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FEDERAL RESERVE BANK OF NEW YORK Circular No. 10829 January 17 1996 [ SECURITIES CREDIT TRANSACTIONS Proposed Amendments to Regulation U Comments Invited by February 15 To All Banks, Brokers and Dealers, and Persons Extending Securities Credit in the Second Federal Reserve District, and Others Concerned: The following statem ent has been issued by the B oard o f G overnors o f the Federal Reserve System: The Federal Reserve Board has issued for public comment proposed amendments to its Regulation U, Credit for Banks for the Purpose of Purchasing or Carrying Margin Stocks. Comment is requested by Febmary 15,1996. The proposed amendments call for: • explicit guidance for banks financing margin stock that has been purchased by their customers through a broker-dealer on a delivery-versus-payment (C.O.D.) basis. • greater flexibility for withdrawals and substitutions of collateral when margin stock is pledged along with cash equivalents and other securities by treating the entire credit as a single loan. In addition, the proposed amendments would conform Regulation U to changes recently proposed for Regulation T about increased loan value for exchange-traded options and money market funds. Printed on the following pages is the text o f the proposal, w hich has been published in the F e d e ra l R egister. Com m ents thereon should be subm itted by February 15, 1996, and may be sent to the Board of Governors, as specified in the B oard’s notice, or to our C om pliance Exam inations Departm ent. W il l ia m J. M c D o n o u g h , P re sid e n t. 63660 Proposed Rules Federal Register Vol. 60, No. 238 Tuesday, December 12, 1995 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 221 [Regulation U; Docket No. R-0905] RtN 7100-AB65 Securities Credit Transactions; Review of Regulation U, “Credit by Banks for the Purpose of Purchasing or Carrying Margin Stocks” Board of Governors of the Federal Reserve System. ACTION: Proposed rule. AGENCY: The Board is proposing amendments to Regulation U, the regulation that covers extensions of credit by banks that are secured in whole or in part by those publicly traded securities defined as “margin stock”. These amendments are being proposed as part of the Board’s program to periodically review its regulations as well as to fulfill the requirements of section 303 of the Riegle Community Redevelopment and Regulatory Improvement Act of 1994. Two of the most important effects of the proposed amendments would be to provide: Explicit guidance for banks financing margin stock purchased by their customers through a broker-dealer on a delivery-versus-payment (or C.O.D.) basis; and greater flexibility for withdrawals and substitutions of collateral when margin stock is pledged along with cash equivalents and other securities by treating the entire credit as a single loan. In addition, amendments would conform Regulation U to changes recently proposed for Regulation T regarding increased loan value for exchange-traded options and money market mutual funds. Technical amendments would update the regulation to reflect a 1991 Board interpretation allowing lead banks to apply Regulation U to syndicated loans independent of other credit extended by syndicate banks and restore language indicating that the exemption for temporary financing of customer SUMMARY: securities transactions does not apply to securities purchased at a broker-dealer. DATES: Comments should be received on or before February 15, 1996. ADDRESSES: Comments should refer to Docket No. R-0905, and may be mailed to William W. Wiles, Secretary, Board of Governors of the Federal Reserve System, 20th Street and Constitution Avenue, NW., Washington, DC 20551. Comments also may be delivered to Room B-222 of the Eccles Building between 8:45 a.m. and 5:15 p.m. weekdays, or to the guard station in the Eccles Building courtyard on 20th Street, NW. (between Constitution Avenue and C Street, NW.) at any time. Comments received will be available for inspection in Room MP-500 of the Martin Building between 9 a.m. and 5 p.m. weekdays, except as provided in 12 CFR 261.8 of the Board’s rules regarding availability of information. including (but not limited to) whether the regulation can be eliminated, simplified, or the burdens imposed thereunder eased. 1. F inancing o f S ecu rities P urchased on a DVP B asis Banks often act as custodians for their customers’ securities. These securities are generally purchased via a registered broker-dealer in a cash account and sent to the bank on a delivery-versuspayment (DVP) basis.1Banks traditionally have not accepted securities in a DVP transaction if the customer does not have the funds to make full payment on hand at the bank. Accepting securities without having the customer’s full payment on hand involves a credit relationship similar to a customer using a margin account at a broker-dealer. In the past few years, System examiners and staff of the Securities and FOR FURTHER INFORMATION CONTACT: Exchange Commission have alleged that Scott Holz, Senior Attorney, or Angela certain banks were financing these DVP Desmond, Senior Counsel, Division of purchases without documentation and Banking Supervision and Regulation, in excess of margin requirements (202) 452-2781. For users of Telecommunications Device for the Deaf contained in Regulation U. The banks were found in violation of Regulation U (TDD), please contact Dorothea or settled charges without admitting or Thompson, (202) 452-3544. denying their culpability.2 SUPPLEMENTARY INFORMATION: The Board Provided customers have sufficient is proposing amendments to Regulation collateral, Board staff believes financing U (12 CFR part 221), “Credit by Banks of securities purchases can be for the Purpose of Purchasing or accommodated within the existing Carrying Margin Stocks,” as part of its provision for revolving-credit program to periodically review its agreements found in § 221.3(c) of regulations and to satisfy requirements Regulation U, with the addition of some under section 303 of the Riegel clarifying language.3* However, it should Community Redevelopment and Regulatory Improvement Act of 1994. be noted that this will not result in The proposed amendments include exactly equal regulation between banks coverage of bank financing of securities and broker-dealers because the purchased by customers through a combination of Board, SEC, and SRO broker-dealer on a cash basis and rules applicable to broker-dealers in this treatment of mixed-collateral loans area cannot be recreated in Regulation (loans secured in part by margin stock and in part by other collateral) as a 1 Customers purchase securities at a brokerdealer on eith er a cash or m argin basis, using eith er single loan if all collateral consists of a cash or m argin account. W h en a custom er securities and cash equivalents. purchases a security on a cash basis, he either Conforming amendments are proposed deposits the fu ll purchase price in the cash account in light of the recently published or asks to have the secu rity sent to his agent (usually a cu stodial bank) against fu ll paym ent o f amendments to Regulation T (12 CFR the purchase price. T h is latter m eth od is described part 220), “Credit by Brokers and in section 220.2(e) o f R egu lation T as a d e liv e ry Dealers” (see 60 FR 33763; June 29, against paym ent, p aym e n t against d elivery, or 1995) that would increase the loan value C.O.D. tra n sa ction and is generally referred to by the indu stry as a D V P transaction. of exchange-traded options and money 2 See, e.g., SEC v. Hansen, 726 F. Supp. 74 market mutual funds. Two technical (S .D .N .Y . 1989). amendments are discussed below. - A p p ly in g the section on revolvin g -cred it ’ In addition to the amendments agreem ents w ill ensure that banks fin an cin g such described in this proposal, comment is purchases establish cred it lim its for their customers, in clu d in g lim its on intraday trading. invited on all areas of Regulation U, Federal Register / Vol. 60, No. 238 / Tuesday, December 12, 1995 / Proposed Rules U.4 Board staff believes that the supervisory structure for banking institutions and the requirement that banks establish credit agreements before financing these transactions will lead banks to impose some additional limitations themselves, but because the additional requirements applicable to broker-dealers are not contained in Regulation T, they cannot be imposed by Regulation U. allocate the credit secured by each tranche. There have been, however, a number of inquiries concerning the interplay of § 221.3(e) (mixed-collateral loans) and § 221.3(f) (withdrawals and substitutions) of Regulation U. As an example, suppose the value of a customer’s nonmargin stock collateral has increased over time but the value of the margin stock has not. In spite of the fact that the overall value of the 2. M ixed-C ollateral Loans collateral has increased, the customer cannot withdraw margin stock because Regulation U does not apply to this “separate” loan does not have extensions of securities credit that are sufficient loan value to permit the not secured at least in part by margin withdrawal. In other words, changes in stock. Loans secured in part by margin collateral value in one tranche have no stock and in part by other collateral are effect on the other tranche. This known as “mixed-collateral” loans and Regulation U has always required some separation requirement makes collateral management extremely difficult. kind of separation for these types of Board staff has tried to respond to loans. Although a single credit inquiries in this area through agreement may be used,5 § 221.3(e) of interpretation of the existing Regulation U states that a loan secured regulation.7 However, in light of the in part by margin stock and in part by growth of revolving credit agreements other collateral “shall be treated as two secured by more than just margin stock, separate loans.” This separation it appears that the current rule is requirement has been the subject of unnecessarily burdensome to effectuate numerous inquiries since the last the statutory scheme of regulation.8 revision of Regulation U and has led to The proposed amendment to the this proposal for a relaxation of the section on mixed collateral loans would regulation in this area.6 still require the regulatory segregation of The section on mixed-collateral loans collateral, but would expand the types does not present a problem when first of collateral that could be securing loans applied at the time the loan that currently can only be secured by commitment is made, as it merely margin stock to include all financial requires a bank to determine the loan instruments (stocks, bonds, and cash value of margin stock collateral and equivalents).9 Acting in good faith, a then verify that the other collateral has bank would be able to value all financial a good faith loan value sufficient to instruments in accordance with the make up the difference between the loan margin requirements in the Supplement value of the margin stock and the to Regulation U (§ 221.8) and permit amount of credit being extended and to substitutions within this group in conformity with the section on 4 A lth ough the Board d o es not h ave a withdrawals and substitutions, meaning m ain ten an ce m argin in its regulation s, brokerthe aggregate loan value of the d ealers are required to m on itor ex ten sio n s o f substituted collateral must at least equal secu rities cred it u nd er SRO ru les, call for ad d ition al collateral w h e n market v a lu es fall b elo w a s p e c ifie d the aggregate loan value of the collateral percentage, and s e ll so m e o f th e cu stom er’s withdrawn. Under the proposed secu rities if th e a d d itio n a l collateral is not receiv ed . amendment, credit secured by In ad d ition , SRO ru les require cu stom ers o p en in g m argin a ccou n ts to d ep o sit a m in im u m am ou n t o f eq u ity in cash or secu rities (generally $2000}. 5 T h e a b ility o f a bank to use a sin gle credit agreem ent w a s a reform instituted in 1983. Before that tim e, separate credit agreem ents w ere requ ired for the stock collateral and the nonstock collateral. 6 Before 1983, R egu lation U co vered loans secured by any stock. A “ m ix ed -colla tera l” loan w as one secured in part by stock and in part by other collateral. N o w that the regu lation ’s scope has been reduced to co ver o n ly loans secured by margin stock, a “ m ix ed -colla tera l” loan is one secured in part by margin stock and in part by other collateral. “ Other colla tera l” m ay in clu de stock that w o u ld have been co vered under the previou s version o f Regulation U and therefore not subject to the provision s co verin g m ixed-collateral loans. T h is reduction in the scope o f the regulation had the unintended effect o f redu cing the fle x ib ility for w ithdraw als and substitutions o f collateral for m ixed-collateral loans. 7 See, e.g., Federal Reserve R egulatory Service 5 923.2, 5-923.41, and 5-923.42. 8 M an y customers w h o h ave securities to p led ge as collateral have m ore than just m argin stock (they often have debt securities as w e ll). T h e section on m ix ed-collateral loans presum es there w ill be no change in the collateral once it has been pled ged. T h e num ber o f in qu iries in this area is an in d ica tion that this is often not the case. 9 O n e o f the goals o f the section on m ixedcollateral loans is to ensure that a len der does not in flate the loan valu e o f nonm argin collateral to offset the fact that the m argin regulations lim it the va lu e o f m argin stock to 50 percent o f its current market value. M ost fin an cial instruments have re a d ily available prices, lessening the p o ssib ility for eva sio n o f the margin requirem ents. Other collateral, such as real estate, boats and autom obiles, is m ore lik e ly to have a less w e ll agreed upon market value. 63661 nonfinancial collateral, such as real estate, would continue to be treated as a separate loan. Comment is invited on the continuing need for separation of collateral between financial instruments and other collateral. 3. C onform ing A m en d m ents Although the Board’s margin regulations provide a level playing field for lenders extending purpose credit secured by margin stock, statutory and other considerations have always made the scope of Regulations G and U less broad than that of Regulation T.10 Two of the proposed amendments to Regulation T would make it less restrictive than Regulation U, leading the Board to propose conforming amendments. The two amendments would allow 50 percent margin for exchange-traded options (currently given no loan value) and good faith loan value for money market mutual funds (currently given 50 percent loan value). In addition, the definitions of “cash equivalent” and “examining authority” would be added from the Regulation T proposal to the definitional section of Regulation U. 4. T ech n ica l A m en d m en ts Two technical amendments are proposed. The first would add a sentence to the “single-credit rule” to reflect a 1991 Board interpretation allowing the lead bank to perform Regulation U compliance for syndicated loans. The other would reinsert language inadvertently deleted in 1983 from one of the Regulation U exemptions for credit extended to persons other than broker-dealers.1 1 5. S ection -b y-S ection E xplanation o f P rop osed C hanges to R egulation U Section 221.1 Authority, Purpose and Scope. No substantive changes. Section 221.2 Definitions. (1) Eliminate letter designations for definitions in § 221.2 and references thereto in §§ 221.1(b), 221.3(a) and 221.7(c)(2). (2) Add definitions (from Regulation T) for cash equivalent and examining authority [referred to in § 221.5(c)(9)(ii)). 10For exa m ple, although the Securities Exchange A c t o f 1934 requires the Board to set margins for all purchases o f securities, it s p e cifica lly exclu des bank loans on n on co n vertib le debt securities. 1 T h e exem p tio n for credit to a custom er to 1 tem p orarily finance the purchase or sale o f securities for prom pt d e liv e ry contain ed a restriction proh ib itin g its use for securities purchased at a broker-dealer. T h is restriction was in ad verten tly d rop p ed in 1983 and it is being reinserted. 63662 Federal Register / Vol. 60, No. 238 / Tuesday, December 12, 1995 / Proposed Rules (3) Exclude money market funds from definition of margin stock so as to give allow them good faith loan value. (4) Edit statement in definition of maximum loan value that “(pluts, calls and combinations thereof have no loan value” to reflect loan value for exchange-traded options. Section 221.3 General Requirements 221.3(a)—General Rule (1) Edit statement in general rule that collateral other than margin stock has good faith loan value to reflect fact that puts and calls that do not qualify as margin stock have no loan value. As noted in the summary, the proposed amendments should improve the regulation by providing explicit guidance on certain lending practices and greater flexibility in verifying compliance for certain types of loans. The Board believes there will be a beneficial economic impact if this proposal is adopted. Comments are invited on this statement. practical utility; (b) the accuracy of the Federal Reserve’s estimate of the burden of the proposed information collection, including the cost of compliance; (c) ways to enhance the quality, utility, and clarity of the information to be collected; and (d) ways to minimize the burden of information collection on respondents, including through the use of automated collection techniques or other forms of information technology. P aperw ork R ed u ction A ct List o f Subjects in 12 CFR Part 221 R egulatory F lexib ility A ct In accordance with section 3506 of the Paperwork Reduction Act of 1995 (44 U.S.C. Ch. 35; 5 CFR 1320 Appendix A.l), the Board reviewed the proposed 221.3(c)—Revolving-Credit or Multiple- rule under the authority delegated to the Draw Agreements Board by the Office of Management and Budget. Comments on the collections of (2) Expand subsection to cover information should be sent to the Office financing of securities purchased on a of Management and Budget, Paperwork payment-against-delivery (or DVP) Reduction Project (7100-0115), basis. Washington, DC 20503, with copies of (3) Clarify that FR U -l is always taken such comments to be sent to Mary M. when arrangement is established and McLaughlin, Federal Reserve Board must be amended for subsequent Clearance Officer, Division of Research disbursements if (i) all collateral is not and Statistics, Mail Stop 97, Board of pledged up front, or (ii) collateral has Governors of the Federal Reserve been withdrawn or substituted between System, Washington, DC 20551. disbursements. The collection of information requirements in this proposed 221.3(d)—Single Credit Rule regulation are found in 12 CFR part 221. (4) Clarify that single credit rule does This information is required by not cover syndicated loans (see Board Regulation U and authorized by the Interpretation on loan participations in Securities Exchange Act of 1934 (15 section 221.124 of Regulation U). U.S.C. 78g and 78w). The respondents are for-profit financial institutions. 221.3(e)—Mixed Collateral Loans Records must be retained for three years (5) Alter application of rule so that after the credit is extinguished. instead of separating margin stock The Federal Reserve may not conduct collateral from nonmargin stock or sponsor, and an organization is not collateral, securities and cash required to respond to, this information equivalents are separated from other collection unless it displays a currently types of collateral. valid OMB control number. The OMB control number is 7100-0115. Section 221.4 Agreements of No additional reporting requirements Nonmember Banks or modifications to existing Editorial change reflects combining of recordkeeping requirements are Forms FR T -l and FR T-2. proposed. The current estimated burden is 4 minutes per response. There are Section 221.5 Special Purpose Loans 10,637 subject respondents making an to Brokers and Dealers estimated average of 212 of the subject No substantive changes. loans annually, for a total of 157,853 Section 221.6 Exempted Transactions hours of annual burden for recordkeeping. Based on an hourly cost Restore language to 221.6(f) that credit of $20, the annual cost to the public is is not to be used by a customer to estimated to be $3,157,060. purchase securities from a brokerBecause the records would be dealer. maintained at banks and the notices are not provided to the Federal Reserve, no Section 221.7 OTC List issue of confidentiality under the No substantive changes. Freedom of Information Act arises. Comments are invited on: (a) Whether Section 221.8 Supplement the proposed collection of information is necessary for the proper performance Allow options that qualify as margin of the Federal Reserve’s functions; stock the same loan value as other including whether the information has margin stock. Banks, banking, Brokers, Credit, Federal Reserve System, Margin, Margin requirements, Investment companies, Investments, Reporting and recordkeeping requirements, Securities. For the reasons set out in the preamble, the Board proposes to amend 12 CFR Part 221 as follows: PART 221—CREDIT BY BANKS FOR THE PURPOSE OF PURCHASING OR CARRYING MARGIN STOCK (REGULATION U) 1. The authority citation for Part 221 is revised to read as follows: Authority: 15 U.S.C. 78c, 78g, 78h, 78q, and 78w. §221.1 [Amended] 2. Section 221.1(b) is amended by removing the word “§ 221.2(b)” and adding “§ 221.2” in its place. 3. Section 221.2 is amended as follows: a. By removing the alphabetic paragraph designations from the definitions and placing the definitions in alphabetical order; b. By removing the paragraph designation (1) in front of the definition of Bank, by designating the text following the work Bank as paragraph (1), by revising newly designated paragraph (1) introductory text and paragraph (2) introductory text; c. By adding new definitions in alphabetical order for Cash equivalent and Examining authority, d. By removing the period at the end of paragraph (6)(iii) and adding “; or” in its place, and by adding new paragraph (6)(iv) to the definition of Margin stock-, e. By revising the third sentence of the definition of Maximum loan value. The additions and revisions read as follows: §2 2 1.2 * Definitions. * * * * Bank (1) Has the meaning given to it in section 3(a)(6) of the Act (15 U.S.C. 78c(a)(6)) and includes: * * * * * (2) Bank does not include: * * * * * Federal Register / Vol. 60, No. 238 / Tuesday, December 12, 1995 / Proposed Rules Cash equivalent means negotiable bank certificates of deposit, bankers acceptances issued by banking institutions in the United States and payable in the United States, and any security issued by an investment company registered under section 8 of the Investment Company Act of 1940 (15 U.S.C. 80a-8) that is a money market fund in compliance with all applicable requirements of SEC Rule 2a-7 (17 CFR 270.2a-7). * * * * * Examining authority means: (1) The national securities exchange or national securities association of which a broker or dealer is a member; or (2) If a member of more than one selfregulatory organization, the organization designated by the Securities and Exchange Commission (SEC) as the examining authority for the creditor. * * * * * Margin stock * * * * * * (iv) A company which is a money market fund in compliance with all applicable requirements of SEC Rule 2a-7 (17 CFR 270.2a-7). Maximum loan value * * * Puts, calls and combinations thereof that do not qualify as margin stock have no loan value. * * * * * * * * 4. Section 221.3 is amended as follows: a. By revising the last sentence of paragraph (a)(1); b. By revising paragraph (c); c. By adding a sentence to the end of paragraph (d)(1); d. By revising paragraph (e). The revisions and additions read as follows: §221.3 General requirements. 7. Section 221.7 is amended by the agreement is not pledged at the time revising paragraph (c)(2) to read as the agreement is originally established. (2) If a purpose statement executed at follows: the time die credit arrangement is § 221.7 Requirements for the list of OTC initially made indicates that the purpose margin stocks. is to purchase or carry margin stock, the * * * * * credit will be deemed in compliance (c) * * * with this part if the maximum loan (2) No longer substantially meets the value of the collateral at least equals the provisions of paragraph (b) of this aggregate amount of funds actually section or the definition of OTC margin disbursed or at the end of any day on stock in § 221.2 of this part. which credit is extended under the * * * * * agreement, the bank calls for additional 8. Section 221.8 is amended by collateral sufficient bring the credit into revising paragraphs (a) and (c) to read as compliance with § 221.8 (the follows: Supplement). For any purpose credit disbursed under the agreement, the bank shall obtain and attach to the executed Form FR U -l a current list of collateral which adequately supports all credit extended under the agreement. (d) * * * (1) * * * Syndicated loans need not be aggregated with other unrelated purpose credit extended by the same bank. * * * * * (e) Mixed collateral loans. (1) A purpose credit secured in part by margin stock and in part by collateral other than securities and cash equivalents shall be treated as two separate loans, one secured by margin stock and any other securities and cash equivalents and one by all other collateral. A bank may use a single credit agreement, if it maintains records identifying each portion of the credit and its collateral. (2) A purpose credit secured entirely by securities and cash equivalents may be treated as a single loan. * * * * * 5. Section 221.4 is amended by revising the parenthetical phrase in the middle of paragraph (a) to read as follows: (a) * * * (1) * * * All other collateral, except for puts and calls, has § 221.4 Agreements of non member banks. good faith loan value, as defined in (a) * * * (See Form FR T -l, T-2) § 221,2 of this part. * * * * * * * * * * * * * (c) Purpose statement for agreements 6. Section 221.6 is amended by involving revolving or multiple-draw revising paragraph (f) to read as follows: credit or financing of securities purchases on a payment-against§ 221.6 Exempted transactions. delivery basis. (1) If a bank extends * * * * * credit, secured directly or indirectly by (f) To any customer, other than a any margin stock, in an amount broker or dealer, to temporarily finance exceeding $100,000, under an the purchase or sale of securities for agreement involving revolving or other prompt delivery, if the credit is to be multiple-draw credit or financing of repaid in the ordinary course of securities purchases on a paymentbusiness upon completion of the against-delivery basis, Form FR U -l transaction and is not extended to must be executed at the time the credit enable the customer to pay for securities arrangement is originally established purchased in an account subject to part and must be amended as described in 220 of this chapter; paragraph (c)(2) of this section for each * * * * * disbursement if all of the collateral for 63663 §221.8 Supplement, maximum loan value of margin stock and other collateral. (a) Maximum loan value of margin stock. The maximum loan value of any margin stock is fifty percent of its current market value. * * * * * (c) Maximum loan value of options. Except for options that qualify as margin stock, puts, calls, and combinations thereof have no loan value. By order of the Board of Governors of the Federal Reserve System, December 6,1995. William W. Wiles, Secretary of the Board. [FR Doc. 95-30131 Filed 12-11-95; 8.45 am] BILUNG CODE 6210-01-P