NEW YORK--(BUSINESS WIRE)--Reports of losses at the Illinois Metropolitan Investment Fund (IMET) due to potentially fraudulent investments highlights the importance of following industry best practices with respect to investment policies, controls, and strong oversight of third-party agents. It also underscores that standards vary across local government investment pools (LGIPs) and operational risks can be high.
IMET is an LGIP and manages investments on behalf of Illinois municipalities. The fund sought to manage itself in a manner similar to money market funds by seeking to maintain a stable net asset value. The LGIP disclosed it had more than $50.4 million invested in repurchase agreements issued by the First Farmers Financial that are now reported to be in default.
Repos are regularly used by LGIPs to invest cash over a very short period of time. For rated pools, the repos typically are conducted with highly rated counterparties and collateralized by government or agency collateral in the event the counterparty defaults. A third-party custodian holds the collateral on behalf of the pool in what is known as a tri-party repo transaction.
In this case, IMET reportedly relied on a third-party investment advisor, Pennant, to vet loans from First Farmer Financial. First Farmer Financial was an unrated counterparty, the repo agreement appears to have been bi-lateral without the benefit of a custodian and the collateral was somewhat esoteric -- private loans originated by First Farmers Financial and purported to carry a guaranteed by the U.S. Department of Agriculture. It now appears the loans did not carry a guarantee, undermining value as a secondary source of repayment.
Generally speaking, LGIPs' first investment objective is safety and preservation of capital and investment guidelines and practices should be in line with this objective.
The case of IMET raises questions about the pool's investment guidelines in relation to other rated pools. For example, are repo transactions with an unrated counterparty permissible and what types of collateral are eligible? IMET's case also begs the questions about policies with respect to bilateral repos where the collateral is not held by a recognized custodian and what oversight was performed by the investment team to review the repo collateral.
For more on LGIP investment best practices, see "Local Government Investment Pools: Best Practices Vary," published June 13, 2014 at www.fitchratings.com.
Additional information is available on www.fitchratings.com.
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