The Bond Market Association announced yesterday that it will develop a set of "guidingprinciples" that dealers should follow in the municipal derivatives market.
TBMA's announcement came as the National Federation of Municipal Analysts issued a whitepaper on analysts' disclosure needs on derivatives and as a member of the GovernmentFinance Officers Association's debt committee outlined proposed guidance on derivativesuse and disclosure for issuers that the panel is expected to consider at a meeting hereon Saturday.
These initiatives were discussed at The Bond Buyer's 3rd Annual Derivatives and Short-Term Finance Institute here, where dealer panelists all applauded the GovernmentalAccounting Standards Board's proposed financial reporting requirements on derivativesfor states and localities.
The dealers said issuers and the municipal derivatives market will only benefit frommore education and disclosure on derivatives. At a morning session, Peter Ghavami, amanaging director at UBS PaineWebber Inc., said GASB's proposals are good because theywill prevent derivatives users from being criticized for nondisclosure.
Robert Barber, a managing director at Merrill Lynch & Co., said at the same session thatthe GASB proposals will help ensure that issuers understand derivatives and do not usethem for the wrong reasons.
Mark Paris, a managing director at Citigroup Global Markets Inc., summed up the panel'ssentiments when he said that derivatives can provide major benefits to issuers who makesure they use them "within acceptable risks so that no transaction ever blows up."
Ghavami agreed, saying, "I do not believe that we're going to see another Orange County,which really was all about leverage," because dealers do not want issuers to usederivatives for speculative purposes. The California county filed for bankruptcy in late1994 after suffering huge losses in its investment pools, which were highly leveragedand very sensitive to interest rate changes.
TBMA's announced initiative to develop guiding principles for dealers in the derivativesmarket came after the group's executive, new products, legal, and policy committees allagreed in a conference call late Wednesday that dealers needed to do something in thisarea, Ronald Stack, the head of TBMA's municipal securities division, said yesterday.
Stack, a managing director and head of public finance at Lehman Brothers, who did notattend the conference, said in a telephone interview that the association is forming aworking group that will be on a "fast track" to develop the principles this summer andissue an exposure draft on them in August for public comments.
Stack could not say what the principles will include, but added that the association'sgoal is to "ensure that the integrity and smooth operation of the market continues byaddressing directly the role of the dealers in the market." The group has not yet beenformed, but Lary Stromfeld of Cadwalader, Wickersham & Taft will be helping to draft theprinciples, he said.
Meanwhile, Ruth Levine, a principal at the Vanguard Group, described the NFMA's whitepaper on derivatives at The Bond Buyer's conference. Levine - who co-headed the groupthat wrote the paper with Diane Viacava, vice president and senior credit officer atMoody's Investors Service - said disclosure in the derivatives market is in "anembryonic state," and that the NFMA hopes the paper will "catalyze industry discussionas to what improved disclosure practices should entail." The group is seeking publiccomments on the paper and has set an Oct. 1 deadline for receiving them.
Levine said six critical areas of interest for analysts are the issuer's mix of fixed-and variable-rate debt, liquidity, required cash flows related to swaps and the impactthose payments have on the financial results, disclosure of how any up-front paymentreceived will be used to meet budgetary or cash flow needs, termination payment for aswap or swaption and any events that would trigger it, and whether the swap transactionis being integrated for tax yield calculation purposes. The 10-page paper can be foundon the NFMA's Web site at www.nfma.org., she said.
At the same session, Patricia Phillips, the director of finance for Virginia Beach, Va.,said the GFOA debt committee expects at a meeting here on Saturday to upgrade andcombine two of its previously issued policies on the use of derivatives and thedevelopment of a derivatives policy. The new policy - or recommended practice, as thedebt panel calls it - would be sent to the GFOA's executive board for approval inOctober.
The new recommended practice will acknowledge that derivatives can be important toolsbut will urge issuers to formally adopt a derivatives policy that, among other things,describes their legal authority to enter into such transactions and the conditions underwhich they would do so. Such policies should discuss the process for electing andprocuring derivatives products as well as the methods for managing a range of risksincluding interest rate, tax, counterparty, and termination risks, Phillips said. Thatrecommended practice will be on GFOA's web site at www.gfoa.org, Phillips said.
During the conference, panelists stressed the need for issuer officials to understandderivatives and the attendant risks. "We're really looking at the issuers to explain touse what they are doing - not the consultants, but the issuers," Levine said.
Three credit rating agency officials took the same position at another session. If anissuer has to turn to its banker or another adviser to explain the swap transaction itwants to enter into, "that's an immediate red flag," Viacava said. However, it isreasonable and wise for issuers to obtain advisers or consultants to help monitor andmanage their derivatives transactions over the long-term, they and the dealers said.
The rating agency analysts were worried that some issuers are entering into swaptions toget up-front payments to ease fiscal stress, without focusing on the fact that they willbe forced to enter into a swap transaction down the road.
