[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