[Federal Register Volume 61, Number 98 (Monday, May 20, 1996)]
[Proposed Rules]
[Pages 25164-25173]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-12630]
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DEPARTMENT OF THE TREASURY
Office of the Assistant Secretary for Financial Markets
Fiscal Service
31 CFR Part 356
Amendments to the Uniform Offering Circular for the Sale and
Issue of Marketable Book-Entry Treasury Bills, Notes and Bonds
AGENCY: Office of the Assistant Secretary for Financial Markets,
Treasury.
ACTION: Advance Notice of Proposed Rulemaking.
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SUMMARY: The Secretary of the Treasury (Secretary) is authorized under
Chapter 31 of Title 31, United States Code, to issue United States
obligations and to offer them for sale under such terms and conditions
as the Secretary may prescribe. The Department of the Treasury
(Department or Treasury) is issuing this Advance Notice of Proposed
Rulemaking to solicit comments on the design details, terms and
conditions, and other features of a new type of marketable book-entry
security the Treasury intends to issue, inflation-protection notes or
bonds, with a return linked to the inflation rate in prices or wages.
The Treasury is specifically interested in comments concerning choice
of index, structure of the security, auction technique, offering sizes,
and maturities. The Treasury also invites comments on other specific
issues raised, as well as on any other issues relevant to the new type
of security.
DATES: Comments must be received on or before June 19, 1996.
ADDRESSES: Comments should be sent to: the Government Securities
Regulations Staff, Bureau of the Public Debt, 999 E Street NW., Room
515, Washington, DC 20239. Comments received will be available for
public inspection and copying at the Treasury Department Library, Room
5030, Main Treasury Building, 1500 Pennsylvania Avenue NW., Washington,
DC 20220.
FOR FURTHER INFORMATION CONTACT: Norman Carleton, Director, Office of
Federal Finance Policy Analysis, Office of the Assistant Secretary for
Financial Markets, at 202-622-2680. In addition, the Treasury plans to
hold a series of investor meetings in New York, Washington, DC,
Chicago, Boston, San Francisco, and possibly other cities in late May
and in June 1996 to discuss the new securities, answer questions, and
solicit comments. To request information about attending any of these
meetings, contact the Office of Financing, Bureau of the Public Debt,
at 202-219-3350.
SUPPLEMENTARY INFORMATION: The Treasury Department intends to issue a
new type of marketable book-entry security with a nominal return linked
to the inflation rate in prices or wages, as officially published by
the United States Government. The Treasury is considering various
indices for this purpose, including the Consumer Price Index for All
Urban Consumers (CPI-U) published by the Bureau of Labor Statistics
(BLS) of the Department of Labor, the core CPI (CPI-U, excluding food
and energy, as published by the BLS), the Gross Domestic Product (GDP)
deflator published by the Bureau of Economic Analysis (BEA) of the
Department of Commerce, and the Employment Cost Index--Private Industry
(ECI) also published by BLS. Through this notice, the Treasury is
soliciting comments on the design details of the planned inflation-
protection securities and on which index (those mentioned above or
another index) would be most likely to result in the broadest market
for the new securities. At the end of this notice is a hypothetical
term sheet with proposed formulas applicable to one of the structures
being considered for the new security.
This advance notice of proposed rulemaking is not an offering of
securities, and any of the currently contemplated features of
inflation-protection securities that are described in this notice may
change. The terms and conditions of particular securities that may be
offered will be set forth in
[[Page 25165]]
the Uniform Offering Circular (31 CFR Part 356) and the applicable
offering announcement.
The Department intends to issue inflation-protection notes or bonds
in order to save on interest costs and to broaden the types of debt
instruments available to investors in U.S. financial markets. Because
the Treasury, rather than the investor, would bear the inflation risk
on an inflation-protection security, the Department expects that the
prices at which it would sell this new type of security would capture
some or all of the inflation risk premium charged by investors on
conventional Treasury securities. In other words, investors should be
willing to pay extra for a security on which the issuer, rather than
the investor, bears the risk of higher than expected inflation.
Consequently, the expected interest costs to the Treasury of inflation-
protection securities should be lower than those on conventional
Treasury securities.
In addition, inflation-protection securities may prove to be
attractive investments to investors who do not now invest in Treasury
securities to any significant extent. For example, certain pension
funds that currently invest in bonds other than Treasury securities
because of the higher yields on private fixed-income securities may
find Treasury inflation-protection notes or bonds useful to include in
their portfolios. The new securities would offer explicit inflation
protection to investors, which has heretofore been unavailable in a
Treasury debt instrument. This inflation protection could prove
attractive for investments for retirement. Also, because the path of
changes in market prices of inflation-protection securities would be
markedly different from that of the market price of conventional fixed-
income instruments or equity investments, inflation-protection
securities could be useful for achieving some portfolio
diversification. This broadening of the market for Treasury securities
should also result in lower overall interest costs for the Treasury
over time.
Indexation Methodology. A design of the inflation-protection
securities that is currently being considered is modeled, with some
modifications, on the Real Return Bonds currently issued by the
Government of Canada. The Department is soliciting comments about this
choice of model and the specific details described below and in the
hypothetical term sheet, as well as the formulas in the appendix.
For this particular structure, the principal amount of the
inflation-protection security is adjusted for inflation, so that the
adjusted value remains the same in constant dollars. This is achieved
by multiplying the principal value of the security at issuance by an
index ratio. The index ratio is the reference index number applicable
for the valuation day divided by the reference index number applicable
for the issue date.
Because the reporting of a monthly price or wage series index
number for a particular month by necessity takes place after the month
has ended and because the market needs to determine accrued interest on
a daily basis, there has to be a lag in the indexation of the security.
For this structure, if it is based on a monthly index that is reported
in the following month, the indexation of the principal on the first
day of any month is based on the index number for the third preceding
month. For example, the index number applicable to the first day of
December is the one reported for September. For other days of the
month, a linear interpolation is made between the index number for the
third preceding month and the one for the second preceding month (in
this example, October). Using the third preceding month as the
reference month is the minimum lag that enables interpolation between
the index number for that month and the following month.
Under this structure, interest is payable semiannually. Interest
payments are a fixed percentage of the value of the inflation-adjusted
principal, in current dollars, for the date on which it is paid.
Alternative Structures. The Treasury has given the most study to
the Canadian model for inflation-protection securities, which in turn
is a modification of the United Kingdom's index-linked gilts. However,
alternative structures are possible, and the Treasury is asking for
comment on whether alternative structures might be more desirable for
U.S. financial markets.
One alternative structure is a zero-coupon inflation-indexed
security. This type of security could prove to be quite volatile in
price, but, if held to maturity, this structure would provide the
greatest certainty about its return, since there would be no
reinvestment risk associated with coupon payments.
In addition to general comments concerning the market for a zero-
coupon inflation-protection security, the Treasury is soliciting
comments about the use for this structure of an index, such as the GDP
deflator, that is subject to retroactive revisions. Since the Treasury
would only make one payment on a zero-coupon inflation-protection
security, revisions would be less of a problem from the cash flow
perspective than with a security that pays interest every six months.
However, the use of an index that is revised retroactively may cause
some impediments to trading the security and would complicate the
applicable tax rules.
Another quite different structure is an inflation-protection
security that pays out principal and interest at periodic intervals.
Ignoring the lags, under this structure, each payment is equal in real
terms, but the proportion of each payment representing principal and
interest changes. In other words, this structure is similar to the cash
flows of a home mortgage, and, more specifically, a price level
adjusted mortgage. This structure may be appealing to investors
desiring a flow of periodic payments that stay constant in real terms.
It is also possible that this structure may be more appealing than a
Canadian-type security to taxable investors concerned about receiving
sufficient cash payments from the security to satisfy the tax on the
income from the security.
Price or Wage Indices. The Treasury is requesting comments on which
price or wage index is likely to result in the broadest market for
inflation-protection securities. Specifically, the Department is
considering (1) the CPI-U, (2) the core CPI, (3) the GDP deflator, and
(4) the ECI. The Treasury also requests comments on whether another
index would serve the desired purpose better.
The CPI-U is the best known measure of inflation, and, as such, is
a logical candidate for indexing the securities. However, the CPI-U may
not be the best index for certain investors. For example, pension
funds' liabilities are more sensitive to change in wages than to
changes in consumer prices.
The core CPI is a less volatile index than the CPI-U, and this may
be appealing to investors. However, while energy and food prices
eventually influence other prices, the core CPI could be criticized for
not completely reflecting any trend that may develop in prices in the
energy and food sectors.
The GDP deflator is a broad measure of price trends in the economy.
As noted above, its use may be better suited to a zero-coupon
inflation-protection security than to a note or bond paying semiannual
coupons, because the GDP deflator, unlike the other indices under
consideration, is subject to periodic revision.
Periodic revisions of an index pose three potential problems. The
first is the need for finality in determining payment amounts. Second,
the change in an index for a given period could be based on an index
number for a previous period that has since been
[[Page 25166]]
revised. An indexation methodology designed to correct for revisions in
previous values of the index would create additional complexity.
Finally, even for a zero-coupon security, revisions may cause
complications in the applicable tax rules throughout the life of the
security. Revisions may be less of a problem for a security that makes
only one payment at maturity than for one that pays interest every six
months.
The ECI may appeal to pension funds, whose liabilities are more
linked to wage, rather than price, inflation. In this regard,
commenters are also asked to address whether the total compensation or
the wages and salaries series of the ECI would be the most useful.
Since the ECI is a quarterly index, the precise indexation methodology
and the formulas in the appendix, which assume a monthly index, would
need to be modified.
The Treasury is also requesting comments on whether a seasonally
adjusted or non-seasonally adjusted series would be preferable.
Seasonal adjustment smoothes out fluctuations, but seasonal factors are
subject to revisions for a considerable period of time.
Calculation of the Price or Wage Series. From time to time,
government statistical agencies, such as the BLS and the BEA, revise
their methodology for calculating indices in order to improve their
accuracy. Such revisions on a forward-going basis may affect the
inflation rate as measured by the index and, therefore, the return to
investors.
For a Canadian-type or level real payment inflation-protection
security, revisions of a price or wage index number that has previously
been reported, however, would not be used for calculations of principal
value or interest payments. This is in order for there to be finality
in determining payment amounts.
When a price or wage index is rebased to a different year, the
Treasury would use the price or wage index series with the same base
year(s) as when the security was first issued, as long as that series
continues to be published. The reason for this is to maintain precision
in the indexation of the security that may otherwise be lost due to
rounding, a problem that becomes more acute if the price or wage index
has increased significantly from the original base year(s) to the new
one. The Department is specifically soliciting comments on this point.
In the case of an index series reported on a monthly basis in the
following month, the Department is considering the following procedure
for the Canadian-type security if the index is reported late. If the
index number for a particular month is not reported by the last day of
the following month, the Department would announce by the end of the
next business day an index number based on the last twelve-month change
in the index available. This number would be used for all subsequent
calculations and would not be replaced by the actual price or wage
index number when it is reported. Since the Treasury may use a price or
wage series that is not seasonally adjusted, the Treasury welcomes
comments on this procedure. The Department believes that this
calculation would rarely, if ever, be necessary.
If the price or wage index for an inflation-protection security is
discontinued while that security is outstanding, the Treasury would
consult with the agency responsible for the index, and, based on such
discussions, the Treasury would select an appropriate substitute index
and methodology for linking the two series. Determinations of the
Secretary in this regard would be final.
Finally, if the Federal Government commences publication of a new
version of the index that is more appropriate for indexation than the
one originally chosen, the Treasury expects it would then use the new
version for indexing new inflation-protection securities. Concerning
the introduction of a new version, the Treasury is requesting
commenters to address whether the Treasury should also index
outstanding inflation-protection securities to the new version starting
from its introduction or whether outstanding securities should remain
indexed to the original series as long as that series continues to be
published.
Auction Technique. The Department is considering offering
inflation-protection securities through a single-price auction. The
exact type of auction has yet to be determined, and the Department is
particularly interested in input from potential auction participants,
as well as others, on this subject.
For a Canadian-type inflation-protection security, options include
two types of single-price auctions where the Treasury asks for bids in
terms of real yield to three decimal places. In the first case, the
highest accepted yield would become the coupon, and the inflation-
protection note or bond would be issued at par. In the second case, the
Treasury would set a coupon after the auction in an increment of
0.125%, and the price of the security would be determined by the
formulas in the appendix.
Also, the Treasury could announce a coupon on the security and
accept bids in terms of price. However, this option runs counter to the
Department's auction practice for its conventional Treasury securities,
and, at least initially, it may be difficult to judge what would be the
appropriate coupon.
Noncompetitive bids up to $5 million per bidder would be permitted
for inflation-protection securities. In order to ensure that enough
competitive bids are accepted to price the security fairly, the
Treasury is considering whether all or part of the noncompetitive bids
should be filled by issuing more securities than the originally
announced public offering amount. The Department is requesting comments
on this issue.
Given the pricing uncertainty inherent in any new type of security,
the Treasury is requesting comments on whether the Treasury should
announce prior to a single-price auction of an inflation-protection
security that it retains, and may exercise, the option to award an
amount greater or less than the announced public offering amount. The
reason for awarding less stems from the use of the single-price auction
technique and the unique nature of this new instrument. If there were
an extremely long tail between the yield necessary to sell, for
example, 95 percent of the announced size and the remaining 5 percent,
awarding less would avoid issuing the security with an unreasonably
high real yield. (In any case, the Secretary reserves the right, in any
auction, to award an amount of securities greater or less than the
offering amount. See 31 CFR 356.33)
The Department also welcomes comments on whether a single-price or
a multiple-price auction would be more appropriate for inflation-
protection securities.
The Treasury is also requesting commenters to address whether any
of the auction rules for conventional Treasury securities are
inappropriate for an offering of inflation-protection securities and
specifically whether there should be a limit to the amount recognized
at a single yield from a bidder or the amount awarded to a single
bidder in an auction of inflation-protection securities.
Frequency. The Treasury contemplates issuance of inflation-
protection securities on a regular quarterly cycle.
Reopenings. The Treasury could reopen an issue of an inflation-
protection note or bond, though the flexibility to do this under
changing market conditions is conditioned by tax issues involving the
original issue discount rules that have yet to be
[[Page 25167]]
decided. A reopening would also be accomplished by an auction. The
Department welcomes comments on whether bids on an issue that is being
reopened should be in terms of real yield or price.
For a Canadian-type security, amounts bid at an auction for a
reopened inflation-protection security would be in terms of original
par amount, not the inflation-adjusted par amount. The Treasury would
announce prior to the auction the index ratio necessary to convert the
original par amount to the inflation-adjusted par value for the
settlement date. This means that if the index ratio for the settlement
date is 1.03, a $1,000 bid amount would translate into $1,030
inflation-adjusted par value. The Treasury is requesting comments on
this procedure.
Also, the Treasury is requesting comments on whether reopenings of
an issue would be important for market liquidity, or whether they would
act as a constraint on prices, given the possibility of additional
supply of the security in the next quarter.
Maturities. The Department's current thinking is that 10-year
inflation-protection notes or 30-year inflation-protection bonds would
be the most appropriate maturity sectors for this instrument. The
Treasury is soliciting comments on which maturity sectors would be most
in demand for inflation-protection notes or bonds.
Amounts. The Department is requesting comments on the appropriate
size of the initial auctions of inflation-protection notes or bonds.
The Treasury intends to increase the size of the auctions from the
initial levels over time.
Book-Entry Form and Systems. The inflation-protection securities
would be offered only in book-entry form. They would be issued and
maintained in the commercial book-entry system which is operated by the
Federal Reserve Banks, acting as fiscal agents for the Treasury
Department. The Treasury also would make inflation-protection
securities available through TREASURY DIRECT, a system designed
primarily to enable investors who do not intend to trade Treasury
securities to hold their book-entry securities directly on the records
of the Treasury.
Eligible amounts for holding and transferring would be in multiples
of $1000 of original par value for a Canadian-type inflation-protection
security. The Treasury is soliciting comments on any operational issues
arising from the fact that the amount of an inflation-protection
security held and transferred on the book-entry systems would be
referred to in terms of the original par value, not the inflation-
adjusted value.
Treasury Tax and Loan Accounts. The Treasury intends to make
inflation-protection securities eligible as collateral for Treasury Tax
and Loan Accounts. Valuation for collateral purposes would depend on
the precise structure of the security.
Stripping. For a Canadian-type security, the Treasury would make
inflation-protection securities eligible for stripping on the
commercial book-entry system at some point after issuance of the new
security had begun. This would not be operationally possible initially.
Eligibility for stripping might extend only to inflation-protection
securities issued after a future effective date.
Taxation. In general, a payment on an inflation-protection security
or an increase in the principal amount of the security attributable to
the inflation adjustment would be includible in taxable income for the
year in which it occurs and would be treated as interest income.
Interest payments on inflation-protection securities generally would
have to be included in the owner's taxable income when received or as
accrued, depending on the owner's method of accounting for tax
purposes. For a zero-coupon inflation-protection security, the
difference between the issue price and the original par amount would be
interest that the holder would include as taxable income on a constant
yield basis. The precise tax treatment in the event the principal
decreases because of a decline in the price or wage index has yet to be
determined. Other tax issues, including the reporting of income on the
securities by brokers and other intermediaries (i.e., custodians), also
remain to be determined. Relevant tax issues would be announced before
the first issue.
Minimum Guarantee. If the sum of all the interest payments and the
inflation-adjusted principal value at maturity of the inflation-
protection note or bond is less than the par value of the note or bond
at issuance, the Treasury would make an additional payment at maturity
for the difference.
After receipt and consideration of responses to this advance notice
of proposed rulemaking, the Department intends to issue a final rule
amending 31 CFR Part 356, ``Sale and Issue of Marketable Book-Entry
Treasury Bills, Notes, and Bonds'' (Uniform Offering Circular). Because
the rule would relate to public contracts and procedures for United
States securities, the notice, public comment, and delayed effective
date provisions of the Administrative Procedure Act are inapplicable,
pursuant to 5 U.S.C. 553(a)(2).
Hypothetical Term Sheet
Note: This hypothetical term sheet assumes that an inflation-
protection note or bond would be linked to a price or wage index
reported monthly and that the index number for each month is
reported the following month.
Issuer: United States Treasury.
Issue: Inflation-protection note or bond.
Payment Dates: Inflation-adjusted principal on the security will be
paid on the maturity date as specified in the offering announcement.
Interest on the security is payable on a semiannual basis on the
interest payment dates specified in the offering announcement through
the date the principal becomes payable. In the event any principal or
interest payment date is a Saturday, Sunday or other day on which the
Federal Reserve Banks are not open for business, the amount is payable
(without additional interest) on the next business day.
Maturities: Ten or thirty years.
Indexing Methodology: To calculate the value of the principal for a
particular valuation date, the value of the principal at issuance is
multiplied by the index ratio applicable to that valuation date.
Semiannual coupon interest is determined by multiplying the value of
the principal at issuance by the index ratio for the coupon payment
date by one-half the stated rate of interest.
Index Ratio: The index ratio for any date is the ratio of the
reference index number (reference INUM) applicable to such date to the
reference INUM applicable to the original issue date.
Reference Inum: The reference INUM for the first day of any
calendar month is the INUM for the third preceding calendar month. (For
example, the reference INUM for December 1 is the INUM reported for
September of the same year, which is released in October.) The
reference INUM for any other day of the month is calculated by a linear
interpolation between the reference INUM applicable to the first day of
the month and the reference INUM applicable to the first day of the
following month.
Any revisions that the agency responsible for the index makes to
any INUM that has been previously released shall not be used in
calculations of the value of Treasury inflation-protection securities.
In the case that the INUM for a particular month is not reported by
the last day of the following month, the Treasury will announce an
index
[[Page 25168]]
number based on the last year-over-year inflation rate as measured by
the chosen index. Any calculations of the Treasury's payment
obligations on the inflation-protection security that need that month's
INUM number will be based on the index number that the Treasury has
announced.
If the applicable price or wage series is discontinued during the
period the inflation-protection security is outstanding, the Treasury
will, in consultation with the agency responsible for the series,
determine an appropriate substitute index and methodology for linking
the discontinued series with the new price or wage index series.
Determinations of the Secretary in this regard will be final.
Strips: Eligible for the STRIPS program at a future date.
Taxation: Appreciation of the principal will be taxed as interest
income in the period the appreciation occurs. Interest payments will be
includible as interest income when received or as they accrue,
depending on the taxpayer's method of accounting. Other tax details
remain to be determined.
Auction Technique: Single-price auction. Options:
(1) Bidders bid for coupon, with bids expressed to three decimal
places. The highest accepted yield becomes the coupon. Security is
issued at par.
(2) Bidders bid real yield, with bids expressed to three decimal
places. Coupon is set near the highest accepted real yield in
increments of \1/8\ of 1 percent. Price is determined by formula in the
appendix using the highest accepted yield.
(3) Before the auction Treasury announces a coupon, securities are
issued at lowest accepted price.
Minimum Guarantee: If the sum of all the interest payments and the
inflation-adjusted principal is less than the par value of the security
at time of issuance, the Treasury will pay an additional sum at
maturity equal to the difference.
Minimums and Multiples to Bid, Hold, and Transfer: The minimum to
bid, hold, and transfer is $1000 original principal value. Larger
amounts must be in multiples of $1000.
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PART 356--SALE AND ISSUE OF MARKETABLE BOOK-ENTRY TREASURY BILLS,
NOTES, AND BONDS (DEPARTMENT OF THE TREASURY CIRCULAR, PUBLIC DEBT
SERIES NO. 1-93)
Authority: 5 U.S.C. 301; 31 U.S.C. 3102, et seq.; 12 U.S.C. 391.
Date: May 15, 1996.
Darcy Bradbury,
Assistant Secretary (Financial Markets).
[FR Doc. 96-12630 Filed 5-16-96; 11:00 am]
BILLING CODE 4810-39-W