U.S.A.: Prospective changes in settlement and custody

A number of initiatives have been taken, in particular by the Depository Trust & Clearing Corporation (DTCC) and its subsidiary OMGEO, to strengthen the functioning of the U.S. securities markets and to reduce risks in the areas of settlement and custody.

We present some of these below, together with our comments on how we believe these important initiatives may impact Clearstream Banking’s¹ U.S. settlement and custody operating model in the future and on what actions we are taking to support these discussions.

Background

The following are among the key initiatives that have been taken in recent months:

• Dematerialisation of physical securities
  
  A White Paper to the industry, dated July 2012, has been issued by DTCC concerning the next steps towards full dematerialisation of physical securities, eliminating the costs and risks they incur.
  
  This White Paper (available at http://www.dtcc.com/) opens a formal discussion within the industry to achieve a consensus on the next steps towards full dematerialisation in the U.S. financial markets. DTCC considers that a complete dematerialisation will contribute to a more cost-effective, efficient, secure and competitive U.S. marketplace. It will also support the industry’s move to a shorter settlement cycle, as handling physical securities, already a burden in today’s markets, could be a source of risk in a shorter cycle.
  
  Our comments: The handling of physical securities, including transfer and registration, is still paper- and labour-intensive. We believe that full dematerialisation should significantly reduce inefficiencies, risks and costs for the industry and we are therefore fully supportive of the initiative. We are in the process of responding to DTCC’s White Paper and will actively monitor progress of the initiative.
  
• Blue Sky initiative Phase 1 - Money Markets Instruments (MMI) processing
  
  Effective 22 June 2012, DTCC has modified the schedules and procedures associated with MMI issuance and processing². MMI new issues are now subject to an earlier cutoff time in DTCC and are exclusively settled via the DTCC - Receiver Authorised Delivery (RAD) function. The MMI valued new issuance (DTCC reason code 82 - issuance DO) submission DTCC cutoff has been changed from 15:20 EST to 14:00 EST for same-day settlement.
  
  Our comments: This initiative provides MMI Issuing and Paying Agents (IPAs) with increased transparency and enables them to make a better informed decision regarding any funding exposure that may exist with an MMI issuer before the 15:00 EST DTCC deadline. This change of local deadline may have an impact on those of our customers that are active in the U.S. MMI market. The “New issues settlement” section of the Creation Link Guide (U.S.A.) has been updated accordingly.
  
  We continue to monitor developments and proposals made under the Blue Sky initiative closely and maintain a continuous dialogue with local market participants to ensure that the interests of our customers are taken into consideration.

• Reduction of settlement cycle
  
  In May 2012, DTCC announced that it has selected the Boston Consulting Group (BCG) to conduct a business case study for reducing the current T+3 settlement cycle for equities and certain debt securities in the U.S.A. BCG will identify the costs and logistics involved in shortening the settlement cycle to T+2, T+1 or T+0 in comparison with the current cycle. The study is expected to be completed in mid-September 2012.
  
  Our comments: This initiative should align the U.S.A. with other markets where T+2 is or will become a standard and result in improvements in terms of settlement efficiency. We will monitor progress and report on the findings of the BCG survey.
  
• Settlement efficiency
  
  In May 2012, OMGEO issued a paper on “How to Make Settlement More Efficient and Less Risky: The global move towards shorter settlement cycles as a significant driver of operational change”.
  
  The paper (available at http://www.omgeo.com/) assesses the likely cost of the current level of settlement failure and explores why, so far, the cost has not been quantified. It concludes with a series of recommendations drawn from the analysis. The most important recommendation is that the matching of trade details on the same day as the trade is executed is an essential prerequisite to shorter settlement cycles.
  
  Our comments: Participants in the U.S. securities markets are confronted at settlement level with a number of issues that could be avoided with the introduction of a proper matching scheme. In practice, only a delivery instruction is required to initiate a transfer of securities in DTCC or FedWire for securities. This entails, in particular, the well-known DK (Don’t Know) process whereby the receiving party can return the securities to the delivering party, creating uncertainties as to the settlement finality and, in the case of transactions against payment, triggering cash management issues. The initiative launched by OMGEO should help to resolve these inefficiencies, at least as far as DTCC-eligible securities are concerned.
  
  We continue to monitor developments under this initiative very closely and are contributing actively to the debate, thanks to the continuous dialogue established with local market players.
  
• Income post-payment adjustments
  
  DTCC filed a rule change (available at www.dtcc.com/legal/rule_filings/dtc/2012.php) with the Securities and Exchange Commission (SEC) on 17 April 2012. If the rule is approved, DTCC will no longer accommodate the requests of Paying Agents to process post-payable adjustments beyond 60 calendar days after the initial payment date. This would apply to principal and income adjustments on all security types. The current infrastructure model allows Paying Agents to process post-payable adjustments up to a year after the initial payment was made. This change is expected to further mitigate risks associated with the reallocation of such principal and income payments.
  
  Our comments: The initiative taken by DTCC is certainly a major attempt to reduce the number of post-payment reversals and contributes to the efforts made by the securities industry to tackle the reversal issue for the benefit of the investor community. We have been a very active voice in the debate, participating in industry calls and meetings, notably with DTCC and the Association of Global Custodians. We also maintain a constant dialogue with individual market players to ensure that the interests of our customers are being considered in the design of market solutions.

Impact on customers

For the time being, there are no impacts on customers other than those mentioned above.

We will provide further information about the progress of the various initiatives as it becomes available.

Further information

For further information, customers may contact Clearstream Banking Customer Service or their Relationship Officer.

1. Clearstream Banking refers collectively to Clearstream Banking AG, registered office at 61, Mergenthalerallee, 65760 Eschborn, Germany and registered in the Register B of the Amtsgericht Frankfurt am Main, Germany under number HRB 7500 (CBF) and Clearstream Banking, société anonyme, registered office at 42, avenue John F. Kennedy, L-1855 Luxembourg, and registered with the Luxembourg Register of Commerce and Companies under number B-9248 (CBL).
2. The information was announced in DTC Important Notice B#0772-12, published on 10 May 2012.