[Federal Register: October 3, 1997 (Volume 62, Number 192)]
[Notices]
[Page 51862-51867]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr03oc97-81]
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FEDERAL FINANCIAL INSTITUTIONS EXAMINATION COUNCIL
Supervisory Policy Statement on Investment Securities and End-
User Derivatives Activities
AGENCY: Federal Financial Institutions Examination Council.
ACTION: Notice and request for comment.
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SUMMARY: The Board of Governors of the Federal Reserve System (FRB),
the Federal Deposit Insurance Corporation (FDIC), the Office of the
Comptroller of the Currency (OCC), the Office of Thrift Supervision
(OTS), and the National Credit Union Administration (NCUA)
(collectively referred to as the agencies), under the auspices of the
Federal Financial Institutions Examination Council (FFIEC), request
comment on a Supervisory Policy Statement on Investment Securities and
End-User Derivatives Activities (1997 Statement) to provide guidance on
sound practices for managing the risks of investment activities. The
agencies also are seeking comment on their intent to rescind the
Supervisory Policy Statement on Securities Activities published on
February 3, 1992 (1992 Statement). Many elements of that prior
statement are retained in the 1997 Statement, while other elements have
been revised or eliminated. Changes in generally accepted accounting
principles, various developments in both securities and derivatives
markets, and revisions to the regulators' approach to risk management
have contributed to the need to reassess the 1992 Statement. In
particular, the agencies are proposing to eliminate the specific
constraints on investing in ``high risk'' mortgage derivative products
that were stated in the 1992 Statement. The agencies believe that it is
a sound practice for institutions to understand the risks related to
their investment holdings. Accordingly, the 1997 Statement substitutes
broader guidance than the specific pass/fail requirements contained in
the 1992 Statement. Other than for the supervisory guidance contained
in the 1992 Statement, the 1997 Statement does not supersede any other
requirements of the respective agencies' statutory rules, regulations,
policies, or supervisory guidance.
DATES: Comments must be received by November 17, 1997.
ADDRESSES: Comments should be sent to Joe M. Cleaver, Executive
Secretary, Federal Financial Institutions Examination Council, 2100
Pennsylvania Avenue, NW, Suite 200, Washington, D.C. 20037 or by
facsimile transmission to (202) 634-6556.
FOR FURTHER INFORMATION CONTACT: FRB: James Embersit, Manager,
Financial Analysis, (202) 452-5249, Division of Banking Supervision and
Regulation; Gregory Baer, Managing Senior Counsel, (202) 452-3236,
Board of Governors of the Federal Reserve System. For the hearing
impaired only, Telecommunication Device for the Deaf (TDD), Dorothea
Thompson, (202) 452-3544, Board of Governors of the Federal Reserve
System, 20th and C Streets, NW, Washington, DC 20551.
FDIC: William A. Stark, Assistant Director, (202) 898-6972, Miguel
D. Browne, Manager, (202) 898-6789, John J. Feid, Chief, Risk
Management, (202) 898-8649, Division of Supervision; Michael B.
Phillips, Counsel, (202) 898-3581, Legal Division, Federal Deposit
Insurance Corporation, 550 17th Street, NW, Washington, DC 20429.
OCC: Kurt Wilhelm, National Bank Examiner, (202) 874-5670, J. Ray
Diggs, National Bank Examiner, (202) 874-5670, Treasury and Market
Risk; Mark J. Tenhundfeld, Assistant Director, (202) 874-5090,
Legislative and Regulatory Activities Division, Office of the
Comptroller of the Currency, 250 E Street, SW, Washington, DC 20219.
OTS: Robert A. Kazdin, Senior Project Manager, (202) 906-5759,
Anthony G. Cornyn, Director, (202) 906-5727, Risk Management; Christine
Harrington, Counsel (Banking and Finance), (202) 906-7957, Regulations
and Legislation Division, Chief Counsel's Office, Office
[[Page 51863]]
of Thrift Supervision, 1700 G Street, NW, Washington, DC 20552.
NCUA: Daniel Gordon, Senior Investment Officer, (703) 518-6360,
Office of Investment Services; Lisa Henderson, Attorney, (703) 518-
6540, National Credit Union Administration, 1775 Duke Street,
Alexandria, VA 22314-3428.
SUPPLEMENTARY INFORMATION: In 1992, the agencies implemented the
FFIEC's Supervisory Policy Statement on Securities Activities. The 1992
Statement addressed: (1) Selection of securities dealers, (2) portfolio
policy and strategies (including unsuitable investment practices), and
(3) residential mortgage derivative products (MDPs).
The final section of the 1992 Statement directed institutions to
subject MDPs to supervisory tests to determine the degree of risk and
the investment portfolio eligibility of these instruments. At that
time, the agencies believed that many institutions had demonstrated an
insufficient understanding of the risks associated with investments in
MDPs. This occurred, in part, because most MDPs were issued or backed
by collateral guaranteed by government sponsored enterprises.
Therefore, most MDPs were not subject to legal investment limits. The
agencies were concerned that the absence of significant credit risk on
most MDPs had allowed institutions to overlook the significant interest
rate risk present in certain structures of these instruments. In an
effort to enhance the investment decision making process at financial
institutions, and to emphasize the interest rate risk of highly price
sensitive instruments, the agencies implemented supervisory tests
designed to identify those MDPs with price and average life risks
greater than a newly issued residential mortgage pass-through security.
These supervisory tests provided a discipline that helped
institutions to better understand the risks of MDPs prior to purchase.
The 1992 Statement generally provided that institutions should not hold
a high risk MDP in their investment portfolios.1 A high risk
MDP was defined as a mortgage derivative security that failed any of
three supervisory tests. The three tests included: an average life
test, an average life sensitivity test, and a price sensitivity
test.2
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\1\ The only exceptions granted were for those high risk
securities that either reduced interest rate risk or were placed in
a trading account. Federal credit unions were not permitted these
exceptions.
\2\ Average Life: Weighted average life of no more than 10
years; Average Life Sensitivity: (a) Weighted average life extends
by not more than 4 years (300 basis point parallel shift in rates),
(b) weighted average life shortens by no more than 6 years (300
basis point parallel shift in rates); Price Sensitivity: price does
not change by more than 17 percent (increase or decrease) for a 300
basis point parallel shift in rates.
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These supervisory tests, commonly referred to as the ``high risk
tests,'' successfully protected institutions from significant losses in
MDPs. By requiring a pre-purchase price sensitivity analysis that
helped institutions to better understand the interest rate risk of
MDPs, the high risk tests effectively precluded institutions from
investing in many types of MDPs that resulted in large losses for other
investors. However, the high risk tests may have created unintended
distortions of the investment decision making process. Many
institutions eliminated all MDPs from their investment choices,
regardless of the risk versus return merits of such instruments. These
reactions were due, in part, to concerns about regulatory burden, such
as higher than normal examiner review of MDPs. By focusing only on
MDPs, the test and its accompanying burden indirectly provided
incentives for institutions to acquire other types of securities with
complex cash flows, often with price sensitivities similar to high risk
MDPs. The emergence of the structured note market is just one example.
The test may have also created the impression that supervisors were
more concerned with the type of instrument involved (i.e., residential
mortgage products), rather than the risk characteristics of the
instrument, since only MDPs were subject to the high risk test. The
specification of tests applied to individual securities may have also
inhibited some institutions from applying more comprehensive analytical
techniques at the portfolio and institutional level.
As a result, the agencies no longer believe that the pass/fail
criteria of the high risk tests as applied to specific instruments are
useful for the supervision of well-managed institutions. The agencies
believe that an effective risk management program, through which an
institution identifies, measures, monitors, and controls the risks of
investment activities, provides a better framework. Consequently, the
agencies are proposing to rescind the 1992 Policy Statement and
eliminate the high risk tests as binding constraints on MDP purchases.
Effective risk management addresses risks across all types of
instruments on an investment portfolio basis and ideally, across the
entire institution. The complexity of many financial products, both on
and off the balance sheet, has increased the need for a more
comprehensive approach to the risk management of investment activities.
To advance such an initiative, the agencies are seeking industry
comment on the practices identified in the proposed policy statement.
The proposal to rescind the high risk tests as a constraint on an
institution's investment activities does not signal that MDPs with high
levels of price risk are either appropriate or inappropriate
investments for an institution. Whether a security, MDP or otherwise,
is an appropriate investment depends upon a variety of factors,
including the institution's capital level, the security's impact on the
aggregate risk of the portfolio, and management's ability to measure
and manage risk. The agencies continue to believe that the stress
testing of MDP investments, as well as other investments, has
significant value for risk management purposes. Institutions should
employ valuation methodologies that take into account all of the risk
elements necessary to price these investments. The proposed policy
statement indicates that the agencies believe, as a matter of sound
practice, institutions should know the value and price sensitivity of
their investments prior to purchase and on an ongoing basis.
The proposed text of the 1997 Statement follows.
Supervisory Policy Statement on Investment Securities and End-User
Derivatives Activities
I. Purpose
This policy statement (Statement) provides guidance to financial
institutions (institutions) on sound practices for managing the risks
of investment securities and end-user derivatives activities. The FFIEC
agencies--the Board of Governors of the Federal Reserve System, the
Federal Deposit Insurance Corporation, the Office of the Comptroller of
the Currency, the Office of Thrift Supervision, and the National Credit
Union Administration--believe that effective management of the risks
associated with securities and derivative instruments represents an
essential component of safe and sound practices. This guidance
describes the practices that a prudent manager normally would follow
and is not intended to be a checklist. Management should establish
practices and maintain documentation appropriate to the institution's
individual circumstances, consistent with this Statement.
[[Page 51864]]
II. Scope
This guidance applies to all securities in held-to-maturity and
available-for-sale accounts as defined in the Statement of Financial
Accounting Standards No. 115 (FAS 115), certificates of deposit held
for investment purposes, and end-user derivative contracts not held in
trading accounts. This guidance covers all securities used for
investment purposes, including: money market instruments, fixed-rate
and floating-rate notes and bonds, structured notes, mortgage pass-
through and other asset-backed securities, and mortgage-derivative
products. Similarly, this guidance covers all end-user derivative
instruments used for nontrading purposes, such as swaps, futures, and
options.3 This Statement applies to all federally-insured
commercial banks, savings banks, savings associations, and federally
chartered credit unions.
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\3\ Federal credit unions are not permitted to purchase asset-
backed securities and may participate in derivative programs only if
authorized by the NCUA.
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As a matter of sound practice, institutions should have programs to
manage the market, credit, liquidity, legal, operational and other
risks of investment securities and end-user derivatives activities
(investment activities). While risk management programs will differ
among institutions, there are certain elements that are fundamental to
all sound risk management programs. These elements include board and
senior management oversight and a comprehensive risk management process
that effectively identifies, measures, monitors, and controls risk.
This Statement describes sound principles and practices for managing
and controlling the risks associated with investment activities.
Institutions should fully understand and effectively manage the
risks inherent in their investment activities. Failure to understand
and adequately manage the risks in these areas constitutes an unsafe
and unsound practice.
III. Board and Senior Management Oversight
Board of director and senior management oversight is an integral
part of an effective risk management program. The board of directors is
responsible for approving major policies for conducting investment
activities, including the establishment of risk limits. The board
should ensure that management has the requisite skills to manage the
risks associated with such activities. To properly discharge its
oversight responsibilities, the board should review portfolio activity
and risk levels, and require management to demonstrate compliance with
approved risk limits. Boards should have an adequate understanding of
investment activities. Boards that do not, should obtain professional
advice to enhance its understanding of investment activity oversight,
so as to enable it to meet its responsibilities under this Statement.
Senior management is responsible for the daily management of an
institution's investments. Management should establish and enforce
policies and procedures for conducting investment activities on both a
long-range (strategic) and day-to-day (operational) basis. Senior
management should have an understanding of the nature and level of
various risks involved in the institution's investments and how such
risks fit within the institution's overall business strategies.
Management should ensure that the risk management process is
commensurate with the size, scope, and complexity of the institution's
holdings. Management should also ensure that the responsibilities for
managing investment activities are properly segregated to maintain
operational integrity. Institutions with significant investment
activities should ensure that back-office, settlement, and transaction
reconciliation responsibilities are conducted and managed by personnel
who are independent of those initiating risk taking positions.
IV. Risk Management Process
An effective risk management process for investment activities
includes: (1) Policies, procedures, and limits; (2) the identification,
measurement, and reporting of risk exposures; and (3) a system of
internal controls.
Policies, Procedures, and Limits
Investment policies, procedures, and limits provide the structure
to effectively manage investment activities. Policies should be
consistent with the organization's broader business strategies, capital
adequacy, technical expertise, and risk tolerance. Policies should
identify relevant investment objectives, constraints, and guidelines
for the acquisition and ongoing management of securities and derivative
instruments. Potential investment objectives include: generating
earnings, providing liquidity, hedging risk exposures, taking risk
positions, modifying and managing risk profiles, managing tax
liabilities, and meeting pledging requirements, if applicable. Policies
should also identify the risk characteristics of permissible
investments and should delineate clear lines of responsibility and
authority for investment activities.
An institution's policies should ensure an understanding of the
risks and cashflow characteristics of its investments. This is
particularly important for products that have unusual, leveraged, or
highly variable cashflows. An institution should not acquire a material
position in an instrument until senior management and all relevant
personnel understand and can manage the risks associated with the
product.
An institution's investment activities should be fully integrated
into any institution-wide risk limits. In so doing, some institutions
rely only on the institution-wide limits, while others may apply limits
at the investment portfolio, sub-portfolio, or individual instrument
level.
The board and senior management should review, at least annually,
the appropriateness of its investment strategies, policies, procedures,
and limits.
Risk Identification, Measurement and Reporting
Institutions should ensure that they identify and measure the risks
associated with individual transactions prior to acquisition and
periodically after purchase. Depending upon the complexity and
sophistication of the risk measurement systems, this can be done at the
institutional, portfolio, or individual instrument level. Prudent
management of investment activities entails examination of the risk
profile of a particular investment in light of its impact on the risk
profile of the institution. To the extent practicable, institutions
should measure exposures to each type of risk and these measurements
should be aggregated and integrated with similar exposures arising from
other business activities to obtain the institution's overall risk
profile.
In measuring risks, institutions should conduct their own in-house
pre-acquisition analyses, or to the extent possible, make use of
specific third party analyses that are independent of the seller or
counterparty. Irrespective of any responsibility, legal or otherwise,
assumed by a dealer, counterparty, or financial advisor regarding a
transaction, the acquiring institution is ultimately responsible for
the appropriate personnel understanding and managing the risks of the
transaction into which it enters.
Reports to the board of directors and senior management should
summarize the risks related to the institution's
[[Page 51865]]
investment activities and should address compliance with the investment
policy's objectives, constraints, and legal requirements, including any
exceptions to established policies, procedures, and limits. Reports to
management should generally reflect more detail than reports to the
board of the institution. Reporting should be frequent enough to
provide timely and adequate information to judge the changing nature of
the institution's risk profile and to evaluate compliance with stated
policy objectives and constraints.
Internal Controls
An institution's internal control structure is critical to the safe
and sound functioning of the organization generally and the management
of investment activities in particular. A system of internal controls
promotes efficient operations, reliable financial and regulatory
reporting, and compliance with relevant laws, regulations, and
institutional policies. An effective system of internal controls
includes enforcing official lines of authority, maintaining appropriate
separation of duties, and conducting independent reviews of investment
activities.
For institutions with significant investment activities, internal
and external audits are integral to the implementation of a risk
management process to control risks in investment activities. An
institution should conduct periodic independent reviews of its risk
management program to ensure its integrity, accuracy, and
reasonableness. Items that should be reviewed include:
(1) Compliance with and the appropriateness of investment policies,
procedures, and limits;
(2) The appropriateness of the institution's risk measurement
system given the nature, scope, and complexity of its activities;
(3) The timeliness, integrity, and usefulness of reports to the
board of directors and senior management.
The review should note exceptions to policies, procedures, and
limits and suggest corrective actions. The findings of such reviews
should be reported to the board and corrective actions taken on a
timely basis.
The accounting systems and procedures used for public and
regulatory reporting purposes are critically important to the
evaluation of an organization's risk profile and the assessment of its
financial condition and capital adequacy. Accordingly, an institution's
policies should provide clear guidelines regarding the reporting
treatment for all securities and derivatives holdings. This treatment
should be consistent with the organization's business objectives,
generally accepted accounting principles (GAAP), and regulatory
reporting standards.
V. The Risks of Investment Activities
The following discussion identifies particular sound practices for
managing the specific risks involved in investment activities. In
addition to these sound practices, institutions should follow any
specific guidance or requirements from their primary supervisor related
to these activities.
Market Risk
Market risk is the risk to an institution's financial condition
resulting from adverse changes in the value of its holdings arising
from movements in interest rates, foreign exchange rates, equity
prices, or commodity prices. An institution's exposure to market risk
can be measured by assessing the effect of changing rates and prices on
either the earnings or economic value of an individual instrument, a
portfolio, or the entire institution. For most institutions, the most
significant market risk of investment activities is interest rate risk.
Investment activities may represent a significant component of an
institution's overall interest rate risk profile. It is a sound
practice for institutions to manage interest rate risk on an
institution-wide basis. This sound practice includes monitoring the
price sensitivity of the institution's investment portfolio (changes in
the investment portfolio's value over different interest rate/yield
curve scenarios). Consistent with agency guidance, institutions should
specify institution-wide interest rate risk limits that appropriately
account for these activities and the strength of the institution's
capital position. These limits are generally established for economic
value or earnings exposures. Institutions may find it useful to
establish price sensitivity limits on their investment portfolio or on
individual securities. These sub-institution limits, if established,
should also be consistent with agency guidance.
It is a sound practice for an institution's management to fully
understand the market risks associated with investment securities and
derivative instruments prior to acquisition and on an ongoing basis.
Accordingly, institutions should have appropriate policies to ensure
such understanding. In particular, institutions should have policies
that specify the types of market risk analyses that should be conducted
for various types or classes of instruments, including that conducted
prior to their acquisition (pre-purchase analysis) and on an ongoing
basis. Policies should also specify any required documentation needed
to verify the analysis.
It is expected that the substance and form of such analyses will
vary with the type of instrument. Not all investment instruments may
need to be subjected to a pre-purchase analysis. Relatively simple or
standardized instruments, the risks of which are well known to the
institution, would likely require no or significantly less analysis
than would more volatile, complex instruments.4
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\4\ Federal credit unions must comply with the investment
monitoring requirements of 12 CFR Sec. 703.90. See 62 FR 32989 (June
18, 1997).
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For relatively more complex instruments, less familiar instruments,
and potentially volatile instruments, institutions should fully address
pre-purchase analyses in their policies. Price sensitivity analysis is
an effective way to perform the pre-purchase analysis of individual
instruments. For example, a pre-purchase analysis should show the
impact of an immediate parallel shift in the yield curve of plus and
minus 100, 200, and 300 basis points. Where appropriate, such analysis
should encompass a wider range of scenarios, including non-parallel
changes in the yield curve. A comprehensive analysis may also take into
account other relevant factors, such as changes in interest rate
volatility and changes in credit spreads.
When the incremental effect of an investment position is likely to
have a significant effect on the risk profile of the institution, it is
a sound practice to analyze the effect of such a position on the
overall financial condition of the institution.
Accurately measuring an institution's market risk requires timely
information about the current carrying and market values of its
investments. Accordingly, institutions should have market risk
measurement systems commensurate with the size and nature of these
investments. Institutions with significant holdings of highly complex
instruments should ensure that they have the means to value their
positions. Institutions employing internal models should have adequate
procedures to validate the models and to periodically review all
elements of the modeling process, including its assumptions and risk
measurement techniques. Managements relying on third parties for market
risk measurement systems and analyses should ensure that they
[[Page 51866]]
fully understand the assumptions and techniques used.
Institutions should provide reports to their boards on the market
risk exposures of their investments on a regular basis. To do so, the
institution may report the market risk exposure of the whole
institution. Otherwise, these reports should contain evaluations that
assess trends in aggregate market risk exposure and the performance of
portfolios in terms of established objectives and risk constraints.
They also should identify compliance with board approved limits and
identify any exceptions to established standards. Institutions should
have mechanisms to detect and adequately address exceptions to limits
and guidelines. Management reports on market risk should appropriately
address potential exposures to yield curve changes and other factors
pertinent to the institution's holdings.
Credit Risk
Broadly defined, credit risk is the risk that an issuer or
counterparty will fail to perform on an obligation to the institution.
For many financial institutions, credit risk in the investment
portfolio may be low relative to other areas, such as lending. However,
this risk, as with any other risk, should be effectively identified,
measured, monitored, and controlled.
An institution should not acquire investments or enter into
derivative contracts without assessing the creditworthiness of the
issuer or counterparty. The credit risk arising from these positions
should be incorporated into the overall credit risk profile of the
institution as comprehensively as practicable. Institutions are legally
required to meet certain quality standards (i.e., investment grade) for
security purchases. Many institutions maintain and update ratings
reports from one of the major rating services. For non-rated
securities, institutions should establish guidelines to ensure that the
securities meet legal requirements and that the institution fully
understands the risk involved. Institutions should establish limits on
individual counterparty exposures. Policies should also provide credit
risk and concentration limits. Such limits may define concentrations
relating to a single or related issuer or counterparty, a geographical
area, or obligations with similar characteristics.
In managing credit risk, institutions should consider settlement
and pre-settlement credit risk. These risks are the possibility that a
counterparty will fail to honor its obligation at or before the time of
settlement. The selection of dealers, investment bankers, and brokers
is particularly important in effectively managing these risks. An
institution's policies should identify criteria for selecting these
organizations and should list all approved firms. The approval process
should include a review of each firm's financial statements and an
evaluation of its ability to honor its commitments. An inquiry into the
general reputation of the dealer is also appropriate. This includes
review of information from state or federal securities regulators and
industry self-regulatory organizations such as the National Association
of Securities Dealers concerning any formal enforcement actions against
the dealer, its affiliates, or associated personnel.
The board of directors, or a committee thereof, should set limits
on the amounts and types of transactions authorized for each securities
firm with whom the institution deals. At least annually, the board of
directors should review and reconfirm the list of authorized dealers,
investment bankers, and brokers.
Sound credit risk management requires that credit limits be
developed by personnel who are as independent as practicable of the
acquisition function. In authorizing issuer and counterparty credit
lines, these personnel should use standards that are consistent with
those used for other activities conducted within the institution and
with the organization's over-all policies and consolidated exposures.
Liquidity Risk
Liquidity risk is the risk that an institution cannot easily sell,
unwind, or offset a particular position at a fair price because of
inadequate market depth. In specifying permissible instruments for
accomplishing established objectives, institutions should ensure that
they take into account the liquidity of the market for those
instruments and the effect that such characteristics have on achieving
their objectives. The liquidity of certain types of instruments may
make them inappropriate for certain objectives. Institutions should
ensure that they consider the effects that market risk can have on the
liquidity of different types of instruments under various scenarios.
Accordingly, institutions should articulate clearly the liquidity
characteristics of instruments to be used in accomplishing
institutional objectives.
Complex and illiquid instruments can often involve greater risk
than actively traded, more liquid securities. Oftentimes, this higher
potential risk arising from illiquidity is not captured by standardized
financial modeling techniques. Such risk is particularly acute for
instruments that are highly leveraged or that are designed to benefit
from specific, narrowly defined market shifts. If market prices or
rates do not move as expected, the demand for such instruments can
evaporate, decreasing the market value of the instrument below the
modeled value.
Operational (Transaction) Risk
Operational (transaction) risk is the risk that deficiencies in
information systems or internal controls will result in unexpected
loss. Sources of operating risk include inadequate procedures, human
error, system failure, or fraud. Inaccurately assessing or controlling
operating risks is one of the more likely sources of problems facing
institutions involved in investment activities.
Effective internal controls are the first line of defense in
controlling the operating risks involved in an institution's investment
activities. Of particular importance are internal controls that ensure
the separation of duties and supervision of persons executing
transactions from those responsible for processing contracts,
confirming transactions, controlling various clearing accounts,
preparing or posting the accounting entries, approving the accounting
methodology or entries, and performing revaluations.
Consistent with the operational support of other activities within
the financial institution, securities operations should be as
independent as practicable from business units. Adequate resources
should be devoted, such that systems and capacity are commensurate with
the size and complexity of the institution's investment activities.
Effective risk management should also include, at least, the following:
Valuation. Procedures should ensure independent portfolio
pricing. For thinly traded or illiquid securities, completely
independent pricing may be difficult. In such cases, operational units
may need to use portfolio manager prices. For unique instruments where
the pricing is being provided by a single source (e.g., the dealer
providing the instrument), the institution should review and understand
the assumptions used to price the instrument.
Personnel. The increasingly complex nature of securities
available in the marketplace makes it important that operational
personnel have strong technical skills. This will enable them to better
understand the complex financial structures of some investment
instruments.
[[Page 51867]]
Documentation. Institutions should clearly define
documentation requirements for securities transactions, saving and
safeguarding important documents, as well as maintaining possession and
control of instruments purchased.
An institution's policies should also provide guidelines for
conflicts of interest for employees who are directly involved in
purchasing and selling securities for the institution from securities
dealers. These guidelines should ensure that all directors, officers,
and employees act in the best interest of the institution. The board
may wish to adopt policies prohibiting these employees from engaging in
personal securities transactions with these same securities firms
without specific prior board approval. The board may also wish to adopt
a policy applicable to directors, officers, and employees restricting
or prohibiting the receipt of gifts, gratuities, or travel expenses
from approved securities dealer firms and their representatives.
Legal Risk
Legal risk is the risk that contracts are not legally enforceable
or documented correctly. Institutions should adequately evaluate the
enforceability of its agreements before individual transactions are
consummated. Institutions should also ensure that the counterparty has
authority to enter into the transaction and that the terms of the
agreement are legally enforceable. Institutions should further
ascertain that netting agreements are adequately documented, executed
properly, and are enforceable in all relevant jurisdictions.
Institutions should have knowledge of relevant tax laws and
interpretations governing the use of these instruments.
Dated: September 29, 1997.
Joe M. Cleaver,
Executive Secretary, Federal Financial Institutions Examination
Council.
[FR Doc. 97-26207 Filed 10-2-97; 8:45 am]
BILLING CODE 6210-01-P, 6720-01-P, 6714-01-P, 4810-01-P, 7535-01-P