Consideration of a Proposed Treasury Securities Lending Facility, 26174-26178 [E6-6639]

Agencies

• DEPARTMENT OF THE TREASURY
• Department of Treasury

[Federal Register Volume 71, Number 85 (Wednesday, May 3, 2006)]
[Notices]
[Pages 26174-26178]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E6-6639]


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DEPARTMENT OF THE TREASURY


Consideration of a Proposed Treasury Securities Lending Facility

AGENCY: Department of the Treasury, Departmental Offices.

ACTION: Notice; request for comments.

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SUMMARY: The Department of the Treasury (``Treasury'') is considering 
whether it should make available an additional, temporary supply of 
Treasury securities on rare occasions when market shortages threaten to 
impair the functioning of the market for Treasury securities and 
broader financial markets, and, if so, how Treasury should accomplish 
this. This document is intended as a vehicle to facilitate public 
discussion. Treasury has not taken any position on the basic question 
of whether it should establish a securities lender of last resort 
facility (SLLR), or, if it does so, how Treasury should implement such 
a facility.

DATES: Comments must be in writing and received by August 11, 2006.

ADDRESSES: Please submit comments to Treasury's Office of Debt 
Management, Attention: Jeff Huther, Director, Office of Debt 
Management, Room 2412, Department of the Treasury, 1500 Pennsylvania 
Avenue, NW., Washington, DC 20220. Because postal mail may be subject 
to processing delay, we recommend that comments be submitted by 
electronic mail to: debt.management@do.treas.gov. All comments should 
be captioned with ``Comments on Securities Lending Facility.'' Please 
include your name, affiliation, address, e-mail address and telephone 
number(s) in your comment. All comments received will be available for 
public inspection by appointment only at the Reading Room of the 
Treasury Library. To make appointments, please call the number below.

FOR FURTHER INFORMATION CONTACT: Jeff Huther, Director, Office of Debt 
Management, 202-622-2630 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

1. Introduction\1\

    A safe, liquid and highly efficient U.S. Treasury securities market 
is an invaluable national asset. Treasury securities play a key role in 
financial markets as risk-free assets, and the extraordinary liquidity 
in the Treasury market has also led to a role for Treasury securities 
as pricing benchmarks for a broad array of private financial assets. 
Moreover, market participants can execute and manage large positions in 
the Treasury market with relatively low costs, making Treasury 
securities the instruments of choice for many in managing interest rate 
risk. Market participants are willing to pay a premium price for these 
special attributes of Treasury securities, which in turn allows the 
U.S. government to borrow at the lowest possible cost over time.
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    \1\ This notice was prepared by the staff of the Office of Debt 
Management, U.S. Department of the Treasury, in consultation with 
the staff of the Markets Group, Federal Reserve Bank of New York. It 
has benefited greatly from comments provided by colleagues in the 
Division of Monetary Affairs at the Board of Governors of the 
Federal Reserve System.
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    Confidence in the safety and liquidity of the Treasury market is 
supported by the efficient settlement and clearing of Treasury 
transactions. This underscores the importance of safeguarding, and 
enhancing where possible, a well-functioning Treasury market. The 
Treasury market generally operates very well--but there have been a few 
instances in which market functioning has been impaired by forces such 
as attempted market manipulation, catastrophic operational disruptions, 
and complications associated with historically low short-term interest 
rates. Some of these episodes have been associated with elevated levels 
of settlement fails as outsized demands for particular Treasury 
securities have outstripped the available supply.2, 3 
Adverse market outcomes in these cases have included one or more of the 
following--distorted prices in the Treasury cash, derivative and 
collateral markets, and deterioration in dealers' market-making 
activities. Left unaddressed, such developments could pose risks to 
efficient Treasury market functioning and result in higher borrowing 
costs for the U.S. Treasury.
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    \2\ Settlement failures occur when the party selling a security 
fails to deliver the security on the agreed upon settlement date. 
Settlement failures occur for a variety of reasons including errors 
and miscommunications. These failures, often called frictional 
failures, are small and are generally resolved quickly. Larger, more 
chronic fails can occur due to wide-scale operational disruptions. 
In addition, under current market conventions, the costs incurred by 
market participants in failing to deliver securities fall with the 
level of the market repo rate. The potential for chronic fails 
episodes thus increases in a very low interest rate environment such 
as that prevailing during the summer of 2003.
    \3\ In the collateral market, market participants borrow 
securities by lending funds against Treasury collateral, typically 
through the use of repurchase agreements. At the inception of the 
transaction, the dealer ``borrows'' the security and lends funds at 
the repo rate. When the transaction matures, the security is 
returned and the loan is repaid with interest. Although sometimes 
described in economic terms as a collateralized loan, a repurchase 
agreement consists of a purchase of securities, followed by a sale 
at the unwind of the transaction.
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    In August of 2005, Treasury announced at its Quarterly Refunding 
that it had concluded that the concept of a backstop securities 
facility warranted further consideration, and indicated that further 
advice from market participants would be sought on this idea. At 
subsequent Quarterly Refundings, Treasury indicated that it was 
continuing to study the desirability of a standing, nondiscretionary 
securities lending facility. This concept was also discussed at 
meetings of the Treasury Borrowing Advisory Committee in August and 
November, 2005.
    To assist in further consideration of this issue, Treasury is 
publishing this notice to seek comment on the question

[[Page 26175]]

of whether establishment by Treasury of an SLLR would be an appropriate 
response to the potential threat of financial market duress described 
above. Assuming that an SLLR was seen as an appropriate response, we 
further seek comment on how we could accomplish this goal. Treasury has 
not taken any position on whether a SLLR would be beneficial, or, if 
so, the way in which an SLLR should be structured or implemented. In 
order to focus the discussion, however, and to solicit meaningful 
reaction and comments, this notice also outlines one potential 
structure for an SLLR.
    To foster discussion and feedback on these basic questions, the 
notice identifies some important policy considerations underlying these 
questions. Section 2 begins by discussing basic issues associated with 
chronic settlement fails and also notes some of the related history of 
past proposals to establish a securities lending facility. Section 3 
contains some basic lender of last resort principles that might apply 
to the design of a securities lending facility. Section 4 summarizes 
some of the potential benefits and costs of a SLLR. Section 5 then 
outlines one of several possible structures for a prototype SLLR and 
evaluates many critical design features, and section 6 addresses 
legislative changes that may be needed and other implementation issues. 
Section 7 concludes with a summary of critical questions for public 
comment. We invite comment on any and all aspects of this notice.

2. Chronic Settlement Fails

    When settlement fails become acute and protracted, the smooth 
functioning of the Treasury market is undermined. Such episodes can 
lead to increased and unintended credit exposures, and can also hamper 
efforts by investors to liquidate positions. In these circumstances, 
resources are diverted from productive activities to the monitoring, 
controlling and clearing of unsettled trades.\4\ Protracted acute fails 
may also shake investors' confidence in the safety and liquidity of 
U.S. Treasury securities at precisely those moments when bolstering 
public confidence is most needed. In such situations, the reliability 
and effectiveness of Treasuries in their benchmark and risk management 
roles could be compromised, with potential adverse spillover effects on 
the functioning of broader capital markets. This was precisely the 
situation encountered in the second half of 2003, when persistent and 
chronic settlement fails plagued the May 2013 ten-year note.\5\
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    \4\ Garbade, Kenneth, D. and John B. Kambhu, ``Why Is the U.S. 
Treasury Contemplating Becoming a Lender of Last Resort for Treasury 
Securities?,'' Federal Reserve Bank of New York, Staff Reports, No. 
223, October 2005, revised April 2006.
    \5\ For a detailed discussion of this episode, see Fleming, 
Michael J. and Kenneth D. Garbade, ``Repurchase Agreements with 
Negative Interest Rates,'' Federal Reserve Bank of New York, Current 
Issues in Economic and Finance, Volume 10, Number 5, April 2004.
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    The risk of acute and protracted settlement fails could potentially 
be alleviated by a temporary increase in the supply of Treasury 
securities. While market participants may be able to implement changes 
in market conventions that improve the availability of securities in 
high demand, only the U.S. Treasury can increase the aggregate supply 
of securities.\6\ There are other options available to Treasury to 
address impaired Treasury market liquidity, including permanently 
increasing supply through a reopening or, in some cases, the issuance 
of a Large Position Report.\7\ However, these options may be limited in 
their effectiveness, disruptive to Treasury's ``regular and 
predictable'' issuance patterns and costly to Treasury's commitment to 
stability of supply.\8\ The 1992 Joint Report on the Government 
Securities Market identified a SLLR as a preferred option to reopenings 
in addressing acute supply shortages. The report states that ``the 
securities lending approach has some significant advantages over 
auctions and taps. It would be a temporary measure to deal with a 
temporary market problem. It provides for a better possibility for the 
Treasury to capture some of the pricing anomaly and thus in effect make 
money for the taxpayer. Finally, like a tap, it is a more flexible 
approach than auctions to ending a squeeze.'' \9\
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    \6\ Garbade and Kambhu (2005/2006) posit that ``forestalling 
chronic settlement fails by introducing a lender of last resort of 
Treasury securities is conceptually similar to forestalling systemic 
bank suspensions by introducing a lender of last resort of money.'' 
Pg. 2.
    \7\ Under 15 U.S.C. 78o-5(f), Treasury may require persons 
holding or controlling large positions in certain Treasury 
securities to report their positions for the purpose of monitoring 
the impact in the Treasury securities market of concentrations of 
positions.
    \8\ Following the post 9/11/2001 reopening of the August 2011 
ten-year note in October 2001, then-Treasury Under Secretary Peter 
Fisher made it clear that reopening securities on an ad hoc basis to 
address shortages was not something that would be utilized 
frequently to address shortages because of the impact on borrowing 
costs. In remarks to the Futures Industry Association on March 14th 
2002, US Fisher stated ``* * * the unscheduled reopening of the 10-
year note last October was undertaken because of concerns about the 
long-term consequences of systemic failure in our credit markets--
even though the uncertainty it engendered may have added to our 
borrowing costs in the short run. For that reason, unscheduled 
reopenings will remain the exception--the exceedingly rare 
exception.''
    \9\ See Department of the Treasury, Securities Exchange 
Commission and Board of Governors of the Federal Reserve System, The 
Joint Report on the Government Securities Market (January 1992). The 
report also identified other options and stated that there were 
advantages and disadvantages of each option.
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3. Objectives and Principles

    We anticipate that the structure and operation of a securities 
lender of last resort would embody many of the basic objectives and 
principles that underlie traditional lender of last resort facilities. 
Fundamentally, a well-designed SLLR would act as a form of 
``catastrophe'' insurance in the Treasury market--in normal 
circumstances, its impact would be minimal, but it would play an 
important role in mitigating the impact of very rare but potentially 
very costly events that weaken investor confidence and threaten the 
overall functioning of the Treasury and broader financial markets. 
Consistent with this broad objective, we anticipate that the design of 
a prototype SLLR could incorporate a few key principles listed below.
     The SLLR would provide additional, temporary supply on 
rare occasions when market shortages threaten to impair the functioning 
of the Treasury and broader financial markets.
    The SLLR would be intended to act only as a backup source for 
Treasury securities during the rare episodes in which Treasury market 
liquidity and functioning has become impaired. The terms and conditions 
should ensure that program usage is confined only to those instances in 
which markets are not operating normally.
     Usage of the SLLR would be determined by market forces 
rather than Treasury discretion.
    Crisis events can occur with little or no warning, and 
administrative discretion in determining whether the SLLR should be 
available could result in delayed access and in speculative uncertainty 
about its availability. The pricing of Treasury securities would be 
less certain in this environment and policymakers could be perceived as 
acting in an arbitrary or capricious manner or engaging in favoritism. 
(We note that such concerns led the U.K. Debt Management Office to 
establish a non-discretionary securities lending facility.) \10\ In 
addition, a transparent

[[Page 26176]]

program that is driven objectively by market forces would be in keeping 
with the Treasury's commitment to a ``regular and predictable'' debt 
management policy.
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    \10\ The U.K. Debt Management Office obtained the authority to 
lend securities in the late 1990s. However, market participants were 
unsure about the criteria that would inform the DMO's decisions to 
influence the supply of securities in this way, and this uncertainty 
was a source of concern. To address such concerns, the DMO proposed 
a non-discretionary facility in 1999 that was implemented in June of 
the following year. Under the terms of the facility, eligible 
institutions could borrow securities at any time. However, the 
securities were made available at a penalty rate that effectively 
discouraged borrowing except in those cases when market conditions 
were extremely tight or disrupted. Since its inception, the non-
discretionary facility has been utilized quite infrequently and 
reportedly has had little, if any, adverse impact on the normal 
operations in the gilt cash, repo, and futures markets.
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     The availability of the SLLR should strengthen investor 
confidence in the continued safety, liquidity and efficiency of 
Treasury markets.
    In many cases, the potential for a substantial decline in market 
liquidity can be self-fulfilling--market participants fearing a 
deterioration in market conditions may pull back from market activities 
such as securities lending, thereby exacerbating the situation. An 
effective SLLR should work to prevent this by bolstering confidence 
among market participants that an additional, transparent supply of 
highly sought after securities would be available.

4. Potential Benefits and Costs of Proposed SLLR

    Market analysts have observed a number of possible benefits and 
costs that might be associated with an SLLR. Among the potential 
benefits, an effective SLLR might bolster overall Treasury market 
liquidity, even in normal circumstances, by insuring against extreme 
shortages of particular securities. Moreover, an SLLR could contribute 
to greater confidence during a financial crisis by assuring investors 
that additional supply of scarce Treasury securities will be available 
in periods of extreme market disruption. If this effect were 
significant, the SLLR could be an effective crisis management tool.\11\ 
Finally, by guarding against widespread settlement fails, a SLLR could 
substantially reduce expected operational and regulatory costs 
associated with settlement of Treasury transactions.
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    \11\ When faced with unprecedented levels of settlement fails 
that persisted for weeks after the 9/11 terrorist attacks, the 
Treasury Borrowing Advisory Committee ``overwhelmingly felt that 
Treasury should expand their ability to enhance liquidity in the 
Treasury market. To accomplish this, they could set up a repo 
facility to help alleviate protracted shortages, in particular, 
large and persistent fails when for some reason emergency 
reopenings, large position reporting, and debt buybacks do not 
work.'' Report of the Treasury Borrowing Advisory Committee (October 
30, 2001).
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    Weighing against these possible benefits, some observers have 
pointed to the potential for significant adverse market effects. In 
particular, some have argued that a SLLR could contribute to moral 
hazard by effectively ``bailing out'' investors with short positions. 
The increase in moral hazard, in turn, might contribute to excessive 
risk-taking in markets. In addition, some have pointed to the potential 
for a SLLR to be ``gamed'' by market participants in a way that would 
be detrimental to investor confidence and that could impair the overall 
functioning of the Treasury cash and repo markets. Such an outcome 
would ultimately feed back in higher borrowing costs for the U.S. 
Treasury. An even broader conceptual question is whether there is a 
clearly-defined weakness in the market structure sufficient to warrant 
the involvement and intervention of the Federal Government in the 
market through a SLLR, and whether such an intervention would undermine 
or reduce private sector incentives to better (and perhaps more 
efficiently) resolve the issues that the SLLR is intended to address.
    Quantifying the potential benefits and costs associated with a SLLR 
is inherently difficult. Other countries have implemented securities 
lending facilities, apparently without significant adverse effects. On 
the other hand, the level of activity in the U.S. Treasury market 
dwarfs that in other sovereign debt markets, so drawing inferences from 
the experience of other countries on this point may not be appropriate.

5. One Possible Structure--Terms, Conditions and Other Operational 
Details

    The critical design features for the SLLR are the basic 
distribution mechanism and the various terms and conditions of 
securities loans, including rate, maturity, and delivery conventions. A 
number of other parameters, such as eligible borrowers, available 
securities, borrowing mechanics and transparency, collateral valuation, 
margins and rights of substitution, borrowing limits, and reporting and 
administrative criteria are also important. Each of these design 
features is discussed in greater detail below.
    The terms and conditions that are presented below are not being 
recommended by Treasury and are being provided solely as a vehicle for 
more focused comment and discussion. Treasury has found in 
conversations with market participants and the public that a ``straw 
man'' model is extremely useful in eliciting views that are ultimately 
applicable to any of the many possible models on which an SLLR could be 
structured. The substantial detail presented in this particular SLLR 
model should not be construed as an endorsement by Treasury of either 
the general concept of implementing an SLLR, or, of this model.
     Distribution Mechanism: Auctions versus Fixed-Rate (Price) 
Standing Facility.
    Securities borrowed from the SLLR could either be fixed in quantity 
with the rate set through an auction or fixed in rate with the quantity 
determined by the borrower. However, only a fixed-rate standing 
facility would ensure that the needed supply of Treasury securities 
would be available to all eligible borrowers. This construct seems to 
be most in line with the concept of ``lender of last resort,'' allowing 
market participants to borrow as much supply as needed to resolve acute 
and protracted settlement fails.
     Rate, Maturity, Delivery and Reporting Options.
    As noted above, these parameters should be set in a such a way that 
borrowing from the SLLR would be a viable option during rare periods of 
severe market stress but would be viewed as too expensive in normal 
market conditions. This could likely be achieved through an appropriate 
combination of the rate, maturity, delivery, and disclosure 
conventions.
    The SLLR could make securities available at an implied rate of zero 
percent. The implied zero percent repo rate could be achieved by 
charging a lending fee equal to the appropriate term general collateral 
repo rate.\12\ The lending fee alone should limit borrowing from the 
SLLR to only those cases when the market repo rate for a particular 
security has fallen to zero. The use of the SLLR could be even more 
narrowly targeted by suitable specifications of the term of the loan

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and a delayed delivery convention. For example, all SLLR loans might be 
offered for a fixed term with a standard forward delivery. Requiring 
that borrowers enter into a term securities loan with an implied zero 
percent repo rate and a forward settlement date would likely limit 
borrowing from the SLLR to periods of severe market disruption when the 
market repo rate was expected to remain at zero for some time and 
widespread settlement failures were expected to persist for an extended 
period. A forward settlement date would further discourage strategic 
use of the facility in implementing short-run trading strategies.
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    \12\ The lending fee would need to be set so as to guarantee the 
absence of arbitrage in the case with an assumed specials rate of 
zero for a security borrowed from the SLLR. For example, suppose the 
SLLR extended one-week term loans with a one-week forward start. In 
this case, a dealer could reverse in general collateral securities 
today for two weeks and earn the general collateral two-week term 
repo rate. The general collateral securities could then be financed 
for one week at the one-week general collateral rate. After one week 
had passed, the general collateral securities would be returned to 
the dealer and they could then be pledged at the SLLR in return for 
scarce securities. The securities borrowed from the SLLR could then 
be financed, by assumption, for one week at zero percent. The 
lending fee in this case would need to be set equal to the one-week 
forward one-week general collateral rate to guarantee the absence of 
arbitrage profits. As an operational matter, the discussion here 
suggests that specifying the appropriate lending fee would likely 
require calculations based upon regular quotes of general collateral 
repo rates across a range of maturities.
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    It is possible that fairly lengthy term and settlement periods--
perhaps a one-week term with a T+5 settlement convention--might be 
required to limit usage only to scenarios in which markets are severely 
disrupted. Alternatively, shorter-term loans with maturities of a day 
or two and with next-day or skip-day settlement might be adequate. 
Input from market participants concerning appropriate settings for the 
term of SLLR loans and the forward delivery convention would be 
particularly useful.
    A final element under the terms of borrowing concerns reporting 
requirements. It may well be desirable to require borrowers to report 
their daily cash, repo, and futures positions, and fails to deliver and 
receive in the security borrowed over an interval bracketing the period 
of borrowing. Reporting of this type would be another factor that would 
discourage use of the SLLR during normal market conditions and could 
also be useful in guarding against possible inappropriate uses of the 
facility.
     Collateral.
    The SLLR would lend securities on a bond-for-bond basis, meaning 
that to borrow securities from the facility, a borrower would have to 
pledge other Treasury securities of equal market value, plus a margin, 
as collateral. A bond-for-bond facility structure would not affect the 
Treasury's cash position, which simplifies cash management for Treasury 
and open-market operations for the Federal Reserve.
    It likely would be desirable to allow institutions to substitute 
collateral while borrowing from the SLLR. If collateral substitution 
capabilities were especially important to market participants, the SLLR 
might include a tri-party arrangement in which a collateral custodian 
would handle the back office work in tracking frequent collateral 
substitutions over the term of a SLLR loan.
     Available Securities.
    The range of securities available through the SLLR could be defined 
in a number of ways. At one end of the spectrum, the SLLR could stand 
ready to lend additional supply for any outstanding CUSIP number. That 
structure would tend to address the inherent difficulties in 
anticipating future problems that could arise. On the other hand, many 
of the market problems faced in the past have involved recently-issued 
nominal coupon securities. This might suggest that the program could be 
limited to on-the-run and once-off-the-run securities. Input from 
market participants about the appropriate range of available securities 
would be quite valuable.
     Borrowing Mechanics and Public Transparency.
    All borrowing requests would be submitted to the Federal Reserve 
Bank of New York (FRBNY) in its capacity as fiscal agent for the United 
States Government. As with other Treasury and Federal Reserve 
operations, the aggregate daily volume of borrowing requests by CUSIP 
would be made public promptly and well before the loans are settled.
    Prompt disclosure would be critical to ensure that market 
participants with direct access to the facility do not gain a 
significant information advantage over those without direct access.\13\ 
In particular, market participants would need to know how the temporary 
supply of an outstanding security would change in order to make 
informed trading and investment decisions. In addition, prompt 
disclosure should help to dispel bond market rumors about potential 
borrowing from the SLLR that might otherwise add to financial market 
volatility. The names of individual borrowers would be kept strictly 
confidential.
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    \13\ Even with prompt disclosure, borrowers may have an 
information advantage. They will certainly know that aggregate 
quantity will rise before it is disclosed to the public. Dealers 
submitting bids for others as well as themselves arguably would have 
the greatest information advantage.
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     Eligible Borrowers.
    The complexity of collateralized bond-for-bond borrowing and the 
anticipated infrequent use of the SLLR suggest the need to limit the 
group of counterparties to a manageable number. For example, direct 
participation might be limited to primary dealers as designated by 
FRBNY. Primary dealers play a critical role in making markets for 
Treasury securities and maintain active trading relationships with 
FRBNY. Market participants who wished to obtain securities from the 
SLLR could place their order through a primary dealer.\14\ This should 
not represent a significant disadvantage to those entities lacking 
direct access to the facility. The SLLR borrowing rate would be known 
to the entire market and competition among primary dealers should 
ensure that other market participants would be able to tap the SLLR 
through a primary dealer at a minimal cost. Moreover, details on the 
usage of the SLLR (the total amount of borrowing for each security) 
would be publicly available.
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    \14\ This structure would be analogous to that employed during 
2000-2001 when the Treasury conducted buyback operations. Non-
primary dealers that wished to participate in such operations placed 
their bids through primary dealers.
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     Collateral Margin and Valuation.
    As noted above, one of the basic options for the SLLR involves the 
provision of term securities loans. In the interest of protecting the 
Treasury from credit risk, only Treasury securities would be accepted 
as collateral. The amount of Treasury collateral required from a 
borrower could also include a margin to protect the Treasury from the 
risk that the market value of the pledged securities might fall below 
the value of the borrowed securities.
    Protecting the Treasury could be enhanced by marking-to-market the 
value of the collateral each day. If the market value of the collateral 
including the margin were to fall below the market value of the 
borrowed securities, a margin call could be made to the borrower to 
provide more collateral and reestablish the margin. Conversely, if the 
market value of the collateral were to change in the borrower's favor, 
excess collateral could be released to the borrower.
     Borrowing Limitations.
    It may be prudent to place some limitations on the total amount of 
securities that any one participant could borrow. Policymakers might 
have some concern, for example, about the motivations and financial 
circumstances of a market participant wishing to borrow enormous 
amounts of a particular security. A per-issue limit could be set in 
such a way that the aggregate amount of securities available from the 
SLLR would be adequate to resolve or substantially mitigate any market 
disruption.
     Rollovers/Loan Extensions.
    Under conditions of severe market dislocations, borrowers may be 
unable to return borrowed securities to the Treasury on the closing leg 
of the lending transaction. In these circumstances, imposing harsh 
penalties for fails back to the Treasury would run counter to the 
intent of the program; market participants in this case would

[[Page 26178]]

find it advantageous to fail to private counterparties in their efforts 
to avoid failing back to the Treasury, potentially exacerbating the 
fails situation that the SLLR would be intended to address. For this 
reason, it might be reasonable to treat fails back to Treasury in the 
same manner that fails among private counterparties are treated. The 
original loan could be extended on a daily basis at a zero percent rate 
with the lending fee thus set equal to the overnight general collateral 
repo rate.

6. Legislative, Regulatory, and Implementation Issues

    Beyond determining the structure for the proposed SLLR, there are a 
number of issues that would need to be addressed prior to 
implementation, including statutory changes concerning the Treasury's 
borrowing authority, debt limit accounting, and the tax treatment of 
borrowed securities. Each of these is considered in more detail below.
     Authority to Issue Securities for the Purpose of 
Securities Lending.
    Although this paper describes the proposed transactions of the SLLR 
as ``lending,'' Treasury would actually be issuing additional 
securities for a temporary period of time. The Secretary of the 
Treasury (``Secretary'') is authorized under Chapter 31 of Title 31, 
United States Code, to issue Treasury securities and to prescribe terms 
and conditions for their issuance and sale. The Secretary is authorized 
to borrow amounts necessary for expenditures authorized by law and may 
issue securities for the amounts borrowed, and may also issue 
securities to buy, redeem or refund outstanding securities. These 
authorities do not appear to encompass the activities of the proposed 
SLLR. As a result, Treasury would likely need to pursue new authority 
to issue securities for the purpose of securities lending in order to 
implement an SLLR.
     Debt Limit Treatment.
    Treasury would also need to consider the implications of issuing 
additional securities, even on a temporary basis, on the debt subject 
to limit. A bond-for-bond SLLR may not provide a one-for-one offset 
accounting treatment for debt limit purposes. Under the current debt 
limit treatment, the par amount of the debt pledged as collateral to 
the facility could partially or fully offset the par amount of the 
securities that are lent. However, because the SLLR would likely use 
the market value of the collateral to determine the market value of 
borrowed and margined securities, to the degree that market values and 
par values differ, there would not be a one-for-one debt limit 
accounting offset in a bond-for-bond SLLR structure. For example, if 
all securities trade close to their par values, borrowing at the SLLR 
would tend to reduce the debt subject to the limit because the par 
value of securities pledged as collateral (including the margin) would 
tend to exceed the par value of securities borrowed. However, if the 
market value of pledged securities were substantially above par value, 
borrowing from the SLLR would likely increase the debt subject to 
limit. Given this uncertainty, Treasury might need to suspend the SLLR 
lending activity during the period leading up to debt-limit increases 
unless there is a legislative change to the current debt limit 
treatment.
     Tax Treatment.
    Some tax issues would need to be addressed. For example, to ensure 
that Treasury securities borrowed from the lending facility are fully 
fungible with the outstanding securities, both the outstanding 
securities and the securities borrowed from the facility would have to 
be treated for Federal tax purposes as being part of the same issue. It 
may be necessary to seek legislation regarding this treatment.

7. Conclusion

    As noted at the outset, maintaining a safe, efficient, and liquid 
Treasury market is a critical public policy objective. Treasury is 
seeking comments on whether a well constructed SLLR might provide low 
cost insurance against certain types of market disruptions during times 
of financial market crisis. An ideal facility would rarely be utilized, 
but would be available to mitigate strains in the Treasury market and 
in broader financial markets. As noted above, there are potential costs 
to be considered as well, including possible increases in moral hazard 
and the risk of significant gaming of the facility.
    Public input in evaluating and designing a SLLR is essential and we 
invite comment on any aspect of the proposed facility, including 
whether it should be established at all. Treasury takes no position on 
whether a SLLR should be established or, if such a facility were 
established, how it should be structured. In this regard, comments 
focusing on potential benefits and costs associated with a SLLR 
together with an overall assessment of the desirability of establishing 
a SLLR would be particularly useful. In addition, comments on the 
various facets of the proposed structure, including various terms and 
conditions and other operational details, would also be most welcome.

Emil W. Henry, Jr.,
Assistant Secretary of the Treasury.
[FR Doc. E6-6639 Filed 5-2-06; 8:45 am]
BILLING CODE 4811-37-P