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Business Procedures Manual

University System of Georgia (USG) institutions are authorized to establish and manage bank accounts, and to make investments of funds subject to restrictions of Board policy and state law.

This section describes the banking and investment process for the University System of Georgia.

9.1.1 Treasurer’s Responsibilities

The Treasurer of the Board of Regents has the responsibility of providing the corporate approval for setting up all new accounts and advising the banks as to approved signatories. The Vice Chancellor for Fiscal Affairs, as the Treasurer of the Board, is responsible for appointing a person or persons at each of the institutions of the University System with authority to sign checks drawn on banks where funds of the respective institutions are deposited. Persons so appointed shall be authorized to sign any documents that may be required by the banks concerned.

When new bank accounts are established, the Treasurer of the Board of Regents must be notified of the planned change and the following information must be provided:

  • New bank name (if applicable)
  • The bank’s Federal Reserve number
  • The institution’s bank account number
  • The name and number of the Federal Reserve Bank in Atlanta with whom the local bank corresponds
  • The name or names of the signatories for the account

This information should reach the Vice Chancellor for Fiscal Affairs’ Office at least ninety (90) days before the effective date of the proposed change.

The Treasurer of the Board is then responsible for sending certified copies of the minutes of the Board of Regents to the new bank, which advises it of corporate authority for the signers to execute checks drawn on University System funds.

Upon accomplishing the above, the old bank account must be closed as soon as all outstanding checks have cleared, since the old account is no longer the bank account of record. Any transactions clearing through the old account, other than clearing outstanding checks and transferring any remaining cash balances, are unauthorized.


9.1.2 Selection of Banks for General Operating and/or Payroll Accounts

Board policy requires that banking services be subject to competitive bid every five (5) years. The process by which banking services are to be competitively bid is governed by the rules and regulations of the state of Georgia Office of Treasurer and Fiscal Services (OTFS) and the state Depository Board. These rules and regulations require that all banks under contract with a USG institution are expected to meet state Depository Board approved criteria. In addition, USG institutions must first contact OTFS when seeking a new banking service. OTFS will recommend a bidding format. Proposals received by the institution must be sent to OTFS, which will provide a pro forma analysis to the institution to make comparisons. Institutions are free to choose a bank among those filing bids if the bank meets approved criteria and is not the highest bidder. Institutions pay fees directly to the bank and receive any interest earned on deposits.

For further information on OTFS banking requirements, institutions are advised to contact the state Office of Treasury and Fiscal Services directly.


9.1.3 Placement of Cash in Time Deposits

All units of the University System of Georgia placing funds in time deposits shall restrict such placements to banks located in the state of Georgia.

The placement of funds in time deposits is usually associated with resources that must be converted periodically to cash to accommodate operational needs. The term of such placements should be in short periods, but should in no case be more than twenty-four (24) months.

When the sources of funds placed in time deposits are trust funds, the period should be short-term in anticipation of appropriate placement in longer-term, permanent-type investments that produce not only income, but also growth.

Authority for investments of any and all funds resides exclusively with the Treasurer of the Board of Regents. When the Treasurer deems delegation of such authority appropriate, such delegation of authority must be in writing and on file in both the Treasurer’s Office and office of the chief fiscal officer of the institution.


9.1.4 Recording of Interest Earned on Bank Accounts

The following guidelines should be used to record interest earned from bank deposits:

  1. Interest earned on CASH IN BANKS – DEMAND DEPOSITS (invested in accounts known as Negotiable Orders of Withdrawal or N.O.W. accounts) is to be budgeted and receipted in unexpended plant funds and, thus, be used for capital outlay purposes.

    Note: For fiscal years 2009 through 2012 only, the Board of Regents Reduction Plan allows institutions to use interest earned on Demand deposits for operating purposes also.

  2. Interest earned on CASH IN BANKS – TIME DEPOSITS, in most instances Certificates of Deposit (C.D.), is to be budgeted and receipted as interest earned in the fund group that provides the resource to purchase the certificate(s).

Resources from restricted funds, auxiliary enterprises funds, loan funds, endowment funds, unexpended plant funds, and student activity funds, which are invested in time deposits, shall appear on the Statement of Net Assets as “Cash and Cash Equivalents”. Further, interest earned on said time deposits shall be reflected in the fund group providing the resource as “Non Operating Revenue – Interest Income.”


9.1.5 Bank Depositories

All depositories, where funds of the Board of Regents of the University System are held in time deposits, shall either give a depository bond in some acceptable security company qualified to do business in Georgia, or, in lieu thereof, may deposit with some other depository satisfactory to the Treasurer of the Board of Regents and the state of Georgia Office of Treasury and Fiscal Services, securities of the following classes, the current market value of which shall be equal to or in excess of the amount of the time deposits:

  • Direct obligations of the United States Government
  • Obligations unconditionally guaranteed by the United States Government
  • Direct obligations of the state of Georgia
  • Direct obligations of any political subdivision of the state of Georgia
  • Georgia municipal, county, or state of Georgia Authority Bonds acceptable to the Treasurer of the Board of Regents

9.1.6 Service on Bank Governing Boards

The chief business officer of each institution of the University System of Georgia and any other officer or employee who participates in the selection of the institution’s depository (bank) are prohibited from serving on the governing boards of banks and other financial institutions, if such banks or other financial institutions have or seek a commercial relationship with that institution.

The president of an institution may serve on the governing board of a bank or financial institution that does not have a commercial relationship with the institution. However, such a bank or financial institution may not be considered by the institution for establishment of a commercial relationship with that institution of the University System of Georgia for not less than two (2) years after the termination of the president as a member of the board.


9.2.1 Investment Policy

Each institution must develop a written investment policy that must be filed with the Vice Chancellor for Fiscal Affairs and Treasurer. The policy must be reviewed and updated at least once every two (2) years. Each institution shall submit an annual report on its investment performance to the Vice Chancellor for Fiscal Affairs and Treasurer, which asserts that investments have been made in accordance with the institution’s written investment policy.

Note: For the schedule of reporting of investment policy changes and annual investment performance, see Section 20.0, Required Reports.

  1. The investment policy should specify overall investment objectives. There may be several different investment objectives, depending on the type of funds to be invested and period of investment to be considered. These may include objectives that attempt to preserve the purchasing power of income and principal, maximize current income, or maximize capital values. Each investment objective should clearly state the time horizon for achieving investment objectives.
  2. The investment policy should also identify the general type of investments permitted under each investment objective. Investment must be consistent with donor intent, Regents policy and applicable federal and state laws.
  3. The investment policy should include asset allocation guidelines, which outline the asset classes and subclasses that will constitute permissible areas for investment of funds. The guidelines should indicate the maximum and normal distribution of funds among the different asset classes or subclasses and the rationale for selecting these criteria. Asset allocation guidelines should also be tied to the investment objective and consider the potential risks associated with different asset allocations. The investment policy should outline the factors to be considered when an institution proposes a change in asset allocation such as during times of significant rate shift affecting the investment portfolio and instability in inflationary trends.
  4. Diversification is fundamental to the management of risk, and is, therefore, a pervasive consideration in prudent investment management. The investment policy should include a diversification plan that considers the asset classes and investment products to be utilized in an attempt to achieve desired return with an acceptable level of risk.
  5. The investment policy should include spending rules and relate these to investment objectives. Variables to be considered include the percentage of return allocated to prevent principal erosion by inflation versus the percentage to be expended currently.
  6. The investment policy should provide for appropriate collateralization of invested funds that, by law, require the pledge of collateral.
  7. Management’s plan for authorization of investment activity, periodic reporting of investment activity, and monitoring of investment results should be outlined in detail in the investment policy.
  8. Criteria to be used in the selection of investment managers and the evaluation of their performance should be described in the investment policy, if the institution chooses to use outside investment managers. These criteria should address the investment manager’s:

    • Professional background and experience;
    • Investment philosophy relative to the institution’s stated investment objectives;
    • Organizational structure and overall product line;
    • Control with respect to ensuring that individual managers adhere to policy objectives and guidelines;
    • Total size of managed assets;
    • Record of performance measured against appropriate benchmarks;
    • Ability to communicate results effectively and in timely fashion;
    • Written contract, executed once an investment manager is selected, that specifies, at a minimum, the requirements listed in section 7.5.2, Investments, in the Board of Regents Policy Manual. In addition, state funds invested must be separately identifiable.

9.2.2 Pooled Investment Funds

Units of the University System of Georgia and their affiliated organizations may participate in the Pooled Investment Fund Program. The characteristics and investment objectives of the four types of pooled funds are detailed below.

Short Term Fund

The Short Term investment fund provides a current return and stability of principal while affording a means of overnight liquidity for projected cash needs. The investment maturities in this fund will range between daily and two (2) years.

INVESTMENT OBJECTIVES

  1. The primary investment objective shall be preservation of principal and current income consistent with permitted investments.
  2. The secondary investment objective shall be to provide a competitive return on the short term funds of the University Systems of Georgia participants, while providing sufficient liquidity for periodic cash needs.
  3. The portfolio shall be limited to domestic fixed income only and shall be well diversified as to issuer and maturity within the scope of permitted investments.
  4. The overall character of the portfolio shall be of U.S. treasury and agency quality, possessing a minimal degree of credit risk.

GENERAL INVESTMENT GUIDELINES

  1. The investment manager will give frequent and active attention to the portfolio to implement the Fund’s investment strategy.
  2. The investment manager is authorized to make investment changes as deemed necessary on a discretionary basis, but only in accordance with the objectives and guidelines set forth in this document.
    The investment manager will meet regularly with the Pooled Fund Program’s Investment Committee, and at least annually with the BOR Business and Finance Committee, to review investment objectives, investment strategies and performance results.
  3. All investments utilized in the Fund will be highly liquid with readily determinable valuations. Generally, it is anticipated that liquidity needs will be met through maturities, portfolio structure and interest income.
  4. For comparative purposes, the portfolio will be measured against the Barclays 9-12 month T-Bill Index and Georgia Fund One (LGIP)>

SPECIFIC INVESTMENT GUIDELINES

  1. Investments in the Fund shall be limited to fixed income securities permitted for investment under Georgia Code Sections 50-17-59 and 50-17-63.
  2. Consistent with the above Code Sections, permitted investments shall include:
    • US Treasury bonds, bills and notes;
    • Eligible bonds, bills and notes of counties or municipalities of the State of Georgia;
    • Eligible industrial revenue and development authority bonds created by the laws of the State of Georgia;
    • Obligations (including mortgage obligations) of subsidiary corporations of the US Federal Government including, but not limited to, the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, and the Government National Mortgage Association;
    • Repurchase agreements collaterialized by obligations of the US Treasury and subsidiary corporations of the US Federal Government. The market value of the collaterial shall be 102% of the repurchase agreement investment.
  3. The average duration of the portfolio will range from 0.3 to 1.25 years and will typically average 0.75 to 1 year.
  4. The maximum maturity (average life) of any individual holding shall not exceed 3 years.
  5. For purposes of determining maturities, the next reset date will be used for floating rate securities, the put date for putable securities, the call date for securities trading on a yield-to-call basis, and the average life on securities with periodic principal payments prior to maturity such as mortgage-backed securities and asset-backed securities.

Legal Fund

The Legal fund provides an opportunity for greater income and modest principal growth to the extent possible with the securities allowed under Georgia Code sections 50-17-59 and 50-17-63. The average maturity of in this fund will typically range between five (5) and ten (10) years, with a maximum maturity of thirty (30) years for any individual investment.

INVESTMENT OBJECTIVES

  1. The Fund’s investment objective is preservation of principal and above average current income consistent with permitted investments.
  2. The portfolio shall be limited to domestic fixed income only and shall be well diversified as to issuer and maturity within the scope of permitted investments.
  3. The overall character of the portfolio shall be US Treasury and Agency quality, possessing a minimal degree of risk.

GENERAL INVESTMENT GUIDELINES

  1. The investment manager will give frequent and active attention to the portfolio to implement the Fund’s investment strategy.
  2. The investment manager is authorized to make investment changes as deemed necessary on a discretionary basis, but only in accordance with the objectives and guidelines set forth in this document.
  3. The investment manager will meet regularly with the Pooled Fund Program’s Investment Committee, and at least annually with the BOR Business and Finance Committee, to review investment objectives, investment strategies and performance results.
  4. All investments utilized in the Fund will be highly liquid with readily determinable valuations.
  5. For comparative purposes, the portfolio will be measured against the Barclays Intermediate Government Bond Index.

SPECIFIC INVESTMENT GUIDELINES

  1. Investments in the Fund shall be limited to fixed income securities permitted for investment under Georgia Code Sections 50-17-59 and 50-17-63.
  2. Consistent with the above Code Sections, permitted investments shall include:
    • US Treasury bonds, bills and notes;
    • Eligible bonds, ills and notes of counties or municipalities of the State of Georgia;
    • Eligible industrial revenue and development authority bonds created by the laws of the State of Georgia;
    • Obligations (including mortgage obligations) of subsidiary corporations of the US Federal Government, including, but not limited to, the Federal Farm Credit Bank, the Federal Home Loan Bank, the Federal National Mortgage Corporation, and the Government National Mortgage Association;
    • Repurchase agreements collateralized by obligations of the US Treasury and subsidiary corporations of the US Federal Government. The market value of the collateral shall be 102% of the repurchase agreement investment.
  3. The portfolio will be of intermediate duration, typically ranging from 75% to 125% of the duration of the benchmark index with an average maturity (average life) of 3 to 5 years.
  4. The maximum maturity of any individual holding shall not exceed 30 years.
  5. For purposes of determining maturities, the next reset date will be used for floating rate securities, the put date for putable secruities, the call date for securities trading on a yield-to-call basis, and the average life on securities with periodic principal payments prior to maturity, such as mortgage-backed securities and asset-backed securities.

Balanced Income Fund

The Balanced Income fund is designed to be a vehicle to invest funds that are not subject to state regulations concerning investing in equities. This fund is comprised of fixed income, equity, and cash equivalent instruments.

INVESTMENT OBJECTIVES

  1. The Fund’s investment objective is to achieve a meaningful total rate of return with an emphasis on current income.
  2. The overall character of the portfolio should be one of above-average quality, possessing an average degree of investment risk..

GENERAL INVESTMENT GUIDELINES

  1. The investment manager will give frequent and active attention to the portfolio to develop and implement the Fund’s investment strategy.
  2. The investment manager is authorized to make investment changes as deemed necessary on a discretionary basis, but only in accordance with the objectives and guidelines set forth in this section..
  3. The investment manager will meet regularly with the Pooled Fund Program’s Investment Committee, and at least annually with the Board of Regents Business and Finance Committee, to review investment objectives, investment strategies and performance results.
  4. All investments utilized in the Fund will be highly liquid with readily determinable valuations.
  5. For comparative purposes, the total equity portion of the portfolio will be reviewed over a full market cycle compared to the Standard & Poor’s 500 Index.
  6. The total fixed income portion of the portfolio will be reviewed over a full market cycle compared to the Barclay’s Aggregate Bond Index.

SPECIFIC INVESTMENT GUIDELINES

  1. The portfolio’s equity allocation range shall be between 30%-40%, with a target of 35%, and shall have the following characteristics:
    • High overall quality;
    • Diversification among large-, mid-, and small cap domestic equities; and
    • Exposure to both growth and value equity styles..
  2. The portfolio’s fixed income allocation shall typically range between 60%-70%, with a target of 65%, and shall have the following characteristics:
    • Allowable investments are currently limited to domestic fixed income only.
    • All issues must be investment grade at the time of purchase.
    • The portfolio will be well diversified as to issuer and maturity.
    • Maturities should generally be of intermediate term, but may periodically emphasize shorter or longer maturities, depending on yield differentials and market conditions.
    • The maximum maturity of any individual issue shall not exceed thirty (30) years at the time of purchase.
    • The average duration of the portfolio shall not exceed ten (10) years.
    • The total fixed income portfolio should have an average credit quality rating of at least A.
  3. Reserves for contingencies and investment purchases are expected to comprise the balance of the fund:
    • Cash reserves should be invested at all times in appropriate overnight investment vehicles.
    • Overnight investments shall be limited to high quality institutional money market mutual funds rated A1, P1 or other high quality short-term debt instruments rated at least AA+.

Total Return Fund

The Total Return fund is another pool designed to be a vehicle to invest funds that are not subject to state regulations concerning investing in equities. This pool offers the greatest percentage of overall equity exposure, with well over half of the funds typically invested in equities.

INVESTMENT OBJECTIVES

  1. The Fund’s investment objective is to achieve a meaningful total rate of return with an emphasis on capital appreciation.
  2. The overall character of the portfolio should be one of above-average quality, possessing a moderate degree of investment risk.

GENERAL INVESTMENT GUIDELINES

  1. The investment manager will give frequent and active attention to the portfolio to develop and implement the Fund’s investment strategy.
  2. The investment manager is authorized to make investment changes as deemed necessary on a discretionary basis, but only in accordance with the objectives and guidelines set forth in this section.
  3. The investment manager will meet regularly with the Pooled Fund Program’s Investment Committee, and at least annually with the BOR Business and Finance Committee, to review investment strategies and performance results.
  4. All investments utilized in the Fund will be highly liquid with readily determinable valuations.
  5. For comparative purposes, the total equity portion of the portfolio will be reviewed over a full market cycle compared to the Standard & Poor’s 500 Index.
  6. The total fixed income portion of the portfolio will be reviewed over a ful market cycle compared to the Barclay’s Aggregate Bond Index.

SPECIFIC INVESTMENT GUIDELINES

  1. The portfolio’s equity allocation range shall be between 60%-70%, with a target of 65%, and shall have the following characteristics:
    • High overall quality;
    • Diversification among large-cap, mid-cap and small-cap domestic equity;
    • Exposure to both growth and value equity styles.
  2. The portfolio’s fixed income allocation shall typically range between 30%-40%, with a target of 35%, and shall have the following characteristics:
    • Allowable investments are currently limited to domestic fixed income only;
    • All investments must be investment grade at the time of purchase;
    • Maturities should generally be of intermediate term, but may periodically emphasize shorter or longer maturities, depending on yield differentials and market conditions;
    • The maximum maturity of any individual issue shall not exceed thirty (30) years at the time of purchase;
    • The average duration of the portfolio shall not exceed ten (10) years; and
    • The total fixed income portfolio should have an average credit quality rating of at least A.
  3. Reserves for contingencies and investment purchases are expected to comprise the balance of the fund:
    • Cash reserves should be invested at all times in appropriate overnight investment vehicles; and.
    • Overnight investments shall be limited to high quality institutional money market mutual funds rated A1, P1 or other high quality short-term debt instruments rated at least AA+.

Diversified Fund

The Diversified fund is designed to gain further diversification and increase exposure to assets that have lower correlation to equity and bond markets by utilizing alternative asset classes. In addition, this fund is constructed to build an optimal portfolio where return is increased and risk is reduced.

INVESTMENT OBJECTIVES

  1. The Fund’s investment objective is to achieve a meaningful total rate of return, with an emphasis on capital appreciation.
  2. The overall character of the portfolio should be one of above-average quality, possessing a moderate degree of investment risk..

GENERAL INVESTMENT GUIDELINES

  1. The investment manager will give frequent and active attention to the portfolio to develop and implement the Fund’s investment strategy.
  2. The investment manager is authorized to make investment changes as deemed necessary, but only in accordance with the objectives and guidelines set forth in this section.
  3. The Investment Manager will meet regularly with the Pooled Fund Program’s Investment Committee, and at least annually with the BOR Business and Finance Committee, to review investment objectives, investment strategies and performance results.
  4. All investments utilized in the Fund will be highly liquid with reaily determinable valuations.
  5. For comparative purposes, the total equity portion of the portfolio will be reviewed over a full market cycle compared to the Standard & Poor’s 500 Index.
  6. The total fixed income portion of the portfolio will be reviewed over a full market cycle compared to the Barclay’s Aggregate Bond Index.

SPECIFIC INVESTMENT GUIDELINES

  1. The portfolio’s equity allocation shall typically range between 50%-75%, with a target of 65%, have the following characteristics:
    • Broad diversification among large-, mid-, and small-cap stocks, international and emerging market equities, and real estate investment trusts (REITs);
    • Exposure to both growth and value equity styles
  2. The portfolio’s fixed income allocation shall typically range between 25-50%, with a target of 35%, and have the following characteristics:
    • Allowable investments include investment grade domestic bonds, dollar-denominated global bonds, and non-dollar denominated global bonds.
    • The portfolio will be well diversified as to issuer and maturity.
    • Maturities generally should generally be intermediate term, but may emphasize shorter or longer maturities, depending on yield differentials and market conditions.
    • The maximum maturity of any individual issue shall not exceed thirty (30) years at the time of purchase.
    • The average duration of the portfolio shall not exceed ten (10) years.
    • The total fixed income portfolio should have an average credit quality rating of at least A.
  3. Reserves for contingencies and stock and bond purchases are expected to comprise the balance of the Fund:
    • Cash reserves should be invested at all times in appropriate overnight investment vehicles.
    • Overnight investments shall be limited to high quality institutional money market mutual funds rated A1, P1 or other high quality short-term debt instruments rated at least AA+..

Diversified Fund for Foundations

INVESTMENT OBJECTIVES

  1. The Fund’s investment objective is to achieve a meaningful total rate of return, with an emphasis on capital appreciation,
  2. The overall character of the portfolio should be one of above-average quality, possessing a moderate degree of investment risk.

GENERAL INVESTMENT GUIDELINES

  1. The investment manager will give frequent and active attention to the portfolio to develop and implement the Fund’s investemtn strategy.
  2. The investment manager is authorized to make investment changes as deemed necessary on a discretionary basis, but only in accordance with the objectives and guidelines set forth in this document.
  3. The Investment Manager will meet regularly with the Pooled Fund Program’s Investment Committee, and at least annually with the BOR Business and Finance Committee, to review investment objectives, investment strategies and performance results.
  4. All investments utilized in the Fund will be highly liquid with readily determinable valuations.
  5. For comparative purposes, the total equity portion of the portfolio will be reviewed over a full market cycle, compared to the Standard & Poor’s 500 Index.
  6. The total fixed income portion of the portfolio will be reviewed over a full market cycle compared to the Barclays Aggregate Bond Index.
  7. The Uniform Prudent Management of Institutional Funds Act (UPMIFA) and FSP FAS 117-1 require charitable organizations to account and report for donor-restricted and board-designated endowments in ways that are substantially different from previous guidance. It is the Fund’s policy to adhere to the statutory requirements of UPMIFA as adopted in the Georgia Code.

SPECIFIC INVESTMENT GUIDELINES

  1. The portfolio’s equity allocation typically shall range between 40%-75%, with a target of 65%, and have the following characteristics:
    • Broadly diversified among large-, mid- andsmall-cap domestic equities, international and emerging market equities, and real estate investment trusts (REITs);
    • Exposure to both growth and value equity styles.
  2. The portfolio’s fixed income allocation shall typically range between 10% -40%, with a target of 20% and have the following characteristics:
    • Allowable investments include investment grade and high yield domestic bonds, dollar-and non-dollar denominated global bonds, and emerging market bonds;
    • The portfolio will be well diversified as to issuer and maturity;
    • Maturities generally should be intermediate term, but periodically may emphasize shorter or longer maturities depending on yield differentials and market conditions;
    • The maximum duration of any individual issue shall not exceed thirty (30) years at the time of purchase; and
    • The average duration of the portfolio shall not exceed ten (10) years.
  3. The Fund may utilize certain alternative asset classes to gain further diversification. The primary purpose for investing in these asset classes is to increase exposure to assets that have lower correlation to traditional equity and fixed income asset classes. The alternative investment allocation typically shall range between 0% -30%, with a target of 15%. The following alternative asset classes are permitted investments.

    • Hedge Funds – The Fund’s approach for investing in this asset class is to use multi-strategy, multi-manager fund of hedge funds, which will provide the best access to a highly diversified pool of hedge fund strategies and managers.
    • Commodities – The return characteristics of this asset class are largely uncorrelated with stock and bond returns; therefore, adding broad commodity exposure can improve diversification, lower the portfolio’s risk profile and potentially enhance return. Achieving this level of diversification has been made easier with the development of registered investment products that passively track a broad range of commodities.
  4. Reserves for contingencies and stock and bond purchases are expected to comprise the balance of the fund:
    • Cash reserves should be invested at all times in appropriate overnight vehicles.
    • Overnight investments shall be limited to high quality, institutional money market funds rated A1, P1 or other high quality short-term instruments rated at least AA+.

9.3.1 Georgia Code 50-17-2

http://www.legis.state.ga.us/cgi-bin/gl_codes_detail.pl?code=50-17-2


Derivatives are financial instruments whose value is derived from the value of something else. They generally take the form of contracts under which the parties agree to payments between them based upon the value of an underlying asset or other data at a particular point in time. Derivatives are leveraged, which means they require minimal or no initial investment on the part of a government but nevertheless achieve changes in fair value that would have required a far larger initial investment. Also, these financial instruments can be settled early with a cash payment or the transfer of an equivalent asset. The main types of derivatives are futures, forwards, options, and swaps.

Derivatives are used to minimize risk for one party while offering the potential for a high return (at increased risk) to another. The diverse range of potential underlying assets and payoff alternatives leads to a huge rate of derivatives contracts available to be traded in the market. They can be based on different types of assets such as commodities, equities (stocks), bonds, interest rates, or exchange rates. They can also be based on various indices such as a stock market index, consumer price index (CPI) as in inflation derivatives, or even an index of weather conditions, along with other derivatives. Their performance can determine both the amount and the timing of the payoffs.

Derivatives will primarily affect USG institutions at the foundation level. However, institutions must review any derivative calculations for their respective foundations and document that they understand the derivative transactions and their impact to the financials for the period being audited.

Note: Governmental Accounting Standards Board (GASB) Statement No. 53, Accounting and Financial Reporting for Derivative Instruments, was created to enhance transparency and improve consistency as they relate to the use of derivative instruments being reported in the financial statements. The financial statement users now get a clearer look into the risks to which their investments are sometimes exposed when they enter into these transactions and how those risks are managed. Derivative instruments are required to be reported at fair value in the entity-wide, proprietary, and fiduciary fund level financial statements.

GASB Statement No. 53 does not apply to:

  1. Normal purchases and sales contracts that are typical transactions in which it is probable that a government will receive or deliver the purchased commodity, such as electricity or natural gas. In other words, the transaction takes place with an expectation that the commodity will actually be used by the purchaser. This contrasts with the futures contract discussed above, in which there is no expectation that the commodity covered by the contract will actually be purchased and received.

  2. Insurance contracts that are accounted for under GASB Statement No. 10, Accounting and Financial Reporting for Risk Financing and Related Insurance Issues.

  3. Financial guarantee contracts under which the holder is reimbursed when a specified debtor fails to make required payments.

  4. Contracts that are not traded on an exchange and have rates based on:

    • A climate, geological, or other physical attribute; or,
    • The price or value of an asset that cannot be readily converted to cash.
  5. Loan commitments, such as to first-time home buyers for mortgages.

9.3.2 Georgia Code 50-17-59

http://www.legis.state.ga.us/cgi-bin/gl_codes_detail.pl?code=50-17-59


9.3.3 Georgia Code 50-17-63

http://www.legis.state.ga.us/cgi-bin/gl_codes_detail.pl?code=50-17-63


9.4.1 Disclosure Requirements for Derivatives

GASB Statement No. 53 requires that the fair value of derivatives be reported in the financial statements. Fair value is either the price an item is expected to garner if sold on the open market between two unrelated willing parties, or the value of future cash flows in today’s dollars. A synthetic guaranteed investment contract, which is one type of derivative, is reported at contract value instead of fair value. Contract value is the amount that contract holders would receive in a permitted participant-initiated transaction.

Footnote disclosures related to derivative instruments are required and must include the following items:

  1. A summary of derivative instrument activity during the reporting period and balances at the end of the reporting period.

  2. Derivative instruments are to be divided into the following categories

    • Hedging derivative instruments, distinguished between fair value hedges and cash flow hedges. Refer to Section 9.4.2 for more information on hedging derivative instruments.
    • Investment derivative instruments

    Within each category, derivative instruments should be aggregated by type (for example, receive-fixed swaps, pay-fixed swaps, swaptions, rate caps, basis swaps, or futures contracts.

Required information presented should include the following information:

  1. Notional amount

  2. Change in fair value during the reporting period and the classification in the financial statements where those changes in fair value are reported.

  3. Fair value as of the end of the reporting period and the classification in the financial statement where those fair values are reported – if derivative instrument fair values are based on other than quoted market prices, the methods and significant assumptions used to estimate those fair values should be disclosed.

  4. Fair value of derivative instruments reclassified from hedging derivative instruments to investment derivative instruments. There are also should be disclosure of the deferral amount that was reported within investment income upon the reclassifications.


9.4.2 Hedging Derivative Instruments

Hedging derivative instruments, like investment derivatives instruments, require that effectively hedged derivatives be reported in the statement of net assets as deferred inflows/outflows of resources utilizing hedge accounting. Changes in the fair value of derivatives entered into with the intent of producing investment income are to be reported within investment income. Changes in the fair value of hedging derivative instruments that have been determined ineffective (ineffective hedging derivative instruments) are also required to be recognized within investment income for the remaining life of the instrument and no longer recognized as deferred inflows/outflows of resources.

Disclosures specifically required for hedging derivative instruments include the following:

  1. Objectives, including:

    • The reason for entering into those instruments;
    • The context needed to understand those objectives;
    • The strategies for achieving those objectives; and,
    • The types of derivative instruments entered into.
  2. Significant terms, including:

    • Notional amount;
    • Reference rates, such as indexes or interest rates;
    • Embedded options, such as caps, floors, or collars;
    • The dates when the hedging derivative instrument was entered into and when it is scheduled to terminate or mature; and,
    • The amount of cash paid or received, if any, when a forward contract or swap (including swaptions) was entered into.

The following risk disclosures for hedging derivatives are required at year-end:

  1. Credit risks based on a nationally recognized statistical rating organization should be disclosed.

  2. Maximum amount of loss due to credit risk the institution would include if the counterparties to the hedging derivative instrument fail to perform according to the terms, without respect to any collateral or other security or netting arrangement, should be disclosed.

  3. Policy of requiring collateral to support hedging derivative instruments should be disclosed.

  4. Policy of entering into master netting arrangements, including summary description of liabilities and amount included in those arrangements, should be disclosed.

  5. Aggregate fair value of hedging derivative instruments in an assets position, net of collateral posted by the counterparties, and the effect of master netting arrangements should be disclosed.

  6. Significant concentrations of net exposure to credit risks should be disclosed.

  7. Interest rate risks of hedging derivative instruments should be evaluated and disclosed if hedging instrument exposes institution to these risks

  8. Basis risks should be disclosed.

  9. Termination risks such as any terminations events that have occurred, dates that the hedging derivative instrument may be terminated, and out of the ordinary termination events should be disclosed.

  10. Rollover risks should be disclosed, including the maturity of the hedging derivative instrument and the maturity of the hedged item.

  11. Market-access risks should be disclosed.

  12. Foreign currency risks should be disclosed.


9.4.3 Definitions

  1. BASIS RISK. The risk that arises when variable rates or prices of a hedging derivative instrument and a hedged item are based on different reference rates.

  2. CALL OPTION. An option that gives its holder the right but not the obligation to purchase a financial instrument or commodity at a certain price for a period of time.

  3. CASH FLOW HEDGE. A hedge that protects against the risk of either changes in total variable cash flows or adverse changes in cash flows caused by variable prices, costs, rates, or terms that cause future prices to be uncertain.

  4. COMMODITY SWAP. A swap that has a variable payment based on the price or index of an underlying commodity.

  5. CREDIT RISK. The risk that a counter-party will not fulfill its obligations.

  6. CRITICAL TERM. A significant term of the hedgeable item and potential hedging derivative instrument that affects whether the changes in cash flows or fair values substantially offset. Examples are the notional or principal amounts, payment dates, and in some cases, fair values at inception, indexes, rates, and options.

  7. FOREIGN CURRENCY RISK. The risk that changes in exchange rates will adversely affect the cash flows or fair value of a transaction.

  8. FORWARD CONTRACT. A contractual agreement to buy or sell a security, commodity, foreign currency, or other financial instrument, at a certain future date for a specific price. An agreement with a supplier to purchase a quantity of heating oil at a certain future time, for a certain price, and a certain quantity is an example of a forward contract.

    Forward contracts are not securities and are not exchange-traded. Some forward contracts, rather than taking or making delivery of a commodity or financial instrument, may be settled by a cash payment that is equal to the fair value of the contract.

  9. FUTURES CONTRACT. An exchange-traded security to buy or sell a security, commodity, foreign currency, or other financial instrument at a certain future date for a specific price. A futures contract obligates a buyer to purchase the commodity or financial instrument and a seller to sell it, unless an offsetting contract is entered into to offset one’s obligation. The resources or obligations acquired through these contracts are usually terminated by entering into offsetting contracts.

  10. HEDGE ACCOUNTING. The financial reporting treatment for hedging derivative instruments that requires that the changes in fair value of hedging derivative instruments be reported as either deferred inflows or deferred outflows.

  11. HEDGEABLE ITEM. An asset or liability, or expected transaction that may be associated with a potential hedging derivative instrument.

  12. HEDGING DERIVATIVE INSTRUMENT. A derivative instrument that is associated with a hedgeable item and significantly reduces an identified financial risk by substantially offsetting changes in cash flows or fair values of the hedgeable item.

  13. INTEREST RATE RISK. The risk that changes in interest rates will adversely affect the fair values of a government’s financial instruments or a government’s cash flows.

  14. INTEREST RATE SWAP. A swap that has a variable payment based on the price of an underlying interest rate or index.

  15. INVESTMENT DERIVATIVE INSTRUMENT. A derivative instrument that is entered into primarily for the purpose of obtaining income or profit, or a derivative instrument that does not meet the effectiveness criteria of a hedging derivative instrument.

  16. LEVERAGE. The means of enhancing changes in fair value while minimizing or eliminating an initial investment. A leveraged investment has changes in fair value that are disproportionate to the initial net investment. An unleveraged investment requires a far greater initial investment to replicate similar changes in fair values. Derivative instruments are leveraged instruments because their changes in fair value are disproportionate to the initial net investment. For example, an interest rate swap that has a notional value of $100 million is entered into with no initial net investment. Thereafter, as interest rates change, the swap produces changes in fair value consistent with a $100 million fixed-rate financial instrument.

  17. MARKET RISK. The risk that changes in market prices will reduce the fair value of an asset, increase the fair value of a liability, or adversely affect the cash flows of an expected transaction.

  18. MARKET-ACCESS RISK. The risk that a government or institution will not be able to enter credit markets or that credit will become more costly. For example, to complete a derivative instrument’s objective, an issuance of refunding bonds may be planned in the future. If at that time the government is unable to enter credit markets, expected cost savings may not be realized.

  19. NOTIONAL AMOUNT. The number of currency units, shares, bushels, pounds, or other units specified in the derivative instrument. It is a stated amount on which payments depend. The notional amount is similar to the principal amount of a bond.

  20. OPTION. A contract that gives its holder the right but not the obligation to buy or sell a financial instrument or commodity at a certain price for a period of time.

  21. PUT OPTION. An option that gives its holder the right but not the obligation to sell a financial instrument or commodity at a certain price for a period of time.

  22. QUALITATIVE METHOD. A method of evaluating effectiveness by qualitative consideration of the critical terms of the hedgeable item and the potential hedging derivative instrument.

  23. QUANTITATIVE METHOD. A method of evaluating effectiveness using a mathematical relationship. Synthetic instrument, dollar-offset, and regression analysis are the quantitative methods specifically addressed in GASB Statement No. 53 and this policy.

  24. REFERENCE RATE. The rate to which a derivative instrument’s variable payment is linked. Common reference rates are LIBOR, the SIFMA swap index, the AAA general obligations index, and the pricing point of a commodity.

  25. REGRESSION ANALYSIS METHOD. A statistical technique that measures the relationship between a dependent variable and one or more independent variables. The future value of the dependent variable is predicted by measuring the size and significance of each independent variable in relation to the dependent variable. Regression analysis included in the text of this policy and GASB Statement No. 53 uses only one independent variable.

  26. ROLLOVER RISK. The risk that a hedging derivative instrument associated with a hedgeable item does not extend to the maturity of that hedgeable item. When the hedging derivative instrument terminates, the hedgeable item will no longer have the benefit of the hedging derivative instrument.

  27. SWAP. A type of derivative instrument in which there is an agreement to exchange future cash flows. These cash flows may be either fixed or variable and may be either received or paid. Variable cash flows depend on a reference rate.

  28. SWAPTION. An option to enter into a swap. When a swaption is an interest rate option, it may be used to hedge long-term debt. When a government sells a swaption a cash payment may be received. Options pricing theory, including time and volatility measures, is used to value swaptions.

  29. SYNTHETIC INSTRUMENT METHOD. A method of evaluating effectiveness that combines a hedge item and a potential hedging derivative instrument into a hypothetical financial instrument to evaluate whether the hypothetical financial instrument pays a substantively fixed rate.

  30. TERMINATION RISK. The risk that a hedging derivative instrument’s unscheduled end will affect a government’s asset and liability strategy or will present the government with potentially significant unscheduled termination payments to the counterparty.

  31. ZERO FAIR VALUE. Value of a derivative instrument that is either entered into or exited with no consideration being exchanged. A zero fair value should be within a dealer’s normal bid/offer spread.


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