[Federal Register Volume 73, Number 60 (Thursday, March 27, 2008)]
[Notices]
[Pages 16403-16405]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E8-6256]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-57542; File No. SR-DTC-2007-11]
Self-Regulatory Organizations; The Depository Trust Company;
Order Approving Proposed Rule Change, as Modified by Amendment No. 1,
To Amend Its Operational Arrangements as It Applies to Structured
Securities
March 20, 2008.
I. Introduction
On September 7, 2007, The Depository Trust Company (``DTC'') filed
with the Securities and Exchange Commission (``Commission'') proposed
rule change SR-DTC-2007-11 pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934 (``Act'').\1\ The proposed rule change
was published for comment in the Federal Register on November 26,
2007.\2\ The Commission received four comments to the proposed rule
change.\3\ On December 14, 2007, DTC filed Amendment No. 1 to the
proposed rule change.\4\ The proposed rule change, as Modified by
Amendment No. 1, was published for comment in the Federal Register.\5\
The Commission received one comment to Amendment No. 1.\6\ For the
reasons discussed below, the Commission is approving the proposed rule
change, as amended.
---------------------------------------------------------------------------
\1\ 15 U.S.C. 78s(b)(1).
\2\ Securities Exchange Act Release No. 56795 (November 15,
2007), 72 FR 66009.
\3\ Simon Griffiths, Vice President, JP Morgan (December 10,
2007); Tom Migneron, Principal, Edward Jones (December 11, 2007);
Dan W. Schneider, Baker & McKenzie LLP, Counsel to the Association
of Global Custodians, Chicago, Illinois (December 12, 2007); Norman
Eaker, Chairman, Securities Industry and Financial Markets
Association, Operations Committee, Gussie Tate, President,
Securities Industry and Financial Markets Association, Dividend
Division, and Thomas Hamilton, Vice Chairman, Securities Industry
and Financial Markets Association, MBS and Securitized Products
Division Executive Committee (December 19, 2007).
\4\ As explained below, Amendment No. 1 replaced and superseded
the original filing in its entirety. Amendment No. 1 removed
reference to the imposition of a processing fee on January 1, 2008,
and corrected the identity of the party that will identify an issue
as conforming or non-conforming and will submit a written
attestation giving the reason for non-conformance.
\5\ Securities Exchange Act Release No. 57283 (February 6,
2008), 73 FR 8384.
\6\ Carol A. Jameson, Vice President and Senior Counsel, The
Depository Trust Company (March 5, 2008).
---------------------------------------------------------------------------
II. Description
DTC's Operational Arrangements is a contractual agreement between
DTC, issuers, and paying agents that outlines the procedural and
operational requirements for an issue to become and remain DTC
eligible. The proposed rule change amends DTC's ``Operational
Arrangements Necessary for an Issue to Become and Remain Eligible for
DTC Services'' (``Operational Arrangements'') as it applies to
Structured Securities in order to: extend the deadline by which paying
agents of such securities must submit periodic payment rate information
to DTC; establish Structured Securities classifications; establish an
exception processing fee applied to certain Structured Securities whose
features prevent paying agents from complying with the extended
deadline; and provide that DTC track and make publicly available
reports on paying agent performance as it relates to timeliness and
accuracy of Structured Securities payment rate information submitted to
DTC.
A Structured Security, such as a collateralized mortgage obligation
or asset-backed security, is a bond backed by a pool of underlying
financial assets. The underlying assets generally consist of
receivables such as mortgages, credit card receivables, or student or
other bank loans for which the timing of principal payments by the
underlying obligors may be variable and unpredictable. A Structured
Security may also incorporate credit enhancements or other rights that
affect the amount and timing of payments to investors.
Communication of periodic payment rates of principal and interest
(``P&I'') to the end investors in Structured Securities depends on
application of
[[Page 16404]]
stringent time frames for information reporting and significant
interdependencies among servicers of the underlying assets,
specifically trustees, custodians, paying agents on the securities,
DTC, and the financial intermediaries that act on behalf of the
investors. Given the complexity of structure and calculations of cash
flow from the underlying assets through the issuer to the end investor
and given the interdependencies on timeliness and accuracy of
performance throughout the chain of servicers and intermediaries,
timely and accurate submission of payment rate information on
Structured Securities may be difficult to achieve. As a result, payment
rates typically are announced late on a significant number of issues,
and the number of post-payable adjustments made to correct inaccurate
payments resulting from inaccurate payment rate information is higher
than for any other security type. Furthermore, the volume of P&I
payments for Structured Securities processed through DTC has grown
rapidly in recent years and currently represents approximately 25% of
all P&I payments processed through DTC. Incorrect and late payment rate
reporting causes increased operations processing costs, inefficient
cash management, and loss of income.
1. Extending the Deadline for Reporting on Payment Detail
Currently, the majority of Structured Securities have features that
prevent paying agents from being able to meet the current Operational
Arrangements payment rate reporting deadline. DTC is amending the
Operational Arrangements to require that the payment notification
regarding Structured Securities be provided to DTC by the paying agent
preferably five business days but no later than one business day prior
to the payable date.\7\ In addition, DTC is extending its current
processing deadline for receipt of payment rate files from 7:00 p.m. to
11:30 p.m. The extended reporting period deadlines should allow paying
agents to provide payment rates in a timely and accurate fashion for a
majority of Structured Securities issues and should permit the
securities to remain eligible for DTC's services while still providing
DTC with adequate time to process the information and make timely
payments to its participants.
---------------------------------------------------------------------------
\7\ Prior to this filing, payment notifications regarding
Structured Securities had to be provided to DTC by the paying agent
preferably five business days but no later than two business day
prior to the payable date.
---------------------------------------------------------------------------
2. Securities Classifications
Due to the complexity of certain Structured Securities, it is
anticipated that the paying agents for certain issues will still not be
able to meet the amended Operational Arrangements requirements for
timely payment rate reporting even with the extended reporting
period.\8\ Therefore, DTC is categorizing Structured Securities as
``conforming'' or ``non-conforming.'' Non-conforming Structured
Securities will be issues for which the underwriter and paying agent
have concluded that the security has features that will likely preclude
the paying agent from submitting payment rate information to DTC in
conformity with the requirements of the Operational Arrangements. The
conforming/non-conforming identification will be made at the time the
security is made eligible at DTC. For each Structured Securities
underwriting that the underwriter and paying agent identify as non-
conforming, the underwriter and paying agent shall submit a written
attestation giving the reason(s) why the paying agent will be unable to
submit payment rate information to DTC in conformity with the
requirements of the Operational Arrangements. DTC will in turn identify
non-conforming Structured Securities to participants and other relevant
parties and will add an indicator to the appropriate DTC systems
functions to denote non-conforming securities. Paying agents also shall
be required to evaluate their entire portfolio of Structured Securities
that have previously been made eligible and are currently on deposit at
DTC to identify non-conforming securities.
---------------------------------------------------------------------------
\8\ Although approximately 15% of Structured Security issues
currently fail to have rates submitted to DTC in a timely manner, it
is estimated that approximately only half of these have structural
impediments to meeting the new requirements. Late reporting in other
instances is believed to be curable by improved servicing and
reporting on the securities.
---------------------------------------------------------------------------
3. Exception Processing Fee Applicable to Non-Conforming Securities
Late payment rate reporting leads to increased costs to DTC and to
servicers and intermediaries. In order to recoup the increased
processing costs, DTC is imposing an exception processing fee to the
managing underwriter of each non-conforming issue at the time of
underwriting. No exception processing fee will be charged retroactively
for issues already on deposit at DTC prior to the implementation of the
fee. The exception processing fee of $4,200 per CUSIP was calculated
based upon anticipated additional costs of P&I processing for non-
conforming Structured Securities.\9\
---------------------------------------------------------------------------
\9\ The fee was filed with the Commission as part of DTC's
annual establishment of fees. Securities Exchange Act Release No.
34-57193 (January 24, 2008), 73 FR 5614.
---------------------------------------------------------------------------
The aggregate net amount of the exception processing fees will be
allocated and rebated on a pro rata basis annually to the DTC
participants for whom DTC processed Structured Securities P&I
allocations. For each participant, DTC will compare the participant's
total number of allocations to the total number of all participants'
allocations, and the resulting percentage would be applied against the
total exception processing fund with the resulting amount being rebated
to the participant. The total exception processing fund will be the sum
of all exception processing fees less DTC's cost to administer the
program.
4. Evaluation and Publication of Paying Agent Performance
DTC will track and evaluate paying agent performance with regard to
timeliness and accuracy of payment rate reporting on Structured
Securities and make these evaluations available to DTC participants and
to the public. The purpose of these evaluations is to identify poor
reporting and payment performance by paying agents.
DTC plans to expand its paying agent evaluation reports (``Report
Cards'') that are currently used to compare rate submission performance
and accuracy of Structured Securities paying agents. Currently the
Report Cards are only distributed among the paying agents being
compared. DTC will now make the Report Cards available on its Web site.
The Report Cards will track and will report on a monthly basis
performance by paying agent with respect to the number of
collateralized mortgage obligations and asset-backed securities
announcements processed, the number of late and amended announcements,
the payment dollars, late payment dollars, the number of payments, and
the number of late payments. Timeliness of payment rate notification on
non-conforming Structured Securities will not be included in the Report
Cards. With respect to all the other items set forth above, paying
agent performance information for both conforming and non-conforming
Structured Securities will be included in the Report Cards.
III. Comment Letters
The Commission received five comments to the proposed rule
change.\10\ Four of the comment letters
[[Page 16405]]
were from industry participants, and one was from DTC in response to
the other four comment letters. While all of the four industry
commenters generally supported the proposal, two raised issues or
sought clarification about the proposal.
---------------------------------------------------------------------------
\10\ Supra notes 3 and 4.
---------------------------------------------------------------------------
The comment letters submitted by JP Morgan and Edward Jones both
expressed their support for the: (1) Extension of the deadline for
reporting on payment detail, (2) creation of the conforming and non-
conforming securities classifications, (3) creation of the exception
processing fee for non-conforming securities, and (4) evaluation and
publication of paying agent performance.
The comment letter written on behalf of the Association of Global
Custodians expressed its support for the: (1) Creation of the
conforming and non-conforming securities classifications and (2)
evaluation and publication of paying agent performance. Although the
commenter expressed support for the extension of the deadline for
reporting payment detail, the commenter stated that DTC should monitor
paying agent performance to determine if the reporting of payment
detail trends toward last-minute reporting or if the extended deadline
does not correlate with a reduced incidence of errors and adjustments.
Although the commenter expressed support for the creation of the
exception processing fee for non-conforming securities, it suggested
that the aggregate net amount of the exception processing fee should be
rebated to participants based on their transactions in non-conforming
securities only rather than to participants based on their transactions
in all Structured Securities.
The comment letter written on behalf of the Securities Industry and
Financial Markets Association expressed support for the: (1) Extension
of the deadline for reporting on payment detail and (2) evaluation and
publication of paying agent performance. Although the commenter
expressed support for the creation of the conforming and non-conforming
securities classifications, it requested guidance on the criteria to be
used to determine whether a Structured Security is non-conforming,
whether an issue's classification can be changed, and when the
classification determination will be required to be submitted to DTC.
The commenter questioned whether it was appropriate to require the
underwriter to sign the classification attestation rather than allowing
the underwriter to rely on the paying agent's attestation.
While the Securities Industry and Financial Markets Association
expressed support for the creation of the exception processing fee, it
questioned whether the underwriter is the appropriate party to pay the
fee. It stated its belief that the costs created by late and erroneous
submissions from conforming issues should not be borne by non-
conforming issue underwriters. The commenter also suggested that the
aggregate net amount of the exception processing fee should be rebated
to participants based on their transactions in non-conforming
securities only rather than to participants based on their transactions
in all Structured Securities.
In its comment letter, DTC stated that the criteria for
categorizing an issue as ``non-conforming'' would consist of a general
good-faith expectation, based on information available at the time, as
to whether it is anticipated that DTC's deadlines for submission of
rate information will be met. It also stated that both the paying agent
and the underwriter will be responsible to sign the classification
attestation and that imposing the exception processing fee on the
underwriter is equitable and consistent with DTC's general practice.
Finally, the commenter confirmed that while it will allocate exception
processing fee revenue pro rata to DTC participants for whom DTC
processed any Structured Securities, it will review the policy toward
the end of 2008 to determine whether future allocations should be
directed to participants based only on their transactions in non-
conforming securities.
IV. Discussion
The Commission finds that the proposed rule change is consistent
with the requirements of the Act and the rules and regulations
thereunder applicable to a registered clearing agency. In particular,
the Commission believes the proposal is consistent with the
requirements of Section 17A(b)(3)(F),\11\ which, among other things,
requires that the rules of a clearing agency are designed to remove
impediments to and perfect the mechanisms of a national system for the
prompt and accurate clearance and settlement of securities
transactions. The Commission finds that by enabling more Structured
Securities to be DTC-eligible and by helping to make the reporting of
information about Structured Securities more accurate and timely, the
proposed rule change, which should make the communication of payment
rate information on Structured Securities quicker and more efficient,
is consistent with this statutory obligation.
---------------------------------------------------------------------------
\11\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------
IV. Conclusion
On the basis of the foregoing, the Commission finds that the
proposal is consistent with the requirements of the Act and in
particular with the requirements of section 17A of the Act \12\ and the
rules and regulations thereunder.
---------------------------------------------------------------------------
\12\ 15 U.S.C. 78q-1.
---------------------------------------------------------------------------
It is therefore ordered, pursuant to section 19(b)(2) of the
Act,\13\ that the proposed rule change (File No. SR-DTC-2007-11), as
modified by Amendment No. 1, be, and hereby is, approved.\14\
---------------------------------------------------------------------------
\13\ 15 U.S.C. 78s(b)(2).
\14\ In approving the proposed rule change, the Commission
considered the proposal's impact on efficiency, competition, and
capital formation. 15 U.S.C. 78c(f).
For the Commission by the Division of Trading and Markets,
pursuant to delegated authority.\15\
---------------------------------------------------------------------------
\15\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------
Florence E. Harmon,
Deputy Secretary.
[FR Doc. E8-6256 Filed 3-26-08; 8:45 am]
BILLING CODE 8011-01-P