02-17679. Self-Regulatory Organizations; the Depository Trust Company; Order Approving a Proposed Rule Change Relating to the Closing of the Mortgage-Backed Securities Division of the Depository Trust Company

July 3, 2002.

On July 24, 2001, The Depository Trust Company (“DTC”) filed with the Securities and Exchange Commission (“Commission”) a proposed rule change pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”). Notice of the proposal was published in the Federal Register on December 17, 2001.^[1] Three comment letters were received.^[2] For the reasons discussed below, the Commission is approving the proposed rule change.

I. Description

The rule change enables DTC to close its Mortgage Backed Securities Division (“MBS Division”). Among other things, the MBS Division provided the facilities for the issuance, immobilization, clearance, and settlement of mortgage-backed securities guaranteed by the Government National Mortgage Association (“GNMA”). However, in May 2000 GNMA publicly announced its decision to utilize the Fedwire system ^[3] of the Board of Governors of the Federal Reserve System (“Fed”) for the clearance and settlement of these mortgage-backed securities.^[4] On March 23, 2002, the conversion of GNMA securities from the MBS Division to the Federal Reserve Banks was completed.

Prior to GNMA's announcement of its decision to move its securities from the MBS Division to the Federal Reserve Banks, the Ginnie Mae Settlement Task Force was organized by The Bond Market Association (“TBMA”) to assess the feasibility of the transfer. That task force consisted of representatives from broker-dealers, custodial banks, clearing banks, GNMA, the Federal Reserve Banks, the Mortgage Bankers Association, DTC, and TBMA. Followiing GNMA's announcement, the task force formed the Ginnie Mae Conversion Subcommittee to develop a conversion plan setting forth conversion details and an implementation schedule. The conversion subcommittee was comprised of representatives from broker-dealers, GNMA, the Federal Reserve Banks, DTC, clearing banks, and custodial banks. In February 2001, the subcommittee issued its Conversion Plan.^[5]

The conversion took place in phases over a series of weekends beginning October 6, 2001, and ending March 23, 2002. During the conversion, different classes of GNMA securities were moved electronically from the MBS Division to the Federal Reserve Banks in accordance with delivery instructions provided to the MBS Division by the MBS Division's participants. Other securities issued through and settled at the MBS Division, namely securities guaranteed by the Department of Veterans Affairs and a limited number of FNMA and FHLMC securities that are collateralized by GNMA securities, were also moved to Federal Reserve Banks during the conversion.

Shortly after the completion of the payment of principal and interest with respect to securities last converted, DTC closed the transaction processing system of the MBS Division and returned the MBS Division participant fund deposits to the MBS Division's participants. DTC will now delete from its rules the rules that applied to the MBS Division.

Although DTC will close its MBS Division, GNMA securities remain eligible for processing at DTC and can be processed at DTC in the same manner as are other Fedwire-eligible securities. Fedwire-eligible securities processed at DTC are deposited and withdrawn free of payment to and from DTC's Fedwire account. Once deposited into DTC's Fedwire account, Fedwire-eligible securities are processed at DTC among DTC participants subject to DTC's rules and procedures applicable to other DTC-eligible fixed income securities.

In connection with the conversion of GNMA securities to the Federal Reserve Banks, DTC considered expanding its processing to permit GNMA securities to be delivered against payment into and from DTC's Fedwire account. DTC solicited comments from its participants, but fewer than a dozen participants expressed an interest in using such a service. In light of the development costs involved and the limited interest expressed by its participants, DTC's Board of Directors concluded that DTC's resources would be better applied to projects that serve a wider participant base.

II. Comments

The Commission received three comment letters. One commenter, Daniel L. Goelzer on behalf of State Street Bank and Trust Company, stated that the transfer of settlement responsibility for GNMA mortgage-backed securities from DTC to the Fedwire system would foster unfair discrimination among participants because securities settled in the Fedwire system are subject to a practice known as “dealer time” ^[6] that does not exist in DTC's MBS Division's settlement environment.^[7] The commenter requested that the Commission institute proceedings under Section 19(b)(2)(B) to determine if DTC's proposed rule change should be disapproved.

Another comment letter submitted by TBMA in response to the State Street letter strongly supported the transfer of GNMA settlement to the Federal Reserve Banks and the subsequent closure of DTC's MBS Division. TBMA argued, among other things, that the proposed rule filing “will promote the effective clearance and settlement of those securities on a basis comparable to mortgage-backed securities of other U.S. government-sponsored enterprises.” ^[8] TBMA also stated that the dealer time guidelines are recommended, voluntary industry practices and are not relevant to the merits of the proposed rule change.

III. Discussion

The Commission finds that the proposed rule change is consistent with the Act's requirements and the rules and regulations thereunder and particularly with the requirements of Section 17A(b)(3)(F) of the Act.^[9] Section 17A(b)(3)(F) of the Act requires that the rules of a clearing agency be designed to promote the prompt and accurate clearance and settlement of securities transactions. Given the decision by GNMA to move its securities to the Federal Reserve Banks and use Fedwire for clearing its mortgage-backed securities, there is no reason for DTC to keep its MBS Division open. Accordingly, the proposed rule change should enable DTC to eliminate unproductive expenditures and use its resources in a more efficient manner to promote the prompt and accurate clearance and settlement of securities transactions.

The concern raised in the State Street letter regarding dealer time concerns an industry practice relating to the settlement of Fedwire-eligible securities and is not the subject of this proposed rule change.^[10] Furthermore, the Fed addressed this issue in a 1995 release adopting new closing times for the Fedwire securities transfer system.^[11] Responding to State Street's suggestion that the Fed also review the need for a dealer turnaround deadline, the Fed stated that “[d]ealer-turnaround time was established by the PSA [the previous name of the BMA] as an industry guideline to promote the smooth functioning of the government securities market” and that “[t]he dealer-turnaround deadline had been reflected in the Federal Reserve Banks” operating circulars; however, the Reserve Banks do not police participant activity with respect to this time.” The Fed concluded that their action (i.e., adopting new closing times) did “not preclude the continuation of an industry standard for a dealer-turnaround time if the industry believes it is needed.” Therefore, because GNMA securities will now be cleared and settled through the Fedwire system, commenters should direct their concerns regarding Fedwire rules to the Fed.

IV. Conclusion

On the basis of the foregoing, the Commission finds that the proposal is consistent with the requirements of the Act and in particular with the requirements of Section 17A of the Act 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-2001-14) be, and hereby is, approved.

For the Commission by the Division of Market Regulation, pursuant to delegated authority.^[12]

Margaret H. McFarland,

Deputy Secretary.

Footnotes

1.  Securities Exchange Act Release No. 45146 (Dec. 10, 2001), 66 FR 65014.

2.  Letters from Daniel L. Goelzer, Baker & McKenzie on behalf of State Street Bank and Trust Company (Dec. 14, 2001); Paul Saltzman, Executive Vice President and General Counsel, The Bond Market Association (Jan. 7, 2001); and Daniel L. Goelzer, Baker & McKenzie on behalf of State Street (Mar. 13, 2002).

3.  The Fedwire system is currently used for, among other things, the issuance and settlement of U.S. Treasury securities and mortgage-backed securities guaranteed by the Federal Home Loan Mortgage Corporation (“FHLMC”) and the Federal National Mortgage Association (“FNMA”).

4.  See 66 FR 44258 (Aug. 22, 2001) (issuance of final rule by GNMA governing payments of book-entry securities).

5.  The Conversion Plan is available online at <www.frbservices.org> and at <www.bondmarkets.com/​regulatory>. A copy of the Conversion Plan is also attached as Exhibit 2 of DTC's filing [DTC Important Notice No. 1483 (Feb. 15, 2001)], which is available through the Commission's Public Reference Section or through DTC.

6.  “Dealer time is a 15-minute window at the end of the Fed's book-entry security processing day during which dealers may make deliveries of securities to customers, but customers may not make deliveries to dealers. As a result of dealer time, institutional clients are unable to make deliveries during the last 15 minutes of the delivery day and are therefore forced to hold positions overnight and to incur significant financing costs. In contrast, dealer participants in the Fedwire system can effect delivery to non-dealers during this 15 minute period, while simultaneously enjoying protection from having to accept delivery. Just as dealer time imposes overnight financing costs on non-dealers, it afford dealers a privileged opportunity to avoid these costs by protecting dealers from receiving positions for which payment would have to be made.” State Street letter (Dec. 14, 2000) at page 2.

7.  [7]: The purpose of the second State Street letter was to submit a letter dated March 1, 2002, from the New York Clearing House Association, the Boston Clearing House Association, and the Bank Depository Users Group to the TBMA, requesting that TBMA rescind its dealer-to-customer good delivery (i.e. dealer time) guidelines.

8.  TBMA letter at page 1.

9.  15 U.S.C. 78q-1(b)(3)(F).

10.  The first State Street letter acknowledged this by recognizing “that disapproval of the DTC rule proposal * * * might not necessarily prevent the transfer of GNMA securities to the Fedwire system or compel the abolition of dealer time.” Goelzer letter (Dec. 14, 2000) at page 7, fn 10.

11.  60 FR 42410 (Aug. 15, 1995).

12.  17 CFR 200.30-3(a)(12).