Chapter 4. System Open Market Account
The FRBNY has been authorized and directed by the FOMC to execute open-market transactions on behalf of the Reserve Banks. The FRBNY holds the resulting securities and agreements in the SOMA.
U.S. Treasury, federal agency, and GSE debt securities, Federal agency and GSE MBS, investments denominated in foreign currencies and commitments to buy or sell related securities, 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 The cost bases of Treasury securities, GSE debt securities, and foreign government debt instruments are adjusted for amortization of premiums or accretion of discounts on an effective interest method.
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 and financial stability 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 FRBNY with premiums and discounts recorded separately and amortized (accreted) using the effective interest method. 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 MBS
Outright Purchases and Sales
MBS are held in the SOMA portfolio at the FRBNY. 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 can result from outright purchases or sales of Federal agency and GSE MBS, and from MBS dollar roll and coupon swap transactions. MBS transactions may be executed as specified pools or "to-be-announced" (TBA) transactions. 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 the 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 FRBNY 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 FRBNY is recorded in Federal Agency MBS Related Liabilities 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 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 TBA or MBS and to buy an equal amount of a different type TBA or MBS with a different coupon. 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 on a settlement-date basis.
40.15 Securities Purchased Under Agreements to Resell (Repurchase Agreements)
The FRBNY 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 primary dealer to repurchase the securities at an established point in time (securities purchased under agreements to resell). The FRBNY may engage in tri-party purchases of securities under agreements to resell ("tri-party agreements"). In a tri-party arrangement, commercial custodial banks manage the collateral clearing, settlement, pricing, and pledging, and provide cash and securities custodial services for and on behalf of the FRBNY and counterparty. 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. 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)
Securities sold under agreements to repurchase are treated as secured borrowing transactions with the associated interest expense recognized over the term of the transaction, generally overnight.
The FRBNY 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 FRBNY is also authorized and directed by the FOMC to execute reverse repurchase agreements with primary dealers, and with a set of expanded counterparties which includes banks, savings associations, GSEs, and domestic money market funds. These reverse repurchase transactions are settled through tri-party arrangements. The FRBNY 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.)2
40.25 Securities Lending
The FRBNY, 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, or Federal agency and GSE debt securities if agency securities are loaned, that have fair value in excess of the securities lent. The FRBNY 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 Investments
The FRBNY, 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). The FRBNY may also enter into transactions to purchase Euro denominated government debt securities under agreements to resell; these transactions are treated as financing transactions where the repurchase agreement is recorded as an asset and interest income is accrued on a daily basis. Balances result from the execution of transactions and foreign currency interventions for the purpose of stabilizing fluctuations in international flows and exchange values of various currencies and other needs specified by the FOMC. This balance includes the amortization of premiums and discounts. Foreign currency denominated investments, 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 accounted for at cost on a settlement-date basis, adjusted for amortization of premiums and accretion of discounts using the effective interest method. These investments are backed by the full faith and credit of the issuing foreign governments, or are contracts with the foreign central banks or the BIS. Foreign currency denominated investments 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. Any negative interest associated with these foreign currency denominated investments is included in interest income and also 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 FRBNY, on behalf of the Reserve Banks, may enter into euro reverse repurchase agreements, under which foreign currencies are sold under agreements to repurchase. The FRBNY 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 FRBNY evaluates SOMA securities holdings for other than temporary impairment resulting from credit risk. The periodic evaluation should be reviewed by RBOPS Accounting Policy and Operations Section, and recording and disclosure of credit impairments require RBOPS Accounting Policy and Operations 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 short-term currency arrangements, generally for up to one year, between two parties, the FRBNY, 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 FRBNY 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. 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 FRBNY in exchange for U.S. dollars at the prevailing market exchange rate. Concurrent with this transaction, the FRBNY and the foreign central bank agree to a second transaction that obligates the foreign central bank to return the U.S. dollars and the FRBNY to return the foreign currency on a specified future date at the same exchange rate as the initial transaction. The foreign currency amounts the FRBNY acquires is reported as an asset. The foreign central bank compensates the FRBNY based on the amount outstanding and the rate under the swap agreement. 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 FRBNY, 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. The FRBNY compensates the foreign central bank based on the amount outstanding and the rate under the swap agreement. The compensation paid during the term of the swap transaction is reported as interest expense.
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 FRBNY and the Treasury. Warehousing agreements are valued daily at current market exchange rates. 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
Net interest earnings and expenses on securities are 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
The following accounts are those for which activity is allocated to each Reserve Bank consistent with the appropriate participation ratios.3
- 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
- MBS fails charge income
- Premium and discount on securities
- Reverse repurchase agreements
- Repurchase agreements
- SOMA domestic other assets
- Realized gains and losses
- Investments denominated in foreign currencies
- Central bank liquidity swaps
- Foreign deposits
- Interest income and interest expense
- Realized gains and losses
All domestic securities activity is participated to each Reserve Bank using the Interdistrict Settlement Account. (See paragraph 5.00.) 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. Related interest income and gains and losses are participated to each Bank according to its current domestic allocation rate. 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 calculates 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.
- 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 the FRBNY'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 FRBNY against each Bank's holdings in the SOMA. 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 portfolio 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.
- The ISA settlement account will be adjusted by debiting it for 5.
- The offset to the above ISA entry is to credit the gold certificate account for 5.
- 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).
- The offset to the final change to gold account (100) is deducted from the SOMA securities account (2,000 - 100 = 1,900).
|Balance before the annual adjustment||105||10||2,000|
|Balance after adjustment||200||-||5||1,900|
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.
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. The domestic allocation rate is also used for reverse repurchase agreements with foreign officials and international accounts. Return to text
3. All activity is participated daily, except acceptances, margin balances, interest expense on margin balances, and MBS fail charge income, which are participated monthly. Return to text