[Federal Register Volume 59, Number 84 (Tuesday, May 3, 1994)]
[Unknown Section]
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From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-10474]


[[Page Unknown]]

[Federal Register: May 3, 1994]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-33958; File No. SR-DTC-93-12]

 

Self-Regulatory Organizations; The Depository Trust Company; 
Order Temporarily Approving a Proposed Rule Change Expanding the Money 
Market Instrument Settlement Program on a Pilot Basis

April 22, 1994.
    On October 19, 1993, The Depository Trust Company (``DTC'') filed 
with the Securities and Exchange Commission (``Commission'') a proposed 
rule change (File No. SR-DTC-93-12) under section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act'')\1\ to implement a pilot 
program to include additional types of money market instruments 
(``MMIs'') in its MMI settlement program. Notice of the proposal was 
published in the Federal Register on November 8, 1993.\2\ The 
Commission did not receive any comment letters on the proposed rule 
change.\3\ For the reasons discussed below, the Commission is granting 
temporary approval of the pilot program until April 30, 1995.
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    \1\15 U.S.C. 78(b)(1) (1988).
    \2\Securities Exchange Act Release No. 33126 (November 1, 1993), 
58 FR 59283.
    \3\At the request of the Commission, the Federal Reserve Bank of 
New York (``FRBNY''), and the Board of Governors of the Federal 
Reserve System (``Fed'') DTC issued a notice to participants 
requesting comment on issues raised by the regulators. DTC received 
ten comment letters. The issues and the comment letters will be 
discussed in detail later in this approval order.
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I. Description

A. Generally

    The proposed rule change makes DTC's existing MMI settlement 
services available for transactions in additional types of MMIs. New 
MMI programs include those for institutional certificates of deposit 
(``CD''), municipal commercial paper, and bankers' acceptances. The 
existing DTC MMI programs to be expanded or enhanced include those for 
corporate commercial paper, medium-term notes, preferred stock in a CP-
like mode, short-term bank notes, and discount notes.
    The new MMI programs, along with the existing MMI programs, are an 
extension of DTC's Same-Day Funds Settlement (``SDFS'') system.\4\The 
automated operating procedures for MMIs are virtually the same as those 
followed by SDFS participants and by Institutional Delivery (``ID'') 
system users for basic depository services in other eligible SDFS 
securities. The MMI issues being made SDFS-eligible will be distributed 
in book-entry-only form by the issuer's issuing agent that, as in the 
commercial paper (``CP'') and medium-term note MMI programs, will send 
MMI issuance instructions to DTC electronically. Settlement of an issue 
will be on the same day as the issuance or on a specified future day. 
The issuer's paying agent, that will also serve as DTC's custodian, 
will hold a master or balance MMI certificate for DTC unless the issuer 
and its issuing and paying agent bank choose to distribute 
uncertificated MMIs through DTC.\5\Because SDFS-eligible MMIs will be 
book-entry-only, participant operating procedures for deposits and 
withdrawals will not apply to MMIs.
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    \4\DTC's SDFS system currently includes the following issue 
types: Corporate commercial paper, municipal notes and bonds, 
municipal variable-rate demand obligations, zero coupon bonds backed 
by U.S. Government securities, continuously offered medium-term 
corporate notes, short-term bank notes, auction-rate and tender-rate 
preferred stocks and notes, collateralized mortgage obligations and 
other asset-backed securities, Government trust certificates and 
Government agency securities not eligible for the Fed's book-entry 
system, retail certificates of deposit, corporate and municipal 
variable mode obligations, corporate bonds, discount notes, and unit 
trusts. For a detailed description and discussion of DTC's SDFS 
system, including the implementation of the commercial paper 
program, refer to Securities Exchange Act Release Nos. 26051 (August 
31, 1988), 53 FR 34853 [File No. SR-DTC-88-06] (order permanently 
approving DTC's SDFS system) and 30986 (July 31, 1992), 57 FR 35856 
[File No. SR-DTC-92-01] (order approving implementation of 
commercial paper program).
    \5\Uncertificated MMIs are not evidenced by any certificate 
whatsoever. Bills, notes, bonds, and other securities have been 
issued in uncertificated form by U.S. government and federal 
agencies for many years.
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B. New MMI Programs

    The fundamental risk in the SDFS system is that a participant will 
default in its payment obligation. The new MMI programs are offered as 
an extension of DTC's current SDFS system; therefore, DTC will employ 
the same risk management controls (e.g., net debit collateralization, 
net debit caps, and receiver-authorized deliveries) to transactions in 
these new programs as are employed in the current SDFS system.\6\
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    \6\supra note 4.
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    Net debit collateralization requires each participant to maintain 
in its account throughout the processing day collateral at least equal 
in value to the participant's net settlement debit. If during the 
processing day a transaction will cause a net debit greater than the 
amount of collateral in the participant's account at the time the 
transaction is being processed, DTC will recycle the transaction until 
there is sufficient collateral in the participant's account. 
Transactions in the new MMI programs also will be subject to the 
participant's net debit cap.\7\ The net debit cap helps to protect 
against abnormal intraday debit peaks that are out of line with a 
participant's prior month's average daily activity level. The net debit 
cap also reduces the possibility that the failure to settle by more 
than one participant will not cause DTC to exceed its liquidity 
resources. The new MMI programs also will utilize the receiver-
authorized delivery control which allows a participant to monitor 
deliveries and payment orders directed to its account before the orders 
are posted to the account.
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    \7\Each participant's net debit is limited throughout the 
processing day to a net debit cap that is the least of the following 
four amounts: (1) an amount forty times the participant's required 
and voluntary deposits to the SDFS fund, (2) an amount that is equal 
to seventy-five percent of DTC's liquidity resources, including cash 
deposits to the SDFS fund and lines of credit for loans to 
facilitate SDFS settlement, (3) an amount, if any, determined by the 
participant's settling bank, and (4) an amount, if any, determined 
by DTC. Supra note 4.
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    In addition, DTC's three failure to settle procedures applicable to 
the CP program will be applicable to the new MMI programs. First, DTC 
will employ the same procedures with regard to the sequence in which 
DTC will use MMI collateral and eliminate payment order debits in a 
failing participant's account. Second, if DTC is notified before 3 p.m. 
eastern standard time (``E.S.T.'') that a paying agent will not pay on 
an MMI issuer's maturity presentments, reorganization presentments, 
periodic principal presentments, or periodic income presentments or if 
DTC is informed of an MMI issuer's bankruptcy and a participant fails 
to settle with DTC on that day, DTC has the authority to reduce the 
settlement credits of participants who had transactions on the day of 
default with the defaulting issuer or the defaulting participant on the 
day of the default. Third, if the paying agent has not settled with DTC 
by noon E.S.T. on the DTC business day following the settlement day or 
if a paying agent is determined to be insolvent according to DTC's 
rules, DTC will notify the issuers utilizing that paying agent and 
provide those issuers with information on any presentments related to 
their MMIs on which the PA failed to pay DTC.

C. Expanded or Improved Existing MMI Programs

    DTC will be expanding its CP program to include ``uncommon CP.'' 
Uncommon CP is CP paying income periodically, a variable amount of 
income, or a variable amount of principal. It also includes CP 
denominated in a foreign currency, CP with a maturity of 271 days to a 
year, or corporate variable-rate demand obligations in CP mode. These 
instruments were not included in the original CP program.
    DTC also will be enhancing their MMI programs for medium-term 
notes, short-term notes, discount notes, and preferred stock in CP-like 
mode. The medium-term note program will be enhanced by DTC's collection 
and allocation of income, principal, reorganization, and maturity 
payments within the SDFS system. Paying agents will no longer have to 
separately wire such payments to DTC. Instead, as with maturity 
payments in the CP program, these payments will be included in each 
paying agent's net settlement figure due to or from DTC at the end of 
each day. Similarly, the short-term note program will be enhanced with 
the inclusion in the SDFS system maturity payments and periodic income 
payments in the SDFS system and in the paying agents' net SDFS amounts 
due to or from DTC. The restriction that short-term notes must have a 
minimum maturity period of thirty days to be included in this program 
will be removed. The short-term notes program, the discount notes 
program, and the preferred stock in CP-like mode program will all 
provide for uncertificated issuer programs. However, one master note or 
certificate may be held for DTC by the paying agent.

II. Discussion

    Section 17A(b)(3)(F)\8\ of the Act requires that the rules of a 
clearing agency be designed to promote the prompt and accurate 
clearance and settlement of securities transactions and to assure the 
safeguarding of securities and funds which are in the custody or 
control of the clearing agency or for which it is responsible. As 
discussed below, the Commission believes the DTC's proposed rule change 
is consistent with DTC's obligations under the Act.
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    \8\15 U.S.C. 78q-1(b)(3)(F) (1988).
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    As previously described, the new MMI programs and the expanded and 
enhanced programs are an extension of DTC's current SDFS system and 
include many of the same risk management features that are employed in 
the SDFS system. The Commission previously examined these features when 
DTC first proposed the SDFS system and again when the CP program was 
added.\9\ At those times, the Commission found, and continues to 
believe, that these risk management measures are consistent with 
Section 17A of the Act and should minimize the impact of a default by a 
participant in the SDFS system.
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    \9\Supra note 4.
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    The use of provisional credits and unwind procedures if an MMI 
issuer were to default, however, could increase the risk of settlement 
gridlock in certain circumstances. For example, if DTC were to confirm 
the insolvency of an MMI issuer before 3:00 p.m.,\10\ DTC would reverse 
all participants' credits attributable to the insolvent issuer without 
regard to any of the risk management controls. Such reversals of 
credits could result in a participant having a net debit that exceeds 
the participant's net debit cap and DTC's liquidity resources. If such 
a participant then failed to settle its net debit with DTC, DTC would 
possibly have difficulty completing other settlements thus creating 
systemic risk.
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    \10\If DTC cannot confirm that an MMI issuer is insolvent before 
3 p.m. EST., DTC will not reverse credits attributable to that 
issuer because after 3 p.m. E.S.T. credits are no longer provisional 
in DTC's SDFS system.
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    As an interim solution, DTC proposed for comment the implementation 
of an additional $500 million line of credit dedicated to the 
completion of settlement in the SDFS system in the event a participant 
fails to settle after application of the unwind procedures. The 
additional line of credit would be supported by securities pledged to 
the SDFS fund and would not be included as a part of DTC's liquidity 
resources when determining a participant's net debit cap. DTC also 
proposed as a long term solution, a SDFS system enhancement that would 
conduct default scenarios to assure that unwind procedures would not 
cause a liquidity problem.\11\
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    \11\DTC has proposed two SDFS system enhancements that will 
eventually replace the additional line of credit dedicated to 
settlement in the SDFS system. The future system enhancements will 
retain unwind procedures but will allow DTC to run intraday 
computerized double default scenarios (i.e., an MMI issuer default 
and an SDFS participant default due to debits created by the unwind 
procedures) to help assure that each participant's net debit is 
within DTC's liquidity resources.
    Under the first system enhancement, DTC will subtract from a 
participant's actual overall SDFS net debit or credit amount the 
amount of the participant's largest provisional net credit due to 
transactions in any single issuer's MMIs. DTC then will limit the 
resulting net debit from all other SDFS transactions (``liquidity 
net debit'') to the amount of DTC's liquidity resources (``liquidity 
net debit cap''), which as of April 18, 1994, was approximately $760 
million. If a transaction will cause a participant's liquidity net 
debit to exceed DTC's liquidity net debit cap, DTC will block and 
recycle the transaction until credits are received from transactions 
in MMIs of MMI issues other than those of the issuer of the largest 
provisional net credit.
    Under the second system enhancement, DTC will subtract the 
amount of a participant's largest provisional net credit due to 
transactions in any single issuer's MMIs from the participant's 
collateral monitor (``simulated collateral monitor''). If a 
transaction will cause the simulated collateral monitor to turn 
negative (i.e., the participant's collateral would be insufficient 
to cover its simulated net debit after the transaction), the 
transaction will be blocked. Blocked transactions will be recycled 
until credits from other transactions in MMIs of issuers other than 
those of the largest provisional net credit cause the simulated 
collateral monitor to be positive.
    DTC expects to implement the two system enhancements subsequent 
to the industry conversion to same-day funds settlement that is 
scheduled for implementation in 1996. Letter from Richard B. Nesson, 
Executive Vice President and General Counsel, DTC, to Peter R. 
Geraghty, [Staff Attorney], Division of Market Regulation, 
Commission (April 18, 1994).
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    DTC solicited comment from its participants regarding (1) the 
necessity of unwind procedures in the SDFS service that override risk 
management controls and (2) if unwind procedures are necessary, whether 
participants would be prepared to absorb the additional costs of 
mechanisms to assure that use of the unwind procedures on the same day 
that any DTC participant failed to settle would not deplete DTC's 
liquidity resources. DTC received ten comment letters from participants 
and two from industry organizations.\12\ Generally, the comments 
supported the use of unwind procedures as a way to replicate the risks 
taken by parties to transactions in the physical MMI market (i.e., to 
place the risk and burden of default on the appropriate party, which is 
on the issuer or the purchaser instead of on the issuing and paying 
agent). The comments also generally supported the interim solution of 
obtaining an additional, dedicated line of credit and allocating its 
cost to SDFS system participants.
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    \12\Letters from Albert Howell, Vice President, Money Market 
Operations, Merrill Lynch, to James Reilly, Vice President, DTC 
(March 7, 1994); Christopher T. Amico, Assistant Vice President, 
Chemical Bank, to James Reilly, Vice President, DTC (February 1, 
1994); Gary S. Schayne, Vice President, Citibank, to James Reilly, 
Vice President, DTC (January 31, 1994); Ronald M. Thalheimer, Vice 
President, The First National Bank of Chicago, to James Reilly, Vice 
President, DTC (February 3, 1994); Michael J. Stein, Vice President, 
State Street Bank and Trust Company, to James Reilly, Vice 
President, DTC (February 7, 1994); Stephen J. Melanaski, Vice 
President, United States Trust Company of New York, to James Reilly, 
Vice President, DTC (January 21, 1994); Mark Handsman, Vice 
President-Assistant Treasurer, Goldman Sachs, to James Reilly, Vice 
President, DTC (February 23, 1994); Michael J. Gardiner, Vice 
President, The Chase Manhattan Bank, N.A., to James Reilly, Vice 
President, DTC (February 28, 1994); S. Michael Barnes, Vice 
President, and Lloyd A. Baggs, Trust Officer, Morgan Guaranty Trust 
Company of New York, to James Reilly, Vice President, DTC (February 
24, 1994); R. May Lee, Assistant General Counsel, Public Securities 
Association, to James Reilly, Vice President, DTC (March 2, 1994); 
Jill M. Considine, President, New York Clearing House to James 
Reilly, Vice President, DTC (March 23, 1994).
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    Two of DTC's bank participants did not support DTC's proposals and 
offered alternative solutions. One of these two commentators argued 
that issuing and paying agents should fund presentments earlier or that 
unwind procedures should be employed earlier in the day.\13\ The other 
commentator suggested that DTC should create a system similar to the 
procedures employed by the Clearing House Interbank Payment System.\14\
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    \13\Letter from State Street Bank and Trust Co., supra note 12.
    \14\Letter from Bankers Trust Co., supra note 12.
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    DTC has agreed to implement the dedicated line of credit as an 
interim solution and proceed with the necessary modifications to 
implement the system enhancements. DTC also has agreed to continue to 
employ its liquidity monitoring system which simulates double default 
scenarios every fifteen minutes beginning at 2 p.m. E.S.T.\15\
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    \15\Letter from Richard B. Nesson, DTC to Christine M. Cumming, 
Vice President, Domestic Banking Department, FRBNY (March 8, 1994).
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    DTC will begin the expansion of its MMI programs with the 
institutional CDs programs. DTC will begin the pilot program with four 
bank issuers and will expand the pilot program over the net two months. 
Until DTC secures the additional $500 million line of credit, the pilot 
program will be limited to: (1) 120 CD programs, (2) A value not to 
exceed $20 billion on deposit with DTC, (3) A percentage of the total 
CD market on deposit at DTC not to exceed 5.7%, and (4) A daily average 
face amount of CD issuances not to exceed $1 billion.\16\ DTC has 
agreed that if prior to securing the $500 million line of credit the 
addition of CDs according to the schedule increases simulated breaches 
of its liquidity resources (currently $760 million), DTC will slow down 
or stop the addition of CD programs after consultation with the 
regulators. DTC also has agreed that if subsequent to attaining the 
additional line of credit, simulations show breaches of DTC's new 
overall liquidity resources, due to the expansion of the MMI program to 
include different types of MMI instruments, DTC again will slow down or 
stop expansion of the program after consultation with the 
regulators.\17\
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    \16\Supra note 11.
    \17\Supra note 15.
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    The Commission believes that the additional risk management 
controls to be implemented with the new and enhanced MMI programs in 
conjunction with the current SDFS system risk management controls 
should help further reduce the possibility that a double default 
scenario will exceed DTC's liquidity resources. In addition, the 
Commission believes the controlled expansion of the SDFS program to 
include additional types of MMIs will reduce the costs, inefficiencies, 
and risks associated with the clearance and settlement of physically 
transferred securities by providing the benefits of centralized, 
automated, book-entry clearance and settlement.

III. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposed rule change is 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,\18\ that the proposed rule change (File No. SR-DTC-93-12) be, and 
hereby is, approved on a temporary basis until April 30, 1995.

    \18\15 U.S.C. 78s(b)(2).
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    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\19\
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    \19\17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-10474 Filed 5-2-94; 8:45 am]
BILLING CODE 8010-01-M