[Federal Register Volume 62, Number 94 (Thursday, May 15, 1997)]
[Notices]
[Pages 26833-26840]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-12751]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-38589; International Series Release No. 1077; File No.
601-01]
Self-Regulatory Organizations; Morgan Guaranty Trust Company of
New York, Brussels Office, as Operator of the Euroclear System; Notice
of Filing of Application for Exemption From Registration as a Clearing
Agency
May 9, 1997.
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''), filed with the Securities and Exchange Commission
(``Commission'') an application on Form CA-1 \2\ for exemption from
registration as a clearing agency pursuant to Section 17A of the
Securities Exchange Act of 1934 (``Exchange Act'') \3\ and Rule 17Ab2-1
thereunder \4\ to the extent it performs the functions of a clearing
agency with respect to U.S. government and agency securities \5\ for
U.S. participants of the Euroclear System.\6\ The Commission is
publishing this notice to solicit comments from interested persons.\7\
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\1\ For purposes of this notice, the term ``Euroclear'' refers
to MGT-Brussels in its capacity as operator of the Euroclear System.
For a complete description of the structure of the Euroclear System,
see Section II.
\2\ Copies of the application for exemption are available for
inspection and copying at the Commission's Public Reference Room.
\3\ 15 U.S.C. 78q-1.
\4\ 17 CFR 240.17Ab2-1.
\5\ For purposes of its application, Euroclear proposes to
define U.S. government and agency securities to include (i)
``government securities'' as defined by Section 3(a)(42) of the
Exchange Act (other than foreign-targeted U.S. government and agency
securities and securities issued or guaranteed by an international
organization such as the World Bank, which Euroclear classifies as
internationally-traded securities that have been accepted for
clearance and settlement in the Euroclear System for many years
under circumstances that Euroclear believes cause its activities
with respect to such securities to fall outside the scope of Section
17A of the Exchange Act and (ii) mortgage-backed securities and
collateralized mortgage obligations issued or guaranteed by the
Federal Home Loan Mortgage Corporation (``FHLMC''), the Federal
National Mortgage Association (``FNMA''), or the Government National
Mortgage Association (``GNMA'').
\6\ The Commission has been advised that MGT-Brussels is
permitted to seek an exemption from clearing agency registration
regarding its operation of the Euroclear System and that no further
authorization from the Board of Directors of the Belgian Cooperative
is required. Letter from Dr. Rolf-Ernst Breuer, Chairman of the
Board of the Belgian Cooperative (March 6, 1997).
MGT itself does not seek an exemption from registration as a
clearing agency to the extent it performs the functions of a
clearing agency with respect to U.S. government or agency
securities. Sections 3(a)(23)(B) of the Exchange Act provides that a
bank as defined under Section 3(a)(6) of the Exchange Act is
excluded from the definition of the term clearing agency if it would
be deemed to be a clearing agency solely by reason of functions
performed by such institution as part of customary banking
activities. MGT believes that as a bank it has the authority to
perform clearing agency functions as part of its customary banking
activities for U.S. government and agency securities outside the
Euroclear context without registering with the Commission as a
clearing agency or otherwise complying with Exchange Act provisions
applicable to clearing agencies generally. Because MGT is not
seeking an exemption from clearing agency registration for its
activities outside the operation of the Euroclear System, the
Commission is not addressing this issue.
\7\ The descriptions set forth in this notice regarding the
structure and operations of the Euroclear System, MGT-Brussels, and
MGT have been largely derived from information contained in MGT-
Brussels' Form CA-1 application and publicly available sources.
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II. Structure of the Euroclear System
MGT is a banking corporation organized under the laws of the State
of New York. MGT-Brussels is the Brussels branch of MGT. MGT-Brussels
is a division 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. Senior management of the Euroclear
Operations Centre makes the decisions regarding the day-to-day
operation of the Euroclear System.
The Euroclear System was established in 1968 by MGT-Brussels, which
was then both its owner and operator. In 1972, a package of rights
described as the Euroclear System was sold to Euroclear Clearance
System Public Limited Company, an English limited liability company
(``ECS-PLC''). The goal of the sale was to broaden the international
market's participation in the formulation of general policy for the
Euroclear System. MGT-Brussels was retained as operator of the
Euroclear System. 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.
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 and to exercise such
rights in relation to MGT-Brussels pursuant to an Operating Agreement.
Neither ECS-PLC nor the Belgian Cooperative is an operating company.
MGT-Brussels maintains all Euroclear System participant accounts on its
own books, has established all subcustody accounts with Euroclear
System subcustodians in its own name, and maintains all of the
contractual relationships with Euroclear System participants and
Euroclear System depositaries in its own name. It also provides all of
the personnel, systems, trademarks, and operational capability used to
deliver the Euroclear System services to Euroclear System participants.
ECS-PLC and the Belgian Cooperative exercise their rights against MGT-
Brussels through their respective Boards of Directors (collectively,
``Euroclear Boards''), which are composed of senior executives from
large financial institutions. The Euroclear Boards meet four times a
year to make policy decisions, such as setting admissions policy,
determining categories of securities accepted, approving depositories,
setting fees and
[[Page 26834]]
rebates, and approving major service developments. The Euroclear Boards
are not involved in the day-today operation of the Euroclear System.
MGT-Brussels, as operator of the Euroclear System, is regulated by
the Belgian Banking and Finance Commission, the Board of Governors of
the Federal Reserve System of the United States, and the New York State
Banking Department. Examinations of MGT-Brussels may be performed by
examiners from these regulatory agencies. In addition, MGT-Brussels has
an external auditor that reports to the Belgian Banking and Finance
Commission and the Audit Committee of MGT. In its capacity as operator
of the Euroclear System, MGT-Brussels is also authorized as a service
company by the Securities and Investment Board under the United Kingdom
Financial Services Act, 1986.
III. Description of Euroclear System Operations
Euroclear provides several services to its participants, including
securities clearance and settlement, securities lending and borrowing,
and custody.\8\
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\8\ 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 the
Operating Procedures of the Euroclear System and other supplementary
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 who are not members of the Euroclear System or of 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 \9\ involving non-U.S. government securities.\10\ 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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\9\ 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 manage market and operational risks. For example, a credit
seeker that is long securities can reduce its financing costs by
entering into a repo with a credit giver (i.e., selling the
securities to the credit giver subject to an agreement to repurchase
the securities at a future date). A credit seeker can also reduce
its financing costs or increase its borrowing capacity by pledging
the securities to a credit giver.
\10\ Government securities issued in the domestic markets in 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. Clearance and Settlement of Trades Between Participants in the
Euroclear System
Transactions between Euroclear System participants in the Euroclear
System can be settled against payment or free of payment. Simultaneous
delivery versus payment (``DVP'') also is provided for settlements
against payment between Euroclear System participants. Upon 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 the participant (e.g., transfers between accounts
maintained by a single participant). Matching of an instruction is
attempted until it is either matched or cancelled.
Internal settlement of DVP 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.\11\
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\11\ 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. Clearance and Settlement of Trades Between a Participant in the
Euroclear System and a Cedel Member
Participants also can send instructions authorizing receipt and
delivery of securities between the Euroclear System and the Cedel
system, both free of payment and against payment. Simultaneous DVP is
possible for settlement of Euroclear System 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, prematching 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.
The bridge 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
occurring when the receiving clearance system confirms acceptance of a
proposed delivery and that confirmation is received by the delivery
clearance system.
3. Clearance and Settlement of Trades Between a Participant in the
Euroclear System and a Counterparty in a Local Market
Participants also can send instructions authorizing receipt and
delivery of securities free of payment and against payment between the
Euroclear System and certain domestic markets' clearance and settlement
[[Page 26835]]
structures. Where participants are expecting to receive or deliver
securities outside the Euroclear System or Cedel, instructions are
matched where possible in accordance with local market rules and
procedures. Notification of matching in the local market is received by
Euroclear from the local depositary. Instructions to deliver securities
outside the Euroclear System are sent to the depositary having custody
of the securities to forward the securities to the location designated
by the counterparty or move the securities by book-entry transfer in
the local clearance system.\12\
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\12\ 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 depositaries. All securities held by a depositary 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. Depositaries receive instructions regarding the movement of
Euroclear System securities directly from Euroclear. Euroclear
participants do not directly deal with depositaries regarding the
settlement of securities transactions within the Euroclear System or
the custody of securities. See Section III.C infra.
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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, a intermediary (i.e., depositary) is used to
perform Euroclear System settlement activities in the local market.\13\
For different instruments in certain markets, Euroclear may have both
direct and indirect links.
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\13\ Transactions with these counterparts are performed on a
book-entry basis in the local clearing system, depositary, or
authorized sub-custodian, or on the basis of a physical delivery.
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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 pool.\14\ With reserved lending and
borrowing, there is a linkage between the borrower and the lender, but
the counterparty's identities are not disclosed.\15\ Consequently, with
both standard and reserved lending and borrowing, borrowers' names and
lenders' names are never revealed to one another.
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\14\ 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 processing. 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 processing. Subsequent to each overnight
securities settlement processing, 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 process, opportunity standard lenders may be contacted by
Euroclear to make additional securities available for borrowing.
\15\ 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 the borrowing requirement and 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
Securiites held by Euroclear participants are held through a
network of depositaries. Depositaries may hold securities on their
premises or deposit these securities with subcustodians or with local
clearance systems. Depositaries of the Euroclear System may include
custodian banks, including some MGT branches, central banks, local
clearance systems, and Cedel. Depositaries are selected based upon
their custody capabilities, financial stability, and reputation in the
financial community. All depositaries and subdepositaries are appointed
with the approval of the Board of the Belgium Cooperative 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 (``Chase'') currently acts as the Euroclear
System's depositary 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 (``DTC'') or
by electronic book-entries on the records of a Federal Reserve
Bank.\16\
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\16\ Euroclear does not believe that its traditional business of
clearing and settling transactions in foreign and internationally-
traded securities comes within the scope of the registration
requirements of Section 17A of the Exchange Act and therefore is not
seeking exemptive relief with respect to such business. For this
purpose, foreign and internationally-traded securities include debt
and equity securities issued by foreign private and governmental
issuers that trade principally in their home markets and/or
internationally, (including foreign domestic debt and equity
securities, Yankee bonds, securities issued by international
organizations such as the World Bank, American and global depositary
shares, and securities denominated or settled in a currency other
than U.S. dollars), as well as Euro and globally-distributed debt
securities and global depositary shares issued by U.S. issuers in a
registered international offering or pursuant to provisions of the
Securities Act of 1933 and the rules and regulations thereunder,
including Regulation S (17 CFR 230.901), Section 4(2) (15 U.S.C.
77d(2)), Rule 144A (17 CFR 230.144A), or some other exemption
(including foreign-targeted U.S. Government and agency securities).
U.S. domestic debt and equity securities are not currently eligible
for clearance and settlement in the Euroclear System.
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Securities deposited in the Euroclear System may be in either
physical (bearer or registered) or dematerialized form. Securities are
held on the books of a depositary in an account in the name of MGT-
Brussels as operator of the Euroclear System. Where the depositary also
is not the local clearing system, securities may be deposited in the
local clearance system where the depositary is located.
All securities accepted by a depositary are credited to a
segregated custody account in the name of MGT-Brussels as operator of
the Euroclear System at the depositary or local clearance system, or to
the depositary's account at the local clearance system.
Each Euroclear System participant has one or more securities
clearance account(s) with associated transit accounts. Securities held
by participants
[[Page 26836]]
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, 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.
D. Banking Services
MGT-Brussels provides certain banking services to Euroclear
participants, acting in its separate banking capacity and not as
operator of the Euroclear System. Banking services provided include:
provision of credit to Euroclear System participants, triparty repo
\17\ and collateral monitoring, and securities lending guarantee.
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\17\ 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 at a specified 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 generally are 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 such securities. In a limited number of
circumstances, MGT-Brussels may agree to permit pledging of client
securities, or the securities of related parties, where the
participant's legal and regulatory regime permits, appropriate legal
opinions are delivered, and certain other conditions are met.
The valuation of securities held in participants's pledged
securities clearance accounts to secure credit extensions from MGT-
Brussles is derived from the market value of the securities pledged,
adjusted according to the type of instrument, currency, the rating of
the issue, the issuer, and the country of the issuer. For debt
securities, accrued interest is added to market value 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.
E. Liens, Rights, and Obligations
In addition to any pledge of specific accounts agreed to by a
participant due to extensions of credit, all assets held in the
Euroclear System are subject to rights of set-off and retention.
Furthermore, participants's 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.\18\ Participants also are subject to
certain obligations toward Euroclear including obligations to cover any
cash or securities debit balances that participants may incur.
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\18\ Article 41 of the Belgian Law of April 6, 1995.
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IV. Euroclear's Request for Exemption
A. Introduction
U.S. government and agency securities are the securities of choice
for cross-border collateral and other transactions. Euroclear does not
currently provide participants with the means to acquire, hold,
transfer, or pledge interests in U.S. government or agency securities
in the Euroclear System. In its exemption request, Euroclear therefore
seeks an exemption from registration as a clearing agency pursuant to
Section 17A of the Exchange Act and Rule 17Ab2-1 thereunder to the
extent it performs the functions of a clearing agency with respect to
U.S. government and agency securities for U.S. participants of the
Euroclear System.
Section 17A of the Exchange Act directs the Commission to promote
Congressional objectives to facilitate the development of a national
clearance and settlement system for securities transactions.\19\
Registration of clearing agencies is a key element of the regulation of
clearing agencies in promoting these statutory objectives. 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 the clearing agency's organization,
capacity, and rules.\20\ The Commission has published the standards
applied by its Division of Market Regulation in evaluating applications
for clearing agency registration.\21\ These requirements are designed
to assure the safety and soundness of the clearance and settlement
system.
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\19\ 15 U.S.C. 78q-1. Section 17A(a)(1) provides:
(1) The Congress finds that--
(A) The prompt and accurate clearance and settlement of
securities transactions, including the transfer of record ownership
and the safeguarding of securities and funds related thereto, are
necessary for the protection of investors and persons facilitating
transactions by and acting on behalf of investors.
(B) Inefficient procedures for clearance and settlement impose
unnecessary costs on investors and persons facilitating transactions
by and acting on behalf of investors.
(C) New data processing and communications techniques create the
opportunity for more efficient, effective, and safe procedures for
clearance and settlement.
(D) The linking of all clearance and settlement facilities and
the development of uniform standards and procedures for clearance
and settlement will reduce unnecessary costs and increase the
protection of investors and persons facilitating transactions by and
acting on behalf of investors. For legislative history concerning
Section 17A, See, e.g., Report of Senate Comm. on Housing and Urban
Affairs, Securities Acts Amendments of 1975: Report to Accompany S.
249, S. Rep. No. 75, 94th Cong., 1st Sess. 4 (1975); Conference
Comm. Report to Accompany S. 249, Joint Explanatory Statement of
Comm. of Conference, H.R. Rep. No. 229, 94th Cong., 1st Sess., 102
(1975).
\20\ 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.
\21\ 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
[[Page 26837]]
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.\22\
\22\ 15 U.S.C. 78q-1(b)(1).
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The Commission reviews every application for exemption against the
standards for clearing agency registration.
Euroclear notes that the Commission previously has 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.\23\ The
Commission also has published notice of an application by Cedel to
amend its exemption from registration as a clearing agency to the
extent it performs the functions of a clearing agency for U.S. domestic
debt and equity securities.\24\
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\23\ Securities Exchange Act Release Nos. 36573 (December 12,
1995), 60 FR 65076 (CCOS) and 38328 (February 24, 1997), 62 FR 9225
(Cedel). The Commission also has granted temporary registration and
partial exemptions from certain provisions of Section 17A to the
Government Securities Clearing Corporation (``GSCC''), Participants
Trust Company (``PTC''), MBS Clearing Corporation (``MBSCC''), Delta
Clearing Corp. (``Delta''), and the International Securities
Clearing Corporation (``ISCC''). Securities Exchange Act Release
Nos. 37983 (November 25, 1996), 61 FR 64183 (GSCC); 38452 (March 28,
1997), 62 FR 16638 (PTC); 37372 (June 26, 1996), 61 FR 35281
(MBSCC); 38224 (January 31, 1997), 62 FR 5869 (Delta); and 37986
(November 25, 1996), 61 FR 64184 (ISCC). In granting these temporary
registrations it was expected that the subject clearing agencies
would eventually apply for permanent clearing agency registration.
\24\ Securities Exchange Act Release No. 38329 (February 24,
1997), 62 FR 9222.
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Euroclear believes that providing it with an exemption from
clearing agency registration would produce substantial benefits to its
participants, would provide U.S. investors and the U.S. national
clearance and settlement system with the same level of protection
against custody, clearance, and settlement risks that full registration
would provide, and would otherwise satisfy the statutory requirements
for an exemption.
B. Participant Benefits
Euroclear believes that the proposed exemption would promote the
U.S. public interest by reducing risk to credit providers and by
reducing costs to credit seekers. Euroclear believes that it is
currently too costly for many international credit providers and credit
seekers to use U.S. government or agency securities to reduce credit
and liquidity risks in a number of international transactions.\25\ As a
result, credit providers currently receive lower quality collateral or
remain unsecured and are subject to a higher level of credit or
liquidity risks in many international transactions. Credit seekers are
subject to higher credit costs and lower credit limits than they would
be if they used U.S. government or agency securities as collateral.
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\25\ Euroclear has advised the Commission in its Form CA-1 that
time zone differences between where a transaction occurs for which
credit support is required and the U.S. (i.e., where transactions in
U.S. government securities are settled) make it too costly to
synchronize transactions in a way to utilize U.S. government
securities to collateralize transactions that give rise to credit or
liquidity risks. Furthermore, Euroclear believes that the lack of a
securities intermediary with a critical mass of both securities and
customers makes it too costly to have U.S. government securities in
the right place at the right time to reduce such credit and
liquidity risks.
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Euroclear believes that if international credit providers suffer
substantial losses or fail because of this condition, it could have
repercussive effects in the United States because of the growing
interdependency among the world's financial markets. Euroclear further
believes that credit seekers from the United States also could face
higher credit costs and lower credit limits at home and abroad because
of the growing interdependency in worldwide financial markets.
Euroclear believes that allowing its system to provide clearance
and settlement services for interests in U.S. government and agency
securities to U.S. entities would reduce these transaction costs and
therefore would reduce the costs and risks of international financial
transactions.
Euroclear also believes that the proposed exemption would promote
the U.S. public interest by increasing competition in the provision of
clearance and settlement services for U.S. government and agency
securities. Euroclear maintains that greater competition can be
expected to result in lower costs and greater innovation by both U.S.
and international clearing agencies.
C. Formal Registration Unnecessary or Inappropriate
Euroclear believes that formal registration would subject it to
substantial additional regulatory burdens without producing any
material benefits for the U.S. public related to the fundamental goal
of safe and sound custody, clearance, and settlement.\26\ Euroclear
further believes that it would be a substantial and unnecessary burden
to require it to regulate the actions of U.S. brokers and dealers,
which it believes are already adequately regulated by the U.S. national
securities exchanges, the NASD, and the Commission itself. Euroclear
also believes that it would not have any market power over the custody,
clearance, or settlement of U.S. government or agency securities and in
fact would operate in a highly competitive, private sector environment.
Finally, Euroclear believes that the recordkeeping, fingerprinting, and
other requirements of Section 17 are effectively satisfied by the
substantially similar recordkeeping, reporting, and other requirements
of U.S. Federal, New York State, and Belgian banking laws.\27\
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\26\ For example, registered clearing agencies are required to
assume the rights and responsibilities of a self-regulatory
organization (``SRO''), including the responsibility to police the
actions of U.S. brokers, dealers, and other securities
intermediaries, and to submit each of its proposed rule changes to
the Commission. Euroclear believes that the rights and
responsibilities of an SRO were designed primarily for U.S. national
securities exchanges, like the New York Stock Exchange and the
American Stock Exchange, and U.S. national securities associations,
like the National Association of Securities Dealers (``NASD''), and
were extended to registered clearing agencies mainly because the
major clearing agencies at the time Section 17A was enacted were
subsidiaries of national securities exchanges or other SROs.
\27\ See e.g., 12 CFR Part 208 (Membership of State Banking
Institutions in the Federal Reserve System [Regulation H]).
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D. Safety and Soundness Protections
Sections 17A(b) (3) (A) and (F) of the Exchange Act require a
clearing agency be organized and its rules be designed to facilitate
the prompt and accurate clearance and settlement of securities
transactions for which it is responsible and to safeguard securities
and funds in its custody or control or for which it is responsible.\28\
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\28\ 15 U.S.C. 78q-1(b) (3) (A) and (F).
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Euroclear has represented to the Commission that its financial
condition, operational safeguards, and the extent to which it is
already subject to substantial U.S. regulatory oversight will provide
U.S. investors and the U.S. national clearance and settlement system
with the same level of protection against custody, clearance, and
settlement risks that full registration would provide.
1. Financial Condition
Euroclear has advised that Commission that MGT, which ultimately is
the entity fiscally responsible for operations of the Euroclear System,
is a U.S. bank that it is ``well-capitalized'' and ``well-managed'' as
those terms are defined under applicable U.S. Federal banking
[[Page 26838]]
regulations.\29\ MGT has represented to the Commission that it has over
$13.5 billion in total capital and a total capital ratio of more than
11 percent \30\ and access to billions of dollars of additional
liquidity in the capital markets. Its senior debt is rated AAA by
Standard & Poor's \31\ and its long-term debt is rated Aa-1 by Moody's
Investors Services.\32\
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\29\ 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'').
\30\ 12 CFR Part 208, Appendix A (defining total capital as the
sum of ``tier 1'' and ``tier 2'' capital and total capital ratio as
total capital divided by total risk-weighted assets).
\31\ Standard & Poor's, ``Morgan (J.P.) & Company Inc.,'' Bank
Ratings Analysis, April 1997, at 1.
\32\ 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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Euroclear states that the financial condition of each of the
securities intermediaries through which it would hold its positions in
U.S. government and agency securities on behalf of Euroclear
participants is similarly strong. It would hold its positions through
an adequately-capitalized and well-managed U.S. bank, which would in
turn hold matching positions through the Federal Reserve Bank of New
York or PTC.
2. Operational Safeguards
Euroclear believes that it has substantially similar subcustodian,
recordkeeping, and auditing policies and procedures as those utilized
by registered clearing agencies. MGT-Brussels is subject to annual on-
site examinations by the Federal Reserve Bank of New York and to
periodic examinations by the New York State Banking Department and the
Belgian Banking and Finance Commission. Euroclear also represents to
the Commission that it has a leading-edge information technology
division and sophisticated contingency recovery facilities and
maintains substantial insurance against the loss or theft of physical
securities.
3. U.S. Federal and Other Regulatory Oversight
MGT-Brussels, as operator of the Euroclear System, is a division of
the foreign branch of a U.S. bank and, accordingly, is subject to the
comprehensive supervision and regulation of the Board of Governors of
the Federal Reserve System. As noted above, 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 Investment Board under the U.K. Financial
Services Act, 1986.
E. Fair Representation
Section 17A(b)(3)(C) of the Exchange Act requires that the rules of
a clearing agency provide for fair representation of the clearing
agency's shareholders or members and participants in the selection of
the clearing agency's directors and administration of the clearing
agency's affairs. This section contemplates that users of a clearing
agency have a significant voice in the direction of the affairs of the
clearing agency.
Although Euroclear participants do not have the right to appoint
MGT directors or members of the Euroclear management, they all have the
right to become members of the Belgian Cooperative and can use such
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, 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 believes that its participants are some of
the world's leading banks, brokers, central banks, and other
professional investors who are able to analyze the risks and benefits
of clearing and settling transactions in the Euroclear System and to
choose competitive substitutes for settling transactions in U.S.
government or agency securities if they are not satisfied with the mix
of risks and benefits in the Euroclear System.
F. Participant Standards
Section 17A(b)(3)(B) of the Exchange Act enumerates certain
categories of persons that a clearing agency's rules must authorize as
potentially eligible for access to clearing agency membership and
services. Section 17A(b)(4)(B) of the Exchange Act contemplates that a
registered clearing agency have financial responsibility, operational
capability, experience, and competency standards that are used to
accept, deny, or condition participation of any participant or any
category of participants enumerated in Section 17A(b)(3)(B), but that
these criteria may not be used to unfairly discriminate among
participants. In addition, the Exchange Act recognizes that a clearing
agency may discriminate among persons in the admission to or the use of
the clearing agency if such discrimination is based on standards of
financial responsibility, operational capability, experience, and
competence.
Any broker-dealer, clearing agency, investment company, bank,
insurance company, or other professional investor that demonstrates it
meets Euroclear's financial and operational criteria may become a
Euroclear System participant. They must demonstrate that they have
adequate financial resources for their intended use of the Euroclear
System and the ability to maintain this financial strength on an
ongoing basis. They also must demonstrate that they have both the
personnel and technological infrastructure to meet the operational
requirements of the Euroclear System. Furthermore, they must show that
they expect to derive material benefit from direct access to Euroclear
and that they are reputable firms.
V. Proposed Exemption
A. Statutory Standards
As noted above, Section 17A of the Exchange Act directs the
Commission to develop a national clearance and settlement system
through, among other things, the registration and regulation of
clearing agencies.\33\ In fostering the development of a national
clearance and settlement system generally and in overseeing clearing
agencies in particular, Section 17A authorizes and directs the
Commission to promote and facilitate certain goals with due regard for
the public interest, the protection of investors, the safeguarding of
securities and funds, and the maintenance of fair competition among
brokers, dealers, clearing agencies, and transfer agents.
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\33\ 15 U.S.C. 78q-1.
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Section 17A(b)(1) authorizes the Commission to exempt applicants
from some or all of the requirements of Section 17A if it finds such
exemptions are 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. The Commission has exercised its
[[Page 26839]]
authority to exempt an applicant entirely from clearing agency
registration on two prior occasions and has granted temporary clearing
agency registrations that included exemptions from specific Section 17A
statutory requirements on five previous occasions.\34\
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\34\ Supra note 23 and accompanying text.
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As discussed above, applicants requesting exemption from clearing
agency registration are required to meet standards substantially
similar to those required of registrants under Section 17A in order to
assure that the fundamental goals of Section 17A (e.g., safe and sound
clearance and settlement) are furthered. Therefore, the Commission
invites commenters to address whether granting MGT-Brussels'
application, as operator of the Euroclear System, for exemption from
clearing agency registration, subject to the conditions set forth
below, would further the goals of Section 17A.
B. Conditions
The Commission would expect to impose two types of conditions on
the operation of the Euroclear System in conjunction with the grant of
any exemption from clearing agency registration: limits on the volume
of transactions in U.S. government and agency securities \35\ involving
a U.S. participant or its affiliate; \36\ and informational
requirements that will allow the Commission to monitor and control any
possible adverse impact that the proposed activities of the Euroclear
System could have on the safety and soundness of the U.S. national
system for the clearance and settlement of eligible U.S. government
securities.
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\35\ The Commission proposes that the U.S. government and agency
securities eligible for Euroclear processing will be the same as
those securities permitted to be processed by Cedel. Accordingly,
eligible securities will include (i) Fedwire-eligible U.S.
government securities, (ii) mortgage backed pass-through securities
that are guaranteed by the Government National Mortgage Association
(``GNMAs''), and (iii) any collateralized mortgage obligation whose
underlying securities are Fedwire-eligible U.S. government
securities or GNMA guaranteed mortgage-backed pass through
securities and which are depository eligible securities
(collectively, ``eligible U.S. government securities''). The
Commission is of the view that this definition should not include
those U.S. government or agency securities currently processed by
Euroclear that are foreign targeted securities and/or guaranteed by
an international organization.
\36\ The Commission is proposing that ``U.S. entity'' should
include (i) any entity organized under the laws of the United States
or any state or subdivision thereof that is registered or regulated
pursuant to state or federal banking laws or state or federal
securities laws and should include, without limitation, U.S.
registered broker-dealers, U.S. banks (as defined by Section 3(a)(6)
of the Exchange Act), and (ii) foreign branches of U.S. banks or
U.S. registered broker-dealers.
Additionally, the Commission is proposing that the term
``affiliate'' should be defined as any Euroclear System participant
having a relationship with a U.S. entity where the U.S. entity has
an arrangement on file at Euroclear to prevent a settlement default
or credit default with respect to the Euroclear System participant
or where Euroclear knows that the U.S. entity has an arrangement to
prevent a settlement default or credit default with respect to the
Euroclear System participant.
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1. Volume Limits
In granting Cedel and CCOS exemptions from clearing agency
registration, the Commission placed a limit on the transactions in
eligible U.S. government securities conducted by U.S. participants or
their affiliates that can be processed through those systems.\37\
Euroclear similarly proposes to limit the average daily volume of
transactions in U.S. government or agency securities involving U.S.
participants \38\ or their affiliates that are settled through the
Euroclear System to five percent of the average daily volume of total
worldwide transactions in U.S. government and agency securities.
Although Euroclear has proposed this volume limit, it has requested
that due to its relatively strong capital position, its operational
safeguards, and its comprehensive regulation by U.S. Federal and state
authorities, this volume limit be transitional in nature. Accordingly,
Euroclear also requests that the Director of the Division be granted
delegated authority from the Commission to increase or eliminate the
volume limit if the Division deems such action appropriate.
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\37\ The CCOS exemptive order contained volume limitations of
US$6 billion net daily settlement for U.S. government securities and
US$24 billion for repurchase agreements and reverse repurchase
agreements transactions in U.S. government securities. These limits
are calculated on an average daily basis over a ninety day period.
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 and reverse repurchase agreements involving
U.S. government securities. In the Cedel exemptive order, the
Commission determined that a percentage-based formula was more
appropriate. Accordingly, Cedel may not process more than 5% of the
total average daily value of the aggregate volume in eligible U.S.
government securities. The total average daily dollar value of
eligible U.S. government securities volume is derived from the total
daily value of securities activity through Fedwire, GSCC, MBSCC,
PTC, and any other source that the Division deems appropriate to
reflect the aggregate volume in eligible U.S. government securities.
Cedel's average daily volume is derived from the value of eligible
U.S. government securities that are processed through Cedel
involving a U.S. counterparty or its affiliate. Based upon December
31, 1996, information, this computation yields an average daily
volume limit of approximately US$49 billion.
\38\ For this purpose Euroclear proposes that ``U.S.
participant'' would mean any participant of the Euroclear System
having a U.S. residence (based on location of its executive office
or principal place of business), including any foreign branch of
such participant.
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The Commission preliminarily believes the proposed volume limit
appears to be 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 the Euroclear System's
activities on the U.S. securities market. Likewise, the Commission
preliminarily believes that the proposed volume limit is sufficiently
narrow in scope so that the safety and soundness of the U.S. markets
would not be compromised if Euroclear or MGT experiences financial or
operational difficulties.
2. Informational Requirements
To facilitate the monitoring of compliance with the proposed volume
limits under the proposed exemption, Euroclear would be required to
provide information on a monthly basis regarding aggregate volume for
all Euroclear System participants for transactions in eligible U.S.
Government securities. Euroclear also would be required to notify the
Commission if there is a material adverse change in any Euroclear
System account maintained by MGT-Brussels for Euroclear System
participants that also are members of affiliates of members of a U.S.
registered clearing agency.\39\ Euroclear also would be required to
respond to any Commission request for information about a U.S.
participant or its affiliate about whom the Commission has concerns.
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\39\ For purposes of the exemption, the Commission preliminarily
believes that the term ``material adverse change'' would include
defaults in settlement for credit reasons in a Euroclear System
account, liquidation of collateral posted by a participant in that
participant's Euroclear System account, or the limitation on the
extensions of credit to a participant through the Euroclear System.
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Euroclear specifically has agreed to promptly provide the Division
with the following 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
[[Page 26840]]
(3) The annual report on the internal controls, policies and
procedures of the Euroclear System (``SAS-70 Report'').\40\
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\40\ In addition, the Division will review the annual reports on
Form 10-K and the quarterly reports on Form 10-Q for J.P. Morgan &
Co. Incorporated, MGT's parent, which are already provided to the
Commission.
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Euroclear also has agreed to provide the Division with prompt
notice upon the occurrence of any of the following events;
(1) The termination of any Euroclear System participant;
(2) The liquidation of any securities collateral pledged by a
participant to secure an extension of credit made through the Euroclear
System;
(3) The institution of any proceedings to have any Euroclear System
participant declared insolvent or bankrupt; or
(4) The disruption or failure in the operations of the Euroclear
System in whole or in part from its regular operating location or its
contingency center.
Finally, Euroclear also has agreed to provide the Commission with
quarterly reports, calculated on a twelve-month rolling basis, of the
following:
(1) The average daily volume of transactions in eligible U.S.
Government securities for U.S. participants and their affiliates that
are subject to the volume limit described in IV.B.1 above; and
(2) The average daily volume of transactions in eligible U.S.
Government securities for all participants, whether or not subject to
the volume limit described in Section IV.B.1 above.
The Commission seeks comment on these proposed volume limits and
the informational requirements. Specifically, commenters are requested
to address the structure and the appropriate size of such limits.
Commenters also are requested to address the types of information which
should be provided to the Commission to help maintain the safety and
soundness of the U.S. clearance and settlement systems and the U.S.
securities markets. Finally, commenters are invited to comment on the
specific information that Euroclear has agreed to provide to the
Commission and on the occurrence of events for which Euroclear must
notify the Commission.
C. Fair Competition
Section 17A of the Exchange Act requires the Commission, in
exercising its authority under that section, to have due regard for the
maintenance of fair competition among clearing agencies.\41\ Therefore,
the Commission must consider an applicant's likely effect on
competition and on the U.S. securities markets in its review of any
application for registration or exemption from registration as a
clearing agency.
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\41\ 15 U.S.C. 78q-1(a)(2).
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Consistent with this approach, the Commission invites commenters to
address whether granting Euroclear an exemption from registration would
result in increased competition, including greater access to the U.S.
securities market by foreign broker-dealers, banks, and clearing
agencies. Such competition may result in the development of improved
systems capabilities, new services, and perhaps lower costs to market
participants. The Commission also invites commenters to address whether
the proposal would impose any burden on competition that is
inappropriate under the Exchange Act.
VI. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing application by June 16, 1997. Such
written data, views, and arguments will be considered by the Commission
in deciding whether to grant Euroclear's request for exemption from
registration. Persons desiring to make written submissions should file
six copies thereof with the Secretary, Securities and Exchange
Commission, 450 Fifth Street, N.W., Washington, D.C. 20549. Reference
should be made to File No. 601-01. Copies of the application and all
written comments will be available for inspection and copying at the
Commission's Public Reference Room, 450 Fifth Street, N.W., Washington,
D.C. 20549.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\42\
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\42\ 17 CFR 200.30-3(a)(16).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-12751 Filed 5-14-97; 8:45 am]
BILLING CODE 8010-01-M
