[Federal Register Volume 63, Number 32 (Wednesday, February 18, 1998)]
[Notices]
[Pages 8232-8241]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-3997]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-39643; International Series Release No. 1114; File No.
601-01]
Self-Regulatory Organizations; Morgan Guaranty Trust Company of
New York, Brussels Office, as Operator of the Euroclear System; Order
Approving Application for Exemption From Registration as a Clearing
Agency
February 11, 1998.
I. Introduction
On March 5, 1997, Morgan Guaranty Trust Company of New York
(``MGT''), Brussels office (``MGT-Brussels''), as operator of the
Euroclear System \1\ pursuant to a contract with Euroclear Clearance
System Societe Cooperative, a Belgian cooperative (``Belgian
Cooperative''),\2\ filled with the Securities and Exchange Commission
(``Commission'') an application on Form CA-1 \3\ for exemption from
registration as a clearing agency pursuant to Section 17A of the
Securities Exchange Act of 1934 (``Exchange Act'') \4\ and Rule 17ab2-1
thereunder.\5\ Notice of MGT-Brussels' application was published in the
Federal Register on May 15, 1997.\6\ Six comment letters were received
in response to the notice of filing of the Euroclear application.\7\
This order grants the application of MGT-Brussels, as operator of the
Euroclear System, for exemption from registration as a clearing agency
to the extent the Euroclear System performs the functions of a clearing
agency with respect to transactions involving U.S. government and
agency securities for its U.S. participants subject to the conditions
and limitations that are set forth below.
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\1\ For purposes of this order, the term ``Euroclear'' refers to
MGT-Brussels in its capacity as operator of the Euroclear System.
MGT-Brussels is the Brussels branch of MGT that has acted as the
operator of the Euroclear System through its Euroclear Operations
Centre since the creation of the Euroclear System in 1968. The
Euroclear Operations Centre is a separate, independent operational
unit established within MGT-Brussels to operate the Euroclear
System.
In 1972, a package of rights described as the Euroclear System
was sold to Euroclear Clearance System Public Limited Company, and
English limited liability company (``ECS-PLC''). ECS-PLC purchased
the rights to receive the revenues generated by the Euroclear System
services, to approve participants, to determine eligible securities,
to establish fees, and to make other similar decisions. MGT-Brussels
retained all of the assets and means necessary to operate the
Euroclear System and granted a license to ECS-PLC to use the
Euroclear System trademarks.
\2\ the Belgian Cooperative was established in 1987 to further
facilitate communication between Euroclear and the international
securities industry and to encourage participation in the Euroclear
System. It received a license from ECS-PLC to exercise some of ECS-
PLC's rights as owner of the Euroclear System. Neither ECS-PLC nor
the Belgian Cooperative is an operating company. Among other thins,
MGT-Brussels maintains all Euroclear System participant accounts on
its own books, maintains all of the contractual relationships with
Euroclear System participants and Euroclear System depositories in
its own name, and provides all of the personnel, systems,
trademarks, and operational capability used to deliver the Euroclear
System services to Euroclear System participants. For a more
complete description of the structure of the Euroclear System, refer
to Section II of the Euroclear notice, Infra note 6.
\3\ Copies of MGT-Brussels' application for exemption
(``Euroclear application'') are available for inspection and copying
at the Commission's Public Reference Room (File No. 601-01).
\4\ 15 U.S.C. 78q-1.
\5\ 17 CFR 240.17Ab2-1.
\6\ 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) (``Euroclear notice'').
\7\ Letters from C.R. Trusler, Director, Nomura International
plc (June 5, 1997); S. Guenzi, Senior Products Manager Custody H.O.-
Financial Institutions, Credito Italiano (June 12, 1997); Harve
Pennanec'h, Head of Back-Office, Capital Markets Divison, Societe
Generale (June 16, 1997); D.G. Pritchard, Director, Global
Collateral Support Unit, NatWest Markets (June 16, 1997); Preben
Borup, Senior Vice President, BG Operations, and Tom Jensen, First
Vice President, Head of Custody and Settlement, BG Operations,
Bikuben Girobank A/S (June 17, 1997); and S.L. Richardson, Executive
Manager, Operations, ANZ Bank (June 18, 1997). The comment letters
for File No. 601-01 are available for inspection and copying in the
Commission's Public Reference Room.
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II. Description of Euroclear System Operations \8\
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\8\ A more complete description of Euroclear System operations
is contained in the Euroclear notice, supra note 6.
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Euroclear provides several services to its participants, including
securities clearance and settlement, securities lending and borrowing,
and securities custody.\9\
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\9\ The contractual relationship between Euroclear and its
participants is defined by the Terms and Conditions Governing the
Use of Euroclear (``Terms and Conditions'') as supplemented by
Supplementary Terms and Conditions Governing the Lending and
Borrowing of Securities through Euroclear (``Supplementary Terms and
Conditions''), the Operating Procedures of the Euroclear System
(``Operating Procedures''), and various other documents, all of
which are governed by Belgian law. Among other things, the Terms and
Conditions provide that Euroclear participants agree that their
rights to securities held through the Euroclear System will be
defined and governed by Belgian law.
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A. Securities Clearance and Settlement
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 (``internal settlement''), with members of Cedel Bank, societe
anonyme, Luxembourg (``Cedel''), the operator of the Cedel system
(``Bridge settlement''), or with counterparties in certain local
markets that are not members of either the Euroclear System or Cedel
(``external settlement'').
The annual volume of transactions settled in the Euroclear System
has grown from about US$3 trillion in 1987 to over US$34.6 trillion in
1996. The fastest growing segments of this activity have been
repurchase and reverse repurchase agreements (``repos''), book-entry
pledging arrangements, securities lending, and other collateral
transactions \10\ involving non-U.S. government securities.\11\
Although the individual certificated or uncertificated government
securities of these countries are immobilized or dematerialized with
the central banks or central securities depositories (``CSDs'') in
their home markets, book-entry positions with respect to such
securities can be acquired, held, transferred, and pledged by book-
entry on the records of Euroclear in any of the 35 currencies available
in the Euroclear System because of the links to local custodian banks,
central banks, CSDs, and national payment systems around the world.
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\10\ Collateral transactions are designed to enable Euroclear
System participants to reduce their financing costs, increase their
yields on securities, reduce their credit and liquidity exposures,
and to manage market and operational risks.
\11\ Government securities of the following countries are
currently eligible for clearance and settlement in the Euroclear
System: Argentina, Australia, Austria, Belgium, Canada, Denmark,
Finland, France, Germany, Hong Kong, Ireland, Italy, Malaysia,
Mexico, the Netherlands, New Zealand, Norway, Portugal, South
Africa, Spain, Sweden, Switzerland, Thailand, and the United
Kingdom.
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1. Internal Settlement: Clearance and Settlement of Trades Between
Euroclear System Participants
Transactions between Euroclear System participants in the Euroclear
System can be settled either against payment or free of payment.\12\
Upon
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receipt of valid instructions for a settlement between participants,
the Euroclear System's computer system attempts to match instructions
between corresponding counterparties on a continuous basis according to
a defined set of matching criteria. Matching generally is required in
order for the instructions to be settled except for certain actions
specifically taken by participants (e.g., transfers between accounts
maintained by the same participant). Matching of an instruction is
attempted until it is either matched or cancelled.
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\12\ When a securities transaction is settled ``against
payment,'' movement of the securities is made in return for a
corresponding payment, usually cash. When a securities transaction
is settled ``free of payment,'' movement of the securities is made
without any corresponding payment, such as when securities are
pledged as collateral.
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Internal settlement of transactions is accomplished by book-entry
transfer and provides for simultaneous exchange of cash and securities.
Settlement is final (i.e., irrevocable and unconditional) at the end of
each of the securities settlement processing cycles of which there are
currently three per day.\13\
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\13\ Euroclear's internal securities processing consists of two
overnight settlement cycles and one daylight settlement cycle.
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The overnight securities settlement process is completed early in
the morning of the business day in Brussels for which settlement is
intended. Daylight securities settlement processing is completed in the
afternoon of each business day with settlement dated for that day. The
daylight settlement cycle, which is restricted to internal settlements,
permits participants to resubmit previously unmatched instructions or
unsettled transactions and permits the processing of new instructions
for same day settlement. All daylight instructions not settled are
automatically recycled for settlement in the next overnight securities
settlement cycle.
2. Bridge Settlement: Clearance and Settlement of Trades Between a
Euroclear System Participant and a Cedel Member
Participants can also send instructions authorizing receipt and
delivery of securities between the Euroclear System and the Cedel
system, both free of payment and against payment. Simultaneous delivery
versus payment (``DVP'') is possible for settlement of trades between a
participant in the Euroclear System and a Cedel member because of the
electronic bridge established between the two organizations.
For settlement of trades between a Euroclear System participant and
a Cedel member, matching of instructions consists of nine daily
comparisons of delivery and receipt instructions. During these
comparisons, each clearance system electronically transmits a file of
proposed deliveries and expected receipts to the other clearance
system. This exchange of information allows each clearance system to
report matching results to its participants.\14\
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\14\ Bridge settlement was enhanced in September 1993 to allow
for multiple overnight transmissions of instructions between Cedel
and the Euroclear System. The bridge provides finality for DVP
cross-system trades when the receiving clearance system confirms
acceptance of a proposed delivery and that confirmation is received
by the delivery clearance system.
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3. External Settlement: Clearance and Settlement of Trades Between a
Euroclear System Participant and a Local Market Counterparty
Participants can also send instruction authorizing receipt and
delivery of securities free of payment and against payment between the
Euroclear System and certain domestic markets' clearance and settlement
structures. Euroclear has two types of relationships, direct and
indirect links, with local market clearance systems. A direct link is
where Euroclear has its own account with the local clearance system and
holds securities and sends instructions directly in that clearance
system. With an indirect link, an intermediary (i.e., a depository) is
used to perform Euroclear System settlement activities in the local
market.\15\ In certain markets, Euroclear may have both direct and
indirect links for different instruments.
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\15\ Securities held by participants in the Euroclear System are
held by custodian banks or local clearing systems. Except where
required by local law, Euroclear will not permit bank subsidiaries
to serve as depositories. All securities held by a depository on its
books for the Euroclear System are credited to a segregated custody
account in the name of MGT-Brussels, as operator of the Euroclear
System. Depositories receive instructions regarding the movement of
Euroclear System securities directly from Euroclear. Euroclear
participants do not directly deal with depositories regarding the
settlement of securities transactions within the Euroclear System or
the custody of securities. See Section II.C. infra.
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B. Securities Lending and Borrowing
Securities lending and borrowing is utilized to increase settlement
efficiency for the borrower and to allow lenders to generate income on
securities held in the Euroclear System. Lenders receive a fee for
securities lending and do not incur safekeeping fees for securities
lent. With standard lending and borrowing, there is no linkage between
a particular borrower and a particular lender. In effect, participants
borrow securities from the lending pools.\16\ With reserved lending and
borrowing, there is a linkage between the borrower and the lender, but
the counterparty's identities are not disclosed.\17\ Consequently with
both standard and reserved lending and borrowing, borrowers' names and
lenders' names are never revealed to one another.
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\16\ A participant that is an ``automatic standard borrower'' is
eligible to borrow securities to execute delivery instructions when
there are insufficient eligible securities available in its
securities clearance accounts to effect a settlement in the
overnight securities settlement process. A participant that is an
``opportunity standard borrower'' sends standard borrowing requests
to Euroclear on a case-by-case basis according to expected borrowing
needs.
A participant that is an ``automatic standard lender'' makes
securities available to the lending pool during each overnight
securities settlement cycle. Subsequent to each overnight securities
settlement cycle, securities borrowed from the lending pool are
allocated back to the lenders according to a given set of
priorities. If the lendable position from automatic standard lenders
for a given issue is expected to be insufficient to meet estimated
borrowing demand in the next overnight securities settlement cycle,
``opportunity standard lenders'' may be contacted by Euroclear to
make additional securities available for borrowing.
\17\ A participant that wishes to reserve securities for future
borrowing can do so by submitting a reserved borrowing request to
Euroclear. Reserved borrowing differs from standard borrowing in
that once a reserve borrower's request matches a lendable supply,
the lender is committed to lend the securities, and the borrower is
obligated to borrow them. Reserved borrowing minimizes the risk of
settlement failure resulting from an inability to obtain a standard
borrowing in the overnight securities settlement process due to a
lack of supply in the lending pool.
An ``automatic reserved lender'' makes securities in its
securities clearance accounts available on demand for reserved
lending subject to the lender's selected options. When a reserved
borrowing request is matched to securities automatically available
for reserved lending, a reservation is initiated and the securities
are blocked in the reserved lender's securities clearance account
from the reservation date to the loan start date. ``Opportunity
reserved lenders'' are contacted by Euroclear when the supply of
lendable securities from automatic reserved lenders is not
sufficient to cover reserved borrowing requests in a given issue.
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Securities lending and borrowing is an integral part of the
overnight securities settlement process. This integration permits
Euroclear to determine borrowing requirements and the supply of
lendable securities on a trade-by-trade basis throughout each overnight
securities settlement processing. Generally, securities lending and
borrowing is available only through the overnight securities settlement
process.
C. Custody
Securitiess held by Euroclear System participants are held through
a network of depositories. Depositories may hold securities on their
premises or hold securities with subcustodians or with local clearance
systems. Depositories of the Euroclear System may include custodian
banks, including some MGT branches, central banks, local clearance
systems, and Cedel. Depositories are
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selected based upon their custody capabilities, financial stability,
and reputation in the financial community. All depositories and
subdepositories are appointed with the approval of the Belgium
Cooperative's board of directors and are reapproved on an annual basis.
This network of depositories allows linkages with domestic markets to
effect external deliveries and receipts of securities thereby
facilitating cross-border securities movements.
Chase Manhattan Bank currently acts as the Euroclear System's
depository in the United States for the limited purpose of holding
positions in certain foreign and internationally-traded securities
(e.g., such as the Regulation S portion of certain global bonds issued
by foreign private issuers, Yankee bonds, and book-entry debt
securities issued by the World Bank) which are represented by
certificates immobilized in The Depository Trust Company or by
electronic book-entries on the records of a Federal Reserve Bank.
Securities deposited in the Euroclear System may be in either
physical form (e.g., bearer or registered) or in dematerialized form.
Securities are held on the books of a depository in an account in the
name of MGT-Brussels as operator of the Euroclear System. Where the
depository is not also the local clearing system, securities may be
deposited in the local clearance system where the depository is
located.\18\
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\18\ All securities accepted by a depository are credited to a
segregated custody account in the name of MGT-Brussels as operator
of the Euroclear System at the depository or local clearance system
or are credited to the depository's account at the local clearance
system.
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Each Euroclear System participant has one or more securities
clearance account(s) with associated transit accounts. Securities held
by participants in the Euroclear System are credited to the
participants' securities clearance accounts or transit accounts.
Euroclear System participants have the option to request the
segregation of their own and client securities in separate securities
clearance accounts.
Securities in the Euroclear System are held in fungible bulk. Under
Belgian law and pursuant to the Terms and Conditions,\19\ each
participant is entitled to a notional portion, represented by the
amounts credited to its securities clearance account(s) and transit
account(s), of the pool of securities of the same type held in the
Euroclear System.\20\
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\19\ Supra note 9.
\20\ Under Belgian law, Euroclear is required to hold interests
in the same amount of any securities that may from time to time be
credited to the accounts of Euroclear System participants and is
prohibited from pledging or otherwise using any such securities for
its own benefit without the consent of the relevant account holder.
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D. Liens, Rights, and Obligations
In addition to any pledge of specific accounts agreed to by a
participant due to extensions of credit by MGT-Brussels \21\ all assets
held in the Euroclear System are subject to rights of set-off and
retention.\22\ Furthermore, participants' assets held in the Euroclear
System (except for assets held for customers and identified as such
pursuant to the Operating Procedures or by agreement with Euroclear)
are subject to a statutory lien in favor of MGT-Brussels, as operator
of the Euroclear System, pursuant to Belgian law.\23\ Participants are
also obligated to cover any cash or securities debit balances that they
may incur.
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\21\ See Section II.E. infra.
\22\ When assets are held subject to the right of set-off, the
holder of the assets may apply the assets to satisfy debts owned to
the holder by the actual owner of the assets. When assets are held
subject to the right of retention, the holder of the assets may
refuse to return the assets to their owner if the owner is indebted
to the holder.
\23\ Article 41 of the Belgian Law of April 6, 1995.
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E. MGT-Brussels Banking Services
MGT-Brussels, acting in its separate banking capacity and not as
operator of the Euroclear System, provides certain banking services to
Euroclear System participants. Banking services provided include the
provision of credit to Euroclear System participants, triparty repo
\24\ and collateral monitoring services, and a securities lending
guarantee.
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\24\ A triparty repo arrangement generally consists of three
parties, the borrower, the lender, and a collateral agent (i.e.,
MGT-Brussels). In this arrangement, the borrower initiates a repo by
``selling'' securities to the lender in exchange for cash from the
lender. Simultaneously with this transaction, the borrower agrees to
repurchase these securities on a specified or undetermined future
date. The collateral agent maintains custody of the securities for
the duration of the repo and handles all operation aspects of the
transaction including distribution of income, substitutions, and
mark to market securities valuations.
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1. Provision of Credit to Euroclear Participants
MGT-Brussels offers credit facilities to Euroclear participants on
an uncommitted basis under limits periodically determined by MGT.
Credit decisions are made according to MGT credit guidelines. Credit
facilities are generally required to be secured and are normally
collateralized by participant assets within the Euroclear System. In
order to secure credit, participants affirm to MGT-Brussels that they
are not pledging client securities and that no other liens have been
granted to third parties on pledged securities.\25\
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\25\ In a limited number of circumstances, MGT-Brussels may
agree to permit pledging of client securities or the securities of
the related parties where the participant's legal and regulatory
regime permits, appropriate legal opinions are delivered, and
certain other conditions are met.
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Securities that participants pledge to secure credit extensions
from MGT-Brussels are valued at their market price which is adjusted
according to the type of instrument, underlying currency, rating of the
issue, the issuer, and the country of the issuer. For debt securities,
accrued interest is added to market price for the purpose of
calculating collateral value.
2. Triparty Repo and Collateral Monitoring
MGT-Brussels also offers monitoring services whereby participants
can use the Euroclear System to facilitate repo settlement/collateral
posting, substitution of securities, and margin monitoring.
3. Securities Lending Guarantee
As part of the Euroclear securities lending and borrowing program,
MGT guarantees securities lenders the return of securities lent or the
cash equivalent if the borrower defaults on its obligation to return
such securities.
III. Comment Letters
The Commission received six comment letters in response to the
notice of filing of the Euroclear application.\26\ All were in favor of
the Commission granting Euroclear an exemption from registration as a
clearing agency. Many of the commenters noted there would be a
reduction in risks and an increase in liquidity as a result of
permitting transactions involving U.S. government and agency securities
to be processed by the Euroclear System. Specifically, several
commenters believed that under an exemption from clearing agency
registration Euroclear could facilitate the use of U.S. government and
agency securities as collateral thereby reducing the risks to credit
providers and the costs to credit seekers. Commenters also believed
that permitting Euroclear to clear and settle U.S. government and
agency securities would increase liquidity and further deepen the
market for these securities which would benefit the U.S. government and
its taxpayers by keeping the costs of borrowing low.
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\26\ Supra note 7.
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Commenters also cited Euroclear's operating record and financial
condition in support of the exemption. Commenters articulated their
belief that
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MGT-Brussels' financial resources and its regulation by the Board of
Governors of the Federal Reserve System (``Federal Reserve Board'') are
sufficient to ensure the safety and soundness of the Euroclear
System.\27\
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\27\ Two commenters believed that due to MGT-Brussels's
financial posture, operational history, and present monitoring by
the Federal Reserve Board, Euroclear should not be subject to any
volume limitations with regard to the amount of U.S. government and
agency securities Euroclear may process. Letters from C.R. Trusler,
Director, Normura International plc (June 5, 1997) and S. Guenzi,
Senior Products Manager Custody H.O.-Financial Institutions, Credito
Italiano (June 12, 1997). A third commenter believed that any volume
limitation should be only temporary. Letter from D.G. Pritchard,
Director, Global Collateral Support Unit, NatWest Markets (June 16,
1997).
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IV. 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.\28\ Registration of clearing agencies is a key
element of the statutory objectives set forth in Section 17A.\29\
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.\30\ Additionally, the Division of Market Regulation
(``Division'') has published the standards it applies in evaluating
applications for clearing agency registration.\31\ These standards are
designed to help assure the safety and soundness of the clearance and
settlement system.
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\28\ 15 U.S.C. 78q-1.
\29\ ``Clearing agency'' is defined in Section 3(a)(23) of the
Exchange Act. 15 U.S.C. 78c(a)(23).
\30\ 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.
\31\ 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), moreover, 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.\32\
\32\ 15 U.S.C. 78q-1(b)(1).
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As a result, in granting either exemptions from portions of Section
17A or from registration, the Commission requires substantial
compliance with Section 17A and the rules and regulations thereunder
based on a review of the standards.\33\
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\33\ The Commission has previously granted exemptions from
clearing agency registration, subject to certain volume limits,
reporting requirements, and other conditions, to the Clearing
Corporation for Options and Securities (``CCOS'') and to Cedel.
Securities Exchange Act Release Nos. 36573 (December 12, 1995), 60
FR 65076 (``CCOS exemptive order'') and 38328 (February 24, 1997),
62 FR 9225 (``Cedel exemptive order'').
The Commission also has granted temporary registrations that
included exemptions from specific statutory requirements of Section
17A. In granting these temporary registrations, it was expected that
the subject clearing agencies would eventually apply for permanent
clearing agency registration. See e.g., Secrities Exchange Act
Release No. 25740 (May 24, 1988), 53 FR 19839 (order approving
Government Securities Clearing with a temporary exemption from
compliance with Section 17A(b)(3)(C)).
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B. Evaluation of Euroclear's Application for Exemption
In the Commission's evaluation of Euroclear's application and the
comments received, the Commission recognized that certain
organizational, operational, and jurisdictional differences would
prevent MGT-Brussels, as operator of the Euroclear System, from
complying fully with all of the registration provisions set forth in
Sections 17A and 19 of the Exchange Act and from meeting all the
requirements set forth in the Standards Release. The evaluation was
also made in the context of the limitations and conditions that the
Commission is including in the exemption granted pursuant to this
order. As discussed more fully below, Euroclear's exemption from
clearing agency registration is subject to limitations on the type and
volume of securities that it may process for its U.S. participants and
requirements to submit certain information to the Commission on a
periodic basis and at the Commission's request. In addition, MGT-
Brussels is subject to regulatory oversight by the Federal Reserve
Board.
1. Safeguarding of Securities and Funds
Sections 17A(b)(3) (A) and (F) of the Exchange Act require that a
clearing agency be organized and its rules be designed to safeguard
securities and funds in its custody or control or for which it is
responsible.\34\ The Commission believes that Euroclear substantially
satisfies this standard. Among other things, the financial condition
of, operational safeguards employed by, and the scheme of U.S. federal
banking oversight of MGT-Brussels, as operator of the Euroclear System,
should help to provide U.S. investors and the U.S. national clearance
and settlement system with a level of protection in the areas of
custody, clearance, and settlement risks that is comparable to those
achieved with full clearing agency registration.
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\34\ 15 U.S.C. 78q-1(b)(3) (A) and (F). Euroclear's relationship
with its participants is governed by various operating agreements,
including the Terms and Conditions, the Supplementary Terms and
Conditions, and the Operating Procedures which define the rights and
responsibilities of Euroclear and its participants. Supra note 9 and
infra Section IV.B.6.
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a. Organization and Processing Capacity. A clearing agency must be
organized in a manner that effectively establishes operational and
audit controls while fostering director independence.\35\ The
independent audit committee of MGT's board of directors is kept
apprised of Euroclear's operations by MGT's regional and functional
audit management. The head of MGT audit management has direct reporting
lines to the audit committee of MGT's board of directors and to the
Vice Chairman of MGT. MGT's audit management receives reports through
Euroclear's separate audit division that is responsible for the
internal audit process. In addition, the audit division has a direct
reporting line to the general manager of Euroclear.
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\35\ Standards Release, supra note 31, 45 FR at 41925-26.
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The internal audit process for Euroclear is based on a risk
assessment methodology. Review of the participant, product, market, and
service dimensions of Euroclear's business, including technology
infrastructure, are considered in this risk based approach. The
internal audit procedures include tests that are designed to
independently assess the strengths and weaknesses of Euroclear's
control environment.
Price Waterhouse currently acts as the independent auditors of MGT
and MGT-Brussels, including Euroclear. Price Waterhouse conducts an
annual audit of MGT's financial statements, which are included in the
annual report of J.P. Morgan & Co. Incorporated on Form 10-
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K, in accordance with generally accepted auditing standards. It also
conducts an annual review of Euroclear's internal controls, policies,
and procedures in accordance with SAS-70 guidelines.\36\ Both reports
are made available to Euroclear participants. Price Waterhouse also
reports to the Belgian Banking and Finance Commission and to MGT's
audit committee.
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\36\ Statement on Accounting Standards No. 70 (``SAS-70'')
issued by the American Institute of Certified Public Accounts sets
forth the guidelines for examination of the internal controls
established for computerized information systems and manual
procedures relating to (i) securities clearance and settlement; (ii)
securities lending and borrowing; (iii) money transfer; and (iv)
custody. See Section IV.C.3. infra. The most recent SAS-70 report
was issued on March 31, 1997 and covers the period from January 1,
1996 to December 31, 1996.
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Based upon the foregoing, the Commission is satisfied that
Euroclear's organizational and processing capacity substantially
satisfies the requirements of the Exchange Act as elaborated on in the
Standards Release because Euroclear's internal organizational
structure, including its system of internal and external audit, is
reasonably designed to provide the necessary flow of information to
MGT's board of directors which should allow the necessary monitoring of
Euroclear's operations and management's performance to assure the
operational capability and integrity of Euroclear.
b. 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.\37\
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\37\ Supra note 31, 45 FR at 41929.
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As discussed in Section II.A. above, Euroclear provides DVP
settlement for securities transactions which are then batched for
processing in one of two overnight cycles or in the daylight cycle
depending upon when the transactions are received. Euroclear itself
does not directly extend credit to its participants. Instead, as
discussed in Section II.E. above, MGT-Brussels, in its banking
capacity, offers credit facilities to Euroclear participants on an
uncommitted basis under limits established and in accordance with
guidelines set by MGT. Such credit facilities are utilized to avoid
transaction failures.
Euroclear does not maintain a clearing fund. However, Euroclear
employs various financial and operational risk management mechanisms,
including its organization, financial condition, insurance, information
technology and systems security, and other operational safeguards to
substantially reduce the risk of financial loss by Euroclear and its
participants. Therefore, the Commission believes that Euroclear's rules
and procedures and the methods by which Euroclear safeguards the
financial security of its clearing facilities substantially satisfies
the requirements of the Exchange Act.
(i) Risk Management Division and Committee
Euroclear has a separate risk management division that is
responsible for risk policy. The risk management division focuses on
identifying, analyzing, and managing the risks of operating a
multicurrency, cross-border clearance and settlement system. It has
developed various risk management tools for identifying and managing
the risks of clearance and settlement and other market activities. In
addition, Euroclear also employs a Risk Advisory Committee (``RAC'') to
review all aspects of risk prior to approval of new and existing
markets, products, and services. The RAC is chaired by the head of
Euroclear's risk management division and includes senior management
from other divisions and reports directly to the Euroclear management
team.
(ii) Financial Condition
MGT, which is the entity with ultimate fiscal responsibility for
operations of the Euroclear System, is a U.S. bank that is ``well-
capitalized'' and ``well-managed'' as those terms are defined under
applicable U.S. Federal banking regulations.\38\ MGT has over $13.5
billion in total capital and a total capital ratio of more than 11
percent\39\ and access to billions of dollars of additional liquidity
in the capital markets. Its senior debt is rated AAA by Standard &
Poor's\40\ and its long-term debt is rated Aa-1 by Moody's Investors
Services.\41\
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\38\ 12 CFR 208.33(b)(1) (definition of ``well-capitalized'')
and 12 CFR 225.2(s) (definition of ``well-managed''). See also 12
CFR 211.2(u) (definition of ``strongly capitalized'') and (x)
(definition of ``well managed'').
\39\ 12 CFR Part 208, Appendix A (defining total capital ratio).
\40\ Standard & Poor's, ``Morgan (J.P.) & Company Inc.,'' Bank
Ratings Analysis, April 1997, at 1.
\41\ Moody's Investor Service, ``Opinion Update: Morgan Guaranty
Trust Company of New York,'' Global Credit Research, February 7,
1997, at 2.
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(iii) Insurance
Euroclear maintains certain insurance coverage against risk of
physical loss or damage for securities in its custody, on the premises
of its depositories, or in transit. Euroclear also maintains insurance
to cover losses arising from forged securities.\42\ Typically,
Euroclear depositories are required to maintain insurance coverage with
respect to securities that they hold on behalf of Euroclear in the same
amounts and covering the same risks as they maintain with respect to
securities they hold for their own account or for the account of other
customers. This insurance coverage must be at least as comprehensive as
the coverage customarily carried by banks in that local market acting
as custodians.
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\42\ Euroclear maintains a Financial Institution Bond (``FIB'')
in an amount of $155,000,000 per loss up to an annual aggregate
maximum of $310,000,000 to cover losses of securities on premises or
in transit. A separate companion policy written concurrently with
the FIB covering electronic and computer crime (``crime policy'') is
subject to the same per loss and aggregate coverage. For losses
exceeding the FIB and the crime policy, Euroclear maintains an
exceed J-Form Bond in an amount of $340,000,000. For physical loss
or forgery of securities on premises or in transit, Euroclear
maintains coverage in an amount of $500,000,000 per occurrence.
Euroclear also maintains various mail, air courier, and messenger
insurance policies.
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(iv) Information Technology
Euroclear has an information technology division that is charged
with the development and maintenance of its information technology
infrastructure. This division is responsible for software engineering,
application system development, and technical support for both systems
software and the telecommunications networks. It provides
communications help-desk facilities and conducts the day to day
operation of Euroclear's data centers and contingency facilities.
Computer equipment utilized in the operation of the Euroclear
System is located at two data centers and a business recovery facility.
All significant systems include full back-up within Euroclear's
computer center.\43\ Emergency back-up power sources are provided
through an independently sourced and routed main power supply, backed
up by on-site diesel generators and batteries. A contingency center
with a capacity of over 300 critical personnel and a back-up computer
center each located at a different site provides the continuity of
operations in the event of serious malfunctions at Euroclear's computer
center.\44\
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\43\ Euroclear has provided the Commission with a written copy
of its back-up recovery plan.
\44\ In 1995, contingency procedures were further enhanced by
the implementation of a remote dual copy facility that provides for
immediate update of data at both the production and contingency
computer centers.
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[[Page 8237]]
(v) Other Operational Safeguards
Euroclear has substantially similar subcustodian, recordkeeping,
and auditing policies and procedures as those utilized by registered
clearing agencies.\45\ Regarding the safekeeping of securities,
Euroclear deposits all securities deposited in the Euroclear System
with a network of depositories (subcustodians), which consists of major
banks, CSDs and central banks, and some MGT branches.\46\ The
depositories either maintain actual possession of security certificates
or with the prior consent of Euroclear deposit them in local CSDs or
central banks. The standard Euroclear depository agreement requires the
subcustodians to physically segregate any securities certificates held
for Euroclear from any securities certificates held for their own
account or for other customers.\47\
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\45\ For example, Euroclear is generally liable to Euroclear
participants for its own negligent or willful misconduct.
\46\ Generally, Euroclear depositories are liable to Euroclear
for their negligent or willful misconduct and indemnify Euroclear
for such liability. Euroclear is obligated to take steps that it
reasonably deems appropriate to recover any loss to participants
caused by the negligent or willful misconduct of any depository and
pass on any recovery to the affected participants. But Euroclear
does not warrant the performance of its network of depositories.
\47\ In its application for exemption from clearing agency
registration, Euroclear stated that in the nearly thirty years since
Euroclear was established, there has not been a material loss or
theft of securities from the Euroclear System. Euroclear also
advised the Commission in its application that for its proposed
activities involving U.S. government and agency securities,
Euroclear will select a U.S. depository bank for such securities
that is an adequately capitalized and well-managed clearing bank.
The U.S. depository bank in turn would hold its positions through
the Federal Reserve Bank of New York or a U.S. registered clearing
agency.
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c. U.S. and Other Regulatory Oversight. In its capacity as operator
of the Euroclear System, 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 Board. The Federal
Reserve Bank of New York conducts annual on-site examinations in
Brussels and otherwise regulates MGT-Brussels' operations, including
its operation of the Euroclear System. MGT-Brussels also is subject to
the comprehensive supervision of the New York State Banking Department
and the Belgian Banking and Finance Commission and is authorized as a
Service Company by the Securities and Investments Board under the U.K.
Financial Services Act, 1986.
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.\48\ This section contemplates that users of a
clearing agency have a significant voice in the direction of the
affairs of the clearing agency.
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\48\ 15 U.S.C. 78q-1(b)(3)(C).
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Although Euroclear participants do not have the right to appoint
MGT directors or members of Euroclear management, they have the right
to become members of the Belgian Cooperative and can use this
membership to influence the range of Euroclear services and the level
of fees charged to them by Euroclear. The board of directors of the
Belgian Cooperative consists of 23 voting members which are nominated
from Euroclear participant organizations representing various financial
sectors and geographical regions. Euroclear's goal was to fashion a
board with a cross-functional composition in order to ensure that
important strategic and policy issues are viewed with a broad market
perspective.
The board meets four times a year with Euroclear management to
discuss major policy and operational issues regarding the Euroclear
System, including new product development and the level of fees.
Moreover, Euroclear's participants are some of the world's leading
banks, brokers, central banks, and other professional investors which
are able to analyze the risks and benefits of clearing and settling
transactions in the Euroclear System. Accordingly, the Commission
believes that the method in which the Belgian 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.
3. 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.\49\ Section 17A(b)(4)(B) of the Exchange Act states that a
registered clearing agency may deny participation to or condition the
participation of any entity that does not meet the financial
responsibility, operational capability, experience, and competency
standards set forth in the clearing agency's rules.\50\ These criteria
may not be used to discriminate unfairly among entities.\51\
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\49\ 15 U.S.C. 78q-1(b)(3)(B). Section 17A(b)(3)(B) requires
that the rules of a clearing agency provide that any (i) registered
broker or dealer, (ii) other registered clearing agency, (iii)
registered investment company, or (iv) other entities designated by
the Commission may become participants in such clearing agency.
\50\ 15 U.S.C. 78q-1(b)(4)(B).
\51\ 15 U.S.C. 78q-1(b)(3)(H).
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Any organization that demonstrates it meets Euroclear's financial
and operational criteria is eligible to become a Euroclear System
participant. A prospective participant must demonstrate that it has
adequate financial resources for its intended use of the Euroclear
System and the ability to maintain this financial adequacy on an
ongoing basis. It also must demonstrate that it has both the personnel
and technological infrastructure to meet the operational requirements
of the Euroclear System. Furthermore, it must show that it expects to
derive material benefit from direct access to Euroclear and that it is
a reputable firm. However, Euroclear does not require that a
prospective applicant possess a particular regulatory status to become
a Euroclear participant.\52\
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\52\ As an exhibit to its application for exemption from
clearing agency registration, Euroclear submitted a ``Participant
Admissions Newsletter'' dated February 11, 1994 which stated that
Euroclear has revised its admission criteria so as to not require
that an applicant be regulated by a government securities for
banking regulatory authority in order to become a Euroclear System
participant. However, Euroclear also stated that it did not believe
that the types of firms utilizing the Euroclear System would change
significantly due to this revision.
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Although Euroclear's admissions policy does not require regulatory
status for its participants, entities enumerated in Section
17A(b)(3)(B) of the Exchange Act \53\ may become Euroclear System
participant if they meet Euroclear's operational and financial
criteria. The Commission recognize that there is a wide variance in the
level of regulatory control exerted upon Euroclear System participant
by the various participants' home jurisdiction. Accordingly, even if
Euroclear required a particular regulatory status as a condition to
becoming a Euroclear System participant, there would be no assurances
that this would provide more uniform admission or reliable protection
for the Euroclear System, its participants, or investors because of the
disparate levels of oversight. Because each of the enumerated
categories of participants is 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 is satisfied that
[[Page 8238]]
Euroclear's participants standards adequately address the requirements
of Section 17A of the Exchange Act.
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\53\ 15 U.S.C. 78q-1(b)(3)(B).
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4. Dues, Fees, and Charges
Sections 17A(b)(3) (D) and (E) of the Exchange Act provide for the
equitable allocation of reasonable dues, fees, and other charges among
clearing agency participants and prohibits a clearing agency from
imposing or fixing prices for services rendered by its
participants.\54\ Fees charged by Euroclear are generally usage-based,
calculated on a sliding scale (where applicable), and are priced in a
competitive environment with other entities that offer international
clearance and settlement services. Euroclear does not fix any prices,
rates, or fees for services rendered by its participants. Accordingly,
the Commission is satisfied that the method by which Euroclear provides
for the equitable allocation of reasonable dues, fees, and other
charges among its participants and the fact that it does not fix the
prices of the services rendered by its participants adequately
addresses the Exchange Act requirements.
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\54\ 15 U.S.C. 78q-1(b)(3) (D) and (E).
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5. Capacity To Enforce Rules and To Discipline Participants
Section 17A(b)(3)(A) of the Exchange Act requires a registered
clearing agency to have the capacity to enforce compliance by its
participants with its rules.\55\ Furthermore, Sections 17A(b)(3) (G)
and (H) require a registered clearing agency to have in place a system
to discipline its participants for violations of its rules and that the
procedures for applying such rules be fair and equitable.\56\
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\55\ 15 U.S.C. 78q-1(b)(3)(A).
\56\ 15 U.S.C. 78q-1(b)(3) (G) and (H).
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MGT-Brussels, as the operator of the Euroclear System, bilaterally
contracts with each of Euroclear's participants to provide clearance
and settlement and other securities services. Neither MGT nor MGT-
Brussels is a self-regulatory organization (``SRO'') as the term is
defined in Section 3(a)(26) of the Exchange Act.\57\ In particular,
MGT-Brussels does not have any disciplinary authority over Euroclear
participants other than the commercial discipline of refusing to
provide services to those participants that fail to satisfy the terms
of their contractual arrangements with MGT-Brussels regarding the use
of the Euroclear System.
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\57\ 15 U.S.C. 78c(a)(26).
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MGT-Brussels contends that the burdens associated with operating as
a clearing agency through an SRO structure as envisioned under the
Exchange Act would outweigh the benefits of such structure to the U.S.
investing public. MGT-Brussels argues that it is already subject to
significant regulatory oversight by the Federal Reserve Board as a
foreign branch of a U.S. bank and that additional regulation as a U.S.
registered clearing agency would be unnecessarily duplicative without
adding any meaningful investor protection. MGT-Brussels maintains that
it would be extremely difficult for it, as a foreign branch of a U.s.
bank to act as a U.S. SRO and to impose meaningful oversight of
Euroclear's U.S. broker-dealer participants. Moreover, MGT-Brussels
notes that it functions in a multi-currency, cross-border regulatory
environment, with an emphasis on international rather than U.S. markets
which decreases the utility of U.S. regulatory oversight for its
operations.
The Commission is sensitive to the myriad of issues which could
arise in connection with requiring MGT-Brussels, in its capacity as
operator of the Euroclear System, to register as a clearing agency and
to be an SRO. Although Euroclear does not have formal disciplinary
authority over its participants, it can influence its participants'
activities by its admissions and termination policies, as well as
through the credit extension by MGT-Brussels, acting in its separate
banking capacity. Furthermore, if Euroclear fails to assure adequate
compliance by its participants with Euroclear's financial and
operational requirements or if Euroclear or its participants operate in
a way that endangers the safety and soundness of U.S. markets of U.S.
market participants, the Commission can alter or withdraw Euroclear's
exemption.
Therefore, the Commission is satisfied that the goals of Sections
17A(b)(3) (G) and (H) requiring registered clearing agencies to have in
place systems to enforce their rules and to discipline their
participants for violations of their rules are substantially fulfilled
under Euroclear's current structure and by the grant of an exemption.
6. Filing of Proposed Rule Changes
Section 19(b) of the Exchange Act requires registered clearing
agencies to file with the Commission copies of all proposed amendments
or additions to the clearing agencies' rules prior to implementation of
such rule changes.\58\ The Commission is vested with the authority to
approve or disapprove such rule proposals in accordance with Section
19(b) of the Exchange Act, which includes a procedure to solicit public
comment on proposed rule changes. Because Euroclear will not be a
registered clearing agency, it will not be subject to the Section 19(b)
rule change process.
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\58\ 15 U.S.C. 78s(b).
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As discussed earlier, the relationship between Euroclear and each
of its participants is governed by the Terms and Conditions, the
Supplementary Terms and Conditions, and the Operating Procedures.\59\
Participants agree to be bound by the provisions of these documents as
a condition of their participation agreement with MGT-Brussels.
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\59\ Supra note 9.
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Euroclear may amend the Terms and Conditions and the Operating
Procedures at any time upon notice to its participants. In the case of
amendments that do no adversely affect participants, Euroclear
participants are deemed to have agreed to such amendments effective
immediately. All amendments that adversely affect participants are
binding on participants ten business days after dispatch of the
notice.\60\ Euroclear also may amend the Supplementary Terms and
Conditions at any time upon notice to participants. However, all
amendments to the Supplementary Terms and Conditions, regardless of
whether they adversely affect Euroclear's participants, are deemed
effective ten days after notice is given to the Euroclear participants
in accordance with the Terms and Conditions.
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\60\ This delay in effectiveness does not apply to Section 22 of
the Operating Procedures, governing Euroclear's Securities Lending
and Borrowing Program. All amendments to Section 22, whether or not
they adversely affect participants, are deemed to have taken effect
ten days after notice of the amendments is given to participants.
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While these procedures are not the substantive equivalent of the
rule filing procedures of the Exchange Act to which registered clearing
agencies are subject, the Commission believes that it is important that
Euroclear's participants receive notice of changes to the Terms and
Conditions, the Supplementary Terms and Conditions, and the Operating
Procedures. Also, as discussed below in Section IV.C. of this order,
Euroclear will be required to provide the Commission with current
copies of the Terms and Conditions, the Supplementary Terms and
Conditions, and the Operating Procedures and notices of any changes
thereto.
C. Scope of Exemption
This order exempts Euroclear from registration as a clearing agency
under Section 17A of the Exchange Act subject to conditions that the
Commission
[[Page 8239]]
believes are necessary and appropriate in light of the statutory
requirements of the Section 17A objective of promoting a safe and
efficient national clearance and settlement system and in light of
Euroclear's structure and operation. The limitations set forth below
reflect the Commission's determination to take a gradual approach
toward permitting an international, unregistered clearing organization,
such as Euroclear, to perform clearing agency functions for
transactions involving U.S. government and agency securities for U.S.
participants. This exemptive order and the conditions and limitations
contained within are consistent with the Commission's recent order
granting Cedel a conditional exemption from clearing agency
registration.\61\
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\61\ Supra note 33.
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1. Securities Covered by the Exemption
This order grants Euroclear the authority to provide clearance,
settlement, and collateral management services for U.S. participants'
\62\ transactions in (i) Fedwire-eligible \63\ U.S. government
securities,\64\ (ii) mortgage-backed pass through securities that are
guaranteed by the Government National Mortgage Association
(``GNMAs''),\65\ 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 which
are depository eligible securities (collectively, ``eligible U.S.
government securities'').\66\ The Commission believes that this
limitation is necessary and appropriate because it will allow Euroclear
to remain an unregistered clearing agency but will allow it to process
its U.S. participants' transactions in U.S. government and agency
securities, which are extremely liquid and are the most desirable
securities to be utilized as collateral to reduce credit and liquidity
risks of international transactions. In addition, Euroclear may request
that the exemption be broadened to provide securities processing
services for securities other than eligible U.S. government securities.
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\62\ For purposes of this order, ``U.S. participant'' means any
Euroclear System participation having a U.S. residence, based upon
the location of its executive office or principal place of business,
including, without limitation, (i) a U.S. bank (as defined by
Section 3(a)(6) of the Exchange Act), (ii) a foreign branch of a
U.S. bank or U.S. registered broker-dealer, and (iii) any broker-
dealer registered as such with the commission even if such broker-
dealer does not have a U.S. residence.
In the Euroclear notice, the Commission proposed that
transactions of eligible U.S. government securities involving
``affiliates'' of U.S. participants be counted towards the volume
limit. For this purpose, an affiliate was deemed to be any Euroclear
System participant having an arrangement with a U.S. entity that is
known to Euroclear which will prevent a settlement or credit default
with respect to the Euroclear System participant. This provision was
intended to parallel the Cedel exemptive order. But because
Euroclear's operational structure makes it unlikely that Euroclear
System participants would utilize such arrangements, the Commission
believes that it is not necessary to employ the affiliate concept in
the context of this order.
\63\ Fedwire is a large-value transfer system operated by the
Federal Reserve Board that supports the electronic transfer of funds
and of book-entry securities.
\64\ For purposes of this order, ``U.S. government securities''
shall include all ``government securities'' as defined in Section
3(a)(42) of the Exchange Act, 15 U.S.C. 78c(a)(42), except that it
shall not include any (i) foreign-targeted U.S. government or agency
securities or (ii) securities issued or guaranteed by the
International Bank for Reconstruction and Development (i.e., the
``World Bank'') or any other similar international organization.
\65\ GNMAs, unlike the mortgage-backed securities guaranteed by
the Federal National Mortgage Association (``Fannie Maes'') and by
the Federal Home Loan Mortgage Association (``Freddie Macs''), are
issued in certificated form and therefore cannot be transferred over
Fedwire.
\66\ The definition of ``eligible government securities'' as set
forth in this order is intended to parallel the definition of that
term as used in the Cedel exemptive order. The definition as set
forth here is also intended to clarify that, for purposes of both
the Cedel and Euroclear exemptions from clearing agency
registration, the Commission does not intend to capture those
transactions involving securities that technically may fall within
the definition of eligible U.S. government securities, but are
securities which trade principally in non-U.S. markets, such as
foreign-targeted government and agency securities and securities
issued by organizations such as the World Bank.
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2. Volume Limits
The Commission is placing a limit on the volume of transactions in
eligible U.S. government securities conducted by U.S. participants that
can be settled through the Euroclear System. Specifically, the average
daily volume of eligible U.S. government securities settled through the
Euroclear system for U.S. participants may not exceed five percent of
the total average daily dollar value of the aggregate volume in
eligible U.S. government securities.\67\ For purposes of this order,
eligible U.S. government securities transactions settled through the
Euroclear System will include (i) internal settlements \68\ of
transactions involving eligible U.S. government securities if a U.S.
participant is on at least one side of the transaction; (ii) Bridge
settlements \69\ with Cedel where a U.S. participant is on the
Euroclear side of the transaction; and (iii) external settlements where
a U.S. participation is on the Euroclear side of the transaction.\70\
Transactions involving the return of securities collateral, securities
substitutions in triparty repo or other collateral or financing
arrangements, and securities realignments where the same U.S.
participant is on both sides of the transaction will not be considered
to be transactions settled through the Euroclear System and
consequently will not be subject to the volume limit.\71\
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\67\ In the orders granting Cedel and CCOS exemptions from
clearing agency registration, the Commission imposed volume limits
on those entities. The CCOS exemptive order contained volume
limitations of US $6 billion average net daily settlement for U.S.
government securities and US $24 billion average net daily
settlements for repurchase agreements in U.S. government securities.
At that time, the CCOS volume limits were designed to limit CCOS's
activity to approximately five percent of the average daily dollar
value of transactions in U.S. government securities and in
repurchase agreements involving U.S. government securities. In the
Cedel exemptive order, the Commission determined that a percentage-
based formula was more appropriate. Consequently, Cedel's volume
limitation is 5% of the total average daily dollar value of the
aggregate volume in eligible U.S. government securities.
\68\ Supra Section II.A.
\69\ Id.
\70\ Pursuant to the reporting requirements described below, the
Commission expects to receive, among other things, gross
transactional volumes regarding all transactions in eligible U.S.
government securities processed by the Euroclear System (i.e.,
whether or not a U.S. participant is involved). In addition, the
Commission expects to monitor the effects such transactions may have
on U.S. markets and U.S. market participants.
\71\ The delivery of eligible U.S. government securities in
either a new or an open triparty repo, collateral, or financing
transaction (collectively, ``repo transactions''), will be treated
as a ``substitution'' and therefore will not be subject to the
volume limit unless it is the first delivery of such securities.
Accordingly, if eligible U.S. government securities are delivered at
the opening of any repo transaction, the initial delivery will count
towards the volume limit but subsequent substitutions of eligible
U.S. government securities will not. Similarly, if other securities
are delivered at the opening of a repo transaction and eligible U.S.
government securities are later substituted for such securities, the
initial delivery of such eligible U.S. government securities will
count towards the volume limit, but subsequent substitutions of
eligible U.S. government securities will not.
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The total average daily dollar value of eligible U.S. government
securities volume will be determined semiannually as the sum of (1) the
average daily transaction value of all Fedwire eligible book-entry
transfers originated on Fedwire as provided to the Commission by the
Federal Reserve Board, (2) the average daily value of all compared
trades in eligible U.S. government securities as provided to the
Commission by the Government Securities Clearing Corporation
(``GSCC''),\72\ (3) the average daily value
[[Page 8240]]
of all compared trades less the netted value of all such compared
trades plus the average daily volume of all trade-for-trade
transactions (i.e., trades not included in the netting system) in
eligible government securities as provided by MBS Clearing Corporation,
(4) the average daily gross settlement value in eligible U.S.
government securities as provided to the Commission by the Participants
Trust Company, and (5) the average daily dollar value of compared
trades in eligible U.S. government securities from any other source
that the Division deems appropriate to reflect the aggregate volume in
eligible U.S. government securities.
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\72\ In the Cedel exemptive order, the Commission determined
that the portion of the volume limit applicable to Cedel that is
derived from GSCC's trade comparison data should be the average
daily value of all compared trades less the netted value of such
trades. This was done to avoid double-counting the netted
transactions with those already accounted for in the reported
Fedwire volume. After further study and discussions with industry
representatives, the Commission has found that a significant number
of the GSCC netted transactions do not pass across Fedwire but
rather are processed internally through clearing banks such as the
Bank of New York and the Chase Manhattan Bank. Consequently, the
Commission now believes that because the risk of double-counting is
small, it is more appropriate to utilize GSCC's gross average daily
value of all compared trades to calculate the volume limit for
eligible U.S. government securities applicable to Euroclear. The
Commission will amend the Cedel exemptive order in the near future
to permit Cedel to calculate its volume limit in accordance with the
method set forth in the order that is applicable to Euroclear.
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The Commission believes that the volume limit is appropriate in
that it is large enough to allow Euroclear to commence operations in
clearing and settling eligible U.S. government securities transactions
involving U.S. participants and to allow the Commission to observe the
effects of Euroclear's activities on the U.S. government securities
market. Likewise, the Commission believes that the volume limit is
sufficiently small in scope so that the safety and soundness of the
U.S. government securities markets should not be compromised if
Euroclear, MGT-Brussels, or any Euroclear participant experiences
financial or operational difficulties.
3. Commission Access to Information
To facilitate the monitoring of compliance with the volume limit
and the impact of Euroclear's operations on the U.S. government
securities market under this order, Euroclear will be required to
provide certain information to the Commission as a continuing condition
of its exemption.\73\ Specifically, Euroclear will be required 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. above and
(2) the average daily volume of transactions in eligible U.S.
government securities for all Euroclear System participants, whether or
not subject to the volume limit.\74\
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\73\ The Division also will have available to it the annual
reports on Form 10-K and the quarterly reports on Form 10-Q filed
with the Commission by J.P. Morgan & Co. Incorporated, MGT's parent.
Furthermore, Euroclear has represented that the Commission will be
permitted to observe Euroclear System operations and to talk to
Euroclear personnel on-site if the Commission so requests.
\74\ In the Euroclear notice, the Commission proposed that
Euroclear provide monthly the aggregate volume of all transactions
in eligible U.S. government securities. Under the terms of the Cedel
exemptive order, the Commission also required Cedel to provide this
information on a monthly basis. After reviewing Cedel's monthly
reports, the Commission has determined that the average daily volume
of eligible U.S. government securities, reported quarterly, would be
a more useful reporting format and will provide the Commission with
adequate information regarding transaction volumes for monitoring
purposes. The Commission will amend the Cedel exemptive order in the
near future to permit Cedel to provide average daily volume of
transactions in eligible U.S. government securities on a quarterly
basis in accordance with the reporting requirements set forth in
this order that are applicable to Euroclear.
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Furthermore, Euroclear is required to promptly provide to the
Commission the following documents (``disclosure documents'') when made
available to Euroclear System participants:
(1) any amendments to or revised editions of (a) the Terms and
Conditions, (b) the Supplementary Terms and Conditions Governing the
Lending and Borrowing of Securities through Euroclear, and (c) the
Operating Procedures of the Euroclear System;
(2) the annual report to shareholders of the Belgian
Cooperative; and
(3) the annual report on the internal controls, policies and
procedures of the Euroclear System (``SAS-70 Report'').\75\
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\75\ Euroclear must amend its Form CA-1 with respect to any
changes to the information reported at items 1, 2, and 3 of its Form
CA-1 to the extent that such changes are not reported in the
disclosure documents.
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In addition, Euroclear 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 as summarized in
this order and in its Form CA-1 dated March 4, 1997, or in any
subsequently filed amended Form CA-1, which would make the information
in this order or in its Form CA-1 incomplete or inaccurate.\76\ This
method of notifying the Commission of proposed changes at Euroclear
will assist the Commission in its overall review of Euroclear and its
operations.\77\
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\76\ Only that portion of the Euroclear application on Form CA-1
affected by any such change must be filed with the Commission as an
amendment. A resubmission of the entire Form CA-1 is not required.
\77\ Neither the requirement to submit the disclosure documents
nor the requirement to amend its Form CA-1 will be applicable to
MGT-Brussels in its separate banking capacity and not as operator of
the Euroclear System.
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As a continuing condition to the exemption, Euroclear is also
required to notify the Commission regarding material adverse changes in
any account maintained by Euroclear for its U.S. participants.\78\ In
addition, Euroclear will be required to respond to a Commission request
for information about any U.S. participant about whom the Commission
has financial solvency concerns, including, for example, a settlement
default by a U.S. participant.\79\
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\78\ For purposes of this order, the term ``material adverse
changes'' will include (i) the termination of any U.S. participant;
(ii) the liquidation of any securities collateral pledged by a U.S.
participant to secure an extension of credit made through the
Euroclear System; (iii) the institution of any proceedings to have a
U.S. participant declared insolvent or bankrupt; or (iv) the
disruption or failure in whole or in part in the operations of the
Euroclear System either at its regular operating location or at its
contingency center.
\79\ If an information request relates to a U.S. participant
that is a ``bank,'' as such term is defined in Section 3(a)(6) of
the Exchange Act, 15 U.S.C. 78c(a)(6), the Commission will, if
necessary, coordinate with the ``appropriate regulatory agency,'' as
such term is defined in Section 3(a)(34) of the Exchange Act, 15
U.S.C. 78c(a)(34).
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4. Modification of Exemption
The Commission may modify by order the terms, scope, or conditions
of Euroclear's exemption from registration as a clearing agency 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.\80\
Furthermore, the Commission may limit, suspend, or revoke this
exemption if the Commission finds that Euroclear has violated or is
unable to comply with any of the provisions set forth in this order if
such action is necessary or appropriate in the public interest, for the
protection of investors, or otherwise in furtherance of the purposes of
the
[[Page 8241]]
Exchange Act for the protection of investors and the public interest.
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\80\ The exemption provided by this order is based upon
representations by Euroclear, its officers and attorneys, facts
contained in the Euroclear application, and other information known
to the Commission regarding the substantive aspects of Euroclear's
proposal (collectively, ``representations and facts''). Any changes
in the representations or facts as presented to the Commission may
require a modification of this order. Responsibility for compliance
with all applicable U.S. securities laws rests with Euroclear and
its U.S. participants, as appropriate. Euroclear also is advised
that this order does not exempt Euroclear 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 Euroclear's application for exemption
from registration as a clearing agency 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 application for exemption from registration as a
clearing agency filed by Morgan Guaranty Trust Company of New York,
Brussels Office, as operator of the Euroclear System (File No. 601-01)
be, and hereby is, approved subject to the conditions contained in this
order.
By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-3997 Filed 2-17-98; 8:45 am]
BILLING CODE 8010-01-M
