[Federal Register Volume 59, Number 84 (Tuesday, May 3, 1994)]
[Unknown Section]
[Page 0]
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