51862 Federal Register / Vol. 62, No. 192 / Friday, October 3, 1997 / Notices

General Counsel, 1200 G Street,

NW, Suite 500, Washington, DC

20005

North American Numbering Plan

Administrator

c/o Bellcore, Ronald R. Conners,

Director, 6 Corporate Place, Room

1F275, Piscataway, NJ 08854–4157

U.S. Department of State

Ambassador Vonya McCann, EB/CIP

Room 4826, 2101 C Street, NW,

Room 4826, Washington, DC 20520

U.S. Department of Commerce

National Telecommunications &

Information Administration, Larry

Irving, Assistant Secretary,

Communications & Information,

14th & Pennsylvania Avenue, NW,

Rm 4898, Washington, DC 20230

[FR Doc. 97–26252 Filed 10–2–97; 8:45 am]

BILLING CODE 6712–01–P

FEDERAL DEPOSIT INSURANCE

CORPORATION

Agency Information Collection

Activities: Submission for OMB

Review; Comment Request

AGENCY: Federal Deposit Insurance

Corporation.

ACTION: Notice of information collection

to be submitted to OMB to review and

approval under the Paperwork

Reduction Act of 1995.

SUMMARY: In accordance with

requirements of the Paperwork

Reduction Act of 1995 (44 U.S.C.

Chapter 35), the FDIC hereby gives

notice that it plans to submit to the

Office of Management and Budget a

request for OMB review and approval of

the information collection system

described below.

Type of Review: Renewal of currently

approved collection.

Title: Application For Consent To

Reduce or Retire Capital.

Form Number: None.

OMB Number: 3064–0079.

Annual Burden:

Number of applications: 120.

Hours to prepare an application: 1.

Total annual burden hours: 120.

Expiration Date of OMB Clearance:

October 31, 1997.

OMB Reviewer: Alexander T. Hunt,

(202) 395–7860, Office of Management

and Budget, Office of Information and

Regulatory Affairs, Washington, D.C.

20503.

FDIC Contact: Steven F. Hanft, (202)

898–3907, Office of the Executive

Secretary, Room F–4080, Federal

Deposit Insurance Corporation, 550 17th

Street N.W., Washington, D.C. 20429.

Comments: Comments on this collection of

information are welcome and should be

submitted on or before November 3, 1997, to

both the OMB reviewer and the FDIC contact

listed above.

ADDRESSES: Information about this

submission including copies of the

proposed collection of information, may

be obtained by calling or writing the

FDIC contact listed above.

SUPPLEMENTARY INFORMATION: This

collection requires insured state

nonmember banks that propose to

change their capital structure to submit

an application containing information

about the proposed change in order to

obtain FDIC’s consent to reduce or retire

capital. The FDIC evaluates the

information contained in the letter

application in relation to statutory

considerations and makes a decision to

grant or to withhold consent.

Dated: September 30, 1997.

Federal Deposit Insurance Corporation.

Robert E. Feldman,

Executive Secretary.

[FR Doc. 97–26238 Filed 10–2–97; 8:45 am]

BILLING CODE 6714–01–M

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.

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
Federal Register / Vol. 62, No. 192 / Friday, October 3, 1997 / Notices 51863

1The 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.

2Average 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.

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 passthrough 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

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.
51864 Federal Register / Vol. 62, No. 192 / Friday, October 3, 1997 / Notices

3Federal credit unions are not permitted to

purchase asset-backed securities and may

participate in derivative programs only if

authorized by the NCUA.

II. Scope

This guidance applies to all securities

in held-to-maturity and available-forsale 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 passthrough 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.

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 preacquisition 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
Federal Register / Vol. 62, No. 192 / Friday, October 3, 1997 / Notices 51865

4Federal credit unions must comply with the

investment monitoring requirements of 12 CFR

§ 703.90. See 62 FR 32989 (June 18, 1997).

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

For relatively more complex

instruments, less familiar instruments,

and potentially volatile instruments,

institutions should fully address prepurchase 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 nonparallel 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
51866 Federal Register / Vol. 62, No. 192 / Friday, October 3, 1997 / Notices

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 presettlement 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.
Federal Register / Vol. 62, No. 192 / Friday, October 3, 1997 / Notices 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

FEDERAL RESERVE SYSTEM

Formations of, Acquisitions by, and

Mergers of Bank Holding Companies

The companies listed in this notice

have applied to the Board for approval,

pursuant to the Bank Holding Company

Act of 1956 (12 U.S.C. 1841 et seq.)

(BHC Act), Regulation Y (12 CFR Part

225), and all other applicable statutes

and regulations to become a bank

holding company and/or to acquire the

assets or the ownership of, control of, or

the power to vote shares of a bank or

bank holding company and all of the

banks and nonbanking companies

owned by the bank holding company,

including the companies listed below.

The applications listed below, as well

as other related filings required by the

Board, are available for immediate

inspection at the Federal Reserve Bank

indicated. The application also will be

available for inspection at the offices of

the Board of Governors. Interested

persons may express their views in

writing on the standards enumerated in

the BHC Act (12 U.S.C. 1842(c)). If the

proposal also involves the acquisition of

a nonbanking company, the review also

includes whether the acquisition of the

nonbanking company complies with the

standards in section 4 of the BHC Act.

Unless otherwise noted, nonbanking

activities will be conducted throughout

the United States.

Unless otherwise noted, comments

regarding each of these applications

must be received at the Reserve Bank

indicated or the offices of the Board of

Governors not later than October 30,

1997.

A. Federal Reserve Bank of New

York (Betsy Buttrill White, Senior Vice

President) 33 Liberty Street, New York,

New York 10045-0001:

1. Canisteo Valley Corporation,

Canisteo, New York; to become a bank

holding company by acquiring 100

percent of the voting shares of First

State Bank, Canisteo, New York.

B. Federal Reserve Bank of Atlanta

(Lois Berthaume, Vice President) 104

Marietta Street, N.W., Atlanta, Georgia

30303-2713:

1. Great Southern Capital Corporation

Employee Stock Ownership Trust,

Meridian, Mississippi; to acquire at least

50 percent of the voting shares of Great

Southern Capital Corporation, Meridian,

Mississippi, and thereby indirectly

acquire Great Southern National Bank,

Meridian, Mississippi.

C. Federal Reserve Bank of St. Louis

(Randall C. Sumner, Vice President) 411

Locust Street, St. Louis, Missouri 63102-

2034:

1. First Citizens Bancshares, Inc.,

Dyersburg, Tennessee; to acquire 100

percent of the voting shares of Bank of

Troy, Troy, Tennessee.

Board of Governors of the Federal Reserve

System, September 30, 1997.

William W. Wiles,

Secretary of the Board.

[FR Doc. 97–26338 Filed 10–2–97; 8:45 am]

BILLING CODE 6210–01–F

DEPARTMENT OF HEALTH AND

HUMAN SERVICES

Centers for Disease Control and

Prevention

[Announcement 811]

National Institute for Occupational

Safety and Health; Research and

Demonstration Grants; Occupational

Safety and Health

Introduction

The National Institute for

Occupational Safety and Health

(NIOSH) of the Centers for Disease

Control and Prevention (CDC) is

soliciting grant applications for research

and demonstration projects related to

occupational safety and health (see the

section Availability of Funds).

CDC is committed to achieving the

health promotion and disease

prevention objectives of Healthy People

2000, a national activity to reduce

morbidity and mortality and improve

the quality of life. This announcement

is related to the priority area of

Occupational Safety and Health. (For

ordering a copy of Healthy People 2000,

see the section Where to Obtain

Additional Information.)

Authority

This program is authorized under the

Public Health Service Act, as amended,

Section 301 (42 U.S.C. 241); the

Occupational Safety and Health Act of

1970, Sections 20(a) and 22 (29 U.S.C.

669(a) and 671); and the Federal Mine

Safety and Health Act of 1977, Section

501 (30 U.S.C. 951). The applicable

program regulations are in 42 CFR part

52.

Smoke-Free Workplace

CDC strongly encourages all grant

recipients to provide a smoke-free

workplace and to promote the non-use

of all tobacco products, and Pub. L.

103–227, the Pro-Children Act of 1994,

prohibits smoking in certain facilities

that receive Federal funds and in which

education, library, day care, health care,

and early childhood development

services are provided to children.

Eligible Applicants

Eligible applicants include domestic

and foreign non-profit and for-profit

organizations, universities, colleges,

research institutions, and other public

and private organizations, including

State and local governments and small,

minority and/or woman-owned

businesses. Exceptions: Foreign

organizations, as well as domestic

institutions with a foreign component,

are ineligible to apply for the Special