Policies and Procedures
Policy DFC- Derivatives Policy
I. POLICY STATEMENT
Denver Public Schools (the “District”) is a political subdivision of the State, organized for the purpose of operating and maintaining a public K-12 educational program for school-age children. The District is governed by a seven-member Board of Education. The Board’s primary functions are to provide for the general operation and personnel of the District, to oversee the property, facilities and financial affairs of the District, and to establish policies for the District. This derivatives policy (the “Policy”) has been crafted in recognition of the unique organizational and advisory role played by the Finance and Audit Committee to the full Board of Education. The Board of Education directs the Superintendent or the Superintendent’s designee to implement this Policy. For the purposes of this Policy, the Superintendent’s designee is presumed to be the Chief Financial Officer (the “CFO”).
The Government Finance Officers Association (“GFOA”) recommends that all state and local governments adopt comprehensive written debt management policies, including derivative and interest rate swap policies. It is the intent that this Policy be informed by “best practices and advisories” developed by organizations such as the GFOA; however the Policy must also reflect the objectives and tolerances of the District. This Policy has been drafted with reference to the guidance of the GFOA as of the date of adoption. It is understood that the GFOA amends and modifies its guidance over time. The CFO is to periodically review the GFOA’s Best Practices and Advisories and recommend conforming modifications to this Policy as warranted.
This Policy governs the District’s consideration and utilization of derivative products, including interest rate swaps and other transactions that may be utilized in conjunction with long-term financial obligations. This Policy addresses the nature of acceptable transactions, counterparty credit rating, concentration, collateralization and other requirements, and other factors related to the rationale for and risks related to such transactions. This Derivatives Policy should be read in its entirety, and read in conjunction with other Policies adopted by the District, including the Debt Policy.
Terms used within this Policy have the meanings assigned to them in the Glossary of Municipal Securities Terms, published by the Municipal Securities Rulemaking Board.
II. POLICY PURPOSE
This policy is promulgated by the District to govern the consideration and utilization of derivative instruments. The Policy applies to Derivative Agreements entered into by the District or any entities on behalf of the District, such as the Denver School Facilities Leasing Corporation. “Derivative Agreement” shall mean a written contract with a counterparty, entered into in connection with the issuance by the District of debt or other long term obligations, with debt or other long term obligations already outstanding, or as a hedge for future anticipated indebtedness, to provide for an exchange of payments based upon fixed and/or variable interest rates. Derivatives shall be inclusive of options on swaps (“swaptions”). The failure by the District to comply with any provision of this policy will not invalidate or impair any Derivative Agreement.
III. CONDITIONS FOR DERIVATIVE AGREEMENTS
Derivative Agreements may be used only for the following purposes:
A. To achieve savings as compared to other, non-derivative type products available in other financial markets;
B. To hedge risk in the context of a particular financing or the overall asset/liability management of the District;
C. To incur variable rate exposure; and/or
D. To accomplish a financial objective not otherwise obtainable using traditional financing methods.
The District must receive an opinion acceptable to the market from a nationally recognized law firm that the Derivative Agreement is a legal, valid and binding obligation of the District and complies with applicable law.
The terms and provisions of any Derivative Agreement will be developed by the Chief Financial Officer, and will provide for, among other matters, the procedures, permitted uses, counterparty credit standards, method of procurement, risk management, and reporting requirements. Associated risks will be risks that are appropriate for the District to take. The Chief Financial Officer may secure advice from financial advisors or a swap advisor to assist in the recommendations.
IV. PROCUREMENT PROCEDURE
As a general practice, the District shall procure Derivative Agreements by competitive bid, with at least three firms solicited. The District shall determine which parties it will allow to participate in a competitive transaction, giving consideration to the credit strength of the counterparties as measured by credit rating or other widely accepted means. The District may procure Derivative Agreements by negotiated methods if it makes a determination that, due to the size or complexity of a particular financing, a negotiated transaction would result in the most favorable terms, conditions, and pricing. The District shall obtain an opinion from an Independent Swap Advisor that the economic terms and conditions of the Derivative Agreement are fair and reasonable to the District.
V. CONTENT OF THE AGREEMENTS
To the extent possible, the Derivative Agreements entered into by the District shall contain the terms and conditions set forth in the International Swap and Derivatives Association, Inc. ("ISDA") Master Agreement, including the schedule, credit support annex, if relevant, and confirmation. The schedule should be modified to reflect specific legal requirements and business terms desired by the District.
The District shall consider including provisions that permit the District to assign its rights and obligations under the Derivative Agreement and to optionally terminate the agreement at its market value at any time. The mechanics for determining termination values at various times and upon various occurrences must be explicit in the swap agreement. In general, the counterparty shall not have the right to optionally terminate or assign an agreement.
The Agreement shall include the following events of default of a counterparty:
A. Failure to make payments when due;
B. Breach of representations and warranties;
D. Failure to comply with downgrade provisions;
E. Commencement of a voluntary case or other proceeding seeking liquidation, reorganization or other relief under any bankruptcy, insolvency or other similar law; and
F. Failure to comply with any other provisions of the agreement after a specified notice period.
The District shall have the right to terminate the agreement upon an event of default by the counterparty. Upon such termination the counterparty will be the affected party for purposes of calculating the termination payment owed.
VI. RISK EVALUATION AND MANAGEMENT
Before entering into, and following the execution of a Derivative Agreement, the Finance and Audit Committee shall be presented an evaluation of all the costs, benefits and risks inherent in the transaction. These risks to be evaluated may include: counterparty risk, termination risk, rollover risk, basis risk, tax event risk, credit risk, and amortization risk. The initial and continual evaluation of risk will conform to the standards of the ISDA.
The District shall endeavor to diversify its exposure to counterparties. To that end, before entering into a transaction, it shall determine its exposure to the relevant counterparty or counterparties and determine how the proposed transaction would affect the exposure. The exposure should not be measured solely in terms of notional amount, but rather how changes in interest rates would affect the District’s "Value at Risk" exposure. The Value at Risk should be based on all outstanding derivative transactions to which the District is party. In addition, the District shall evaluate the potential impact of any derivative transaction on its credit position. Risk evaluation is the responsibility of the CFO and will be undertaken by the District or by a credentialed representative or agent. Risk evaluation will be undertaken in a manner which is consistent with prevailing best practice(s). The following table is a guide to risk categories.
VII. CRITERIA FOR COUNTERPARTY SELECTION
The wise choice of one or more counterparty(ies) and the ongoing monitoring of their creditworthiness are essential elements of a swap program. The District may enter into a Derivative Agreement if the counterparty or its guarantor has by at least one nationally recognized credit rating agency credit ratings in the two highest rating categories (without regard to modifiers), and the counterparty has demonstrated experience in successfully executing Derivative Agreements. If more than one credit rating agency has evaluated the credit worthiness of a potential counterparty, each published rating is to be considered and reported. If after entering into an agreement, the counterparty does not maintain the minimum ratings in the two highest rating categories, or as otherwise specified in the swap documents, then the agreement shall be subject to termination unless (a) the counterparty provides either a substitute guarantor or assigns the agreement, in either case, to a party meeting the rating criteria reasonably acceptable to the District, or (b) the counterparty (or guarantor) collateralizes the Derivative Agreement in accordance with the criteria set forth in this Policy and the Derivative Agreement. In addition, if after entering into an agreement, a rating of the counterparty is downgraded below Baa2/BBB or as otherwise specified in the documents, then the agreement shall be subject to termination unless the counterparty provides either a substitute guarantor or assigns the agreement, in either case, to a party meeting the rating criteria reasonably acceptable to the District. It is understood that existing agreements with counterparties shall continue to be subject to the collateralization requirements specific to such derivative transactions.
VIII. COLLATERALIZATION PROVISIONS
Should the ratings of the counterparty, or if secured, the entity unconditionally guaranteeing its payment obligations not satisfy the requirements of having at least two ratings of at least A3 from Moody’s Investor Services and A- from Standard and Poor’s, then the obligations of the counterparty shall be fully and continuously collateralized by (a) direct obligations of the United States of America, (b) obligations the principal and interest on which are guaranteed by the United States of America, or (c) direct obligations of United States Agencies and such collateral shall be deposited with the District or an agent thereof. Collateral requirements shall be subject to specific threshold and minimum transfer amounts. The specific collateralization requirements for each interest rate swap transaction shall be set forth in the corresponding derivative documentation. It is understood that existing agreements with counterparties shall continue to be subject to the collateralization requirements specific to such transactions.
IX. LONG TERM IMPLICATIONS
In evaluating a particular transaction involving the use of Derivative Agreements, the District shall review long-term implications associated with entering into Derivative Agreements, including: cost of borrowing, historical interest rate trends, variable rate capacity, credit enhancement capacity, opportunities to refund related debt obligations and other similar considerations. The required minimum present value savings to the District of a derivative transaction issued to refund outstanding debt shall be at least twice the minimum required for fixed rate refunding to compensate for the inherent risks associated with the use of derivative instruments.
This Derivatives Policy should be read in its entirety, and read in conjunction with other Policies adopted by the District, including the Debt Policy. The District shall favor Derivative Agreements of shorter duration; for example, 10 years instead of 20 plus years. Shorter duration agreements would reduce the District’s counterparty exposure, and if the District has collateral requirements under the agreement, the required collateral would be less. The term of the agreement cannot exceed the term of the securities.
The District shall reflect the use of Derivative Agreements on its financial statements in accordance with generally accepted accounting principles, including the Governmental Accounting Standards Board pronouncements and guidance, and in accordance with relevant statutes. Further, the District will provide appropriate swap disclosures to credit rating agencies, to investors in connection with bond offerings, and to the municipal secondary market. Appropriate disclosure includes information about legal authority, risks, guidelines, and market value.
The District shall monitor its use of Derivative Agreements and the credit condition of its counterparties and credit enhancement providers on obligations associated with outstanding Derivative Agreements, on an as needed basis but in no event less frequently than on a quarterly basis. If such monitoring activity deems the credit condition to be adverse to the District’s interests, the CFO is to notify the Board promptly with a recommended course of action. Such credit conditions may include but are not limited to:
A. Preparing a description of each contract, including a summary of its terms and conditions, the notional amount, rates, maturity and other provisions thereof;
B. Determining any amounts which were required to be paid and received, and that the amounts were paid and received;
C. Assessing the counterparty risk, termination risk, and other risks associated therewith, which shall include the aggregate marked to market value for each counterparty and relative exposure compared to other counterparties and a calculation of the District’s Value at Risk for each counterparty;
D. Determining that each counterparty is in compliance with its rating requirements and providing current ratings, rating outlooks and other information relevant to its credit condition;
E. Determining that each counterparty is in compliance with the downgrade provisions, if applicable (see Criteria for Counterparty Selection);
F. Determining that all posted collateral, if required, has a net market value of at least the collateral requirements specified in the Derivative Agreement; and
G. Providing the current ratings, rating outlooks and other relevant information for all credit enhancement providers associated with the swaps or the related bonds. The District will take steps annually to provide full and complete disclosure of all Derivative Agreements to rating agencies, and will adhere to best practices for transparency and disclosure in its documents.
XI. POLICY REVIEW AND REVISION
This Derivatives Policy shall be reviewed annually by the Chief Financial Officer and the Finance and Audit Committee, and may be amended by the Board of Education as conditions warrant. This Derivatives Policy was initially presented to the Finance and Audit Committee on August 30, 2011, and approved by the Board of Education on [October 20, 2011] and replaces any previous derivatives and interest rate swap policies of the District.
Adopted: October 20, 2011