The Depository Trust Company (“DTC”) filed with the Securities and Exchange Commission (“Commission”) on September 23, 2016 advance notice SR–DTC–2016–802 (“Advance Notice”) pursuant to Section 806(e)(1) of the Payment, Clearing, and Settlement Supervision Act of 2010 (“Payment, Clearing and Settlement Supervision Act”)
The Advance Notice is a proposal by DTC to modify (i) the DTC Rules, By-laws and Organization Certificate (“Rules”),
Specifically, DTC proposes to: (i) With respect to delivery of MMI securities, require purchasers of the securities (or their custodian, if applicable) to acknowledge that they agree to receive the securities via DTC's Receiver Authorized Delivery (“RAD”) system before DTC processes the transaction; (ii) with respect to cash, require an issuing and paying agent (“IPA”) of an MMI issuer to acknowledge its funding obligations for MMI presentments before DTC processes the transaction, except in limited circumstances where there are no funding obligations;
Today, according to DTC, when an issuer issues MMI securities at DTC, the IPA for that issuer sends issuance instructions to DTC electronically, which results in crediting the applicable MMI securities to the DTC account of the IPA. The MMI securities are then delivered by DTC to the accounts of the applicable DTC participants (“Participants”) that are purchasing the issuance, typically as custodians for individual investors, in accordance with their purchase amounts. The IPA's delivery instructions may be free of payment or, most often, for payment (
When MMI securities of a particular acronym
Under the current Rules, the effect of an RTP is for DTC to reverse all processed MMI security deliveries of that MMI acronym, including issuances, related funds credits and debits, and presentments, which means that the securities would fail to settle. This reversal of processed (but not yet settled) transactions could override DTC's risk management controls (
Currently, to mitigate the risks associated with an RTP, the Rules and the Settlement Guide provide for the Largest Provisional Net Credit control (“LPNC Control”). Under the LPNC Control, DTC withholds from each Participant's Net Debit Cap the two largest intraday net MMI credits owed to that Participant. The MMI credits withheld are not included in the calculation of the Participant's Collateral Monitor or its net debit balance. This provides protection in the event that processed (but not yet settled) MMI transactions are reversed by DTC as a result of an RTP.
According to DTC, its Rules and procedures relating to settlement
The proposal would eliminate provisions for intra-day reversals of processed MMI Obligations based on an IPA's RTP or issuer insolvency of which DTC becomes aware, as described below.
Pursuant to the proposal, DTC would no longer automatically process MMI Obligations. DTC's processing of MMI Obligations involves the delivery of cash and/or securities. With respect to securities, DTC would require purchasers of MMI issuances (or their custodian, if applicable) to acknowledge in RAD that they agree to receive the MMI securities before DTC processes the transaction. With respect to cash, an IPA would make an MMI funding acknowledgment using a new DTC platform designed to accept such acknowledgments. When an MMI funding acknowledgement is received, DTC would attempt to process transactions in the acronym(s) for which the MMI funding acknowledgment pertains.
If the IPA has provided an MMI funding acknowledgment for the full amount of presentments, then all transactions in that acronym would be sent to the normal DTC processing system and tested against DTC's risk management controls. If the IPA provides an MMI funding acknowledgement for only partial funding of the presentments, then DTC would undertake the proposed “MMI Optimization” process to determine whether risk management controls would be satisfied by all deliverers and purchasers of the acronym and determine whether all parties would maintain adequate positions to complete the applicable transactions. However, as long as the issuances that could satisfy deliverer and purchaser risk controls for that MMI acronym are equal to or greater than the maturing presentments of that acronym, the applicable transactions (
If DTC does not receive the necessary acknowledgments from both the IPA and purchasers for an acronym for which maturing MMI Obligations are due on that day and/or DTC is aware, through ordinary business channels, that the issuer of an acronym is insolvent (“Acronym Payment Failure”), then DTC would not process transactions in the acronym.
In the event of an Acronym Payment Failure, DTC would: (i) Prevent further issuance and maturity activity for the acronym in DTC's system; (ii) prevent deliveries of MMI securities of the acronym and halt all activity in that acronym; (iii) set the collateral value of the MMI securities in the acronym to zero for purposes of calculating the Collateral Monitor of any affected Participant; and (iv) notify Participants of the Acronym Payment Failure via DTC's current notification process. Notwithstanding the occurrence of an Acronym Payment Failure, the IPA would remain liable for funding pursuant to any MMI funding acknowledgment previously provided for that business day.
A “Temporary Acronym Payment Failure” would occur when an IPA notifies DTC that it temporarily refuses to pay income presentments, and only income presentments, for an acronym, which typically would be due to an issuer's inability to fund income presentments on that day. A Temporary Acronym Payment Failure would only be initiated if there are no maturity presentments, principal presentments, and/or reorganization presentments on that business day. DTC would require the issuer and/or IPA to resolve such a situation by the next business day.
In the event of a Temporary Acronym Payment Failure, DTC would: (i) Temporarily devalue to zero all of the issuer's MMI securities for purposes of calculating the Collateral Monitor, unless and until the IPA acknowledges funding with respect to the income payments on the following business day; (ii) notify Participants of the delayed payment; and (iii) block from DTC's systems all further issuances and maturities by that issuer for the remainder of the business day on which notification of the Temporary Payment Failure was received by DTC. An IPA would not be able to avail itself of a Temporary Acronym Payment Failure for the same acronym on consecutive business days.
The Commission understands that the proposal would not: (i) Decrease the total number and value of transactions that would pass DTC's risk controls throughout the processing day; or (ii) increase the volume of transactions that would fail to settle. The Commission also understands that the proposal would reduce blockage caused by DTC. Non-MMI transactions and fully funded MMI transactions would likely have a reduction in blockage as a result of the elimination of the LPNC Control. The elimination of the LPNC Control would no longer withhold billions of dollars of settlement credits as it does today, thus permitting MMI transactions subject to the LPNC Control to process earlier in the day. Moreover, it is expected that the value and volume of MMI transactions recycling due to failure to meet DTC's risk management controls during the late morning and afternoon periods would be reduced, as a result of such transactions being held outside of DTC's processing system while they await the necessary acknowledgments.
Similar to the LPNC Control, the RVPNA Control is used to prevent a Participant from delivering free of value or undervalued any MMI securities that were received for payment on the same day.
Although the Act does not specify a standard of review for an advance notice, its stated purpose is instructive: To mitigate systemic risk in the financial system and promote financial stability by, among other things, promoting uniform risk management standards for systemically important financial market utilities and strengthening the liquidity of systemically important financial market utilities.
• Promote robust risk management;
• promote safety and soundness;
• reduce systemic risks; and
• support the stability of the broader financial system.
The Commission has adopted risk management standards under Section 805(a)(2) of the Act
The Commission believes that the proposed changes in the Advance Notice are consistent with the objectives and principles described in Section 805(b) of the Act.
First, the Commission believes that the changes proposed in the Advance Notice promote robust risk management. Under the proposal, DTC would no longer automatically process MMI presentments. Instead, before it processes a presentment, DTC would require purchasers of MMI issuances (or their custodian, if applicable) to acknowledge in RAD that the purchasers agree to receive the MMI securities before DTC processes the transaction. The proposal would also require the applicable IPA to provide an MMI funding acknowledgment, as applicable. The MMI funding acknowledgement would be a commitment by the IPA to make the applicable funds available to DTC. Although the proposed changes would establish new requirements before DTC would process such MMI transactions, the Commission believes that the benefits of eliminating the risk of a potential override of DTC's risk management controls from an RTP supports such requirements.
DTC also would employ the proposed MMI Optimization, which would, for MMI transactions that await funding, continually test the net effect of transactions, across multiple MMI issuers, on receiving and delivering Participants' risk controls and then process the transactions once the controls are met. MMI Optimization would help maximize processing and facilitate more timely settlement of transactions, thus reducing risks that transactions may not settle.
Second, the Commission believes that the changes proposed in the Advance Notice promote safety and soundness. Currently, as described above, if DTC were to reverse MMI transactions because of an RTP, the reversal could override DTC's risk management controls. The Advance Notice would eliminate RTPs and resulting reversals of MMI transactions, and thus eliminates this opportunity to override DTC's risk management controls.
Third, the Commission believes that the Advance Notice helps reduce systemic risk. As described above, DTC would no longer automatically process MMI presentments. Rather, DTC would require purchasers to authorize delivery via RAD and IPAs to provide a funding acknowledgment before processing MMI presentments, as applicable. Because these changes would eliminate the risk of reversals due to an RTP, the changes would mitigate the risk of a potential override of DTC's risk management controls. In turn, this would reduce DTC's exposure to potential failures, promote DTC's safety and soundness, as discussed above, and thereby reduce the systemic risk to the financial system.
Fourth, the Commission believes that the Advance Notice promotes the stability of the broader financial system. As described above, the LPNC Control currently withholds from each Participant the two largest intraday net MMI credits out of all of the MMI credits owed to that Participant in order to protect DTC from a Participant breaching its Net Debit Cap or having insufficient collateral in the event of a reversed because of an RTP. However, withholding the credits makes them unavailable to the Participant, which can cause blockage (
Because DTC would no longer process MMI transactions without a purchaser's RAD acknowledgement and an IPA's MMI funding acknowledgement, as applicable, RTPs and resulting intraday reversals no longer present the risk that the LPNC and RVPNA Controls are meant to address. As such, DTC would eliminate these controls. This change would make available to Participants the intraday credits that were previously withheld, which would decrease intraday liquidity blockage for the Participant and enable DTC to process MMI transactions earlier. Thus, Participants would have less exposure to intraday reversals that increase liquidity and settlement risk and a more complete view of their actual intraday net debit and credit balances.
For the above reasons, the Commission believes that the changes proposed in the Advance Notice promote robust risk management, promote safety and soundness, reduce systemic risks, and support the stability of the broader financial system consistent with Section 805(b) of the Act.
The Commission also believes that the Advance Notice is consistent with the Clearing Agency Standards, in particular Rule 17Ad–22(d)(12) under the Exchange Act.
It is therefore noticed, pursuant to Section 806(e)(1)(I) of the Payment, Clearing and Settlement Supervision Act,
By the Commission.