Treasury Provides Government Securities Broker/Dealers With Exemptive Relief In Calculating Haircuts For Options On Certain Mortgage-Backed Securities

Executive Summary

The Department of the Treasury (Treasury) is granting an exemption from the haircut treatment for written mortgage-backed options under Section 402.2a of the Treasury regulations implementing the Government Securities Act of 1986. Treasury consulted with the staff of the Securities and Exchange Commission (SEC) who did not object to the exemption, before granting it.

Discussion of the Exemption

The exemption, available to all registered government securities broker/dealers subject to the capital requirements of Section 402.2, is applicable to written over-the-counter options on mortgage-backed securities, provided the underlying fixed-rate mortgage-backed security is a Treasury Market Risk Instrument (TMRI), as defined in Section 402.2(e). The current Treasury haircut for a position in a 30-year pass-through, fixed-rate mortgage-backed security, that is a TMRI, is 3.3 percent. This haircut percentage recognizes the shorter effective maturity of a 30-year pass-through security, due to the repayment of its principal during the security's life.

Since the risk of holding a position in mortgage-backed securities options derives from the risk inherent in a position in the underlying security, Treasury determined to apply the same haircut factor to both types of instruments. Treasury's exemption allows a registered government securities broker/dealer to calculate its market risk haircut for such options by applying a 3.3 percent haircut factor in lieu of the factor prescribed in SEC Rule 15c3-1a (17 CFR 240.15c3-1a, Appendix A) and then completing the computation of the Other Securities Haircut as outlined in Section 402.2a of the Treasury regulations.

Treasury advises that additional analysis of the mortgage-backed securities market and changes to the SEC or Treasury capital regulations may lead to modification or termination of the exemption. Otherwise, the exemption is now available to registered government securities broker/ dealers subject to Treasury's capital requirements.

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Questions concerning this Notice may be directed to Janet Marsh, District Coordinator, Compliance Department, at (202) 728-8228.