The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
Federal R eserve Bank OF DALLAS ROBERT D. M C T E E R , J R . P R E S ID E N T AND C H IE F E X E C U T IV E O F F IC E R September 10 , 1992 d a lla s ,t e x a s 75222 Notice 92-81 TO: The Chief Executive Officer of each member bank and others concerned in the Eleventh Federal Reserve District SUBJECT Advance Notice of Proposed Rulemaking in Connection with Review of Regulation T (Credit By Brokers and Dealers) DETAILS The Federal Reserve Board has issued an advance notice of proposed rulemaking and has requested public comment in connection with a review of Regulation T (Credit by Brokers and Dealers). This action is part of the B o a r d ’s program to review periodically all regulations to determine whether any provisions are in need of updating and whether any substantive changes are necessary because of new products or developments in the securities markets. Although Board staff has developed a list of issues that could be addressed during this review of the provisions of Regulation T, comment is invited on all areas of the regulation. The Board must receive comments by October 16, 1992. Comments should be addressed to William W. Wiles, Secretary, Board of Governors of the Federal Reserve System, 20th Street and Constitution Avenue, N.W., Washington, D.C. 20551. All comments should refer to Docket No. R-0772. ATTACHMENT Attached is a copy of the policy statement as it appears on pages 37109-12, Vol. 57, No. 160, of the Federal Register dated August 18, 1992. MORE INFORMATION For more information, please contact Eugene Coy at (214) 744-7480. For additional copies of this B a n k ’s notice, please contact the Public Affairs Department at (214) 922-5254. Sincerely yours, For additional copies, bankers and others are encouraged to use one of the following toll-free numbers in contacting the Federal Reserve Bank of Dallas: Dallas Office (800) 333-4460; El Paso Branch Intrastate (800) 592-1631, Interstate (800) 351-1012; Houston Branch Intrastate (800) 392-4162, Interstate (800) 221-0363; San Antonio Branch Intrastate (800) 292-5810. This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org) 37109 Proposed Rules Federal Register Vol. 57, No. 160 Tuesday, August 18, 1992 This section of the FEDERAL. REGISTER contains notices to the public of the proposed issuance of rules and regulations. The purpose of these notices is to give interested persons an opportunity to participate in the rule making prior to the adoption of the final rules. FEDERAL RESERVE SYSTEM 12 CFR Part 220 [Regulation T; Docket No. R-0772] Securities Credit Transactions; Review of Regulation T, “Credit by Brokers and Dealers” AGENCY: Board of Governors of the Federal Reserve System. ACTION: Advance notice of proposed rulemaking and request for comment. -------------------------- — --- m ---------------------------------- SUMMARY: As part of a program of continually reviewing regulations, the Board proposes to amend Regulation T to recognize the current financial environment, classify new products and transactions, and clarify the reach of existing definitions. Comment is invited on all areas of Regulation T. Regulation T was completely rewritten in 1983 after several years of review and comments. The completely revised and simplified regulation appears in general to have met the Board’s statutory obligations under the Securities Exchange Act of 1934 with a greatly reduced burden. The Board has amended Regulation T several times since 1983 to increase the types of securities that can be purchased on credit and/or used as collateral in a margin account and to allow brokerdealers to help customers exercise employee stock options. In 1990 the Board adopted a series of amendments to accommodate transactions in foreign securities. The continuing introduction of new products and types of transactions and the expansion of global markets, however, creates the need for a more broadly based review. In addition, over the past several years, Board staff has issued numerous opinions concerning the provisions of Regulation T. Some of these opinions may be codified in the regulation as a result of this review. After the review of Regulation T is completed, the Board may propose related changes to its other margin regulations. Regulations G, U, and X. Comments should be received on issue again. Comment is requested on the advisability of such amendments, or before October 16,1992. subject to the considerations explained ADDRESSES: Comments, which should below. . refer to Docket No. R-0772, may be The Board has long taken the position mailed to Mr. William W. Wiles, that an investor with a given amount of Secretary, Board of Governors of the Federal Reserve System, 20th Street and money should not be able to effect a Constitution Avenue, NW„ Washington, - greater amount of short selling than long buying. There is some concern about DC 20551. Comments addressed to Mr. encouraging customers of U.S. brokerWiles may also be delivered to the dealers to sell short in countries that do Board’s mail room between 8:45 a.m. and 5:15 p.m., and to the security control not have such a requirement. Also, some countries allow short sales to be room outside of those hours. Both the mail room and the security control room effected without disclosure of the parties and without identifying whether are accessible from the courtyard the sale is short or long. Comments entrance on 20th Street between should, therefore, address the possible Constitution Avenue and C Street, NW. Comments may be inspected in room B- effect that allowing broker-dealers to arrange for foreign short sales could 1122 between 9:00 a.m. and 5:00 p.m., except as provided in § 261.8 of the have on short sales in the United States. Board’s Rules Regarding the Availability In addition, comment is invited on the of Information, 12 CFR 261.8. appropriateness of allowing brokerdealers to arrange for the borrowing and FOR FURTHER INFORMATION CONTACT: lending of foreign securities without Laura Homer, Assistant Director, or regard to the limitations found in § Scott Holz, Senior Attorney (202/452/ 220.16 of Regulation T, the section which 2781), Division of Banking Supervision covers broker-dealers when they lend or and Regulation, Board of Governors of borrow securities directly. As discussed the Federal Reserve System. For the immediately below, the Board is also hearing impaired only, Telecommunications Device for the Deaf inviting comment on that section. If that section is amended to allow broker(TDD), Dorothea Thompson (202) 452dealers greater freedom when borrowing 3544, Board of Governors of the Federal and lending securities, an amendment to Reserve System, 20th and C Streets, the arranging section may not be NW„ Washington, D.C. needed. Comments should address SUPPLEMENTARY INFORMATION: situations in which it is appropriate to Comment is invited on all areas of Regulation T. Some of the areas already allow broker-dealers to arrange transactions of this type which they identified for review are listed below in cannot effect themselves. alphabetical order. da tes: Arranging In 1990, the Board adopted a number of amendments to Regulation T to accommodate transactions in foreign securities. The "arranging” provision found in § 220.13 was amended at that time to allow broker-dealere to arrange for a customer to obtain credit from a foreign lender on foreign securities without regard to the broker-dealer’s ability to extend the credit itself. In adopting the amendment, the Board declined to add language suggested by some commenters to allow brokerdealers to arrange (1) short sales in foreign markets, and (2) loans of foreign securities. The Board indicated that these proposed enlargements would be addressed after some experience was gained with the amendments adopted at that time. The Securities Industry Association has recently raised the Borrowing and Lending of Securities Section 220.16 of Regulation T restricts the ability of broker-dealers to borrow and lend securities in two ways: (1) A loan of securities must be for a permitted purpose, i.e., to complete a short sale or failure to receive securities, and (2) a loan of securities must be at least 100 percent collateralized with specific types of collateral. Board staff is unaware of other valid purposes for borrowing and lending securities. If commenters believe other purposes should be permitted, they should identify appropriate situations. Comment is invited on additional types of appropriate collateral. Originally, all loans of securities had to be collateralized by cash. Treasury securities were the first noncash instruments allowed as collateral for these loans. The Board expanded the list 37110 Federal Register / Vol. 57, No. 160 / Tuesday. August 18, 1992 / Proposed Rules of acceptable collateral in 1982 to include securities issued or guaranteed by United States agencies and certain bank letters of credit, certificates of deposit, and bankers acceptances. Since that time, Board staff has indicated it believes that marginable foreign sovereign debt securities should be allowed as collateral for loans of securities denominated in that foreign currency. One of the reasons for restricting the ability of broker-dealers to borrow and lend securities is the possible evasion of the margin requirements by someone who obtains 100 percent credit on a security through characterization of the transaction as a stock loan. Permissible collateral for broker-dealers who borrow securities from their customers is also covered in Securities and Exchange Commission (SEC) Rule 15c3-3 (17 CFR 240.15c3-3), the SEC’s customer protection rule. The Board intends to coordinate its approach in this area with that of the SEC as closely as possible, while taking into account the different reasons for the two rules. As noted above in the section on arranging, it has been suggested that broker-dealers should be able to arrange for the borrowing and lending of foreign securities without regard to the purpose of the transaction or the collateral securing it. Interested commenters should identify those situations in which it would be appropriate to allow brokerdealers to arrange these transactions outside of the parameters of § 220.18 of Regulation T. Section 220.16 as currently written clearly applies to exempted securities. Comment is invited on the need for continuing regulation of borrowing and lending of U.S. government securities in Regulation T. At least one primary dealer has argued that government securities dealers cannot easily document that their securities borrowing and lending is for a permitted purpose, although short sales and fails are the primary reasons for such transactions (see staff opinion in the Federal Reserve Regulatory Service at 5-615.19). In addition, the enactment of the Government Securities Act of 1986 has imposed new regulation in this market, raising the question of whether Regulation T requirements are still appropriate. Borrowing by Creditors Section 8(a) of the Securities Exchange Act of 1934 (15 U.S.C. 78h(a)} restricts the ability of broker-dealers to borrow using exchange-traded securities as collateral. Under this section, the only lenders taw hom a broker-dealer can pledge exchange-traded securities are banks that are members of the Federal Reserve System; nonmember banks (including foreign banks with U.S. branches and agencies) that have agreed to be bound by the provisions in the Federal Reserve Act, the Banking Act of 1933, and the Securities Exchange Act of 1934 covering securities loans; and other broker-dealers as specified in Regulation T. The requirements of section 8(a) can be found in § 220.15 of Regulation T and § 221.4 of Regulation U (12 CFR 221.4). In addition, § 207.4 of Regulation G (12 CFR 207.4) mirrors the statutory limitation by prohibiting lenders who are neither banks nor broker-dealers from lending to brokerdealers on the collateral of margin stock, unless the loan is to meet emergency needs arising from exceptional circumstances. Some broker-dealers have expressed the opinion that the statutory limitation on the types of lenders to whom they can pledge exchange-traded securities is overly restrictive and anti-competitive. The Board does not have the authority to expand the eligible types of lenders for loans that are not to meet "emergency needs.” Comment is invited on whether the Board should recommend legislative changes to permit additional types of entities, such as insurance companies, to lend to brokerdealers on the collateral of exchangetraded securities. Cash Account Since the last revision of Regulation T in 1983, Board staff has received many inquiries concerning the ability to use a cash account for transactions not specifically authorized in § 220.8, the section governing cash accounts. Investors and some self regulatory organizations (SROs) have indicated that certain institutional customers are precluded, either under state law or corporate charter, from opening a margin account cr leaving cash and securities at a broker-dealer. These customers sometimes wish to engage in a variety of transactions, generally involving options, where their risk is limited to an amount deposited in a cash account or evidenced by an escrow receipt. Situations which Board staff could not conclude were covered by the language of § 220.8 have sometimes been referred to the SEC for a possible “no-action" position (see staff opinion in the Federal Reserve Regulatory Service at 5-666.251). Comment is invited on possible revisions to the cash account provisions to accommodate transactions in which combinations of securities limit the customer’s exposure and cash or securities in the account cover that exposure. Another area in which Board staff has received numerous inquiries about the cash account concerns transactions in exempted securities. These questions generally concern net settlement of multiple transactions or repurchase/ reverse repurchase agreements. Transactions in a cash account are settled individually to prevent "free riding," the purchase of a security by a customer who does not have the ability to pay for it followed by the sale of the same security so that the purchase can be paid for with the proceeds of its sale. In order to reduce the number and size of large-dollar wire transfers, however, Board staff has not objected to net settlement in the cash account of transactions in exempted securities for institutional customers whose business is conducted on a delivery-versuspayment basis through a depository environment. An SRO has noted that institutions sometimes purchase U.S. government securities in a cash account and finance their purchase through a repurchase agreement. This type of transaction appears to be more appropriate for the margin account given the current language of the cash account but some customers may be unable to use a margin account. Comment is invited on the appropriate treatment of transactions in exempted securities in a cash account. Repurchase transactions are also discussed generally in a separate section below. Cross-Margining Financial futures and options on financial futures are often based on the same securities index as index options traded on a national securities exchange. Although one may be a "commodity” and the other a “security," the products are related. The concept of ‘‘cross-margining’’ includes the recognition that positions in financial futures can be used to hedge positions in securities index options and vice versa. While most would agree that crossmargining should be encouraged, there is a statutory limitation in this area. Section 7(c) of the Securities Exchange Act of 1934 generally prohibits brokerdealers from extending credit to purchase or carry securities unless the loan is collateralized by securities in accordance with Board rules. This statutory prohibition has prevented Board staff from opining that commodities can serve as margin for related securities positions under Regulation T. In lieu of an opinion. Board staff has indicated that it does not object to the issuance of an SEC "no action” position permitting cross- Federal Register / Vol. 57, No. 160 / Tuesday, August 18, 1992 / Proposed Rules_______ 37111 margining for specialists in certain circumstances. Comment is solicited on methods of accommodating crossmargining. Derivative Securities Margin requirements for securities positions are found in the Regulation T supplement, § 220.18. Margin depends on the type of security involved: margin “Customer” Status of Certain BrokerDealers equity security, margin debt security, exempted security, short options Broker-dealers who use another position, etc. Different margins are broker-dealer to clear and carry their required for long purchases and short proprietary trades are treated as sales. Following the introduction of customers of the clearing broker-dealer. standardized, exchange-traded options It has been suggested that “customer” in 1973, the Board amended Regulation status for these broker-dealers is T frequently to accommodate new unnecessary as they are also subject to options products and transactions. In the SEC’s net capital rule (17 CFR 1985, the Board simplified its rules in 240.15c3-l). However, this may present this area by defining margin for the equitable problems if the SEC’s net writing of options by reference to the capital rule requires less capital for maintenance rules of the exchange that broker-dealers with no public customers trades the option. In the past few years, than the amount of margin required for a a variety of new products have been non-broker-dealer with the same developed, such as index participations positions. and capped options, that do not fit If broker-dealers continue to be easily into one of the categories in the treated as customers of their clearing supplement. Board staff has tried to broker-dealers for proprietary positions, respond to inquiries on new products on should the provision in Regulation T an ad hoc basis. Comment is invited on covering joint and common back offices possible generic approaches to (§ 220.11(a)(2)) be amended? This categorizing the margin treatment of the provision allows broker-dealers who do continuing list of new product^, not clear and carry their own especially those with characteristics of transactions to avoid being treated as more than one type of security. customers of their clearing firms if the There appears to be an increasing non-clearing broker-dealer has an number of transactions involving ownership interest in the clearing firm. nonstandardized, over-the-counter When the Board adopted this provision, options. The margin for these options is it declined to define an appropriate ratio the amount required by the maintenance between the non-clearing brokermargin rules of the broker-dealer’s SRO. dealer’s interest in the clearing firm and Margin must be collected for the amount of transactions it needs nonstandardized options that are cleared. However, several SROs have “issued, endorsed, or guaranteed” by the expressed concern that this Section of broker-dealer. Board staff has recently Regulation T is being abused by non been asked about over-the-counter clearing broker-dealers who make a options that are not issued, endorsed, or minimal investment in a clearing firm. If guaranteed by a broker-dealer. The this section of the regulation is being argument has been made that a brokerused by broker-dealers to avoid other dealer who buys such an option from its provisions of Regulation T, comment is customer is merely purchasing a security invited on how those sections can be and no margin need be charged to the amended to reduce the incentive to customer because the broker-dealer abuse the section on joint and common does not have a continuing obligation back offices. vis-a-vis the customer. One of the Questions have also arisen on the reasons broker-dealers traditionally treatment of foreign broker-dealers. endorse or guarantee OTC options is to Some parts of Regulation T apply to make them transferable. Although OTC brakerdealers generally, such as the options that are not endorsed or section on borrowing and lending guaranteed by a broker-dealer may not securities (§ 220.16). Other parts apply be transferable, there is nothing to stop only to broker-dealers registered with a broker-dealer from writing a similar the SEC, such as omnibus accounts (§ option to offset the option purchased 220.10). Should Regulation T take greater from the customer. This is in many ways account of foreign broker-dealers? If so, the equivalent of endorsing a customer how can the phrase “foreign brokeroption for sale to another investor. dealer” be defined? Also, should Comment is requested on the affiliated foreign broker-dealers be appropriate treatment of OTC options, treated differently from non-affiliated whether or not endorsed or guaranteed foreign broker-dealers? by a broker-dealer. Extensions of Time Most customer purchases in a margin or cash account must be paid for within seven business days of trade date or the broker-dealer is required to cancel or otherwise liquidate the transaction. Under §§ 220.4(c)(3) and 220.8(d), a broker-dealer may obtain an extension of this time period from an SRO. One SRO has asked the SEC to approve a rule requiring broker-dealers to obtain extensions of time from their designated examining authority. Staff of the SEC is -currently studying this issue and exploring the possibility of requiring the SRO that grants the extension to do compliance examinations. Others have suggested that broker-dealers should be able to grant extensions of time without approval from any SRO. There is some concern that this would allow brokerdealers to grant more favorable extensions to certain customers. In addition, the Board believes settlement and payment should occur as soon as possible. Tne Group of Thirty, a private sector group concerned with international financial issues, has recommended a world-wide standard of settlement on the third day after trade date. The Board may consider shortening the time for customer payment once the settlement period is shortened from the current five days. Comment is invited on the current need for changes to rules regarding extensions of time for customer payment. Hedges, Offsets, and Cover in Lieu of Margin Under § 220.18(c), the short sale of a nonexempted security requires a margin of 150 percent of the security’s current market value. One hundred percent is met by the proceeds of the short sale and the customer must post an additional 50 percent margin. The additional 50 percent is not required if the account also holds securities “exchangeable or convertible within 90 calendar days without restriction other than the payment of money.” Concerns have been raised about the equity of using a corporate warrant as a hedge for a short sale of the underlying stock because the warrant is not of comparable value to the underlying security. In addition, the continuing proliferation of derivative securities has led to the suggestion that like, but not identical, products should be recognized as hedges. Comment is invited on this area. Commenters who believe the relationship between like products should be recognized should describe how close a correlation between the 37112 Federal Register / Vol. 57, No. 160 / Tuesday, August 18, 1992 / Proposed Rules products should be required for the hedge to be recognized. Specialists in options are permitted good faith credit in their specialty option and any “permitted offset positions” specified in § 220.12(b). However, permitted offsets are determined by the “underlying” security, defined in § 220.2(aa) as “the security that will be delivered upon exercise of an option.” This precludes the use of permitted offsets for specialists in cash-settled index options, as no securities are delivered upon exercise. While this can be remedied by changing definitions, comment is invited generally on the area of permitted offsets. Although margin for the writing of exchange-traded options is generally determined by reference to the rules of the exchange that trades the option, the Federal Reserve still determines what qualifies as cover and positions in lieu of margin for equity securities options. Section 220.5(c) of Regulation T recognizes lesser margin requirements for various option positions such as certain spreads and straddles. These combinations are treated as one position for Regulation T purposes. Board staff has received letters from investors who believe certain new or additional strategies should be recognized, especially multiple combinations of option positions. Comment is invited on improvements and simplifications in this area. Two-Tiered Market One of the issues often discussed in the past few years is the ability of socalled sophisticated investors to operate with lesser regulation than so-called average investors. In the margin area, the Board took note of sophisticated investors when it amended, in 1975, the general prohibition on broker-dealers arranging for credit they cannot themselves extend to allow brokerdealers to arrange for credit in private placements. The Board’s rationale was that the SEC and the courts have recognized that private placements are made to limited, sophisticated group of persons who will not be lured into the transaction by the availability of credit. At the SRO level, the New York Stock Exchange has established special accounts with less regulation for large institutions. Comment is invited on the desirability of adopting less restrictive rules to apply to specified customers who are sophisticated investors. Comments must necessarily address how such customers can be identified and which restrictions can be eliminated. Repurchase and Reverse Repurchase Agreements (See Also Cash Account Above) It is generally recognized that while repurchase (repo) and reverse repurchase agreements involve the purchase and sale of a security, the transactions can be used as a financing tool. The Board has not specified the exact treatment of these agreements for purposes of Regulation T. Because U.S. government securities are entitled to good faith loan value and are often valued at very close to 100 percent of their current market value, the repo of such a security does not present problems under Regulation T from a credit standpoint On the other hand, the repo of a margin equity security at greater than 50 percent would be a violation of the margin regulations. Corporate debt securities fall somewhere in between U.S. government securities and corporate equities. Most corporate debt securities are entitled to good faith loan value. However, the combination of credit risk and the maintenance rules of the SROs means that such securities are not generally given as high a loan value as U.S. government securities. Comment is When-Distributed Securities Purchases in the cash account must generally be paid for within seven business days from trade date. A 1943 amendment to Regulation T recognized an exception for “when-distributed” securities. These securities were usually issued by public utility companies undergoing reorganizations. The amendment allows customers a maximum of seven business days from the date when the “when-distributed” security is made available, rather than seven business days from trade date. In the 1980s, the cash account provision on “whendistributed” securities (§ 220.8(b)(l)(i)(C)) was used in connection with privatizations in the United Kingdom done on an installment basis. While publicly-traded stock is not sold on an installment basis in this country, large issues in the U.K. have used this method. Characterizing these securities as not being distributed until final payment is made therefor allowed U.S. broker-dealers to participate in the offering without being viewed as arranging for impermissible credit in a new issue. Board staff indicated that it would not object to the use of the “when-distributed” exception as an invited on how repurchase agreements can be defined to identify those transactions that may be effected without restriction under the margin regulations. Additional comment is sought concerning which accounts may be used to effect such transactions. accommodation to a foreign government privatizing its state-owned companies. Questions have recently been raised about the ability of foreign private issuers to use the “when-distributed” language in Regulation T. Comment is invited on this area, including possible amendments that would recognize foreign sovereign and possibly private installment sale offerings without relying on the “when-distributed” exception. By order of the Board of Governors of the Federal Reserve System , August 13,1992. W illiam W. W iles, Secretary of the Board. [FR Doc. 92-19640 Filed 8-17-92; 8:45 am] BILLING CODE 6 2 1 0 -0 1 -F
@FedFRASER