Financial Instruments Omnibus

Primary Objective: The objective of this project is to consider potential revisions to existing standards regarding investment reporting and disclosure requirements that could address significant issues that have been identified in practice

Status: The Board reviewed the ballot draft of Statement No. 59, Financial Instruments Omnibus at the June 2010 meeting. The Board approved the release of the Statement. 

• Project Plan
• Minutes for Deliberations
• Project staff:
  • Randy Finden

Financial Instruments Omnibus—Project Plan

Background:

External investment pools

Statement 31 provides guidance on the reporting of external investment pools. This project element is a consideration of the effectiveness of the current external investment pool reporting requirements. Research has commenced to evaluate current practice, especially in regards to pools that do not measure their investments at fair value—“2a7-like” pools. When the investments of an external investment pool meet certain credit quality and maturity requirements, Statement 31 provides that investments may be measured at amortized cost and that participants in the pool also may report their positions at amortized cost. Statement 31 describes these external investment pools as 2a7-like pools. However, important authoritative guidance that clarifies what is a 2a7-like pool is only contained in the Comprehensive Implementation Guide (level “d” in the hierarchy of generally accepted accounting principles [GAAP hierarchy]).

The scope of this project element includes all external investment pools, but chiefly focuses on one type of pool—2a7-like investment pools. As already mentioned, 2a7-like external investment pools do not measure their investments at fair value, measuring them at amortized cost instead. The amortized cost measurement is limited to external investment pools that meet specific requirements of section or rule 2a7 of the 1940 Investment Companies Act. Rule 2a7 requires that in order to be able to use amortized cost, the investments held by a mutual fund must be of very high credit quality and short maturity. The high credit quality requirement is intended to limit the investment portfolio’s credit risk; the short maturity requirement is intended to limit interest rate risk. In Securities and Exchange Commission (SEC) practice, mutual funds that meet the requirements of rule 2a7 are permitted to be labeled as money market funds. The GASB’s intent was that a 2a7-like external investment pool is a governmental external investment pool that, if it was under the supervision (had filed with) the SEC, would meet all requirements for money market funds. This intent was clearly spelled out in the Comprehensive Implementation Guide.

Unallocated insurance contracts

The objectives of this project element are to address the appropriate measurement of unallocated insurance contracts and to update terminology of the existing literature to unallocated insurance contracts. Unallocated insurance contracts are addressed in the accounting guidance for defined contribution plans in Statement No. 25, Financial Reporting for Defined Benefit Pension Plans and Note Disclosures for Defined Contribution Plans, and for other postemployment benefit (OPEB) plans in Statement 43.

Interest rate risk disclosures for mutual funds

GASB Statement No. 40, Deposit and Investment Risk Disclosures, requires a disclosure of interest rate risk for mutual funds (paragraph 15). This topic considers whether Statement 40’s interest rate risk disclosure should be limited to bond mutual funds. The scope of this project element is limited to the appropriate interest rate risk disclosure for mutual funds.

Revenue-based contract exclusion

The scope exclusions of Statement 53, paragraph 17, do not exclude contracts that have payments based on the volumes of sales or services. Unless paragraph 17 is revised, some lease and royalty contracts would be within the scope of the Statement and reported as derivative instruments.

Investor’s initial rate of return

Paragraph 64 of Statement 53 discussed circumstances in which the economic characteristics of an embedded derivative instrument would not be considered to be closely related to the economic characteristics and risks of the companion instrument. Research suggests that on the criteria—leveraged yield (paragraph 64c(5))—should be edited for clarity.

Accounting and Financial Reporting Issues:

1. Are external investment pool investments being measured and reported in a manner consistent with Statement 31? 
    
2. When an external investment pool no longer meets the 2a7-like requirements, what are the implications? 
    
3. Should any of the guidance included in the Comprehensive Implementation Guide regarding external investment pools be included in a Statement issued by the Board (raising the guidance in the GAAP hierarchy)? 
    
4. Are unallocated insurance contracts measured appropriately? 
    
5. If the interest rate risk disclosure required by Statement 40 is appropriate only for bond mutual funds, a revision to the existing literature would be suggested. 
    
6. Should the scope of paragraph 17 of Statement 52 be expanded to exclude contracts that are not exchange-traded and have payments based on specific volumes of sales or service revenues? 
    
7. Should paragraph 64c(5)a be revised to indicate that an investor has the potential of a “double” rate of return?  

Financial Instruments Omnibus—Minutes for Deliberations

Minutes of Teleconference, June 1, 2010

The Board reviewed and discussed a ballot draft of the final Statement on various financial instrument accounting and financial reporting issues. The Board members suggested changes to further clarify the guidance. After discussion, the Board voted unanimously to issue Statement No. 59, Financial Instruments Omnibus.

Minutes of Meeting, May 11-13, 2010

The Board reviewed the preballot draft of the proposed Statement, Financial Instruments Omnibus. Changes to further clarify the meaning of “2a7-like” investment pools were discussed and approved. These changes focused on the responsibilities of a group of individuals that fulfills the functions of a board of directors with specific exceptions that recognize the government environment. A ballot draft of a final Statement is scheduled to be discussed at the June teleconference, if time permits.

Minutes of Teleconference, April 20, 2010

The Board revisited the issues surrounding 2a7-like external investment pools. The Board tentatively decided that the organizational structure of a 2a7-like pool should include a group of individuals that fulfills the functions of the board of directors of a nongovernmental entity. The requirements of that structure can be satisfied even if the chief administrative officer of the 2a7-like pool is an elected official. The Board tentatively amended the text related to 2a7-like external investment pools for the final standard.

Minutes of Meeting, March 29-31, 2010

The Board discussed comment letters received in response to the Exposure Draft, Financial Instruments Omnibus. The Board began redeliberations by discussing the proposed amendments to the reporting guidance for unallocated insurance contracts which was to report these contracts at fair value. The Board tentatively decided to revise the proposed amendment so that unallocated insurance contracts would be reported as interest-earning investment contracts according to the provisions of Statement No. 31, Accounting and Financial Reporting for Certain Investments and for External Investment Pools, as amended.

Next, the Board discussed the proposed amendments to Statement 31 that would include guidance currently found in the Comprehensive Implementation Guide concerning how to determine if an external investment pool is 2a7-like. The Board tentatively agreed that this guidance should be moved from the Comprehensive Implementation Guide to category (a) GAAP. However, no tentative decisions were reached, pending the staff’s research regarding references to boards of directors as the term is used in SEC requirements. The Board will further consider the issues at the April teleconference.

Next, the Board discussed proposed amendments to guidance found in Statement No. 40, Deposit and Investment Risk Disclosures, regarding interest rate risk disclosures for mutual funds. The Board tentatively agreed that interest rate risk disclosures for a government’s investment in a mutual fund, external investment pool, or other pooled investment should be limited to an investment in a debt mutual fund, an external debt investment pool, or other pooled debt investment.

Next, the Board discussed the proposed amendments to Statement No. 53, Accounting and Financial Reporting for Derivative Instruments, and tentatively agreed to generally adopt the Exposure Draft proposals in the final standard. That is, contracts that include nonperformance penalties should be outside the scope of Statement 53. Likewise, nonexchange traded revenue-based contracts should not be within the scope of Statement 53. An element of the hybrid instrument guidance should be amended to indicate that an investor has the potential for at least a doubled yield. The Board, however, did tentatively provide for modifications to paragraph 7 of the Exposure that addressed financial guarantees. That modification would indicate that financial guarantees that meet the definition of an investment derivative instrument should be within the scope of Statement 53.

Next, the Board tentatively agreed to include the amendment to NCGA Statement 4, Accounting and Financial Reporting Principles for Claims and Judgments and Compensated Absences, that was presented in an appendix in the Exposure Draft in the text of the final standard.

Finally, the Board tentatively agreed that the effective date of the final Statement should remain as periods beginning after June 15, 2010, with early implementation encouraged.

Minutes of Teleconference, June 23, 2009

The Board reviewed the ballot draft of the Exposure Draft, Financial Instruments Omnibus, and made a few editorial changes to the document. The Board voted to issue the Exposure Draft. It is expected to be posted on the GASB website June 30. The Board balloted the document out of session and voted 7-0 to approve the issuance of the due process document.

Minutes of Meeting, June 2-4, 2009

The Board reviewed the preballot draft of the Exposure Draft, Financial Instruments Omnibus. The Board discussed and tentatively agreed that the proposed Statement would be effective for fiscal periods beginning after June 15, 2010. It also tentatively agreed that the Exposure Draft will not present any specific questions in the Notice to Recipients section. Editorial changes to the draft were made by the Board and will be reflected in the ballot draft. The Board also agreed that the markup of affected standards shown in Appendix C of the Exposure Draft should be reviewed for excessive markings. The Board is scheduled to discuss a ballot draft of the proposed Statement and vote on the issuance of this Exposure Draft at the teleconference on June 23, 2009.

Minutes of Meeting, April 21-23, 2009

The Board discussed the staff research concerning governments’ participation in the credit default swap market. In light of that research, the Board tentatively decided that the scope exception in Statement No. 53, Accounting and Financial Reporting for Derivative Instruments, for financial guarantee contracts should be amended. The Exposure Draft will propose that a financial guarantee contract that is a derivative instrument and is associated with a bond that a government holds as an investment would be reported as a derivative instrument according to Statement 53. Because this project consists of various amendments to existing standards, the issue of how these changes would be presented was discussed. The Board tentatively decided that the best method of presentation of the Exposure Draft would include the text of the proposed standard with an appendix containing the mark-up of the affected text. This appendix would then be eliminated in the final standard. The staff also indicated that at the June meeting, more information will be provided about the regulatory environment of money market funds (rule 2a7 funds).

The Board also discussed the proposed effective date and transition for the standard and concluded to delay this decision until it reviews the preballot draft of the Exposure Draft at the June meeting.

Minutes of Meeting, March 10-12, 2009

The Board began its discussion of various topics related to potential amendments to current financial instruments standards. First, the Board tentatively decided that a proposal should be developed to amend Statement No. 31, Accounting and Financial Reporting for Certain Investments and for External Investment Pools, to include guidance currently found in the Comprehensive Implementation Guide concerning how to determine if an external investment pool is 2a7-like.

The Board also tentatively decided that this proposed amendment should include a provision that external investment pools that do not qualify for the 2a7-like exception should be measured at fair value. Second, the Board tentatively decided that guidance pertaining to deposit placement services for FDIC insured deposits should be included in the Comprehensive Implementation Guide and not included within the scope of this project. Third, the Board tentatively decided that a proposal should be developed for the accounting for unallocated insurance contracts, in Statements No. 25, Financial Reporting for Defined Benefit Pension Plans and Note Disclosures for Defined Contribution Plans, and No. 43, Financial Reporting for Postemployment Benefit Plans Other Than Pension Plans, to update and revise that guidance so that these contracts are measured at fair value. Fourth, the Board tentatively decided that a proposal should be developed to amend Statement No. 40, Deposit and Investment Risk Disclosures, to limit interest rate risk disclosures to bond mutual funds. Fifth, the Board discussed the optional disclosures for realized gains and losses outlined in paragraph 15 of Statement 31 and tentatively decided that this issue would more appropriately be addressed in the fair value measurements project. During deliberations, the Board directed the staff to review current disclosures as part of the fair value research to determine if state and local governments are currently making this disclosure. Sixth, the Board tentatively decided that a proposal should be developed to specifically exclude non-exchange-traded revenue-based contracts from the scope of Statement No. 53, Accounting and Financial Reporting for Derivative Instruments, so that questions raised regarding the application of the Statement guidance to lease and royalty contracts can be appropriately addressed. Seventh, the Board tentatively decided that additional research needs to be conducted to determine if a proposal should be developed to modify the current scope exception that excludes financial guarantees that meet the definition of a derivative in Statement 53. Eighth, the Board tentatively decided that a proposal should be developed to specifically exclude both fixed and variable penalties for nonperformance from the net settlement characteristic of Statement 53. Ninth, the Board discussed Statement 53’s treatment of a swap termination and entering into a similar swap. The Board tentatively decided not to propose a change in Statement 53’s treatment of these transactions.

Finally, the Board tentatively decided that a proposal should be developed to revise paragraph 64c(5)a of Statement 53 to indicate that leveraged yield could be present if the initial rate of return on the companion instrument has the potential to double the yield.

Financial Instruments Omnibus—Major Tentative Decisions:

Statement No. 59, Financial Instruments Omnibus, was approved in June 2010.