[Federal Register Volume 63, Number 32 (Wednesday, February 18, 1998)]
[Notices]
[Pages 8232-8241]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-3997]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-39643; International Series Release No. 1114; File No. 
601-01]


Self-Regulatory Organizations; Morgan Guaranty Trust Company of 
New York, Brussels Office, as Operator of the Euroclear System; Order 
Approving Application for Exemption From Registration as a Clearing 
Agency

February 11, 1998.

I. Introduction

    On March 5, 1997, Morgan Guaranty Trust Company of New York 
(``MGT''), Brussels office (``MGT-Brussels''), as operator of the 
Euroclear System \1\ pursuant to a contract with Euroclear Clearance 
System Societe Cooperative, a Belgian cooperative (``Belgian 
Cooperative''),\2\ filled with the Securities and Exchange Commission 
(``Commission'') an application on Form CA-1 \3\ for exemption from 
registration as a clearing agency pursuant to Section 17A of the 
Securities Exchange Act of 1934 (``Exchange Act'') \4\ and Rule 17ab2-1 
thereunder.\5\ Notice of MGT-Brussels' application was published in the 
Federal Register on May 15, 1997.\6\ Six comment letters were received 
in response to the notice of filing of the Euroclear application.\7\ 
This order grants the application of MGT-Brussels, as operator of the 
Euroclear System, for exemption from registration as a clearing agency 
to the extent the Euroclear System performs the functions of a clearing 
agency with respect to transactions involving U.S. government and 
agency securities for its U.S. participants subject to the conditions 
and limitations that are set forth below.
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    \1\ For purposes of this order, the term ``Euroclear'' refers to 
MGT-Brussels in its capacity as operator of the Euroclear System. 
MGT-Brussels is the Brussels branch of MGT that has acted as the 
operator of the Euroclear System through its Euroclear Operations 
Centre since the creation of the Euroclear System in 1968. The 
Euroclear Operations Centre is a separate, independent operational 
unit established within MGT-Brussels to operate the Euroclear 
System.
    In 1972, a package of rights described as the Euroclear System 
was sold to Euroclear Clearance System Public Limited Company, and 
English limited liability company (``ECS-PLC''). ECS-PLC purchased 
the rights to receive the revenues generated by the Euroclear System 
services, to approve participants, to determine eligible securities, 
to establish fees, and to make other similar decisions. MGT-Brussels 
retained all of the assets and means necessary to operate the 
Euroclear System and granted a license to ECS-PLC to use the 
Euroclear System trademarks.
    \2\ the Belgian Cooperative was established in 1987 to further 
facilitate communication between Euroclear and the international 
securities industry and to encourage participation in the Euroclear 
System. It received a license from ECS-PLC to exercise some of ECS-
PLC's rights as owner of the Euroclear System. Neither ECS-PLC nor 
the Belgian Cooperative is an operating company. Among other thins, 
MGT-Brussels maintains all Euroclear System participant accounts on 
its own books, maintains all of the contractual relationships with 
Euroclear System participants and Euroclear System depositories in 
its own name, and provides all of the personnel, systems, 
trademarks, and operational capability used to deliver the Euroclear 
System services to Euroclear System participants. For a more 
complete description of the structure of the Euroclear System, refer 
to Section II of the Euroclear notice, Infra note 6.
    \3\ Copies of MGT-Brussels' application for exemption 
(``Euroclear application'') are available for inspection and copying 
at the Commission's Public Reference Room (File No. 601-01).
    \4\ 15 U.S.C. 78q-1.
    \5\ 17 CFR 240.17Ab2-1.
    \6\ Securities Exchange Act Release No. 38589 (May 9, 1997), 62 
FR 26833 (notice of filing of application for exemption from 
registration as a clearing agency) (``Euroclear notice'').
    \7\ Letters from C.R. Trusler, Director, Nomura International 
plc (June 5, 1997); S. Guenzi, Senior Products Manager Custody H.O.-
Financial Institutions, Credito Italiano (June 12, 1997); Harve 
Pennanec'h, Head of Back-Office, Capital Markets Divison, Societe 
Generale (June 16, 1997); D.G. Pritchard, Director, Global 
Collateral Support Unit, NatWest Markets (June 16, 1997); Preben 
Borup, Senior Vice President, BG Operations, and Tom Jensen, First 
Vice President, Head of Custody and Settlement, BG Operations, 
Bikuben Girobank A/S (June 17, 1997); and S.L. Richardson, Executive 
Manager, Operations, ANZ Bank (June 18, 1997). The comment letters 
for File No. 601-01 are available for inspection and copying in the 
Commission's Public Reference Room.
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II. Description of Euroclear System Operations \8\
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    \8\ A more complete description of Euroclear System operations 
is contained in the Euroclear notice, supra note 6.
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    Euroclear provides several services to its participants, including 
securities clearance and settlement, securities lending and borrowing, 
and securities custody.\9\
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    \9\ The contractual relationship between Euroclear and its 
participants is defined by the Terms and Conditions Governing the 
Use of Euroclear (``Terms and Conditions'') as supplemented by 
Supplementary Terms and Conditions Governing the Lending and 
Borrowing of Securities through Euroclear (``Supplementary Terms and 
Conditions''), the Operating Procedures of the Euroclear System 
(``Operating Procedures''), and various other documents, all of 
which are governed by Belgian law. Among other things, the Terms and 
Conditions provide that Euroclear participants agree that their 
rights to securities held through the Euroclear System will be 
defined and governed by Belgian law.
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A. Securities Clearance and Settlement

    The Euroclear System functions as a clearance and settlement system 
for internationally traded securities. Securities settlement through 
the Euroclear System can occur with other participants in the Euroclear 
System (``internal settlement''), with members of Cedel Bank, societe 
anonyme, Luxembourg (``Cedel''), the operator of the Cedel system 
(``Bridge settlement''), or with counterparties in certain local 
markets that are not members of either the Euroclear System or Cedel 
(``external settlement'').
    The annual volume of transactions settled in the Euroclear System 
has grown from about US$3 trillion in 1987 to over US$34.6 trillion in 
1996. The fastest growing segments of this activity have been 
repurchase and reverse repurchase agreements (``repos''), book-entry 
pledging arrangements, securities lending, and other collateral 
transactions \10\ involving non-U.S. government securities.\11\ 
Although the individual certificated or uncertificated government 
securities of these countries are immobilized or dematerialized with 
the central banks or central securities depositories (``CSDs'') in 
their home markets, book-entry positions with respect to such 
securities can be acquired, held, transferred, and pledged by book-
entry on the records of Euroclear in any of the 35 currencies available 
in the Euroclear System because of the links to local custodian banks, 
central banks, CSDs, and national payment systems around the world.
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    \10\ Collateral transactions are designed to enable Euroclear 
System participants to reduce their financing costs, increase their 
yields on securities, reduce their credit and liquidity exposures, 
and to manage market and operational risks.
    \11\ Government securities of the following countries are 
currently eligible for clearance and settlement in the Euroclear 
System: Argentina, Australia, Austria, Belgium, Canada, Denmark, 
Finland, France, Germany, Hong Kong, Ireland, Italy, Malaysia, 
Mexico, the Netherlands, New Zealand, Norway, Portugal, South 
Africa, Spain, Sweden, Switzerland, Thailand, and the United 
Kingdom.
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1. Internal Settlement: Clearance and Settlement of Trades Between 
Euroclear System Participants
    Transactions between Euroclear System participants in the Euroclear 
System can be settled either against payment or free of payment.\12\ 
Upon

[[Page 8233]]

receipt of valid instructions for a settlement between participants, 
the Euroclear System's computer system attempts to match instructions 
between corresponding counterparties on a continuous basis according to 
a defined set of matching criteria. Matching generally is required in 
order for the instructions to be settled except for certain actions 
specifically taken by participants (e.g., transfers between accounts 
maintained by the same participant). Matching of an instruction is 
attempted until it is either matched or cancelled.
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    \12\ When a securities transaction is settled ``against 
payment,'' movement of the securities is made in return for a 
corresponding payment, usually cash. When a securities transaction 
is settled ``free of payment,'' movement of the securities is made 
without any corresponding payment, such as when securities are 
pledged as collateral.
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    Internal settlement of transactions is accomplished by book-entry 
transfer and provides for simultaneous exchange of cash and securities. 
Settlement is final (i.e., irrevocable and unconditional) at the end of 
each of the securities settlement processing cycles of which there are 
currently three per day.\13\
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    \13\ Euroclear's internal securities processing consists of two 
overnight settlement cycles and one daylight settlement cycle.
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    The overnight securities settlement process is completed early in 
the morning of the business day in Brussels for which settlement is 
intended. Daylight securities settlement processing is completed in the 
afternoon of each business day with settlement dated for that day. The 
daylight settlement cycle, which is restricted to internal settlements, 
permits participants to resubmit previously unmatched instructions or 
unsettled transactions and permits the processing of new instructions 
for same day settlement. All daylight instructions not settled are 
automatically recycled for settlement in the next overnight securities 
settlement cycle.
2. Bridge Settlement: Clearance and Settlement of Trades Between a 
Euroclear System Participant and a Cedel Member
    Participants can also send instructions authorizing receipt and 
delivery of securities between the Euroclear System and the Cedel 
system, both free of payment and against payment. Simultaneous delivery 
versus payment (``DVP'') is possible for settlement of trades between a 
participant in the Euroclear System and a Cedel member because of the 
electronic bridge established between the two organizations.
    For settlement of trades between a Euroclear System participant and 
a Cedel member, matching of instructions consists of nine daily 
comparisons of delivery and receipt instructions. During these 
comparisons, each clearance system electronically transmits a file of 
proposed deliveries and expected receipts to the other clearance 
system. This exchange of information allows each clearance system to 
report matching results to its participants.\14\
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    \14\ Bridge settlement was enhanced in September 1993 to allow 
for multiple overnight transmissions of instructions between Cedel 
and the Euroclear System. The bridge provides finality for DVP 
cross-system trades when the receiving clearance system confirms 
acceptance of a proposed delivery and that confirmation is received 
by the delivery clearance system.
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3. External Settlement: Clearance and Settlement of Trades Between a 
Euroclear System Participant and a Local Market Counterparty
    Participants can also send instruction authorizing receipt and 
delivery of securities free of payment and against payment between the 
Euroclear System and certain domestic markets' clearance and settlement 
structures. Euroclear has two types of relationships, direct and 
indirect links, with local market clearance systems. A direct link is 
where Euroclear has its own account with the local clearance system and 
holds securities and sends instructions directly in that clearance 
system. With an indirect link, an intermediary (i.e., a depository) is 
used to perform Euroclear System settlement activities in the local 
market.\15\ In certain markets, Euroclear may have both direct and 
indirect links for different instruments.
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    \15\ Securities held by participants in the Euroclear System are 
held by custodian banks or local clearing systems. Except where 
required by local law, Euroclear will not permit bank subsidiaries 
to serve as depositories. All securities held by a depository on its 
books for the Euroclear System are credited to a segregated custody 
account in the name of MGT-Brussels, as operator of the Euroclear 
System. Depositories receive instructions regarding the movement of 
Euroclear System securities directly from Euroclear. Euroclear 
participants do not directly deal with depositories regarding the 
settlement of securities transactions within the Euroclear System or 
the custody of securities. See Section II.C. infra.
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B. Securities Lending and Borrowing

    Securities lending and borrowing is utilized to increase settlement 
efficiency for the borrower and to allow lenders to generate income on 
securities held in the Euroclear System. Lenders receive a fee for 
securities lending and do not incur safekeeping fees for securities 
lent. With standard lending and borrowing, there is no linkage between 
a particular borrower and a particular lender. In effect, participants 
borrow securities from the lending pools.\16\ With reserved lending and 
borrowing, there is a linkage between the borrower and the lender, but 
the counterparty's identities are not disclosed.\17\ Consequently with 
both standard and reserved lending and borrowing, borrowers' names and 
lenders' names are never revealed to one another.
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    \16\ A participant that is an ``automatic standard borrower'' is 
eligible to borrow securities to execute delivery instructions when 
there are insufficient eligible securities available in its 
securities clearance accounts to effect a settlement in the 
overnight securities settlement process. A participant that is an 
``opportunity standard borrower'' sends standard borrowing requests 
to Euroclear on a case-by-case basis according to expected borrowing 
needs.
    A participant that is an ``automatic standard lender'' makes 
securities available to the lending pool during each overnight 
securities settlement cycle. Subsequent to each overnight securities 
settlement cycle, securities borrowed from the lending pool are 
allocated back to the lenders according to a given set of 
priorities. If the lendable position from automatic standard lenders 
for a given issue is expected to be insufficient to meet estimated 
borrowing demand in the next overnight securities settlement cycle, 
``opportunity standard lenders'' may be contacted by Euroclear to 
make additional securities available for borrowing.
    \17\ A participant that wishes to reserve securities for future 
borrowing can do so by submitting a reserved borrowing request to 
Euroclear. Reserved borrowing differs from standard borrowing in 
that once a reserve borrower's request matches a lendable supply, 
the lender is committed to lend the securities, and the borrower is 
obligated to borrow them. Reserved borrowing minimizes the risk of 
settlement failure resulting from an inability to obtain a standard 
borrowing in the overnight securities settlement process due to a 
lack of supply in the lending pool.
    An ``automatic reserved lender'' makes securities in its 
securities clearance accounts available on demand for reserved 
lending subject to the lender's selected options. When a reserved 
borrowing request is matched to securities automatically available 
for reserved lending, a reservation is initiated and the securities 
are blocked in the reserved lender's securities clearance account 
from the reservation date to the loan start date. ``Opportunity 
reserved lenders'' are contacted by Euroclear when the supply of 
lendable securities from automatic reserved lenders is not 
sufficient to cover reserved borrowing requests in a given issue.
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    Securities lending and borrowing is an integral part of the 
overnight securities settlement process. This integration permits 
Euroclear to determine borrowing requirements and the supply of 
lendable securities on a trade-by-trade basis throughout each overnight 
securities settlement processing. Generally, securities lending and 
borrowing is available only through the overnight securities settlement 
process.

C. Custody

    Securitiess held by Euroclear System participants are held through 
a network of depositories. Depositories may hold securities on their 
premises or hold securities with subcustodians or with local clearance 
systems. Depositories of the Euroclear System may include custodian 
banks, including some MGT branches, central banks, local clearance 
systems, and Cedel. Depositories are

[[Page 8234]]

selected based upon their custody capabilities, financial stability, 
and reputation in the financial community. All depositories and 
subdepositories are appointed with the approval of the Belgium 
Cooperative's board of directors and are reapproved on an annual basis. 
This network of depositories allows linkages with domestic markets to 
effect external deliveries and receipts of securities thereby 
facilitating cross-border securities movements.
    Chase Manhattan Bank currently acts as the Euroclear System's 
depository in the United States for the limited purpose of holding 
positions in certain foreign and internationally-traded securities 
(e.g., such as the Regulation S portion of certain global bonds issued 
by foreign private issuers, Yankee bonds, and book-entry debt 
securities issued by the World Bank) which are represented by 
certificates immobilized in The Depository Trust Company or by 
electronic book-entries on the records of a Federal Reserve Bank.
    Securities deposited in the Euroclear System may be in either 
physical form (e.g., bearer or registered) or in dematerialized form. 
Securities are held on the books of a depository in an account in the 
name of MGT-Brussels as operator of the Euroclear System. Where the 
depository is not also the local clearing system, securities may be 
deposited in the local clearance system where the depository is 
located.\18\
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    \18\ All securities accepted by a depository are credited to a 
segregated custody account in the name of MGT-Brussels as operator 
of the Euroclear System at the depository or local clearance system 
or are credited to the depository's account at the local clearance 
system.
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    Each Euroclear System participant has one or more securities 
clearance account(s) with associated transit accounts. Securities held 
by participants in the Euroclear System are credited to the 
participants' securities clearance accounts or transit accounts. 
Euroclear System participants have the option to request the 
segregation of their own and client securities in separate securities 
clearance accounts.
    Securities in the Euroclear System are held in fungible bulk. Under 
Belgian law and pursuant to the Terms and Conditions,\19\ each 
participant is entitled to a notional portion, represented by the 
amounts credited to its securities clearance account(s) and transit 
account(s), of the pool of securities of the same type held in the 
Euroclear System.\20\
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    \19\ Supra note 9.
    \20\ Under Belgian law, Euroclear is required to hold interests 
in the same amount of any securities that may from time to time be 
credited to the accounts of Euroclear System participants and is 
prohibited from pledging or otherwise using any such securities for 
its own benefit without the consent of the relevant account holder.
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D. Liens, Rights, and Obligations

    In addition to any pledge of specific accounts agreed to by a 
participant due to extensions of credit by MGT-Brussels \21\ all assets 
held in the Euroclear System are subject to rights of set-off and 
retention.\22\ Furthermore, participants' assets held in the Euroclear 
System (except for assets held for customers and identified as such 
pursuant to the Operating Procedures or by agreement with Euroclear) 
are subject to a statutory lien in favor of MGT-Brussels, as operator 
of the Euroclear System, pursuant to Belgian law.\23\ Participants are 
also obligated to cover any cash or securities debit balances that they 
may incur.
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    \21\ See Section II.E. infra.
    \22\ When assets are held subject to the right of set-off, the 
holder of the assets may apply the assets to satisfy debts owned to 
the holder by the actual owner of the assets. When assets are held 
subject to the right of retention, the holder of the assets may 
refuse to return the assets to their owner if the owner is indebted 
to the holder.
    \23\ Article 41 of the Belgian Law of April 6, 1995.
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E. MGT-Brussels Banking Services

    MGT-Brussels, acting in its separate banking capacity and not as 
operator of the Euroclear System, provides certain banking services to 
Euroclear System participants. Banking services provided include the 
provision of credit to Euroclear System participants, triparty repo 
\24\ and collateral monitoring services, and a securities lending 
guarantee.
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    \24\ A triparty repo arrangement generally consists of three 
parties, the borrower, the lender, and a collateral agent (i.e., 
MGT-Brussels). In this arrangement, the borrower initiates a repo by 
``selling'' securities to the lender in exchange for cash from the 
lender. Simultaneously with this transaction, the borrower agrees to 
repurchase these securities on a specified or undetermined future 
date. The collateral agent maintains custody of the securities for 
the duration of the repo and handles all operation aspects of the 
transaction including distribution of income, substitutions, and 
mark to market securities valuations.
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1. Provision of Credit to Euroclear Participants
    MGT-Brussels offers credit facilities to Euroclear participants on 
an uncommitted basis under limits periodically determined by MGT. 
Credit decisions are made according to MGT credit guidelines. Credit 
facilities are generally required to be secured and are normally 
collateralized by participant assets within the Euroclear System. In 
order to secure credit, participants affirm to MGT-Brussels that they 
are not pledging client securities and that no other liens have been 
granted to third parties on pledged securities.\25\
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    \25\ In a limited number of circumstances, MGT-Brussels may 
agree to permit pledging of client securities or the securities of 
the related parties where the participant's legal and regulatory 
regime permits, appropriate legal opinions are delivered, and 
certain other conditions are met.
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    Securities that participants pledge to secure credit extensions 
from MGT-Brussels are valued at their market price which is adjusted 
according to the type of instrument, underlying currency, rating of the 
issue, the issuer, and the country of the issuer. For debt securities, 
accrued interest is added to market price for the purpose of 
calculating collateral value.
2. Triparty Repo and Collateral Monitoring
    MGT-Brussels also offers monitoring services whereby participants 
can use the Euroclear System to facilitate repo settlement/collateral 
posting, substitution of securities, and margin monitoring.
3. Securities Lending Guarantee
    As part of the Euroclear securities lending and borrowing program, 
MGT guarantees securities lenders the return of securities lent or the 
cash equivalent if the borrower defaults on its obligation to return 
such securities.

III. Comment Letters

    The Commission received six comment letters in response to the 
notice of filing of the Euroclear application.\26\ All were in favor of 
the Commission granting Euroclear an exemption from registration as a 
clearing agency. Many of the commenters noted there would be a 
reduction in risks and an increase in liquidity as a result of 
permitting transactions involving U.S. government and agency securities 
to be processed by the Euroclear System. Specifically, several 
commenters believed that under an exemption from clearing agency 
registration Euroclear could facilitate the use of U.S. government and 
agency securities as collateral thereby reducing the risks to credit 
providers and the costs to credit seekers. Commenters also believed 
that permitting Euroclear to clear and settle U.S. government and 
agency securities would increase liquidity and further deepen the 
market for these securities which would benefit the U.S. government and 
its taxpayers by keeping the costs of borrowing low.
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    \26\ Supra note 7.
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    Commenters also cited Euroclear's operating record and financial 
condition in support of the exemption. Commenters articulated their 
belief that

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MGT-Brussels' financial resources and its regulation by the Board of 
Governors of the Federal Reserve System (``Federal Reserve Board'') are 
sufficient to ensure the safety and soundness of the Euroclear 
System.\27\
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    \27\ Two commenters believed that due to MGT-Brussels's 
financial posture, operational history, and present monitoring by 
the Federal Reserve Board, Euroclear should not be subject to any 
volume limitations with regard to the amount of U.S. government and 
agency securities Euroclear may process. Letters from C.R. Trusler, 
Director, Normura International plc (June 5, 1997) and S. Guenzi, 
Senior Products Manager Custody H.O.-Financial Institutions, Credito 
Italiano (June 12, 1997). A third commenter believed that any volume 
limitation should be only temporary. Letter from D.G. Pritchard, 
Director, Global Collateral Support Unit, NatWest Markets (June 16, 
1997).
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IV. Discussion

A. Statutory Standards

    Section 17A of the Exchange Act directs the Commission, having due 
regard for the public interest, the protection of investors, the 
safeguarding of securities and funds, and the maintenance of fair 
competition, to use its authority to facilitate the establishment of a 
national system for the prompt and accurate clearance and settlement of 
securities transactions.\28\ Registration of clearing agencies is a key 
element of the statutory objectives set forth in Section 17A.\29\ 
Before granting registration to a clearing agency, Section 17A(b)(3) of 
the Exchange Act requires that the Commission make a number of 
determinations with respect to, among other things, a clearing agency's 
organization, rules, and ability to provide safe and accurate clearance 
and settlement.\30\ Additionally, the Division of Market Regulation 
(``Division'') has published the standards it applies in evaluating 
applications for clearing agency registration.\31\ These standards are 
designed to help assure the safety and soundness of the clearance and 
settlement system.
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    \28\ 15 U.S.C. 78q-1.
    \29\ ``Clearing agency'' is defined in Section 3(a)(23) of the 
Exchange Act. 15 U.S.C. 78c(a)(23).
    \30\ 15 U.S.C. 78q-1(b)(3). See also Section 19 of the Exchange 
Act, 15 U.S.C. 78s, and Rule 19b-4, 17 CFR 240.19b-4, setting forth 
procedural requirements for registration and continuing Commission 
oversight of clearing agencies and other self-regulatory 
organizations.
    \31\ Securities Exchange Act Release No. 16900 (June 17, 1980), 
45 FR 41920 (``Standards Release''). See also, Securities Exchange 
Act Release No. 20221 (September 23, 1983), 48 FR 45167 (omnibus 
order granting registration as clearing agencies to The Depository 
Trust Company, Stock Clearing Corporation of Philadelphia, Midwest 
Securities Trust Company. The Options Clearing Corporation, Midwest 
Clearing Corporation, Pacific Securities Depository, National 
Securities Clearing Corporation, and Philadelphia Depository Trust 
Company).
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    Section 17A(b)(1), moreover, provides that the Commission:

    May conditionally or unconditionally exempt any clearing agency 
or security or any class of clearing agencies or securities from any 
provisions of [Section 17A] or the rules or regulations thereunder, 
if the Commission finds that such exemption is consistent with the 
public interest, the protection of investors, and the purposes of 
[Section 17A], including the prompt and accurate clearance and 
settlement of securities transactions and the safeguarding of 
securities and funds.\32\

    \32\ 15 U.S.C. 78q-1(b)(1).
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    As a result, in granting either exemptions from portions of Section 
17A or from registration, the Commission requires substantial 
compliance with Section 17A and the rules and regulations thereunder 
based on a review of the standards.\33\
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    \33\ The Commission has previously granted exemptions from 
clearing agency registration, subject to certain volume limits, 
reporting requirements, and other conditions, to the Clearing 
Corporation for Options and Securities (``CCOS'') and to Cedel. 
Securities Exchange Act Release Nos. 36573 (December 12, 1995), 60 
FR 65076 (``CCOS exemptive order'') and 38328 (February 24, 1997), 
62 FR 9225 (``Cedel exemptive order'').
    The Commission also has granted temporary registrations that 
included exemptions from specific statutory requirements of Section 
17A. In granting these temporary registrations, it was expected that 
the subject clearing agencies would eventually apply for permanent 
clearing agency registration. See e.g., Secrities Exchange Act 
Release No. 25740 (May 24, 1988), 53 FR 19839 (order approving 
Government Securities Clearing with a temporary exemption from 
compliance with Section 17A(b)(3)(C)).
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B. Evaluation of Euroclear's Application for Exemption

    In the Commission's evaluation of Euroclear's application and the 
comments received, the Commission recognized that certain 
organizational, operational, and jurisdictional differences would 
prevent MGT-Brussels, as operator of the Euroclear System, from 
complying fully with all of the registration provisions set forth in 
Sections 17A and 19 of the Exchange Act and from meeting all the 
requirements set forth in the Standards Release. The evaluation was 
also made in the context of the limitations and conditions that the 
Commission is including in the exemption granted pursuant to this 
order. As discussed more fully below, Euroclear's exemption from 
clearing agency registration is subject to limitations on the type and 
volume of securities that it may process for its U.S. participants and 
requirements to submit certain information to the Commission on a 
periodic basis and at the Commission's request. In addition, MGT-
Brussels is subject to regulatory oversight by the Federal Reserve 
Board.
1. Safeguarding of Securities and Funds
    Sections 17A(b)(3) (A) and (F) of the Exchange Act require that a 
clearing agency be organized and its rules be designed to safeguard 
securities and funds in its custody or control or for which it is 
responsible.\34\ The Commission believes that Euroclear substantially 
satisfies this standard. Among other things, the financial condition 
of, operational safeguards employed by, and the scheme of U.S. federal 
banking oversight of MGT-Brussels, as operator of the Euroclear System, 
should help to provide U.S. investors and the U.S. national clearance 
and settlement system with a level of protection in the areas of 
custody, clearance, and settlement risks that is comparable to those 
achieved with full clearing agency registration.
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    \34\ 15 U.S.C. 78q-1(b)(3) (A) and (F). Euroclear's relationship 
with its participants is governed by various operating agreements, 
including the Terms and Conditions, the Supplementary Terms and 
Conditions, and the Operating Procedures which define the rights and 
responsibilities of Euroclear and its participants. Supra note 9 and 
infra Section IV.B.6.
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    a. Organization and Processing Capacity. A clearing agency must be 
organized in a manner that effectively establishes operational and 
audit controls while fostering director independence.\35\ The 
independent audit committee of MGT's board of directors is kept 
apprised of Euroclear's operations by MGT's regional and functional 
audit management. The head of MGT audit management has direct reporting 
lines to the audit committee of MGT's board of directors and to the 
Vice Chairman of MGT. MGT's audit management receives reports through 
Euroclear's separate audit division that is responsible for the 
internal audit process. In addition, the audit division has a direct 
reporting line to the general manager of Euroclear.
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    \35\ Standards Release, supra note 31, 45 FR at 41925-26.
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    The internal audit process for Euroclear is based on a risk 
assessment methodology. Review of the participant, product, market, and 
service dimensions of Euroclear's business, including technology 
infrastructure, are considered in this risk based approach. The 
internal audit procedures include tests that are designed to 
independently assess the strengths and weaknesses of Euroclear's 
control environment.
    Price Waterhouse currently acts as the independent auditors of MGT 
and MGT-Brussels, including Euroclear. Price Waterhouse conducts an 
annual audit of MGT's financial statements, which are included in the 
annual report of J.P. Morgan & Co. Incorporated on Form 10-

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 K, in accordance with generally accepted auditing standards. It also 
conducts an annual review of Euroclear's internal controls, policies, 
and procedures in accordance with SAS-70 guidelines.\36\ Both reports 
are made available to Euroclear participants. Price Waterhouse also 
reports to the Belgian Banking and Finance Commission and to MGT's 
audit committee.
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    \36\ Statement on Accounting Standards No. 70 (``SAS-70'') 
issued by the American Institute of Certified Public Accounts sets 
forth the guidelines for examination of the internal controls 
established for computerized information systems and manual 
procedures relating to (i) securities clearance and settlement; (ii) 
securities lending and borrowing; (iii) money transfer; and (iv) 
custody. See Section IV.C.3. infra. The most recent SAS-70 report 
was issued on March 31, 1997 and covers the period from January 1, 
1996 to December 31, 1996.
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    Based upon the foregoing, the Commission is satisfied that 
Euroclear's organizational and processing capacity substantially 
satisfies the requirements of the Exchange Act as elaborated on in the 
Standards Release because Euroclear's internal organizational 
structure, including its system of internal and external audit, is 
reasonably designed to provide the necessary flow of information to 
MGT's board of directors which should allow the necessary monitoring of 
Euroclear's operations and management's performance to assure the 
operational capability and integrity of Euroclear.
    b. Financial Risk Management. The Standards Release states that a 
clearing agency should establish a clearing fund and promulgate rules 
to assure an appropriate level of contributions in accordance with, 
among other things, the risks to which the clearing agency is subject 
for the protection of clearing agency participants and for the national 
system for clearance and settlement.\37\
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    \37\ Supra note 31, 45 FR at 41929.
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    As discussed in Section II.A. above, Euroclear provides DVP 
settlement for securities transactions which are then batched for 
processing in one of two overnight cycles or in the daylight cycle 
depending upon when the transactions are received. Euroclear itself 
does not directly extend credit to its participants. Instead, as 
discussed in Section II.E. above, MGT-Brussels, in its banking 
capacity, offers credit facilities to Euroclear participants on an 
uncommitted basis under limits established and in accordance with 
guidelines set by MGT. Such credit facilities are utilized to avoid 
transaction failures.
    Euroclear does not maintain a clearing fund. However, Euroclear 
employs various financial and operational risk management mechanisms, 
including its organization, financial condition, insurance, information 
technology and systems security, and other operational safeguards to 
substantially reduce the risk of financial loss by Euroclear and its 
participants. Therefore, the Commission believes that Euroclear's rules 
and procedures and the methods by which Euroclear safeguards the 
financial security of its clearing facilities substantially satisfies 
the requirements of the Exchange Act.
(i) Risk Management Division and Committee
    Euroclear has a separate risk management division that is 
responsible for risk policy. The risk management division focuses on 
identifying, analyzing, and managing the risks of operating a 
multicurrency, cross-border clearance and settlement system. It has 
developed various risk management tools for identifying and managing 
the risks of clearance and settlement and other market activities. In 
addition, Euroclear also employs a Risk Advisory Committee (``RAC'') to 
review all aspects of risk prior to approval of new and existing 
markets, products, and services. The RAC is chaired by the head of 
Euroclear's risk management division and includes senior management 
from other divisions and reports directly to the Euroclear management 
team.
(ii) Financial Condition
    MGT, which is the entity with ultimate fiscal responsibility for 
operations of the Euroclear System, is a U.S. bank that is ``well-
capitalized'' and ``well-managed'' as those terms are defined under 
applicable U.S. Federal banking regulations.\38\ MGT has over $13.5 
billion in total capital and a total capital ratio of more than 11 
percent\39\ and access to billions of dollars of additional liquidity 
in the capital markets. Its senior debt is rated AAA by Standard & 
Poor's\40\ and its long-term debt is rated Aa-1 by Moody's Investors 
Services.\41\
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    \38\ 12 CFR 208.33(b)(1) (definition of ``well-capitalized'') 
and 12 CFR 225.2(s) (definition of ``well-managed''). See also 12 
CFR 211.2(u) (definition of ``strongly capitalized'') and (x) 
(definition of ``well managed'').
    \39\ 12 CFR Part 208, Appendix A (defining total capital ratio).
    \40\ Standard & Poor's, ``Morgan (J.P.) & Company Inc.,'' Bank 
Ratings Analysis, April 1997, at 1.
    \41\ Moody's Investor Service, ``Opinion Update: Morgan Guaranty 
Trust Company of New York,'' Global Credit Research, February 7, 
1997, at 2.
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(iii) Insurance
    Euroclear maintains certain insurance coverage against risk of 
physical loss or damage for securities in its custody, on the premises 
of its depositories, or in transit. Euroclear also maintains insurance 
to cover losses arising from forged securities.\42\ Typically, 
Euroclear depositories are required to maintain insurance coverage with 
respect to securities that they hold on behalf of Euroclear in the same 
amounts and covering the same risks as they maintain with respect to 
securities they hold for their own account or for the account of other 
customers. This insurance coverage must be at least as comprehensive as 
the coverage customarily carried by banks in that local market acting 
as custodians.
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    \42\ Euroclear maintains a Financial Institution Bond (``FIB'') 
in an amount of $155,000,000 per loss up to an annual aggregate 
maximum of $310,000,000 to cover losses of securities on premises or 
in transit. A separate companion policy written concurrently with 
the FIB covering electronic and computer crime (``crime policy'') is 
subject to the same per loss and aggregate coverage. For losses 
exceeding the FIB and the crime policy, Euroclear maintains an 
exceed J-Form Bond in an amount of $340,000,000. For physical loss 
or forgery of securities on premises or in transit, Euroclear 
maintains coverage in an amount of $500,000,000 per occurrence. 
Euroclear also maintains various mail, air courier, and messenger 
insurance policies.
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(iv) Information Technology
    Euroclear has an information technology division that is charged 
with the development and maintenance of its information technology 
infrastructure. This division is responsible for software engineering, 
application system development, and technical support for both systems 
software and the telecommunications networks. It provides 
communications help-desk facilities and conducts the day to day 
operation of Euroclear's data centers and contingency facilities.
    Computer equipment utilized in the operation of the Euroclear 
System is located at two data centers and a business recovery facility. 
All significant systems include full back-up within Euroclear's 
computer center.\43\ Emergency back-up power sources are provided 
through an independently sourced and routed main power supply, backed 
up by on-site diesel generators and batteries. A contingency center 
with a capacity of over 300 critical personnel and a back-up computer 
center each located at a different site provides the continuity of 
operations in the event of serious malfunctions at Euroclear's computer 
center.\44\
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    \43\ Euroclear has provided the Commission with a written copy 
of its back-up recovery plan.
    \44\ In 1995, contingency procedures were further enhanced by 
the implementation of a remote dual copy facility that provides for 
immediate update of data at both the production and contingency 
computer centers.

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[[Page 8237]]

(v) Other Operational Safeguards
    Euroclear has substantially similar subcustodian, recordkeeping, 
and auditing policies and procedures as those utilized by registered 
clearing agencies.\45\ Regarding the safekeeping of securities, 
Euroclear deposits all securities deposited in the Euroclear System 
with a network of depositories (subcustodians), which consists of major 
banks, CSDs and central banks, and some MGT branches.\46\ The 
depositories either maintain actual possession of security certificates 
or with the prior consent of Euroclear deposit them in local CSDs or 
central banks. The standard Euroclear depository agreement requires the 
subcustodians to physically segregate any securities certificates held 
for Euroclear from any securities certificates held for their own 
account or for other customers.\47\
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    \45\ For example, Euroclear is generally liable to Euroclear 
participants for its own negligent or willful misconduct.
    \46\ Generally, Euroclear depositories are liable to Euroclear 
for their negligent or willful misconduct and indemnify Euroclear 
for such liability. Euroclear is obligated to take steps that it 
reasonably deems appropriate to recover any loss to participants 
caused by the negligent or willful misconduct of any depository and 
pass on any recovery to the affected participants. But Euroclear 
does not warrant the performance of its network of depositories.
    \47\ In its application for exemption from clearing agency 
registration, Euroclear stated that in the nearly thirty years since 
Euroclear was established, there has not been a material loss or 
theft of securities from the Euroclear System. Euroclear also 
advised the Commission in its application that for its proposed 
activities involving U.S. government and agency securities, 
Euroclear will select a U.S. depository bank for such securities 
that is an adequately capitalized and well-managed clearing bank. 
The U.S. depository bank in turn would hold its positions through 
the Federal Reserve Bank of New York or a U.S. registered clearing 
agency.
---------------------------------------------------------------------------

    c. U.S. and Other Regulatory Oversight. In its capacity as operator 
of the Euroclear System, MGT-Brussels is a division of the foreign 
branch of a U.S. bank and accordingly is subject to the comprehensive 
supervision and regulation of the Federal Reserve Board. The Federal 
Reserve Bank of New York conducts annual on-site examinations in 
Brussels and otherwise regulates MGT-Brussels' operations, including 
its operation of the Euroclear System. MGT-Brussels also is subject to 
the comprehensive supervision of the New York State Banking Department 
and the Belgian Banking and Finance Commission and is authorized as a 
Service Company by the Securities and Investments Board under the U.K. 
Financial Services Act, 1986.
2. Fair Representation
    Section 17A(b)(3)(C) of the Exchange Act requires that the rules of 
a clearing agency provide for fair representation of the clearing 
agency's shareholders or members and participants in the selection of 
the clearing agency's directors and administration of the clearing 
agency's affairs.\48\ This section contemplates that users of a 
clearing agency have a significant voice in the direction of the 
affairs of the clearing agency.
---------------------------------------------------------------------------

    \48\ 15 U.S.C. 78q-1(b)(3)(C).
---------------------------------------------------------------------------

    Although Euroclear participants do not have the right to appoint 
MGT directors or members of Euroclear management, they have the right 
to become members of the Belgian Cooperative and can use this 
membership to influence the range of Euroclear services and the level 
of fees charged to them by Euroclear. The board of directors of the 
Belgian Cooperative consists of 23 voting members which are nominated 
from Euroclear participant organizations representing various financial 
sectors and geographical regions. Euroclear's goal was to fashion a 
board with a cross-functional composition in order to ensure that 
important strategic and policy issues are viewed with a broad market 
perspective.
    The board meets four times a year with Euroclear management to 
discuss major policy and operational issues regarding the Euroclear 
System, including new product development and the level of fees. 
Moreover, Euroclear's participants are some of the world's leading 
banks, brokers, central banks, and other professional investors which 
are able to analyze the risks and benefits of clearing and settling 
transactions in the Euroclear System. Accordingly, the Commission 
believes that the method in which the Belgian Cooperative's directors 
are selected and interact with Euroclear's management adequately 
addresses the requirements of fair representation under Section 
17A(b)(3)(C) of the Exchange Act.
3. Participation Standards
    Section 17A(b)(3)(B) of the Exchange Act enumerates certain 
categories of persons that a clearing agency's rules must authorize as 
potentially eligible for access to clearing agency membership and 
services.\49\ Section 17A(b)(4)(B) of the Exchange Act states that a 
registered clearing agency may deny participation to or condition the 
participation of any entity that does not meet the financial 
responsibility, operational capability, experience, and competency 
standards set forth in the clearing agency's rules.\50\ These criteria 
may not be used to discriminate unfairly among entities.\51\
---------------------------------------------------------------------------

    \49\ 15 U.S.C. 78q-1(b)(3)(B). Section 17A(b)(3)(B) requires 
that the rules of a clearing agency provide that any (i) registered 
broker or dealer, (ii) other registered clearing agency, (iii) 
registered investment company, or (iv) other entities designated by 
the Commission may become participants in such clearing agency.
    \50\ 15 U.S.C. 78q-1(b)(4)(B).
    \51\ 15 U.S.C. 78q-1(b)(3)(H).
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    Any organization that demonstrates it meets Euroclear's financial 
and operational criteria is eligible to become a Euroclear System 
participant. A prospective participant must demonstrate that it has 
adequate financial resources for its intended use of the Euroclear 
System and the ability to maintain this financial adequacy on an 
ongoing basis. It also must demonstrate that it has both the personnel 
and technological infrastructure to meet the operational requirements 
of the Euroclear System. Furthermore, it must show that it expects to 
derive material benefit from direct access to Euroclear and that it is 
a reputable firm. However, Euroclear does not require that a 
prospective applicant possess a particular regulatory status to become 
a Euroclear participant.\52\
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    \52\ As an exhibit to its application for exemption from 
clearing agency registration, Euroclear submitted a ``Participant 
Admissions Newsletter'' dated February 11, 1994 which stated that 
Euroclear has revised its admission criteria so as to not require 
that an applicant be regulated by a government securities for 
banking regulatory authority in order to become a Euroclear System 
participant. However, Euroclear also stated that it did not believe 
that the types of firms utilizing the Euroclear System would change 
significantly due to this revision.
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    Although Euroclear's admissions policy does not require regulatory 
status for its participants, entities enumerated in Section 
17A(b)(3)(B) of the Exchange Act \53\ may become Euroclear System 
participant if they meet Euroclear's operational and financial 
criteria. The Commission recognize that there is a wide variance in the 
level of regulatory control exerted upon Euroclear System participant 
by the various participants' home jurisdiction. Accordingly, even if 
Euroclear required a particular regulatory status as a condition to 
becoming a Euroclear System participant, there would be no assurances 
that this would provide more uniform admission or reliable protection 
for the Euroclear System, its participants, or investors because of the 
disparate levels of oversight. Because each of the enumerated 
categories of participants is eligible for Euroclear System membership 
and because Euroclear has accepted a wide range of participants based 
upon its standards of financial responsibility, operational capability, 
experience, and competence, the Commission is satisfied that

[[Page 8238]]

Euroclear's participants standards adequately address the requirements 
of Section 17A of the Exchange Act.
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    \53\ 15 U.S.C. 78q-1(b)(3)(B).
---------------------------------------------------------------------------

4. Dues, Fees, and Charges
    Sections 17A(b)(3) (D) and (E) of the Exchange Act provide for the 
equitable allocation of reasonable dues, fees, and other charges among 
clearing agency participants and prohibits a clearing agency from 
imposing or fixing prices for services rendered by its 
participants.\54\ Fees charged by Euroclear are generally usage-based, 
calculated on a sliding scale (where applicable), and are priced in a 
competitive environment with other entities that offer international 
clearance and settlement services. Euroclear does not fix any prices, 
rates, or fees for services rendered by its participants. Accordingly, 
the Commission is satisfied that the method by which Euroclear provides 
for the equitable allocation of reasonable dues, fees, and other 
charges among its participants and the fact that it does not fix the 
prices of the services rendered by its participants adequately 
addresses the Exchange Act requirements.
---------------------------------------------------------------------------

    \54\ 15 U.S.C. 78q-1(b)(3) (D) and (E).
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5. Capacity To Enforce Rules and To Discipline Participants
    Section 17A(b)(3)(A) of the Exchange Act requires a registered 
clearing agency to have the capacity to enforce compliance by its 
participants with its rules.\55\ Furthermore, Sections 17A(b)(3) (G) 
and (H) require a registered clearing agency to have in place a system 
to discipline its participants for violations of its rules and that the 
procedures for applying such rules be fair and equitable.\56\
---------------------------------------------------------------------------

    \55\ 15 U.S.C. 78q-1(b)(3)(A).
    \56\ 15 U.S.C. 78q-1(b)(3) (G) and (H).
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    MGT-Brussels, as the operator of the Euroclear System, bilaterally 
contracts with each of Euroclear's participants to provide clearance 
and settlement and other securities services. Neither MGT nor MGT-
Brussels is a self-regulatory organization (``SRO'') as the term is 
defined in Section 3(a)(26) of the Exchange Act.\57\ In particular, 
MGT-Brussels does not have any disciplinary authority over Euroclear 
participants other than the commercial discipline of refusing to 
provide services to those participants that fail to satisfy the terms 
of their contractual arrangements with MGT-Brussels regarding the use 
of the Euroclear System.
---------------------------------------------------------------------------

    \57\ 15 U.S.C. 78c(a)(26).
---------------------------------------------------------------------------

    MGT-Brussels contends that the burdens associated with operating as 
a clearing agency through an SRO structure as envisioned under the 
Exchange Act would outweigh the benefits of such structure to the U.S. 
investing public. MGT-Brussels argues that it is already subject to 
significant regulatory oversight by the Federal Reserve Board as a 
foreign branch of a U.S. bank and that additional regulation as a U.S. 
registered clearing agency would be unnecessarily duplicative without 
adding any meaningful investor protection. MGT-Brussels maintains that 
it would be extremely difficult for it, as a foreign branch of a U.s. 
bank to act as a U.S. SRO and to impose meaningful oversight of 
Euroclear's U.S. broker-dealer participants. Moreover, MGT-Brussels 
notes that it functions in a multi-currency, cross-border regulatory 
environment, with an emphasis on international rather than U.S. markets 
which decreases the utility of U.S. regulatory oversight for its 
operations.
    The Commission is sensitive to the myriad of issues which could 
arise in connection with requiring MGT-Brussels, in its capacity as 
operator of the Euroclear System, to register as a clearing agency and 
to be an SRO. Although Euroclear does not have formal disciplinary 
authority over its participants, it can influence its participants' 
activities by its admissions and termination policies, as well as 
through the credit extension by MGT-Brussels, acting in its separate 
banking capacity. Furthermore, if Euroclear fails to assure adequate 
compliance by its participants with Euroclear's financial and 
operational requirements or if Euroclear or its participants operate in 
a way that endangers the safety and soundness of U.S. markets of U.S. 
market participants, the Commission can alter or withdraw Euroclear's 
exemption.
    Therefore, the Commission is satisfied that the goals of Sections 
17A(b)(3) (G) and (H) requiring registered clearing agencies to have in 
place systems to enforce their rules and to discipline their 
participants for violations of their rules are substantially fulfilled 
under Euroclear's current structure and by the grant of an exemption.
6. Filing of Proposed Rule Changes
    Section 19(b) of the Exchange Act requires registered clearing 
agencies to file with the Commission copies of all proposed amendments 
or additions to the clearing agencies' rules prior to implementation of 
such rule changes.\58\ The Commission is vested with the authority to 
approve or disapprove such rule proposals in accordance with Section 
19(b) of the Exchange Act, which includes a procedure to solicit public 
comment on proposed rule changes. Because Euroclear will not be a 
registered clearing agency, it will not be subject to the Section 19(b) 
rule change process.
---------------------------------------------------------------------------

    \58\ 15 U.S.C. 78s(b).
---------------------------------------------------------------------------

    As discussed earlier, the relationship between Euroclear and each 
of its participants is governed by the Terms and Conditions, the 
Supplementary Terms and Conditions, and the Operating Procedures.\59\ 
Participants agree to be bound by the provisions of these documents as 
a condition of their participation agreement with MGT-Brussels.
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    \59\ Supra note 9.
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    Euroclear may amend the Terms and Conditions and the Operating 
Procedures at any time upon notice to its participants. In the case of 
amendments that do no adversely affect participants, Euroclear 
participants are deemed to have agreed to such amendments effective 
immediately. All amendments that adversely affect participants are 
binding on participants ten business days after dispatch of the 
notice.\60\ Euroclear also may amend the Supplementary Terms and 
Conditions at any time upon notice to participants. However, all 
amendments to the Supplementary Terms and Conditions, regardless of 
whether they adversely affect Euroclear's participants, are deemed 
effective ten days after notice is given to the Euroclear participants 
in accordance with the Terms and Conditions.
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    \60\ This delay in effectiveness does not apply to Section 22 of 
the Operating Procedures, governing Euroclear's Securities Lending 
and Borrowing Program. All amendments to Section 22, whether or not 
they adversely affect participants, are deemed to have taken effect 
ten days after notice of the amendments is given to participants.
---------------------------------------------------------------------------

    While these procedures are not the substantive equivalent of the 
rule filing procedures of the Exchange Act to which registered clearing 
agencies are subject, the Commission believes that it is important that 
Euroclear's participants receive notice of changes to the Terms and 
Conditions, the Supplementary Terms and Conditions, and the Operating 
Procedures. Also, as discussed below in Section IV.C. of this order, 
Euroclear will be required to provide the Commission with current 
copies of the Terms and Conditions, the Supplementary Terms and 
Conditions, and the Operating Procedures and notices of any changes 
thereto.

C. Scope of Exemption

    This order exempts Euroclear from registration as a clearing agency 
under Section 17A of the Exchange Act subject to conditions that the 
Commission

[[Page 8239]]

believes are necessary and appropriate in light of the statutory 
requirements of the Section 17A objective of promoting a safe and 
efficient national clearance and settlement system and in light of 
Euroclear's structure and operation. The limitations set forth below 
reflect the Commission's determination to take a gradual approach 
toward permitting an international, unregistered clearing organization, 
such as Euroclear, to perform clearing agency functions for 
transactions involving U.S. government and agency securities for U.S. 
participants. This exemptive order and the conditions and limitations 
contained within are consistent with the Commission's recent order 
granting Cedel a conditional exemption from clearing agency 
registration.\61\
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    \61\ Supra note 33.
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1. Securities Covered by the Exemption
    This order grants Euroclear the authority to provide clearance, 
settlement, and collateral management services for U.S. participants' 
\62\ transactions in (i) Fedwire-eligible \63\ U.S. government 
securities,\64\ (ii) mortgage-backed pass through securities that are 
guaranteed by the Government National Mortgage Association 
(``GNMAs''),\65\ and (iii) any collateralized mortgage obligation whose 
underlying securities are Fedwire-eligible U.S. government securities 
or GNMA guaranteed mortgage-backed pass through securities and which 
are depository eligible securities (collectively, ``eligible U.S. 
government securities'').\66\ The Commission believes that this 
limitation is necessary and appropriate because it will allow Euroclear 
to remain an unregistered clearing agency but will allow it to process 
its U.S. participants' transactions in U.S. government and agency 
securities, which are extremely liquid and are the most desirable 
securities to be utilized as collateral to reduce credit and liquidity 
risks of international transactions. In addition, Euroclear may request 
that the exemption be broadened to provide securities processing 
services for securities other than eligible U.S. government securities.
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    \62\ For purposes of this order, ``U.S. participant'' means any 
Euroclear System participation having a U.S. residence, based upon 
the location of its executive office or principal place of business, 
including, without limitation, (i) a U.S. bank (as defined by 
Section 3(a)(6) of the Exchange Act), (ii) a foreign branch of a 
U.S. bank or U.S. registered broker-dealer, and (iii) any broker-
dealer registered as such with the commission even if such broker-
dealer does not have a U.S. residence.
    In the Euroclear notice, the Commission proposed that 
transactions of eligible U.S. government securities involving 
``affiliates'' of U.S. participants be counted towards the volume 
limit. For this purpose, an affiliate was deemed to be any Euroclear 
System participant having an arrangement with a U.S. entity that is 
known to Euroclear which will prevent a settlement or credit default 
with respect to the Euroclear System participant. This provision was 
intended to parallel the Cedel exemptive order. But because 
Euroclear's operational structure makes it unlikely that Euroclear 
System participants would utilize such arrangements, the Commission 
believes that it is not necessary to employ the affiliate concept in 
the context of this order.
    \63\ Fedwire is a large-value transfer system operated by the 
Federal Reserve Board that supports the electronic transfer of funds 
and of book-entry securities.
    \64\ For purposes of this order, ``U.S. government securities'' 
shall include all ``government securities'' as defined in Section 
3(a)(42) of the Exchange Act, 15 U.S.C. 78c(a)(42), except that it 
shall not include any (i) foreign-targeted U.S. government or agency 
securities or (ii) securities issued or guaranteed by the 
International Bank for Reconstruction and Development (i.e., the 
``World Bank'') or any other similar international organization.
    \65\ GNMAs, unlike the mortgage-backed securities guaranteed by 
the Federal National Mortgage Association (``Fannie Maes'') and by 
the Federal Home Loan Mortgage Association (``Freddie Macs''), are 
issued in certificated form and therefore cannot be transferred over 
Fedwire.
    \66\ The definition of ``eligible government securities'' as set 
forth in this order is intended to parallel the definition of that 
term as used in the Cedel exemptive order. The definition as set 
forth here is also intended to clarify that, for purposes of both 
the Cedel and Euroclear exemptions from clearing agency 
registration, the Commission does not intend to capture those 
transactions involving securities that technically may fall within 
the definition of eligible U.S. government securities, but are 
securities which trade principally in non-U.S. markets, such as 
foreign-targeted government and agency securities and securities 
issued by organizations such as the World Bank.
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2. Volume Limits
    The Commission is placing a limit on the volume of transactions in 
eligible U.S. government securities conducted by U.S. participants that 
can be settled through the Euroclear System. Specifically, the average 
daily volume of eligible U.S. government securities settled through the 
Euroclear system for U.S. participants may not exceed five percent of 
the total average daily dollar value of the aggregate volume in 
eligible U.S. government securities.\67\ For purposes of this order, 
eligible U.S. government securities transactions settled through the 
Euroclear System will include (i) internal settlements \68\ of 
transactions involving eligible U.S. government securities if a U.S. 
participant is on at least one side of the transaction; (ii) Bridge 
settlements \69\ with Cedel where a U.S. participant is on the 
Euroclear side of the transaction; and (iii) external settlements where 
a U.S. participation is on the Euroclear side of the transaction.\70\ 
Transactions involving the return of securities collateral, securities 
substitutions in triparty repo or other collateral or financing 
arrangements, and securities realignments where the same U.S. 
participant is on both sides of the transaction will not be considered 
to be transactions settled through the Euroclear System and 
consequently will not be subject to the volume limit.\71\
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    \67\ In the orders granting Cedel and CCOS exemptions from 
clearing agency registration, the Commission imposed volume limits 
on those entities. The CCOS exemptive order contained volume 
limitations of US $6 billion average net daily settlement for U.S. 
government securities and US $24 billion average net daily 
settlements for repurchase agreements in U.S. government securities. 
At that time, the CCOS volume limits were designed to limit CCOS's 
activity to approximately five percent of the average daily dollar 
value of transactions in U.S. government securities and in 
repurchase agreements involving U.S. government securities. In the 
Cedel exemptive order, the Commission determined that a percentage-
based formula was more appropriate. Consequently, Cedel's volume 
limitation is 5% of the total average daily dollar value of the 
aggregate volume in eligible U.S. government securities.
    \68\ Supra Section II.A.
    \69\ Id.
    \70\ Pursuant to the reporting requirements described below, the 
Commission expects to receive, among other things, gross 
transactional volumes regarding all transactions in eligible U.S. 
government securities processed by the Euroclear System (i.e., 
whether or not a U.S. participant is involved). In addition, the 
Commission expects to monitor the effects such transactions may have 
on U.S. markets and U.S. market participants.
    \71\ The delivery of eligible U.S. government securities in 
either a new or an open triparty repo, collateral, or financing 
transaction (collectively, ``repo transactions''), will be treated 
as a ``substitution'' and therefore will not be subject to the 
volume limit unless it is the first delivery of such securities. 
Accordingly, if eligible U.S. government securities are delivered at 
the opening of any repo transaction, the initial delivery will count 
towards the volume limit but subsequent substitutions of eligible 
U.S. government securities will not. Similarly, if other securities 
are delivered at the opening of a repo transaction and eligible U.S. 
government securities are later substituted for such securities, the 
initial delivery of such eligible U.S. government securities will 
count towards the volume limit, but subsequent substitutions of 
eligible U.S. government securities will not.
---------------------------------------------------------------------------

    The total average daily dollar value of eligible U.S. government 
securities volume will be determined semiannually as the sum of (1) the 
average daily transaction value of all Fedwire eligible book-entry 
transfers originated on Fedwire as provided to the Commission by the 
Federal Reserve Board, (2) the average daily value of all compared 
trades in eligible U.S. government securities as provided to the 
Commission by the Government Securities Clearing Corporation 
(``GSCC''),\72\ (3) the average daily value

[[Page 8240]]

of all compared trades less the netted value of all such compared 
trades plus the average daily volume of all trade-for-trade 
transactions (i.e., trades not included in the netting system) in 
eligible government securities as provided by MBS Clearing Corporation, 
(4) the average daily gross settlement value in eligible U.S. 
government securities as provided to the Commission by the Participants 
Trust Company, and (5) the average daily dollar value of compared 
trades in eligible U.S. government securities from any other source 
that the Division deems appropriate to reflect the aggregate volume in 
eligible U.S. government securities.
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    \72\ In the Cedel exemptive order, the Commission determined 
that the portion of the volume limit applicable to Cedel that is 
derived from GSCC's trade comparison data should be the average 
daily value of all compared trades less the netted value of such 
trades. This was done to avoid double-counting the netted 
transactions with those already accounted for in the reported 
Fedwire volume. After further study and discussions with industry 
representatives, the Commission has found that a significant number 
of the GSCC netted transactions do not pass across Fedwire but 
rather are processed internally through clearing banks such as the 
Bank of New York and the Chase Manhattan Bank. Consequently, the 
Commission now believes that because the risk of double-counting is 
small, it is more appropriate to utilize GSCC's gross average daily 
value of all compared trades to calculate the volume limit for 
eligible U.S. government securities applicable to Euroclear. The 
Commission will amend the Cedel exemptive order in the near future 
to permit Cedel to calculate its volume limit in accordance with the 
method set forth in the order that is applicable to Euroclear.
---------------------------------------------------------------------------

    The Commission believes that the volume limit is appropriate in 
that it is large enough to allow Euroclear to commence operations in 
clearing and settling eligible U.S. government securities transactions 
involving U.S. participants and to allow the Commission to observe the 
effects of Euroclear's activities on the U.S. government securities 
market. Likewise, the Commission believes that the volume limit is 
sufficiently small in scope so that the safety and soundness of the 
U.S. government securities markets should not be compromised if 
Euroclear, MGT-Brussels, or any Euroclear participant experiences 
financial or operational difficulties.
3. Commission Access to Information
    To facilitate the monitoring of compliance with the volume limit 
and the impact of Euroclear's operations on the U.S. government 
securities market under this order, Euroclear will be required to 
provide certain information to the Commission as a continuing condition 
of its exemption.\73\ Specifically, Euroclear will be required to 
provide the Commission with quarterly reports, calculated on a twelve-
month rolling basis, of (1) the average daily volume of transactions in 
eligible U.S. government securities for U.S. participants that are 
subject to the volume limit as described in Section IV.C.2. above and 
(2) the average daily volume of transactions in eligible U.S. 
government securities for all Euroclear System participants, whether or 
not subject to the volume limit.\74\
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    \73\ The Division also will have available to it the annual 
reports on Form 10-K and the quarterly reports on Form 10-Q filed 
with the Commission by J.P. Morgan & Co. Incorporated, MGT's parent. 
Furthermore, Euroclear has represented that the Commission will be 
permitted to observe Euroclear System operations and to talk to 
Euroclear personnel on-site if the Commission so requests.
    \74\ In the Euroclear notice, the Commission proposed that 
Euroclear provide monthly the aggregate volume of all transactions 
in eligible U.S. government securities. Under the terms of the Cedel 
exemptive order, the Commission also required Cedel to provide this 
information on a monthly basis. After reviewing Cedel's monthly 
reports, the Commission has determined that the average daily volume 
of eligible U.S. government securities, reported quarterly, would be 
a more useful reporting format and will provide the Commission with 
adequate information regarding transaction volumes for monitoring 
purposes. The Commission will amend the Cedel exemptive order in the 
near future to permit Cedel to provide average daily volume of 
transactions in eligible U.S. government securities on a quarterly 
basis in accordance with the reporting requirements set forth in 
this order that are applicable to Euroclear.
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    Furthermore, Euroclear is required to promptly provide to the 
Commission the following documents (``disclosure documents'') when made 
available to Euroclear System participants:

    (1) any amendments to or revised editions of (a) the Terms and 
Conditions, (b) the Supplementary Terms and Conditions Governing the 
Lending and Borrowing of Securities through Euroclear, and (c) the 
Operating Procedures of the Euroclear System;
    (2) the annual report to shareholders of the Belgian 
Cooperative; and
    (3) the annual report on the internal controls, policies and 
procedures of the Euroclear System (``SAS-70 Report'').\75\
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    \75\ Euroclear must amend its Form CA-1 with respect to any 
changes to the information reported at items 1, 2, and 3 of its Form 
CA-1 to the extent that such changes are not reported in the 
disclosure documents.
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    In addition, Euroclear will be required to file with the Commission 
amendments to its application for exemption on Form CA-1 if it makes 
any fundamental change affecting its clearance and settlement business 
with respect to eligible U.S. government securities as summarized in 
this order and in its Form CA-1 dated March 4, 1997, or in any 
subsequently filed amended Form CA-1, which would make the information 
in this order or in its Form CA-1 incomplete or inaccurate.\76\ This 
method of notifying the Commission of proposed changes at Euroclear 
will assist the Commission in its overall review of Euroclear and its 
operations.\77\
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    \76\ Only that portion of the Euroclear application on Form CA-1 
affected by any such change must be filed with the Commission as an 
amendment. A resubmission of the entire Form CA-1 is not required.
    \77\ Neither the requirement to submit the disclosure documents 
nor the requirement to amend its Form CA-1 will be applicable to 
MGT-Brussels in its separate banking capacity and not as operator of 
the Euroclear System.
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    As a continuing condition to the exemption, Euroclear is also 
required to notify the Commission regarding material adverse changes in 
any account maintained by Euroclear for its U.S. participants.\78\ In 
addition, Euroclear will be required to respond to a Commission request 
for information about any U.S. participant about whom the Commission 
has financial solvency concerns, including, for example, a settlement 
default by a U.S. participant.\79\
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    \78\ For purposes of this order, the term ``material adverse 
changes'' will include (i) the termination of any U.S. participant; 
(ii) the liquidation of any securities collateral pledged by a U.S. 
participant to secure an extension of credit made through the 
Euroclear System; (iii) the institution of any proceedings to have a 
U.S. participant declared insolvent or bankrupt; or (iv) the 
disruption or failure in whole or in part in the operations of the 
Euroclear System either at its regular operating location or at its 
contingency center.
    \79\ If an information request relates to a U.S. participant 
that is a ``bank,'' as such term is defined in Section 3(a)(6) of 
the Exchange Act, 15 U.S.C. 78c(a)(6), the Commission will, if 
necessary, coordinate with the ``appropriate regulatory agency,'' as 
such term is defined in Section 3(a)(34) of the Exchange Act, 15 
U.S.C. 78c(a)(34).
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4. Modification of Exemption
    The Commission may modify by order the terms, scope, or conditions 
of Euroclear's exemption from registration as a clearing agency if the 
Commission determines that such modification is necessary or 
appropriate in the public interest, for the protection of investors, or 
otherwise in furtherance of the purposes of the Exchange Act.\80\ 
Furthermore, the Commission may limit, suspend, or revoke this 
exemption if the Commission finds that Euroclear has violated or is 
unable to comply with any of the provisions set forth in this order if 
such action is necessary or appropriate in the public interest, for the 
protection of investors, or otherwise in furtherance of the purposes of 
the

[[Page 8241]]

Exchange Act for the protection of investors and the public interest.
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    \80\ The exemption provided by this order is based upon 
representations by Euroclear, its officers and attorneys, facts 
contained in the Euroclear application, and other information known 
to the Commission regarding the substantive aspects of Euroclear's 
proposal (collectively, ``representations and facts''). Any changes 
in the representations or facts as presented to the Commission may 
require a modification of this order. Responsibility for compliance 
with all applicable U.S. securities laws rests with Euroclear and 
its U.S. participants, as appropriate. Euroclear also is advised 
that this order does not exempt Euroclear from the anti-fraud or 
anti-manipulation provisions of the Exchange Act or any of the rules 
promulgated thereunder.
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V. Conclusion

    The Commission finds that Euroclear's application for exemption 
from registration as a clearing agency meets the standards and 
requirements deemed appropriate for such an exemption.
    It is therefore ordered, pursuant to Section 19(a)(1) of the 
Exchange Act, that the application for exemption from registration as a 
clearing agency filed by Morgan Guaranty Trust Company of New York, 
Brussels Office, as operator of the Euroclear System (File No. 601-01) 
be, and hereby is, approved subject to the conditions contained in this 
order.

    By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-3997 Filed 2-17-98; 8:45 am]
BILLING CODE 8010-01-M