[Federal Register Volume 63, Number 34 (Friday, February 20, 1998)]
[Notices]
[Pages 8711-8723]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-4255]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-39661; International Series Release No. 1117; File No. 
600-30]


Self-Regulatory Organizations; Emerging Markets Clearing 
Corporation; Order Granting Temporary Registration as a Clearing Agency

February 13, 1998.
    On May 30, 1997, the Emerging Markets Clearing Corporation 
(``EMCC'') filed with the Securities and Exchange Commission 
(``Commission'') an application on Form CA-1 \1\ for registration as a 
clearing agency pursuant to Sections 17A and 19 of the Securities 
Exchange Act of 1934 (``Exchange Act'') \2\ and Rule 17Ab2-1 
thereunder.\3\ Notice of EMCC's application was published in the 
Federal Register on July 10, 1997.\4\ Eight comment letters were 
received in response to the notice of filing of the EMCC 
application.\5\ This order grants FMCC registration as a clearing 
agency for a period not to exceed eighteen months and exempts EMCC from 
certain provisions of the Exchange Act.
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    \1\ On June 2, 1997, June 17, 1997, August 7, 1997, October 14, 
1997, October 21, 1997, and October 28, 1997, EMCC filed amendments 
to its application. Copies of the application are available for 
inspection and copying at the Commission's Public Reference Room.
    \2\ 15 U.S.C. 78q-1 and 78s.
    \3\ 17 CFR 240.17Ab2-1.
    \4\ Securities Exchange Act Release No. 38810 (July 1, 1997), 62 
FR 37093 (``EMCC Notice'').
    \5\ Letters from Jonathan Kord Lagemann, attorney for Asialuck 
Limited (July 15, 1997); JP Morgan (July 30, 1997); Emerging Markets 
Traders Association (August 8, 1997); UBS Limited (August 7, 1997); 
Euro Brokers Maxcor Inc. (undated); EMCC European Operations 
Committee (August 8, 1997); Salomon Brothers Inc. (August 8, 1997); 
and Merrill Lynch, Pierce, Fenner & Smith Incorporated (August 6, 
1997).
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Table of Contents

I. Description

A. EMCC Organization
B. Eligible Securities

[[Page 8712]]

C. Clearance Services
D. Settlement Services
E. Buy-ins/Sell-outs
F. Release of Clearing Data

II. Comment Letters

III. Discussion

A. Statutory Standards
B. Participant Standards
    1. Eligible Categories of Members
    2. Examination of Applicants
    3. Membership Standards
    4. Membership Agreement
    5. Compliance with the Statutory Membership Requirements
C. Fair Representation
    1. Governance Procedures
    2. Provision of Information to Participants
D. Safety and Soundness Considerations
    1. Clearing Fund
    a. Clearing Fund Formula
    b. Margin Composition and Investment
    c. Loss Allocation
    d. Use of Clearing Fund
    2. Standard of Care
    3. Operational Capacity
    4. Audit Committee and Internal Audit Department
    5. Securities, Funds, and Data Controls
E. Capacity to Enforce Rules
    1. Participant Monitoring
    2. Ceasing to Act
    3. Hearing Procedures
F. Dues, Fees, and Charges

IV. Conclusion

I. Description of EMCC

A. EMCC Organization

    EMCC is a corporation organized under the laws of the State of New 
York. EMCC was formed by the Emerging Markets Traders Association 
(``EMTA'') \6\ and the International Securities Clearing Corporation 
(``ISCC'') \7\ in response to an industry initiative to reduce risk in 
the clearance and settlement of emerging markets debt instruments. 
Currently, the International Securities Markets Association 
(``ISMA''),\8\ the National Securities Clearing Corporation 
(``NSCC''),\9\ and EMTA are the owners of EMCC.\10\
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    \6\ EMTA is a trade association organized in 1990 as a New York 
not-for-profit corporation by financial institutions to promote the 
development of trading markets in emerging market instruments. At 
the end of 1996, EMTA had 154 members, which were mainly broker-
dealers and banks. EMTA owns 100% of the outstanding voting 
securities of EMTA Black, Inc. EMTA Black, Inc. in turn owns 100% of 
the outstanding voting securities of each of Clear-EM, Inc.; match-
EM, Inc.; and Net-EM, Inc. Match-EM, Inc. is the owner of Match-EM, 
which is an electronic post-trade confirmation and matching system 
for Brady bonds and sovereign loans operated by GE Information 
Services, Inc. (``GE''). Match-EM also enables EMTA to disseminate 
daily market volume and price data. Match-EM began operations in May 
1995.
    \7\ ISCC is the wholly owned subsidiary of the National 
Securities Clearing Corporation and is registered as a clearing 
agency under the Exchange Act. Securities Exchange Act Release No. 
26812 (May 12, 1989), 54 FR 21691 (order approving temporary 
registration of ISCC as a clearing agency). ISCC continues to 
operate under its temporary registration. Securities Exchange Act 
Release No. 38703 (May 30, 1997), 62 FR 31183.
    \8\ ISMA is an industry association composed of broker-dealer 
firms. ISMA has approximately 820 members in 48 countries. ISMA is 
organized under the laws of Switzerland and is registered in the 
United Kingdom (``U.K.'') as a designated investment exchange. ISMA 
owns TRAX, a trade matching and reporting system started in 1989. 
ISMA's wholly-owned subsidiary, International Securities Market 
Association Limited (``ISMA Ltd.''), operates TRAX. U.K. broker-
dealers can use TRAX to fulfill their U.K. reporting requirements.
    \9\ NSCC is a clearing agency registered under Section 17A of 
the Exchange Act. Securities Exchange Act Release No. 20221 
(September 23, 1983), 48 FR 45167 (order approving full registration 
of NSCC as a clearing agency). NSCC is owned by the New York Stock 
Exchange, Inc., the American Stock Exchange, Inc., and the National 
Association of Securities Dealers, Inc.
    \10\ EMTA owns 300 shares (37.5% of the outstanding shares), 
NSCC owns 300 shares (37.5% of the outstanding shares), and ISMA 
owns 200 shares (25% of the outstanding shares). No later than June 
30, 1998, EMCC intends to issue shares to persons that have 
contributed to the EMCC development fund and to finance EMCC's 
initial operations in such amounts and at such times as determined 
by EMCC. EMCC will file a proposed rule change prior to any such 
issuances.
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B. Eligible Securities

    EMCC has been established as a clearing agency to facilitate the 
clearance and settlement of transactions in U.S. dollar-denominated 
Brady bonds at Cedel and Euroclear (collectively referred to as 
``depositories'').\11\ Currently, Brady bonds \12\ are settled through 
the facilities of Cedel Bank, Societe anonyme (``Cedel'') and the 
Euroclear system, which is operated by the Brussels Office of Morgan 
Guaranty Trust Company of New York (``Euroclear'').\13\ In the future, 
EMCC may expand its clearance and settlement services to include other 
emerging markets debt instruments.\14\
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    \11\ Initially, only Brady bonds will be eligible for processing 
at EMCC. As defined in EMCC's rules, Brady bonds are: (i) any bond 
or note issued in connection with the restructuring of indebtedness 
by a sovereign or an agency or entity thereof under the auspices of 
the Brady plan or under any similar restructuring or financing plan 
whether or not collateralized and including bonds or notes issued in 
exchange thereof or (ii) any warrant or similar right originally 
issued attached to a Brady bond. The term does not include 
securities offered by a sovereign debtor to investors through normal 
underwriting syndication channels.
    \12\ Pursuant to a plan developed by then U.S. Treasury 
Secretary Nicholas Brady, certain countries have issued 
collateralized debt securities (i.e., Brady bonds) in exchange for 
outstanding bank loans as part of an internationally supported 
sovereign debt restructuring. Typically, the collateral would be 
U.S. Treasury securities. More recently, some issues of Brady bonds 
have been issued without collateral.
    \13\ For a description of Cedel, see Securities Exchange Act 
Release No. 38328 (February 24, 1997), 62 FR 9225 (order approving 
application for limited exemption from registration as a clearing 
agency). For a description of Euroclear, see 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).
    \14\ EMCC will file proposed rule changes with the Commission 
prior to expanding the categories of securities eligible for 
processing at EMCC.
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C. Clearance Services

    Dealers and interdealer brokers (``broker'') will submit 
transaction data relating to trades to be settled at EMCC to a locked-
in trade source which will match such data using its own criteria. 
Initially, the locked-in trade sources designated by EMCC are Match-EM 
and TRAX.\15\ Upon completion of the matching process, each locked-in 
trade source will submit transaction data to EMCC.\16\
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    \15\ See supra notes 6 and 8.
    \16\ TRAX will only submit data to EMCC on matched trades that 
members have designated as EMCC trades. Match-EM will submit data to 
EMCC on all trades submitted to it. EMCC will segregate out for 
processing all data on trades between two EMCC members. However, if 
an EMCC member maintains two accounts with Match-EM, EMCC will only 
process trades in the EMCC designated account.
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    EMCC will receive data from the locked-in trade sources three times 
each business day: (1) Between 8:00 a.m. and 8:30 a.m. eastern time 
(``ET'') (``early morning transmission''); (2) between 11:00 a.m. and 
11:30 a.m. ET (``midmorning transmission''); and (3) between 9:00 p.m. 
and 9:30 p.m. ET (``evening transmission''). At approximately 10:30 
a.m. ET and 11:30 p.m. ET, EMCC will send to its members and to the 
locked-in trade sources a report of data that was rejected because it 
did not meet EMCC's or the depositories' operational parameters.\17\ 
Any correction or cancellation of data must be done through the locked-
in trade sources.\18\
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    \17\ Such parameters include complete information and valid 
characters. In addition, EMCC has established a maximum delivery 
size of $20 million.
    \18\ Any cancellation or correction must be received by EMCC no 
later than the early morning transmission two business days after 
trade date (``T+2'').
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    EMCC will report to each member on its ``accepted trade report'' 
data on all trades: (a) That are matched by the locked-in trade 
sources; (b) that are received by EMCC by the early morning 
transmission two days after trade date (``T+2''); (c) that are eligible 
for processing by EMCC (i.e., U.S. dollar denominated Brandy bonds); 
and (d) that are not rejected by EMCC based on the operational 
parameters. EMCC will interpose itself as the counterparty and 
guarantor on a trade-for-trade basis with respect to the trades it 
reports on its accepted trade report unless EMCC notifies or has made 
information available to its members that trades

[[Page 8713]]

listed on the accepted trade report are not assumed and guaranteed 
because EMCC has ceased to act for the original counterparty.\19\ 
EMCC's guarantee will be effective with respect to: (a) Trades reported 
on the evening accepted trade report at the later of midnight ET or one 
half hour after the issuance of the preliminary margin report \20\ and 
(b) trades reported on the morning accepted trade report at the later 
of 1:00 p.m. ET or two and one-half hours after issuance of the final 
margin report.\21\
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    \19\ EMCC does not interpose itself as the counterparty and 
guarantor for transactions reported on the settlement instructions 
only report.
    \20\ See Infra Section III.D.1.a for a description of the 
preliminary margin report.
    \21\ See infra Section III.D.1.a for a description of the final 
margin report.
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    Matched trades that are eligible for processing and that are 
received on T+2 in the midmorning transmission will be listed on a 
settlement instructions only report (``SIO report''). For trades listed 
on this report, EMCC will provide settlement instructions on behalf of 
its members to the depositories but will not novate or guarantee the 
trade. EMCC will not accept transaction data sent after the midmorning 
transmission on T+2.
    Upon standing instructions of a member, EMCC will also include on 
the SIO report uncompared transaction on T+2. If EMCC receives by the 
early morning transmission on T+2 updated data from Match-EM indicating 
that an uncompared trade has been cancelled or compared, EMCC will not 
include data on the trade on the SIO report. If submitted in time, 
these trades will be reported on the accepted trade report. If not, 
they will be processed by the depositories, but will not be guaranteed 
by EMCC.
    Accepted trade reports will be made available to members at 
approximately 10:30 a.m. ET and 11:30 p.m. ET. The morning report will 
contain data on matched trades received in the early morning 
transmission. The evening report will contain data on matched trades 
received in the midmorning and evening transmissions. The SIO report 
will be issued at approximately 12:00 p.m. ET. At approximately 12:30 
p.m. on T+2, EMCC will send settlement instructions to the depositories 
based on trade data contained in the accepted trade reports and in the 
SIO reports.

D. Settlement Services

    EMCC is a member of both Euroclear and Cedel. For trades listed on 
the accepted trade report, EMCC will transmit settlement instructions 
to the appropriate depository on behalf of members with EMCC as the 
counterparty to each side of the trade. EMCC will send instructions to 
the depository at 12:30 p.m. on T+2 for settlement the next day 
(``T+3''). The settlements will be made on a delivery against payment/
receive against payment basis through EMCC's account at each 
depository.\22\
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    \22\ Unless otherwise specified, EMCC assumes that bonds will be 
delivered with attached warrants.
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    In accordance with the depositories' rules, settlement will occur 
only if the receiver has sufficient cash or line of credit to pay for 
the delivery and the deliverer has sufficient securities to make full 
delivery.\23\ The depositories will notify EMCC and its members each 
day at midnight ET of the status of trades indicating which have 
settled and which were scheduled to settlement but are still pending. 
EMCC will not provide settling trade reports or fail reports to its 
members.
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    \23\ Both Cedel and Euroclear employ mechanisms that can look 
beyond the initial counterparties' obligations. Cedel has a 
``chaining'' program which scans open transactions until all cash 
and securities resulting from same day settlements are reemployed to 
settle further transactions for same day value. Therefore, for back-
to-back transfers for equivalent funds, customers may not need to 
pay because proceeds from sales are used to settle purchases.
    Euroclear's chaining program operates somewhat differently. In 
scanning open transactions, the Euroclear program will only look to 
the next settlement. For example, if a member does not have 
sufficient funds to receive securities, Euroclear will ascertain 
whether that member has a corresponding securities deliver 
obligation to another member. In such case, Euroclear will complete 
both transactions if the counterparty to the deliver obligation has 
sufficient funds to pay for the securities. But if the counterparty 
to the securities deliver obligation did not have sufficient funds 
to settle the transaction, Euroclear, unlike Cedel, would not look 
to subsequent settlements for funds and securities. Accordingly, 
where EMCC as the counterparty to EMCC member trades has 
insufficient funds to accept deliveries, Euroclear's system will 
only look to EMCC's member to determine if sufficient funds exist. 
In order to permit Euroclear to ``look through'' EMCC for settlement 
and deliveries, EMCC will maintain a line of credit of at least $50 
million at Euroclear. EMCC's line of credit will permit Euroclear to 
review not only the available funds of EMCC's member but also such 
member's subsequent counterparty, if any.
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    If a member fails to accept delivery of securities from EMCC 
because it has insufficient funds, EMCC will send a fail compensation 
instruction to the appropriate depository. The next day (presuming that 
the member is not insolvent), the depository will debit the account of 
the member that had insufficient funds and credit its counterparty's 
account an amount of money based on the depository's overnight 
borrowing interest rate multiplied by the amount of funds which were 
not paid.
    With respect to transactions reflected on a member's SIO report, 
EMCC will send instructions on the afternoon of T+2 to the depository 
on behalf of that member for T+3 settlement. EMCC will not monitor the 
settlement of these transactions.

E. Buy-ins/Sell-outs

    EMCC's rules permit a member to buy-in or a sell-out of Brady bonds 
in the event that a transaction has not been completed by five days 
after settlement date (``SD+5'').\24\ EMCC may also initiate a buy-in 
or sell-out if it determines that such action is necessary to protect 
EMCC, its members, its creditors, or its investors; to safeguard 
securities or funds in EMCC's custody or control; or to promote the 
prompt and accurate clearance and settlement of securities 
transactions.
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    \24\ A buy-in or sell-out may be initiated by submitting a 
``pre-advice'' notice to EMCC. Upon receipt of the pre-advice 
notice, EMCC will transmit the notice to the member with the fail 
obligation. If the instruments or money covered by the pre-advice 
notice are not received within two business days after the date of 
the pre-advice notice, then the member that requested the buy-in or 
sell-out must deliver to EMCC a buy-in or sell-out notice between 
two to five business days after issuance of the pre-advice notice in 
order to proceed with the buy-in or sell-out. Upon receipt of the 
buy-in or sell-out notice, EMCC will transmit a buy-in or sell-out 
notice to the member with the fail obligation. Execution of the buy-
in or sell-out will take place through an agent selected by EMCC on 
the fifth business day following the issuance of the buy-in or sell-
out notice.
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    While a member may request a buy-in or sell-out for deliver and 
receive obligations for warrants, EMCC will only complete the buy-in or 
sell-out of warrants at the requesting member's expense in the event 
that EMCC ceases to act for the member's counterparty. In addition, if 
EMCC ceases to act for the defaulting member after the pre-advice 
notice has been submitted but before the execution of the buy-in or 
sell-out, EMCC will only proceed with the buy-in or sell-out after 
confirming with the requesting firm that it wants to proceed at its 
expense.

F. Release of Clearing Data

    Pursuant to EMCC's rules, EMCC may release its members' transaction 
data to EMTA in accordance with a written agreement between EMCC and 
EMTA. Such data may be used only for the purpose of promoting market 
transparency on a noncommercial basis. On June 9, 1997, EMCC and EMTA 
entered into a letter agreement that provides for the public 
dissemination of information relating to the aggregate and per trade 
transaction volumes and prices of trades processed by EMCC.

II. Comment Letters

    The Commission received eight comment letters in response to the

[[Page 8714]]

notice of filing of EMCC's application.\25\ Seven were in favor of 
granting EMCC's application for registration. These commenters stated 
that EMCC would be effective in reducing the risks, particularly 
counterparty risk, involved in settling Brady bonds. In addition, many 
of these commenters thought that EMCC would provide a cost-effective 
means of settling Brady bond trades.
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    \25\ Supra note 5.
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    The one commenter that opposed EMCC's application stated that EMTA 
has failed to respond to a New York Stock Exchange subpoena and that 
such conduct was inconsistent with the conduct expected of a registered 
clearing agency. EMCC responded to this commenter by stating that EMTA 
had in fact responded to the subpoena and that EMTA's actions were 
irrelevant to EMCC's application because EMTA's involvement is limited 
to an ownership interest in EMCC pursuant to which it may elect only 
one director out of the 21 directors on EMCC's board.

III. 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.\26\ Registration of clearing agencies is a key 
element of the statutory objectives set forth in Section 17A.\27\ 
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.\28\ Additionally, the Division of Market Regulation has 
published the standards it applies in evaluating applications for 
clearing agency registration.\29\
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    \26\ 15 U.S.C. 78q-1. For legislative history concerning Section 
17A, see, e.q., Report of Senate Comm. on Housing and Urban Affairs, 
Securities Acts Amendments of 1975: Report to Accompany S. 249, S. 
Rep. No. 75, 94th Cong., 1st Sess. 4 (1975); Conference Comm. Report 
to Accompany S. 249, Joint Explanatory Statement of Comm. of 
Conference, H.R. Rep. No. 229, 94th Cong., 1st Sess., 102 (1975).
    \27\ ``Clearing agency'' is defined in Section 3(a)(23) of the 
Exchange Act. 15 U.S.C. 78c(a)(23).

    \28\ 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.
    \29\ 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) 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.\30\
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    \30\ 15 U.S.C. 78q-1(b)(1)
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As a result, in granting exemptions from portions of Section 17A, the 
Commission requires substantial compliance with Section 17A and the 
rules and regulations thereunder based on a review of the 
standards.\31\
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    \31\ The Commission has granted temporary registrations that 
included exemptions from specific statutory requirements of Sections 
17A. In granting these temporary registrations, the subject clearing 
agencies were expected to become registered on a permanent basis. 
See, e.g., Securities Exchange Act Release No. 25740 (May 24, 1988), 
53 FR 19839 (order approving Government Securities Clearing 
Corporation's temporary registration as a clearing agency with a 
temporary exemption from compliance with Section 17A(b)(3)(C)).
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B. Participant Standards

1. Eligible Categories of Members
    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.\32\ As discussed in the Standards Release, a clearing agency 
may also accept specific categories of persons other than those 
enumerated but must be cognizant of the impact that any additional 
category of members may have on the clearing agency and must take steps 
to address any such risk. While entities falling into the specified 
categories are eligible for membership, applicants must also satisfy 
the other criteria established by EMCC and discussed later in this 
release.
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    \32\ The classes are registered brokers or dealers, registered 
clearing agencies, registered investment companies, banks, and 
insurance companies.
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    A partnership, corporation, limited liability company, or other 
organization, entity, or individual will be qualified to become a 
member of EMCC if it satisfies at least one of the following 
qualifications: (a) It is a broker or dealer registered under the 
Exchange Act; (b) it is a broker or deraler registered or regulated 
under the laws of another jurisdiction;\33\ (c) it is a bank or trust 
company, including a trust company having limited power, which is a 
member of the Federal Reserve System or is supervised and examined by 
state or federal authorities in the U.S. having supervision over banks; 
(d) it is a bank or trust company, which is supervised and examined by 
the banking regulator in another jurisdiction; or (e) if it does not 
qualify under (a) through (d) but is the successor or assign of any 
member and has demonstrated to the board of directors that its business 
and capabilities are such that it could use EMCC's services without 
undue risk to EMCC, then such successor or assign may become a member 
for the limited purpose of winding up its business with EMCC in an 
orderly manner.
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    \33\ Initially, only broker-dealers that are organized under the 
laws of the U.K. will be eligible for admission. EMCC will file a 
proposed rule change setting forth membership criteria prior to 
admission of other categories of non-U.S. broker-dealers.
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    After the issuance of shares to persons which have contributed to 
the development fund for the organization and initial operation of 
EMCC,\34\ all applicants that EMCC accepts for membership will be 
required to be either a shareholder of EMCC or an affiliate or 
subsidiary of a shareholder of EMCC. EMCC may deny an application to 
become a member or to use one or more services of EMCC upon a 
determination by EMCC that EMCC does not have adequate personnel, 
space, data processing capacity, or other operational capability at 
such time to perform its services for the applicant or member without 
impairing the ability of EMCC to provide services for its existing 
members, to assure the prompt, accurate, and orderly processing and 
settlement of securities transactions, or to otherwise carry out its 
functions. However, any such applications which are denied will be 
approved as promptly as the capabilities of EMCC permit. Further 
Section 17A(b)(3)(F) of the Exchange Act requires that the rules of a 
clearing agency should not be designed to discriminate in the admission 
of members.
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    \34\ See supra note 10.
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2. Examination of Applicants
    The Standards Release notes that a registered clearing agency is 
empowered by the Exchange Act to examine and verify the qualifications 
of an applicant in accordance with the procedures

[[Page 8715]]

established by the rules of the clearing agency. However, the Standards 
Release also states that such authority could be used only subject to a 
clearing agency's responsibility not to discriminate in the admission 
of participants and not to impose any burden on competition not 
necessary or appropriate in furtherance of the purposes of the Exchange 
Act.
    Each applicant for admission to EMCC must provide a copy of its 
financial statements for the two most recent fiscal years certified by 
the applicant's independent certified public accountants. To the extent 
that such audited financial statements are not prepared in accordance 
with U.S. generally accepted accounting principles (``GAAP''), the 
applicant must provide EMCC with a discussion of the material 
variations of such accounting principles from U.S. GAAP.
    A U.S. broker-dealer applicant must provide copies of its Form X-
17A-5 FOCUS Reports or Form G-405 FOGS Reports for the last two years 
and any supplemental reports required to be filed with the Commission 
pursuant to Exchange Act Rule 17a-11 \35\ or 17 CFR 405.3. If the 
applicant is a U.K. broker-dealer subject to regulation by the 
Securities and Futures Authority (``SFA'') or any successor 
organization, it must provide EMCC with its SFA monthly reports and 
returns for the prior 24 months and if necessary and feasible, 
financial statements prepared in accordance with U.S. GAAP.
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    \35\ 17 CFR 240.17a-11.
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    A bank applicant must provide all quarterly financial statements 
covered by the last audited financial statement plus all subsequent 
quarterly financial statements. A U.S. bank applicant also must provide 
copies of its three most recent Consolidated Reports of Condition and 
Income (``Call Reports'') and information as to its capital levels and 
ratios. A non-U.S. bank applicant also must provide all material 
regulatory filings made with its primary regulator in its home country 
over the prior two years.
    If required by EMCC, an applicant must provide a certificate of the 
chief executive or chief financial officer of the applicant that no 
material adverse changes have occurred in the financial condition of 
the applicant since the date of the most recent financial statements or 
reports filed with EMCC; that the applicant has not guaranteed the 
obligations of any other person; and that the applicant is not subject 
to any other contingent liabilities except as set forth in such 
financial statements, reports, or the certificate.
    All applicants must fill out a questionnaire that elicits 
information on any liabilities of the applicant, the types of business 
conducted by the applicant, and the applicant's operational 
capabilities. All applicants must provide to EMCC an opinion of outside 
counsel as to the member's organization, the validity and 
enforceability of the member's agreement, and the need for regulatory 
approvals. In addition, the opinion of non-U.S. applicants must also 
opine as to jurisdictional and conflict-of-law issues. A non-U.S. 
applicant must represent that it is in good standing with its home 
country's financial regulatory authority.
3. Membership Standards
    Section 17A(b)(4)(B) of the Exchange Act contemplates that a 
registered clearing agency have financial responsibility, operational 
capability, experience, and competency standards that are used to 
accept, deny, or condition participation of any participant or any 
category of participants, but that these criteria may not be used to 
unfairly discriminate among participants. The Standards Release states 
that a clearing agency may discriminate among persons in the admission 
to or the use of the clearing agency if such discrimination is based on 
standards of financial responsibility, operational capability, 
experience, and competence.
    EMCC's board or the membership and risk committee of the board may 
approve an application to become a member upon a determination that 
such applicant meets the applicable admission criteria. The applicant 
must have adequate personnel, physical facilities, books and records, 
accounting systems, and internal procedures to enable it to 
satisfactorily handle transactions and communicate with EMCC, to 
fulfill anticipated commitments to and meet the operational 
requirements of EMCC with necessary promptness and accuracy, and to 
conform to any condition and requirement that EMCC reasonably deems 
necessary for its protection or that of its members.
    The applicant must have an established business history of a 
minimum of three years or personnel with sufficient operational 
background and experience to ensure, in the judgment of the board, the 
ability of the firm to conduct its business. The applicant must agree 
to make and have sufficient financial ability to make all anticipated 
payments required to be made to EMCC. The applicant must be in 
compliance with the capital requirements imposed by its designated 
examining authority or appropriate regulatory agency, any other self-
regulatory organizations, and any other regulatory authority or self-
regulatory authority to which it is subject by statute, regulation, or 
agreement. The applicant cannot be subject to a statutory 
disqualification as defined in Section 3(a)(39) of the Exchange Act 
\36\ or similar order. EMCC may deny an application if it has 
reasonable grounds to believe that the applicant or any associated 
person meets a disqualification criteria specified in EMCC's rules.\37\
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    \36\ 15 U.S.C. 78c(a)(39).
    \37\ For example, disqualification criteria will include closer 
than normal surveillance by the applicant's designated examining 
authority or appropriate regulatory agency, violations of the 
federal securities laws, convictions of any criminal offense 
involving securities transactions, or any injunction against 
engaging in securities transactions. In addition, if the applicant 
has been enjoined from engaging in securities related business or 
has been expelled from a self-regulatory organization, EMCC must 
deny the application.
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    If the applicant is a U.S. broker or dealer, its aggregate 
indebtedness/excess net capital ratio must be less than 950%, or its 
excess net capital/aggregate debit items ratio must be in excess of 
5.25% and its excess net capital must equal at least $100 million. If 
the applicant is a U.K. broker or dealer, its financial resources must 
be at least 120% of its financial resources requirement and its excess 
financial resources must equal at least $100 million. However, a broker 
or dealer applicant may have excess regulatory capital of at least $50 
million if the membership and risk committee of EMCC's board of 
directors makes a written finding that other credit factors of the 
applicant compensate for the lower financial resources.\38\
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    \38\ EMCC will consider any ratings assigned by a nationally 
recognized statistical rating organization, any significant adverse 
off-balance sheet items, and the applicant's significant business 
lines as compared to its internal risk management controls and short 
term funding arrangements.
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    In addition, if the applicant is a bank, it must have net worth as 
of the end of the quarter prior to the effective date of its membership 
determined in accordance with U.S. GAAP of at least $500 million. 
However, an applicant bank may be accepted if it has a net worth of at 
least $200 million if the membership and risk committee of EMCC's board 
of directors makes a written finding that other credit factors of the 
applicant compensate for the lower net worth.\39\
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    \39\ In making such determination, EMCC will consider the 
applicant's return on average assets, capital to total assets ratio, 
nonperforming assets to total assets ratio, and liquid assets to 
total assets ratio. EMCC will also consider the ratings assigned to 
the applicant by a nationally recognized statistical rating 
organization, any significant off-balance sheet items, and the 
applicant's risk management controls.

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[[Page 8716]]

    If a U.S. broker applicant is applying to become a broker member, 
it must have excess net capital of at least $10 million and must agree 
to submit trading data to EMCC in such instruments as requested by 
EMCC. EMCC will determine the broker's potential margin calls, and the 
broker must demonstrate an ability to meet such margin calls and any 
loss allocation assessments. The broker can demonstrate this ability by 
agreeing to submit to EMCC only transactions with EMCC members on both 
sides and by demonstrating a low error rate.\40\
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    \40\ If a broker has a margin obligation because one of its 
counterparties fails to submit data on a trade prior to 8:00 a.m. ET 
on T+1, the nonsubmitting counterparty must compensate the broker 
for the cost of financing the payment obligation and may be subject 
to fine by EMCC.
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    During the first six months of EMCC's operations, EMCC will permit 
a broker to become an EMCC member which cannot demonstrate its ability 
to meet potential margin calls if it meets an alternate criterion. Such 
applicant must maintain a clearing relationship with an EMCC member 
which is not a broker. Pursuant to the clearing relationship, the 
clearing firm must take the place of the broker on T+1 for all trades 
that do not have EMCC members on both sides. The broker will have a 
fixed clearing fund deposit in lieu of the required margin deposit. 
However, EMCC will calculate each day for such broker a preliminary and 
final required fund deposit excluding any positions that resulted from 
a systems failure of a counterparty resulting in a failure to submit 
trade data. If the required fund deposit exceeds the broker's fixed 
deposit, EMCC will not guarantee any transactions to the broker until 
its required fund deposit is equal to or lower than its fixed 
deposit.\41\ However, EMCC will guarantee completion of the broker's 
trades to the original EMCC counterparties pursuant to the loss 
allocation rules relating to a broker's default.\42\ In addition, if 
the broker's required fund deposit exceeds its fixed deposit, the 
broker will not be subject to assessment for loss allocations \43\ and 
the broker will be charged a market rate of interest on the difference 
between its required fund deposit and its fixed deposit. EMCC will 
notify all dealer members whenever a broker's required fund deposit 
exceeds its fixed deposit.
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    \41\ The broker could lower its required fund deposit by 
depositing additional funds with EMCC. If it does not deposit 
additional funds, its required fund deposit will exceed its fixed 
deposit until at least the end of the next month (because its 
required fund deposit its based on the highest margin calculation 
during the current month and the prior month).
    \42\ Because EMCC is not guaranteeing trades to the broker, if a 
dealer counterparty becomes insolvent, the broker is responsible for 
completing the trade to its counterparty on the other side. As a 
result, the nondefaulting EMCC dealer member does not receive the 
benefit of EMCC's guarantee of brokered trades. In such a situation, 
if the broker is then unable to complete the trade, EMCC will then 
guarantee the broker's trade to its EMCC member counterparty. 
However, the trade is treated as a direct trade between the broker 
and its counterparty. Thus, under the loss allocation rules, the 
dealer would be allocated a greater portion of its loss than if the 
broker had not exceeded its fixed deposit requirement.
    \43\ Because EMCC is not guaranteeing trades to the broker, 
there would be no loss from direct trades entered into with the 
broker.
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    The foregoing financial responsibility standards are minimum 
requirements, and EMCC's board may impose higher standards based upon 
the level of the anticipated positions and obligations of an applicant, 
the anticipated risk associated with the volume and types of 
transactions an applicant proposes to process through EMCC, and the 
overall financial condition of an applicant. If an applicant does not 
itself satisfy its capital requirements, the board may include for such 
purposes the capital of an affiliate of the applicant if the affiliate 
has delivered to EMCC a guaranty, satisfactory in form and substance to 
the board, of the obligations of the applicant to EMCC.
4. Membership Agreement
    Each applicant to become a member of EMCC will be required to sign 
a membership agreement pursuant to which the member's books and records 
must at all times be open to inspection by EMCC and the member must 
furnish EMCC with any information with respect to the member's business 
and transactions as EMCC may require. However, upon ceasing to be a 
member, EMCC cannot inspect a member's books and records or require 
information relating to transactions that occurred after the time the 
member ceased to be a member.
    Membership in EMCC and use of EMCC's services are governed by the 
laws of the state of New York. Each member must agree to submit to the 
jurisdiction of the courts of the state of New York and the U.S. 
District Court for the Southern District of New York and to appoint a 
person acceptable to EMCC as its agent to receive on its behalf service 
of process. Each member must also agree that any judgment obtained in 
an action or proceeding may be enforced in the courts of any 
jurisdiction where the member or any of its property may be found, and 
the member must irrevocably submit to the jurisdiction of each such 
court with respect to any such action or proceeding. To the fullest 
extent permitted by law, each member must waive all immunity whether on 
the basis of sovereignty or otherwise from jurisdiction, attachment 
both before and after judgment, and execution to which it might 
otherwise be entitled in any action or proceeding in any county or 
jurisdiction relating in any way to the agreement or to any 
transaction.
    The membership agreement also provides EMCC with an additional 
source of information for risk control purposes. Upon the request of 
and at no charge to EMCC, members must provide research that they 
provide to any of their customers relating to EMCC eligible instruments 
and events or conditions which might affect the price of EMCC eligible 
instruments.
5. Compliance With the Statutory Membership Requirements
    The Commission notes that EMCC's rules do not provide for the 
admission of certain of the statutory categories of members (e.g., 
registered investment companies).\44\ The Commission believes that 
EMCC's provision for limited categories of members is appropriate at 
least during EMCC's initial phases of operations. The Commission also 
notes that during the comment period, EMCC did not receive any comments 
from anyone in the category of entities not covered by EMCC's rules. 
Therefore, the Commission is granting EMCC a temporary exemption from 
Section 17A(b)(3)(B) of the Exchange Act with respect to this 
requirement.
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    \44\ Supra note 32.
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    EMCC's rules also make certain categories of entities eligible for 
EMCC services that are not within the statutory categories (i.e., non-
U.S. banks and U.K. broker-dealers).\45\ As discussed in the Standards 
Release, clearing agencies may admit additional categories of members 
provided that the goals of safety and soundness are met. The Commission 
believes that the admission criteria EMCC has established for non-U.S. 
banks and U.K. broker-dealers are consistent with the goals of safety 
and soundness. As discussed above, EMCC will obtain legal opinions from 
foreign members to assure that EMCC will be able to enforce its rules 
and member's agreement. In addition, EMCC will obtain information from 
the participant regarding its regulatory status in its home country and 
will obtain copies of all regulatory filings made in its home

[[Page 8717]]

country. Thus, the Commission believes that EMCC's current procedures 
for acceptance of non-U.S. participants are consistent with the goals 
of the Exchange Act.
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    \45\ EMCC's admission criteria for non-U.S. entities initially 
will apply only to non-U.S. banks and U.K. broker-dealers.
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C. 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. This section contemplates that users of a clearing 
agency have a significant voice in the direction of the affairs of the 
clearing agency.
1. Governance Procedures
    EMCC's board has a total of 21 directors, divided into four 
classes. The first three classes consist of five directors each 
(``participant directors'').\46\ The fourth class has six directors, 
consisting of one director selected by EMTA, one director selected by 
ISMA, two directors selected by NSCC, and two directors selected by 
EMCC. The term of office of the participant directors is three years 
with the term of one class of directors expiring each year.\47\ 
Participant directors may not serve for more than six consecutive 
years. The term of the fourth class is one year.
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    \46\ A member along with any of its affiliates which are members 
may only have one representative sitting on the board.
    \47\ The term of the initial directors in class one will expire 
in 1998, the term of the initial directors in class two will expire 
in 1999, and the term of the initial directors in class three will 
expire in 2000.
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    A nominating committee selected by the board will select 
individuals to serve as participant directors. Members may also 
nominate individuals to serve as participant directors by filing with 
EMCC's Secretary at least 30 days prior to the date of the annual 
meeting a petition signed by the lesser of five percent of the 
participants of ten participants. If any member files a petition for 
participant director, EMCC's Secretary will mail ballots to all 
members. Members will then be provided the opportunity to vote for 
participant directors.\48\
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    \48\ Members will have three votes for each $1.00 of average 
clearing fund deposits during the twelve month period ending on the 
last day of the second month prior to the date of determination and 
two votes for each $1.00 of the average monthly fee payable or paid 
by the member to EMCC during the same twelve month period.
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    Because members are given an opportunity both to nominate board 
members and to vote in any contested election, members should have a 
meaningful voice in the governance of EMCC. Therefore, the Commission 
believes that EMCC's election procedures provide fair representation to 
its members.
2. Provision of Information to Participants
    The Standard Release states that participants should have 
sufficient information concerning a clearing agency's affairs to 
participate meaningfully in its administration. Clearing agencies 
should furnish participants with audited annual financial statements, 
an annual report on internal accounting control prepared by an 
independent public accountant, and notices of any proposed rule 
changes.
    The Standards Release states that the annual financial statements 
should be provided to participants within 60 days following the close 
of the clearing agency's fiscal year and should be prepared in 
accordance with generally accepted accounting principles. The Standards 
Release also states that the report on internal accounting control 
should be furnished to all participants promptly after it becomes 
available and no later than 60 days after the period covered by the 
report.\49\ The Standards Release also states that a notice of a 
proposed rule change should be provided to participants prior to or as 
soon as possible after filing with the Commission and should provide a 
description of the rule change, its purpose, and its effect. After 
review of EMCC's rules and procedures, the Commission finds that such 
rules and procedures are consistent with EMCC's obligations to provide 
information to its participants.
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    \49\ The Standards Release also states that the report on 
internal accounting control should be based on a study and an 
evaluation which was made for the purpose of reporting on the 
clearing agency's overall system of internal accounting control and 
should disclose any material weaknesses discovered and any 
corrective action taken or proposed to be taken. The Commission 
expects EMCC to prepare its reports in accordance with these 
principles.
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D. Safety and Soundness Considerations

    Sections 17A(b)(3)(A) and (F) of the Exchange Act require that a 
clearing agency be organized and its rules be designed to facilitate 
the prompt and accurate clearance and settlement of securities 
transactions for which it is responsible and to safeguard securities 
and funds in its custody or control or for which it is responsible.\50\ 
In the Standards Release, the Division enumerated certain requirements 
that should be met to comply with this standard.
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    \50\ 15 U.S.C. 78q-1(b)(3)(A) and (F).
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1. Clearing Fund
    The Standards Release states that a clearing agency should have a 
clearing fund which is based on a formula applicable to all users and 
is composed of cash or highly liquid securities. The rules of a 
clearing agency should limit the investments that can be made with the 
cash portion of its clearing fund to government securities or other 
safe and liquid investments. The clearing fund should only be used to 
protect participants and the clearing agency from defaults of 
participants and from clearing agency losses not resulting from day to 
day expenses and not covered by insurance or other resources of the 
clearing agency. While the Standards Release states that a clearing 
agency could use temporary applications of the clearing fund in limited 
amounts to meet unexpected and unusual requirements for funds, the 
regular or substantial use of a clearing fund for operational purposes 
would be inappropriate.\51\
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    \51\ The Standards Release also states that there may be 
legitimate purposes for which a clearing fund may be used for a 
longer period of time so long as (a) the funds are properly 
protected, (b) the funds are used to facilitate the process of 
clearance and settlement, and (c) the participants and the 
Commission approve such use during the registration proceedings.
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a. Clearing Fund Formula
    EMCC will maintain and will manage a clearing fund for the purpose 
of limiting or eliminating EMCC's exposure to loss in the event a 
member fails to perform its obligations to EMCC. Each member will be 
obligated to make deposits to EMCC's clearing fund. EMCC will set the 
initial required clearing fund deposit for each member based on the 
expected nature and level of the member's activity. A member's required 
margin deposit will be equal to the largest single final daily margin 
amount computed, as described below, for that member for the month 
during which such margin calculation is being performed and for the 
previous calendar month. The minimum required clearing fund deposit for 
each member will be U.S. $1,000,000.
    Every day, EMCC will calculate margin in the morning and in the 
evening but will only collect margin based on the morning 
calculation.\52\ EMCC will generally calculate the margin amount as 
follows: (mark-to-

[[Page 8718]]

 market amount + volatility amount)  x  event risk factor.\53\
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    \52\ EMCC refers to the amount that each member must contribute 
to the clearing fund as its margin requirement.
    \53\ EMCC has provided the results of a stress test in which the 
proposed formula was applied using three months of data on EMCC 
eligible transactions obtained from Match-EM. The test assumed for 
each member that the market in which such member had its highest 
concentration of positions experienced an abnormal negative market 
move (i.e., the ``stressed market''). All securities positions for 
that member in other countries were run under the baseline 
assumptions of no unusual market movements. The tests assumed first 
a 10 standard deviation market drop in the stressed market and 
second a 4 standard deviation market gain in the stressed market. 
The test assumed that bonds on the opposite sides of the stressed 
market had correlations of 80% while bonds on the same side of the 
stressed market had 100% correlation.
    Under this test, EMCC had no exposure 73.64% of the time. EMCC 
had exposure between $1 and $1 million 9.18% of the time. EMCC had 
exposure of greater than $10 million 1.7% of the time. The highest 
exposures were four occurrences of an exposure of approximately $15 
million and one exposure of approximately $50 million. EMCC has 
represented that it will continue to conduct periodic stress testing 
on a quarterly basis. Results of the stress tests will be reviewed 
with the membership and risk committee of EMCC's board of directors, 
and EMCC will reconsider the event risk factor if warranted by the 
results of the stress tests. The Commission directs EMCC to make the 
results available to Commission staff periodically. For example, 
EMCC is currently conducting stress testing based on data from 
trading during the week of October 27, 1997, a volatile period for 
the Brady bond markets. EMCC has stated that it will provide the 
Commission with the results of this testing.
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    The mark-to-market amount will be based on all trades due to settle 
on or after that day and all fails, unless EMCC has received notice 
from the depository that such trade or fail has settled.\54\ The mark-
to-market amount will be based on the difference between the market 
price and the contract value of the trade. If the net mark-to-market is 
a credit, the firm will have a zero mark-to-market charge.
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    \54\ EMCC will receive notice at midnight ET (or 6:00 a.m. in 
Brussels and Luxembourg) from Euroclear and Cedel of all trades that 
have settled. At that time, Euroclear and Cedel have already 
completed most of their settlements of that day (i.e., the notice 
issued at midnight ET on Friday morning will indicate trades that 
will settle Friday at the depository). Thus, when EMCC calculates 
the margin in the morning and the evening, it will have received 
notice of which trades have settled or failed for the day.
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    The volatility amount for the evening calculation will be based on 
all trades due to settle on or after that day and all fails, unless 
EMCC has received notice from the depository that such trade or fail 
has settled.\55\ The volatility amount for the morning calculation will 
be based on all trades due to settle on or after the current day and 
all fails calculated as of the prior day whether or not EMCC has 
received notice of the settlement of such trades or fails. Thus, the 
morning volatility amount will include trades that have already settled 
that day while the evening volatility amount will only include trades 
that have not settled.\56\ In order to calculate the volatility amount, 
each security will be placed into one of four liquidity categories 
based on the average bid/offer spread. The liquidity category into 
which a security is placed will determine the volatility formula to be 
applied to that security.\57\ The sum of the volatility amounts for 
each security will be the clearing member's volatility amount.\58\
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    \55\ Supra note 54.
    \56\ By including transactions in the morning volatility 
calculation whether or not they have settled, EMCC insures that data 
on three days of pending trades (i.e., the number of days that EMCC 
is guaranteeing) is included. At the time of the morning volatility 
calculation, the trades entered into three days before will have 
settled, but EMCC will not have received data for the trades entered 
into on the current day. Thus, by including data for trades settling 
that day, EMCC will be using three days of data. EMCC will use fails 
as of the prior day because fails as of the current day would 
include trades due to settle that day (i.e., these trades would be 
double counted as trades due to settle that day and fail trades). 
With respect to the evening volatility calculation, EMCC will have 
received data on trades entered into on that day and therefore will 
have data on three days of pending trades on which to base its 
calculation.
    \57\ The four liquidity classes and their bid/offer spreads are 
as follows: L1--\3/8\ of a point or less; L2--\3/4\ of a point or 
less; L3--2 points or less; L4--greater than 2 points or no trading 
activity for a certain period of days.
    \58\ For each L4 security, the volatility amount is the value of 
the position  x 30%. For L1, L2, and L3 securities of each issuer, 
EMCC will take the larger of the following formula with: (a) the 
member's long positions in lines 1 and 2 and short positions in 
lines 3 and 4; and (b) the member's short positions in lines 1 and 2 
and long positions in lines 3 and 4.
    1. (value of long or short L1+L2) x 2 Std plus
    2. (value of long or short L3) x 4 Std plus
    3. (value of long or short L1+L2) x 2 Std  x  CC plus
    4. (value of long or short L3) x 1 Std  x  CC
    Std is equal to a one standard deviation move over a five day 
holding period based on the higher of a calculation using price data 
for one year and three months. CC is the smallest correlation 
coefficient between any security of that issuer in which the member 
has short position and any security of that issuer in which the 
member has a long position. The correlation coefficient will be 
based on one year's pricing data and will be updated daily.
    EMCC may adjust the fixed percentage applied to L4 securities or 
the number of standard deviations applied to L1, L2, and L3 
securities without prior notice in order to increase the volatility 
calculations when warranted by circumstances. These adjustments may 
be made on a country by country basis or a bond by bond basis either 
for all members or for members unduly concentrated.
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    The event risk factor, which is designed to give EMCC an additional 
cushion against events in countries not covered by two standard 
deviations, will initially be set at 1.25. EMCC may adjust the event 
risk factor for an individual member or for all members without prior 
notice to the member(s). EMCC also will increase margin requirements by 
use of a global holiday risk factor to take into account days on which 
U.S. banks are closed but securities markets are open.
    The preliminary margin amount will be calculated each evening and 
will be reported to members at approximately 11:30 p.m. on a 
preliminary margin report. The report will show the member's current 
deposit, preliminary margin amount, and preliminary amount due, if any. 
However, members are not required to make any payment to EMCC based on 
the preliminary margin report.
    The final margin amount will be calculated each morning and will be 
reported to members at approximately 10:30 a.m. on a final margin 
report. The final margin report will indicate each member's current 
deposit, final margin amount, and final amount due, if any. A member 
will be required to pay any obligation with respect to its margin 
obligation reflected on the final margin report no later than the later 
of 11:30 a.m. ET or one hour after the final margin report is made 
available. Margin deficits of less than $100,000 will not have to be 
paid by members. Payment must be made through the U.S. Fedwire system.
    EMCC also has the authority to collect amounts over and above the 
daily margin requirement in order to obtain adequate assurances of the 
financial responsibility or operational capability of a member. EMCC 
has created a policy statement on procedures to follow in determining 
whether additional clearing fund deposits are needed.\59\ EMCC also may 
collect additional margin if a member has been placed on surveillance 
status.\60\
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    \59\ Each day, EMCC will calculate a net country position and a 
net geographical position for each member. The net country position 
will be the sum of the settlement values of the member's positions 
in L1, L2, and L3 securities plus the sum of the absolute settlement 
values of the member's net position in L4 securities of each 
country. The net geographical position will be the sum of the net 
country positions in Latin America, Eastern Europe, Asia, and 
Africa. An undue concentration will be deemed to exist for a bank 
when its net country position exceeds 20% of net worth or its net 
geographical position exceeds 30% of net worth. An undue 
concentration will be deemed to exist for a broker-dealer when its 
net country position exceeds 50% of excess regulatory capital or its 
net geographical position exceeds 80% of excess regulatory capital. 
Under such circumstances, EMCC will contact the member to request 
information on the nature and magnitude of non-Brady bond exposure 
and on any hedging positions. After analyzing a member's responses, 
EMCC may request additional clearing fund deposits if it determines 
an additional deposit is necessary.
    \60\ EMCC will put a member on surveillance status if any of the 
following factors are present: (a) the member fails to meet any 
financial standard for admission or continuance as a member; (b) the 
member's capital position falls below the standards for admission; 
(c) the member experiences an inability to meet its money or 
securities settlement obligations to EMCC; (d) EMCC's board 
determines that a significant reorganization, change in control, or 
management of the member is likely to impair the member's ability to 
meet its money or securities settlement obligations to EMCC; or (e) 
the member has been placed on surveillance status by another self-
regulatory organization or comparable regulatory organization. EMCC 
also will have the discretion to put a member on surveillance status 
if any of the following factors are present: (a) it experiences a 
significant operational problem; (b) the member's positions are 
significantly disproportionate to its usual activity in light of 
current industry conditions; (c) EMCC receives notification from the 
member's designated examining authority or appropriate regulatory 
agency or comparable regulatory organization of a pending 
investigation or administrative action that could call into question 
the member's ability to meet its obligations to EMCC; or (d) the 
member experiences any condition that could materially affect its 
financial or operational capability so as to potentially increase 
EMCC's exposure to loss or liability.

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[[Page 8719]]

    The Commission preliminarily believes that EMCC's method of 
calculating clearing fund requirements is consistent with its 
obligations to safeguard securities and funds. The Commission will to 
review the results form EMCC's future stress tests. Prior to any grant 
of permanent registration as a clearing agency, the Commission will 
reevaluate EMCC's clearing fund formula.
b. Margin Composition and Investment
    Members will be required to pay margin in cash, U.S. Treasury 
securities, or letters of credit from banks that have been approved by 
EMCC. If letters of credit are used as margin, no more than 70% of a 
member's requirement may be satisfied with letters of credit, and as a 
minimum, the greater of $100,000 or 10% of the member's margin 
requirement (up to a maximum of $1,000,000) must be in cash. 
Furthermore, no more than 20% of EMCC's total clearing fund may be 
letters of credit from any one issuer. If letters of credit are not 
used, the greater of $100,000 or 5% of the member's margin requirement 
(up to a maximum of $1,000,000) must be in cash. A haircut of 5% will 
be applied to letters of credit and treasury securities.
    Pursuant to EMCC's rules, EMCC may invest any cash deposited as 
margin in securities issued or guaranteed as to principal or interest 
by the U.S. or agencies or instrumentalities of the U.S. (``government 
securities''), repurchase agreements related to such securities, or 
otherwise pursuant to the investment policy adopted by EMCC. As part of 
its application, EMCC has filed a copy of its investment policy.\61\ 
EMCC's investment policy provides that EMCC clearing fund cash may be 
invested only in government securities with terms of one year or less 
or in overnight repurchase agreements with government securities as 
underlying collateral. The repurchase agreements must conform to 
certain standards set forth in the investment policy regarding custody 
and market value of the collateral and eligible counterparty. If not 
invested, cash funds will be deposited by EMCC in its name in a 
depository institution selected by EMCC. EMCC will retain all 
investment income from cash deposits.
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    \61\ If EMCC amends its investment policy, it will file a 
proposed rule change with the Commission.
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    The Commission believes that EMCC's investment policy and required 
margin composition are consistent with EMCC's obligations under the 
Exchange Act as explained in the Standards Release because they require 
that EMCC's clearing fund is composed of liquid securities and that the 
cash portion of the clearing fund is invested appropriately.
c. Loss Allocation
    EMCC will establish an overnight exposure cap for each member. This 
cap will be set at the lesser of: (a) 5% of excess net capital for U.S. 
broker-dealers, 5% of excess financial resources for U.K. broker-
dealers, and 1% of shareholders' equity for banks; or (b) $20 million. 
If a member's preliminary margin calculation is in excess of its 
overnight exposure cap, the member will be subject to fines. The loss 
allocation method applied to trades of an insolvent member will be 
dependent open whether a defaulting member has exceeded its overnight 
exposure cap.
    When a failed member is not a broker, EMCC will classify trades as 
brokered or direct.\62\ If there was an overnight exposure cap 
violation, EMCC will further classify such trades as trades received by 
EMCC before the violation (``old trades'') or trades received by EMCC 
after the violation (``new trades''). Any collateral of the defaulting 
member will be divided between direct trades and brokered trades in 
proportion to the amount of losses attributable to old trades in each 
category. If there is insufficient collateral to cover all of the 
losses attributable to old trades: (a) Losses attributable to brokered 
transactions that are old trades will be allocated pro rata among all 
members based upon each member's average final daily margin amount for 
the prior 30 calendar days; \63\ and (b) losses attributable to direct 
transactions that are old trades will be allocated among all the 
original counterparties in proportion to the amount of losses created 
by each member's transactions.
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    \62\ If the failed member's counterparty was an interdealer 
broker, but the interdealer broker's counterparty on the other side 
was not an EMCC member, EMCC will consider the trade to be a direct 
trade between the insolvent and the interdealer broker. In other 
words, ``brokered trades'' are trades where the interdealer broker 
is an EMCC member and EMCC members are on both sides.
    \63\ A member that is assessed pursuant to this provision may 
limit its assessment to its current margin requirement if it chooses 
to terminate its membership.
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    After the losses from old trades have been satisfied, EMCC will 
determine if any clearing fund collateral of the defaulting member 
remains. EMCC will net new trades to obtain a net loss per security 
issue. Any remaining clearing fund of the defaulting member will be 
applied to the smallest loss, then the next remaining smallest loss 
until there is no remaining clearing fund of the defaulting member. 
Next, EMCC will take the smallest remaining losses up to an amount that 
equals the amount of the defaulting member's overnight exposure cap 
(``under the cap losses'') and will allocate the under the cap losses 
as follows: (a) Losses attributable to direct transactions will be 
allocated back to the original counterparties in an amount equal to the 
losses attributable to each member's trades; and (b) losses 
attributable to brokered transactions will be allocated pro rata among 
all EMCC members based upon each member's final daily margin amount 
calculated with respect to the prior 30 calendar days. Any remaining 
losses attributable to new trades will be allocated as follows: (a) 
Losses attributable to direct transactions will be allocated back to 
the original counterparties in an amount equal to the losses 
attributable to each member's trades; and (b) losses attributable to 
brokered transactions will be allocated first to the broker members 
that were counterparties to the trades to the extent of the loss 
attributable to each trade up to a maximum allocation of $3 million per 
broker and then pro rata among members that were counterparties to 
brokers that reach their maximum allocation and that were on the 
opposite side of the market in the same security issues creating a loss 
with the same settlement dates and approximately the same prices.
    Different loss allocation rules will apply when the defaulting 
member is a broker. In such cases, any collateral of the defaulting 
member will be applied first to losses resulting from old trades. If 
there are remaining losses from old trades, such losses will be 
allocated among all the original counterparties in proportion to the 
amount of loss created by each member's transactions. EMCC then will 
net new trades to obtain a net loss per security issue. Any remaining 
clearing fund of the defaulting member will be applied to the smallest 
loss, then

[[Page 8720]]

the next remaining smallest loss until there is no remaining clearing 
fund. Any remaining loss after application of clearing fund will be 
allocated to the counterparties to the transactions giving rise to such 
loss to the extent of the loss attributable to such transactions.
d. Use of Clearing Fund
    EMCC's rules provide that the use of clearing fund deposits is 
limited to: (a) Satisfaction of losses or liabilities of EMCC arising 
from the failure of a member to satisfy an obligation to EMCC, or (b) 
providing EMCC with a source of collateral: (i) To finance the 
temporary receipt by EMCC of EMCC eligible instruments that cannot be 
redelivered to a member due to the inability of the member to pay for 
the receipt but only if such inability constitutes the failure by the 
member to meet its securities settlement obligations to EMCC; (ii) to 
finance only on an intraday basis the receipt of EMCC eligible 
instruments that will be redelivered to another member at a depository, 
provided that no more than 10% of the total clearing fund may be used 
for this purpose and that eligible letters of credit will be used to 
the maximum extent practicable prior to the use of treasury securities, 
and that cash will not be used; \64\ and (iii) to temporarily finance 
the amount of any loss or liability allocated to a member prior to such 
time as such member's actual clearing fund is applied to the loss. If 
EMCC pledges any part of the clearing fund deposits for more than 60 
days as a source of temporary financing, EMCC will by the 74th day 
consider such amount to be a loss and will allocate such loss in 
accordance with the loss allocation rules.
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    \64\ This provision will automatically expire the earlier of the 
first anniversary of EMCC's commencement of operations or the date 
on which EMCC begins its netting service.
---------------------------------------------------------------------------

    The Commission believes that EMCC's uses of clearing fund to 
satisfy losses or to finance settlements related to the failure of a 
member is consistent with the Exchange Act and the Standards Release. 
As a general rule, the Commission believes that procedures permitting 
the routine use of clearing fund assets to finance on a daily basis the 
receipt of instruments in the normal settlement process is not 
consistent with the Exchange Act or the guidelines set forth in the 
Standards Release. However, the Commission believes that the 
limitations EMCC has established on its use of assets for the routine, 
daily financing of security receipts (i.e., intraday financing, 10% 
limitation, and use of letters of credit first to the extent possible) 
and the limited purpose for which EMCC intends to use the clearing fund 
collateral (i.e., to collateralize a line of credit at Euroclear to 
permit ``chaining'' \65\), are reasonably designed and should not cause 
undue risk to EMCC. The intraday financing procedures will allow EMCC 
to collateralize its line of credit at Euroclear, which is needed to 
allow EMCC to conduct its business effectively and efficiently, while 
still providing adequate protection to the assets of its clearing fund. 
Therefore, the Commission is granting EMCC a temporary exemption from 
Sections 17A(b)(3)(A) and 17A(b)(3)(F) of the Exchange Act to permit 
EMCC to use a portion of its clearing fund as described in (ii) above 
until the earlier of one year after EMCC has commenced operations or 
the date on which EMCC begins its netting service.\66\
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    \65\ See supra note 23.
    \66\ When EMCC institutes netting, the need for repeated use of 
the clearing fund to facilitate chaining will be greatly reduced.
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2. Standard of Care
    The Division stated in the Standards Release that the rules of a 
clearing agency should provide that it is liable to a participant for 
failure to deliver the participant's securities resulting from: (1) The 
negligence or misconduct of the clearing agency, the clearing agency's 
subcustodian or agent, or any of their respective employees; (2) the 
placement on fully-paid participant securities of a lien or charge of 
any kind in favor of the clearing agency, the clearing agency's 
subcustodian or agent, or any person claiming through any one or more 
of them; (3) larceny; (4) mysterious disappearance; or (5) any other 
cause for which the clearing agency has assumed responsibility. 
Subsequent to issuance of the Standards Release, the Commission has 
stated that clearing agencies should perform their functions under a 
high standard of care and that at a minimum custody functions should be 
performed under an ordinary negligence standard.\67\ The Commission has 
also stated that custody functions include all functions related to 
transaction processing and the safekeeping of customer funds and 
securities.\68\
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    \67\ Securities Exchange Act Release Nos. 26154 (October 3, 
1988), 53 FR 39556 (registration order of The Intermarket Clearing 
Corporation [``ICC'']); 26450 (January 12, 1989), 54 FR 2010 
(registration order of the Delta Government Options Corp. 
[``DGOC'']); 26812 (May 12, 1989), 54 FR 21691 (registration order 
of ISCC); and 27611 (January 12, 1990), 55 FR 1890 (second 
registration order of DGOC).
    \68\ See, e.g., ICC registration order, supra note 67.
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    The member's agreement between EMCC and each member provides that 
EMCC is not subject to any liability under the agreement, including any 
liability with respect to EMCC's failure to provide any services under 
the agreement or EMCC's rules, except for losses resulting from EMCC's 
gross negligence, criminal act, or willful misconduct in connection 
with its duties. However, with respect to the safeguarding of 
securities or funds within its custody or control, the member's 
agreement provides that EMCC is not be subject to any liability for any 
act or omission in connection with the safeguarding of securities or 
funds within its custody or control except for losses, costs, or 
expenses resulting from EMCC's negligence, criminal act, or willful 
misconduct. The agreement further provides that EMCC will not be liable 
for any consequential or special damages which may result from EMCC's 
failure to perform its obligations under the agreement.
    The Commission believes that EMCC's standard of care is consistent 
with the Exchange Act and prior Commission positions. However, the 
Commission preliminarily believes that a clearing agency should accept 
some responsibility for damages that are foreseeable and related to 
securities settlement (e.g., damages resulting from a buy-in or sell-
out conducted as a result of EMCC's negligence in delivering or not 
delivering funds or securities). At this time, the Commission is 
temporarily registering EMCC as a clearing agency but intends to review 
this issue further.
3. Operational Capacity
    Pursuant to a service agreement, ISCC has agreed to perform 
services for EMCC with respect to EMCC's clearing agency activities. 
ISCC will furnish the services for a fee designed to cover ISCC's 
costs. ISCC will provide EMCC with technical services in the following 
areas: data processing, operations, planning and development, 
communications, and research and development. Currently, ISCC provides 
limited clearing agency services and has seven employees whose duties 
are generally limited to operational functions.
    Pursuant to its service agreement, ISCC may use outside parties to 
fulfill its commitments to EMCC. Many of ISCC's functions will be 
performed by NSCC. Specifically, NSCC through ISCC will provide EMCC 
with management and administrative services in the following areas: 
financial, personnel, corporate communications, marketing, regulatory 
or compliance, and legal. The Securities Industry Automation

[[Page 8721]]

Corporation (``SIAC''),\69\ through ISCC and NSCC, also will provide 
EMCC with clerical and data processing services. In addition, ISCC will 
rely on International Depository & Clearing, L.L.C. (``IDC'') \70\ for 
product development, marketing and sales, and planning functions.
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    \69\ SIAC is owned by the New York Stock Exchange and the 
American Stock Exchange.
    \70\ IDC is a company equally owned by NSCC and The Depository 
Trust Company, both registered clearing agencies. However, IDC is 
not a regulated entity.
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    As discussed above, EMCC has no independent capacity to match 
trades. Instead, it will rely on Match-EM and TRAX for such services. 
EMCC has verified that its board of directors has authorized the 
selection of Match-EM and TRAX after review of information describing 
these entities' operations and capacity testing.\71\ Furthermore, EMCC 
has represented that Match-EM and TRAX have procedures in place 
relating to capacity planning and systems testing, and that EMCC will 
receive and will furnish to the Commission documentation relating to 
such areas.
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    \71\ Copies of the materials that EMCC's board of directors 
relied on were filed with the Commission as part of EMCC's 
application.
---------------------------------------------------------------------------

    While EMCC's operational structure will be unusual for a clearing 
agency, the Commission believes that its structure and operational 
arrangements will provide an adequate level of service. The Commission 
notes in particular that EMCC's core functions, such as its managerial 
functions, will not be performed by an unregistered entity. The 
Commission will monitor EMCC's operation during the term of its 
temporary registration and will review its structure and outsourcing 
arrangements prior to granting permanent registration.
4. Audit Committee and Internal Audit Department
    The Standards Release states that each clearing agency should have 
an audit committee composed of nonmanagement directors. A nonmanagement 
director is a director who is not associated with the clearing agency 
other than in a user capacity or with any entity which furnishes 
securities processing services to the clearing agency. The audit 
committee should have responsibility for reviewing the work performed 
by the clearing agency's independent public accountant.
    EMCC's bylaws provide that the board of directors may appoint an 
audit committee consisting of three or more directors other than 
directors that are members of Class IV (i.e., directors elected by 
EMTA, ISMA, or NSCC), or are officers of EMCC. The audit committee has 
responsibility for reviewing with the independent certified public 
accountant the scope of its auditing procedures and the financial 
statements of EMCC to be certified by the accountant.
    The Standards Release also states that a clearing agency should 
have an internal audit department which is adequately staffed with 
qualified personnel. The internal audit committee should report 
periodically to the audit committee. NSCC's internal audit department 
will perform EMCC's internal auditing functions. The audit department 
reports directly to EMCC's audit committee. Accordingly, with regard to 
internal audits, the Commission believes that EMCC fulfills the 
Exchange Act's requirements.
5. Securities, Funds, and Data Controls
    The Standards Release provides that a clearing agency should have, 
among other things, off-site storage of back-up data, written 
procedures detailing steps involved in handling funds and securities, 
and emergency mechanisms for establishing and maintaining 
communications with participants and other entities. In addition, 
clearing agencies should have adequate insurance coverage.
    EMCC has represented that through its facilities manager, SIAC, it 
has access to two computer sites in different locations, both of which 
are capable of being operated independently and are capable of handling 
total member activity. Data received will be automatically written to 
both sites. EMCC has provided a detailed written statement of security 
measures that will be used to prevent unauthorized access to EMCC's 
processing facilities. EMCC maintains blanket bond insurance and all 
risk insurance.
    The Standards Release emphasizes that a clearing agency should 
assure the integrity and accuracy of its automatic data processing 
operations. More recently, the Commission has issued automation review 
guidelines for clearing agencies that provide a more specific outline 
of clearing agencies' obligations with respect to such things as 
capacity planning, contingency planning, data security, 
telecommunications, systems development, and internal/external 
audit.\72\ EMCC has acknowledged that it has obligations with respect 
to capacity planning and systems testing under these guidelines and has 
represented that it will fulfill its responsibilities with respect to 
these obligations.\73\
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    \72\ Securities Exchange Act Release Nos. 27445 (November 16, 
1989), 54 FR 48703 and 29185 (May 9, 1991), 56 FR 22490; and 
Memorandum from Division of Market Regulation to all registered 
clearing agencies regarding Development of an Automation Review 
Policy Statement For Clearing Agencies (April 25, 1994). Available 
for copying and inspection in the Commission's Public Reference 
Room.
    \73\ As discussed above in Section III.D.3., EMCC has 
represented to the Commission that March-EM and TRAX will provide to 
EMCC information in these areas and that EMCC will provide the 
information to the Commission.
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    The Commission has also been monitoring efforts within the industry 
to prepare computer systems for the Year 2000 date change.\74\ EMCC has 
represented that it is Year 2000 compliant and will take appropriate 
actions to ensure that the parties with which it conducts business 
(e.g., vendors, and members) will be Year 2000 compliant on a timely 
basis.\75\ Based on the foregoing, the Commission believes that EMCC 
has adequate controls with respect to securities, funds, and data 
processing.
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    \74\ See Report to the Congress on the Readiness of the United 
States Securities Industry and Public Companies To Meet the 
Information Processing Challenges of the Year 2000, U.S. Securities 
and Exchange Commission (June 1997).
    \75\ Letter from EMCC (October 8, 1997).
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E. Capacity To Enforce Rules

    Section 17A(b)(3)(A) of the Exchange Act provides that a clearing 
agency must be organized and have the capacity to enforce (subject to 
any rule or order of the Commission pursuant to Section 17(d) or 
19(g)(2) of the Exchange Act) compliance by its participants with the 
rules of the clearing agency. Sections 17A(b)(3)(G) and (H) require 
that the rules of a clearing agency provide that its participants shall 
be appropriately disciplined for violations of any provision of those 
rules and provide fair procedures for disciplining participants, 
denying participation in the clearing agency to any person, prohibiting 
or limiting access to the clearing agency's services, and reviewing 
summary suspensions.
1. Participant Monitoring
    EMCC's Rule 13 authorizes EMCC to examine the financial 
responsibility and operational capability of any member or applicant to 
become a member. Pursuant to Rule 13, EMCC may require a member to 
furnish EMCC with adequate assurances of its financial responsibility 
and operational capability, including additional reporting by a member 
of its financial or operational condition; increased clearing fund 
deposits; and other assurances as may be required by EMCC.

[[Page 8722]]

    EMCC also has general continuance standards that require a member 
to promptly inform EMCC in the event that it is no longer in compliance 
with any of the relevant standards for membership or has had any 
materially adverse change. The board may require additional financial 
reporting if a member no longer meets the standards for admission to 
membership; if it has violated any rule to EMCC; if it fails to satisfy 
in a timely manner any obligation to EMCC; if there is a material 
change in control or financial condition of such member; or if the 
board determines that it is necessary or advisable to protect EMCC, its 
other members, or its creditors or investors; to safeguard securities 
and funds in the custody or control of EMCC; or to promote the prompt 
and accurate processing, clearance, or settlement of securities 
transactions. The board must also make a determination as to whether 
the member should be placed on surveillance status consistent with its 
rules.\76\
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    \76\ See, supra note 60.
---------------------------------------------------------------------------

2. Ceasing to Act
    Section 17A(b)(5)(C) of the Exchange Act provides that a clearing 
agency may summarily suspend and close the accounts of a participant 
that is expelled or suspended from any self-regulatory organization; 
that is in default of any delivery of funds or securities to the 
clearing agency; or that is in such financial or operational difficulty 
that the clearing agency determines and so notifies the appropriate 
regulatory agency for such participant that such suspension and closing 
of accounts are necessary for the protection of the clearing agency, 
its participants, creditors, or investors.
    Upon providing notice to a member, EMCC may at any time cease to 
act for such member if the board of directors determines that adequate 
cause exists to do so.\77\ EMCC may cease to act either with regard to 
a particular transaction or with regard to transactions generally. EMCC 
will promptly notify all members when it ceases to act for a member. A 
member for which EMCC has ceased to act may request a hearing to review 
EMCC's decision.
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    \77\ Such cause may exist if one or more factors are found, 
including: the member has failed to perform any of its obligations 
or has failed to make any required payment to EMCC; the member is no 
longer in compliance with the admissions standards or continuance 
standards; the board has reasonable grounds to believe the member 
has been responsible for any fraudulent or dishonest conduct or 
breach of fiduciary duty or has made any material misstatement to 
EMCC in connection with its application to be a member of any EMCC 
service; the board has reasonable grounds to believe the member is 
in financial or operation difficulty; the member is in breach of any 
requirement imposed by an appropriate regulatory agency, self-
regulatory organization, or any regulatory body; the member is not 
paying its debts as they become due or is otherwise involved in a 
bankruptcy proceeding; the member is dissolved or ceases to carry on 
its business; the member contests the validity of any agreement with 
EMCC; the member fails to perform its contracts with EMCC; or the 
board has reasonable grounds to believe that ceasing to act is 
necessary either for the protection of EMCC or for any of the other 
members or to facilitate the orderly and continuous performance of 
EMCC's services. EMCC Rule 15, Section 1.
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    If certain factors are present, EMCC will treat a member as 
insolvent.\78\ EMCC will notify all members of the treatment of the 
member as insolvent. Upon a determination of insolvency, EMCC will 
immediately cease to act for such member. EMCC will delete all trades 
of that member to which EMCC's guaranty has not attached except trades 
that the board determines will promote an orderly market. EMCC will 
then close out the guaranteed trades and the trades that the board has 
determined to accept. EMCC will close out by buying in or selling out 
securities deliverable by or to the insolvent. The close out procedure 
will be completed by EMCC as promptly as practicable after EMCC has 
given notice of the treatment of the member as insolvent.
---------------------------------------------------------------------------

    \78\ Such circumstances include: the member provides notice to 
EMCC that it is insolvent; the board or any regulatory body 
determines that the member is insolvent; a court order is entered 
adjudging the member to be insolvent; the member files or consents 
to the filing of a petition seeking bankruptcy relief, the member 
makes a general assignment to its creditors; the member is 
dissolved; or a resolution is passed by the member that it be wound 
up, liquidated, or dissolved. EMCC Rule 17, Section 1.
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3. Hearing Procedures
    Section 17A(b)(5) of the Exchange Act provides that in any 
proceeding to determine whether a participant should be denied 
participation, prohibited or limited with respect to access to the 
clearing agency's services, or disciplined, the clearing agency must 
notify the participant of the specific ground of the denial of services 
of the charges brought against the member. The clearing agency must 
provide the member with an opportunity to be heard on the grounds of 
the denial or to defend against any charges. The clearing agency must 
keep a record of the proceeding.
    A member may request a hearing by filing with EMCC a written 
request setting forth the contested action of EMCC. Within seven 
business days after filing the request or three business days in the 
case of summary action, the objecting member must provide EMCC with a 
detailed written statement setting forth the contested action and the 
basis for objection. EMCC will notify the member in writing of the date 
and place of the hearing at least five business days prior to the 
hearing.
    The hearing will be before a panel drawn from participant directors 
on the membership committee unless the contested action was taken by 
the membership committee. In such a case, the panel will be drawn from 
participant directors on the executive committee. The committee will 
select the members of the panel. The objecting members will have an 
opportunity to be heard and may be represented by counsel. The panel 
will make a decision within ten business days after conclusion of the 
hearing. Although the panel's decision is considered final, the board 
may overturn any decision adverse to the member.
    The Commission believes that EMCC has the capacity to enforce its 
rules. EMCC has criteria to determine when its has cause to cease to 
act for a member or when it must treat a member as insolvent. A member 
for which EMCC has ceased to act or for which EMCC has limited its 
access to EMCC services may request a hearing pursuant to EMCC's rules. 
The hearing procedures are consistent with the guidelines discussed in 
the Standards Release. Therefore, the Commission believes that EMCC's 
rules in this are consistent with the Exchange Act.

F. Dues, Fees, and Charges

    Sections 17A(b)(3)(D) and (E) of the Exchange Act require that the 
rules of the clearing agency provide for the equitable allocation of 
reasonable dues, fees, and other charges among its participants and 
prohibits a clearing agency from imposing or fixing prices for services 
rendered by its participants. EMCC's proposed fee schedule is generally 
usage based. EMCC does not impose any schedule of prices or fix rates 
or other fees for services rendered by its customers. Accordingly, the 
Commission is satisfied that the method by which EMCC provides for the 
equitable allocation of reasonable dues, fees, and other charges among 
its customers and its prohibitions regarding the fixing of prices of 
its customers substantially satisfies the Exchange Act requirements.

IV. Conclusion

    The Commission finds that EMCC's application for registration as a 
clearing agency meets the standards and requirements deemed appropriate 
except as otherwise discussed in this order for which EMCC has received 
temporary exemptions.

[[Page 8723]]

    The Commission has granted EMCC partial exemptions from Section 
17A(b)(3)(B) of the Exchange Act to permit EMCC to limit the eligible 
categories of members and from Sections 17A(b)(3)(A) and 17A(b)(3)(F) 
of the Exchange Act to permit EMCC to use a portion of its clearing 
fund to collateralize a line of credit at Euroclear subject to the 
limitations discussed above. The Commission finds that granting the 
above exemptions 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 as well as 
the safeguarding of securities and funds. The Commission reserves the 
right to modify, by order (including such orders as the Commission may 
issue under Section 19(b) of the Exchange Act in connection with 
changes to EMCC's rules), the terms, scope, or conditions of the 
exemptions from the Exchange Act, if it determines such modification is 
appropriate for the protection of investors or in the public interest.
    It is therefore ordered, pursuant to Section 19(a)(1) of the 
Exchange Act, that the applications for registration as a clearing 
agency filed by EMCC (File No. 600-30) be and hereby is approved until 
August 20, 1999 and that EMCC be granted the exemptions described above 
subject to the terms, exemptions, and other qualification contained in 
this order.

    By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-4255 Filed 2-19-98; 8:45 am]
BILLING CODE 8010-01-M