[Federal Register Volume 59, Number 25 (Monday, February 7, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-2725]


[[Page Unknown]]

[Federal Register: February 7, 1994]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-33548; File Nos. SR-DTC-93-08 and SR-NSCC-93-07]

 

Self-Regulatory Organizations; The Depository Trust Company et 
al.; Order Approving a Proposed Rule Change Relating to a Netting 
Contract and Limited Cross-Guaranty Agreement

January 31, 1994.
    On July 8, 1993, and June 2, 1993, The Depository Trust Company 
(``DTC'') and the National Securities Clearing Corporation (``NSCC''), 
respectively, filed with the Securities and Exchange Commission 
(``Commission'') proposed rule changes (File Nos. SR-DTC-93-08 and SR-
NSCC-93-07) under Section 19(b)(1) of the Securities Exchange Act of 
1934 (``Act'')\1\ to establish a Netting Contract and Limited Cross-
Guaranty Agreement between DTC and NSCC (``DTC/NSCC Agreement'')\2\ 
Notice of the proposal was published in the Federal Register on 
November 10, 1993.\3\ No comment letters were received. For the reasons 
discussed below, the Commission is approving the proposed rule changes.
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    \1\15 U.S.C. 78(b)(1) (1988).
    \2\NSCC's Rules refer to the agreement as the Clearing Agency 
Cross-Guaranty Agreement.
    \3\Securities Exchange Act Release No. 33145 (November 3, 1993), 
58 FR 59766.
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I. Description

A. Netting

    Many participants of DTC are also members of NSCC (``common 
members''), and NSCC itself is a DTC participant. For many years, DTC 
and NSCC have provided for a consenting common member's credit balance 
in DTC's Next-Day Funds Settlement (``NDFS'') system or a credit 
balance at NSCC to be applied to its debit balance at the other 
clearing agency. In practice, a common member's daily settlement credit 
at one of the clearing agencies serves to reduce or eliminate any daily 
settlement debit of that common member at the other organization.\4\
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    \4\This procedure is commonly referred to as cross-endorsement 
because originally the crediting clearing agency's check or draft 
payable to the common member was endorsed to the debiting clearing 
agency. Over 90% of common members have consented to this procedure. 
Under the procedure, which is now automated, computer programs 
determine which consenting members have a credit balance at one 
clearing agency and a debit balance at the other. The programs then 
aggregate for each clearing agency the applicable portions of all 
the credit balances of common members with debit balances at the 
other clearing agency. These aggregate amounts are then paid by each 
clearing agency to the other with corresponding payment entries 
being reflected in each common member's DTC and NSCC settlement 
statements.
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    The Federal Deposit Insurance Corporation Improvement Act of 1991 
(``FDICIA'') validates netting contracts that provide for the netting 
of payment obligations and payment entitlements between and among 
clearing organizations and their members.\5\ Under FDICIA, a payment 
under a netting contract is not subject to disaffirmance by the 
receiver or trustee in a subsequent insolvency proceeding. The netting 
provisions of FDICIA were designed to reduce systemic risk to the 
financial markets.
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    \5\12 U.S.C. 4401-4407 (1991).
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    The purpose of the netting provision of the DTC/NSCC Agreement is 
to establish a netting contract that meets the standards for FDICIA 
protection. The netting provision provides that on each common business 
day that any common member has a credit balance at one clearing agency 
and a debit balance at the other, the two balances will be netted, and 
the following payments will be made: (1) Each common member with a net 
debit amount will pay that amount to the clearing agency with the net 
debit amount; (2) a clearing agency with a net credit amount with 
respect to a common member shall pay that amount to the common member; 
and (3) for each common member with a credit balance that equals its 
debit balance, the clearing agency with the credit balance shall pay 
that amount to the clearing agency with the debit balance.
    The balances covered under the netting provision that will be 
available to NSCC will be only those in DTC's NDFS system. DTC will 
have the right, however, to use a NDFS credit balance to offset an open 
debit balance in DTC's Same-Day Funds Settlement (``SDFS'') system 
before applying the remainder, if any, to a debit balance at NSCC.

B. Limited Guaranty

    The DTC/NSCC Agreement also contains a provision limiting the 
guaranty from each clearing agency to the other clearing agency that 
will be invoked when a common member fails. Any resources remaining 
after a failed common member's obligations to the guaranteeing clearing 
agency have been satisfied, including at DTC that common member's SDFS 
obligations, will be made available to the other clearing agency. The 
guaranty is not absolute but rather is limited to the extent of the 
resources relative to the failed member remaining at the guaranteeing 
clearing agency. The principal resources will be settlement net credit 
balances, including in certain cases a common member's SDFS net credit 
balance at DTC, and the failed member's deposits to the clearing 
agencies' clearing funds.
    For example, if a common member has a DTC NDFS net debit balance 
that exceeds its credit balance at NSCC, the operation of the netting 
provision will reduce that net debit balance by the amount of the NSCC 
credit. If that common member then fails, DTC will apply the member's 
DTC participants fund deposit to the remaining net debit balance and to 
any SDFS net debit balance. If the participants fund deposit is 
insufficient to satisfy completely all DTC net debit balances, the 
limited guaranty provision will enable DTC to look to NSCC to pay any 
deficiency but only if and to the extent that the NSCC resources 
attributable to the common member exceed the common member's 
obligations to NSCC. Similarly, NSCC will be able to look to DTC if the 
common member has a NSCC net debit balance.
    There can be situations where a failed common member still owes 
money either to DTC or to NSCC after netting and after payment of the 
guaranty. However, the exposure to DTC's or NSCC's other participants 
or members will be reduced by the operation of the DTC/NSCC Agreement.

C. Changes to DTC's and NSCC's Rules

    In connection with the implementation of the DTC/NSCC Agreement, 
DTC is amending its Rules 1, 2, 4, and 9 and NSCC is amending its Rules 
1, 4, 12, and 31. The modifications will incorporate the netting 
provision into DTC's and NSCC's Rules so that DTC's participants and 
NSCC's members become parties to and are bound by the netting provision 
of the DTC/NSCC Agreement. The modifications to DTC's and NSCC's Rules 
also will incorporate the limited guaranty provision so that a failed 
common member is obligated to DTC or NSCC to the extent that DTC or 
NSCC is obligated to the other clearing agency under the limited 
guaranty provision.\6\
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    \6\For a detailed discussion of the specific amendments DTC and 
NSCC are making to their rules, refer to Securities Exchange Act 
Release No. 33145, supra note 3.
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II. Discussion

    Section 17A(a)(2)(A) of the Act directs the Commission to 
facilitate the establishment of a national system for the prompt and 
accurate clearance and settlement of securities transactions and to 
facilitate the establishment of linked or coordinated facilities for 
clearance and settlement of transactions.\7\ The Commission believes 
that the DTC/NSCC Agreement is an important step towards achieving such 
a national system because the DTC/NSCC Agreement mandates netting of a 
common member's settlement obligations at each of the clearing 
corporations.
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    \7\15 U.S.C. 78q-1(a)(2)(A).
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    Section 17A(b)(3)(F) of the Act requires that the rules of a 
clearing agency be designed to assure the safeguarding of securities 
and funds which are in its custody or control or for which it is 
responsible.\8\ DTC, NSCC, and their participants and members should 
gain protection from the netting and guarantee provisions of the DTC/
NSCC Agreement because a common member's credit balance at one clearing 
agency will be paid to the other clearing agency, if the common member 
has a debit balance at that clearing agency, instead of to the common 
member. This should reduce the risk that a common member will fail to 
fulfill its settlement obligation at one clearing corporation but still 
collect a credit from the other clearing corporation. If a common 
member fails, the limited guarantee will be invoked so that remaining 
resources attributable to the common member at one clearing agency will 
be available to fulfill the common member's obligation at the other 
clearing agency.
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    \8\15 U.S.C. 78q-1(b)(3)(F).
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    The same section of the Act also requires that a clearing agency's 
rules be designed to foster cooperation and coordination with persons 
engaged in the clearance and settlement of securities transactions. The 
Commission believes that the DTC/NSCC Agreement fosters such 
cooperation and coordination as evidenced by the risk reduction and 
payment efficiencies that should be experienced by DTC, NSCC, and 
common members upon implementation of the agreement.

III. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposed rule changes are consistent with the requirements of the Act 
and in particular with the requirements of Section 17A of the Act, and 
the rules and regulations thereunder.
    It Is Therefore Ordered, pursuant to Section 19(b)(2) of the 
Act,\9\ that the proposed rule changes (File Nos. SR-DTC-93-08 and SR-
NSCC-93-97) be, and hereby are, approved.

    \9\15 U.S.C. 78s(b)(2).
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    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\10\
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    \10\17 CFR 200.3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-2725 Filed 2-4-94; 8:45 am]
BILLING CODE 8010-01-M