[Federal Register: February 20, 1998 (Volume 63, Number 34)]

[Notices]

[Page 8645-8649]

From the Federal Register Online via GPO Access [wais.access.gpo.gov]

[DOCID:fr20fe98-62]

=======================================================================

-----------------------------------------------------------------------

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.

-----------------------------------------------------------------------

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.

---------------------------------------------------------------------------

\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.

---------------------------------------------------------------------------

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

[[Page 8649]]

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