[Federal Register Volume 66, Number 3 (Thursday, January 4, 2001)]
[Notices]
[Pages 819-822]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-216]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-43775; International Series Release No. 1241; File No. 
601-01]


Self-Regulatory Organizations; Morgan Guaranty Trust Company, 
Brussels Office, as Operator of the Euroclear System and Euroclear 
Bank, S.A.; Order Approving Application to Modify an Existing Exemption 
from Clearing Agency Registration

December 28, 2000.

I. Introduction

    On September 21, 2000, Morgan Guaranty Trust Company of New York, 
Brussels office (``MGT-Brussels''), as operator of the Euroclear 
System,\1\ and Euroclear Bank, S.A., (``Euroclear Bank'') filed with 
the Securities and Exchange Commission (``Commission'') an application 
on Form CA-1 \2\ to modify an existing exemption from clearing agency 
registration (``Modification Application'') pursuant to section 17A of 
the Securities Exchange Act of 1934 (``Exchange Act'') \3\ and Rule 
17Ab2-1 thereunder.\4\ The existing exemption enables MGT-Brussels as 
operator of the Euroclear System to perform the functions of a clearing 
agency with respect to transactions involving U.S. government agency 
securities for its U.S. participants subject to certain limitations 
without registering as a clearing agency.\5\ The Modification 
Application substitutes Euroclear Bank for MGT-Brussels as operator of 
the Euroclear System. Notice of the application was published in the 
Federal Register on December 1, 2000.\6\ No comment letters were 
received in response to the notice of filing of the Modification 
Application. This order grants the Modification Application.
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    \1\ MGT-Brussels presently operates the Euroclear System 
pursuant to an operating agreement with Euroclear Bank. The 
Euroclear System functions as a clearance and settlement system for 
internationally traded securities. Securities settlement through the 
Euroclear System can occur with other participants in the Euroclear 
System, with members of Clearstream, formerly Cedel Bank, societe 
anonyme, Luxembourg (``Clearstream''), or with counterparties in 
certain local markets that are not members of either the Euroclear 
System or Clearstream.
    \2\ Copies of the application for exemption are available for 
inspection and copying at the Commission's Public Reference Room.
    \3\ 15 U.S.C. 78q-1.
    \4\ 17 CFR 240.17Ab2-1.
    \5\ Securities Exchange Act Release No. 39643 (February 11, 
1998), 63 FR 8232.
    \6\ Securities Exchange Act Release No 43592 (November 17, 
2000), 65 FR 75324 (December 1, 2000).
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II. Description

    On February 11, 1998, the Commission approved an application by 
MGT-Brussels as operator of the Euroclear System for an exemption from 
registration as a clearing agency under section 17A (the ``1998 
Exemption Order''). The 1998 Exemption Order granted MGT-Brussels as 
operator of the Euroclear System the authority to provide clearance, 
settlement, and collateral management services for its U.S. 
participants' transactions in: (i) Fedwire-eligible U.S. Government 
securities; (ii) mortgage-backed pass through securities that are 
guaranteed by the Government National Mortgage Association (``GNMAs''); 
and (iii) any collateralized mortgage obligation whose underlying 
securities are Fedwire-eligible U.S. Government securities or GNMA 
guaranteed mortgage-backed pass through securities and that are 
depository eligible securities collectively (collectively ``Eligible 
U.S. Government Securities'').
    On January 1, 2000, the owners and operators \7\ decided that MGT-
Brussels would be replaced by Euroclear Bank as operator of the 
Euroclear System. In May 2000, Euroclear Bank was created. On July 27, 
2000 the Belgian Banking and Finance Commission (``BFC'') granted 
Euroclear Bank a Belgian Banking license. MGT-Brussels will continue to 
operate the Euroclear System until the changeover, which is scheduled 
to occur on December 31, 2000. At the Changeover, the business and 
related assets and liabilities of the Euroclear System will vest in and

[[Page 820]]

virtually all of the MGT-Brussels staff will be transferred to 
Euroclear Bank.
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    \7\ Copies of the application for amendment to exemption from 
registration as a clearing agency are available for inspection and 
copying at the Commission's Public Reference Room. See volume 2 of 
9, exhibit S of the application for amendment to exemption for a 
description of the change in ownership structure of the Euroclear 
System.
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    As a result of the changeover, Euroclear Clearance System Public 
Limited Company (``Euroclear PLC''), a limited liability company 
organized under the laws of the United Kingdom, will own 58.5% of 
Euroclear Bank. Calar Investments, a wholly-owned subsidiary of 
Euroclear PLC, will own 35.5% of Euroclear Bank. The remaining five 
percent of Euroclear Bank will be owned by the former members of 
Euroclear Clearance System Societe Cooperative (the ``Cooperative''), 
the predecessor of Euroclear Bank.

III. Comment Letters

    The Commission received no comment letters in response to the 
notice of filing of the Modification Application.

IV. Discussion

A. Statutory Standards

    Under section 17A(b)(1) of the Exchange Act, 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.\8\
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    \8\ 15 U.S.C. 78q-1(b)(1).
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    In granting the 1998 Exemption Order, the Commission required the 
Euroclear System to be substantial compliance with section 17A and the 
rules and regulations.\9\ Therefore, to approve the Modification 
Application, Euroclear Bank must demonstrate that the Euroclear System 
will continue to be in substantial compliance with Section 17A.
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    \9\ Section 17A(b)(3) of the Exchange Act requires that the 
Commission make a number of determinations with respect to the 
clearing agency's organization, capacity, and rules. 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. The Commission has 
published the standards applied by its Division of Market Regulation 
in evaluating applications for clearing agency registration. 
Securities Exchange Act Release No. 16900 (June 17, 1980), 45 FR 
41920 (Standards Release). These requirements are designed to assure 
the safety and soundness of the clearance and settlement system.
    The 1998 Exemption Order provided that the Commission could 
modify the terms, scope, or conditions of the exemption from 
registration if the Commission determines that the modification is 
necessary or appropriate in the public interest, for the protection 
of investors, or otherwise in furtherance of the purposes of the 
Exchange Act.
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B. Evaluation of the Modification Application

    Euroclear Bank will operate the Euroclear System in the manner 
currently operated by MGT-Brussels and employing the same personnel, 
operating systems, risk management and operating procedures as MGT-
Brussels.
1. Safety and Soundness Protections
    a. Financial Condition. Section 17A(b)(3) and (F) of the Exchange 
Act require a clearing agency to 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.\10\ The Commission believes that the Euroclear System as 
operated by Euroclear Bank will substantially satisfy this standard.
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    \10\ In the 1998 Exemptive Order the Commission relied on MGT-
Brussels' representations that its financial condition, operational 
safeguards, and the extent to which it is already subject to 
substantial U.S. regulatory oversight because Morgan Guaranty Trust 
Company of New York, the entity which is ultimately fiscally 
responsible for MGT-Brussels' operations, was a U.S. bank that was 
``well capitalized'' and ``well managed'' as those terms are defined 
under applicable U.S. Federal Banking regulations. 1998 Exemptive 
Application at 26837 and 26838.
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    Euroclear Bank's senior debt is expected to be rated at least AA by 
Fitch IBCA Limited and AA by S&P. Euroclear Bank's and Euroclear PLC's 
annual statements of financial condition will be made available to all 
shareholders and participants on a timely basis in accordance with 
local custom. The financial condition of each of the securities 
intermediaries through which it holds its positions in U.S. government 
and agency securities is similarly strong. Euroclear Bank's depositary 
bank in the United States is currently Chase Manhattan Bank. Its Tier 1 
capital ratio was 8.5% as of March 31, 2000. S&P rated Chase's most 
recent offering of Class A Notes AAA and its offering of Class B Notes 
A-.
    b. Operational Safeguards. A clearing agency must be organized in a 
manner that has established effective operational and audit controls 
while fostering director independence.\11\ Euroclear Bank's personnel, 
systems, and procedures will essentially be the same as those of MGT-
Brussels. Approximately 1300 MGT-Brussels personnel, representing all 
but 11 people in the entire MGT-Brussels workforce currently working at 
the Euroclear Operations Centre are expected to continue to be employed 
by the Euroclear Bank.
    Further Euroclear Bank will continue the following operational 
safeguards:
    (1) Euroclear Bank will have an audit committee comprised entirely 
of three to four outside directors. There will be a direct reporting 
line from the internal audit division to the audit committee as 
recommended by the Basel Committee.
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    \11\ Standards Release, supra note 9 at 45 FR 41925-26. As 
described in the 1998 Exemptive Order, the Commission was satisfied 
that MGT-Brussels' organizational and processing capacity 
substantially satisfied the Exchange Act requirements because MGT-
Brussels' internal organizational structure, including its system of 
internal and external audit, is reasonably designed to provide the 
necessary flow of information to Morgan Guaranty Trust Company of 
New York's board of directors.
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    (2) Euroclear Bank will have a separate audit division that will be 
responsible for the internal audit process.\12\
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    \12\ The internal audit process of Euroclear Bank will, like 
that of MGT-Brussels, be based on a risk assessment methodology. 
Review of the participant, product, market and service dimensions of 
the Euroclear business, including technology infrastructure, will 
continue to be considered in this risk driven approach. Internal 
audit procedures will include tests, which are designed to 
independently assess the strengths and weaknesses of Euroclear 
Bank's control environment. The audit division will determine the 
scope of its audits independently of management and will report 
directly to the Managing Director and General Manager. Periodic 
reports will also be made to the audit committee.
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    (3) PricewaterhouseCoopers has agreed to continue to act as the 
independent auditors of Euroclear Bank and, as such, will conduct an 
audit of Euroclear Bank's annual report and perform an annual review of 
Euroclear Bank's internal controls, policies and procedures in 
accordance with SAS-70 guidelines.
    (4) Euroclear Bank will take over MGT-Brussels' data centers and 
contingency recovery facilities.
    c. Regulatory Oversight. Euroclear Bank will be subject to the 
comprehensive supervision on a consolidated basis by the BFC. The BFC 
is primary regulator of credit institutions in Belgium. It is 
responsible for ensuring that credit institutions satisfy the 
authorization requirements and operating criteria of Belgium banking 
laws and regulations. Any credit institution wishing to operate in 
Belgium must be licensed by the BFC. In addition, any depositary bank 
through which U.S. government and agency securities would be held by 
Euroclear Bank would similarly be subject to the comprehensive 
supervision of the Federal Reserve Board or some other U.S. Federal 
bank regulatory agency.

[[Page 821]]

    d. Financial Risk Management. The Standards Release states that a 
clearing agency should establish a clearing fund and promulgate rules 
to assure an appropriate level of contributions in accordance with, 
among other things, the risks to which the clearing agency is subject 
for the protection of clearing agency participants and for the national 
system for clearance and settlement. Euroclear Bank will not have a 
clearing fund, but will have a separate risk management department that 
is responsible for identifying and controlling the risks of operating a 
multicurrency, cross-border clearance and settlement system.\13\ The 
risk management department reports to the Chief Financial Officer. 
Euroclear Bank expects to maintain insurance coverage similar to that 
of MGT-Brussels with respect to securities at rest or in transit 
against risk of physical loss or damage, including securities held on 
the premises of its depositories, as well as fraudulent securities. It 
is also anticipated that Euroclear Bank will add new insurance coverage 
for operational errors. Euroclear Bank will take over MGT-Brussels' 
information technology division, with the same systems and the same 
personnel as MGT-Brussels, which will be in charge of the development 
and maintenance of its information technology infrastructure.
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    \13\ The Euroclear System as operated by MGT-Brussels does not 
maintain a clearing fund. However, MGT-Brussels employed various 
financial and operational risk management mechanisms. In the 1998 
Exemption Order, the Commission found that MGT-Brussels' rules and 
procedures and the methods substantially satisfied the requirements 
of the Exchange Act.
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2. Fair Representation
    Section 17A(b)(3)(C) of the Exchange Act requires that the rules of 
a clearing agency provide for fair representation of the clearing 
agency's shareholders or members and participants in the selection of 
the clearing agency's directors and administration of the clearing 
agency's affairs. This section contemplates that users of a clearing 
agency have a significant voice in the direction of the affairs of the 
clearing agency.\14\
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    \14\ Participants of the Euroclear System operated by MGT-
Brussels did not have the right to appoint the directors of Morgan 
Guaranty Trust Company of New York. However, they could become 
members of the Cooperative and could use this membership to 
influence the range of MGT-Brussels services and the level of fees 
charged by MGT-Brussels. The board of directors of the Cooperative 
consisted of 23 members that were nominated from Euroclear's 
participant organizations representing various financial sectors and 
geographic regions. In the 1998 Exemption Order, the Commission 
found that the method in which the Cooperative's directors are 
selected and interact with Euroclear's management adequately 
addresses the requirements of Fair Representation under section 
17A(b)(3)(C) of the Exchange Act.
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    The conversion of the Cooperative into Euroclear Bank did not 
change the participation rights of the Cooperative's 1,248 participant 
institutions. However, since the change of corporate form, Euroclear 
Bank participants will not automatically become shareholders. To become 
a shareholder, a new participant will have to purchase shares from 
current shareholders in Euroclear Bank or in PLC. Euroclear 
participants will be represented on the boards of Euroclear Bank and 
Euroclear PLC. Board members will be nominated from Euroclear 
participant organizations representing various financial sectors and 
geographical regions.

E. Participation Standards

    Section 17A(b)(3)(B) of the Exchange Act enumerates certain 
categories of persons that a clearing agency's rules must authorize as 
potentially eligible for access to clearing agency membership and 
services. 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 enumerated in section 17A(b)(3)(B), but that 
these criteria may not be used to unfairly discriminate among 
applicants or participants. In addition, the Exchange Act recognizes 
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.\15\
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    \15\ Because each of the enumerated categories of participants 
was eligible for Euroclear system membership and because Euroclear 
has accepted a wide range of participants based upon its standards 
of financial responsibility, operational capability, experience and 
competence, the Commission was satisfied that MGT-Brussels' 
participants standards adequately address the requirements of 
Section 17A of the Exchange Act.
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    Euroclear Bank's standards for the admission of participants will 
be similar to those applied in the past. Consistent with section 
17A(b)(4), any broker-dealer, clearing agency, investment company, 
bank, insurance company or other professional investor that 
demonstrates it meets certain financial and operational criteria may 
become a Euroclear participant. The applicant also must demonstrate the 
ability to maintain these financial and operational standards on an on-
going basis. They must demonstrate that they have both the personnel 
and technological infrastructure to meet the operational requirements 
of the Euroclear System. They must show that they expect to derive 
material benefit from direct access to Euroclear and that they are 
reputable firms.

IV. Scope of Modification Application

    This order modifies the 1998 Exemption Order by replacing MGT-
Brussels with Euroclear Bank as operator of the Euroclear System.
1. Volume Limits
    The volume limitations in the 1998 Exemption Order are unchanged. 
Specifically, the average daily volume of eligible U.S. government 
securities processed through Euroclear Bank as operator of the 
Euroclear System may not exceed five percent of the total average daily 
dollar value of the aggregate volume in eligible U.S. government 
securities.
2. Commission Access to Information
    To continue to facilitate the Commission's monitoring of the 
operation of the Euroclear System's under the 1998 Exemption Order, 
Euroclear Bank will continue to provide the Commission with quarterly 
reports, calculated on a twelve-month rolling basis, of (1) the average 
daily volume of transactions in eligible U.S. government securities for 
U.S.participants that are subject to the volume limit as described in 
Section IV.C.2 of the 1998 Exemption Order and (2) the average daily 
volume of transactions in eligible government securities for all 
Euroclear System participants, whether or not subject to the volume 
limit as described in Section IV.C.2 of the 1998 Exemption Order.\16\
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    \16\ Euroclear Bank also continues to agree to provide 
information to the Commission as described in the 1998 Exemption 
Order.
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    The Commission will require the execution of a satisfactory 
Memorandum of Understanding (``MOU'') with the BFC, Belgium banking and 
securities regulatory, to facilitate the provision of information by 
Euroclear Bank to the Commission. In addition, the Commission will 
monitor Euroclear Bank through review of information provided by to the 
BFC by Euroclear Bank and its external auditors.\17\
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    \17\ As described in the 1998 Exemption Order, MGT-Brussels is a 
division of the foreign branch of a U.S. bank and accordingly is 
subject to the comprehensive supervision and regulation of the 
Federal Reserve Bank of New York. Because there will be no similar 
U.S. regulation of Euroclear Bank, the Modification Application is 
contingent upon the execution of a satisfactory MOU with the BFC to 
facilitate the provision of information by Euroclear Bank to the 
Commission.

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3. Modification of Order
    The Commission may modify by order the terms, scope, or conditions 
of Euroclear's exemption from registration as a clearing agency granted 
to Euroclear Bank as operator of the Euroclear System if the Commission 
determines that such modification is necessary or appropriate in the 
public interest, for the protection of investors, or otherwise in 
furtherance of the purposes of the Exchange Act.\18\ Furthermore, the 
Commission may limit, suspend, or revoke this exemption if the 
Commission finds that Euroclear Bank has violated or is unable to 
comply with any of the provisions set forth in this order if such 
aciton is necessary or appropriate in the public interest, for the 
protection of investors, or otherwise in furtherance of the purposes of 
the Exchange Act for the protection of investors and the public 
interest.
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    \18\ The exemption provided by this order is based upon 
representations by Euroclear Bank, its officers and attorneys, facts 
contained in Euroclear Bank's Modification Application, and other 
information known to the Commission regarding the substantive 
aspects of Euroclear Bank's proposal (collectively, 
``representations and facts''). In addition, as described in the 
1998 Exemption Order, Euroclear Bank, like MGT-Brussels, will be 
required to file with the Commission amendments to its application 
for exemption on Form CA-1 if it makes any fundamental change 
affecting its clearance and settlement business with respect to 
eligible U.S. government securities. Any changes in the 
representations or facts as represented to the Commission may 
require a modification of this order. Responsibility for compliance 
with all applicable U.S. securities laws rests with Euroclear Bank 
and its U.S. participants, as appropriate. Euroclear Bank also is 
advised that this order does not exempt Euroclear Bank from the 
anti-fraud or anti-manipulation provisions of the Exchange Act or 
any of the rules promulgated thereunder.
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V. Conclusion

    The Commission finds that the application by MGT-Brussels and 
Euroclear Bank to modify the exemption from registration as a clearing 
agency for Euroclear Bank as operator of the Euroclear System meets the 
standards and requirements deemed appropriate for such an exemption.
    It is Therefore Ordered, pursuant to section 19(a)(1) of the 
Exchange Act, that the Modification Application to modify the exemption 
from registration as a clearing agency filed by MGT-Brussels and 
Euroclear Bank (File No. 601-01) be, and hereby is, approved subject to 
the conditions contained in this order.

By the Commission.
Jonathan G. Katz,
Secretary.
[FR Doc. 01-216 Filed 1-3-01; 8:45 am]
BILLING CODE 8010-01-M