Depository Trust Company Rulemaking:
Order Approving a Proposed Rule Change Implementing the Matching Feature in the Institutional Delivery System
SECURITIES AND EXCHANGE COMMISSION
(Release No. 34-39832; File No. SR-DTC-95-23)
April 6, 1998
Self-Regulatory Organizations; The Depository Trust Company; Order Approving a Proposed Rule Change Implementing the Matching Feature in the Institutional Delivery System
On November 8, 1995, The Depository Trust Company ("DTC") filed with the Securities and Exchange Commission ("Commission") a proposed rule change (File No. SR-DTC-95-23) under Section 19(b)(1) of the Securities Exchange Act of 1934 ("Act")
1 to implement a matching feature in DTC's Institutional Delivery ("ID") system. Notice of the proposal was published in the Federal Register on January 19, 1996.
2 The Commission received 39 comment letters. For the reasons discussed below, the Commission is approving the proposed rule change.
In a previous filing with the Commission, DTC described several additional features that it planned to add to the ID system, one of which was a matching feature.
3 The purpose of DTC's present rule filing is to obtain approval of implementation of the matching feature.
The matching feature is an enhancement to the current procedures for confirmation and affirmation processing in the ID system. Currently, when a broker-dealer executes a trade on behalf of an institution, it can use the ID system to notify the institution of the execution of the trade ("notification of order execution"). After receiving a notification of order execution, the institution then can use the ID system to furnish the broker-dealer with instructions for the proper allocation of the trade among the institution's different accounts ("allocation instructions").
4 Using the allocation instructions, the broker-dealer furnishes the ID system with the information necessary ("trade data") for the ID system to produce a confirmation, which then is delivered through the ID system to the institution. If the confirmation accurately represents the institution's requested trade and the proper allocation, the institution or its designated affirming party affirms the trade (i.e., acknowledges that it will settle the trade on settlement date) by sending an affirmed confirmation to the broker-dealer through the ID system. The trade then goes into DTC's settlement process.
Under the rule change, if a broker-dealer and an institution elect to use the matching feature the ID system will compare trade data submitted by the broker-dealer with allocation instructions submitted by the institution. If the trade data and allocation instructions match and if the institution also is the affirming party, the ID system will produce a matched affirmed confirmation. At this point, the trade will go into DTC's settlement process.If the trade data and allocation instructions match but the institution is not the affirming party, the ID system will produce a matched confirmation and will send it to the designated affirming party to be affirmed.
Throughout the day, broker-dealers and institutions will be able to use the ID system's inquiry capabilities to view any unmatched items. At the end of the day, an "unmatched report" will be generated for each broker-dealer and institution. This report will list all broker-dealer trade data and allocation instructions that were not matched by the end of the day. Unmatched trades appearing on the unmatched report will be carried over from day to day unless the broker-dealer or institution cancels its instruction or the institution affirms the trade.
II. Comment Letters
The Commission received 39 comment letters in response to the filing.
6 In its comment letter, Thomson commended DTC for its efforts to improve the efficiency of the domestic securities market, but expressed concern over the potentially anticompetitive impact of the proposed rule change on unregistered entities that provide confirmation and affirmation services. Specifically, Thomson stated that it is concerned that approval of DTC's proposed matching feature "will impose a serious and unwarranted burden on competition if certain antiquated self-regulatory organization (SRO) rules are interpreted in a way that prevents Thomson from providing its own matching service to its clients."
7 Thomson requested the Commission not to approve DTC's proposed matching feature "unless assurance is obtained that the SROs will not interpret their rules in such an anticompetitive fashion." Thomson stated that "[b]efore approving DTC's current proposal, the Commission should ensure that the combination of allocations and confirmations into one step does not result in an unintended expansion of the scope of the antediluvian SRO Rules [to regulate the communication of allocation information between institutions and their brokers]."
The remaining 38 commenters supported Commission approval of adding the matching feature to the ID system.
9Many of these commenters expressed multiple reasons why the matching feature should be approved. Twenty-five commenters stated that they believe that approval of the matching feature will streamline the settlement process and allow it to occur more expeditiously.
10 Nine commenters stated that they believe that the matching feature will reduce risk in the settlement cycle and will promote safety and soundness in the clearance and settlement of securities transactions.
11 Twenty-two commenters stated that they believe that the matching feature is an essential step towards a shorter settlement cycle.
12 Fifteen commenters stated that they believe that the electronic trade confirmation vendors for DVP/RVP trades should be regulated entities and voiced concern over potential changes to the SRO confirmation rules and the use of unregulated systems for the confirmation/affirmation of securities transactions.
Two commenters stated that they believe that the issue of DTC's matching proposal is separate from the issue of whether multiple electronic trade confirmation systems are appropriate.
14 One of these commenters stated that it believes that the importance of DTC's matching procedure outweighs any anticompetitive effects it would have on other trade confirmation systems and that its implementation should not be delayed.
Under Section 19(b)(2) of the Act,
16 the Commission must approve a proposed rule change filed by an SRO (including a clearing agency) unless the Commission finds that the proposed rule change is inconsistent with the requirements of the Act and the regulations thereunder applicable to the SRO. Sections 17A(b)(3)(A), (F), and (I) of the Act
17 require, among other things, that a clearing agency be organized and its rules be designed to facilitate and promote the prompt and accurate clearance and settlement of securities transactions and that the rules not impose any burden on competition not necessary or appropriate in furtherance of the purposes of the Act.
The Commission believes that DTC's matching feature should promote efficiencies in the clearance and settlement of securities transactions by combining some of the steps that normally are required for the settlement of institutional trades under traditional confirmation/affirmation processing. The Commission believes further that this combination of steps should streamline the clearance and settlement process which in turn should reduce the likelihood of errors and the number of trades that settle late because presettlement steps have not been completed by settlement time.
The Commission notes that although combining processing steps by a matching intermediary enhances processing efficiency, it also focuses processing risk and eliminates a separate affirmation step that would allow the broker-dealer or its customer to detect errors that could delay settlement or cause the trade to fail. However, DTC is a registered clearing agency and therefore is subject to statutory and regulatory risk control requirements and to the Commission's supervision. As a result, the Commission believes that DTC's proposal is consistent with its obligations under the Act, including its responsibility to facilitate the prompt and accurate clearance and settlement of securities transactions.
In reviewing the proposed rule change, the Commission has also considered the impact that it would have on competition.
18 The Commission notes that the use of the matching feature by DTC participants is optional and that the SRO confirmation rules do not require the use of the matching feature in the confirmation and affirmation of securities transactions. The Commission believes that the proposed rule change itself does not impose any inappropriate burden on competition. Rather, any possible burden on competition identified by Thomson arises from potential interpretations of SRO rules governing member use of confirmation and affirmation services.
In response to Thomson's concerns, the Commission has postponed approving DTC's matching feature while the effort to resolve issues relating to the operation of the SRO confirmation rules has been ongoing. The NYSE, the NASD, and the MSRB recently have filed proposed rule changes with the Commission to amend their SRO confirmation rules.
19 Under these proposed rule changes, broker-dealers would be permitted to use the services of certain qualified entities that are not registered clearing agencies to carry out the type of confirmation/affirmation processing now handled by the ID system. These qualified entities would be required to submit affirmed confirmations to a registered clearing agency for trade settlement. The Commission believes that these rule changes should increase competition in the business of traditional confirmation/affirmation processing.
The proposed changes to the SRO confirmation rules do not address whether entities other than registered clearing agencies may provide matching services. The Commission has carefully examined the legal and policy issues that are raised in connection with matching services and has concluded that matching trade data and allocation instructions for institutional securities trades should be considered a clearing agency function under Sections 3(a)(23) and 17A of the Act.
Under the Commission's interpretation, registration as a clearing agency or a conditional exemption from registration would be required to conduct matching services. The Commission has issued a release that presents its analysis of this issue.
On approval of its rule filing, DTC may provide matching services because it is a registered clearing agency. This approval will continue irrespective of the Commission's ultimate decision on whether or not matching is a clearing agency function. The Commission notes that DTC's matching proposal itself does not impose anticompetitive burdens on others but rather offers improved services to all DTC users. Furthermore, the Commission believes that DTC's proposal does not have an anticompetitive effect. Under the Commission's interpretation outlined above, any entity wishing to compete with DTC will either register as a clearing agency or will obtain an exemption from registration and will then offer a similar matching service. Therefore, the Commission believes that approval of the proposed rule change should not be delayed on competition grounds.
Because the Commission finds that DTC's matching feature is designed to facilitate the prompt and accurate clearance and settlement of securities transactions by enhancing the confirmation/affirmation process in DTC's ID system and otherwise is consistent with Section 17A(b)(3) of the Act, the Commission is approving DTC's proposed rule change.
The Commission finds that DTC's proposal is consistent with the requirements of the Act and particularly with Section 17A 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-95-23) be, and hereby is, approved.
By the Commission.
Jonathan G. Katz
SEC News Digest
Self Regulatory Organizations
Approval of Proposed Rule Change
The Commission approved a proposed rule change filed by The Depository Trust Company (File No. SR-DTC-95-23) under Section 19(b) of the Exchange Act implementing the matching feature in the Institutional Delivery system.
(Release No. 34-39832)
15 U.S.C. 78(b)(1).
Securities Exchange Act Release No. 36685 (January 5, 1996), 61 FR 1417.
Securities Exchange Act Release No. 33466 (January 12, 1994), 59 FR 3139 [File No. SR-DTC-93-07] (order approving proposed rule change relating to the ID system).
Use of the ID system by DTC participants for notice of order execution and allocation instructions is optional.
In the ID system, the affirming party may be the institution, the institution's agent, or another party designated by the institution (i.e., an "interested party").
Letters from: P. Howard Edelstein, President, Thomson Electronic Settlements Group, Thomson Trading Services, Inc., ("Thomson") (February 9, 1996); Harold L. Johnson, Deputy General Counsel, Municipal Securities Rulemaking Board ("MSRB") (February 28, 1996); George J. Minnig, Managing Director, Pershing, (May 23, 1996); Walter Psaila, Senior Vice President, Director of Clearance and Settlement, Paine Webber, (May 22, 1996); Vito DiMattia, Senior Vice President, NatWest Securities ("NatWest") (May 23, 1996); Patrick K. Blackburn, Senior Vice President, The Chicago Corporation ("TCC") (May 22, 1996); J. Phillip Smith, President, Lewco Securities Corp. ("Lewco") (May 28, 1996); John J. Sanders, Jr., Principal, Robertson Stephens & Company ("Robertson") (May 29, 1996); Arthur Quartermaine, Director, Global Operations, Goldman, Sachs & Co. ("Goldman") (May 22, 1996); Philip Lanz, Managing Director, Bear Stearns, (May 29, 1996); Nicholas Sariano, First Vice President, Dean Witter Reynolds, Inc. ("Dean Witter") (May 31, 1996); Richard A. Bednarz, Managing Director & Product Manager, Princeton Financial Systems, Inc. ("Princeton Financial") (June 4, 1996); James R. Hiatrides, Managing Director, Scudder, Stevens & Clark, Inc. ("Scudder") (June 5, 1996); Frank J. Simonds, Vice President, Investment Management Services, Trust Operations, NBD Bank ("NBD") (June 3, 1996); Neil C. Carfora, Vice President, State Street Bank and Trust Company ("State Street") (June 6, 1996); Arthur L. Thomas, Senior Vice President, Director, Global Operations Services, Merrill Lynch, (June 14, 1996); Ernest A. Pittarelli, Managing Director, UBS Securities LLC ("UBS") (June 6, 1996); Peter J. Murray, Director, CS First Boston ("CS First") (June 21, 1996); Jenny Mastragelo, Equity Trading, Operations, Eaton Vance Management ("Eaton") (June 13, 1996); George J. Minnig, Chairman, Regulatory and Clearance Committee, Securities Industry Association ("SIA") (June 24, 1996); Ed Brands, Chairperson, Bank Depository User Group ("BDUG") (June 28, 1996); Dennis J. Donnelly, Senior Managing Director, McDonald & Company Securities, Inc. ("McDonald") (June 28, 1996); Denise R. Youngblood, Munder Capital Management ("Munder") (June 22, 1996); Jill M. Considine, President, New York Clearing House, (July 3, 1996); Richard F. Woerner, Controller, Merganser Capital Management Corporation ("Merganser") (June 26, 1996); Robert Donovan, Senior Vice President, Legg Mason Wood Walker, Inc. ("Legg Mason") (May 28, 1996); Jerome J. Clair, Senior Vice President, Smith Barney, (July 9, 1996); Stephen L. Zeitz, Director, Investment Operations, Providian Capital Management ("Providian") (July 10, 1996); Ronald L. Grooms, Sr. Vice President & Treasurer, Invesco Funds Group, Inc. ("Invesco Funds") (July 8, 1996); Dennis J. Donnelly, Senior Managing Director, McDonald & Company Securities, Inc. ("McDonald") (June 28, 1996); John E. Nolan, Senior Vice President, Raymond James & Associates, Inc. ("Raymond James") (June 12, 1996); Roselyn Kracov, State Street Bank & Trust Company, Co-Chair, Industry Standardization for Institutional Trade Communication ("ISITC") (July 31, 1996); Dan O'Keefe, Senior Vice President, The Northern Trust
Company ("Northern Trust") (August 30, 1996); Stephen M. Wellman, Vice President/Director of Operations, Pilgrim Baxter & Associates ("Pilgrim Baxter") (August 23, 1996); Jean Hendrick, Senior Vice President, Asset Management Services, Barnett Bank ("Barnett") (September 11, 1996); Jennifer Parker, SAFECO Asset Management ("SAFECO") (November 22, 1996); Operations Advisory Committee, to The Honorable Arthur Levitt, Jr., Commission (December 12, 1996); Debra P. Turner, Wedge Capital Management ("Wedge Capital") (February 5, 1997); Wendy A. Laidlaw, Administrative Manager, R.M. Davis, Inc., ("R.M. Davis") (February 28, 1997).
The exchanges, the National Association of Securities Dealers ("NASD"), and the Municipal Securities Rulemaking Board ("MSRB") currently have rules that prohibit broker-dealers from accepting delivery versus payment and receipt versus payment ("DVP/RVP") orders from their customers unless a customer or its agent uses the facilities of a registered clearing agency for the confirmation, acknowledgment (
, affirmation), and book entry settlement of all depository eligible securities ("SRO confirmation rules"). The SRO confirmation rules are: American Stock Exchange Rule 423(5); Chicago Stock Exchange Article XV, Rule 5; New York Stock Exchange ("NYSE") Rule 387(a)(5); Pacific Exchange Rule 9.12(a)(5), Philadelphia Stock Exchange Rule 274(b); NASD Rule 11860(a)(5); and MSRB Rule G-15(d)(ii).
Currently, the SRO confirmation rules preclude broker-dealers and institutions from using Thomson's services for the confirmation and affirmation of DVP/RVP trades in depository eligible securities settling in the United States because Thomson is not a registered clearing agency. However, the SRO confirmation rules do not prevent broker-dealers from using Thomson's trade allocation or certain other services.
In December 1996, Thomson filed a petition with the Commission requesting that the Commission use its authority to amend the SRO confirmation rules to allow Thomson to offer confirmation/affirmation services. Many of the comment letters that the Commission received in response to Thomson's petition also expressed support for approving DTC's matching feature.
Pershing, Paine Webber, TCC, Robertson, Goldman, Bear Stearns, Princeton Financial, State Street, Merrill Lynch, CS First, BDUG, SIA, Munder, New York Clearing House, Legg Mason and Smith Barney, Providian, Invesco Funds, Raymond James, ISITC, Northern Trust, Pilgrim Baxter, Barnett, SAFECO, Operations Advisory Committee, Wedge Capital, R.M. Davis.
Pershing, UBS, SIA, BDUG, New York Clearing House, and Bear Stearns, Providian, Pilgrim Baxter, Operations Advisory Committee; R.M. Davis.
Pershing, Paine Webber, TCC, Robertson, Princeton Financial, Scudder, State Street, Merrill Lynch, Eaton, McDonald, Munder, New York Clearing House, Merganser, and Legg Mason, Providian, Invesco Funds, Raymond James, McDonald, ISITC, Northern Trust, Pilgrim Baxter, Operations Advisory Committee, Wedge Capital.
MSRB, Pershing, Paine Webber, TCC, Robertson, CS First, Bear Stearns, Dean Witter, SIA, BDUG, NBD, State Street, UBS, Smith Barney, Barnett.
New York Clearing House, Operations Advisory Committee.
New York Clearing House.
15 U.S.C. 78s(b)(2).
15 U.S.C. 78q-1(b)(3)(A), (F), and (I).
The Commission has also considered the proposed rule's impact on efficiency and capital formation.
Securities Exchange Act Release Nos. 39830 (April 6, 1998) [File No. SR-NYSE-98-07], 39831 (April 6, 1998) [File No. SR-NASD-98-20], and 39833 (April 6, 1998) [File No. SR-MSRB-98-06].
15 U.S.C. 78c(a)(23) and 78q-1.
Securities Exchange Act Release No. 39829 (April 6, 1998).
Last update: 04/17/98