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Business Lags-HIC Repos

July 24, 1989

Mr. Tom O'Nell
Review Examiner (Compliance)
Federal Deposit Insurance Corporation
550 17th Street, N.W.
Washington, D.C. 20429

Dear Mr. O'Nell:

The Department has received an inquiry from a noticed financial institution requesting a clarification of section 403.5(b) of the regulations promulgated by the Department of the Treasury under the Government Securities Act of 1986 (the “GSA”, Pub. L. 99-571, 100 Stat. 3208, 15 U.S.C. 78o-5). The issue raised by the financial institution involves the temporary lag provision contained in section 403.5(b) as it relates to the hold-in-custody repurchase transaction provisions of section 403.5(d). The specific issue to be addressed is whether a security for which a financial institution has taken contractual title from a third party, and has a rightful expectation to hold at the end of a day, is an acceptable security for a hold-in-custody repurchase transaction, provided that a financial institution makes every good-faith effort to secure delivery from the third party on the contracted receipt date and to remedy any failure to receive within the required time.

It is suggested that sections 403.5(b), (c), and (d) of the GSA regulations would permit an overnight hold-in-custody repurchase transaction for which a financial institution is only contractually and not physically in control of the underlying security and that these provisions would not require a financial institution to break the hold-in-custody repurchase transaction after the fact if it failed to receive delivery of the security by the close of the trading day. It is represented that such one day lags, which may occur infrequently as a result of normal business operations, would fall within Treasury's definition of temporary lag.

It is also claimed that it is operationally impossible to assure that any security to be used for a new hold-in-custody repurchase transaction on a given day would be, at the start of the day, already in a financial institution's possession. Furthermore, holding securities already in a financial institution's possession at the start of the trading day, in anticipation of new hold-in-custody repurchase transactions that may or may not materialize, could hinder the flow of securities over the securities wire.

After consulting with the appropriate regulatory agencies for depository institutions, the Securities and Exchange Commission (SEC) and the National Association of Securities Dealers, and noting the representations made by the requesting financial institution, we are unable to concur with an interpretation of section 403.5 that would permit a fail on an overnight repurchase transaction resulting from normal business lags. A financial institution that does not have securities at the end of the business day to back an overnight repurchase transaction is in violation of the possession or control requirement of section 403.5(d)(1)(vi) of the GSA regulations. The concept of normal business lag as provided in section 403.5(b) may not be applied to allow a financial institution to avoid possession or control of securities for the entire term of an overnight repurchase transaction. Normal business lag is intended to refer to intra-day lags where a financial institution need not have possession or control of securities at every given moment during the business day.

In order to remain in compliance with section 403.5, it is not necessary for a financial institution to have in its possession or control at the beginning of the day the securities that would be used for all overnight hold-in-custody repurchase transactions. However, even though a repurchase transaction may have been initiated, final settlement of the transaction cannot take place if a financial institution does not have the securities in its possession or control at the close of the business day. It is suggested that it would be prudent for a financial institution to examine its procedures and take appropriate measures to ensure that sufficient securities are available at the end of the day to cover all overnight repurchase transactions that have been entered into with its customers.

In addition to the GSA regulations, financial institutions should be aware that a policy statement on due bills has been issued by the Office of the Comptroller of the Currency (OCC). Banking Circular 182 sets forth guidelines concerning the proper use of due bills by national banks and the principles enumerated in the circular are applicable to repurchase transactions. In particular, it discusses the requirement that the customer be advised of the inability of a financial institution dealer to consummate a transaction. It is our understanding that your agency as a general matter supports the guidelines contained in OCC Banking Circular 182.

Any enforcement action in response to a violation of the GSA rules would be determined by the appropriate regulatory agency, after taking into consideration the specific facts of the case.

This interpretation is being issued to each appropriate regulatory agency for depository institutions. Pursuant to 17 CFR 400.2(c)(7)(i), this letter will be immediately available to the public.

Sincerely,
Van Zeck
for Richard L. Gregg
Commissioner

Identical Letters addressed to:
Mr. Larry Clark, Federal Home Loan Bank System
Mr. Robert Plotkin, Federal Reserve Board
Mr. Owen Carney, Office of the Comptroller of the Currency (with minor changes
in paragraph referencing OCC Circular 182)