her group is concerned that the GFOA's policy fails to distinguish among derivative securities, exchange-trade derivatives, and privately negotiated derivatives transactions. The result is "confusion about the existing regulatory environment," she said.

The financial regulators responsible for these activities "understand the benefits of the existing regulatory framework. Chairman Greenspan concluded that 'legislation relating to derivatives is neither necessary or desirable at this time,'" Evans said.

But Catherine Spain, chief lobbyist for the GFOA's federal liaison center here, said in a telephone interview yesterday that state and local issuer officials worry about derivative products.

"People are concerned about this stuff. They are so concerned that some have suggested we shouldn't do derivatives [at all]. We've been shocked that [some of the] regulators have said that there are no problems. We [review that] as playing [them] down," Spain said.

"Regulators [may] say this, but we are the end users. We still think there's room for improvement," she said. "There is a role for the federal government, and we've identified some vehicles, one of which may be regulation, legislation," she said. But "you shouldn't read into this that [we are] calling for regulation."

Spain said the association developed the statements of policy and recommended practices in a "very well-thought-out process."

"GFOA's executive board has encouraged us to do more of that," Spain said. "They think it's the role of the association. That's what we're about."

"As an organization, we have to have a formal policy position in order to testify before Congress," Spain said. "If we want to be player and say we don't think everything [is] hunky dory, we have to have a position of the organization."

Micah Green, executive vice president of the Public Securities Association, said, "We are encouraged that GFOA has not called for legislation as a first resort to addressing the concerns that they've raised in these statements.

"PSA believes that legislation is not needed and that the regulators as well as the industry is actively working to deal with many of the issues raised by GFOA," Green said. "We look forward to workign with them on this effort."

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