by Glenn Cheney

Norwalk, Conn. - The Governmental Accounting Standards Board has issued an exposure draft of a proposed standard on the disclosure of risks associated with investments, proprietary funds and deposits.

While the proposed standard would help prevent governmental financial woes, such as the crisis of Orange County, California, in the 1990s, the board is proud that the proposal comes not in response to current crisis but in proactive prevention of future crises.

"We don’t think there’s a crisis coming, but risk disclosure is an issue and we feel like we need to bring some disclosures to the street," said GASB project manager Randal J. Finden.

The current standards on investment risk disclosures fall under GASB Statement 3, Deposits with Financial Institutions, Investments (including Repurchase Agreements) and Reverse Purchase Agreements. The new proposal, Deposit and Investment Risk Disclosures, amends Statement 3 to reflect recent federal banking reforms.

Custodial credit risk disclosures have been modified to limit required disclosures to deposits and investments exposed to significant custodial credit risk.

The ED proposes new requirements for the disclosure of risks related to changes in interest rates. It was an environment of rapidly rising interest rates that brought Orange County to the brink of financial collapse. Under the proposed rules, disclosures would indicate the basis for their sensitivity regarding investments that are highly sensitive to changes in interest rates such as inverse floaters, enhanced variable-rate investments and certain asset-backed securities.

The new proposal expands required disclosures to include disclosures of credit risk and policies governing deposit and investment.

Cognizant of recent concerns about the burden of accounting standards, the board took pains to write a statement that is effective without being unnecessarily onerous.

"Our experience, at this point, after talking with our advisors and doing a field test, is that this proposal is pretty solid," Finden said. "We went out and talked to investment managers, asked them what kinds of measures they pay attention to, what should we be concerned about. The difficulty in developing the proposal was in the minutia. Where do you draw the line between overkill with a data dump versus targeted disclosures that are limited?"

The Government Finance Officers Association, which worked with GASB to develop the proposal, is satisfied that the board has come close to the mark. "We think the changes here are very positive, and we are very supportive," said Stephen Gauthier, GFOA director of technical services.

Gauthier said that the association is especially pleased with the inclusion of exception reporting for custodial credit risk. The proposed standard would expand the scope of considered risks as it allows governments to disclose risk problems that are not specified in the statement.

The standard also requires governments to report risks in the same perspective that government management assesses them. The greater flexibility in reporting avoids irrelevant boilerplate disclosures.

"We like the idea of sharing with financial information users the way in which managers are viewing and assessing the situation," Gauthier said.

The minimized minutia of the proposed standard came at the suggestion of the GFOA. "We encouraged GASB to make sure the language of the statement would not create the false impression that governments were providing highly detailed recountings of the terms of agreements but just broad outlines," Gauthier said. "We don’t want to overwhelm people with the details of information."

The proposal has also found initial support in the investment community. "The proposal provides better information for everyone who looks at governmental accounting, whether it’s the citizens or people deciding if they want to invest in the entity’s bonds," said Mary Metastasio, vice president, Safeco Asset Management, who manages municipal bonds and served on the GASB task force that helped develop the proposal. "You get a better picture of the types of securities and the quality of securities that the entity is investing in."

The proposal is part of a broader GASB project on financial instruments. Next year, the board expects to continue progress with a statement on derivatives, hedging and interest rate swaps. Interest rate swaps, Finden said, have become increasingly popular investment devices among state and municipal governments.

The comment period for the exposure draft ends on Sept. 27, 2002. If adopted as proposed, the effective date will be for fiscal years beginning after June 15, 2004.

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