Clearing Agency Rulemaking:
Notice of Filing of Application for Exemption From Registration as a Clearing Agency
SECURITIES AND EXCHANGE COMMISSION
(Release No. 34-41003; File No. 600-31)
January 29, 1999
Self-Regulatory Organizations; Thomson Financial Technology Services, Inc.; Notice of Filing of Application for Exemption From Registration as a Clearing Agency
On January 11, 1999, Thomson Financial Technology Services, Inc. (TFTS)
filed with the Securities and Exchange Commission (Commission) an application on Form CA-1 for exemption from registration as a clearing agency pursuant to Section 17A of the Securities Exchange Act of 1934 (Exchange Act)2
and Rule 17Ab2-1 thereunder.3
TFTS is requesting an exemption from clearing agency registration in connection with its proposal to offer two services: an electronic trade confirmation (ETC) service and a central matching service. The Commission is publishing this notice to solicit comments on the exemption request.4
A. Confirmation and Affirmation of Institutional Securities Transactions
The confirmation/affirmation process is used to communicate the terms and acknowledgment of trades among institutional customers, broker-dealers, and custodian banks. Securities trades for institutional customers generally involve greater sums of money, greater amounts of securities, and more participants than trades for retail customers. As a result, there are more steps between order entry and final settlement in an institutional transaction than in a retail transaction.
Typically, in an institutional trade, the institution's investment manager places an order with a broker-dealer. After the broker-dealer executes the trade, it advises the institution of the execution details. The institution then informs the broker-dealer how the trade should be allocated among its accounts. The broker-dealer then sends confirmations of the allocated trades back to the institution. The institution reviews the confirmations, and if they are accurate, the institution affirms the trade with the broker-dealer by sending an affirmed confirmation. Generally, the parties involved in an institutional trade use an ETC service to transmit the messages necessary to confirm and affirm the trade. The trade is then ready for the settlement process (i.e., the transfer of securities and money for completion of the trade).
B. The Commission’s Interpretive Release on Matching
The development of "matching services" has been a recent step in the evolution of the confirmation/affirmation process. The term matching in this context describes a process in which an intermediary compares the broker-dealer's trade data submission with the institution's allocation instructions to determine whether the two descriptions agree. If the trade data and allocation instructions match, the intermediary produces an affirmed confirmation. Matching services eliminate the separate steps of producing a confirmation from the trade data, review of the confirmation by the institution, and issuance of an affirmed confirmation by the institution.
On April 6, 1998, we issued an interpretive release regarding matching services (Matching Release). In the Matching Release, we concluded that an entity that provides matching services as an intermediary between broker-dealers and institutional customers is a clearing agency within the meaning of Section 3(a)(23) of the Exchange Act and is subject to the registration requirements of Section 17A of the Exchange Act.
III. TFTS’s Request for Exemption
A. TFTS’s Proposed Service
TFTS would offer two types of services under an exemption from clearing agency registration. First, TFTS would offer an ETC service that would transmit messages among broker-dealers, customers, and custodian banks regarding the terms of a trade executed for the customer. As noted above, ETC services are usually used to confirm and affirm securities trades for institutional investors. Second, TFTS would offer a central matching service under which it would act as an intermediary in the confirmation/affirmation process to compare a broker-dealer’s trade data with a customer’s allocation instructions to produce an affirmed confirmation.
All electronic messages that are sent through TFTS’s systems will originate at the sender’s (i.e., the broker-dealer or the customer) computer terminal and will be routed through TFTS’s data center. TFTS’s data center will copy and store the data that passes through it. In its Form CA-1, TFTS represents that it will not perform other functions of a clearing agency such as net settlement, maintaining a balance of open positions between buyers and sellers, or marking securities to the market.
TFTS has agreed to certain undertakings as a condition of obtaining an exemption from clearing agency registration:
- to make available to the Commission prior to the commercial operation of its central matching service an audit report that addresses all the areas discussed in the Commission’s Automation Review Policies (ARPs);
- to make available to the Commission on an annual basis (beginning in the central matching service’s second year of operation) reports prepared by competent, independent audit personnel that are generated in accordance with the annual risk assessment of the areas set forth in the ARPs, and field work associated therewith;
- to provide the Commission with twenty business days’ advance notice of any material changes that TFTS makes to its matching service, provided that such changes shall not be subject to regulatory approval;
- to provide the Commission with prompt notification of significant systems outages, to be defined as outages lasting more than thirty minutes;
- to respond to the Commission’s requests for additional information relating to TFTS’s matching service and to provide access to the Commission to conduct on-site inspections of all facilities (including automated systems and systems environment), records, and personnel related to the matching service, provided that such requests for information shall be made and such inspections shall be conducted solely for the purpose of reviewing the matching service’s operations and compliance with the federal securities laws and the terms and conditions of TFTS’s exemptive order;
- to supply the Commission or its designee with periodic reports regarding the affirmation rates for depository-eligible transactions that settle in the United States effected by institutional investors that utilize TFTS’s matching service;
- to preserve a copy or record of all trade details, allocation instructions, central trade matching results, reports and notices sent to customers, reports regarding affirmation rates that are sent to the Commission or its designee, and any complaint received from a customer, all of which pertain to the operation of the matching service, for a period of not less than five years, the first two years in an easily accessible place; and
- to develop fair and reasonable linkages between the matching service and the Depository Trust Company and other central matching services regulated by the Commission.
B. Statutory Standards
Section 17A(b)(1) of the Exchange Act requires all clearing agencies to register with us before performing any of the functions of a clearing agency. However, Section 17A(b)(1) also states that, upon our own motion or upon a clearing agency’s application, we may conditionally or unconditionally exempt the clearing agency from any provisions of Section 17A or the rules or regulations thereunder if we find that such exemption is consistent with the public interest, the protection of investors, and the purposes of Section 17A. TFTS believes that the undertakings it has proposed as a condition of obtaining an exemption from clearing agency registration will allow it to protect the public interest and strike the appropriate balance between safety and soundness and the need to foster efficiency, competition, and capital formation.
We have exercised our authority to conditionally exempt an applicant from clearing agency registration on three prior occasions. In those cases, the applicants requesting exemption from clearing agency registration were required to meet standards substantially similar to those required of registrants under Section 17A in order to assure that the fundamental goals of that section were furthered (i.e., safety and soundness of the national clearance and settlement system).
In the Matching Release, we stated that an entity that limited its clearing agency functions to providing matching services might not have to be subject to the full range of clearing agency regulation. In addition, we stated that an entity seeking an exemption from clearing agency registration for matching would be required to: (1) provide us with information on its matching services and notice of material changes to its matching services; (2) establish an electronic link to a registered clearing agency that provides for the settlement of its matched trades; (3) allow us to inspect its facilities and records; and (4) make periodic disclosures to us regarding its operations.
TFTS’s matching service would be the only clearing agency function that it would perform under an exemptive order. While we believe that TFTS’s matching services could have a significant impact on the national clearance and settlement system, we do not believe that TFTS’s matching services raise all of the concerns raised by an entity that performs a wider range of clearing agency functions. TFTS represents in its Form CA-1 that as a condition of its exemption it will comply with the conditions suggested by the Commission in the Matching Release. Therefore, we believe that it may not be necessary to require TFTS to satisfy all of the standards required of registrants under Section 17A.
We anticipate that in addition to considering the public interest and the protection of investors, the primary factor in our consideration of TFTS’s Application will be whether TFTS is so organized and has the capacity to be able to facilitate prompt and accurate matching services subject to the specific conditions that it has proposed. In particular, TFTS has represented that, among other things, it will provide us with (1) an independent audit report that addresses all the areas discussed in the Commission’s ARPs prior to beginning commercial operations and annually thereafter, (2) on-site inspection rights, and (3) a current balance sheet and income statement prior to beginning operations.
We expect that any exemption from clearing agency registration for TFTS would contain all of the conditions that TFTS has proposed in its Form CA-1. We request comment on whether these conditions are sufficient to promote the purposes of Section 17A and to allow us to adequately monitor the effects of TFTS’s proposed activities on the national system for the clearance and settlement of securities transactions. In addition, we invite commenters to address whether granting TFTS an exemption from clearing agency registration would impose any burden on competition that is not necessary or appropriate in furtherance of the Exchange Act.
IV. Solicitation of Comments
Comments are due by [insert date 30 days from date of publication in the Federal Register]. These comments will be considered in deciding whether to grant TFTS’s application for exemption from registration as a clearing agency. Six copies of the comments should be filed with the Secretary, Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549. Comments also may be submitted electronically at the
following E-mail address: email@example.com. All comment letters should refer to File No. 600-31; this file number should be used on the subject line if E-mail is used. 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.
Jonathan G. Katz
SEC NEWS DIGEST
SELF REGULATORY ORGANIZATIONS
Thomson Financial Technology Services, Inc. ("TFTS") has filed an application for exemption from clearing agency registration (File No. 600-31) in order to provide matching services for securities trades. The Commission is publishing a notice to solicit comment on TFTS’s application.
Publication of the notice is expected in the Federal Register during the week of February 1, 1999.
(Release No. 34-41003)
TFTS is a wholly owned subsidiary of Thomson Information Services, Inc., which is indirectly owned by the Thomson Corporation. The Thomson Corporation is a public company incorporated under the laws of Ontario, Canada
215 U.S.C. 78q-1.
17 CFR 240.17Ab2-1
Copies of TFTS's Form CA-1 are available for inspection and copying at the Commission's Public Reference Room in File No. 600-31. TFTS also submitted a document entitled "Application for Exemptive Order" which we do not consider part of the Form CA-1.