[Federal Register Volume 63, Number 28 (Wednesday, February 11, 1998)]
[Notices]
[Pages 6935-6938]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-3373]
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FEDERAL FINANCIAL INSTITUTIONS EXAMINATION COUNCIL
Repurchase Agreements of Depository Institutions With Securities
Dealers and Others; Notice of Modification of Policy Statement
AGENCY: Federal Financial Institutions Examination Council (FFIEC).
ACTION: Modification of policy statement.
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SUMMARY: FFIEC has modified its policy statement on Repurchase
Agreements of Depository Institutions with Securities Dealers and
Others (Policy Statement). The Policy Statement provides guidance to
insured depository institutions about entering into repurchase
agreements in a safe and sound manner. The FFIEC is making changes to
the Policy Statement to eliminate outdated material, provide
clarification, and to streamline the contents of the Policy Statement.
EFFECTIVE DATE: This Policy Statement is modified effective February
11, 1998.
FOR FURTHER INFORMATION CONTACT:
Federal Deposit Insurance Corporation (FDIC): William A. Stark,
Assistant Director, Division of Supervision, (202) 898-6972; Kenton
Fox, Senior Capital Markets Specialist, Division of Supervision, (202)
898-7119; Leslie Sallberg, Counsel, Legal Division (202)898-8876, FDIC,
550 17th Street N.W., Washington, D.C., 20429.
Office of Thrift Supervision (OTS): William J. Magrini, Senior
Project Manager, Supervision Policy, (202) 906-5744; Vern McKinley,
Attorney, Chief Counsel's Office, (202) 906-6241, OTS, 1700 G Street
N.W., Washington, D.C., 20552.
Office of the Comptroller of the Currency (OCC): Joseph W. Malott,
National Bank Examiner, Treasury and Market Risk, (202) 874-5670;
Donald N. Lamson, Assistant Director, Securities and Corporate
Practices, (202) 874-5210, OCC, 250 E Street, S.W., Washington, D.C.,
20219.
Board of Governors of the Federal Reserve System (FRB): Michael
Martinson, Deputy Associate Director, (202) 452-3640, Susan Meyers,
Senior Securities Regulation Analyst, (202) 452-3626, Division of
Banking Supervision and Regulation. FRB, 20th Street and Constitution
Avenue, N.W., Washington, DC, 20551. For the hearing impaired only,
Telecommunication Device for the Deaf (TDD), Diane Jenkins (202) 452-
3544.
SUPPLEMENTARY INFORMATION: FFIEC consists of representatives from the
FDIC, OCC, FRB, OTS, and National Credit Union Administration (NCUA).
FFIEC developed the Policy Statement to establish guidelines for
insured depository institution repurchase agreement activities,
including guidelines for written repurchase agreements, policies and
procedures, credit risk management, and collateral management. FFIEC
adopted the Policy Statement on October 21, 1985 (50 FR 49764, December
4, 1985), and the OCC, FRB, and FDIC each adopted the FFIEC's Policy
Statement shortly thereafter. The OTS has not separately adopted the
Policy Statement, but refers federal savings associations to the FFIEC
version.
On November 14, 1997, FFIEC voted to make certain changes to the
Policy Statement. First, the Policy Statement has been updated and
streamlined to reflect the enactment of the Government Securities Act
of 1986 and the Government Securities Act Amendments of 1993, 15 U.S.C.
78o-5 (GSA). The Policy Statement section, Dealings with Unregulated
Securities Dealers, has been removed. The GSA established a regulatory
structure for government securities dealers, making this section
obsolete. A new section, Legal Requirements, has been added to the
Policy Statement. The first subsection, Government Securities
Regulations, presents general information on the requirements of the
GSA.
Second, the Policy Statement has been updated to generally cover
the other laws and regulations applicable to repurchase agreements.
These include the antifraud provisions of the securities laws, the
requirements of the Uniform Commercial Code, and lending limitations.
Third, the list of written repurchase agreement provisions has been
updated with an expanded list of provisions to reflect current market
practice. These provisions include terms of transaction initiation,
confirmation and termination, payments and transfers of securities,
collateral segregation, collateral repricing, rights to principal and
interest payments, required disclosures for hold-in-custody repurchase
agreements, and disclosures required by regulatory agencies.
In addition to the revisions to the Policy Statement previously
described, minor changes to the Policy Statement have also been made to
improve clarity and readability.
For these reasons, the FFIEC has modified the Policy Statement to
read as follows. Each of the federal banking agencies will take
appropriate action in connection with the modification of the Policy
Statement.
Federal Financial Institutions Examination Council Supervisory Policy;
Repurchase Agreements of Depository Institutions With Securities
Dealers and Others
Purpose
Depository institutions and others involved with repurchase
agreements 1 have sometimes incurred significant losses as a
result of a default or fraud by the counterparty to the transaction.
Inadequate credit risk management and the failure to exercise effective
control over securities collateralizing the transactions are the most
important factors causing these heavy losses.
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\1\ The term ``repurchase agreement'' in this policy statement
refers to both repurchase and reverse repurchase agreements. A
repurchase agreement is one in which a party that owns securities,
acquires funds by selling the specified securities to another party
under a simultaneous agreement to repurchase the same securities at
a specified price and date. A reverse repurchase (resale) agreement
is one in which a party provides funds by purchasing specified
securities pursuant to a simultaneous agreement to resell the same
securities at a specified price and date.
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The following guidelines are examples of elements that address
credit risk management and exposure to counterparties under securities
repurchase agreements and for controlling the securities in those
transactions. Depository institutions that enter into repurchase
agreements with securities dealers and others should consider these
guidelines. Each depository institution that actively engages in
repurchase agreements must have adequate policies and controls to suit
their particular circumstances. The examining staffs of the federal
supervisory agencies will review written policies and procedures of
depository institutions to determine their adequacy
[[Page 6936]]
in light of the scope of each depository institution's operations.
I. Legal Requirements
A. Government Securities Regulations
Securities sold under an agreement to repurchase that is
collateralized by U.S. government and agency obligations are subject to
regulations of the Treasury Department issued under the Government
Securities Act of 1986, 15 U.S.C. 78o-5 (GSA). These regulations appear
at 17 CFR Parts 400 to 450. Particular attention should be given to the
requirements and ``Required Disclosures'' in 17 CFR 403.5. Institutions
engaging in hold-in-custody repurchase transactions should also give
attention to 17 CFR 450.
B. Other Laws and Regulations
Federal and state laws such as the antifraud provisions of the
securities laws and the requirements of the Uniform Commercial Code may
apply to a repurchase agreement.
Resale transactions of national banks and thrift institutions are
subject to the lending limitations of 12 U.S.C. 84. In addition, state-
chartered institutions should consult with their counsel or state
regulatory authorities as to the applicability of state lending
limitations. Depository institutions should also consider other rules
that may apply to the transactions depending on the type of bank
charter.
II. Credit Policy Guidelines for Securities Purchased Under Agreement
to Resell
All depository institutions that engage in securities repurchase
agreement transactions should establish written credit policies and
procedures governing these activities. These policies and procedures
usually address:
A. Counterparties
Policies normally include ``know your counterparty'' principles.
Engaging in repurchase agreement transactions in volume and in large
dollar amounts frequently requires the services of a counterparty who
is also a dealer in the underlying securities. Some firms that deal in
the markets for U.S. Government and federal agency securities are
subsidiaries of, or related to, financially stronger and better-known
firms. However, these stronger firms may be independent of their U.S.
Government securities subsidiaries and affiliates and may not be
legally obligated to stand behind the transactions of related
companies. Without an express written guarantee, the stronger firm's
financial position cannot be relied upon to assess the creditworthiness
of a counterparty.
Depository institutions should know the legal entity that is the
actual counterparty to each repurchase agreement transaction. This
includes knowing about the actual counterparty's character, integrity
of management, activities, and the financial markets in which it deals.
Depository institutions should be particularly careful in conducting
repurchase agreements with any firm that offers terms that are
significantly more favorable than those currently prevailing in the
market.
In certain situations, depository institutions may use, or serve
as, brokers or finders to locate repurchase agreement counterparties or
particular securities. When using or acting as this type of agent, the
name of each counterparty should be fully disclosed. Depository
institutions should not enter into undisclosed agency or ``blind
brokerage'' repurchase transactions in which the counterparty's name is
not disclosed.
B. Credit Analysis
Periodic evaluations of counterparty creditworthiness should be
conducted by individuals who routinely make credit decisions and who
are not involved in the execution of repurchase agreement transactions.
Before engaging in initial transactions with a new counterparty,
depository institutions should obtain audited financial statements and
regulatory filings from the proposed counterparty, and should require
the counterparty to provide similar information on a periodic and
timely basis in the future.
The credit analysis should consider the counterparty's financial
statements and those of any related companies that could have an impact
on the financial condition of the counterparty. When transacting
business with a subsidiary, consolidated financial statements of a
parent are not adequate. Repurchase agreements should not be entered
into with any counterparty that is unwilling to provide complete and
timely disclosure of its financial condition. The depository
institution also should inquire about the counterparty's general
reputation and whether state or federal securities regulators or self-
regulatory organizations have taken any enforcement actions against the
counterparty or its affiliates.
C. Credit Limits
Depository institutions usually establish maximum position and
temporary exposure limits for each approved counterparty based upon
credit analysis performed. Periodic reviews and updates of those limits
are necessary.
When assigning individual repurchase agreement counterparty limits,
the depository institution should consider overall exposure to the same
or related counterparty throughout the organization. Repurchase
agreement counterparty limitations should consider the overall
permissible dollar positions in repurchase agreements, maximum
repurchase agreement maturities, limitations on the maturities of
collateral securities, and limits on temporary exposure that may result
from decreases in collateral values or delays in receiving collateral.
III. Guidelines for Controlling Collateral for Securities Purchased
Under Agreement to Resell
Repurchase agreements can be a useful asset and liability
management tool, but repurchase agreements can expose a depository
institution to serious risks if they are not managed appropriately. It
is possible to reduce repurchase agreement risk if the depository
institution executes written agreements with all repurchase agreement
counterparties and custodian banks. Compliance with the terms of these
written agreements should be monitored on a daily basis.
The marketplace perceives repurchase agreement transactions as
similar to lending transactions collateralized by highly liquid
securities. However, experience has shown that the collateral
securities probably will not serve as protection if the counterparty
becomes insolvent or fails, and the purchasing institution does not
have control over the securities. This policy statement provides
general guidance on the steps depository institutions should take to
protect their interest in the securities underlying repurchase
agreement transactions (see ``C. Control of Securities''). However,
ultimate responsibility for establishing adequate procedures rests with
management of the institution. The depository institution's legal
counsel should review repurchase agreements to determine the adequacy
of the procedures used to establish and protect the depository
institution's interest in the underlying collateral.
A. General Requirements
Before engaging in repurchase transactions, a depository
institution should enter into a written agreement covering a specific
repurchase agreement transaction or master agreement governing all
repurchase agreement transactions with each counterparty. Valid written
agreements
[[Page 6937]]
normally specify all the terms of the transaction and the duties of
both the buyer and seller. The agreement should be signed by authorized
representatives of the buyer and seller. Senior managers of depository
institutions should consult legal counsel regarding the content of the
repurchase and custodial agreements. Counsel should review the
enforceability of the agreement with consideration as to the differing
rules of liquidation for agreements with different counterparties, such
as broker/dealers, banks, insurance companies, municipalities, pension
plans, and foreign counterparties. Repurchase and custodial agreements
normally specify, but are not limited to, the following:
Terms of transaction initiation, confirmation and termination;
Provisions for payments and transfers of securities;
Requirements for segregation of collateral securities;
Acceptable types and maturities of collateral securities;
Initial acceptable margin for collateral securities of various
types and maturities;
Margin maintenance and collateral repricing provisions;
Provisions for collateral substitution;
Rights to interest and principal payments;
Events of default and the rights and obligations of the parties;
Required disclosures for transactions in which the seller retains
custody of purchased securities;
Disclosures required by regulatory agencies; and
Persons authorized to transact business for the depository
institution and its counterparty.
B. Confirmations
Some repurchase agreement confirmations may contain terms that
attempt to change the depository institution's rights in the
transaction. The depository institution should obtain and compare
written confirmations for each repurchase agreement transaction to be
certain that the information on the confirmation is consistent with the
terms of the agreement. Confirmations normally identify the essential
terms of the transaction, including the identity of specific collateral
securities and their market values.
C. Control of Securities
As a general rule, a depository institution should obtain
possession or control of the underlying securities and take necessary
steps to protect its interest in the securities. The legal steps
necessary to protect its interest may vary with applicable facts and
law, and accordingly should be undertaken with the advice of counsel.
Particular attention should also be given to the possession or control
requirements under 17 CFR 450 for depository institutions when acting
as a custodian for any type of repurchase agreement. Additional
prudential management controls may include:
(1) Direct delivery of physical securities to the institution, or
transfer of book-entry securities by appropriate entry in an account
maintained in the name of the depository institution by a Federal
Reserve bank which maintains a book-entry system for U.S. Treasury
securities and certain agency obligations (for further information as
to the procedures to be followed, contact the Federal Reserve bank for
the district in which the depository institution is located);
(2) Delivery of either physical securities to, or in the case of
book-entry securities, making appropriate entries in the books of a
third-party custodian designated by the depository institution under a
written custodial agreement which explicitly recognizes the depository
institution's interest in the securities as superior to that of any
other person; or
(3) Appropriate entries on the books of an independent third-party
custodian exercising independent control over the exchange of
securities and funds and acting pursuant to a tripartite agreement with
the depository institution and the counterparty. The third-party
custodian should ensure adequate segregation, free of any lien or
claim, and specific identification and valuation of either physical or
book-entry securities.
If control of the underlying securities is not established, the
depository institution may be regarded only as an unsecured general
creditor of an insolvent counterparty. Under these circumstances,
substantial losses are possible. Accordingly, a depository institution
should not enter into a repurchase agreement without obtaining control
of the securities unless all of the following minimum procedures are
observed:
It is completely satisfied as to the creditworthiness of the
counterparty;
The transaction is within credit limitations that have been pre-
approved by the board of directors, or a committee of the board, for
unsecured transactions with the counterparty;
The depository institution has conducted periodic credit
evaluations of the counterparty;
The depository institution has ascertained that collateral
segregation procedures of the counterparty are adequate; and
It obtains a written and executed repurchase agreement and pays
particular attention to the provisions of 17 CFR 403.5.
Unless prudential internal procedures of these types are instituted
and observed, the financial supervisory agency may cite the depository
institution for engaging in unsafe or unsound practices.
All receipts and deliveries of either physical or book-entry
securities should be made according to written procedures, and third-
party deliveries should be confirmed in writing directly by the
custodian. The depository institution normally obtains a copy of the
advice of the counterparty to the custodian requesting transfer of the
securities to the depository institution. Where securities are to be
delivered, the depository institution should not make payment for
securities until the securities are actually delivered to the
depository institution or its agent. In addition, custodial contracts
normally provide that the custodian take delivery of the securities
subject to the exclusive direction of the depository institution.
Substitution of securities should not be allowed without the prior
written consent of a depository institution. The depository institution
should give its consent before the delivery of the substitute
securities to the depository institution or a third-party custodian and
receive a written list of specific securities substituted and their
respective market values. Any substitution of securities should take
into consideration the following discussion of ``Margin Requirements.''
D. Margin Requirements
Under the repurchase agreement a depository institution should pay
less than the market value of the securities, including the amount of
any accrued interest, with the difference representing a predetermined
margin. When establishing an appropriate margin, a depository
institution should consider the size and maturity of the repurchase
transaction, the type and maturity of the underlying securities, and
the creditworthiness of the counterparty. Margin requirements on U.S.
government and federal agency obligations underlying repurchase
agreements should allow for the anticipated price volatility of the
security until the maturity of the repurchase agreement. Less
marketable securities may require additional margin to compensate for
less liquid market conditions. Written repurchase agreement policies
and procedures normally require daily mark-to-market of repurchase
agreement securities to
[[Page 6938]]
the bid side of the market using a generally recognized source for
securities prices. Repurchase agreements normally provide for
additional securities or cash to be placed with the depository
institution or its custodian bank to maintain the margin within the
predetermined level.
Margin calculations should also consider accrued interest on
underlying securities and the anticipated amount of accrued interest
over the term of the repurchase agreement, the date of interest
payment, and which party is entitled to receive the payment. In the
case of pass-through securities, anticipated principal reductions
should also be considered when determining margin adequacy.
E. Maturity and Renewal Procedures
Depository institutions should follow prudent management procedures
when administering any repurchase agreement. For longer term repurchase
agreements, management should monitor daily the effects of securities
substitutions, margin maintenance requirements (including consideration
of any coupon interest or principal payments) and possible changes in
the financial condition of the counterparty. Engaging in open
repurchase agreement transactions without maturity dates may be
regarded as an unsafe and unsound practice unless the depository
institution has, in its written agreement, retained rights to terminate
the transaction quickly to protect itself against changed
circumstances. Similarly, automatic renewal of short-term repurchase
agreement transactions without reviewing collateral values, adjusting
collateral margin, and receiving written confirmation of the new
contract terms, may be regarded as an unsafe and unsound practice. If
additional margin is not deposited when required, the depository
institution's rights to sell securities or otherwise liquidate the
repurchase agreement should be exercised without hesitation.
IV. Guidelines for Controlling Collateral for Securities Sold Under
Agreement to Repurchase
Depository institutions normally use current market values (bid
side), including the amount of any accrued interest, to determine the
price of securities that are sold under repurchase agreements.
Counterparties should not be provided with excessive margin. Thus, the
written repurchase agreement contract normally provides that the
counterparty must make additional payment or return securities if the
margin exceeds agreed upon levels. When acquiring funds under
repurchase agreements it is prudent business practice to keep at a
reasonable margin the difference between the market value of the
securities delivered to the counterparty and the amount borrowed. The
excess market value of securities sold by a depository institution may
be viewed as an unsecured loan to the counterparty subject to the
unsecured prudential limitations for the depository institution and
should be treated accordingly for credit policy and control purposes.
Dated: February 5, 1998.
Joe M. Cleaver,
Executive Secretary, Federal Financial Institutions Examination
Council.
[FR Doc. 98-3373 Filed 2-10-98; 8:45 am]
BILLING CODES 6210-01-P; 6720-01-P; 6714-01-P; 4810-01-P
