[Federal Register Volume 63, Number 28 (Wednesday, February 11, 1998)]
[Notices]
[Pages 7022-7026]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-3367]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-39623; File No. SR-DCC-97-10]


Self-Regulatory Organizations; Delta Clearing Corp.; Notice of 
Filing of Proposed Rule Change Relating to the Clearing of Repurchase 
Agreement Instrument Transactions

February 5, 1998.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ notice is hereby given that on December 31, 1997. Delta 
Clearing Corp. (``DCC'') filed with the Securities and Exchange 
Commission (``Commission'') the proposed rule change as described in 
Items I, II, and III below, which items have been prepared primarily by 
DCC. The Commission is publishing this notice to solicit comments from 
interested persons on the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The proposed rule change will revise DCC's rules to authorize DCC 
to clear and to settle repurchase agreement instrument transactions 
(``RAIT'').

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, DCC included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. DCC has prepared summaries, set forth in sections (A), 
(B), and (C) below, of the most significant aspects of such 
statements.\2\
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    \2\ The Commission has modified the text of the summaries 
prepared by DCC.
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(A) Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    A RAIT is a transaction pursuant to which the counterparties agree 
to pay each other interest on an agreed upon amount (``notional 
amount'')\3\ for the agreed term of the RAIT. One counterparty 
(``selling member'') will pay interest that is based on the market rate 
of interest for a repurchase agreement (``repo'') with treasury 
securities as the underlying collateral and that is adjusted on a daily 
basis throughout the term of the transaction (``floating rate''). The 
other counterparty (``purchasing member'') will pay interest based on a 
rate of interest that remains constant throughout the term of the 
transaction (``fixed rate''). This proposed rule change will permit DCC 
to clear and to settle RAITs.
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    \3\ The notional amount must be $1 million or a multiple 
thereof. The notional amount is used solely as reference and is not 
exchanged between the parties.
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1. Structure of the Transaction
    The parties will negotiate between themselves: (1) The notional 
amount, (2) the type of repo to be referenced for the floating rate, 
(3) the fixed rate, (4) the date the RAIT will start (``commencement 
date''), (5) the date the RAIT will end (``expiration date''), and (6) 
any premium that may be paid to one counterparty as consideration for 
entering into the transaction.

[[Page 7023]]

    On the trade date,\4\ the parties will report the agreed upon 
transaction terms to DCC either directly or through a broker authorized 
by DCC.\5\
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    \4\ Trade date will be defined as the date on which members or 
their broker report a RAIT to DCC.
    \5\ Section 3 of this notice contains a description of the trade 
reporting requirements.
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    The parties' payment obligations will begin on the commencement 
date and will end on the day before the expiration date. The 
commencement date may be prior to or after the trade date. However, 
RAITs with a commencement date which is prior to the trade date will 
only be permitted to allow one party to enter into a RAIT with a new 
counterparty to close out its existing RAIT position.\6\ Any premium 
will be paid on the later of the first business day following the 
commencement date or the first business day following the trade 
date.\7\
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    \6\ Such transaction is referred to as a closing transaction and 
is discussed below in Section 4 of this notice.
    \7\ Premium payments must be made to DCC by the later of 11:00 
a.m. or the opening of FedWire and will be paid by DCC six hours 
later. Members' obligations to pay premiums will be netted with 
their right to receive premiums.
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    The expiration date (also referred to as the settlement sum payment 
date) may not be earlier than the later of the second business day 
following the trade date or the second business day following the 
commencement date.\8\ In addition, the expiration date may not be later 
than the earlier of the first anniversary of the trade date or the 
first anniversary of the commencement date.
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    \8\ This time period will give DCC an opportunity to collect 
margin on all RAITs on the day after the RAIT is accepted by DCC for 
clearance.
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    Prior to 8:00 a.m. on the expiration date, DCC will notify each 
member of any amount required to be paid by or to such member with 
respect to RAITs expiring on such date (``settlement sum'').\9\ This 
information will be included on the daily RAIT activity reports sent to 
members. Members will be required to make any payment indicated on the 
daily reports prior to the settlement time on the expiration date.\10\
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    \9\ Section 2 of this notice sets forth the formula that will be 
used to determine the settlement sum.
    \10\ Settlement time is defined as the later of 11:00 a.m. or 
the opening of FedWire.
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    The failure of a member to pay any premium or any settlement sum 
will constitute a violation of the procedures. The defaulting member 
will be suspended in accordance with Article 4 of DCC's procedures 
(subject to deferral for up to two hours) and may be sanctioned in 
accordance with Article 5.
2. Calculation of Payment
    The members must select as the floating rate one of the five 
special collateral rates or the general collateral rate. The special 
collateral rates will equal the rate of interest for repos in which the 
treasury securities underlying such agreements are the most recently 
issued treasury security with an original maturity of two years, three 
years, five years, ten years, or thirty years. The general collateral 
rate will be the rate of interest for repos in which the treasury 
securities underlying such agreements are any securities other than the 
most recently issued treasury securities with an original maturity of 
two, three, five, ten, or thirty years.\11\
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    \11\ Participants in the treasury repo market finance other 
treasury securities at a rate (i.e., the general collateral rate) 
which does not otherwise distinguish the maturity date of the 
collateral underlying such treasury repos. For example, market 
participants finance a treasury security with a remaining term to 
maturity of 8.5 years and a treasury security with a remaining term 
to maturity of 1.5 years at the same overnight repo rate unless 
either of these treasury securities is the most recently issued 
treasury security of the applicable maturity in which event 
participants would finance that treasury security at the applicable 
special collateral rate for newly-issued treasury securities of that 
maturity.
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    Each special collateral rate and the general collateral rate will 
be determined by DCC at the close of business on each business day upon 
a reputable pricing source selected by DCC.\12\ DCC will then multiply 
the applicable floating rate by the notional amount and divide by 360 
to determine the floating rate amount. Any daily floating rate amount 
determined for a business day will apply to any following nonbusiness 
day.\13\
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    \12\ Prior to the commencement of clearing RAITs, DCC will 
notify its members of the pricing source to be used. (DCC initially 
intends to contract with GovPX, Inc. [``GovPX''] as its pricing 
source for determining the special and general collateral rates.) 
DCC will also notify members of any change in the pricing source. 
Any change in DCC's pricing source will not be applicable to RAITs 
entered into based upon a previous pricing source unless otherwise 
agreed to by the members to any such transaction.
    \13\ For example, the daily floating rate amount calculated for 
each Friday during the term of the transaction also will apply for 
the immediately following weekend days.
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    The fixed rate will be a fixed percentage carried out to three 
decimal points. As a result, the fixed rate amount will remain constant 
each day during the term of a transaction. The daily fixed rate amount 
will be obtained by multiplying the fixed rate by the notional amount 
and dividing that amount by 360.
    At the end of a RAIT, DCC will calculate the sum of the daily 
floating rate amounts and the sum of the daily fixed rate amounts in 
each case calculated from and including the commencement date through 
and excluding the expiration date. The difference between these amounts 
is the settlement sum. If the sum of the daily floating rate amount is 
in excess of the sum of the daily fixed rate amount, the selling member 
will be required to pay the settlement sum to DCC for payment to the 
purchasing member. If the sum of the daily fixed rate amounts is in 
excess of the sum of the daily floating rate amounts, the purchasing 
member will be required to pay the settlement sum to DCC for payment to 
the selling member.
3. Trade Reporting and Acceptance
    The trade reporting procedure for RAITs will be similar to the 
trade reporting procedures for option transactions cleared by DCC.\14\ 
The transactions may be reported to DCC by the member counterparties or 
by the broker for the transaction. Members will be required to report 
RAITs to DCC on the date upon which the members agree to the trades. 
RAITs made between 9:00 a.m. and 12:00 p.m. on any business day will 
have to be reported to DCC by telephone prior to 12:30 p.m. of that 
business day.\15\ RAITS agreed to between 12:00 noon and 5:00 p.m. on 
any business day will have to be reported to DCC by telephone prior to 
5:30 p.m. of that business day. Members or their broker will have to 
submit written trade reports for all trades by 5:30 p.m. of that 
business day.
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    \14\ Trade reporting for options transactions is described in 
Article 23 of DCC's procedures.
    \15\ All references to time are Eastern Time (``ET'').
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    Both the verbal and written trade report for each transaction will 
need to report (a) The identities of the purchasing member and the 
selling member, (b) the trade date, (c) the commencement date, (d) 
whether any party is required to pay a premium and if so the party 
required to pay such premium and the amount, (e) the notional amount, 
(f) the fixed rate, (g) the floating rate, (h) the expiration date, (i) 
whether a selling or purchasing transaction, (j) whether an opening or 
closing transaction,\16\ and (k) such other information as may be 
prescribed.\17\
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    \16\ An opening transaction creates or increases a member's 
short or long position. A closing transaction decreases a member's 
short or long position.
    \17\ Records maintained by members with respect to RAITs will 
need to show the trade date, any premium, the party required to pay 
the premium, the notional amount, the fixed rate, the floating rate, 
the expiration date, and whether an opening or closing transaction.
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    DCC will orally confirm that submitted trade reports contain the 
required information and that the parties agreed as to the terms of the

[[Page 7024]]

transaction. As with option and repo transactions, DCC may reject a 
RAIT for various reasons, including if the RAIT causes a member to 
exceed its exposure limit established by DCC.\18\ If DCC rejects a RAIT 
for any reason, it will promptly notify the members by telephone. If 
DCC rejects a RAIT because the members' trade reports do not match, the 
members are required to cooperate with DCC to reconcile any 
differences. When DCC accepts a RAIT for clearance, DCC will enter into 
matching transactions with each member so that DCC will act as the 
counterparty to the purchasing and selling members with respect to 
their rights and obligations under the RAIT.
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    \18\ Note 21 contains a definition of exposure limit.
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4. Netting
    A long position with respect to RAITs will be defined as the 
aggregate rights and obligations of a member as the purchaser of one or 
more RAITs. A short position with respect to RAITs will be defined as 
the aggregate rights and obligations of a member as the seller of one 
or more RAITs. A member's long position or short position will be 
determined by reference to the applicable notional amount.\19\
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    \19\ For example, if a member is the purchaser of a RAIT with a 
notional amount of $3,000,000, the member will have a long position 
in that RAIT for a notional amount of $3,000,000. Similarly, if a 
member is the seller of a RAIT with a notional amount of $2,000,000, 
the member will have a short position in that RAIT for a notional 
amount of $2,000,000.
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    Transactions entered into by a member with the same commencement 
date, floating rate, fixed rate, and expiration date will be defined in 
the procedures as being part of the same ``series of instruments.'' To 
the extent that a member is the seller of one RAIT and the purchaser of 
another RAIT in the same series of instruments, such member's long and 
short positions in such RAITs will be netted.\20\
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    \20\ For example, if the two transactions described in note 19 
involved the same commencement date, floating rate, fixed rate, and 
expiration date and were entered into by the same member, the 
members's long and short positions in those RAITs would be netted 
and the member would have a net long position of $1,000,000 in that 
series of instruments.
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    If a member wants to close out an existing position, it must enter 
into a RAIT that has the same commencement date as that existing 
position (i.e., a date that is prior to the trade date). If the RAIT is 
the same series of instruments as the earlier RAIT and the member's 
position is on the opposite side (e.g., the member was the selling 
member and is now the purchasing member), the new RAIT will be netted 
against the old RAIT. If the notional amount of the two RAITs is the 
same, the member will no longer have a position with DCC in this series 
of instruments. Such a transaction will be referred to as a closing 
transaction.
5. Margin
    At present, DCC has established exposure limits for each 
member.\21\ These exposure limits apply to exposure for option 
transactions and term repos on an aggregate basis. DCC also calculates 
a member's margin requirements for options transactions and term repos 
on an aggregate basis,\22\ and members are required to maintain such 
margin with DCC's clearing bank in the form required by DCC.\23\
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    \21\ Exposure limit currently is defined as the limit prescribed 
for each member on the aggregate incremental margin due to DCC for 
that day that the member may incur or carry in respect of its short 
position in options, the settlement of exercised options, and its 
positions in repos.
    \22\ Overnight repos are subject to separate margin 
requirements. Section 2203 of DCC's procedures.
    \23\ Provisions relating to margin are set forth in Article 22 
of DCC's procedures.
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    Under the proposed rule, a member's exposure for options 
transactions, term repos, and RAITs will be determined by aggregating a 
member's exposure with respect to each transaction type. The member's 
margin requirement will be reduced by a net positive position with 
respect to a transaction type and will be increased by a net negative 
position with respect to a transaction type.
    Under the proposed rule change, margin provisions now applicable to 
options and repo positions will become applicable to RAIT positions. 
For example, DCC will have the right to collect intraday margin if DCC 
determines such action is appropriate to reflect the change of the 
value of a member's positions in RAITs during the day. In addition, 
members will be able to borrow from DCC up to 35% of their net positive 
exposure, if any, aggregating all their transactions in DCC's clearing 
system.\24\
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    \24\ To the extent that members with negative exposures to DCC 
have not made required margin payments to DCC, DCC will not permit 
members with positive exposure to borrow against their positive 
exposures.
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    Margin will be collected on a daily basis prior to the settlement 
time on each business day. Margin for RAITs will be collected for the 
first time on the first business day following the trade date. This is 
true even in the case of transactions with a future commencement date 
(``forward-start'') where margin will be collected prior to the 
commencement date based on mark-to-market and performance margin 
exposure. During this period prior to the commencement date, margin 
will also be collected to cover any premium payments which may be 
required to be made on the premium settlement date.
    A member's margin requirement with respect to RAITs will be the sum 
of accrual margin, mark-to-market margin, and performance margin.\25\ 
All payment obligations of accrual margin, mark-to-market margin, and 
performance margin will be discounted at the then prevailing general 
collateral rate to calculate the member's margin requirement.\26\
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    \25\ Accrual margin, mark-to-market margin, and performance 
margin are explained later in this notice.
    \26\ DCC believes that discounting is appropriate in order to 
reflect the current value of the payment obligation. DCC believes 
the general collateral rate accurately reflects the time value of 
money under circumstances in which the payment obligations are 
linked to and secured by treasury securities and that discounting by 
another interest rate such as the overnight rate on federal funds or 
the London interbank offered rate (``LIBOR'') would result in too 
steep a discount to the future payment obligation thus leaving DCC 
unnecessarily exposed to a member.
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    a. Accrual Margin. Accrual margin will take into account the 
positive or negative interest amounts accrued with respect to a RAIT 
based upon the daily fixed and floating rate amounts through the date 
on which margin is calculated discounted at the current general 
collateral rate. In the case of a forward-start RAIT, accrual margin 
will not be applied during the period between the trade date and the 
commencement date.
    b. Mark-to-Market. Mark-to-market margin involves a mark-to-market 
valuation of a member's RAIT positions based upon a comparison of the 
daily fixed rate amount for the transaction and the current interest 
rates on comparable repos.\27\ The calculation

[[Page 7025]]

with respect to such mark-to-market value will be: (notional size) 
times (number of days to end of RAIT/360) times (difference between the 
fixed rate and current repo rate). The calculation, after discounting 
the resulting value at the prevailing general collateral rate through 
the applicable expiration date, produces the mark-to-market value for 
both members to a RAIT. The payor of the fixed rate will incur an 
obligation to deposit mark-to-market margin in the event that the 
comparable interest rates are less than the RAIT's fixed rate. 
Conversely, the floating rate payor will incur an obligation to deposit 
mark-to-market margin in the event that the comparable repo rates are 
greater than the RAIT's fixed rate. In the case of a forward-start 
RAIT, mark-to-market margin also will take into account the premium 
required to be paid or received by the member on the premium settlement 
date for the RAIT.\28\
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    \27\ DCC intends to solicit members with respect to selecting 
comparable repos for each of the six indexes. During the course of 
each business day, the marketplace establishes the applicable 
interest rates for repos for each of the six indices based upon the 
number of days from the current business day to the prospective 
expiration date for each such repo agreement. The number of days 
between the current business day and prospective expiration date are 
quoted in standard units of time starting with weekly increments for 
the most immediate prospective expiration dates and eventually 
quoted in months for the most distant expiration date structures. 
For example, market participants will quote fixed rates for repos 
for each of the following time units: one week, two weeks, three 
weeks, one month, two months, and three months through to one year, 
inclusive. Such term structure of interest rates are established and 
routinely quoted for each of the five special collateral rates and 
the general collateral rate. Such term structures are supplied by 
the market on a continuous basis. In identifying such term 
structures, DCC will be able to establish benchmark pricing. In the 
event a RAIT's remaining term to maturity falls between two quoted 
time units, DCC will interpolate between the two time units on a 
linear basis to derive the appropriate rate for the comparable term 
structure for such RAIT. For example, the interpolated rate for a 
RAIT with forty days remaining to its expiration date would be 3.44% 
assuming the one month rate was 3.40% and the two month rate was 
3.52% [(3.52%-3.40%) (10/30) + 3.40%]. Such benchmark pricing would 
be equivalent to ``end of day'' pricing for outstanding RAITs with 
respect to calculating DCC's exposures to members and will be 
utilized in the margining process.
    \28\ On the first business day following the trade date of a 
forward-start RAIT, the member required to pay premium on the 
premium settlement date will be required to deposit margin in an 
amount equal to such premium obligation. Conversely, the member 
entitled to receive premium will have a net positive value with 
respect to the premium payment until the premium payment is made on 
the premium settlement date.
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    c. Performance Margin. Performance margin will adjust a member's 
margin requirement based on a hypothetical three standard deviation 
movement adverse to the member in the fixed rates on comparable 
repos.\29\ For each period to maturity and reference rate, DCC will 
determine the volatility of the rates on the comparable repos based 
upon the changes in such rates during the immediately preceding 100-day 
period. The calculation for performance margin will be (notional size) 
times (# of days to end of RAIT/360) times (# of basis points 
representing three standard deviations).
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    \29\ Note 27 contains a description of comparable repos.
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    d. Application of Margin in Event of Default. If a DCC member 
becomes insolvent or otherwise defaults on a payment obligation, DCC 
will attempt to transfer that member's positions to other DCC members. 
If DCC cannot locate a third party willing to accept the transaction, 
DCC will be required to liquidate the transaction based upon the RAITs' 
values as calculated for accrual and mark-to-market margins. To the 
extent that DCC would be required to pay a third party to assume a RAIT 
or would be required to pay the nondefaulting counterparty upon the 
liquidation of a RAIT, DCC will pay the third party or the 
nondefaulting counterparty, as applicable, the equivalent of the 
accrual and mark-to-market margin for the RAIT.
6. Maximum Potential System Exposure (``MPSE'')
    DCC is required to ensure that MPSE does not at any time exceed 
one-third of the coverage provided by DCC's credit enhancement 
facility.\30\ To the extent necessary to ensure that MPSE does not 
exceed the prescribed limit, a member may be restricted from entering 
into opening transactions, may be required to reduce or eliminate 
existing positions through closing transactions, and may be required to 
pay additional margin.
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    \30\ MPSE represents the liability to DCC of its members' 
positions reduced by margin on hand or to be collected by the next 
day.
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    With respect to RAITs, DCC will calculate MPSE by adjusting all 
member positions by a hypothetical adverse six standard deviation 
movement in the repo rates for comparable repos.\31\ The standard 
deviation for MPSE will be determined by reference to the most volatile 
100-day period from the earliest date from which repo rate information 
is available to DCC to the present.\32\
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    \31\ Note 27 contains a definition of comparable repos.
    \32\ Pricing data for at least a five-year period for each repo 
rate is available from the dealer community, and DCC intends to 
obtain such data. DCC intends to file with the Commission a 
supplemental information report which will show the applicable 
reference periods and other relevant data for determining volatility 
for MPSE purposes. DCC acknowledges that the Commission's receipt of 
the supplemental information report in a form which is acceptable to 
the Commission will be a condition to the Commission's approval of 
this filing.
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7. Operational Implications
    DCC believes its current operating environment is sufficiently 
robust and appropriately configured to accommodate RAITs. DCC's current 
arrangements with its clearing bank with respect to the payment and the 
receipt of margin and premium payments and the prospective arrangements 
with respect to the payment of funds with respect to expired RAITs are 
within DCC's existing capabilities. DCC's systems will be adapted to 
incorporate RAIT related exposure management requirements into DCC's 
established mechanism regarding exposure management. Such other 
necessary system enhancements will be introduced as DCC consults with 
the user community during the RAIT development and implementation 
process.
    DCC believes that the proposed rule change is consistent with the 
requirements of Section 17A of the Act \33\ and the rules and 
regulations thereunder which require that a clearing agency be 
organized and its rules be designed to promote the prompt and accurate 
clearance and settlement of securities transactions, to safeguard funds 
and securities in DCC's possession and control, and to remove 
impediments to and to perfect the mechanism of a national system for 
the prompt and accurate clearance and settlement of securities 
transactions. DCC believes that the amendment contemplated by the 
proposed rule change will permit wider utilization of the clearing 
system by members and will provide a clearing service which addresses 
market needs.
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    \33\ 15 U.S.C. 78q-1.
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(B) Self-Regulatory Organization's Statement on Burden on Competition

    DCC does not believe that the proposed rule change will impose any 
burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act.

(C) Self-Regulatory Organization's Statement on Comments on the 
Proposed Rule Change Received from members, or Others

    No comments on the proposed rule change were solicited or received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within thirty-five days of the date of publication of this notice 
in the Federal Register or within such longer periods: (i) As the 
Commission may designate up to ninety days of such date if it finds 
such longer period to be appropriate and publishes its reasons for so 
finding, or (ii) as to which the self-regulatory organization consents, 
the Commission will:
    (a) by order approve the proposed rule change, or
    (b) institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549. 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the

[[Page 7026]]

Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for inspection and copying in the 
Commission's Public Reference Section, 450 Fifth Street, N.W., 
Washington, D.C. 20549. Copies of such filing also will be available 
for inspection and copying at the principal office of DCC. All 
submissions should refer to File No. SR-DCC-97-10 and should be 
submitted by March 4, 1998.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\34\
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    \34\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-3367 Filed 2-10-98; 8:45 am]
BILLING CODE 8010-01-M