[Federal Register Volume 59, Number 240 (Thursday, December 15, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-30781]
[[Page Unknown]]
[Federal Register: December 15, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-35061; File No. SR-GSCC-94-7]
Self-Regulatory Organizations; Government Securities Clearing
Corporation; Notice of Filing of a Proposed Rule Change Relating to
Changes in Membership Standards
December 7, 1994.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\1\ notice is hereby given that on October 11, 1994, the
Government Securities Clearing Corporation (``GSCC'') filed with the
Securities and Exchange Commission (``Commission'') the proposed rule
change as described in Items I, II, and III below, which items have
been prepared primarily by GSCC. On December 5, 1994, GSCC filed an
amendment to the proposed rule change.\2\ The Commission is publishing
this notice to solicit comments on the proposed rule change from
interested persons.
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\1\15 U.S.C. 78s(b)(1) (1988).
\2\The amendment made a rating by A.M. Best for insurance
company applicants for netting members permissible rather than
mandatory and expanded the category of rating organizations that
GSCC will accept to establish the qualifications of insurance
company applicants for netting membership. Letter from Jeffrey F.
Ingber, General Counsel and Secretary, GSCC, to Jerry Carpenter,
Assistant Director, Office of Securities Processing, Division of
Market Regulation, Commission (December 1, 1994).
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I. Self-Regulatory Organization's Statement of the Terms of
Substance of the Proposed Rule Change
The proposed rule change will establish minimum financial standards
for two current Netting System membership categories: insurance
companies and registered investment companies.\3\
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\3\While GSCC's rules provide that insurance companies and
registered investment companies may become Netting System members,
no insurance companies or investment companies have applied for
membership.
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II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, GSCC included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. GSCC has prepared summaries, set forth in sections (A),
(B), and (C) below, of the most significant aspects of such statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
(a) The purpose of the proposed rule change is to establish minimum
financial standards for two current Netting System membership
categories: insurance companies and registered investment companies.
(1) Proposed Minimum Financial Standards for Insurance Companies
(A) Background. In general, there are two types of insurance
companies that operate in the United States: stock companies and mutual
insurers. Insurance in the United States also is provided by other
types of entities, including governmental units such as the Pension
Benefit Guaranty Corp., the Federal Crop Insurance Corp., and the
Federal Deposit Insurance Corp.
Insurance companies are regulated primarily by the various states
in which they organize and operate. While stock companies generally are
subject to requirements regarding both the amounts of paid-in capital
and the surplus that must be retained, typically the means of ensuring
that an insurance company is financially responsible is largely
performed by statutory and administrative requirements for the
maintenance of reserves that bear a reasonable relation to risks
presented by the insurer's outstanding contractual obligations.
There are various agencies that rate insurance companies. A.M. Best
(``Best'') was the first rating agency to report on the condition of
insurance companies and remains the most widely known of them.
Standards & Poor's (``S&P''), Moody's, and Duff & Phelps (``D&P'') also
rate insurance companies.
A new measure of the financial strength of insurance companies, a
risk-based capital rating, recently has been introduced. In December
1992, the National Association of Insurance Commissioners (``NAIC'')
adopted a model law that establishes standards for the adequacy of life
insurance company surplus levels based upon the risk profile of their
operations and investments.\4\ The model law establishes a risk-based
capital ratio based on four main risk categories (investment risk,
underwriting risk, interest rate risk, and business risk) at or below
which an insurance commissioner must act and place an insurer under
varying degrees of state control.
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\4\In December 1993, the NAIC adopted similar risk-based
standards for property and casualty insurance companies. It is
expected that these standards will be implemented this year.
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(B) Proposed standards. Given that insurance companies are
primarily state-regulated, there historically has been a lack of
uniformity of regulatory financial standards for them. GSCC believes
that the best proxy for such a uniform financial standard, such as the
Commission's net capital rule, are the analysis and rating of each
insurance company provided by the rating agencies. GSCC also believes
it appropriate to establish a ``size'' test that at least initially
only insurance companies of substantial size can meet and believes it
is appropriate to require that insurance company netting members have a
satisfactory risk-based capital ratio.
More specifically, GSCC is seeking to establish the following
minimum financial standards for insurance company netting members in
order to ensure that only sufficiently creditworthy institutions are
accepted into Netting System membership:
(1) A Best's rating of ``A-'' or better (if the member is rated by
Best),\5\
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\5\Best's ratings are as follows:
A++ and A+ = superior
A and A- = excellent
B++ and B+ = very good
B and B- = good
++ and + = fair
C and C- = marginal
D = below minimum standards
E = under state supervision
F = in liquidation
Currently, approximately one-third of all life insurance
companies rated by Best and over one-half of all property and
casualty insurance companies rated by Best have a rating of A- or
better.
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(2) A rating by at least one of the other three major rating
agencies (D&P Moody's, or S&P) of at least ``A-'' or ``A3'', as
applicable (or an equivalent rating by either a nationally-recognized
statistical rating organization or another rating agency acceptable to
GSCC),\6\
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\6\GSCC believes it to be prudent to have the reassurance of a
high rating from a rating agency in addition to Best.
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(3) No rating by any one of the other three major rating agencies
of less than ``A-'' or ``A3'', as applicable,\7\
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\7\A rating of below ``A-'' or ``A3'' by one of the other three
major rating agencies indicates some weakness.
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(4) A risk-based capital ratio of at least 200 percent,\8\ and
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\8\The risk-based capital percentage is calculated using the
company's ``total adjusted capital'' (which is the sum of its
statutory surplus, assets valuation reserve, voluntary investment
reserves, and half of the annual dividend liability as adjusted for
the capital contributed by subsidiaries) as the numerator and its
``authorized control level risk-based capital'' (which is the
capital level at which the state insurance commissioner may place
the insurer under regulatory control) as the denominator. A ratio of
200 percent or more is necessary for an insurance company to avoid
any regulatory action.
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(5) Statutory capital (consisting of adjusted policyholders'
surplus plus the company's asset valuation reserve) of no less than
$500 million.\9\
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\9\Currently, this standard encompasses roughly the twenty-five
largest life insurers plus the twenty-five largest property and
casualty insurers.
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(C) Proposed reporting requirements. Each applicant for membership
in GSCC's Netting System that is an insurance company will be required
to provide its two most recent annual statements and three most recent
quarterly financial statements filed with the NAIC, the Commission,
and/or the applicant's regulatory authority in its state of domicile.
In order to monitor the financial status of insurance company netting
members, each such member will be required to provide GSCC with copies
of its quarterly and annual financial statements and any intervening
amendments and addendums thereto at the time that such statements are
filed with the NAIC, the Commission, and/or member's regulatory
authority in its state of domicile.
(2) Proposed Minimum Financial Standards for Registered Investment
Companies
(A) General information. An investment company is a company that
sells shares or certificates that represent an interest in a pool of
financial assets. A registered investment company is an investment
company that files a registration statement with the Commission and
meets all the other requirements of the Investment Company Act of 1940
(``Investment Company Act''). The Investment Company Act classifies
investment companies into three broad types: face-amount certificates
companies, unit investment trusts, and management companies (which are
further classified as open-end or closed-end and diversified or non-
diversified).
The vast majority of investment companies are open-end and closed-
end funds. An open-end investment company, better known as a mutual
fund, has a floating number of outstanding shares and continuously
issues and redeems shares at their current net asset value. A closed-
end investment company, also known as an investment trust, has a fixed
number of outstanding shares that are traded like stock, often on the
major exchanges.
In addition to the registration requirement for investment
companies, they are required to disclose their financial condition and
investment policies and to provide investors complete information about
their activities. The Investment Company Act also:
(1) Prohibits such companies from substantially changing the nature
of their business or investment policies without stockholder approval;
(2) Bars persons guilty of security frauds from serving as officers
and directors;
(3) Prevents investment bankers from constituting more than a
minority of the directors of such companies;
(4) Requires that management contracts and any material changes
thereto be submitted to security holders for their approval;
(5) Prohibits transactions between such companies and their
directors, officers, or affiliated companies or persons except when
approved by the Commission;
(6) Forbids such companies to issue senior securities except under
specified conditions and upon specified terms;
(7) Prohibits pyramiding of such companies and cross-ownership of
their securities; and
(8) Imposed asset-to-debt coverage rate restrictions.
Other provisions of the Investment Company Act involve advisory
fees not conforming to an adviser's fiduciary duty, sales and
repurchases of securities issued by investment companies, exchange
offers, and other activities of investment companies including special
provisions for periodic payment plans and face-amount certificate
companies.
Investment company securities also must be registered under the
Securities Act of 1933. Investment companies must file periodic reports
and are subject to the Commission's proxy and insider trading rules.
(B) Proposed minimum financial standards. An important criterion
used by market participants and other registered clearing agencies in
assessing the creditworthiness of a registered investment fund is asset
size. In view of this, GSCC management recommends that registered
investment company netting members be required to have and maintain a
minimum of $500 million in net assets either directly and/or under
management. This would ensure that only a sizeable entity will qualify
for Netting System membership.\10\
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\10\This minimum level of assets is significantly higher than
the requirements imposed by other registered clearing agencies on
their registered investment company members. By example, the Midwest
Securities Trust Company has a requirement of $50 million in net
assets, and MBS Clearing Corporation's requirement is $10 million in
net worth.
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Moreover, the following additional criteria will be considered on a
case-by-case basis in evaluating the membership application of any
registered investment company for Netting System membership:
(1) Quality and experience of management;
(2) Years in business;
(3) Open-end versus closed-end;
(4) Leverage restrictions;
(5) Range of permissible investment; and
(6) As applicable, the company's ratings.
This combination of required and discretionary standards will help
to ensure that only a registered investment company of high credit
quality will be eligible to become a Netting System member.
(C) Proposed reporting requirements. Each applicant for membership
in GSCC's Netting System that is a registered investment company will
be required to provide copies of its two most recent reports on Form N-
SAR filed semi-annually with the Commission pursuant to Rule 30b1-1
under the Investment Company Act and copies of each of its three most
recent reports, communications, and prospectuses (and any amendments
and supplements thereto) transmitted to shareholders and filed with the
Commission. In order to monitor the financial status of registered
investment company netting members, such members will be required to
provide GSCC with its report on Form N-SAR and reports, communications,
and prospectuses (and any amendments and supplements thereto)
transmitted to shareholders and filed with the Commission at the time
such reports are filed with the Commission.
(b) The proposed rule change will allow GSCC, in a prudent and
creditworthy manner, to provide the benefits of its comparison and
netting processes to additional netting members and to ensure that it
can appropriately monitor such members. Thus GSCC believes that the
proposed rule change is consistent with the requirements of Section 17A
of the Act and the rules and regulations thereunder.\11\
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\11\15 U.S.C. 78q-1 (1988).
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B. Self-Regulatory Organization's Statement on Burden on Competition
GSCC does not believe that the proposed rule change imposes any
burden on competition not necessary or appropriate in furtherance of
the purposes of the Act.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received from Members, Participants, or Others
Comments on the proposed rule change have not yet been solicited or
received. Members will be notified of the rule change and comments will
be solicited by an Important Notice. GSCC will notify the Commission of
any written comments received by GSCC.
III. Date of Effectiveness of the Proposed Rule Change and Timing
for Commission Action
Within thirty five days of the date of publication of this notice
in the Federal Register or within such longer period (i) as the
Commission may designate up to ninety days of such date if it finds
such longer period to be appropriate and publishes its reasons for so
finding or (ii) as to which the self-regulatory organization consents,
the Commission will:
(A) By order approve such proposed rule change or
(B) Institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing. Persons making written submissions
should file six copies thereof with the Secretary, Securities and
Exchange Commission, 450 Fifth Street, N.W., Washington, DC 20549.
Copies of the submission, all subsequent amendments, all written
statements with respect to the proposed rule change that are filed with
the Commission, and all written communications relating to the proposed
rule change between the Commission and any person, other than those
that may be withheld from the public in accordance with the provisions
of 5 U.S.C. Sec. 552, will be available for inspection and copying in
the Commission's Public Reference Section, 450 Fifth Street, N.W.,
Washington, DC 20549. Copies of such filing will also be available for
inspection and copying at the principal office of GSCC. All submissions
should refer to file number SR-GSCC-94-7 and should be submitted by
January 5, 1995.
For the Commission by the Division of Market Regulation,
pursuant to delegated authority.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-30781 Filed 12-14-94; 8:45 am]
BILLING CODE 8010-01-M
