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Financial Institution Letters

Sweep Account Disclosure Requirements
Frequently Asked Questions
July 6, 2009

July 6, 2009

In January 2009, the FDIC Board of Directors adopted the final rule entitled "Processing of Deposit Accounts in the Event of an Insured Depository Institution Failure" (12 CFR Section 360.8). This rule codifies the FDIC's practices for determining deposit and other account balances at a failed insured depository institution. It also includes disclosure requirements for certain sweep accounts.

The following Frequently Asked Questions (FAQs) address the disclosure requirements of Section 360.8. The information provided in the FAQs is a compilation of staff guidance provided in connection with actual questions received from industry representatives on the applicable issues. (Please note that the opinions expressed in the FAQs are staff views and should only be considered advisory in nature. Staff opinions are not binding upon the FDIC or its Board of Directors. Also, the information is not meant to be all inclusive.)

The final rule was published in the Federal Register on February 2, 2009 (74 Fed. Reg. 5797, and can be accessed through this link- PDF (PDF Help). The Federal Register notice provides details on complying with the rule.

1. Q: Could you clarify the types of sweep accounts subject to the disclosure requirements?

A: For the purposes of disclosure, a sweep account involves the pre-arranged transfer of funds from a deposit account to: (1) an investment vehicle located outside the depository institution or (2) another account or investment vehicle located within the depository institution. Sweep arrangements subject to the disclosure requirements are those allowing for the recurring movement of funds, typically daily, between the deposit account and the other account or sweep investment vehicle. Excluded from this definition are accounts involving:

a. Customer-initiated transactions not pre-arranged through the deposit account agreement.

b. Transactions used to amortize a loan according to a regular payment schedule, such as monthly or biweekly.

c. Deposit-to-deposit sweeps that do not result in a change in insurance status of the funds. These include zero-balance accounts (ZBAs) and reserve sweeps. ZBAs involve a master concentration account connected with one or more subsidiary accounts. The account instructions typically call for any funds residing in the subsidiary accounts at the end of the day to be swept to the master concentration account. All accounts associated with a ZBA usually are owned by the same legal entity; thus, the movement of funds between the master and subsidiary accounts will not involve a change in insurance status for the customer. Likewise, reserve sweeps typically involve a transaction deposit account connected to a money market deposit account, usually structured as a sub-account, between which funds are moved on a periodic basis. In some cases, the customer may not be aware that a sub-account has been established. Whether or not the customer is aware of such arrangements, a deposit-to-deposit sweep where the insurance status of the customer is unchanged is not covered by the disclosure requirements.

d. Bill-paying arrangements.

2. Q: What are the most common sweep arrangements covered by the disclosure requirements?

A: The three most common sweep arrangements involve:

a. A Eurodollar deposit (typically a Cayman Island or Nassau branch deposit) or an International Banking Facility (IBF) deposit.

b. Repurchase agreements.

c. Money market mutual funds.

The FDIC also is aware of sweep arrangements that transfer funds into Fed Funds and holding company commercial paper. Another arrangement uses the swept funds to pay down the customer's loan with the depository institution. This type of loan sweep is not an arrangement used to amortize a loan; rather, excess funds in the deposit account are swept daily to pay down the loan balance and the following day the swept funds are made available to the customer's deposit account.

3. Q: When do the sweep disclosure requirements of the rule become effective?

A: (1) For sweep account agreements in effect on July 1, 2009, the disclosures must be provided to sweep account customers within 60 days after July 1, 2009 (i.e., no later than September 1, 2009) and at least annually thereafter. (2) Starting July 1, 2009, the institution must provide the disclosures when the institution enters into a new sweep account agreement with a customer and at least annually thereafter. (3) Starting July 1, 2009, the institution must provide the disclosures when the institution renews an existing sweep account agreement with a customer and at least annually thereafter.

4. Q: What type of disclosure is required by the rule?

A: Institutions must prominently disclose in writing to sweep account customers whether their swept funds are deposits within the meaning of 12 U.S.C. 1813(l). If the funds are not deposits, the institution must further disclose the status such funds would have if the institution failed, e.g., general creditor status or secured creditor status. Disclosure can be made through various means, such as client letters, transactions confirmation statements or account statements. The disclosure must be consistent with how such funds are reported on Call and Thrift Financial Reports.

5. Q: What approach will the FDIC take in determining how swept funds will be treated in the event of failure?

A: The rule establishes the following three principles to be used in establishing deposit and other account balances in the event of failure.

a. The FDIC generally will use end-of-day ledger balances as normally calculated by the depository institution.

b. It is the receiver's responsibility upon taking control of a failed institution to block funds from moving out of or into the institution.

c. The receiver may correct deposit and other account balances, if necessary to protect the first two principles.

Additionally, the FDIC will apply the following guidelines for funds swept internally within the insured depository institution:

a. Ownership of the funds and the nature of the claim will be based on the institution's records.

b. Depositor-owned funds residing in a general ledger account will be a deposit for insurance purposes.

c. The full amount of swept funds attributable to an individual customer residing in an omnibus account will be treated as belonging to that customer, regardless of any netting of debits and credits for the customer in the omnibus account.

6. Q: How do the FDIC's established principles (to be applied in the event of failure) coincide with a bank's normal posting processes?

A: The FDIC generally will follow the bank's normal posting process on the day of failure to arrive at the end-of-day deposit and other account balances used for claims purposes. This means that sweep processes designed to move funds internally within the institution typically will be carried out on the day of failure, even if these processes are scheduled to occur after the FDIC takes control of the institution. Since most sweep transactions are scheduled to move funds prior to the institution's normal end-of-day, these processes will occur on the day of failure. For claims purposes, the FDIC will use deposit and other account balances as reflected on the institution's end-of-day ledger. The mechanics and timing of how funds move within the institution are important to determine how swept funds will be treated in the event of failure.

For sweep arrangements that move funds outside the institution (external) the receiver may block such funds from leaving the institution when it takes control. If the external sweep is blocked, such swept funds will be treated as if they had not left the originating deposit account. In the case where externally swept funds have left the institution by the time the receiver takes control, the sweep transaction will be deemed completed and posted to the deposit account according to normal procedures.

7. Q: How are the various individual sweep account arrangements treated in the event of failure?
A: The February 2, 2009, Federal Register-PDF (PDF Help) notice on the rule illustrates how various sweep account arrangements are treated in the event of failure.

8. Q: What is the priority scheme used by the FDIC when it acts as a receiver for a failed insured depository institution?

A: The FDIC follows the following statutory priority scheme:

a. Administrative expenses of the receiver

b. Deposits (insured and uninsured)

c. General creditors (including foreign and IBF deposits)

d. Subordinated debt

e. Shareholder interests

The FDIC operates under statutory depositor preference requirements. 12 U.S.C. 1821(d)(11). Under normal procedures the depositor class must be paid in full before general creditors receive any value.

9. Q: Will the FDIC provide specific disclosure language for the various types of sweep products?

A: No. Those who commented on the final rule suggested that the FDIC be flexible as to the disclosure requirements and not prescribe specific language. Also, providing sample disclosure language might not be practical because sweep agreements vary considerably.

10. Q: Do the disclosure requirements apply when funds are swept into an investment vehicle unaffiliated with the bank, as opposed to a proprietary or otherwise affiliated investment vehicle?

A: Yes, the disclosure requirements apply to covered sweep arrangements regardless of the affiliation of the investment vehicle.

11. Q: We have a sweep product that moves funds from a non-interest bearing transaction account, covered in full by the FDIC's Transaction Account Guaranty Program, into an interest-bearing deposit account not covered by the guarantee. Is this sweep arrangement subject to disclosure under this rule because the insurance status of the customer may change?

A: No, but such arrangements will require a disclosure under the FDIC's Transaction Account Guaranty Program (12 CFR Section 370.5). Please see the FDIC's FAQs on the TAGP.

12. Q: Our trust department is responsible for managing certain trust assets, either in a fiduciary or custodial capacity. The management of such assets periodically generates cash for the trust customers which is invested according to prearranged instructions. This idle cash is moved to an omnibus demand deposit account residing on the books of the bank where it may rest overnight or longer before being transmitted to an investment vehicle, typically a money market mutual fund. Is this a sweep arrangement subject to disclosure?

A: No. Under this arrangement, the funds in question do not originate from a deposit account, as required by the definition of a sweep product subject to the disclosure requirements.

13. Q: The rule distinguishes between repo sweep arrangements properly executed and those that are not properly executed. What is the difference?

A: In a properly executed repo sweep, as of the institution's end-of-day, the sweep customer either becomes the legal owner of identified assets (usually securities) or obtains a perfected interest in these assets. In an improperly executed repo sweep, the sweep customer obtains neither an ownership interest nor a perfected interest in the applicable assets.

14. Q: Regarding a repo sweep arrangement, what does the FDIC consider to be a perfected interest in a security?

A: Each institution must determine for itself whether a security interest is perfected under the relevant state law. The FDIC generally considers three elements in determining whether the customer has a perfected security interest in a security subject to a repo sweep: (1) the particular security in which the customer has an interest has been identified, and this identity is indicated in a daily confirmation statement; (2) the customer has "control" of the particular security; and (3) there is no substitution of the security during the term of the repurchase agreement even if the agreement allows for substitution with the customer/buyer's consent.

15. Q: How can a bank satisfy the first element for a properly executed repurchase agreement – that a particular security be identified?

A: The buyer's interest must be indicated by a confirmation identifying the security (i.e., CUSIP or mortgage-backed security pool number) and also specifying the issuer, maturity date, coupon rate, par amount and market value. Fractional interests in a specific security must be identified, if relevant. An arrangement where bulk segregation or pooling of repurchase collateral without identification of specific securities does not result in the buyer receiving an identified interest in specifically identifies securities. For example, the practice of confirming only "various securities" in connection with a repurchase agreement is not sufficient to comply with this requirement, and the agreement will not be properly perfected.

16. Q: How can a bank satisfy the second element for a properly executed repurchase agreement – that the customer has "control" of the security? A: The customer must be able to direct the disposition of the security in the event of default. The two most common arrangements used by a depository institution (seller) to hold securities used in repurchase agreements are tri-party and hold-in-custody (HIC).

a. In a tri-party arrangement, the securities are held by an independent third party acting as a custodian. As custodian, the third party has possession over the securities and performs certain functions including effecting the buyer's orders regarding the securities. It should be noted that solely transferring the securities to a third party custodian does not transfer control. Rather, the customer/buyer must be able to direct the custodian as to the disposition of the securities in the event of a default by the seller. If the seller is the sole party who can direct the custodian to act with respect to the securities, control has not been transferred.

b. In a HIC arrangement: (1) the depository institution maintains physical possession of the securities or (2) a third party maintains physical possession of the securities but the third party accepts direction regarding the securities solely from the depository institution. A HIC arrangement may result in a transfer of control of the security to the customer/buyer if the repurchase agreement allows the depository institution, acting as agent for the customer, to effect the customer's orders regarding the securities, such as transferring the securities to the customer in the event of failure.

17. Q: How can a bank satisfy the third element for a properly executed repurchase agreement regarding the "right of substitution"?

A: Unless perfection is otherwise accomplished, there must be no substitution of the security during the term of the repurchase agreement even if the agreement allows for substitution with the customer/buyer's consent.

As a practical matter, substitution generally is not exercised. Repo sweeps typically are overnight investments where the customer may own the security, or an interest in a security, for only a few hours, i.e., late evening to early morning. During such a short time period, it may be impractical to exercise substitution. Substitution of securities in an overnight transaction will result in an unperfected interest in the securities. If substitution occurs, the securities specifically identified in the confirmation will be inaccurate. Therefore, substitution will defeat proper execution because securities will not have been specifically identified.

The FDIC has concerns about the ability to perfect a security interest when there is a substitution clause in a repurchase sweep agreement; however, the clause itself may not defeat perfection. If a substitution clause is present in the repurchase sweep agreement, the depository institution should acknowledge that substitution will not be exercised and indicate this through the sweep disclosure to the customer. Further, newly issued or amended repurchase sweep agreements, including contract renewals, may not contain a substitution clause.

A repurchase agreement may allow for the repurchase of the identified security prior to scheduled maturity and the simultaneous sale of a new security to the customer/buyer for the remaining maturity. The new sale would generate a new confirmation statement to the buyer and the FDIC would not view perfection of the security interest as being defeated assuming the other two elements of control are met.

18. Q: The rule states that in an improperly executed repo sweep, the swept funds would be treated as if they had not left the deposit account from which they originated. Does this mean these funds must be reported as a deposit on the Call Report or Thrift Financial report?

A: Yes. Such reporting must be made after July 1, 2009 – the effective date of the disclosure requirements in the final rule on the "Processing of Deposit Accounts in the Event of an Insured Depository Institution Failure."

19. Q: The rule indicates that funds resting in an omnibus account in connection with a next-day money market mutual funds sweep are deposits. Does this mean these funds must be reported as a deposit on the Call Report or Thrift Financial Report?

A: Yes. Such reporting must be made after July 1, 2009 – the effective date of the disclosure requirements in final rule on the "Processing of deposit Accounts in the Event of an Insured Depository Institution Failure."

20. Q: Regulations under the Government Securities Act (17 CFR Section 403.5) require, among other things, that depository institutions advise the owner of a repurchase agreement that the funds held by the depository institution pursuant to the repurchase agreement "are not a deposit and therefore are not insured by the Federal Deposit Insurance Corporation." How can a depository institution comply with this disclosure requirement and the FDIC's disclosure requirements for sweep accounts?

A: The depository institution can explain in the disclosure that, unless the institution improperly executes the repurchase agreement, the funds involved in the repurchase agreement are not deposits and, thus, are not insured as such by the FDIC.

Last Updated 7/6/2009

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