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U.S. Securities and Exchange Commission

Speech by SEC Staff:
ICAA STP/T+1 Conference

Remarks by

Larry E. Bergmann

Senior Associate Director, Division of Market Regulation
U.S. Securities & Exchange Commission

Before the ICAA STP/T+1 Conference

September 25, 2002

The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publications or statements by any of its employees. The views expressed herein are mine and do not necessarily reflect the views of the Commission or my colleagues on the staff of the Commission.

Good afternoon. It is a pleasure to be here today. I thank David Tittsworth for inviting me to this conference, and it is always a pleasure to return to Boston. As usual, before I start, I need to remind you that these comments represent my views - they may not represent the views of the Commission or my colleagues on the staff.

I have been asked to share with you the SEC staff's perspective on the current status of the straight through processing/T+1 initiative. As we are all aware, the industry focus has shifted to achieving straight through processing by 2004 and evaluating the merits of a conversion to T+1 settlement in mid-2004. This conference is being held at an important point in the STP/T+1 initiative when we consider all of the distractions of the past year. There can be no doubt that the challenges we faced this past year were enormously difficult and complex. We at the Commission are keenly aware of the remarkable pressures that have been brought to bear on the securities industry. First and foremost, the tragic events of September 11, 2001-- in their shadow, business continuity and contingency planning have taken on a whole new importance. Firms also are facing new compliance requirements under the Patriot Act to ensure that our marketplace does not assist terrorist activities. And the industry is valiantly trying to address these and other pressures and costs in a strained business climate.

For many firms, the initial reaction to these many and varied challenges may be to buckle down and cut seemingly unnecessary costs to improve or preserve the bottom line. This is an inevitable reaction in trying times. Some firms are asking themselves, with everything that is going on, where does STP/T+1 fit in?

To understand the Commission staff's perspective on STP/T+1, one must look to Congress' findings and the Commission's statutory mandate, found in Section 17A of the Securities Exchange Act of 1934. Congress expressed the following principles and objectives for our national clearance and settlement system:

  • The prompt and accurate clearance and settlement of securities transactions is necessary to protect investors;

  • Inefficient procedures for clearance and settlement impose unnecessary costs on investors and intermediaries;

  • New data processing and communication techniques create the opportunity for more efficient, effective, and safe procedures;

  • The linkage of all clearance and settlement facilities and the development of uniform standards and procedures for clearance and settlement will reduce unnecessary costs and protect investors and intermediaries; and

  • The Commission, having due regard for the public interest, the protection of investors, the safeguarding of securities and funds, and the maintenance of fair competition, must facilitate the establishment of a national system for the prompt and accurate clearance and settlement of securities transactions.

The higher objective is, of course, investor confidence. People who invest in securities markets need to know that their product will be delivered on time, at the agreed upon terms, and that they won't lose their funds and securities because of insolvency, mismanagement, or operational difficulties.

I think that you would agree that, in an ideal world, once a trade has been executed it would go directly to settlement. Then there would be virtually no risk of failure to settle the trade. But we don't live in that ideal world. The settlement process does take time, and this time equals risk. Reducing that risk involves changes and costs: not just to overhaul systems, but to change behavior.

First, I'd like to start with a flashback - the debate we had ten years ago about the costs to shorten the settlement cycle from T+5 to T+3. I do this not because I harbor any illusions that the move from T+5 to T+3 and the STP/T+1 project are the same. The STP/T+1 project is much harder and much costlier because we are talking about an overhaul of our settlement process. Nevertheless, remembering what we learned from experience should serve us well in the future.

T+5 to T+3

When the Commission proposed shortening the settlement cycle from T+5 to T+3, there was significant opposition to the move. The opponents of T+3 settlement could be divided into three categories. First, some believed that T+3 was unnecessary and would not reduce risk. Second, others were concerned about the potential cost of systems and operational changes needed to conduct business in a T+3 settlement environment. They argued particularly that they wouldn't be able to implement the necessary behavior changes: for example, getting retail investors to pay by T+3. Third, some believed that T+3 would hurt competition and put them out of business.

But the move to T+3, including the systems, operational, and behavioral modifications, was made. In fact, the move to T+3 went smoother than most expected. Furthermore, in looking back at the success our markets have had over the last seven years, it's evident that the move to a T+3 settlement cycle achieved its goals of a safer and more sound and efficient clearance and settlement system without causing any of the problems some expected.

T+3 Rollout

While there was substantial apprehension in the industry about moving to T+3, there was ample incentive from our experiences with the 1987 market break and the failure of Drexel Burnham Lambert. Some of us can remember when the Group of Thirty initiated its study in response to the 1987 market break. The goal of the industry-led G-30 project was to develop a framework that would reduce risk, increase efficiency, and lower cost in the clearance and settlement systems. One of its 9 recommendations was to implement a "rolling settlement" system with final settlement on T+3.

The Bachmann Task Force, formed in 1992 at the Commission's urging, operated under the premise that there are universal benefits to be gained from increasing the safety and soundness of the clearance and settlement system and reducing systemic weakness. The Bachmann Task Force also emphasized that the industry and the Commission must carefully balance the benefits achieved by enhancing the existing settlement systems with the costs imposed on broker-dealers and institutional and public investors.

While this may be an interesting history lesson, what is its relevance for us today?

The move to T+3 was reactive: it followed studies of what the 1987 market break revealed about the U.S. clearance and settlement system. These changes were necessary before the market break, but there wasn't the incentive to make them. And further back, the 1975 Amendments to the Exchange Act that established a national system for clearance and settlement were enacted largely in response to the Paperwork Crisis of the late 1960s.

The STP/T+1 initiative has developed differently because there was no "event" that sparked it. Instead, a forward-looking industry recognized that the settlement system risk identified by G-30 and Bachmann still exist, and decided to act in a proactive way to face looming challenges. One concern is that without an explicit T+1 goal, this initiative will lose momentum. This would be unfortunate because it is better to plan and develop changes proactively rather than in reaction to the next crisis.

Reducing Risk and Enhancing Efficiency

"T+1" is a useful focal point, but in some ways is a misnomer. The fundamental goal of the T+1 project is not next day settlement, it is risk reduction and efficiency. And STP is an essential part of achieving that goal-some estimate about 80%. Even if T+1 settlement is deferred, the industry must concentrate on the building blocks to achieve risk reduction and efficiency.

This is not only a U.S. concern. In November 2001, the International Organization of Securities Commissions (IOSCO) and the Committee on Payment and Settlement Systems (CPSS) published a report titled "Recommendations for Securities Settlement Systems." The Commission is an active participant in IOSCO and endorsed publication of this report. I would suggest this report as recommended reading to see the standards that our industry is expected to meet, particularly as we become more global. 1 I believe that the recommendations in the IOSCO/CPSS report will serve as focal points for improvements to the U.S. settlement systems, and indeed for settlement systems worldwide. I expect that IOSCO and the CPSS will soon adopt an assessment methodology for each jurisdiction to use to assess the operation of its securities settlement system against the recommendations. In addition, we expect that the Group of 30 will soon issue a report that also calls for significant improvements in the global settlement process.

One of the issues covered in the IOSCO/CPSS report is the importance of confirming trade information as quickly as possible. Recommendation 4 states that street-side trades between brokers should be confirmed no later than trade date (T+0). Brokers should confirm and affirm trades with their institutional customers no later than T+1. This recommendation is not keyed to any particular settlement cycle. It is keyed to identifying problem trades as early as possible. The report recognizes that further automation of the process is the key to achieving these goals worldwide--especially in high-volume markets and for cross-border trading.

Early detection should help to avoid errors in recording trades, which could result in inaccurate books and records, increased and mismanaged market risk and credit risk, and increased costs. In addition, speedy and accurate verification of trades is an important precondition for avoiding settlement failures, especially when the settlement cycle is relatively short.

Use of new technology and procedures in the clearance and settlement of trades will help the industry achieve greater reliability and efficiency. This is also the goal of straight through processing.

High on the list of efficiency enhancements are matching services. These services are intended to replace the current confirmation-affirmation process, which requires a broker and its institutional customer to send information back and forth in sequential steps in order to approve a trade for settlement.

In 1998, the Commission concluded: (1) that this type of matching service is a clearing agency function as defined in the 1934 Act, but (2) entities that only provide matching services don't need to comply with all the statutory requirements applicable to self-regulatory organizations, in general, and to clearance and settlement in particular. The Commission reached this conclusion, in part, because a matching service provider does not itself:

    (1) Hold funds or securities;

    (2) Net trades; or

    (3) Make book-entry movements of securities or monies.

Instead, the Commission concluded that a tailored exemption from registration would be appropriate. While a matching service may be exempted from many of the requirements that apply to a registered clearing agency, an exemption would nevertheless have conditions designed to achieve the objectives of the '34 Act with respect to the national system for the clearance and settlement of securities transactions.

The Commission has granted Omgeo, a joint venture between DTCC and Thomson Financial, Inc., an exemption from clearing agency registration to provide matching services in the United States. GSTP has filed a request for a similar exemption from clearing agency registration. In addition, SunGard has announced that it also intends to file for an exemption. I encourage you to consider commenting when these applications are published.

When the Commission published the Omgeo application for exemption for comment, a number of letters expressed support because of their belief that matching services in general would help the industry achieve STP and T+1. There were also a number of comment letters that expressed concerns that Omgeo would impede competition because of its projected market share in providing electronic trade confirmation services. The Commission was very sensitive to these concerns. As a result, the Omgeo exemption order contains a number of conditions, including:

  1. Obtaining an audit that addresses the areas discussed in the SEC's Automated Review Policy guidelines for its computer systems.

  2. Providing the Commission with advance notice of any material changes to the matching service.

  3. Providing the Commission with notice of significant outages.

  4. Responding to the Commission's requests for information.

  5. Submitting periodic reports.

  6. Maintaining certain records.

  7. And, developing linkages to other central matching service providers.

The Omgeo Exemption Order includes conditions designed to help establish interoperability among competing matching services. Omgeo must link to other matching services so that no matter what matching service a broker-dealer and its institutional client use, they will be able to communicate trade and allocation data. The Order sets out a procedure for Omgeo to negotiate links with other matching services. These procedures require input from the members of the securities industry.

Omgeo must also publish its specifications and rules and provide advance notice of any material changes, updates, or revisions to its links. Omgeo must support industry communication protocols, message format standards, and message file protocols.

The fees for using the linkages must be fair and reasonable. The Order provides for items to be considered in determining what's fair and reasonable and sets a 60-day time limit for Omgeo to negotiate the fees with another matching provider.

Omgeo cannot charge customers of other matching services more than it charges its own customers for the same service. Omgeo must also provide access to its databases and systems for transmitting messages. Once a link has been established, Omgeo is required to maintain the quality, capacity, and service levels of the interfaces with the other matching service.

Omgeo must also process trades on a first-in-time priority basis.

With the Omgeo approval Order, the Commission adhered to its guiding principles but adapted them to the evolving clearance and settlement industry. The Commission expects that all matching service providers will have substantially similar interoperability conditions.

Should Use of a Matching Service be Mandatory?

The ICAA has expressed concern over the SIA Legal and Regulatory Subcommittee proposal that the Commission mandate the use of a central trade matching system for investment advisers and other market participants. While the ICAA agrees that the process of allocating trades among an adviser's accounts, and especially the process of submitting the allocation information to the other parties to the trade, must be streamlined to accomplish STP/T+1, it does not believe that it is necessary, or desirable, to attempt to accomplish these goals by adopting new Commission or SRO rules mandating use of central trade matching utilities. ICAA believes that many investment advisers will want to participate in automated trade matching and electronic confirmation systems as a business necessity because they will find it impossible to function in a STP/T+1 environment in any other way. However, the ICAA believes that some advisers will find that, due to a small number of client, broker-dealer, and custodian relationships, they can operate efficiently in a STP/T+1 environment using existing or enhanced proprietary communication links. Such advisers see no business necessity and would see no increased efficiency through participation in automated trade matching and electronic confirmation systems than they would through use of phone or fax.

Mandatory use of matching services is an open issue. Perhaps business demands will result in a de facto mandate. Perhaps market integrity or safety and soundness concerns will require a mandate. We expect to seek comment on this important issue.

The second risk reducing and efficiency enhancing area that I would like to briefly address is the immobilization/dematerialization of securities. The problems associated with processing paper -- expense, risk, and time -- are obvious to everyone in the industry.

CPSS/IOSCO Recommendation 6 is that securities should be immobilized or dematerialized and transferred by book entry in CSDs to the greatest extent possible.

The September 11 experience demonstrates ways that physical certificates add cost and operational risk to the financial system. Several broker-dealers stored stock certificates for their customers in vaults beneath the World Trade Center, and those vaults were destroyed in the terrorist attacks. Furthermore, several broker-dealers had large numbers of certificates that were being processed and destroyed when their offices were destroyed. In addition, during the week of 9/11 all of DTC's operations had to be switched to alternate sites. While settlement activity continued without significant problems, DTC had to suspend certificate processing until Saturday, 9/15. These problems would not have occurred if the US, like many foreign jurisdictions, operated either a dematerialized or an immobilized book-entry only system.

Many, therefore, believe that the use of certificates should be further reduced, if not eliminated, in order to avoid the operational and other problems involved in processing paper.

Another important CPSS/IOSCO recommendation is number 7 which states that CSDs should eliminate principal risk by linking securities transfers to funds transfers in a way that achieves delivery versus payment. The report makes clear that a DVP mechanism reduces risk only to the extent that trades are actually settled on a DVP basis. While the U.S. has a very reliable DVP settlement process, many trades in fact settle outside this process because participants do not submit required information in time for DTC to process it. During 2003, I expect the Commission staff to join with the Federal Reserve Board and perhaps other regulators to conduct an assessment of the U.S. clearance and settlement system using IOSCO/CPSS recommendations as the guide. I expect that our assessment on this recommendation will find a need for improvement here. Achieving that improvement will require action by all participants in the trading process.

In order to assist that assessment process and to generally examine the operation of our national clearance and settlement system, I expect that the Commission will publish a concept release which will seek views on how to improve the system. I think many approaches, including STP and T+1, will be explored. I urge you to submit comments, concerns, and suggestions in response to the release because your input is important.


The Commission has the responsibility to promote the prompt and accurate clearance and settlement of securities transactions. We are sensitive to your concerns about the system's efficiency, and with the burdens that changes may have on the industry.

Achieving straight through processing will streamline back-office procedures, increase efficiency to the system, and reduce operational risk. Manual intervention will become the exception rather than the norm. As a result, fewer fails will occur, and accurate trade data will reach the clearing agencies more quickly. Back office staff can then focus on processing new trades rather than correcting older errors.

We are counting on the ICAA to continue to work with us, and with industry groups such as the SIA, the Bond Market Association, and others to ensure that the interests of the investment advisory profession are fully represented.

We must not lose focus or momentum in improving the safety, soundness, and efficiency of our clearance and settlement system. The integrity of our markets and investor protection critically depend on it.

Thank you

1 www.IOSCO.org and www.BIS.org.



Modified: 10/02/2002