[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]
-----------------------------------------------------------------------
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.
---------------------------------------------------------------------------
\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).
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
\8\ 15 U.S.C. 78q-1(b)(1).
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
(2) Euroclear Bank will have a separate audit division that will be
responsible for the internal audit process.\12\
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
(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.
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
\16\ Euroclear Bank also continues to agree to provide
information to the Commission as described in the 1998 Exemption
Order.
---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
[[Page 822]]
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.
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
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