SECURITIES AND EXCHANGE COMMISSION
(Release No. 34-38810; International Series Release No. 1090; File No. 600-
30)
July 1, 1997
Self-Regulatory Organizations; Emerging Markets Clearing Corporation;
Notice of Filing of Application for Registration as a Clearing Agency
I. INTRODUCTION
On May 30, 1997, the Emerging Markets Clearing Corporation ("EMCC")
filed with the Securities and Exchange Commission ("Commission") an
application on Form CA-1 for registration as a clearing agency pursuant to
Section 17A of the Securities Exchange Act of 1934 ("Exchange
Act")<(1)> and Rule 17Ab2-1 thereunder<(2)> in order to perform
the functions of a clearing agency with respect to transactions in U.S.
dollar-denominated Brady bonds.<(3)> The Commission is publishing
this notice to solicit comments from interested persons.<(4)>
Comments are solicited on all aspects of the EMCC application, and in
particular the matters discussed in Section IV of this notice.
II. STRUCTURE OF THE EMCC SYSTEM
EMCC is a corporation organized under the laws of the State of New
York. EMCC was formed by the Emerging Markets Traders Association ("EMTA")
and the International Securities Clearing Corporation ("ISCC") in response
<(1)> 15 U.S.C. 78q-1.
<(2)> 17 CFR 240.17Ab2-1.
<(3)> On June 2, 1997, and June 17, 1997, EMCC filed
amendments to its application. Copies of the
application are available for inspection and copying at
the Commission's Public Reference Room.
<(4)> The descriptions set forth in this notice regarding the
structure and operations of EMCC have been largely
derived from information contained in EMCC's Form CA-1
application and publicly available sources.
to an industry initiative to reduce risk in the clearance and settlement of
emerging markets debt instruments.
Initially, EMCC will be owned by EMTA, the National Securities
Clearing Corporation ("NSCC"), and the International Securities Markets
Association ("ISMA"). EMTA will be issued 300 shares (37.5% of the
outstanding shares), NSCC will be issued 300 shares (37.5% of the
outstanding shares), and ISMA will be issued 200 shares (25% of the
outstanding shares).<(5)>
EMTA is a trade association organized as a New York not-for-profit
corporation in 1990 by financial institutions to promote the orderly
development of trading markets in emerging market instruments. As of the
end of 1996, EMTA had 154 members, which were mainly broker-dealers and
banks. EMTA owns 100% of the outstanding voting securities of EMTA Black,
Inc. EMTA Black, Inc. in turn owns 100% of the outstanding voting
securities of each of Clear-EM, Inc., Match-EM, Inc., and Net-Em, Inc.
Match-EM, Inc. is the owner of Match-EM, which is an electronic post-trade
confirmation and matching system for Brady bonds and sovereign loans
operated by GE Information Services, Inc. ("GE"). Match-EM also enables
EMTA to disseminate daily market volume and price data. Match-EM began
services in May 1995.
ISMA is an industry association composed of member broker-dealer
firms. ISMA has approximately 820 members in 48 countries. ISMA is
<(5)> After the initial issuance of shares to EMTA, NSCC, and
ISMA, EMCC intends to issue shares to persons that have
contributed to the EMCC development fund and to finance
EMCC's initial operations in such amounts and at such
times as determined by EMCC. EMCC intends to issue
shares no later than June 30, 1998. EMCC will file a
proposed rule change prior to any such issuances.
======END OF PAGE 2======
organized under the laws of Switzerland and is registered in the United
Kingdom ("U.K.") as a designated investment exchange. ISMA owns TRAX, a
trade matching and reporting system started in 1989. U.K. broker-dealers
can use TRAX to fulfill their U.K. reporting requirements. ISMA's wholly-
owned subsidiary, International Securities Market Association Limited
("ISMA Ltd."), operates TRAX.
NSCC is a clearing agency registered under Section 17A of the Exchange
Act.<(6)> NSCC is owned by the New York Stock Exchange, Inc., the
American Stock Exchange, Inc., and the National Association of Securities
Dealers, Inc. NSCC is the parent corporation of ISCC, which is also
registered as a clearing agency under the Exchange Act.<(7)>
III. DESCRIPTION OF EMCC OPERATIONS
EMCC is being established as a clearing agency initially to facilitate
the clearance and settlement of transactions in U.S. dollar-denominated
Brady bonds.<(8)> Currently, Brady bonds are settled through the
<(6)> See Securities Exchange Act Release No. 20221
(September 23, 1983), 48 FR 45167 (order approving full
registration of NSCC as a clearing agency).
<(7)> See Securities Exchange Act Release No. 26812 (May 12,
1989), 54 FR 21691 (order approving temporary
registration of ISCC as a clearing agency). ISCC
continues to operate under its temporary registration.
Securities Exchange Act Release No. 38703 (May 30,
1997), 62 FR 31183.
<(8)> Brady bonds were first issued pursuant to a plan
developed by then U.S. Treasury Secretary Nicholas
Brady to assist debt-ridden countries restructure their
sovereign debt into commercially marketable securities.
The plan provided for the exchange of bank loans for
collateralized debt securities as part of an
internationally supported sovereign debt restructuring.
Typically, the collateral would be U.S. Treasury
securities. The first Brady bonds were issued in 1990
(continued...)
======END OF PAGE 3======
======END OF PAGE 4======
facilities of Cedel Bank, Soci‚t‚ anonyme ("Cedel") and the Euroclear
system, which is operated by the Brussels Office of Morgan Guaranty Trust
Company of New York ("Euroclear").<(9)> As more fully described
below, EMCC will facilitate the settlement of Brady bonds at Cedel and
Euroclear ("depositories").
A. Clearance Services
Brady bonds are traded in an over-the-counter market composed of
dealers and interdealer brokers where trading is either directly between
<(8)>(...continued)
for Mexico. Later securities that did not strictly
adhere to the terms of the plan (e.g., such securities
may not have been collateralized) were also referred to
as Brady bonds.
The definition of Brady bonds used to denote securities that
will be eligible for processing by EMCC will be somewhat
broader than the traditional usage of the term. As defined
in EMCC's rules, Brady bonds are: (i) any bond or note
issued in connection with the restructuring of indebtedness
by a sovereign or an agency or entity thereof under the
auspices of the Brady plan or under any similar
restructuring or financing plan whether or not
collateralized and including bonds or notes issued in
exchange thereof or (ii) any warrant or similar right
originally issued attached to a Brady bond. The term does
not include securities offered by a sovereign debtor to
investors through normal underwriting syndication channels.
EMCC intends to offer clearance and settlement services for
other emerging markets debt instruments in the future. EMCC
will file proposed rule changes with the Commission prior to
expanding the categories of securities eligible for
processing at EMCC.
<(9)> For a description of Cedel, see Securities Exchange Act
Release No. 38328 (February 24, 1997), 62 FR 9225
(order approving application for limited exemption from
registration as a clearing agency). For a description
of Euroclear, see Securities Exchange Act Release No.
38589 (May 9, 1997), 62 FR 26833 (notice of application
for limited exemption from registration as a clearing
agency).
======END OF PAGE 5======
dealers or between dealers through interdealer brokers. Generally, Brady
bonds that have warrants associated with them are traded to include the
warrants. In order to participate in EMCC, dealers and interdealer brokers
will need to submit transaction data to a locked-in trade source which will
match such data using its own criteria. Initially, the locked-in trade
sources designated by EMCC will be Match-EM and TRAX.
Upon completion of the matching process, each locked-in trade source
will submit all of its transaction data to EMCC regardless of whether the
counterparties are EMCC members. EMCC will then segregate all data on
trades between two EMCC members to input into the EMCC system. As a
result, all EMCC members that decide to use Match-EM or TRAX as a part of
their normal trading process will be locked into settlement at EMCC and
will be unable to select an alternative settlement process. While EMCC
members will be able to delete their trades from EMCC's clearance system by
submitting cancellation instructions through the locked-in trade source,
such action may result in the trade legally being considered cancelled
(i.e., the members would be required to reconfirm such trades outside of
TRAX or Match-EM and therefore would not receive the benefit of using
TRAX's or Match-EM's automated confirmation system).
EMCC will receive data from the locked-in trade sources three times
each business day: (1) at approximately 8:30 a.m. eastern time ("ET")
("early morning transmission"), (2) at approximately 11:30 a.m. ET
("midmorning transmission"), and (3) at approximately 9:30 p.m. ET
("evening transmission"). EMCC will review such data to determine whether
it meets EMCC's and the depositories' operational parameters and will
======END OF PAGE 6======
reject trades that do not meet such parameters.<(10)> At
approximately 10:30 a.m. ET and 11:30 p.m. ET, EMCC will send out to its
members and to the locked-in trade sources a report of data that was
rejected because it did not meet the operational parameters. Any
correction or cancellation of data must be done through the locked-in trade
sources.<(11)>
EMCC will report to each member on its "accepted trade report" data on
all trades: (a) that are eligible for processing by EMCC (i.e., U.S. dollar
denominated Brady bonds), (b) that are matched by the locked-in trade
sources, (c) that are received by EMCC on trade date ("T"), on T+1, and in
the early morning transmission on T+2, and (d) that are not rejected by
EMCC based on the operational parameters. Matched trades that are eligible
for processing and that are received on T+2 in the midmorning transmission
will be listed on a "settlement instructions only report."<(12)>
Transaction data received by EMCC in the evening transmission on T+2 and
thereafter will not be accepted by EMCC because it will be unable to submit
timely settlement instructions to the depository.
EMCC may also receive uncompared transaction data from the locked-in
trade sources. If EMCC does not receive by the early morning transmission
<(10)> Such parameters include complete information and valid
characters. In addition, EMCC has established a
maximum delivery size of $20 million.
<(11)> Any cancellation or correction must be received by EMCC
no later than the early morning transmission two
business days after trade date ("T+2").
<(12)> EMCC provides settlement instructions on behalf of its
members with respect to trades listed on the settlement
instructions only report to the depositories for
settlement directly between the members.
======END OF PAGE 7======
on T+2 updated data from a locked-in trade source indicating that an
uncompared trade has been cancelled or compared, EMCC will include data on
the uncompared trade on the settlement instructions only report if the
submitting member has requested EMCC to do so pursuant to the member's
standing instructions.
Accepted trade reports will be made available to members at
approximately 10:30 a.m. ET and 11:30 p.m. ET. The morning report will
contain data on matched trades received in the early morning transmission.
The evening report will contain data on matched trades received in the
midmorning and evening transmission. The settlement instructions only
report will be issued at approximately noon. The settlement instructions
only report will contain data on matched trades received in the midmorning
transmission on T+2 and data on unmatched trades received by the midmorning
transmission on T+2. At approximately 12:30 p.m. on T+2, EMCC will send
settlement instructions to the depositories based on trade data contained
in the accepted trade reports and in the settlement instructions only
report.
B. Risk Management Services
EMCC will interpose itself as the counterparty and guarantor on a
trade-for-trade basis with respect to the trades it reports on its accepted
trade report ("novation") unless EMCC notifies or has made information
available to its members that trades listed on the accepted trade report
are not assumed and guaranteed because EMCC has ceased to act for the
original counterparty.<(13)> EMCC's guarantee will be effective with
<(13)> EMCC does not interpose itself as the counterparty and
guarantor for transactions reported on the settlement
instructions only report.
======END OF PAGE 8======
respect to: (a) trades reported on the evening accepted trade report at the
later of (i) midnight ET or (ii) one half hour after the issuance of the
preliminary margin report<(14)> and (b) trades reported on the
morning accepted trade report at the later of (i) 1:00 p.m. ET or (ii) two
and one half hours after issuance of the final margin report.<(15)>
The result is a novation of the original contract between the
counterparties, creating an obligation on the part of the seller to deliver
the securities to EMCC and on the part of the purchaser to receive and pay
for the securities delivered by EMCC.
C. Settlement Services
EMCC will be a member of both Euroclear and Cedel. EMCC will transmit
settlement instructions to the appropriate depository on behalf of members
with EMCC as the counterparty to each side of the trade. With respect to
each transaction reported on an accepted trade report which has not been
deleted, EMCC will send receive and deliver instructions to the depository
at 12:30 p.m. on T+2. If the accepted trade report indicates that a member
has a securities receive obligation, EMCC will notify the depository to
deliver the bonds from EMCC's account into the member's account against
payment on the next day ("T+3"). If the member had a securities deliver
obligation reflected on the accepted trade report, EMCC will instruct the
depository to deliver the specified quantity of bonds from the member's
account into EMCC's account against the receipt of the corresponding
<(14)> See infra Section IV.C.1.a for a description of the
preliminary margin report.
<(15)> See infra Section IV.C.1.a for a description of the
final margin report.
======END OF PAGE 9======
payment price on T+3.<(16)>
Settlement will occur in accordance with the rules of Euroclear or
Cedel. Essentially, the receiver must have sufficient cash or line of
credit to pay for the delivery, and the deliverer must have sufficient
securities to make full delivery.<(17)> The depositories will notify
<(16)> Consistent with industry conventions, EMCC assumes that
the bonds will be delivered with attached warrants
unless otherwise specified.
<(17)> Both Cedel and Euroclear employ mechanisms that can
look beyond the initial counterparties' obligations.
Cedel has a "chaining" program which scans open
transactions until all cash and securities resulting
from same day settlements are reemployed to settle
further transactions for same day value. Therefore,
for back-to-back transfers for equivalent funds,
customers may not need to pay because proceeds from
sales are used to settle purchases. However, Cedel's
chaining program is limited when transactions are sent
through its bridge connection with Euroclear. EMCC has
informed the Commission that its members currently do
not intend to use Cedel as a depository. If this
changes, EMCC intends to maintain a line of credit at
Cedel of approximately $40 million to allow the receipt
and delivery of securities across the bridge.
Euroclear's chaining program operates somewhat differently.
In scanning open transactions, the Euroclear program will
only look to the next settlement. For example, if a member
does not have sufficient funds to receive securities,
Euroclear will review to see if that member has a
corresponding securities deliver obligation to another
member. In such case, Euroclear will complete both
transactions if the counterparty to the deliver obligation
has sufficient funds to pay for the securities. But if the
counterparty to the securities deliver obligation did not
have sufficient funds to settle the transaction, Euroclear,
unlike Cedel, would not look to subsequent settlements for
funds and securities. Accordingly, if EMCC inserts itself
as a common counterparty without sufficient funds to accept
deliveries, Euroclear's system will only look to EMCC's
member to determine if sufficient funds exist. Therefore,
EMCC will maintain a line of credit between $60 and $100
million at Euroclear to reduce settlement inefficiencies.
EMCC's line of credit will permit Euroclear to review not
(continued...)
======END OF PAGE 10======
EMCC and its members each day at midnight ET of the status of trades
indicating which have settled and which are still pending. EMCC will not
provide settling trade reports or fail reports to its members.
If a member cannot accept delivery of securities because of
insufficient funds, EMCC will generate a fail compensation instruction and
will transmit it to the appropriate depository. Pursuant to that
instruction, the depository will debit the account of the member that had
insufficient funds and credit its counterparty's account an amount of money
based on the depository's overnight borrowing interest rate multiplied by
the amount of funds which were not paid.
With respect to matched transactions reflected on the settlement
instructions only report, EMCC will send instructions on the afternoon of
T+2 to the depository on behalf of the members listed as counterparties.
The depository will be advised to deliver on T+3 bonds from the account of
the member with the deliver obligation to the account of the member with
the receive obligation against payment. EMCC will not monitor the
settlement of these transactions.
With respect to uncompared transactions reflected on the settlement
instructions only report, EMCC will send instructions on the afternoon of
T+2 to the depository on behalf of the member submitting the data naming
the other member as the counterparty to the instruction. EMCC will not
monitor the settlement of these transactions.
D. Buy-ins/Sell-outs
EMCC's rules will permit a buy-in or a sell-out in the event that a
<(17)>(...continued)
only the available funds of EMCC's member but also such
member's subsequent counterparty, if any.
======END OF PAGE 11======
transaction has not been completed by five days after settlement date
("SD+5") as described below. A buy-in or sell-out may be initiated by the
member with the receive or deliver obligation, respectively, by submitting
a pre-advice notice to EMCC. Upon receipt of the pre-advice notice, EMCC
will transmit the pre-advice notice to the corresponding member with the
fail obligation. If the instruments or money covered by the pre-advice
notice are not received within two business days after the date of the pre-
advice notice, then the member that requested the buy-in or sell-out will
need to deliver to EMCC a buy-in or sell-out notice between two to five
business days after issuance of the pre-advice notice in order to proceed
with the buy-in or sell-out. Upon receipt of the buy-in or sell-out
notice, EMCC will transmit a buy-in or sell-out notice to the member with
the fail obligation. Execution of the buy-in or sell-out will take place
through an agent selected by EMCC on the fifth business day following the
issuance of the buy-in or sell-out notice. EMCC also may initiate a buy-in
or sell-out if it determines that such action is necessary to protect EMCC,
its members, its creditors, or its investors; to safeguard securities or
funds in EMCC's custody or control; or to promote the prompt and accurate
clearance and settlement of securities transactions.
EMCC will also use the buy-in and sell-out procedures for deliver and
receive obligations for warrants. However, if EMCC has ceased to act for a
member with fail obligations prior to the execution of the buy-in or sell-
out, EMCC will undertake the buy-in or sell-out only at the expense of the
member that submitted the pre-advice notice. If EMCC ceases to act for the
defaulting member after the pre-advice notice has been submitted but before
the execution of the buy-in or sell-out, EMCC will first confirm with the
======END OF PAGE 12======
requesting firm that it wants to proceed with the buy-in at the requesting
firm's expense.
E. Release of Clearing Data
Pursuant to EMCC's rules, EMCC may release transaction data of its
members to EMTA in accordance with a written agreement between EMCC and
EMTA. Such data may be used only for the purpose of promoting market
transparency on a noncommercial basis. On June 9, 1997, EMCC and EMTA
entered into a letter agreement that provides for the release of
information relating to the aggregate and per trade transaction volumes and
prices of trades processed by EMCC.
IV. EMCC'S REQUEST FOR REGISTRATION
A. Introduction
Brady bonds are the most actively traded emerging market debt
instrument. In the first quarter of 1997, Brady bonds represented $671
billion of the $1.6 trillion traded in emerging markets instruments. Brady
bonds constitute approximately 12% of the total $1.2 trillion issued of
emerging market instruments.<(18)>
While Brady bonds currently are cleared and settled either through
Euroclear or Cedel, neither guarantees settlement of these transactions.
Furthermore, dealers have exposure to brokers until the assumption of risk
by clearing firms on the afternoon of T+1. As a result, parties to a
transaction retain a high degree of settlement risk. EMCC was developed in
response to an industry initiative to reduce risk in the clearance and
settlement of emerging market debt instruments. Therefore, in order to
provide the benefits of guaranteed settlement to the Brady bond market,
<(18)> Broward Daily Business Review, May 20, 1997, at A3.
======END OF PAGE 13======
EMCC seeks registration as a clearing agency pursuant to Section 17A of the
Exchange Act and Rule 17Ab2-1.
B. Goals of Clearing Agency Registration
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 and regulation of clearing agencies is a key element in
<(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).
======END OF PAGE 14======
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 standards developed by its Division of Market Regulation which
are used in evaluating applications for clearing agency
registration.<(21)>
C. Safety and Soundness Protections
Sections 17A(b)(3)(A) and (F) of the Exchange Act require that 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.<(22)> In the
Standards Release, the Division enumerated certain requirements that should
be met to comply with this standard.
<(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).
<(22)> 15 U.S.C. 78q-1(b)(3)(A) and (F).
======END OF PAGE 15======
1. Clearing Fund
The Standards Release stated that a clearing agency should have a
clearing fund which is based on a formula applicable to all users and is
comprised of cash or highly liquid securities. The rules of a clearing
agency should limit the investments that can be made with the cash portion
of its clearing fund to government securities or other safe and liquid
investments. The clearing fund should only be used to protect participants
and the clearing agency (a) from defaults of participants and (b) from
clearing agency losses not resulting from day to day expenses and not
covered by insurance or other resources of the clearing agency. While the
Standards Release stated that a clearing agency could use temporary
applications of the clearing fund in limited amounts to meet unexpected and
unusual requirements for funds, the regular or substantial use of a
clearing fund for operational purposes would be inappropriate.<(23)>
The clearing agency should provide for the maximum assessment to which any
participant is subject. Comment is requested on whether EMCC meets these
standards as described below.
a. Clearing Fund Formula
EMCC will maintain and will manage a clearing fund for the purpose of
limiting or eliminating EMCC's exposure to loss in the event a member would
fail to perform its obligations to EMCC. Each member will be obligated to
make deposits to EMCC's clearing fund. The initial required clearing fund
<(23)> The Standards Release also stated that there may be
legitimate purposes for which a clearing fund may be
used for a longer period of time so long as (a) the
funds are properly protected, (b) the funds are used to
facilitate the process of clearance and settlement, and
(c) the participants and the Commission approve such
use during the registration proceedings.
======END OF PAGE 16======
deposit for each member will be set by EMCC based on the expected nature
and level of the member's activity. The minimum required clearing fund
deposit for each member will be US $1,000,000.
Every day, EMCC will calculate margin in the morning and in the
evening but will only collect margin based on the morning calculation.
EMCC will generally calculate the margin amount as follows: (mark to market
amount + volatility amount) x event risk factor.<(24)> The mark to
<(24)> EMCC has represented that it performed a stress test in
which the proposed formula was applied using three
months of data on EMCC eligible transactions obtained
from Match-EM. The test assumed for each member that
the market in which such member had its highest
concentration of positions experienced an abnormal
negative market move (i.e., the "stressed market").
All securities positions for that member in other
countries were run under the baseline assumptions
(i.e., no unusual market movements). The tests assumed
first a 10 standard deviation market drop in the
stressed market and second a 4 standard deviation
market gain in the stressed market. The test assumed
that bonds on the opposite sides of the stressed market
had correlations of 80% while bonds on the same side of
the stressed market had 100% correlation.
However, the test did not attempt to take into account any
spillover effect (i.e., where the sudden drop of prices in a
country's bond market resulted in a similar drop in the bond
markets of other countries with similar risk profiles).
EMCC states that it is difficult to quantify any spillover
effects. EMCC believes that spillover effects are addressed
because the test assumes that for each firm the stressed
event occurred in the country in which the firm was most
concentrated and therefore would most adversely effect the
value of the firm's position and also assumes a degree of
deviation from the mean that was substantially higher than
was the case in the Mexican debt crisis.
Under this test, EMCC had no exposure 73.64% of the time.
EMCC had exposure between $1 and $1 million 9.18% of the
time. EMCC had exposure of greater than $10 million 1.7% of
the time. The highest exposures were four occurrences of an
exposure of approximately $15 million and one exposure of
approximately $50 million.
======END OF PAGE 17======
market amount will be based on all trades due to settle on or after that
day and all fails unless EMCC has received notice from the depository that
such trade or fail has settled.<(25)> The mark to market amount will
be based on the difference between the market price and the contract value
of the trade. If the net mark-to-market is a credit, the firm will have a
zero mark-to-market.
The volatility amount for the evening calculation will be based on all
trades due to settle on or after that day and all fails unless EMCC has
received notice from the depository that such trade or fail has settled.
The volatility amount for the morning calculation will be based on all
trades due to settle on or after the current day and all fails calculated
as of the prior day whether or not EMCC has received notice of the
settlement of such trades or fails. Thus, the morning volatility amount
will include trades that have already settled that day, while the evening
volatility amount will only include trades that have not
settled.<(26)> In order to calculate the volatility amount, each
<(25)> EMCC will receive notice at midnight ET (or 6:00 a.m.
in Brussels and Luxembourg) from Euroclear and Cedel of
all trades that have settled. At that time, Euroclear
and Cedel have already completed most of the
settlements of that day (i.e., the notice issued at
midnight ET on Friday morning will indicate trades that
will settle Friday at the depository). Some trades
will settle later, but EMCC will receive notice of them
before it begins its processing day. Thus, when EMCC
calculates the margin in the morning and the evening,
it will have received notice of which trades have
settled or failed for the day.
<(26)> The reason for including transactions in the morning
volatility calculation whether or not they have settled
is to insure that data on three days of pending trades
is included. EMCC believes that because it is
guaranteeing three days of trades, it is appropriate
(continued...)
======END OF PAGE 18======
security will be placed into one of four liquidity categories based on the
average bid/offer spread, which will determine which volatility formula
will be applied to that security.<(27)> The sum of the volatility
amounts for each security will be the clearing member's volatility
amount.<(28)>
<(26)>(...continued)
that data on three days of trading activity is included
in the volatility calculation. At the time of the
morning volatility calculation, the trades entered into
three days before will have settled, but EMCC will not
have received data for the trades entered into on the
current day. Thus, by including data for trades
settling that day, EMCC will be using three days of
data. EMCC will calculate fails as of the prior day
because fails calculated as of the current day would
include trades due to settle that day (i.e., these
trades would be double counted as trades due to settle
that day and fail trades). With respect to the evening
volatility calculation, EMCC will have received data on
trades entered into on that day. Thus, it is no longer
necessary to include trades that have settled that day.
<(27)> The four classes and spreads are as follows: L1 - 3/8
or less; L2 - 3/4 or less; L3 - 2 or less; L4 - greater
than 2 or no trading activity for a certain period of
days.
<(28)> For each L4 security, the volatility amount is the
value of the position x 30%. For L1, L2, and L3
securities of each issuer, EMCC will take the larger of
the following formula with: (a) the member's long
positions in lines 1 and 2 and short positions in lines
3 and 4 and (b) the member's short positions in lines 1
and 2 and long positions in lines 3 and 4.
1. (value of long or short L1+L2) x 2 Std PLUS
2. (value of long or short L3) x 4 Std PLUS
3. (value of short or long L1+L2) x 2 Std x CC PLUS
4. (value of short or long L3) x 1 Std x CC
Std. is equal to a one standard deviation move over a five
day holding period based on the higher of a calculation
using price data for one year and three months. CC is the
smallest correlation coefficient between any security of
(continued...)
======END OF PAGE 19======
The event risk factor, which is designed to give EMCC an additional
cushion against events in countries not covered by two standard deviations,
will initially be set at 1.25. EMCC may adjust the event risk factor for a
member or for all members without prior notice to the member(s). EMCC also
will increase margin requirements by multiplying a global holiday risk
factor to the formula to take into account days on which U.S. banks are
closed but securities markets are open.
The preliminary margin amount will be calculated each evening and will
be reported to members at approximately 11:30 p.m. on a preliminary margin
report. The report will show the member's current deposit, preliminary
margin amount, and preliminary amount due, if any. However, members will
not be required to make any payment to EMCC based on the preliminary margin
report.
The final margin amount will be calculated each morning and will be
reported to members at approximately 10:30 a.m. on a final margin report.
A member's required margin deposit will be equal to the largest single
final daily margin amount computed for that member for the month during
which such margin calculation is being performed and for the previous
calendar month. The final margin report will indicate each member's
<(28)>(...continued)
that issuer in which the member has a short position and any
security of that issuer in which the member has a long
position. The correlation coefficient will be based on one
year's pricing data and will be updated daily.
EMCC may adjust the fixed percentage applied to L4
securities or the number of standard deviations applied to
L1, L2, and L3 securities without prior notice in order to
increase the volatility calculations when warranted by
circumstances. These adjustments may be made on a country
by country basis or a bond by bond basis either for all
members or for members unduly concentrated.
======END OF PAGE 20======
current deposit, final margin amount, and final amount due, if any. A
member will be required to pay any obligation with respect to its margin
obligation reflected on the final margin report no later than the later of
11:30 a.m. ET or one hour after the final margin report is made available.
Margin deficits of less than $100,000 will not be considered to be a margin
deficit. Payment must be made through the U.S. Fedwire system.
EMCC also will have the authority to collect additional amounts over
and above the daily margin requirement in order to obtain adequate
assurances of the financial responsibility or operational capability of a
member. EMCC has created a policy statement on procedures to follow in
determining whether additional clearing fund deposits are
needed.<(29)> EMCC also may collect additional margin if a member
<(29)> Each day, EMCC will calculate a net country position
and a net geographical position for each member. The
net country position will be the sum of the settlement
values of the member's position in L1, L2, and L3
securities plus the sum of the absolute settlement
values of the member's position in L4 securities of
each country. The net geographical position will be
the sum of the net country positions in Latin America,
Eastern Europe, Asia, and Africa. An undue
concentration will be deemed to exist for a bank when
the net country position exceeds 20% of net worth or
the net geographical position exceeds 30% of net worth.
An undue concentration will be deemed to exist for a
broker-dealer when the net country position exceeds 50%
of excess regulatory capital or the net geographical
position exceeds 80% of excess regulatory capital.
Under such circumstances, EMCC will contact the member
to request information on the nature and magnitude of
non-Brady bond exposure and on any hedging positions.
If EMCC is not satisfied with the answers to these
questions, EMCC may request additional clearing fund
deposits.
======END OF PAGE 21======
has been placed on surveillance status.<(30)>
b. Margin Composition and Investment
Members will be required to pay margin in cash, U.S. Treasury
securities, or letters of credit from banks that have been approved by
EMCC. If letters of credit are used as margin, no more than 70% of a
member's requirement may be satisfied with letters of credit and, as a
minimum, the greater of $100,000 or 10% of the member's margin requirement
(up to a maximum of $1,000,000) must be in cash. Furthermore, no more than
20% of EMCC's total clearing fund may be letters of credit from any one
issuer. If letters of credit are not used, the greater of $100,000 or 5%
of the member's margin requirement (up to a maximum of $1,000,000) must be
<(30)> EMCC will put a member on surveillance status if any of
the following factors are present: (a) the member
fails to meet any financial standard for admission or
continuance as a member, (b) the member's capital
position falls below the standards for admission, (c)
the member experiences an inability to meet its money
or securities settlement obligations to EMCC, (d)
EMCC's board determines that a significant
reorganization, change in control, or management of the
member is likely to impair the member's ability to meet
its money or securities settlement obligations to EMCC,
or (e) the member has been placed on surveillance
status by another self-regulatory organization or
comparable regulatory organization. EMCC also will
have the discretion to put a member on surveillance
status if any of the following factors are present: (a)
it experiences a significant operational problem, (b)
the member's positions are significantly
disproportionate to its usual activity in light of
current industry conditions, (c) EMCC receives
notification from the member's designated examining
authority or appropriate regulatory agency or
comparable regulatory organization of a pending
investigation or administrative action that could call
into question the member's ability to meet its
obligations to EMCC, or (d) the member experiences any
condition that could materially affect its financial or
operational capability so as to potentially increase
EMCC's exposure to loss or liability.
======END OF PAGE 22======
in cash. A haircut of 5% will be applied to letters of credit and treasury
securities.
EMCC may invest any cash deposited as margin in securities issued or
guaranteed as to principal or interest by the U.S. or agencies or
instrumentalities of the U.S., repurchase agreements related to EMCC, or
otherwise pursuant to the investment policy adopted by EMCC. If not
invested, cash funds will be deposited by EMCC in its name in a depository
institution selected by EMCC. EMCC will retain all investment income from
cash deposits. Comment is requested as to whether such investments are
consistent with the standard that investments should be limited to safe and
liquid investments such as government securities.
c. Loss Allocation
EMCC will establish an overnight exposure cap for each member. This
cap will be set at the lesser of (a) 5% of excess net capital for U.S.
broker-dealers, 5% of excess financial resources for U.K. broker-dealers,
and 1% of shareholders' equity for banks or (b) $20 million. If a member's
preliminary margin calculation is in excess of its overnight exposure cap,
the member will be subject to fines. The loss allocation method applied to
trades of an insolvent member will be dependent upon whether the insolvent
member has exceeded its overnight exposure cap.
When the failed member is not an interdealer broker, EMCC will
classify trades as brokered or direct.<(31)> If there was an
<(31)> If the failed member's counterparty was an interdealer
broker, but the interdealer broker's counterparty on
the other side was not an EMCC member, EMCC will
consider the trade to be a direct trade between the
insolvent and the interdealer broker. In other words,
"brokered trades" are trades where the interdealer
(continued...)
======END OF PAGE 23======
overnight exposure cap violation, EMCC will further classify such trades as
trades received by EMCC before the violation ("old trades") or trades
received by EMCC after the violation ("new trades"). Any collateral of the
defaulting member will be divided between direct trades and brokered trades
in proportion to the amount of losses attributable to old trades in each
category. If there is insufficient collateral to cover all of the losses
attributable to old trades: (a) losses attributable to brokered
transactions that are old trades will be allocated pro rata among all
members based upon each member's average final daily margin amount for the
prior 30 calendar days<(32)> and (b) losses attributable to direct
transactions that are old trades will be allocated among all the original
counterparties in proportion to the amount of losses created by each
member's transactions.
After the losses from old trades have been satisfied, EMCC will
determine if any clearing fund collateral of the defaulting member remains.
EMCC will net new trades to obtain a net loss per issue of securities. Any
remaining clearing fund of the defaulting member will be applied to the
smallest loss, then the next remaining smallest loss until there is no
remaining clearing fund of the defaulting member.<(33)> EMCC then
<(31)>(...continued)
broker is an EMCC member and EMCC members are on both
sides.
<(32)> A member that is assessed pursuant to this provision
may limit its assessment to its current margin
requirement if it chooses to terminate its membership.
<(33)> For example, after netting new trades in each issue of
securities, EMCC may determine that there are losses of
$2 million, $4 million, $3 million, and $10 million in
four issues and EMCC has collateral of the defaulting
(continued...)
======END OF PAGE 24======
will segregate the smallest remaining losses up to an amount that equals
the amount of the defaulting member's overnight exposure cap ("under the
cap losses").<(34)> The under the cap losses will be allocated as
follows: (a) losses attributable to direct transactions will be allocated
back to the original counterparties in an amount equal to the losses
attributable to the member's trades and (b) losses attributable to brokered
transactions will be allocated pro rata among all EMCC members based upon
each member's final daily margin amount calculated with respect to the
prior thirty calendar days. Any remaining losses attributable to new
trades will be allocated as follows: (a) losses attributable to direct
transactions will be allocated back to the original counterparties in an
amount equal to the losses attributable to the member's trades and (b)
losses attributable to brokered transactions will be allocated first to the
interdealer broker member that was a contraparty to such trade to the
extent of the loss attributable to such trade up to a maximum allocation of
$3 million per interdealer broker and then pro rata among members that were
contraparties to interdealer brokers that reach their maximum allocation
and that were on the opposite side of the market in the same issue of
securities creating a loss with the same settlement date and at
approximately the same price.
<(33)>(...continued)
member of $8 million. EMCC will satisfy the $2 million
loss first, then the $3 million loss, then a portion of
the $4 million loss.
<(34)> For example, if after netting there are losses of $5
million, $7 million, $9 million, and $3 million in four
issues and the defaulting member had an overnight
exposure cap of $10 million, EMCC will segregate out
the $3 million loss, the $5 million loss, and $2
million of the $7 million loss.
======END OF PAGE 25======
Different loss allocation rules will apply when the defaulting member
is a broker. In such cases, any collateral of the defaulting member will
be applied first to losses resulting from old trades. If there are
remaining losses from old trades, such losses will be allocated among all
the original contraparties in proportion to the amount of loss created by
each member's transactions. EMCC then will net new trades to obtain a net
loss per issue of securities. Any remaining clearing fund of the
defaulting member will be applied to the smallest loss, then the next
remaining smallest loss until there is no remaining clearing fund. Any
remaining loss after application of clearing fund will be allocated back to
the contraparties to the transactions giving rise to such loss to the
extent of the loss attributable to such transactions.
d. Use of Clearing Fund
EMCC's rules will provide that the use of clearing fund deposits is
limited to satisfaction of losses or liabilities of EMCC arising from the
failure of a member to satisfy an obligation to EMCC or as an incident to
the clearance and settlement by EMCC and to provide EMCC with a source of
collateral to meet its temporary financing needs. If EMCC pledges any part
of the clearing fund deposits for more than 60 days as a source of
temporary financing, EMCC will by the 74th day consider such amount to be a
loss and will allocate such loss in accordance with the loss allocation
rules. Comment is requested whether EMCC's proposed uses of its clearing
fund are consistent with the requirement that temporary applications of the
clearing fund should be used only in limited amounts to meet unexpected and
unusual requirements for funds and that the regular or substantial use of a
clearing fund for operational purposes would be inappropriate.
======END OF PAGE 26======
2. Standard of Care
The Division stated in the Standards Release that the rules of a
clearing agency should provide that it is liable to a participant for
failure to deliver the participant's securities resulting from (i) the
negligence or misconduct of the clearing agency, the clearing agency's
subcustodian or agent, or any of their respective employees, (ii) the
placement on fully-paid participant securities of a lien or charge of any
kind in favor of the clearing agency, the clearing agency's subcustodian or
agent, or any person claiming through any one or more of them, (iii)
larceny, (iv) mysterious disappearance, or (v) any other cause for which
the clearing agency has assumed responsibility. Since the date of the
Standards Release, the Commission has further clarified its position on
clearing agency liability, stating that clearing agencies should perform
their functions under a high standard of care and at a minimum custody
services should be performed under an ordinary negligence
standard.<(35)> The Commission also has stated that custody
functions include all functions related to transaction processing and the
safekeeping of customer funds and securities.<(36)>
As proposed, EMCC's member's agreement, executed between EMCC and each
member, will provide that EMCC is not subject to any liability under the
<(35)> Securities Exchange Act Release Nos. 26154 (October 3,
1988), 53 FR 39556 (registration order of the
Intermarket Clearing Corporation ["ICC"]); 26450
(January 12, 1989), 54 FR 2010 (registration order of
the Delta Government Options Corp. ["DGOC"]); 26812
(May 12, 1989), 54 FR 21691 (registration order of
ISCC); and 27611 (January 12, 1990), 55 FR 1890 (second
registration order of DGOC).
<(36)> See, e.g., ICC registration order, supra note 35.
======END OF PAGE 27======
agreement, including any liability with respect to EMCC's failure to
provide any services under the agreement or EMCC's rules, except for losses
resulting from EMCC's gross negligence, criminal act, or willful misconduct
in connection with its duties. The agreement further will provide that
EMCC will not be liable for any consequential or special damages which may
result from EMCC's failure to perform its obligations under the agreement.
EMCC's rules will provide that EMCC will have no responsibility for
errors which may occur in any transmission of data to EMCC except in the
case of EMCC's gross negligence. EMCC's rules also will provide that EMCC
will have no liability for errors made by it in the conversion of data from
a yield basis to a price basis or vice versa or from the comparison of such
converted data if EMCC has acted in good faith and takes prompt action to
correct any error.
The Commission preliminarily believes that EMCC's proposed standard of
care is inconsistent with the Exchange Act and prior Commission positions.
Because EMCC's actions bear directly upon the safeguarding of securities
and funds, the Commission believes that EMCC's activities constitute
custodial functions for which a negligence standard is appropriate.
Furthermore, the Commission has never approved a gross negligence standard
as a blanket standard of liability for a fully functioning clearing
agency.<(37)> The Commission invites comment upon the
<(37)> While the Commission approved the temporary
registration of the Government Securities Clearing
Corporation ("GSCC") under a gross negligence standard,
such clearing agency's functions at the time were
limited to comparison of data. In addition, the
Commission urged GSCC to adopt a negligence standard
for all functions affecting member settlements,
including comparison of data. Securities Exchange Act
(continued...)
======END OF PAGE 28======
appropriateness of EMCC's proposed standard of liability.
3. Processing Capacity
ISCC has agreed pursuant to a service agreement to perform services
for EMCC with respect to EMCC's clearing agency activities. ISCC will
furnish the services necessary to conduct EMCC's operations for a fee
designed to cover ISCC's costs. ISCC will provide EMCC with technical
services in the following areas: data processing, operations, planning and
development, communications, and research and development. Currently, ISCC
has seven employees. Such employees' duties are generally limited to
operational functions. ISCC currently provides limited clearing agency
services. Many of ISCC's functions are performed by NSCC or by the
International Depository & Clearing, L.L.C. ("IDC"). IDC is a company
equally owned by NSCC and The Depository Trust Company, both registered
clearing agencies. However, IDC is not regulated in any manner. The
Commission invites comments as to whether ISCC has sufficient capacity to
act as the facilities manager and operate another clearing agency.
ISCC may use outside parties to fulfill its commitments to EMCC.
Specifically, NSCC through ISCC will provide EMCC with management and
administrative services in the following areas: financial, personnel,
corporate communications, marketing, regulatory or compliance, and legal.
The Securities Industry Automation Corporation ("SIAC"), through ISCC and
NSCC, also will provide EMCC with managerial, clerical, and data processing
services. In addition, ISCC will rely on employees of IDC for product
<(37)>(...continued)
Release No. 25740 (May 24, 1988), 53 FR 19839. GSCC
continues to operate under its temporary registration.
Securities Exchange Act Release No. 38698 (May 30,
1997), 62 FR 30911.
======END OF PAGE 29======
development, marketing and sales, planning, participant services, and
executive (i.e., decision making) functions. The Commission asks for
comment as to whether these service arrangements are appropriate, and
particularly whether it is appropriate that an unregulated entity such as
IDC perform the above functions for a clearing agency.
In addition, as discussed above, EMCC has no independent capacity to
match trades. Instead, it relies on Match-EM and TRAX for such services,
neither of which is regulated in the U.S. EMCC has represented that it has
no contractual agreement with either GE (the operator of Match-EM) or ISMA
Ltd. (the operator of TRAX) that would permit it to review their
operational capabilities. Because the failure of Match-EM or TRAX could
result in EMCC being unable to fulfill its clearance and settlement
functions with respect to those trades which either Match-EM or TRAX should
have matched and reported to EMCC, the Commission requests comment on
whether the current arrangement is consistent with EMCC's obligations to
ensure that it has sufficient operational capability. Specifically, the
Commission believes that at a minimum, EMCC should obtain sufficient
information to be able to make a determination that Match-EM and TRAX are
operating in a manner that ensures that they will be able to accurately
match and to report trades on a timely basis to EMCC. Furthermore, the
Commission believes that it should have access to the materials that EMCC
has relied on to make this determination. Comment is requested as to
whether other conditions should be applied.
4. Audit Committee and Internal Audit Department
The Standards Release stated that clearing agencies should have an
audit committee composed of nonmanagement directors. A nonmanagement
======END OF PAGE 30======
director is a director who is not associated with the clearing agency other
than in a user capacity or with any entity which furnishes securities
processing services to the clearing agency. The audit committee should
have responsibility for reviewing the work performed by the clearing
agency's independent public accountant.
EMCC's bylaws will provide that the board of directors may appoint an
audit committee consisting of three or more directors other than officers
of EMCC. The audit committee will have responsibility for reviewing with
the independent certified public accountants the scope of their auditing
procedures and the financial statements of EMCC to be certified by the
accountants. The Commission notes that EMCC's bylaws do not prohibit the
directors that are representatives of NSCC, ISMA, and EMTA from serving on
the audit committee. Comment is requested as to whether the relationship
and the services provided by NSCC, ISMA, and EMTA are such that the
individuals representing these entities on EMCC's board should not serve on
the audit committee. The Standards Release stated that a clearing
agency should have an internal audit department which is adequately staffed
with qualified personnel. NSCC's internal audit department will perform
EMCC's internal auditing functions.
5. Securities, Funds, and Data Controls
The Standards Release provides that a clearing agency should have off-
site storage of up-to-date files, written procedures detailing steps
involved in handling funds and securities, and emergency mechanisms for
establishing and maintaining communications with participants and other
entities. In addition, clearing agencies should have adequate insurance.
EMCC has represented that through its facilities manager, SIAC, it has
======END OF PAGE 31======
access to two computer sites in different locations, both of which are
capable of being operated independently and are capable of handling total
participant activity. Data received will be automatically written to both
sites. EMCC has provided a detailed written statement of security measures
that will be used to prevent unauthorized access to EMCC's processing
facilities. EMCC maintains blanket bond insurance and all risk insurance.
D. 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.
1. Governance Procedures
EMCC's board will have a total of 21 directors, divided into four
classes. The first three classes will consist of five directors each
("participant directors"). The fourth class will have six directors,
consisting of one director selected by EMTA, one director selected by ISMA,
two directors selected by NSCC, and two directors selected by the EMCC
board. The term of office of the participant directors will be three
years, with the term of one class of directors expiring each
year.<(38)> Participant directors may not serve for more than six
consecutive years. The term of the fourth class will be one year.
<(38)> The term of the initial directors in class one will
expire in 1998, the term of the initial directors in
class two will expire in 1999, and the term of the
initial directors in class three will expire in 2000.
======END OF PAGE 32======
Members may nominate individuals to serve as participant directors by
filing with EMCC's Secretary at least thirty days prior to the date of the
annual meeting a petition signed by the lesser of five percent of the
participants or ten participants.<(39)> A nominating committee
selected by the board will also select individuals to serve as participant
directors. If any member files a petition for participant director, EMCC's
Secretary will mail ballots to all members. Members will then be provided
the opportunity to vote for participant directors.<(40)>
2. Provision of Information to Participants
The Standards Release stated that participants should have sufficient
information concerning a clearing agency's affairs to participate
meaningfully in its administration. Clearing agencies should furnish
participants with audited annual financial statements, an annual report on
internal accounting control prepared by an independent public accountant,
and notices of any proposed rule changes.
The Standards Release stated that the annual financial statements
should be provided within 60 days following the close of the clearing
agency's fiscal year prepared in accordance with generally accepted
accounting principles. EMCC's rules will provide that EMCC will undertake
to provide to all members audited financial statements and a report
prepared by independent public accountants within 60 days following the
<(39)> Only one director may be selected which is an officer
of any single participant or its affiliate.
<(40)> Members will have three votes for each $1.00 of average
clearing fund deposits during the twelve month period
ending on the last day of the second month prior to the
date of determination and two votes for each $1.00 of
the average monthly fee payable or paid by the member
to EMCC during the same twelve month period.
======END OF PAGE 33======
close of its fiscal year. EMCC also will undertake to provide unaudited
financial statements to its members within 30 days following the close of
each of EMCC's fiscal quarters.
The Standards Release stated that the report on internal accounting
control should be based on a study and an evaluation which was made for the
purpose of reporting on the clearing agency's overall system of internal
accounting control. The report should disclose any material weaknesses
discovered and any corrective action taken or proposed to be taken. The
report should be furnished to all participants promptly after it becomes
available and no later than 60 days after the period covered by the report.
EMCC indicated in its Form CA-1 that it intends to prepare an annual
internal accounting control report. However, EMCC does not provide that
such report will be given to its participants.
As discussed in the Standards Release, the notice of proposed rule
changes should be provided to participants prior to or as soon as possible
after filing with the Commission and should provide a description of the
rule change, its purpose, and its effect. EMCC's rules will provide that
it will immediately notify all members and registered clearing agencies of
all proposals it has made to change, revise, add, or repeal any rule,
including a brief description of the proposal, its purpose, and its effect.
E. 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
======END OF PAGE 34======
eligible for access to clearing agency membership and services.<(41)>
In addition, a clearing agency may accept specific categories of persons
other than those enumerated, but a clearing agency should be cognizant of
the impact that participation may have on the safety of the clearing agency
and should provide safeguards to protect against that risk. 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.
1. Members
EMCC will provide services to those organizations, entities, or
persons that qualify as members under EMCC's rules, that apply to EMCC to
act for them, whose applications are approved by EMCC, and that have
contributed to EMCC's clearing fund. A partnership, corporation, limited
liability company, or other organization, entity, or individual will be
qualified to become a member of EMCC if it satisfies at least one of the
following qualifications: (a) it is a broker or dealer registered under the
Exchange Act; (b) it is a broker or dealer registered or regulated under
<(41)> The classes are registered brokers or dealers,
registered clearing agencies, registered investment
companies, banks, and insurance companies.
======END OF PAGE 35======
the laws of the jurisdiction other than the U.S. in which it is organized
or established; (c) it is a bank or trust company, including a trust
company having limited power, which is a member of the Federal Reserve
System or is supervised and examined by state or federal authorities in the
U.S. having supervision over banks; (d) it is a bank or trust company,
which is supervised and examined by the banking regulator in the
jurisdiction other than the U.S. in which it is organized or established;
or (e) if it does not qualify under (a) through (d) but is the successor or
assigns of any member and has demonstrated to the board of directors that
its business and capabilities are such that it could use EMCC's services
without undue risk, then such successor or assigns may become a member for
the limited purpose of winding up its business with EMCC in an orderly
manner. Initially, only broker-dealers that are organized under the laws
of the U.K. will be eligible for admission under (b) above. Comment is
requested as to the advisability of admission of non-U.S. participants and
whether the proposed admission standards provide sufficient protection to
EMCC and the national clearance and settlement system.
After the issuance of shares to persons which have contributed to the
development fund for the organization and initial operation of
EMCC,<(42)> all applicants that EMCC accepts for membership will be
required to be either a shareholder of EMCC or an affiliate or subsidiary
of a shareholder of EMCC. EMCC may deny an application to become a member
or to use one or more services of EMCC upon a determination by EMCC that
EMCC does not have adequate personnel, space, data processing capacity, or
other operational capability at such time to perform its services for the
<(42)> See supra note 5.
======END OF PAGE 36======
applicant or member without impairing the ability of EMCC to provide
services for its existing members, to assure the prompt, accurate, and
orderly processing and settlement of securities transactions, or to
otherwise carry out its functions. However any such applications which are
denied will be approved as promptly as the capabilities of EMCC permit.
2. Financial Reports
All applicants for admission to EMCC will need to provide a copy of
the applicant's financial statements for the two fiscal years ending
immediately preceding the year in which application is made, certified
without qualification by the applicant's independent certified public
accountants. To the extent that such audited financial statements are not
prepared in accordance with U.S. generally accepted accounting principles
("GAAP"), the applicant will be required to provide EMCC with a discussion
of the material variations of such accounting principles from U.S. GAAP.
A U.S. broker-dealer applicant will need to provide copies of the its
Form X-17A-5 FOCUS Reports ("FOCUS Reports") or Form G-405 Reports on
Finances and Operations ("FOGS Reports") for the last 24 months if a
monthly filer or the last eight quarters if a quarterly filer submitted to
its designated examining authority and any supplemental reports required to
be filed with the Commission pursuant to Exchange Act Rule 17a-
11<(43)> or 17 C.F.R. Section 405.3. A bank applicant will need to
provide all quarterly financial statements covered by the last audited
financial statement plus all subsequent quarterly financial statements. A
U.S. bank applicant also will need to provide copies of its three most
recent Consolidated Reports of Condition and Income ("Call Reports")
<(43)> 17 CFR 240.17a-11.
======END OF PAGE 37======
submitted to its appropriate regulatory agency and, to the extent not
contained within such Call Reports or to the extent that the applicant does
not have Call Reports, information containing each of the applicant's
capital levels and ratios, as such levels and ratios are required to be
provided to its appropriate regulatory agency. A non-U.S. bank applicant
also will need to provide all material regulatory filings made with its
primary regulator in its home country over the prior two years. If the
applicant is a U.K. broker-dealer subject to regulation by the Securities
Futures Association ("SFA"), it will need to provide EMCC with its SFA
monthly reports and returns for the prior twenty-four months and if
necessary and feasible, financial statements prepared in accordance with
U.S. GAAP.
If required by EMCC, an applicant will need to provide a certificate
of the chief executive or chief financial officer of the applicant that no
material adverse changes have occurred in the financial condition of the
applicant since the date of the most recent financial statements, FOCUS
Report, FOGS Report, Call Report, or comparable reports to regulatory
authorities, as applicable, filed with EMCC; that the applicant has not
guaranteed the obligations of any other person; and that the applicant is
not subject to any other contingent liabilities, except as set forth in
such financial statements, FOCUS Report, FOGS Report, Call Report,
comparable reports to regulatory authorities, or the certificate.
3. Admission Criteria for Members
The board or the membership and risk committee of the board may
approve an application to become a member upon a determination that such
applicant meets the applicable admission criteria. The applicant must have
======END OF PAGE 38======
adequate personnel, physical facilities, books and records, accounting
systems, and internal procedures to enable it to satisfactorily handle
transactions and communicate with EMCC, to fulfill anticipated commitments
to and meet the operational requirements of EMCC with necessary promptness
and accuracy, and to conform to any condition and requirement that EMCC
reasonably deems necessary for its protection or that of its members.
The applicant must have an established business history of a minimum
of three years or personnel with sufficient operational background and
experience to ensure, in the judgment of the board, the ability of the firm
to conduct its business. The applicant must agree to make and have
sufficient financial ability to make all anticipated payments required to
be made to EMCC. The applicant must be in compliance with the capital
requirements imposed by its designated examining authority or appropriate
regulatory agency, any other self-regulatory organizations, and any other
regulatory authority or self-regulatory authority to which it is subject by
statute, regulation, or agreement. The applicant cannot be subject to an
order of statutory disqualification as defined in Section 3(a)(39) of the
Exchange Act<(44)> or an order of similar effect issued by a federal
or state banking authority in the U.S. or any non-U.S. regulator.
EMCC must have received no substantial information that would
reasonably and adversely reflect on the applicant or any associated person
to such an extent that the applicant should be denied membership in EMCC.
However, no application will be denied on such basis unless the board has
reasonable grounds to believe that the applicant or any associated person
<(44)> 15 U.S.C. 78c(a)(39).
======END OF PAGE 39======
meets a disqualification criteria specified in EMCC's rules.<(45)>
In addition, if the applicant is a bank, it must have net worth as of
the end of the quarter prior to the effective date of its membership
determined in accordance with U.S. GAAP of at least $500 million. However,
an applicant bank may be accepted if it has a net worth of at least $200
million if the membership and risk committee of EMCC's board of directors
makes a formal finding that will become part of EMCC's books and records to
the effect that other credit factors of the applicant compensate for the
lower net worth.<(46)>
If the applicant is a U.S. broker or dealer, its aggregate
indebtedness/excess net capital ratio must be less than 950% or its excess
net capital/aggregate debit items ratio must be in excess of 5.25% and its
excess net capital must equal at least $100 million. However, a U.S.
broker-dealer applicant may have excess net capital of at least $50 million
if the membership and risk committee of EMCC's board of directors makes a
formal finding that will become part of EMCC's books and records to the
effect that other credit factors of the applicant compensate for the lower
<(45)> For example, disqualification criteria will include
closer than normal surveillance by the applicant's
designated examining authority or appropriate
regulatory agency, violations of the federal securities
laws, convictions of any criminal offense involving
securities transactions, or any injunction against
engaging in securities transactions.
<(46)> In making such determination, EMCC will consider the
applicant's return on average assets, capital to total
assets ratio, non-performing assets to total assets
ratio, and liquid assets to total assets ratio. EMCC
also will consider the ratings assigned to the
applicant by a nationally recognized statistical rating
organization, any significant off balance sheet items,
and the applicant's risk management controls.
======END OF PAGE 40======
excess net capital.<(47)>
If the applicant is a U.K. broker or dealer, its financial resources
must be at least 120% of its financial resources requirement and its excess
financial resources must equal at least $100 million. However, the
applicant may have excess financial resources of at least $50 million if
the membership and risk committee of EMCC's board of directors makes a
formal finding that will become part of EMCC's books and records to the
effect that other credit factors of the applicant compensate for the lower
excess financial resources.<(48)>
If a U.S. broker applicant is applying to become an interdealer broker
member, it must have excess net capital of at least $10 million and must
agree to submit trading data to EMCC in such instruments as requested by
EMCC. EMCC will determine the interdealer broker's potential margin calls,
and the interdealer broker must demonstrate an ability to meet such margin
calls and loss allocation assessments. The interdealer broker can
demonstrate this ability by agreeing to submit to EMCC only transactions
with EMCC members on both sides and by demonstrating a low error
<(47)> EMCC will consider any ratings assigned by a nationally
recognized statistical rating organization, any
significant adverse off-balance sheet items, and the
applicant's significant business lines as compared to
its internal risk management controls and short term
funding arrangements.
<(48)> EMCC will consider any ratings assigned by a nationally
recognized statistical rating organization, any
significant adverse off-balance sheet items, and the
applicant's significant business lines as compared to
its internal risk management controls and short term
funding arrangements.
======END OF PAGE 41======
rate.<(49)>
During the first six months of EMCC's operations, EMCC will permit an
interdealer broker to become an EMCC member which does not meet the $10
million excess net capital requirement if it meets an alternate criterion.
Such applicant must maintain a clearing relationship with an EMCC member
which is not an interdealer broker. Pursuant to the clearing relationship,
the clearing firm must take the place of the interdealer broker on T+1 on
all trades which do not have EMCC members on both sides. The interdealer
broker will have a fixed clearing fund deposit in lieu of the required
margin deposit. However, EMCC will calculate each day for such interdealer
broker a preliminary and final required fund deposit excluding any
positions that resulted from a systems failure of a contraparty resulting
in a failure to submit trade data. If the required fund deposit exceeds
the broker's fixed deposit, EMCC will not guarantee any transactions to the
broker until its required fund deposit is equal to or lower than its fixed
deposit.<(50)> However, EMCC will guarantee completion of the
<(49)> If an interdealer broker has a margin payment because
one of its contraparties fails to submit data on a
trade prior to 8:00 a.m. ET on T+1, the contraparty
must compensate the interdealer broker for the cost of
financing the payment obligation and may be subject to
fine by EMCC.
<(50)> The interdealer broker could lower its required fund
deposit by depositing additional funds with EMCC. If
it does not deposit additional funds, its required fund
deposit will exceed its fixed deposit until at least
the end of the next month (because its required fund
deposit is based on the highest margin calculation
during the current month and the prior month).
======END OF PAGE 42======
interdealer broker's trades to the original EMCC contraparties.<(51)>
In addition, if the interdealer broker's required fund deposit exceeds its
fixed deposit, the interdealer broker will not be subject to assessment for
loss allocations<(52)> and the interdealer broker will be charged a
market rate of interest on the difference between its required fund deposit
and its fixed deposit. EMCC will notify all dealer members whenever an
interdealer broker's required fund deposit exceeds its fixed deposit.
Comment is requested as to whether this alternative standard provides
sufficient protection to EMCC. Specifically, EMCC will be guaranteeing
trades to EMCC members in the event that an interdealer broker becomes
insolvent even though it will not have collected margin from the broker to
cover the loss. Furthermore, this provision does not set forth any minimum
excess net capital requirements for brokers to meet before becoming EMCC
members. Comment is requested as to whether such provisions are consistent
with a clearing agency's obligations to have appropriate membership
standards.
<(51)> Because EMCC is not guaranteeing trades to the broker,
if a dealer contraparty becomes insolvent, the broker
is responsible for completing the trade to its
contraparty on the other side. As a result, the
nondefaulting EMCC dealer member does not receive the
benefit of EMCC's guarantee of brokered trades. If the
broker is unable to complete the trade, EMCC will then
guarantee the broker's trade to its EMCC member
contraparty. However, the trade is treated as a direct
trade between the broker and its contraparty. Thus,
under the loss allocation rules, the dealer would be
allocated a greater portion of its loss than if the
broker had not exceeded its fixed deposit requirement.
<(52)> Because EMCC is not guaranteeing trades to the
interdealer broker, there would be no loss from direct
trades entered into with the broker. Therefore, there
would beno reason to assess the broker for such loss.
======END OF PAGE 43======
The foregoing financial responsibility standards are minimum
requirements, and the board may impose greater standards based upon the
level of the anticipated positions and obligations of an applicant, the
anticipated risk associated with the volume and types of transactions an
applicant proposes to process through EMCC, and the overall financial
condition of an applicant. If an applicant does not itself satisfy the
above minimum capital requirements, the board may include for such purposes
the capital of an affiliate of the applicant if the affiliate has delivered
to EMCC a guaranty, satisfactory in form and substance to the board, of the
obligations of the applicant to EMCC.
4. Membership Agreement
Each applicant to become a member of EMCC will be required to sign a
membership agreement pursuant to which the applicant agrees to abide by the
rules of EMCC. Under the agreement, the member's books and records must at
all times be open to inspection by EMCC, and EMCC must be furnished with
all such information in respect of the member's business and transactions
as EMCC may require. However, upon ceasing to be a member, EMCC cannot
inspect such member's books and records or require information relating to
transactions that occurred after the time when it ceased to be a member.
The member must agree to submit to the jurisdiction of the courts of
the state of New York and the U.S. District Court for the Southern District
of New York and to appoint a person acceptable to EMCC as its agent to
receive on its behalf service of process. Under the agreement, membership
in EMCC and use of EMCC's services is governed by the laws of the state of
New York. The member must agree that any judgment obtained in an action or
proceeding may be enforced in the courts of any jurisdiction where the
======END OF PAGE 44======
applicant or any of its property may be found, and the applicant must
irrevocably submit to the jurisdiction of each such court in respect of any
such action or proceeding. To the fullest extent permitted by law, members
must waive all immunity whether on the basis of sovereignty or otherwise
from jurisdiction, attachment both before and after judgment, and execution
to which it might otherwise be entitled in any action or proceeding in any
county or jurisdiction relating in any way to the agreement or to any
transaction.
The membership agreement also provides EMCC with an additional source
of information for risk control purposes. Upon the request of and at no
charge to EMCC, members must provide research that they provide to any of
their customers relating to EMCC eligible instruments and events or
conditions which might affect the price of EMCC eligible instruments.
F. Capacity to Enforce Rules
Section 17A(b)(3)(A) of the Exchange Act provides that a clearing
agency must be organized and have the capacity to enforce (subject to any
rule or order of the Commission pursuant to Section 17(d) or 19(g)(2) of
the Exchange Act) compliance by its participants with the rules of the
clearing agency. In order to do so, a clearing agency must have procedures
for determining whether a participant is experiencing financial or
operational difficulties. Sections 17A(b)(3)(G) and (H) require that the
rules of a clearing agency provide that its participants shall be
appropriately disciplined for violations of any provision of those rules
and provide fair procedures for disciplining participants, denying
participation in the clearing agency to any person, prohibiting or limiting
access to the clearing agency's services, and reviewing summary
======END OF PAGE 45======
suspensions.
1. Financial Standards
EMCC s Rule 13 will authorize EMCC to examine the financial
responsibility and operational capability of any member or applicant to
become a member and to require a member to furnish EMCC with adequate
assurances of its financial responsibility and operational capability.
Pursuant to this rule, a member may be required to provide additional
assurances with respect to financial responsibility and operational
capability, including additional reporting by a member of its financial or
operational condition; increased clearing fund deposits by a member; and
other assurances as may be required by EMCC.
EMCC also will have general continuance standards that require a
member to promptly inform EMCC in the event that it no longer is in
compliance with any of the relevant standards for membership or any
materially adverse change. The board may require additional financial
reporting if the member no longer meets the standards for admission to
membership, it has violated any rule of EMCC, it fails to satisfy in a
timely manner any obligation to EMCC, there is a material change in control
or financial condition of such member, or the board determines that it is
necessary or advisable to protect EMCC, its other members, or its creditors
or investors, to safeguard securities and funds in the custody or control
of EMCC, or to promote the prompt and accurate processing, clearance, or
settlement of securities transactions. The board must also make a
determination as to whether the member should be placed on surveillance
status consistent with its rules.<(53)>
<(53)> See supra note 30.
======END OF PAGE 46======
2. Ceasing to Act
Section 17A(b)(5)(C) provides that a clearing agency may summarily
suspend and close the accounts of a participant that has been and is
expelled or suspended from any self-regulatory organization; that is in
default of any delivery of funds or securities to the clearing agency; or
that is in such financial or operational difficulty that the clearing
agency determines and so notifies the appropriate regulatory agency for
such participant that such suspension and closing of accounts are necessary
for the protection of the clearing agency, its participants, creditors, or
investors.
Upon providing notice to the member, EMCC may at any time cease to act
for a member if the board of directors determines that adequate cause
exists to do so.<(54)> EMCC may cease to act either with regard to a
<(54)> Such cause may exist if one or more of certain factors
are found, including: the member has failed to perform
any of its obligations or has failed to make any
required payment to EMCC; the member is no longer in
compliance with the admissions standards or continuance
standards; the board has reasonable grounds to believe
the member has been responsible for any fraudulent or
dishonest conduct or breach of fiduciary duty or has
made any material misstatement to EMCC in connection
with its application to be a member or any EMCC
service; the board has reasonable grounds to believe
the member is in financial or operation difficulty; the
member is in breach of any requirement imposed by an
appropriate regulatory agency, self-regulatory
organization, or any regulatory body; the member is not
paying its debts as they become due or is otherwise
involved in a bankruptcy proceeding; the member is
dissolved or ceases to carry on its business; the
member contests the validity of any agreement with
EMCC; the member fails to perform its contracts with
EMCC; or the board has reasonable grounds to believe
that ceasing to act is necessary either for the
protection of EMCC or for any of the other members or
to facilitate the orderly and continuous performance of
EMCC's services.
======END OF PAGE 47======
particular transaction or with regard to transactions generally. EMCC will
promptly notify all members when it ceases to act for a member. A member
for which EMCC has ceased to act may request a hearing to review EMCC's
decision.
If certain factors are present, EMCC will treat a member as
insolvent.<(55)> EMCC will notify all members of the treatment of
the member as insolvent. Upon a determination of insolvency, EMCC will
immediately cease to act for such member. EMCC will delete all trades of
that member to which EMCC's guaranty has not attached except trades that
the board determines will promote an orderly market. EMCC will then close
out the guaranteed trades and the trades that the board has accepted. EMCC
will close out by buying in or selling out securities deliverable by or to
the insolvent. The close out procedure will be completed by EMCC as
promptly as practicable after EMCC has given notice of the treatment of the
member as insolvent.
3. Hearing Procedures
Section 17A(b)(5) of the Exchange Act provides that in any proceeding
to determine whether a participant should be denied participation,
prohibited or limited with respect to access to the clearing agency's
services, or disciplined, the clearing agency must notify the participant
of the specific grounds of the denial of services or the charges brought
<(55)> Such circumstances include: the member provides notice
to EMCC that it is insolvent; the board or any
regulatory body determines that the member is
insolvent; a court order is entered adjudging the
member to be insolvent; the member files or consents to
the filing of a petition seeking bankruptcy relief; the
member makes a general assignment to its creditors; the
member is dissolved; or a resolution is passed by the
member that it be wound up, liquidated, or dissolved.
======END OF PAGE 48======
against the member. The clearing agency must provide the member with an
opportunity to be heard on the grounds of the denial or to defend against
any charges. The clearing agency must keep a record of the proceeding.
A member may request a hearing by filing with EMCC a written request
setting forth the contested action of EMCC. Within seven business days
after filing the request or three business days in the case of summary
action, the objecting member must provide EMCC with a detailed written
statement setting forth the contested action and the basis for objection.
EMCC will notify the member in writing of the date and place of the hearing
at least five business days prior to the hearing.
The hearing will be before a panel drawn from participant directors on
the membership committee unless the contested action was taken by the
membership committee. In such a case, the panel will be drawn from
participant directors on the executive committee. The committee will
select the members of the panel. The objecting member will have an
opportunity to be heard and may be represented by counsel. The panel will
make a decision within ten business days after conclusion of the hearing.
Although the panel's decision is considered final, the board may overturn
any decision adverse to the member.
G. Equitable Allocation of Dues, Fees, and Charges
Section 17A(b)(3)(D) of the Exchange Act requires that the rules of
the clearing agency provide for the equitable allocation of reasonable
dues, fees, and other charges among its participants. EMCC's proposed fee
schedule provides that it will charge $5 for input, $7.50 for late
instructions after 9:00 p.m. on T, $25 for late instructions after 11:00
======END OF PAGE 49======
a.m. on T+1, and $7.50 for net settlement.<(56)>
H. Burden on Competition
Section 17A(b)(3)(I) of the Exchange Act requires that the rules of a
clearing agency not impose any burden on competition not necessary or
appropriate in furtherance of the purpose of the Exchange Act. As
discussed in Section III.A., EMCC will automatically receive data on all
trades of EMCC members that have been submitted to TRAX or Match-EM. EMCC
members do not have the ability to exclude trades from the EMCC clearance
system unless they confirm trades without using TRAX's and Match-EM's
automated confirmation system. Although EMCC's rules do not require that
EMCC members submit all of their eligible trades to EMCC, as a practical
matter EMCC members that want to obtain the benefit of Match-EM or TRAX
must settle at EMCC. The Commission is concerned that this aspect of
EMCC's operations could either force EMCC members to settle all their
eligible trades at EMCC or result in trades being excluded from automated
processing.<(57)> In addition, EMCC's arrangements with the locked-
in trade sources could result in inhibiting future clearing agencies from
beginning operations. Comment is requested as to whether this aspect of
<(56)> The Commission understands that EMCC may adjust its fee
schedule soon after being registered (providing that
the Commission grants EMCC registration).
<(57)> To exclude trades from EMCC settlement, EMCC members
would be forced to use manual processes to confirm
trades. Members may want to exclude trades from EMCC's
system for various reasons. For example, if the trade
would cause a member to exceed its overnight exposure
cap, it may want to process the trade through other
means. In addition, brokers may have agreed to only
submit trades to EMCC with EMCC members on both sides.
Information on such trades would then be generally
unavailable which would reduce market transparency.
======END OF PAGE 50======
EMCC's operations is consistent with the Exchange Act.
V. SOLICITATION OF COMMENTS
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing application by [insert date 30 days from
date of publication in the Federal Register]. 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. 600-30.
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.<(58)>
Jonathan G. Katz
Secretary
<(58)> 17 CFR 200.30-3(a)(16).