Source: https://www.fdic.gov/regulations/laws/rules/4000-9690.html
Timestamp: 2019-04-26 03:44:23+00:00

Document:
By memorandum of December 1, 1994, you requested our review of the draft of three apparent violations of law to be included in the FDIC's Report of Examination of the Bank as of November 1, 1994. We note, in passing, that the issues raised entailed a considerable amount of original legal research which necessarily was time consuming. Nevertheless, we apologize for the delay in responding.
The first violation cited by the examiners is of section 403.5(d)(1)(i) of the G.S.A. Regulations, 17 C.F.R. § 403.5(d)(1)(i), which requires that the institution obtain a written repurchase agreement for each repurchase transaction. During their examination of the Bank, the examiners found that for 14 repurchase transactions the Bank had no written repurchase agreement. Assuming there is valid evidence supporting the examiners' conclusion, the Bank is in violation of the regulation cited.
The second violation cited by the examiners is of section 403.5(d)(1)(iv) of the G.S.A. Regulations, 17 C.F.R. § 403.5(d)(1)(iv). It appears that the examiners have inadvertently cited subparagraph (iv) of this regulation when they meant to cite subparagraph (v). Subparagraph (iv) requires that, if the seller under a repurchase agreement retains the right to substitute securities for those originally subject to the agreement, such right must be included in the written repurchase agreement. As discussed above, paragraph 8 of the Bank's repurchase agreement states that the Bank reserves the right to substitute different but similar securities for those originally subject to the repurchase transaction. Thus, the Bank's repurchase agreement complies with subparagraph (iv). However, subsection (v) of the regulation requires a very specific disclosure "which must be prominently displayed in the written repurchase agreement immediately preceding the provision governing the right to substitution . . . ." The required specific disclosure is not included in the Bank's repurchase agreement. Accordingly, the Bank should be cited for a violation of section 403.5(d)(1)(v) of the G.S.A. Regulations, 17 C.F.R. § 403.5(d)(1)(v), instead of section 403.5(d)(1)(iv) of the G.S.A. Regulations, 17 C.F.R. § 403.5(d)(1)(iv).
The last apparent violation cited by the examiners pertains to the frequency and content of customer confirmations. The Bank provides a confirmation of the securities involved in the transaction to a customer when the repurchase agreement is initially entered into and on at least a monthly basis thereafter. Section 403.5(d)(1)(ii) of the G.S.A. Regulations, 17 C.F.R. § 403.5(d)(1)(ii), requires written confirmation of the specific securities involved in the repurchase transaction at the end of the day each transaction was initiated. Because the Bank's repurchase agreements mature and automatically renew on a daily basis, they are considered a newly initiated transaction each day they are renewed and must be accompanied by a daily written confirmation to the customer of the securities involved.3 The Bank's failure to provide daily written confirmations constitutes a violation of section 403.5(d)(1)(ii).
The Bank is also cited for a violation of section 403.5(d)(2)(i) of the G.S.A. Regulations, 17 C.F.R. § 403.5(d)(2)(i), which pertains to the type of information required in a confirmation given in accordance with the above-described requirements.4 The examiner's discussion of this violation fails to identify what information is currently not provided, simply stating "[t]he bank does not now provide these customer disclosures." We recommend that, if this violation is based solely on the fact that no daily confirmations are provided, that should be made clear. Otherwise, the apparent violation should be revised to provide a specific description of the missing information.
Whether the Bank may enter into repurchase agreements involving fractional interests in government securities is not specifically addressed by the G.S.A. Regulations or any published interpretation of those regulations. To answer the examiner's question regarding "pooling of collateral," it is necessary to understand what "pool repurchase transactions"
The Department's understanding is that, under ["Pool Repurchase Transactions"], a dealer will set aside a pool of securities with an aggregate value at least equal to the amount of its outstanding repurchase transactions. The dealer does not identify specific securities as belonging to specific counterparties, and confirmations for these repurchase transactions do not include a description of specific collateral. Instead, the confirmation would only refer to "various securities."
The Department has serious questions whether any type of property interest in securities is conveyed to a counterparty when specific securities are not allocated to that counterparty's repurchase transactions. . . . [W]hether a repurchase transaction is characterized as a secured loan, as an outright sale of a security accompanied by the obligation to later repurchase that security, or as a transaction conveying some other type of limited interest in the underlying securities . . . it does not appear that the described practice of segregating collateral for repurchase transactions in pooled or bulk form is effective to transfer an interest in securities.
Furthermore, it is not clear that interests would be conveyed under the existing Treasury and other agency regulations governing transactions in book-entry securities applicable to government securities . . . . If this is the case, then it appears that a counterparty to a pool repurchase transaction would have no greater rights than a general creditor in the event of a failure of its dealer counterparty with respect to a hold-in-custody repurchase transaction.
Given these concerns, the Department has concluded that bulk segregation or pooling of repurchase collateral without identification of specific securities should not be permitted and that the practice of confirming only "various securities" in connection with repurchase transactions is not sufficient to comply with the requirements of § . . . 403.5(d).
52 Fed. Reg. 19,642, 19,659 (1987). The focus of the Department of the Treasury's concern is to ensure that a buyer under a repurchase agreement receives an identified interest in specifically identified government securities. That concern is satisfied where the customer receives a specific fractional interest in a specifically identified government security, e.g., "repurchase agreements to A and B in the amount of $200,000 each, giving A and B each an undivided 50 percent interest in U.S. Government Bond XYZ with a par value of $450,000 with a coupon interest rate of 3--1/2 percent, and a market value of $500,000."9 Accordingly, although we have found no published opinion addressing the question, we believe repurchase agreements with appropriate confirmations which specifically identify the security involved and the fractional interest of the customer would not constitute a "pooled transaction" and would not run afoul of the G.S.A. Regulations.
One of the fundamental objectives that gave rise to the enactment of the GSA, and the subsequent issuance of regulations thereunder, was to strengthen customer protection in hold-in-custody repo transactions. The requirement that financial institutions maintain and allocate specific securities to specific customers is aimed at protecting customer securities in the event of the failure of a financial institution. Without timely and proper allocation, it may not be clear if an interest in the securities has been conveyed to the counterparty. The allocation requirement focuses on eliminating duplicative use of securities as well as precluding pooling of securities (i.e., failing to identify and record specific securities on the books and records of the institution).

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