[Federal Register Volume 60, Number 99 (Tuesday, May 23, 1995)]
[Notices]
[Pages 27360-27362]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-12520]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-35720; File No. SR-DTC-95-06]
Self-Regulatory Organizations; The Depository Trust Company;
Order Granting Accelerated Approval of a Proposed Rule Change Modifying
the Same-Day Funds Settlement System to Accommodate the Overall
Conversion to Same-Day Funds Settlement for Securities Transactions
May 16, 1995.
On March 22, 1995, The Depository Trust Company (``DTC'') filed
with the Securities and Exchange Commission (``Commission'') a proposed
rule change (File No. SR-DTC-95-06) pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934 (``Act'').\1\ Notice of the proposal
was published in the Federal Register on April 21, 1995.\2\ No comment
letters were received. For the reasons discussed below, the Commission
is granting accelerated approval of the proposed rule change.
\1\ 15 U.S.C. 78s(b)(1) (1988).
\2\ Securities Exchange Act Release No. 35613 (April 17, 1995),
60 FR 19971.
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I. Description of the Proposal
DTC currently processes the money settlements related to different
types of securities transactions in either the next-day funds \3\
settlement (``NDFS'') system or the same-day funds \4\ settlement
(``SDFS'') system. The NDFS system is used primarily for the money
settlement of equity, corporate debt, and municipal debt issue
transactions. The SDFS system began operation in 1987 and is used
primarily for the money settlement of transactions in commercial paper
and other money market instruments (``MMIs'').\5\
\3\ The term ``next-day funds'' refers to payment by means of
certified checks that are for value on the following day.
\4\ The term ``same-day funds'' refers to payment in funds that
are immediately available and generally are transferred by
electronic means.
\5\ For a description of the SDFS system, refer to Securities
Exchange Act Release Nos. 24689 (July 9, 1987), 52 FR 26613 [File
No. SR-DTC-87-04] (order granting temporary approval to DTC's SDFS
settlement service); 26051 (August 31, 1988), 53 FR 34853 [File No.
SR-DTC-88-06] (order granting permanent approval to DTC's SDFS
settlement service); 33958 (April 22, 1994), 59 FR 22878 [SR-DTC-93-
12] (order temporarily approving DTC's MMI settlement program
through April 1, 1994); and 35655 (April 30, 1995), 60 FR 22423
[File No. SR-DTC-95-05] (order temporarily approving DTC's MMI
settlement program through April 30, 1996).
DTC and the National Securities Clearing Corporation (``NSCC'')
jointly have issued three memoranda which describe DTC's and NSCC's
respective plans for converting their payment systems to SDFS.\6\ DTC's
sections of the memoranda describe its plan to combine its NDFS and
SDFS systems into a single system which will be based on the design of
the current SDFS system with some modifications. DTC's and NSCC's plans
are in accord with the 1989 recommendation of the international Group
of Thirty \7\ that all securities transactions should settle in same-
day funds.\8\
\6\ The Depository Trust Company and National Securities
Clearing Corporation, Memorandum (July 1, 1992) (``1992
Memorandum''); The Depository Trust Company and National Securities
Clearing Corporation, Memorandum (July 26, 1993) (``1993
Memorandum''); The Depository Trust Company and National Securities
Clearing Corporation, Memorandum (July 29, 1994) (``1994
Memorandum'').
\7\ The Group of Thirty was established in 1978 as an
independent, nonpartisan, nonprofit organization composed of
international financial leaders whose focus is on international
economic and financial issues.
\8\ Group of Thirty, Clearance and Settlement Systems in the
World's Securities Markets (March 1989) (``Group of Thirty
Report'').
Under the conversion plan, all issues currently settling in DTC's
NDFS system will be transferred to the SDFS system on a single day,
which DTC anticipates will occur in the fourth quarter of 1995 or the
first quarter of 1996.\9\ In order to assure an efficient conversion,
certain modifications to the current SDFS system will be implemented at
various times during 1995 prior to the overall conversion date. The
purpose of the current rule change is to convert DTC's current SDFS
system Participants Fund to an all cash fund and to modify certain risk
management controls and other features of the SDFS system. The
Participants Fund for the NDFS system will not be affected by this rule
change. The rule change implements a number of the modifications
described in the 1994 Memorandum.\10\
\9\ Only one DTC Participants Fund will be needed when the NDFS
system and the SDFS system are combined into a new SDFS system.
\10\ Supra note 6 and accompanying text.
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Currently, the SDFS system Participants Fund consists of cash and
securities and has separate components for money market instruments and
for other SDFS system securities.\11\ The rule change converts DTC's
SDFS system Participants Fund to an all-cash fund with no separate
component for the MMI Program.\12\ The rule change also
[[Page 27361]] decreases the minimum deposit to the SDFS system
Participants Fund from $200,000 to $10,000 and changes the method of
calculating a participant's required deposit.
\11\ Currently, the SDFS system Participants Fund consists of
approximately $253 million in cash and $567 million in pledged
securities.
\12\ Under the conversion plan, the SDFS system Participants
Fund will consist of $400 million in cash. Based on current activity
levels, DTC believes that a $400 million cash-only Participants Fund
will provide sufficient protection against present liquidity and
credit risks. Pursuant to its rules, DTC may change the formulas
used to determine a participant's required deposit or require a
participant to make additional deposits to the Participants Fund.
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The new SDFS Participants Fund formula bases each participant's
required deposit on the amount of liquidity that the participant uses
in the system. A participant's liquidity use will be determined using a
sixty day rolling average of the participant's intraday net debit
peaks.\13\ The rule change requires a participant to deposit in the
SDFS Participants Fund an amount equal to that participant's
proportional liquidity needs.\14\
\13\ The new SDFS system will monitor the levels of a
participant's net settlement debits during each day and will record
the highest net debit experienced by that participant. This measure
of liquidity is referred to as the participant's ``intraday debit
peak.''
\14\ For example, assume DTC had three participants, A, B, and
C, and had established $400,000,000 as the size of the SDFS system
Participants Fund. Each participant's minimum deposit would be
$10,000 for a total of $30,000 which leaves $399,970,000 as the
incremental fund deposit amount needed for the Participants Fund. In
order to allocate the $399,970,000 among the three participants,
their respective average intraday net debit peaks would be used.
Assume Participant A's average net debit peak is $300,000,000,
Participant B's is $500,000,000, and Participant C's is
$500,000,000. Since all incurred net debit peaks of at least
$300,000,000, each created liquidity needs of $300,000,000 and would
contribute equally to provide DTC's first $300,000,000. Each would
be responsible for a $10,000 minimum deposit plus a $99,990,000
incremental deposit bringing the total to $100,000,000 for each
participant and $300,000,000 in total. Participants B and C would be
assigned an additional $100,000,000 increment since they were
responsible for creating liquidity needs up to $500,000,000.
Together, A, B, and C would be assigned incremental amounts totaling
$499,970,000. Since the goal is to create a $400,000,000
Participants Fund, the $499,970,000 must be prorated downward to
399,970,000, the amount needed in addition to their minimum
contributions to achieve $400,000,000. Each participant's increments
would be reduced by applying a factor of .799988 (i.e., 399,970,000/
499,970,000). Their required deposits would then be as follows:
A: $10,000 + ($99,990,000 x .799988)=$80,000,800
B: $10,000 + ($199,990,000 x .799988)=$159,999,600
C: $10,000 + ($199,990,000 x .799988)=$159,999,600
Total: $400,000,000
In addition, the rule change modifies certain risk management
controls in the SDFS system. The method used to calculate the net debit
cap for each participant is being changed \15\ and the maximum net
debit cap for each participant is being increased to $900,000,000 from
approximately $580,000,000 today. The rule change also adds the Largest
Provisional Net Credit (``LPNC'') calculation control which is designed
to protect DTC against the combined failure of an issuer of MMIs and a
participant. The LPNC control creates a provisional net balance by
withholding a participant's largest net settlement credit due to
transactions in any single issuer's MMIs. DTC's risk management
controls will be applied to the provisional net balance that is created
by the LPNC procedure, and transactions that cause the provisional net
balance to violate those risk management controls will not be
completed.\16\
\15\ A participant's net debit cap will be based on an average
of the participant's three highest intraday net debit peaks over a
rolling three-month period multiplied by factors ranging from 1 to 2
based on a sliding scale relative to the size of the participant's
net debit peaks. Net debit caps will be determined by and will be
applied to a participant's simulated net debit balances caused by
the Largest Provisional Net Credit (``LPNC'') procedure describe
below.
\16\ DTC will subtract the amount of a participant's largest
provisional net credit due to transactions in any single issuer's
MMIs from the participant's collateral monitor (``simulated
collateral monitor'') and net debit or credit balance (``simulated
balance''). If a transaction will cause the simulated collateral
monitor to turn negative (i.e., the participant's collateral would
be insufficient to cover its simulated net debit after the
transaction) or the resulting net debit balance to exceed the
participant's net debit cap, the transaction will be blocked.
Blocked transactions will be recycled until credits from other
transactions in MMIs of issuers other than those of the largest
provisional net credit cause the simulated collateral monitor to be
positive or the resulting net debit to be within the net debit cap
limits.
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The rule change also modifies certain aspects of DTC's Participant
Operating Procedures on reclamations \17\ for both the NDFS and the
SDFS system, the Receiver Authorized Delivery (``RAD'') service \18\
and the recycle algorithm for deliver orders.\19\ The modified
procedures provide for the validation of all reclaims by DTC's system.
When a participant submits a reclaim for processing in DTC's NDFS or
SDFS systems, DTC's system will verify that a corresponding original
delivery that was completed on the same day exists for every reclaim
presented for processing.
\17\ A reclamation is the return of a delivery order or a
payment order by a participant.
\18\ RAD allows participants to review and either approve or
cancel incoming deliveries before they are processed in DTC's
system.
\19\ DTC's Account Transfer Processor system provides for the
recycling or pending of transactions that cannot be completed due to
a participant's insufficient positions or violations of risk
management controls (i.e., Net Debit Cap and Collateral Monitor).
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The modified procedures also establish a minimum threshold of
$15,000,000 for bilateral RAD limits. Participants currently are
permitted to set individual dollar limits against other possible
contra-participants so that deliveries with a settlement value
exceeding the specified limit will not be processed until the receiver-
participant has reviewed and approved the delivery. To limit the number
of transactions subject to RAD, participants will not be able to set
RAD limits at an amount less than $15 million.
The new recycle algorithm for deliver orders will offer SDFS system
users a second recycle options for deliver orders. Transactions that
are recycled because of insufficient positions or violations of risk
management controls are currently prioritized based on transaction type
and then on transaction size (``Option 1''). The new option (``Option
2'') provides participants with the ability to choose whether pending
transactions caused by an insufficient position will be recycled in the
order in which they were entered (i.e., first in, first out) or in the
Option 1 prioritization schedule.\20\
\20\ Under Options 1 and 2, CNS deliveries are always given the
highest priority on the recycle queue.
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Most of the modifications to be implemented by the rule change will
be effective on dates to be specified by DTC in the second quarter of
1995. The control involving the LPNC calculation and the $15,000,000
threshold for bilateral RAD limits will be made effective on dates to
be specified by DTC in the third quarter of 1995.
II. Discussion
Section 17A(b)(3)(F) requires that the rules of a clearing agency
be designed to promote the prompt and accurate clearance and settlement
of securities transactions and to assure the safeguarding of securities
and funds in the custody or control of the clearing agency or for which
it is responsible.\21\ As discussed below, the Commission believes that
DTC's proposed rule change is consistent with DTC's obligations under
the Act.
\21\ 15 U.S.C. 78q-1(b)(3)(F) (1988).
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The Commission believes that DTC's SDFS system rules and procedures
provides certain protections for DTC and its participants from
financial loss associated with member defaults and insolvencies. The
rule change contains a number of protections designed to decrease the
chance of member default and to limit loss in the event of a default.
Those protections include an all-cash SDFS Participants Fund, a new
Participants Fund formula based on liquidity use, a new net debit cap
formula, a new fixed net debit cap of $900 million, and the application
of the LPNC control.
The new SDFS Participants Fund will be comprised of approximately
$400 [[Page 27362]] million in cash deposit and $700 million in
committed line(s) of credit.\22\ In the event that a participant fails
to settle for any reason, the all-cash fund in most cases should
provide enough immediate liquidity to complete settlement without
causing DTC to use its lines of credit. The size of the fund, $400
million in cash, was designed to provide sufficient liquidity to cover
all but a few of DTC's largest participants' individual net settlement
debits. The $700 million in committed lines of credit should provide
additional liquidity sufficient to cover the large end-of-day net
debits expected to be produced by these few largest participants with
the application of a new net debit cap of $900 million.
\22\ The current SDFS Participants Fund consists of
approximately $253 million in cash contributions, $50 million in
internal sources, $500 million in external lines of credit and $500
million in additional external lines of credit exclusively dedicated
to the MMI program.
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Although the minimum deposit to the Participants Fund has been
decreased from $200,000 to $10,000, participants will be required to
deposit additional amounts based on the size of their intraday net
debits weighted against other participants' net debits. As a result,
the cash deposits in the SDFS system fund will be increased from $210
to $400 million. The allocation under the new Participants Fund formula
will apportion fund deposits among participants in proportion to the
liquidity requirements they generate in the system. The new
Participants Fund formula also will more accurately reflect each
participant's liquidity requirements because it is based on a
participant's net debit peaks for the prior sixty days. The current
fund formula is based on a participant's average gross debits and
credits only for the prior month. While the use of gross debits and
credits reflects a participant's activity levels, the use of net debit
peaks reflects a participants actual liquidity needs.
The changes to DTC's risk management controls also are intended to
protect DTC and its participants against the inability of one or more
participants to fulfill its or their settlement obligations. DTC's risk
management controls are based on the Board of Governors of the Federal
Reserve System's guidelines for book-entry securities systems that
settle over Fedwire.\23\ The new net debit cap formula establishes a
single net debit cap as opposed to the several adjustable and fixed net
debit caps currently used in the SDFS system.\24\ The new net debit cap
will better reflect the participants most recent liquidity needs and
not just its liquidity needs for the prior month\25\ because it will be
calculated daily using a 90-day rolling average.\26\ By requiring
participants to have sufficient collateral to support their net debits
and by ensuring that their net debits do not exceed their net debit
caps, the new LPNC procedure should help to ensure that the occurrence
of a combined MMI issuer's default and a participant's failure to
settle does not expose DTC to loss and liquidity risks. The application
of the LPNC procedure to both the net debit cap and the
collateralization procedures should result in a failing participant's
net debit remaining collateralized and within its net debit cap if the
MMI issuer in which it has the largest net credit also defaulted.
\23\ ``Federal Reserve Policy Statement on Private Delivery-
Against-Payment Systems,'' Board of Governors of the Federal Reserve
System (June 15, 1989).
\24\ A participant's net debit cap currently is the least of the
following: (1) An amount which is a multiple of the participant's
mandatory and voluntary deposits in the fund; (2) an amount equal to
75% of DTC's lines of credit; (3) an amount, if any, determined by
the participant's settling bank; or (4) an amount, if any,
determined by DTC.
\25\ Because a participant's current adjustable net debit cap is
based on the participant's mandatory fund deposit, it will only
change on a monthly basis as the required deposit changes. However,
a participant may choose to increase its adjustable net debit cap at
any time by making voluntary deposits.
\26\ Supra note 15.
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The rule change implements certain modifications to DTC's current
SDFS system to provide for an efficient conversion to SDFS environment
for all securities transactions. The Commission believes that the
overall conversion to a SDFS system will help reduce systemic risk by
eliminating overnight credit risk. The SDFS system also will reduce
risk by achieving closer conformity with the payment methods used in
the derivatives markets, government securities markets and other
markets.
For the reasons described above, the Commission believes that DTC's
proposed rule change fulfills the requirements of Section 17A(b)(3)(F)
of the Act because the proposal assures the safeguarding of securities
and funds in the custody and control of DTC. Furthermore, the proposed
rule change facilitates the overall conversion of DTC's payment system
to an SDFS system which should facilitate the prompt and accurate
clearance and settlement of securities transactions.
DTC has requested that the Commission find good cause for approving
the proposed rule change prior to the thirtieth day after the date of
publication of notice of the filing. The Commission finds good cause
for so approving the proposed rule change because the modifications
implemented by the rule change are part of the planned conversion of
DTC's entire money settlement system to an SDFS system. The Commission
believes that participants should have the opportunity to become
familiar with the SDFS system capability and the new risk management
controls prior to the complete conversion to an SDFS system for
securities transactions.
III. Conclusion
On the basis of the foregoing, the Commission finds that the
proposal is consistent with the requirements of the Act, particularly
with Section 17A(b)(3)(F) of the Act and the rules and regulations
thereunder.
It is therefore ordered, pursuant to Section 19(b)(2) of the Act,
that the proposed rule change (File No. SR-DTC-95-06) be, and hereby
is, approved.
For the Commission by the Division of Market Regulation,
pursuant to delegated authority.\27\
\27\ 17 CFR 200.30-3(a)(12) (1994).
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-12520 Filed 5-22-95; 8:45 am]
BILLING CODE 8010-01-M
