Self-Regulatory Organizations; The Depository Trust Company; Notice of Filing and Immediate Effectiveness of a Proposed Rule Change Relating to DTC's Enhancement of its Repo Tracking System

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-34652; File No. SR-DTC-94-12] September 12, 1994.

Self-Regulatory Organizations; The Depository Trust Company;

Notice of Filing and Immediate Effectiveness of a Proposed Rule Change

Relating to DTC's Enhancement of its Repo Tracking System

Pursuant to Section 19(b)(1) of the Securities Exchange Act of

1934, as amended, (``Act'')\1\ notice is hereby given that on July 27,

1994, The Depository Trust Company (``DTC'') filed with the Securities

and Exchange Commission (``Commission'') the proposed rule change as

described in Items I, II, and III below, which Items have been prepared

primarily by DTC. The Commission is publishing this notice to solicit

comments on the proposed rule change from interested persons.

---------------------------------------------------------------------------

\1\15 U.S.C. 78s(b)(1) (1988).

---------------------------------------------------------------------------

I. Self-Regulatory Organization's Statement of the Terms of Substance

of the Proposed Rule Change

The proposed rule change consists of two enhancements to DTC's Repo

Tracking System (``RTS''). The first enhancement enables a participant

of DTC to instruct DTC to eliminate that participant's obligation to

DTC for a specific payment date on a CUSIP and to eliminate the

corresponding entitlement of the participant's counterparty on that

payment date. The second enhancement replaces the single ``catchall''

Repo position for each participant with a series of Repo position memo

accounts, one for each counterparty of that participant.

II. Self-Regulatory Organization's Statement of the Purpose of, and

Statutory Basis for, the Proposed Rule Change

In its filing with the Commission, DTC included statements

concerning the purpose of and basis for the proposed rule change and

discussed any comments it received on the proposed rule change. The

text of these statements may be examined at the places specified in

Item IV below. DTC has prepared summaries, set forth in sections A, B,

and C below, of the most significant aspects of such statements.

(A) Self-Regulatory Organization's Statement of the Purpose of, and

Statutory Basis for, the Proposed Rule Change

The purpose of this proposed rule change is to provide a repo buyer

an instruction to inform DTC to inhibit the buyer's debit for a

specific income payment on a CUSIP and to inhibit the corresponding

income payment to the counterparty. DTC's current RTS procedures

include a Repo Deliver Order instruction (``DO'' with Reason Code 81),

a Repo Reclaim instruction (also Reason Code 81), and a Repo Adjustment

instruction.\2\ The first two instructions effect book-entry transfer

of securities and also instruct DTC to adjust certain accounts, called

``Repo positions,'' of participants. The third instruction, which can

be issued only by a participant that is forfeiting the right to receive

future distributions, instructs DTC to adjust Repo positions without

effecting book-entry transfers of securities.

---------------------------------------------------------------------------

\2\For a detailed description of the Repo Deliver Order

instruction, Repo Reclaim instruction, and Repo Adjustment

instruction, refer to Securities Exchange Act Release No. 28579, 55

FR 45896 [File No. SR-DTC-90-10] (order approving rule changes

relating to procedures and processing repurchase transactions).

---------------------------------------------------------------------------

DTC's existing procedures provide for the participant obligated for

future distributions (i.e., the repo buyer) to instruct DTC to negate

that obligation.\3\ DTC will eliminate the participant's obligation on

future distributions and the counterparty's (i.e., the repo seller)

entitlement to the future distributions upon receipt of a letter of

instruction in a prescribed form from the obligated participant. The

proposed rule change provides that DTC will eliminate the participant's

obligation on a specific distribution and the counterparty's

corresponding entitlement to the specific distribution upon receipt of

a letter of instruction in a prescribed form from the obligated

participant.

---------------------------------------------------------------------------

\3\For a description of DTC's procedures, refer to Securities

Exchange Act Release No. 3135 (November 30, 1992) 57 FR 57519 [File

No. SR-DTC-92-18] (order approving rule changes relating to DTC's

enhancement to its Repo Tracking System).

---------------------------------------------------------------------------

DTC will accept the instructions from two days before the

distribution payment date until 11:30 a.m. (Eastern) on the

distribution payment date. DTC will require the instructing participant

to notify the counterparty participant, and the non-participant

counterparty where applicable, of the instructions to DTC.

After DTC receives an instruction, on distribution payment date it

will process a cash adjustment offsetting the RTS entry through the

cash adjustment (``CADJ'') function on participants terminal system

(``PTS''). The repo seller will receive an unsolicited message

describing the offsetting adjustment over the PTS network. This

information also will be accessible through the CADJ inquiry

capability. The repo buyer's daily settlement statement on payment date

will show a debit automatically effected by RTS and a credit of equal

amount effected by CADJ, and the repo seller's daily settlement

statement on payment date will show an RTS credit offset by a CADJ

debit. The CADJ adjustment will be final and will not be reversed if

the repo seller fails to settle with DTC that day.\4\

---------------------------------------------------------------------------

\4\DTC's Rule 9, including the amendments made to Rule 9 by SR-

DTC-90-10, authorizes this procedure.

---------------------------------------------------------------------------

When DTC receives instructions to eliminate the obligated

participant's obligation with respect to a specific distribution, DTC

will implement the instructing participant's instructions without

making any determination about the parties' legal obligations to each

other. The parties to the repo transaction will then be responsible for

settling that particular distribution payment outside of RTS. DTC will

not be responsible for processing any further entries on the payment.

The repo buyer's instructions will apply only to that particular

distribution, and subsequent distributions will be tracked in RTS as

usual.

Currently, RTS has a single catchall repo position in which all of

a participant's obligations and entitlements are aggregated. The

proposed rule change will establish a separate repo position memo

account for each participant with each of its counterparties. The

purpose of the proposed rule change is to give participants easier

access to information about their RTS obligation and entitlements.

If any participant of DTC becomes insolvent or DTC ceases to act on

its behalf, DTC's existing RTS procedures will unwind all of the

participant's Repo positions to eliminate any DTC obligations to

automatically allocate future distributions created by past RTS

transactions with the terminated participant (without affecting the

courterparties' legal obligations of right with respect to the

terminated participant). Before permitting a participant to voluntarily

retire, DTC will verify that the retiring participant has closed out

all its entitlements and obligations for future distributions created

by past Repo instructions.

The proposed rule change is consistent with the requirements of the

Act, specifically with section 17A of the Act, and the rules and

regulations thereunder because it facilitates the prompt and accurate

clearance and settlement of securities transactions by giving users of

DTC's RTS the same degree of control over income on securities that

they have outside DTC and by improving RTS users' access to information

about their RTS obligations and entitlements.

(B) Self-Regulatory Organization's Statement on Burden on Competition

DTC does not believe that the proposed rule change will impose any

burden on competition not necessary or appropriate in furtherance of

the purposes of the Act.

(C) Shelf-Regulatory Organization's Statement on Comments on the

Proposed Rule Change Received from Members, Participants or Others

DTC developed the specific payment date RTS inhibition in response

to participants' requests to add this flexibility to existing RTS.

Under the existing RTS, returns of principal on securities that return

principal in periodic payments until maturity, such as collateralized

mortgage obligations (CMOs), are paid to the repo sellers with the

exception of the final payment at maturity. The final payment at

maturity and redemption proceeds on other types of securities are paid

to the repo buyers regardless of RTS status. In addition, a repo buyer

may direct that all future distributions on a security be paid to it

rather than the seller, consistent with the Master Repurchase Agreement

of the Public Securities Association.

However, participants perceived a need for specific single payment

date RTS inhibition in cases such as when a CMO periodic payment before

the final payment includes a principal component large enough to

significantly affect the value of the collateral securing the repo.

This can happen because of the volume of mortgage prepayments. For

example, on a multi-tranche CMO a particular tranche might not be

receiving any principal payments (with those payments allocated to

earlier tranches), but then due to prepayments paying down the earlier

tranches that tranche might suddenly receive a sizeable prepayment of

principal. One participant reported incidents where the prepayment

amounted to 50% or more of the value of the tranches. DTC's review of

its records spotted numerous prepayments exceeding 10% of tranche value

with some as high as 85%. Although the tranche remains outstanding, its

value as repo collateral is dramatically decreased, and the repo buyer

is exposed to significant credit risk until the mark-to-the-market

payment is received.

While a repo buyer faced with risk because of a large intermediate

principal paydown could eliminate the risk by instructing DTC to

redirect all future distributions on the CUSIP to the repo buyer

instead of the repo seller,\5\ such action would deprive both the repo

buyer and the repo seller of the advantages of RTS for future

distributions on the CUSIP. Participants thus requested a more

restricted method of inhibiting an RTS payout. The proposed rule change

was developed after a number of conference with participants. DTC

received a written comment from the Dividend Division of the Securities

Industry Association supporting the proposed amendment to Repo

tracking.\6\

---------------------------------------------------------------------------

\5\For a detailed description of redirecting future

distributions, refer to Securities Exchange Act Release No. 32395

(June 1, 1993), 58 FR 32162 [File No. SR-DTC-92-18] (order approving

rule changes relating to DTC's enhancement of its Repo Tracking

System).

\6\Letter from Stephen Hopkins, President, Dividend Division of

Securities Industry Association, to Donald Donahue, Operator and

Reorganization Officer, DTC (January 17, 1994).

---------------------------------------------------------------------------

The software to support individual repo position memo accounts for

each participant-counterparty combination was developed for stock loan

income tracking, a proposed rule change that was filed separately.\7\

Once the programming was done, it was cost-effective to import it into

RTS to improve participants's access to RTS information.

---------------------------------------------------------------------------

\7\Securities Exchange Act Release No. 34218 (June 15, 1994),

[File No. SR-DTC-94-07] (notice of filing of a proposed rule change

relating to the establishment of the stock loan income-tracking

system).

---------------------------------------------------------------------------

III. Date of Effectiveness of the Proposed Rule Change and Timing for

Commission Action

The foregoing rule change has become effective pursuant to Section

19(b)(3)(A)(iii) of the Act and Rule 19b-4(e)(4) thereunder because it

effects a change in an existing service of DTC that does not adversely

affect the safeguarding of securities or funds in the custody or

control of DTC or for which DTC is responsible and does not

significantly affect the respective rights or obligations of DTC or its

participants. At any time within sixty days of the filing of such

proposed rule change, the Commission may summarily abrogate such rule

change if it appears to the Commission that such action is necessary or

appropriate in the public interest, for the protection of investors, or

otherwise in furtherance of the purposes of the Act.

IV. Solicitation of Comments

Interested persons are invited to submit written data, views, and

arguments concerning the foregoing. Persons making written submissions

should file six copies thereof with the Secretary, Securities and

Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549.

Copies of the submission, all subsequent amendments, all written

statements with respect to the proposed rule change that are filed with

the Commission, and all written communications relating to the proposed

rule change between the Commission and any person, other than those

that may be withheld from the public in accordance with the provisions

of 5 U.S.C. Sec. 552, will be available for inspection and copying in

the Commission's Public Reference Room at the address above.

Copies of such filing also will be available for inspection and

copying at the principal office of DTC. All submissions should refer to

the file Number SR-DTC-94-12 and should be submitted by October 7,

1994.

For the Commission by the Division of Market Regulation,

pursuant to delegated authority.\8\

---------------------------------------------------------------------------

\8\17 CFR 200.30-3(a)(12) (1993).

---------------------------------------------------------------------------

[FR Doc. 94-22915 Filed 9-15-94; 8:45 am]

BILLING CODE 8010-01-M