[Federal Register Volume 62, Number 170 (Wednesday, September 3, 1997)]
[Rules and Regulations]
[Pages 46444-46446]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-23422]
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DEPARTMENT OF THE TREASURY
Fiscal Service
31 CFR Part 344
[Department of the Treasury Circular, Public Debt Series No. 3-72]
Regulations Governing United States Treasury Certificates of
Indebtedness, Treasury Notes, and Treasury Bonds--State and Local
Government Series
AGENCY: Bureau of the Public Debt, Fiscal Service, Treasury.
ACTION: Final rule.
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SUMMARY: The Department of the Treasury (Department or Treasury) is
issuing in final form an amendment to its regulations governing State
and Local Government Series (SLGS) securities. It has been brought to
the attention of the Department that the SLGS securities program can be
misused when subscriptions for SLGS securities are used as a cost-free
interest rate hedge or option (option) for speculation in open market
securities. This final rule clarifies that the use of SLGS securities
for option purposes is prohibited. The purpose of the SLGS securities
program is to assist state and local government issuers of tax-exempt
bonds in meeting certain Federal tax restrictions, not to provide a
cost-free option.
Treasury is considering first, whether it would be consistent with
the purposes of the SLGS securities program to allow SLGS securities to
serve as options if Treasury were appropriately compensated and second,
if the answer to the first question is affirmative, whether there is a
practical way for the Department to charge for the use of SLGS
securities as options. Neither question, however, has yet been
answered. Unless Treasury does determine that it would be both
advisable and practical to allow SLGS securities to serve as options if
Treasury is appropriately compensated, the use of SLGS securities for
such purpose will continue to be an inappropriate use of SLGS
securities.
EFFECTIVE DATE: September 3, 1997.
FOR FURTHER INFORMATION CONTACT: Howard Stevens, Director, Division of
Special Investments at 304-480-7752, Jim Kramer-Wilt, Attorney/Adviser,
Office of the Chief Counsel, at 304-480-5190 or Edward C. Gronseth,
Deputy Chief Counsel, Office of the Chief Counsel, at 304-480-5192.
SUPPLEMENTARY INFORMATION:
1. Background
The SLGS securities program was established and is maintained to
assist state and local government issuers in meeting yield restriction
and rebate requirements applicable to tax-exempt bonds under the
Internal Revenue Code. On October 28, 1996, the Department published
revised regulations to make the SLGS securities program a more flexible
and competitive investment vehicle for issuers. In response to requests
by state and local government issuers to shorten the minimum time for
subscribing for SLGS securities, the Treasury revised the regulations
to permit an issuer to subscribe for SLGS securities up to 60 days
prior to their scheduled issue date and then to cancel that
subscription within five days of that issue date for subscriptions of
$10 million or less and within seven days for subscriptions of more
than $10 million, without penalty. The regulations also provide that an
issuer canceling a SLGS securities subscription after that five/seven-
day period is not subject to a monetary penalty, but is prohibited from
subscribing for SLGS securities for a six month period.
The Department understands that the ability to cancel a SLGS
securities subscription without a monetary penalty has led some market
participants to conclude that they can both subscribe for SLGS
securities and enter into a contract for the purchase of securities on
the open market for the same defeasance transaction or fund deposit in
order to create a cost-free option in connection with a defeasance
escrow or fund.
The prices established by the Treasury for the SLGS securities do
not include the cost of an option. The Treasury believes it is
inappropriate for government bodies to use the SLGS securities program
to create an option. Treasury is considering first, whether it would be
consistent with the purposes of the SLGS securities program to allow
SLGS securities to serve as options if Treasury were appropriately
compensated and second, if the answer to the first question is
affirmative, whether there is a practical way for the Department to
charge for the use of SLGS securities as options. Neither question,
however, has yet been answered. Unless Treasury does determine that it
would be both advisable and practical to allow SLGS securities to serve
as options if Treasury is appropriately compensated, the use of SLGS
securities for options will continue to be an inappropriate use of SLGS
securities. The Department has therefore decided to amend the SLGS
securities regulations to clarify that transactions in which issuers
use SLGS securities to provide a cost-free interest rate hedge or
option are prohibited.
The following examples are illustrative of certain acceptable and
unacceptable practices:
(1) In order to fund an escrow for an advance refunding, an issuer
simultaneously enters into a purchase contract for open market
securities and subscribes for SLGS securities, such that either
purchase is sufficient to pay the cash flows on the outstanding bonds
to be refunded but together, the purchases are greatly in excess of the
amount necessary to pay the cash flows. The issuer plans that, if
interest rates decline during the period between the date of
subscribing for the SLGS securities and the requested date of issuance
of the SLGS securities, the issuer will enter into an offsetting
agreement to sell the open market securities and use the bond proceeds
to purchase the SLGS securities to fund the escrow. If, however,
interest rates do not decline in that period, the issuer plans to use
the bond proceeds to purchase the open market securities to fund the
escrow and cancel the SLGS securities subscription. This arrangement in
effect allows the SLGS securities program to provide a cost-free option
to the issuer, and this amendment to the regulation clarifies that such
transactions are prohibited.
(2) The existing escrow for an advance refunding contains open
market securities which produces a negative arbitrage. In order to
reduce or eliminate this negative arbitrage, the issuer subscribes for
SLGS securities at a yield higher than the yield on the existing
escrow, but less than the permitted yield. At the same time, the issuer
agrees to sell the open market securities in the existing escrow to a
third party and use the proceeds to purchase the SLGS securities if
interest rates decline between the date of subscribing for the SLGS
securities and the requested date of issuance of the SLGS securities.
The issuer and the third party further agree that if interest rates
increase during this period, the issuer will cancel the SLGS securities
subscription. This arrangement in effect allows the SLGS securities
program to provide a cost-free
[[Page 46445]]
option to the issuer, and this amendment to the regulation clarifies
that such a transaction is prohibited.
(3) Under the same facts as in Example 2, except that in this case,
the agreement entered into by the issuer with a third party to sell the
open market securities in order to obtain funds to purchase the SLGS
securities is not conditioned upon changes in interest rates on
Treasury securities. No option is created, and the issuer would not be
prohibited from subscribing for SLGS securities.
(4) The issuer subscribes for SLGS securities fifteen days before
the settlement date of its bonds at the maximum rates on such day, but
the resulting yield in the escrow is less than the permitted yield. The
rates on the SLGS securities rise over the next few days, and, within
the time periods permitted for cancellation by these regulations, the
issuer cancels the earlier subscription and resubscribes at the higher
rates. This transaction is permissible.
(5) An issuer holds a portfolio of open market securities in an
account that produces negative arbitrage. In order to reduce or
eliminate this negative arbitrage, the issuer subscribes for SLGS
securities for purchase in sixty days. At the same time, the issuer
sells an option to purchase the portfolio of open market securities. If
interest rates increase, the holder of the option will not exercise its
option and the issuer will cancel the SLGS securities subscription. On
the other hand, if interest rates decline, the option holder will
exercise the option and the issuer will use the proceeds to purchase
the SLGS securities. This arrangement uses the SLGS securities program
to provide the issuer with a cost-free option and this amendment to the
regulation clarifies that such transactions are prohibited.
2. Section by Section Summary
Subpart A--General Information
(1) 344.1(f)--This is a new paragraph titled Impermissible
transactions which applies to all escrows and funds subject to yield or
rebate restrictions. It is impermissible to subscribe for SLGS
securities for deposit in an escrow or fund (such as a reserve or
construction fund) if, at any time between the close of business on the
date of subscription and the close of business on the date of issue,
the amount of SLGS securities subscribed for, plus the amount of other
securities, if any, already in such escrow or fund, plus the amount of
other securities the government body has acquired, or has the right to
acquire for deposit in such escrow or fund, exceeds the total amount of
securities needed for such escrow or fund. Securities held in the
escrow or fund that are not subject to an agreement conditioned on
changes in the interest rate on open market Treasury securities on or
prior to the date of issue of the SLGS securities shall not be included
in such computation. An adjustment in the initial subscription amount
in accordance with 31 CFR Sec. 344.3(b)(3)(ii) will not in and of
itself make the transaction impermissible.
(2) 344.1(g)--This is the paragraph formerly numbered 344.1(f) and
is amended to state that the Secretary may revoke the issuance of any
security and may declare the subscriber ineligible thereafter to
subscribe for SLGS securities if the subscriber uses SLGS securities in
an impermissible manner as described in section 344.1(f), if the
Secretary deems such action in the public interest.
(3) 344.1 (h), (i) & (j)--These paragraphs are renumbered 344.1
(i), (j) and (k) respectively.
(4) 344.3(b)(3)(iii)--This paragraph is amended to read that an
interest rate cannot e changed to a rate that exceeds the maximum
interest rate in the table that was in effect for a security of
comparable maturity on the date the initial subscription was submitted,
unless the issuer obtains a higher rate by canceling and resubscribing
in compliance with the provisions of 344.3(b)(1).
Procedural Requirements
This final rule is not a significant regulatory action as defined
in Executive Order 12866. Therefore, an assessment of anticipated
benefits, costs and regulatory alternatives is not required.
This final rule relates to matters of public contract. The notice
and public procedures requirements of the Administrative Procedure Act
are inapplicable, pursuant to 5 U.S.C. 553(a)(2). Since no notice of
proposed rulemaking was required, the provisions of the Regulatory
Flexibility Act (5 U.S.C. 601 et. seq.) do not apply.
There are no collections of information required by this final
rule, and, therefore, no approval pursuant to the Paperwork Reduction
Act is required.
List of Subjects in 31 CFR part 344
Bonds, Government securities, Securities.
Dated: August 27, 1997.
Gerald Murphy,
Fiscal Assistant Secretary.
For the reasons set forth in the preamble, part 344 of Title 31 of
the Code of Federal Regulations is revised to read as follows:
PART 344--REGULATIONS GOVERNING UNITED STATES TREASURY CERTIFICATES
OF INDEBTEDNESS, TREASURY NOTES, AND TREASURY BONDS--STATE AND
LOCAL GOVERNMENT SERIES
1. The authority citation for part 344 continues to read:
Authority: 26 U.S.C. 141 note; 31 U.S.C. 3102.
2. Section 344.1 is amended by redesignating paragraphs (f) through
(j) as (g) through (k), adding a new paragraph (f) and amending
paragraph (g)(3) as follows:
Sec. 344.1 General provisions.
* * * * *
(f) Impermissible Transactions. It is impermissible to subscribe
for SLGS securities for deposit in a defeasance escrow or fund if, at
any time between the close of business on the date of subscription and
the close of business on the date of issue, the amount of SLGS
securities subscribed for, plus the amount of other securities, if any,
already in such escrow or fund, plus the amount of other securities the
government body has acquired, or has the right to acquire for deposit
in an escrow or fund, exceeds the total amount of securities needed to
fund such escrow or fund. Securities held in the escrow or fund that
are not subject to an agreement conditioned on changes in the interest
rate on open market Treasury securities on or prior to the date of
issue of the SLGS securities shall not be included in such computation.
An adjustment in the subscription amount in accordance with 31 CFR
344.3(b)(3)(ii) will not in and of itself make the transaction
impermissible.
(g) Reservations.
* * * * *
(3) To revoke the issuance of any security, and to declare the
subscriber ineligible thereafter to subscribe for securities under this
offering if the Secretary deems such action in the public interest and
if any security is issued on the basis of an improper certification,
other misrepresentations (other than as the result of an inadvertent
error) or in an impermissible transaction as set forth in
Sec. 344.1(f).
* * * * *
[[Page 46446]]
3. Section 344.3 is amended by revising paragraph (b)(3)(iii) to
read as follows:
Sec. 344.3 Subscription for purchase.
* * * * *
(b) * * *
(3) * * *
(iii) An interest rate cannot be changed to a rate that exceeds the
maximum interest rate in the table that was in effect for a security of
comparable maturity on the date the initial subscription was submitted,
unless the issuer obtains a higher rate by canceling and resubscribing
in compliance with the provisions of Sec. 344.3(b)(1).
* * * * *
[FR Doc. 97-23422 Filed 8-29-97; 12:14 pm]
BILLING CODE 4810-39-U
