On December 7, the Governmental Accounting Standards Board will vote on a proposal to allow Local Government Investment Pools, or LGIPs, to continue using amortized cost accounting and stable NAVs -- in effect, "de-coupling" LGIPs from the SEC's pending money market fund reforms. The move is in direct response to pending money market fund reforms; many LGIPs have investment guidelines that don't allow them to have floating NAV investments or fees and gates. GASB, which, "establishes accounting and financial reporting standards for U.S. state and local governments," issued an Exposure Draft of the proposed guidelines for LGIPs on June 22, entitled, "Accounting and Financial Reporting for Certain External Investment Pools." After a two month comment period that ended August 31, slight tweaks were made, and GASB is slated to vote on the revised proposal next Monday. If approved, it will be go into effect once the final rule is posted on the GASB web site in December.
GASB posted recent commentary explaining the proposed change. It says, "In December, the GASB is scheduled to issue final guidance on ... certain investment pools operated by governments (also known as external investment pools). This proposal is intended to address rule changes recently adopted by the Securities and Exchange Commission (SEC) that will impact the related financial reporting requirements based on a reference to those rules in current GASB literature. Some local government investment pools function much like money market funds. Typically, those government investment funds pool the resources of participating governments and invest in various securities as permitted under state law. By pooling their cash together, participating governments benefit in a variety of ways, including economies of scale, professional management, and enhanced liquidity."
It continues, "Under the SEC's new rules that have been incorporated by reference in current GASB standards, which take effect in 2016, many of these pools and their participants are not expected to qualify for reporting investments on an amortized cost basis, which is currently allowed under the SEC's "2a7-like" pool provisions in the standards. After deliberating comments received on the June 2015 Exposure Draft, the GASB is completing final guidance that will establish criteria for pools and pool participants to qualify for reporting investments at amortized cost."
GASB's June press release, entitled, "GASB Issues Proposed Guidance on External Investment Pools and Component Units," explained, "Existing standards provide that external investment pools may measure their investments at amortized cost for financial reporting purposes if they follow substantially all of the provisions of the U.S. Securities and Exchange Commission's Rule 2a7 for money market funds. Likewise, participants in those pools are able to report their position in the pool at amortized cost per share. The proposal would replace the reference in GASB literature to Rule 2a7 with the GASB's own set of criteria. This is being done in response to major changes to Rule 2a7 that take effect in 2016. Under the rule changes, many government pools would expect to no longer qualify for amortized cost reporting. This would represent a significant change from current practice for both the pools and their participants."
GASB Chairman David Vaudt commented, "The Exposure Draft on external investment pools should help avoid confusion ahead of forthcoming regulatory rule changes. The Exposure Draft on blending requirements will clarify reporting entity presentation of certain component units incorporated as not-for-profit corporations."
LGIPs, which manage approximately $300 billion, are not required to register with the SEC, but they have mostly conformed to the requirements of the Rule 2a-7 money market mutual fund regulations. Following the SEC's reform announcement in July 2014, GASB received a flood of requests to study the impact of the reforms on the accounting and financial reporting of the pools. They surveyed pool participants, pool sponsors, money managers, and consultants, and came up with their Exposure Draft. As mentioned, the major change in in the proposal is that LGIPs are not required to have floating NAVs or fees and gates. Otherwise, the separate, standalone criteria for LGIPs will basically follow the rules as outlined in the 2010 amendments to 2a-7.
GASB received mostly positive feedback on its proposal in the 22 comment letters it received. One of the letters, from Federated Investors' Amy Michaliszyn, says, "We strongly support the proposal of GASB to de-link GASB standards from the Securities and Exchange Commission's ("SEC's") Rule 2a-7, which was recently amended to restrict the use of amortized cost accounting for certain money market mutual funds Although we suggest improvements to the proposal, we do not intend these suggestions to detract from our overall support of the proposal, and urge GASB to adopt the proposal with minor modifications."
Michaliszyn continues, "The central element of the proposal is to modify the prior GASB guidelines pertaining to the use of amortized cost accounting in financial statements of LGIPs; the prior guidance incorporated by reference SEC Rule 2a-7. The current proposal would instead set forth specific criteria for use of amortized cost by LGIPs. Federated strongly supports this decision by GASB to de-link external pool accounting from Rule 2a-7.... [W]e suggest that the basic premise for the use of amortized cost for debt instruments -- that the owner intends to hold them to maturity and has the capability to do so -- not be forgotten. If they are not sold and do not default, any deviation between book value and market value is never realized."
The Federated letter adds, "The categories of portfolio criteria included in paragraph 4 of the proposal -- portfolio diversification, liquidity, weighted average maturity (WAM), weighted average life (WAL), maximum maturity of individual instruments, dollar denomination and credit quality of instruments, and reporting of a "shadow price" -- broadly speaking, are consistent with that approach. Inclusion of the objective that the LGIP seeks to maintain a stable net asset value ("NA V") per unit is also appropriate as a criterion."
Debra Goodnight from PFM Asset Management also comments, “For many of our investment management clients, their legislative and entity-specific investment policy requirements include reference to investing in "Rule 2a-7" SEC registered money market funds and can also include the necessity for the investments of operating or bond proceeds accounts to maintain a "$1.00 NAV". We appreciate GASB's quick and proactive response to the impact of "2a-7like" related standards in light of the 2014 SEC amendments to Rule 2a-7."
She adds, "Now is the time that many government finance officers are considering shifting investments out of money market funds before the implementation of the SEC 2a-7 changes in October 2016 to variable net asset values, or a floating NAV, for registered prime funds.... In this environment, it is becoming increasingly challenging for governmental entities to find suitable options for meeting their short term investment needs without increasing investment risks. Our belief is that GASB previously chose to reference the requirements of Rule 2a-7 as a way to adopt a set of standards that would be consistent with guidance for nonpublic institutions. The SEC requirements were meant to address a broad spectrum of investors that have far less certainty of cash flows, differing risk tolerances, and a wider variety of investment options. The 2014 amendments to Rule 2a-7 widens the divide between controls perceived as necessary to safeguard the national financial infrastructure versus those needed for public entities."
