Financial Derivatives:

Actions Taken or Proposed Since May 1994

GGD/AIMD-97-8: Published: Nov 1, 1996. Publicly Released: Nov 1, 1996.

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Jean G. Stromberg
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GAO conducted a follow-up review of the regulation of financial derivative products, focusing on actions taken or proposed since May 1994 to: (1) strengthen corporate governance and internal controls for derivatives dealers and major end-users; (2) improve regulation of major U.S. derivatives dealers; (3) provide federal oversight of major derivatives dealers that are unregulated affiliates of securities firms and insurance companies; (4) promulgate comprehensive and consistent accounting and disclosure requirements for derivatives; and (5) harmonize regulatory and accounting standards internationally.

GAO found that: (1) market participants, regulators, and others have taken or proposed a number of actions to improve the management, oversight, and disclosure of derivatives risks consistent with GAO's prior recommendations; (2) federal bank regulators are: (a) requiring capital that more accurately reflects derivatives risks; (b) collecting more extensive information on bank derivatives activities; and (c) examining banks using guidelines that are better focused on derivatives risks; (3) the Financial Accounting Standards Board (FASB) has issued enhanced disclosure rules, as GAO recommended, and has proposed an accounting standard for derivatives that should help stem misleading accounting practices and would require that all derivatives be recorded in financial statements; (4) the Securities and Exchange Commission (SEC) has also proposed more qualitative and quantitative disclosures about derivatives use by public companies; (5) internationally, there has been progress toward greater regulatory harmonization and coordination, as evidenced by major international regulatory initiatives and information-sharing agreements; (6) although market participants, regulators, and others have acted to improve the management, oversight, and disclosure of derivatives risks, many of the concerns that GAO identified in its 1994 report still remain; (7) compliance with guidelines and recommended risk management practices is essentially voluntary for derivatives dealers and end-users other than regulated entities; (8) SEC has acknowledged that there may be benefits associated with management or auditor reports on internal control systems of SEC registrants that are major dealers and end-users of complex derivative products as GAO recommended, but has stated that it is focusing on accounting for and providing greater disclosure of market risk for derivative products; (9) the over-the-counter derivatives dealing activities of securities firm and insurance company affiliates, which are still growing, continue to be largely unregulated; (10) FASB has proposed, but still has not issued, comprehensive accounting standards for derivatives that would provide financial statement users with appropriate, consistent financial information on which to base their investment, management, or oversight decisions; and (11) many of the concerns expressed in GAO's 1994 report are still valid; it is too soon to determine the effectiveness of many of the actions taken or proposed to date; and some of GAO's recommendations have yet to be fully implemented.

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