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FDIC Federal Register Citations

[Federal Register: February 11, 1998 (Volume 63, Number 28)]
[Notices]               
[Page 6935-6938]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr11fe98-63]
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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the Policy Statement to eliminate outdated material, provide 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

Last Updated 02/11/1998 regs@fdic.gov