FINANCE AND ADMINISTRATION CABINET

Office of the Secretary

(Amendment)

 

††††† 200 KAR 14:011. Qualified Investments.

 

††††† RELATES TO: KRS 42.500(9)-(14), 42.520, 42.525, 17 C.F.R. 270.2a-7, 15 U.S.C. 80a, 26 U.S.C. 1-9834

††††† STATUTORY AUTHORITY: KRS 42.500(10), 42.520(2), 42.525

††††† NECESSITY, FUNCTION, AND CONFORMITY: KRS 42.500(10) requires the State Investment Commission to promulgate administrative regulations for the investment and reinvestment of state funds. KRS 42.520(2) requires the commission to promulgate administrative regulations concerning the assignment of priorities to public depositories. KRS 42.525(1) requires the commission to promulgate administrative regulations for the investment and reinvestment of state funds and the acquisition, retention, management, and disposition of investments. This administrative regulation establishes the standards that govern the commonwealth's investment and cash management programs.

 

††††† Section 1. Definitions. (1) "Commission" means the State Investment Commission.

††††† (2)["Floating rate" means that the interest rate:

††††† (a) Is paid on the specific security changes periodically on a pre-established schedule;

††††† (b) May be tied directly to an index plus some spread or margin; and

††††† (c) Includes hybrid adjustable rate mortgages if the first repricing date is less than six (6) years from the issuance date.

††††† (3)] "Hedge" means a position in a financial instrument taken to minimize or eliminate the risk associated with an existing instrument or portfolio of instruments.

††††† (3)[(4)] "Interest rate swaps" means an agreement governed by an International Swap and Derivatives Association master contract between two (2) parties to exchange, or have the conditional right to exchange, specified cash flows.

††††† (4)[(5)] "NRSRO" means "Nationally Recognized Statistical Ratings Organization", which is a credit rating agency that is registered with the Securities and Exchange Commission, and which provides its opinion on the creditworthiness of an entity and the financial obligations issued by that entity.

††††† (5)[(6)] "Office" means the Office of Financial Management.

††††† (6)[(7)] "Options" means a contract that provides the right, but not the obligation, to buy or sell a specific amount of a security within a predetermined time period and includes specific bonds or notes, an exchange traded futures contract, or the cash value of an index.

††††† (7)[(8)] "Pools" means the investment pools that are managed by the Office of Financial Management, under the guidance of the commission.

 

††††† Section 2. The commission shall:

††††† (1) Not invest state funds in an institution or instrument that it deems unsafe and a threat to the security of state funds;

††††† (2) Maintain adequate liquidity to meet the cash needs of the state; and

††††† (3) Within the limits established by this administrative regulation, invest in securities that maximize yield or return to the Commonwealth.

 

††††† Section 3. (1) The commission may:

††††† (a) Engage in securities lending.

††††† (b) Allow inter-pool transfers to meet short term cash needs.

††††† (2) Within the limited term pool, if borrowing exceeds thirty-three (33) percent of the value of the poolís total assets resulting from a change in values of net pool assets at any time, the pool shall then reduce borrowing to no more than thirty-three (33) percent within three (3) business days and shall continue to use prudence in bringing the percentage of borrowing back into conformity.

 

††††† Section 4. Interest earned on the cash balances shall be calculated daily on an accrual basis.

 

††††† Section 5. Investment Criteria. (1) The criteria to determine the amount of funds per investment instrument shall be the:

††††† (a) Liquidity needs of the state in aggregate as budgeted;

††††† (b) Rates available per instrument; and

††††† (c) Safety of principal and interest.

††††† (2) An investment instrument shall qualify if it is specified by:

††††† (a) KRS 42.500;

††††† (b) This administrative regulation;

††††† (c) 200 KAR 14:081; or

††††† (d) 200 KAR 14:091.

 

††††† Section 6. Investment Securities. The commission shall invest only in the following security types:

††††† (1) U.S. Treasury, agency, and government sponsored entity agency securities with a maturity of less than seven (7) years, or an embedded put of less than three (3) years.

††††† (2) Mortgage pass-through securities issued by U.S. government agencies or by government sponsored entities, including Government National Mortgage Association, Fannie Mae, Freddie Mac, and Small Business Administration with an average life of less than four (4) years at the time of purchase, using Bloomberg consensus prepayment projections, if available, or other reasonable prepayment assumptions if there is no consensus. The commission may hold pass-throughs purchased under this subsection which have an average life of less than six (6) years, using Bloomberg consensus prepayment projections, if available, or other reasonable prepayment assumptions if there is no consensus.

††††† (3) Real estate mortgage investment conduit obligations, as defined by the Internal Revenue Code, 26 U.S.C. 1-9834, also known as collateralized mortgage obligations, or CMOs, rated in the highest category by an NRSRO with an average life of less than four (4) years at the time of purchase, using Bloomberg consensus prepayment projections, if available, or other reasonable prepayment assumptions if there is no consensus. The commission may hold CMOs purchased under this subsection which have an average life of less than six (6) years, using Bloomberg consensus prepayment projections, if available, or other reasonable prepayment assumptions if there is no consensus.

††††† (4) Asset-backed securities (ABS) rated in the highest category by an NRSRO with an average life of four (4) years or less.

††††† (5) U.S. dollar denominated corporate and Yankee securities issued by foreign and domestic issuers, rated in one (1) of the three (3) highest categories by an NRSRO, with a maturity not longer than five (5) years, or an embedded put of less than three (3) years.

††††† (6) U.S. dollar denominated sovereign debt rated in one (1) of the three (3) highest categories by an NRSRO, with a maturity not to exceed five (5) years.

††††† (7)(a) Money market securities, including:

††††† 1. Commercial paper;

††††† 2. Certificates of deposit; and

††††† 3. Bankersí acceptances issued by banks having the highest short-term rating by an NRSRO.

††††† (b) Maturities shall be limited to 180 days for bankers' acceptances and 270 days for all other money market securities.

††††† (8) Repurchase agreements collateralized at a minimum of 102 percent (marked to market daily) with treasuries, agencies, and agency mortgage backed obligations[that meet the requirements established by subsection (4) of this section,] with a maximum maturity of one (1) year[if executed with approved broker-dealers as provided by Section 8 of this administrative regulation] and a maximum of three (3) years for the Kentucky Bank Repurchase Program participants.

††††† (9) Municipal obligations rated in one (1) of the three (3) highest categories by an NRSRO, with a maturity not to exceed five (5) years. The maturity and credit restriction shall be waived for obligations issued by the Commonwealth of Kentucky or any entity within the Commonwealth of Kentucky.

††††† (10) Mutual funds in which the underlying holdings of the fund are in securities in which the pools could invest directly.

††††† (11) In meeting credit standards listed previously in this section, the lowest rating issued by an NRSRO shall be used to determine compliance. The commission, at a minimum on an annual basis, shall determine which NRSROís shall be used.

 

††††† Section 7. Limits on Investment Securities. (1) U.S. agency mortgage backed securities and collateralized mortgage obligations shall not exceed twenty-five (25) percent of total pool assets in aggregate.

††††† (2) Asset-backed securities shall not exceed twenty (20) percent of total pool assets.

††††† (3) U.S. dollar denominated corporate and Yankee and sovereign securities issued by foreign and domestic issuers shall not exceed thirty-five (35) percent of an individual pool or $25,000,000 per issuer within an individual pool, inclusive of commercial paper, bankersí acceptances, and certificates of deposit unless:

††††† (a) These securities are guaranteed by the full faith and credit of the United States government; or

††††† (b) These securities were purchased between February 19, 2009 and March 31, 2009.

††††† (4) Municipal securities shall not exceed $25,000,000 per issuer.

††††† (5) U.S. dollar denominated sovereign debt shall not exceed five (5) percent of any individual portfolio and $25,000,000 per issuer.

††††† (6)[(5)] The investment amount for a single mutual fund shall not exceed ten (10) percent of total pool assets.

††††† (7)[(6)] The credit and diversification requirements documented in this administrative regulation shall apply at the time of purchase based on book value for the Limited Term Pool and market value for other pools.

††††† (8)[(7)] The limits set forth in this section may be waived by unanimous vote of the commission if a situation arises which could damage the stateís credit.

 

††††† Section 8. Risk Management. The pools may utilize interest rate swaps, over-the-counter and exchange traded U.S. Treasury contracts and options to manage the portfolio's exposure to interest rate risk. These instruments shall only be used if the results are demonstratively superior to cash market transactions.

 

††††† Section 9. Pools and Operating Procedures. (1)(a)[The limited-term pool shall be managed to meet the requirements of Rule 2a-7 of the Investment Company Act of 1940, 17 C.F.R. 270.2a-7. Terms used in this section shall have the definitions prescribed in the Investment Company Act of 1940, 15 U.S.C. 80a-1 through 80a-64.

††††† (b)] The limited-term pool shall not purchase a security with a final maturity exceeding 365[397] days[, except for governmental securities, which may have a final maturity of up to 762 days].

††††† (b)[(c)] The weighted average maturity, adjusted for interest rate resets and demand features, shall not exceed sixty (60) days; and the weighted average life, adjusted for demand features only but not interest rate resets, shall not exceed 120 days.

††††† (c)[(d)] At a minimum:

††††† 1. Ten (10) percent of the pool shall be invested in cash, direct obligations of the U.S. government or securities that mature or are subject to a demand feature payable within one (1) business day; and

††††† 2. Thirty (30) percent of the pool shall be invested in cash, direct obligations of the U.S. government, government agency discount note maturing in sixty (60) days or less or securities that mature or are subject to a demand feature payable within five (5) business days.

††††† (d)[(e)] All securities purchased for the pool shall be rated by an NRSRO.

††††† (e)[(f)] No more than five (5) percent of the pool shall be invested in illiquid securities.

††††† (f)[(g)] No more than three (3) percent of the pool shall be invested in second tier securities and no more than five-one hundredths (.05) percent of the pool shall be invested in a second tier security issuer.

††††† (g)[(h)] The net asset value of pool shares shall be computed using the amortized cost method of valuing the poolís investments.

††††† (h)[(i)] The shadow net asset value using the market value of pool holdings shall be computed no less than monthly and made public within sixty (60) days of the calculation date.

††††† (i)[(j)] Stress testing of the pool based on redemption and changes in market value shall be performed no less than quarterly and reported to the commission.

††††† (j)[(k)] Monthly portfolio listings shall be published to a public Web site and shall remain available for no less than six (6) months.

††††† (2)(a) Except as provided by paragraph (b) of this subsection, state funds held in agency or university accounts, the interest of which accrues to the agency or university, shall be placed in the intermediate pool.

††††† (b) These funds may be placed in the limited-term pool, if the commission determines that the liquidity needs of an agency require shorter term investment.

††††† (c) The duration of the intermediate pool shall not exceed three (3) years.

 

††††† Section 10. Approved Broker-Dealers. (1) A broker-dealer who was approved by the commission prior to the effective date of this administrative regulation shall be considered an approved broker-dealer.

††††† (2) Except as provided by subsection (1) of this section, a broker-dealer shall be approved by the commission if the broker-dealer has met the requirements established by subsection (3), (4), or (5) of this section, as applicable.

††††† (3) An approved broker-dealer shall be a broker dealer who meets one (1) of the following qualifications:

††††† (a) Is a primary dealer of the Federal Reserve;

††††† (b) Maintains an office in Kentucky, and has either $25,000,000 in excess net capital or has trades that are guaranteed by a primary dealer of the Federal Reserve;[or]

††††† (c) Has a minimum of $100,000,000 in excess net capital; or

††††† (d) Is an alternative trading system as defined by the Securities and Exchange Commission.

††††† (4)[An approved broker-dealer for repurchase agreements shall:

††††† (a) Have transaction amounts limited to his excess net capital;

††††† (b) Have executed the:

††††† 1. Public Securities Association Master Repurchase Agreement prior to entering into a repurchase transaction; and

††††† 2. Appropriate third-party custodial agreement or Custodial Undertaking in connection with Master Repurchase Agreement for tri-party repurchase agreements; and

††††† (c) Be primary dealer of the Federal Reserve.

††††† (5)] An approved broker-dealer for hedge vehicles shall:

††††† (a) Have at least $100,000,000 in excess net capital;

††††† (b) Have market value transactions limited to his excess net capital; and

††††† (c) Have executed the:

††††† 1. International Swap and Derivatives Association Agreement prior to the implementation of a swap; and

††††† 2. Commonwealth of Kentucky Master Agreement, Over-the-counter Option Transactions - U.S. Treasury Securities, prior to the implementation of an over the counter option transaction.

††††† (5)[(6)](a) Within 180 days of the end of each broker-dealer's fiscal year, a broker-dealer shall submit a copy of the broker-dealer's audited financial statements for that fiscal year.

††††† (b) A broker-dealer who wishes to be approved by the commission as an approved broker-dealer shall submit a copy of the broker-dealer's current audited financial statements.

††††† (6)[(7)] Notwithstanding the broker-dealer requirements described in this section, the state may purchase securities directly from the issuer.

 

††††† Section 11. Incorporation by Reference. (1) The following material is incorporated by reference:

††††† (a) "Securities Industry and Financial Markets Association Master Repurchase Agreement", 12/08;

††††† (b) "Custodial Undertaking in Connection with Master Repurchase Agreement, Bank of New York", 12/08;

††††† (c) "Custodial Undertaking in Connection with Master Repurchase Agreement, Chase Manhattan", 12/08;

††††† (d) "International Swap and Derivatives Association Agreement", 12/02; and

††††† (e) "Commonwealth of Kentucky Master Agreement, Over-the-counter Option Transactions - U.S. Treasury Securities", 12/97.

††††† (2) This material may be inspected, copied, or obtained, subject to applicable copyright law, at State Investment Commission, Suite 76, Capitol Annex, Frankfort, Kentucky 40601, Monday through Friday, 8 a.m. to 4:30 p.m.

 

LORI FLANERY, Secretary

††††† APPROVED BY AGENCY: May 15, 2015

††††† FILED WITH LRC: May 15, 2015 at 11 a.m.

††††† PUBLIC HEARING AND PUBLIC COMMENT PERIOD: A public hearing on this administrative regulation shall be held on June 23, 2015 from 10:00 a.m. to 12:00 p.m., in Room 381, Capitol Annex Building, Frankfort, Kentucky 40601. Individuals interested in being heard at this hearing shall notify this agency in writing at least five (5) workdays prior to the hearing, of their intent to attend. If no notification of intent to attend the hearing is received by that date, the hearing may be cancelled. This hearing is open to the public. Any person who wishes to be heard will be given an opportunity to comment on the proposed administrative regulation. A transcript of the public hearing will not be made unless a written request for a transcript is made. If you do not wish to be heard at the public hearing, you may submit written comments on the proposed administrative regulation. Written comments shall be accepted until the end of the day on June 30, 2015. Send written notification of intent to be heard at the public hearing or written comments on the proposed administrative regulation to the contact person.

††††† CONTACT PERSON: Doug Hendrix, Deputy General Counsel, Finance and Administration Cabinet, 392 Capitol Annex, Frankfort, Kentucky 40601, phone (502) 564-6660, fax (502) 564-9875.

 

REGULATORY IMPACT ANALYSIS AND TIERING STATEMENT

†††††

Contact Person: Doug Hendrix

††††† (1) Provide a brief summary of:

††††† (a) What this administrative regulation does: It provides standards for the investment and reinvestment of state funds and the acquisition, retention, management and disposition of the investments by the State Investment Commission ("SIC").

††††† (b) The necessity of this administrative regulation: KRS 42.525(10) directs the SIC to promulgate regulations regarding the management and investment of the stateís funds.

††††† (c) How this administrative regulation conforms to the content of the authorizing statutes: Sets forth the criteria and requirements for the management and investment of state funds.

††††† (d) How this administrative regulation currently assists or will assist in the effective administration of the statutes: It provides the guidelines the SIC and Finance and Administration Cabinetí Office of Financial Management must follow regarding the management and investment of state funds.

††††† (2) If this is an amendment to an existing administrative regulation, provide a brief summary of:

††††† (a) How the amendment will change this existing administrative regulation: The amendments eliminate a reference to Securities and Exchange Commission Rule 2a-7 (17 C.F.R. 270.2a-7), which is being amended by the SEC (effective October 2016). The SECís amendments would allow the SIC to impose liquidity fees and redemption gates to withdrawals from money market mutual funds. Eliminating the reference to Rule 2a-7 will eliminate the implication that the SIC has powers it does not possess. The amendment also allows repurchase agreement transactions with counter-parties other than broker-dealers, expanding the SICís options in structuring these transactions. It deletes a definition that is unnecessary to the regulation.

††††† (b) The necessity of the amendment to this administrative regulation: The regulation must be amended to avoid issues with the SECís new Rule 2a-7.

††††† (c) How the amendment conforms to the content of the authorizing statutes: The amendment conforms to the authorizing statute by clarifying SICís authority in managing and investing the stateís funds.

††††† (d) How the amendment will assist in the effective administration of the statutes: The amendments strengthen SICís limitations on investment of state funds.

††††† (3) List the type and number of individuals, businesses, organizations, or state and local governments affected by this administrative regulation: The amendments should have minimal impact.

††††† (4) Provide an analysis of how the entities identified in question (3) will be impacted by either the implementation of this administrative regulation, if new, or by the change, if it is an amendment, including:

††††† (a) List the actions that each of the regulated entities identified in question (3) will have to take to comply with this administrative regulation or amendment: N/A

††††† (b) In complying with this administrative regulation or amendment, how much will it cost each of the entities identified in question (3): N/A

††††† (c) As a result of compliance, what benefits will accrue to the entities identified in question (3): N/A

††††† (5) Provide an estimate of how much it will cost the administrative body to implement this administrative regulation:

††††† (a) Initially: No additional costs.

††††† (b) On a continuing basis: No additional costs.

††††† (6) What is the source of the funding to be used for the implementation and enforcement of this administrative regulation:† N/A††††††

††††† (7) Provide an assessment of whether an increase in fees or funding will be necessary to implement this administrative regulation, if new, or by the change if it is an amendment: No increase in fees or funding.

††††† (8) State whether or not this administrative regulation established any fees or directly or indirectly increased any fees: No

††††† (9) TIERING: Is tiering applied? Tiering is not applied; the amended regulation relates to the investment of state funds only by the SIC and has no impact on governments or small businesses. The Office of Financial Management is staff for the SIC.

 

FISCAL NOTE ON STATE OR LOCAL GOVERNMENT

†††††

††††† 1. What units, parts or divisions of state or local government (including cities, counties, fire departments, or school districts) will be impacted by this administrative regulation? SIC and Office of Financial Management (which provides staff for SIC).

††††† 2. Identify each state or federal statute or federal regulation that requires or authorizes the action taken by the administrative regulation. Amendments to 17 C.F.R. 270.2a-7

††††† 3. Estimate the effect of this administrative regulation on the expenditures and revenues of a state or local government agency (including cities, counties, fire departments, or school districts) for the first full year the administrative regulation is to be in effect. None†† (a) How much revenue will this administrative regulation generate for the state or local government (including cities, counties, fire departments, or school districts) for the first year? None

††††† (b) How much revenue will this administrative regulation generate for the state or local government (including cities, counties, fire departments, or school districts) for subsequent years? None

††††† (c) How much will it cost to administer this program for the first year? No additional costs.

††††† (d) How much will it cost to administer this program for subsequent years? No additional costs.

††††† Note: If specific dollar estimates cannot be determined, provide a brief narrative to explain the fiscal impact of the administrative regulation.

††††† Revenues (+/-):

††††† Expenditures (+/-):

††††† Other Explanation: