Regulatory Treatment of Fungible TINTS Stripped from Inflation-Indexed Securities
Identical letters addressed to:
Samuel Luque, Jr., National Association of Securities Dealers Regulation;
Raymond J. Hennessy, New York Stock Exchange;
Herbert A. Biern, Board of Governors of the Federal Reserve;
Kurt Wilhelm, Office of the Comptroller of the Currency; and
Miguel Brown, Federal Deposit Insurance Corporation
November 3, 1998
Mr. Michael A. Macchiaroli
Associate Director
Division of Market Regulation
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Dear Mr. Macchiaroli:
In January 1997, the Department of the Treasury (the Treasury) began issuing Treasury inflation-indexed securities, whose principal value is adjusted for inflation as measured by the U.S. Government.1 When these securities were introduced, they were immediately eligible for the STRIPS (Separate Trading of Registered Interest and Principal of Securities) program. STRIPS is the Treasury's program under which eligible securities can be separated into principal and interest components (stripped interest components are also referred to as “INTS”). However, due to the complexities associated with the way inflation-indexed securities adjust for inflation, TINTS stripped from different inflation-indexed securities were not initially fungible (i.e., interchangeable). The Treasury, working together with market participants, has developed a methodology that will permit TINTS stripped from different inflation-indexed securities to be fungible effective March 31, 1999.2
The purpose of this interpretive letter is to provide market participants with guidance and clarification regarding the treatment of fungible TINTS stripped from inflation-indexed securities under the regulations implementing the Government Securities Act of 1986 (GSA regulations, 17 CFR 400 et seq.), as amended. Market participants are urged to read this letter in conjunction with the Treasury's letter of January 1997, 3 which provided initial guidance and clarification of the treatment of inflation-indexed securities under the GSA rules. Although this letter also addresses the treatment of principal components stripped from inflation-indexed securities under the GSA rules, the treatment of these components remains unchanged from the January 1997 letter because they are not fungible. This letter is also intended to foster consistent application of the GSA rules among affected entities, including government securities broker-dealers who conduct transactions in inflation-indexed TINTS and stripped principal components.
Large Position Rules
The Treasury's large position rules require that only STRIPS principal components be included in the computation of the net trading position, which is one of the component positions to be included in large position reports (17 CFR Part 420). Positions in principal components stripped from inflation-indexed securities must be computed on the basis of par amount for such reports.
Capital Treatment
Treasury inflation-indexed security transactions of specialized government securities broker-dealers registered with the Securities and Exchange Commission (SEC) under Section 15C of the Securities Exchange Act of 1934 (15 U.S.C. 78o-5) (15C firms) are subject to the Treasury's capital rules, including the market risk haircuts. As stated in the Treasury's guidance letter of January 17, 1997, 4 under the GSA capital rules, the market risk haircut for an inflation-indexed security, including the stripped principal and interest components thereof, is identical to the market risk haircut for a Treasury fixed-principal security, including the stripped principal and interest components thereof, with the same maturity.
Although inflation-indexed TINTS are now fungible, the GSA capital rule treatment with respect to such TINTS remains unchanged. Therefore, the market risk haircut for an inflation-indexed TINT would be identical to the market risk haircut for a TINT from a Treasury fixed-principal security when the TINTS have the same maturity category. For example, under section 402.2(f)(1) of the GSA capital rules, the market risk haircut for an inflation-indexed TINT with a 10-year maturity date would be determined first by classifying the TINT into the “category H” maturity classification, the same classification as a 10-year TINT from a Treasury fixed-principal security. The GSA capital rule treatment of principal components stripped from inflation-indexed securities also remains unchanged.
Financial and Operational Reporting
In accordance with section 405.2 of the GSA rules, which adopts SEC Rule 17a-5 (17 CFR 240.17a-5), with modifications, 15C firms are required to submit Form G-405 (the FOGS report) periodically. In its January 1997 letter, the Treasury stated that, consistent with the requirements for Treasury fixed-principal securities, the FOGS reports should reflect the inflation-indexed security at its mark-to-market value. This same treatment applies to both fully-constituted Treasury securities and STRIPS components. Thus, FOGS reports should reflect inflation-indexed TINTS and stripped principal components at their mark-to-market values.
Recordkeeping
Pursuant to section 404.2 of the GSA regulations, which adopts SEC Rule 17a-3 (17 CFR 240.17a-3), with modifications, 15C firms are required to make and keep, among other things, blotters or other records of original entry, securities position records (i.e., stock records), and order tickets. To foster uniform recordkeeping practices in the government securities market with respect to inflation-indexed TINTS and stripped principal components, the Treasury believes that certain clarifications of these requirements are warranted. Under paragraphs (a)(1), (a)(5), (a)(6), and (a)(7) of SEC Rule 17a-3, as adopted by section 404.2 of the GSA regulations, transactions in stripped components of inflation-indexed securities must be recorded as follows: (1) Blotters or other records of original entry (paragraph (a)(1)) must include the adjusted value5 and the purchase or sale price for TINTS, as well as the par amount and the purchase or sale price for stripped principal components; (2) the securities position record (paragraph (a)(5)) must include the adjusted value for TINTS and the par amount for stripped principal components; and (3) order tickets (paragraphs (a)(6) and (7)) must include the purchase or sale price and other terms and conditions of the order for both TINTS and stripped principal components.
Financial institutions that have filed, or are required to file, notice as government securities broker-dealers (noticed banks) must make and keep securities position records pursuant to 17 CFR 404.4(a)(3)(i)(A). Consistent with the requirement for 15C firms, securities position records of the noticed banks must include the adjusted values for inflation-indexed TINTS and the par amounts for principal components stripped from inflation-indexed securities.
Confirmations/Safekeeping Receipts
Under 17 CFR 403.4(e), which adopts paragraph (b)(4) of SEC Rule 15c3-3 (17 CFR 240.15c3-3(b)(4)), with modifications, 15C firms must include on confirmations for hold-in-custody repurchase agreements transactions (HICs): the adjusted value and the market value of inflation-indexed TINTS, as well as the par amount and the market value of principal components stripped from inflation-indexed securities. Under paragraph 403.5(d)(2)(i) of the GSA rules, all financial institutions conducting HICs must also include: the adjusted value and the market value of inflation-indexed TINTS, as well as the par amount and the market value of principal components stripped from inflation-indexed securities.
Under section 450.4(b), which applies to the custodial holdings of depository institutions, such entities are required to issue confirmations or safekeeping receipts that would include the adjusted value for inflation-indexed TINTS and the par amount for principal components stripped from inflation-indexed securities.
Consultation/Conclusion
We have consulted with the staffs of the SEC and appropriate regulatory agencies for banks (bank ARAs) in considering the issues in this letter. Based on discussions with the SEC staff, the treatment of inflation-indexed TINTS and stripped principal components under the SEC's capital, recordkeeping, reporting, and HIC confirmation rules would be consistent with their treatment pursuant to the GSA regulations discussed above. Any questions regarding the application of SEC rules, including Rule 10b-10 (17 CFR 240.10b-10), should be directed to the staff of the SEC.
Based on discussions with the staffs of the bank ARAs, the treatment of inflation-indexed TINTS and stripped principal components under the bank ARA recordkeeping rules would be consistent with the GSA and SEC recordkeeping treatment. Similarly, the application of the bank ARA confirmation rules would parallel SEC Rule 10b-10. Questions regarding the application of bank ARA rules to inflation-indexed TINTS and stripped principal components should be directed to the staffs of the bank ARAs.
This letter reflects the GSA regulatory treatment of fungible TINTS stripped from inflation-indexed securities and principal components stripped from inflation-indexed securities at this time. Any changes in the facts and circumstances regarding these components, such as new knowledge about their price behavior, could lead to a different interpretation or to an amendment of the appropriate regulations.
Any questions pertaining to the issues raised in this letter involving the regulatory treatment of inflation-indexed TINTS and principal components should be directed to the Government Securities Regulations Staff at 202-219-3632.
Pursuant to 17 CFR 400.2(c)(7)(i), this letter will be made immediately available to the public.
Sincerely,
Van Zeck
Commissioner
cc:Caite McGuire (SEC)
Larry Clark (OTS)
Paula Simpkins (The Bond Market Association)
Footnotes:
1 See 31 CFR Part 356 (Uniform Offering Circular), 62 FR 846 (January 6, 1997).
2 See 31 CFR Part 356, as amended by a final rule published at 63 FR 35782 (June 30, 1998). To achieve fungibility, inflation-indexed TINTS with the same maturity (i.e., payment) date would be assigned the same CUSIP number, regardless of the underlying inflation-indexed security from which the TINT was stripped. Fungibility applies only to TINTS; principal components are not fungible. TINTS from eligible fixed-principal securities have been fungible since July 29, 1985.
3 See letter from Richard L. Gregg, Commissioner, Bureau of the Public Debt, Department of the Treasury, to Michael A. Macchiaroli, Associate Director, Division of Market Regulation, Securities and Exchange Commission (January 17, 1997).
4 Id.
5 See 31 CFR Part 356, as amended, supra note 2. Unlike other Treasury securities, TINTS are not expressed in par amounts. TINTS from inflation-indexed securities are maintained and transferred at their adjusted value, while TINTS from fixed-principal securities are maintained and transferred at their original payment value.