Self-Regulatory Organizations; National Securities Clearing Corporation; Notice of Filing and Order Granting Accelerated Approval on a Temporary Basis of a Proposed Rule Change Limiting the Use of Letters of Credit to Collateralize Clearing Fund Contributions

SECURITIES AND EXCHANGE COMMISSION

[Release No 34-34745; File No. SR-NSCC-94-18]

Self-Regulatory Organizations; National Securities Clearing

Corporation; Notice of Filing and Order Granting Accelerated Approval

on a Temporary Basis of a Proposed Rule Change Limiting the Use of

Letters of Credit to Collateralize Clearing Fund Contributions

September 29, 1994.

Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934

(``Act''),\1\ notice is hereby given that on September 14, 1994, the

National Securities Clearing Corporation (``NSCC'') filed with the

Securities and Exchange Commission (``Commission'') the proposed rule

change (File No. SR-NSCC-94-18) as described below. The Commission is

publishing this notice and order to solicit comments from interested

persons and to grant accelerated approval of the proposed rule change

through September 30, 1995.

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

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

of the Proposed Rule Change

The proposed rule change increases the minimum cash clearing fund

contribution for those members who use letters of credit as clearing

fund collateral and sets a limit on the amount of a member's required

clearing fund contribution that may be collateralized with letters of

credit.\2\

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\2\The proposed rule change was originally filed on October 27,

1989, and was approved temporarily through December 31, 1990.

Securities Exchange Act Release no. 27664 (January 31, 1990), 55 FR

4297 [File No. SR-NSCC-89-16]. Subsequently, the Commission granted

a number of extensions to the temporary approval to allow the

Commission and NSCC sufficient time to review and assess the use of

letters of credit as clearing fund collateral. Most recently

temporary approval was granted until September 30, 1994. Securities

Exchange Act Release No. 34304 (July 1, 1994), 59 FR 35542 [File No.

SR-NSCC-94-10].

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

Statutory Basis for, the Proposed Rule Change

In its filing with the Commission, NSCC 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. NSCC 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

NSCC is seeking approval of a proposed rule change that modified

the amount of a member's required clearing fund deposit that may be

collateralized by letters of credit. Specifically, the proposed rule

change increases the minimum cash contribution for any member who uses

letters of credit from $50,000 to the greater of $50,000 or 10% of that

member's required clearing fund deposit up to a maximum of $1,000,000.

In addition, the rule change provided that only 70% of a member's

required clearing fund deposit may be collateralized with letters of

credit. The rule change also adds headings to the clearing fund formula

section for purposes of clarity and includes other nonsubstantive

drafting changes. The effect of the proposed rule change is to increase

the liquidity of the clearing fund and to limit NSCC's exposure to

unusual risks resulting from the reliance on letters of credit.

Since obtaining temporary approval of the original filing in 1989,

NSCC has filed clearing fund composition reports with the Commission.

NSCC states that between December 31, 1989, and December 31, 1993, as a

result of the new requirements, it has observed the following changes

in the composition of the clearing fund:

1. cash deposits have increased by approximately 225%;

2. the value of securities deposited has increased by approximately

205%;\3\ and

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\3\Securities eligible for deposit as clearing fund collateral

include U.S. or municipal bonds in the first or second rating of any

nationally known statistical service. NSCC Rule 4, Sec. 1.

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3. letter of credit deposits have declined by approximately 40%.\4\

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\4\In October of 1989 when the Commission initially granted

temporary approval of NSCC's proposal, letters of credit accounted

for 76% of the total dollar value of required clearing fund

deposits. By May 28, 1993, letters of credit accounted for less than

30%. During the period from June 1, 1992, to May 28, 1993, letters

of credit accounted for an average of 30.49% of the total dollar

value of required clearing fund deposits, and for no month during

that period did the portion of letters of credit used for required

clearing fund deposits rise above 34%. Letter from Karen L.

Saperstein, Vice President/Director of Legal & Associate General

Counsel, NSCC, to Jerry W. Carpenter, Branch Chief, Division of

Market Regulation, Commission (June 10, 1993).

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NSCC states that the proposal is consistent with its requirements

under Section 17A of the Act because it enhances NSCC's ability to

safeguard securities and funds in its custody or under its control.

B. Self-Regulatory Organization's Statement on Burden on Competition

NSCC does not believe that the proposed rule will have an impact or

impose a burden on competition.

C. Self-Regulatory Organization's Statement on Comments on the Proposed

Rule Change Received From Members, Participants, or Others

No new written comments have been solicited or received.\5\ NSCC

will notify the Commission of any written comments it receives.

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\5\Since the initial filing of the proposed rule change NSCC has

received one letter of comment. In the letter Wedbush Morgan

Securities, Inc. opposed NSCC's proposal because they believed it

would increase the cost of posting collateral. Letter from Edward W.

Wedbush, President, Wedbush Morgan Securities, Inc., to David F.

Hoyt, Assistant Secretary, NSCC (November 9, 1989).

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

Commission Action

Section 17A(b)(3)(F) of the Act requires that a clearing agency's

rules be designed, among other things, to ensure the safeguarding of

securities and funds in its possession or control or for which it is

responsible and to protect investors and the public interest.\6\ NSCC's

proposal to limit the use of letters of credit to collateralize

clearing fund obligations should make NSCC's clearing fund more liquid.

A liquid clearing fund is necessary to ensure the safety and soundness

of a clearing agency. NSCC's proposal is therefore consistent with the

requirements under the Act with regard to NSCC's obligation to

safeguard securities and funds and to protect the interests of

investors and of the public.

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\6\15 U.S.C. 78q-1(b)(3)(F) (1988).

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Although letters of credit are a useful means of funding clearing

agency guarantee deposits, their unrestricted use may present risks to

clearing agencies. Because letters of credit reflect the issuer's

promise to pay funds upon presentation of stipulated documents by the

holder, a clearing agency holding letters of credit will be exposed to

risk should the issuer refuse to honor its promise to pay. Furthermore,

because under the Uniform Commercial Code the issuer may defer honoring

a payment request until the close of business on the third banking day

following receipt of the required documents, the clearing agency either

may have to await payment or may have to seek alternative short-term

financing. This waiting period could reduce a clearing agency's

liquidity and thereby could hinder its ability to meet its payment

obligations on a timely basis.\7\

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\7\While the Division of Market Regulation (``Division'')

believes that NSCC's reducing from 100% to 70% the percentage of a

clearing member's required clearing fund contribution that can be

collateralized with letters of credit, the Division is still

concerned that 70% may be too high a percentage. Consequently the

Division and NSCC are continuing their reviewing of the 70%

concentration limit and its effect on NSCC's clearing fund.

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As indicated above, since the proposal first received temporary

approval, NSCC has experienced over a 200% increase in both cash and

securities deposited as clearing fund collateral. Because cash and

securities are generally more liquid than letters of credit, the

enhanced level of such deposits helps to ensure the liquidity of the

clearing fund in the event of a major member insolvency, catastrophic

loss, or major settlement loss. By reducing the risk associated with

the use of letters of credit, the proposal is consistent with NSCC's

responsibilities under the Act to safeguard securities or funds in its

custody or control and to protect investors and the public in general.

NSCC has requested that the Commission find good cause for

approving the proposed rule change prior to the thirtieth day after the

date of publication of notice of the filing. The Commission finds good

cause for so approving because accelerated approval of the proposal

will keep effective NSCC's rules that restrict member's usage of

letters of credit as clearing fund deposits and thereby help reduce the

exposure of NSCC's clearing fund to the potential liquidity risks

associated with using letters of credit to collateralize member's

clearing fund obligations. Moreover, since it was first introduced in

1989, NSCC's proposal has been open for public comment and has elicited

only one opposing comment. Thus the Commission does not foresee that

approval of the proposal will elicit further opposition.

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, NW., Washington, DC 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 any person, other than those that

may be withheld from the public in accordance with provisions of 5

U.S.C. 552, will be available for inspection and copying in the

Commission's Public Reference Section, 450 Fifth Street, NW.,

Washington, DC 20549. Copies of such filing will also be available for

inspection and copying at the principal office of NSCC. All submissions

should refer to File No. SR-NSCC-94-18 and should be submitted by

October 27, 1994.

V. Conclusion

On the basis of the foregoing, the Commission finds that the

proposed rule filing is consistent with the Act and in particular with

Section 17A of the Act.

It Is Therefore Ordered, pursuant to Section 19(b)(2) of the

Act,\8\ that the proposed rule change (File No. SR-NSCC-94-18) be, and

hereby is approved through September 30, 1995.

\8\15 U.S.C. 78s(b)(2) (1988).

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For the Commission by the Division of Market Regulation,

pursuant to delegated authority.\9\

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\9\17 CFR 200.30-3(a)(12) (1994).

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Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 94-24797 Filed 10-5-94; 8:45 am]

BILLING CODE 8010-01-M