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Board of Governors of the Federal Reserve System
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Financial Accounting Manual

Chapter 4: System Open Market

 

 

40.01 General

The New York Reserve Bank has been authorized and directed by the Federal Open Market Committee (FOMC) to execute open-market transactions on behalf of the Reserve Banks. The New York Reserve Bank holds the resulting securities and agreements in the System Open Market Account (SOMA).

U.S. Treasury, Federal agency, and government sponsored enterprise (GSE) debt securities, Federal agency and GSE mortgage-backed securities (MBS), outstanding commitments under dollar roll and coupon swap transactions, and investments denominated in foreign currencies comprising the SOMA are recorded at amortized cost, on a settlement-date basis. Rather than using the fair value presentation, amortized cost more appropriately reflects the Bank's securities holdings given the System's unique responsibility to conduct monetary policy. Differences between fair value and amortized cost have no direct effect on the quantity of reserves available to the banking system, or on the ability of the Reserve Banks, as the central bank, to meet their financial obligations and responsibilities. Accounting for securities held in the SOMA on a settlement-date basis better reflects the timing of the transaction's effect on the quantity of reserves in the banking system.1

Both the domestic and foreign components of the SOMA portfolio may involve transactions that result in gains or losses when holdings are sold prior to maturity. Decisions regarding securities and foreign currency transactions, including their purchase and sale, are motivated by monetary policy objectives rather than profit. Accordingly, market values, earnings, and any gains or losses resulting from the sale of such securities and currencies are incidental to the open market operations and do not motivate decisions related to policy or open market activities. The Reserve Banks do not present a statement of cash flows because their liquidity and cash position do not affect their ability to meet their financial obligations and responsibilities. The financial statement footnote disclosures, however, include cash flow information for significant categories of Reserve Bank activities, such as open market operations, lending, and capital expenditures. Profit motivated entities provide a cash flow statement to disclose their ability to generate future cash flows and thus the ability to meet their obligations. This does not represent a risk to the Reserve Banks.

40.10 U.S. Treasury, Federal Agency, and GSE Debt Securities

These securities are held in the SOMA at the New York Reserve Bank with premiums and discounts recorded separately and amortized (accreted) on a straight-line basis. Earnings are accrued daily to the interest accrued account (see paragraph 40.60) and all realized gains and losses are determined by specific issue based on average cost. These assets and related income and the associated gains and losses are participated to each Reserve Bank based on the Bank's designated share of the domestic SOMA portfolio. (See paragraph 40.70.)

40.13 Federal Agency and GSE Mortgage-Backed Securities (MBS)

Outright Purchases and Sales

MBS are held in the SOMA portfolio at the New York Reserve Bank. Interest income on Federal agency and GSE MBS is accrued using the effective interest method and includes amortization of premiums, accretion of discounts, and paydown gains or losses. The premiums and discounts related to Federal agency and GSE MBS are amortized over the term of the security to stated maturity, and the amortization of premiums and accretion of discounts are accelerated when principal payments are received. Paydown gains and losses represent the difference between the principal amount paid and the amortized cost basis of the related security.

Earnings are accrued daily to the interest accrued account (see paragraph 40.60) and all realized gains and losses are determined by specific issue based on average cost. These assets, related income, and the associated gains and losses are participated to each Reserve Bank based on the Bank's designated share of the domestic SOMA portfolio. (See paragraph 40.70.)

MBS Commitments

MBS commitments can result from outright purchases of Federal agency and GSE MBS dollar roll and coupon swap transactions. These "to-be-announced" (TBA) transactions are agreements between a buyer and a seller with regards to type of security, coupon, face value, price, and settlement date; however, the actual pools and characteristics of underlying mortgage collateral are not known until allocation day. Allocation day is two business days before settlement date. The Securities Industry and Financial Markets Association (SIFMA) releases a monthly schedule that indicates specific days that settlement is expected to occur. The New York Reserve Bank requires the posting of cash collateral for commitments as part of the risk management practices used to mitigate counterparty risk, and the resulting cash collateral held by the New York Reserve Bank is recorded in Federal Agency MBS Fails account. (See paragraph 11.94.) Interest expense on the margin balance held for TBA exposure is calculated daily and recorded monthly. Counterparties to MBS commitment transactions incur a daily charge when they fail to deliver the securities on settlement date. The fails charge is calculated daily and accrued monthly. The margin expense and fails charge are participated to each Reserve Bank based on the Bank's designated share of the domestic SOMA portfolio on a monthly basis. (See paragraph 40.70.)

Dollar Roll Transactions

A mortgage dollar roll is a transaction in which the investor sells or purchases MBS or TBA securities for delivery in the current month and simultaneously contracts to repurchase or resell substantially similar (although not necessarily the same) securities on a specified future date. Transfers of MBS upon settlement of the initial TBA MBS transactions are accounted for as purchases or sales in accordance with FASB ASC Topic 860, Transfers and Servicing, and the related outstanding commitments are accounted for on a settlement-date basis.

Coupon Swap Transactions

A coupon swap is a trade with a single counterparty in which the investor agrees to simultaneously sell one type of TBA MBS and to buy an equal amount of a different type TBA MBS. Based on the terms of the coupon swap transactions, transfers of MBS upon settlement of the initial TBA MBS transactions are accounted for as purchases or sales in accordance with ASC 860 and the related outstanding commitments are accounted for as sales or purchases upon settlement.2

40.15 Securities Purchased Under Agreements to Resell (Repurchase Agreements)

The New York Reserve Bank is authorized by the FOMC to acquire U.S. Treasury, Federal agency, and GSE debt securities, as well as Federal agency and GSE MBS, under agreement with a dealer to repurchase the securities at an established point in time (securities purchased under agreements to resell). The New York Reserve Bank may engage in tri-party purchases of securities under agreements to resell ("tri-party agreements"). Tri-party agreements are conducted with two custodial banks that manage the clearing and settlement of collateral. Acceptable collateral under tri-party agreements is determined by the FOMC. The tri-party agreements are accounted for as financing transactions with the associated interest income accrued over the life of the agreements. The repurchase agreements generally consist entirely of agreements through third-party custodial arrangements. Repurchase agreements are participated to each Reserve Bank based on the Bank's designated share of the domestic SOMA portfolio. (See paragraph 40.70.)

40.20 Securities Sold Under Agreements to Repurchase (Reverse Repurchase Agreements)

In December 2002, the New York Reserve Bank replaced matched sale-purchase transactions with securities sold under agreements to repurchase. Securities sold under agreements to repurchase, unlike matched-sale purchase transactions, which were accounted for as separate sale and purchase transactions at an agreed upon rate at the commencement of the transaction, are treated as secured borrowing transactions with the associated interest expense recognized over the term of the transaction, generally overnight.

The New York Reserve Bank is authorized by the FOMC to sell U.S. Treasury, Federal agency, and GSE debt securities, as well as Federal agency and GSE MBS, under agreements to repurchase. The New York Reserve Bank is also authorized and directed by the FOMC to execute reverse repurchase agreements with primary dealers or selected money market funds through a tri-party arrangement. The New York Reserve Bank also executes reverse repurchase agreements with foreign official and international accounts as part of a service offering to account holders. The par values of securities that are sold under agreements to repurchase are deducted from the SOMA portfolio balance when calculating assets available for collateral for Federal Reserve notes. Reverse repurchase agreements are participated to each Reserve Bank based on the Bank's designated share of the domestic SOMA portfolio. (See paragraph 40.70.)3

40.25 Securities Lending

The New York Reserve Bank, on behalf of the Reserve Banks, may lend, on an overnight or term basis, U.S. Treasury, Federal agency, and GSE debt securities held in the SOMA to securities dealers and to banks participating in U.S. government clearing arrangements. These securities-lending transactions are fully collateralized by Treasury securities that have fair value in excess of the securities lent. The New York Reserve Bank charges the participating dealer or bank a fee for borrowing securities and a fee if the borrower fails to deliver the borrowed securities at maturity. Securities-lending fees are participated to each Reserve Bank based on the Bank's designated share of the domestic SOMA portfolio. (See paragraph 40.70.)

40.30 Foreign Currency Denominated Assets

The New York Reserve Bank, on behalf of the Reserve Banks, holds foreign currency deposits and foreign government debt instruments denominated in foreign currencies with foreign central banks and the Bank for International Settlements (BIS). Balances result from market and off-market transactions for the purpose of stabilizing fluctuations in international flows and exchange values of various currencies and other needs specified by the FOMC. Foreign currency holdings are invested in so far as practicable, considering needs for minimum working balances. This balance includes the amortization of premiums and discounts and the accrual of interest. Foreign-currency-denominated assets, realized and unrealized gains and losses, and interest are participated to each Reserve Bank based on the Bank's designated share of the foreign SOMA portfolio. (See paragraph 40.70.)

Investments denominated in foreign currencies are limited, by FOMC policy, to an average maturity of no more than eighteen months (calculated using the Macaulay duration) and are accounted for at cost on a settlement-date basis, adjusted for amortization of premiums and accretion of discounts using the straight line method. These investments are guaranteed as to principal and interest by the foreign governments, or are contracts with the foreign central banks or the BIS. Foreign-currency-denominated assets of the Reserve Banks are revalued daily at current market exchange rates, with any translation gains or losses recognized in profit and loss. Interest income is recorded on the accrual basis. Gains and losses resulting from sales of securities are determined by specific issue based on average cost.

40.35 Euro Reverse Repurchase Agreements

The New York Reserve Bank, on behalf of the Reserve Banks, may enter into euro reverse repurchase agreements, under which foreign currencies are sold under agreements to repurchase. The maximum duration of a euro reverse repurchase agreement is 30 days, and the New York Reserve Bank pays interest at a specified interest rate. These transactions are treated as financing transactions where the currency received is treated as a liability and interest payable is accrued on a daily basis. The liability for euro reverse repurchase agreements, as well as the related accrued interest and interest expense is participated to each Reserve Bank based on the Bank's designated share of the foreign SOMA portfolio. (See paragraph 40.70.)

40.40 SOMA Portfolio Holdings - Impairments

The New York Reserve Bank evaluates SOMA securities holdings for other than temporary impairment resulting from credit risk. The periodic evaluation, recording, and disclosure of credit impairments require RBOPS Financial Reporting and Control Section approval.

40.50 Central Bank Liquidity Swaps

Central Bank liquidity swaps, which can be structured as either U.S. dollar liquidity or foreign currency liquidity swap arrangements, are renewable, short-term currency arrangements, generally for up to one year, between two parties, the New York Reserve Bank, on behalf of the Reserve Banks, and an FOMC authorized foreign central bank. The parties mutually agree to exchange their currencies up to a prearranged maximum amount and for an agreed-upon period of time. These arrangements give the Federal Reserve temporary access to the foreign currencies that it needs to support its international operations and gives the authorized foreign central bank temporary access to dollars.

Subject to the swap agreement provisions, the New York Reserve Bank may invest the foreign currencies received under the swap arrangements in interest-bearing instruments, and the interest income on these holdings is accrued and included in interest income on investments denominated in foreign currencies. Drawings under the swaps are structured so that the party initiating the transaction (drawer) bears the exchange rate risk upon maturity. Each day the swap commitments (both the foreign currency received and the obligation) are revalued at current exchange rates. Any gains or losses resulting from the revaluation of the resulting foreign currency holdings are participated among the Reserve Banks based on the Bank's designated share of the foreign SOMA portfolio. (See paragraph 40.70.)

U.S. dollar liquidity swaps

At the initiation of each U.S. dollar liquidity swap transaction, the foreign central bank transfers a specified amount of its currency to a restricted account for the New York Reserve Bank in exchange for U.S. dollars at the prevailing market exchange rate. Concurrent with this transaction, the New York Reserve Bank and the foreign central bank agree to a second transaction that obligates the foreign central bank to return the U.S. dollars and the New York Reserve Bank to return the foreign currency on a specified future date at the same exchange rate as the initial transaction. The foreign currency amounts the New York Reserve Bank acquires is reported as an asset. The foreign central bank compensates the New York Reserve Bank based on the foreign currency amounts it holds. The compensation received during the term of the swap transaction is reported as interest income.

Foreign currency liquidity swaps

The structure of foreign currency liquidity swap transactions involves the transfer by the New York Reserve Bank, at the prevailing market exchange rate, of a specified amount of U.S. dollars to an account for the foreign central bank in exchange for its currency. The foreign currency amount received is reported as a liability.

40.55 Warehousing Agreement

The FOMC has an agreement to "warehouse" foreign currencies for the U.S. Treasury and the Exchange Stabilization Fund (ESF). This is an arrangement under which the FOMC agrees to exchange, at the request of the Treasury, U.S. dollars for foreign currencies held by the Treasury or ESF for a limited period of time. The purpose of the warehousing facility is to supplement the U.S. dollar resources of the Treasury and ESF for financing purchases of foreign currencies and related international operations. In general, this transaction is similar to the swap; however, the parties are the New York Reserve Bank and the Treasury. Amounts are participated to each Reserve Bank based on the Bank's designated share of the foreign SOMA portfolio. (See paragraph 40.70.)

40.60 Interest Earnings and Expense

Interest on securities is accrued daily. Consistent with market convention, interest accruals and the amortization of premiums and discounts are recognized beginning on the day that securities purchases settle and ending the day before securities mature or sales settle.

40.70 SOMA Participation

In this Section:

Participated Accounts

The following accounts are those for which daily activity is allocated to each Reserve Bank consistent with the appropriate participation ratios.

Domestic portfolio:

  • Federal agency and GSE obligations bought outright
  • U.S. Treasury securities bought outright
  • MBS, related short-term investments, fail assets and liabilities, and cash margin accounts
  • Interest accrued and interest payable--includes fees on securities lending
  • Interest income and interest expense
  • Premium and discount on securities
  • Reverse repurchase agreements
  • Repurchase agreements
  • SOMA domestic other assets
Foreign portfolio:
  • Investments denominated in foreign currencies
  • Central bank liquidity swaps
  • Foreign deposits

Domestic Participation

All domestic securities activity, with the exception of acceptances, margin balances, and interest expense on margin balances, is participated to each Reserve Bank on daily basis using the Interdistrict Settlement Account. (See paragraph 5.00.)4 The participation includes the related interest accrued and premium amortization or discount accretion. Specific securities are not participated to the individual Reserve Banks and the amounts on each Bank's books reflect an undivided interest. Gains and losses are participated to each Bank based on holdings at the opening of business. Allocation is made on the basis of percentages that are derived from an annual settlement of interdistrict clearings and equalization of gold certificate holdings as explained below. The percentages that are used for allocating the account are calculated as follows:

  • In April of each year the Board and the Markets Group at the New York Reserve Bank calculate the average daily balance on each Bank's Interdistrict Settlement account during the preceding 12 months. The average daily settlement account balance (plus or minus) is applied to each Bank's gold certificate account total.
  • In this calculation, an amount is set aside in New York Reserve Bank's account to accommodate future gold sales by the U.S. Treasury.
  • A calculation is then made of the amount each Bank should have in its gold certificate account to equal the System average of gold certificates to Federal Reserve notes outstanding. In this calculation, an amount is set aside in New York Reserve Bank's account to accommodate future gold sales by the U.S. Treasury.
  • The adjustment that would be required in each Bank's gold certificate total is applied by the New York Reserve Bank against each Bank's holdings in the System Open Market Account. Thus, a desired decrease in a Bank's gold certificate account is achieved by increasing the Bank's holdings of securities.
  • The resulting percentage of each Bank's participation in the SOMA Account is used, until the next reallocation, as the basis for allocating the daily SOMA transactions.
  • The following is a simplified illustration of the procedure that is performed each April: Assume that Reserve Bank A has gold certificates balance of 105, securities of 2,000, outstanding Federal Reserve notes of 2,000, and during the 12 months ending in March, its ISA settlement account averaged -5. The gold certificate total of all Banks combined is 10 percent of the combined Federal Reserve notes.

    1. The ISA settlement account will be adjusted by debiting it for 5
    2. The offset to the above ISA entry is to credit the gold certificate account for 5.
    3. The gold certificate account will be adjusted to equal ten percent of the outstanding notes total (2,000 x 10% = 200), increasing the gold account by 100 (200 -100 = 100).
    4. The offset to the final change to gold account (100) is deducted from the SOMA securities account (2,000 - 100 = 1,900).
Example: Gold ISA SOMA
Dr. Cr. Dr. Cr. Dr. Cr.
Balance before the annual adjustment 105     10 2,000  
1. ISA     5      
2. Gold   5        
3. Gold 100          
4. Securities           100
Balance after adjustment 200   - 5 1,900  
Foreign Participation

All foreign currency denominated activity is participated based on the ratio of each Reserve Bank's capital and surplus to the Reserve Banks' aggregate capital and surplus using the preceding December 31 balances. Specific securities are not participated to the individual Reserve Banks and the amounts on each Bank's books reflect an undivided interest. The accounts are reallocated annually.


References

1. The annual audited financial statements, however, are adjusted to reflect foreign-exchange contracts that are unsettled at year-end, effectively adopting trade-date accounting for the audited financial statements only. Return to text

2. Principally, the securities in coupon swaps have different coupon rates; therefore, they do not meet the "substantially the same" criteria of ASC 860. Return to text

3. The domestic allocation rate is also used for reverse repurchase agreements with foreign officials and international accounts. Return to text

4. Acceptances, margin balances and interest expense on margin balances are participated monthly. Return to text

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Last update: February 18, 2014