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Statement by Peter D. Sternlight, Executive Vice President, Federal Reserve Bank of New York, before the Subcommittee on Domestic Monetary Policy of the Committee on Banking, Finance and Urban Affairs, U.S. House of Representatives, April 28, 1992.

Statement by Peter D. Sternlight, Executive Vice President, Federal Reserve Bank of New York, before the Subcommittee on Domestic Monetary Policy of the Committee on Banking, Finance and Urban Affairs, U.S. House of Representatives, April 28, 1992

It is a pleasure for me to respond to your committee's invitation to testify today on matters related to the U.S. government securities market. As an official of the Federal Reserve Bank of New York, which is significantly involved in processing Treasury auctions, I thought it would be useful to focus my statement on the current status of automating Treasury auctions. I would also be happy to give my views, from my vantage point at the Federal Reserve Bank of New York, on other matters the committee may wish to raise.

Automation of Treasury auctions is a highpriority matter for the Treasury and the Federal Reserve. Planning work in this regard was under way before the events of last August, but our timetable has been expedited in the wake of the events of the past year--notably the revelation of certain abusive practices by individuals at Salomon Brothers pertaining to Treasury auction rules.

The work on auction automation may be thought of as a several-staged approach. The first phase, which has been developed by the Federal Reserve Bank of Kansas City, encompasses a system that provides for the electronic submission of bids placed throughout the country, mainly by noncompetitive bidders, using the Federal Reserve's standard "Fedline" terminal. Fedline is the standard terminal that is currently in use to connect the Federal Reserve Banks with depository institutions for a variety of operational purposes. Although this system can facilitate the submission of electronic bids, it is not designed to handle the last-minute rush of large competitive bids that, in fact, make up the bulk of the dollar volume of auction bidding. Moreover, Fedline does not have an automated backup system. Designed mainly for noncompetitive bidders, many of which bid through relatively small financial institutions, the system is expected to serve its intended purpose very well. In the aggregate, of course, noncompetitive bids, though individually small, can add up to sizable amounts and can be a significant factor in auctions. MOreover, some large institutions in the New York Federal Reserve District have expressed interest in using this new electronic system to submit noncompetitive bids on behalf of customers. The first phase is expected to be available countrywide by about the middle of this year.

When this first phase is completed, more than 9,000 depository institutions that have Fedline terminals connected to their Reserve Banks will be able to enhance their terminals and submit bids electronically. Other bidders, including nonbank securities brokers and dealers, will also be able to install Fedline terminals and submit bids electronically. This will be a significant step in broadening public access to the auctions across the nation. But I should note again that the first phase is limited because it could not handle--and was never designed to handle--the last-minute flurry of large competitive bids; nor does it have a reliable automated backup system.

Phase 2 of the automation process comprises a system designed specifically to meet the more demanding needs, including backup capabilities, of large competitive bidders, The system is being designed by the Federal Reserve Bank of New York, in accordance with Treasury specifications, and the project is on track for completion by about the end of this year. This system will be able to handle the last-minute rush of competitive bids with a very high degree of reliability and backup recoverability in the event of adverse circumstances. The system will also assist Treasury and Federal Reserve staff in monitoring auctions and enforcing the Treasury's rules.

Bidders under this system will also make use of the Fedline terminal but with enhanced software that upgrades it to a so-called "Fast Fedline terminal." Software development for the Phase 2 system, which consists of analysis, design, and coding, is scheduled for completion before midyear. Currently, system analysis is complete; software design is close to completion; and coding is nearly two-thirds done.

Because of the critical importance of this application, we have set aside six full months for testing after the completion of the system's software development. First, we will thoroughly test the system ourselves for four months to make sure that it works properly, paying particular attention to backup contingency capabilities. I cannot stress too much the overriding importance of a reliable backup procedure; a hitch in the smooth and timely conduct of an auction could have disturbing repercussions in the Treasury market and, more generally, in financial markets.

Overlapping the last month of our testing will be testing of the system's communications and security components with the large competitive bidders, who will be familiarizing themselves with the system at the same time. Then there will be a month or so of volume and stress tests-- posing different kinds of challenging situations to make sure the system can stand up to all the operational contingencies that may be at all likely to confront it. Finally, we will spend about a month in parallel operations--that is, bidders will continue to submit tenders manually but will also submit them electronically--to check the system in a production environment. If all goes well, and I note again that we are on track so far, we expect to be able to go "live" by about the end of this year--as indicated in the schedule in the Joint Report to the Congress earlier this year.

Although Phase 2 will essentially automate the auction process at the Reserve Bank level, there are also plans for carrying the process further. A third phase will automate the Treasury's procedures for combining the input from the various Reserve Banks around the country, and a fourth phase will comprise the automated issuance of securities to successful bidders. These latter phases should be completed in 1993 or 1994.


With respect to proposed legislation regarding the conduct of Treasury auctions (H.R.4450), I would like to make a few comments from the standpoint of the Federal Reserve Bank of New York. A major provision of this bill is to require the Federal Reserve to implement an automated Treasury auction by the end of this year.

We welcome the support and encouragement of your committee, and of others in the Congress, in this important effort. Speedy implementation of automation is a high-priority matter for both the Federal Reserve and the Treasury, but I should note that an even more critical consideration is that the job be done right. A crash program to meet a legislated deadline would serve us ill if the new procedures were implemented before we were totally comfortable that they could do the job. We have a special concern about the ability to recover very rapidly from any computer processing interruption. As I said earlier, we are now on track to complete what we call Phase 2 of the auction automation effort by about the end of this year--that's the phase that automates the transmission and processing of large competitive tenders, in effect the "core" of the auction. But if we find in the course of quality testing that another month or two is needed to iron out potential bugs, I believe that time should be taken to do the job properly. I'm confident that the Treasury shares this view.

I should add that for many years the Federal Reserve has acted as the Treasury's agent in matters of debt management. Responsibility for determining the method, amount, and timing of Treasury debt issuance appropriately rests with the Treasury. We are therefore not at all comfortable with the role of being directly required by law to do certain things with respect to auctions when we serve only as Treasury's fiscal agent. If auction changes are to be mandated with a time deadline--which is questionable in itself--it would seem more appropriate to us that the Congress direct its requirements to the Treasury, which can in turn instruct us accordingly. A similar comment would apply to several matters covered in the proposed legislation, including not only auction automation but also the eligibility of bidders, experimentation with a single-price auction, and employment of continuous sale procedure for marketing short-term securities.

We also welcome the committee's support for more open access to Treasury auctions. Indeed, that has been an important part of the motivation for developing an automated system. The move toward more open access is also thoroughly consistent with several changes in auction rules that the Treasury has made in recent months. This move includes permitting registered brokers and dealers (as well as primary dealers and depository institutions) to submit bids on behalf of customers and to bid without having to post a deposit, provided they have an autocharge agreement with a bank. Another recent change in Treasury rules consistent with broadening auction access was the increase in the maximum noncompetitive award on coupon-bearing issues. With all due respect, however, it does seem to me that specific measures undertaken to implement more open access are better left to Treasury discretion--to be sure, with appropriate congressional oversight--rather than seeking to have specific aspects of open access mandated.

The Federal Reserve, as well as the Treasury, is deeply concerned that auction participants maintain the highest level of integrity in their bidding activities. With active cooperation by the Federal Reserve, the Treasury has developed revised standards for participation that we believe are consistent with a broadening of access and maintenance of high integrity. We understand and share congressional concern that the events of last year not impair public confidence in the auction process. However, we do not believe that additional legislation is needed to achieve that result. At a minimum, the measures adopted in recent months should be given time to work, and the automation plans now being devised and tested should be allowed to come to fruition on their expedited but prudent schedule. If, at some point, new regulatory authority with respect to the conduct of Treasury finance is deemed necessary, we believe such authority is more appropriately placed with the Treasury, to which the Congress has already given substantial regulatory responsibility for the U.S. government securities market.
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Publication:Federal Reserve Bulletin
Article Type:Transcript
Date:Jun 1, 1992
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