[Federal Register Volume 63, Number 34 (Friday, February 20, 1998)]
[Notices]
[Pages 8645-8649]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-4143]
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FEDERAL DEPOSIT INSURANCE CORPORATION
Repurchase Agreements of Depository Institutions With Securities
Dealers and Others; Notice of Modification of Policy Statement
AGENCY: Federal Deposit Insurance Corporation (FDIC).
ACTION: Modification of policy statement.
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SUMMARY: As part of the FDIC's systematic review of its regulations and
written policies under section 303(a) of the Riegle Community
Development and Regulatory Improvement Act of 1994 (CDRI), the FDIC is
adopting modifications recently made by the Federal Financial
Institutions Examination Council (FFIEC) to its policy statement on
Repurchase Agreements of Depository Institutions with Securities
Dealers and Others (Policy Statement). The Policy Statement provides
guidance to insured
[[Page 8646]]
depository institutions about entering into repurchase agreements in a
safe and sound manner. The FDIC is adopting the changes to the Policy
Statement which the FFIEC has made to update and streamline the Policy
Statement.
EFFECTIVE DATE: February 20, 1998.
FOR FURTHER INFORMATION CONTACT: William A. Stark, Assistant Director,
(202/898-6972), Kenton Fox, Senior Capital Markets Specialist, (202/
898-7119), Division of Supervision; Leslie Sallberg, Counsel, (202/898-
8876), Legal Division, FDIC, 550 17th Street, N.W., Washington, D.C.
20429.
SUPPLEMENTARY INFORMATION:
Background
The FDIC is conducting a systematic review of its regulations and
written policies. Section 303(a) of the CDRI (12 U.S.C. 4803(a))
requires the FDIC, the Office of the Comptroller of the Currency (OCC),
the Board of Governors of the Federal Reserve System (FRB), and the
Office of Thrift Supervision (OTS) (collectively, the federal banking
agencies) to each streamline and modify its regulations and written
policies in order to improve efficiency, reduce unnecessary costs, and
eliminate unwarranted constraints on credit availability. Section
303(a) also requires each of the federal banking agencies to remove
inconsistencies and outmoded and duplicative requirements from its
regulations and written policies.
The 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. The OCC,
FRB, and FDIC each adopted the FFIEC's original Policy Statement, (50
FR 49764, December 4, 1985) with the FDIC's adoption taking place on
December 31, 1985. 2 FDIC, Law, Regulations, and Related Acts (FDIC)
5265.
On February 11, 1998, the FFIEC published a notice making changes
to its Policy Statement in order to update, clarify and streamline it.
63 FR 6935. There are three principal revisions 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 deleted. 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.
Consistent with the goals of the CDRI review, the FDIC is adopting
the FFIEC's modifications to the Policy Statement to eliminate outdated
material, provide clarification, and to streamline the contents of the
Policy Statement. The modified Policy Statement reads as follows:
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 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:
[[Page 8647]]
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 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.
[[Page 8648]]
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 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
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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.
By order of the Board of Directors.
Dated at Washington, D.C., this 10th day of February, 1998.
Federal Deposit Insurance Corporation.
Robert E. Feldman,
Executive Secretary.
[FR Doc. 98-4143 Filed 2-19-98; 8:45 am]
BILLING CODE 6714-01-P