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is it and how and when to use it.” The FINS concept, as recommended by the working committee, was endorsed by the National Group. The working committee will develop implementation strategy.
Jack Griffiths and George White reported on Standard Funds Settlement. After some discussion relative to historical and source data issues, the recommendation of a "Funds Valued Tomorrow” environment was presented. It was further recommended, that for the sake of equity on the part of depository participants, implementation should take place as soon as possible. The National Group approved the recommendations of this committee and the working committee will now develop implementation strategy.
John Meyer reported on the status of Uniform Commercial Code changes in the various states and also shared some observations relative to H.R. 5050. Sam Stewart is scheduled to be in Washington shortly, and he will attempt to visit with Representative Moss or a member of his staff in an effort to update them on the present status of the various regional depositories. The National Group encouraged Sam in this regard since so much is happening so rapidly in the depository environment that an updating might be helpful.
The National Group maintains its position as stated in the past relative to proposed legislation on the rule making for and regulation of depositories.
The Hartford and Boston areas are still studying the possibility of developing regional depositories. The question of whether or not these areas should be included on the National Group was once again reviewed. It was decided that the opportunity for membership should remain open, yet membership should not be granted until the criteria, as previously established, is met.
John Perkins referred to the status reports presented earlier and reinforced the need for full interface as soon as possible. Although studies, correspondence pilot one-way interfaces, and conversations are and have been going on relative to this issue, he felt that the regional depositories are sufficiently well along to be more specific in this area. He restated the fact that there is no doubt in his mind that there is general agreement in principle on the entire issue of interface. As a result, he requested that by July 1, a letter be submitted to him by each of the four depositories (DTC, MSTC, PSD, and NCC) stating the guidelines for interface.
Mr. Perkins also circulated a letter dated May 29, 1973, which he had received from Representative John E. Moss. It was felt that the progress of the National Group was considerable and that responding to Representative Moss' letter should not present any problems.
The meeting adjourned without a specific date being established for the next meeting.
NATIONAL COORDINATING GROUP FOR
July 5, 1973.
Commerce Committee, Congress of the United States, House of Representa
tivcs, Washington, D.C. DEAR MR. Moss: Your letter of May 29, 1973, relative to the progress being made by the National Coordinating Group was very timely. It just so happened that the National Group was scheduled to meet on June 4, and we had an opportunity at that time to discuss it.
I would like to respond to your letter by directing my comments to the three questions which you raised :
(1) “Guidelines for the interface of regional depositories”.
As you will notice in the minutes of our meeting, Enclosure A, a considerable amount of work has been devoted to depository interface. Some of the guidelines have been completed, and others are being developed, including:
DEPOSITORIES AS ELIGIBLE DEPOSITORS
The foundation for depository interface is provided by each depository's being a depositor in the other depositories. Thus, Depository “A”, being a depositor in Depository “R”, can receive and deliver securities by book-entry from and to other depositors in "B", just like any other of “B's" depositors. Of course. "A" would be receiving and delivering in “B” on instruction of its own participants. In this respect "A" is little different from broker and bank depositors who are parties to book-entry transactions in depository “B” on behalf of their many customers.
A pilot interface test has been in progress for several months between the Midwest and New York Depositories. Details are now being worked out for a similar test between the Midwest and the West Coast.
Each depository's rules approved by the SEC provide that a depository shall be eligible to be a “Participant” (i.e., depositor).
DEPOSITORIES AS CUSTODIANS FOR ONE ANOTHER
Under the Uniform Commercial Code a "clearing corporation" must, as a practical matter, keep possession of securities held by it or place them in a custodian bank. Interface depends on the capacity of depositories to act as custodians for each other.
This interrelationship among depositories can be accomplished when depositories are chartered as banks (i.e., trust companies incorporated under banking law). This has now been done, as concerns the Midwest, West Coast, and New York depositories.
REGULATORY COORDINATION AND SUPERVISION
Although each of the three depositories will be subject to examination and supervision by their respective state banking departments, what might be called another aspect of depository interface is coordinated regulation.
This has been accomplished by the taking of two steps. The first is the submission of each depository's articles of incorporation, by-laws, and rules to the SEC for review and approval. This has been done by the Midwest and New York depositories, and is in process for the one on the West Coast.
The other step is to obtain coordinated bank supervision and examination. This is to be accomplished by having each depository become a member of the Federal Reserve System. The New York depository has already received such membership and the Midwest is in the process of applying.
An important question of depository interface is the manner in which the cash side of securities transactions is settled both among depositories and between a given depository and its depositors.
A working committee of the National Coordinating Group has studied this matter in depth and has made recommendations which have been adopted by the National Coordinating Group.
A copy of the Working Committee report is enclosed. (Enclosure B).
OTHER INTERFACE MATTERS
Task forces from the depositories are working on a number of technical and procedural matters. Interdepository custodian agreements are being drafted. The use of facsimile and other fast transmission methods is being worked out. Enclosure C, a report on “Applicability of Electrical Communications Within a Depository” is being used to advantage. Other operating-level questions as to detail are surfacing and, one-by-one, being disposed of.
Attention is also being given to some longer-range opportunities for efficiency and effectiveness. Development of a standard financial industry numbering system (FINS) has been approved and steps authorized to implement. This standard is not urgently needed now, but will definitely be needed later to facilitate use of modern communications technology.
In general, it is believed that depositories can-as they are the hub—act as leaders, stimulators, and catalysts among the entire financial community in bringing modern technology to a major part of the trade completion process. Even for transactions in securities which cannot be made eligible for depositoriesbut every effort should be made to expand the eligible list-the related systems effect should be substantial.
(2) "Whether banks are giving financial support to the development of depositories."
The answer to this question is "yes"-"banks are giving financial support to the development of depositories."
(a) Six Chicago banks have committed $1,000,000 in the next 12 months for the further development of the Midwest Securities Trust Company. This commitment is reflected in paragraph 3 (page 8) of a Memorandum of Understanding executed by the six banks and the Midwest Stock Exchange, a copy of which is enclosed. (Enclosure D).
(b) The West Coast banks have committed, for Phase 1, $2.26 million for the development of the Pacific Securities Depository. The total projected capital investment for the whole project is $7.4 million.
(c) The 12 New York Clearing House banks have contributed to BASIC from its formal inception on March 11, 1970, the amount of $650,000 or 50 per cent of the $1,300,000 expenses incurred by BASIC to date. The remaining 50 per cent has been paid by the American Stock Exchange, National Association of Securities Dealers, and the New York Stock Exchange, each of whom assume 1/3 of the aforementioned 50 per cent.
The Memorandum of Understanding executed in September, 1971, on a Comprehensive Securities Depository System between American Stock Exchange and the New York Clearing House banks is reproduced on pages 1922–28 of your 1971 hearings. For ease of reference, a copy is enclosed herewith. (Enclosure E).
(d) In addition to these incurred and contemplated out-of-pocket expenditures the Midwest, West Coast, and New York banks have contributed extensively the time and experience of many of their officers and staff to the actual development and usage of the depositories in their respective areas and to the development of a Comprehensive Securities Depository System. Some of these contributions are evidenced, among other things, by their work pertaining to depository interface, insurance questions, the CHIPS, CUSIP and FINS Systems, Standardization of Funds Settlement for Securities Transactions, development of collateral loan programs for brokers and banks at depositories and by banks depositing securities with depositories, as participants, on a trial basis pending clarification of regulatory and other questions.
The American Bankers Association has expended time, effort, and advice in furthering the necessary amendments to the UCC and by conducting and participating in seminars as to depository procedures and benefits.
It is clear that banks are not only "giving financial support to the development of depositories” but are incurring further and indirect costs by contributing people, time, and experience in large measure.
These commitments reflect the view that through participation in the development of depositories the banks, all of whom have fiduciary responsibilities, can assure that depositories will have the appropriate character, operational, financial, legal capabilities, and regulatory atmosphere.
(3) “What, if any, new problems have arisen in the development of the interregional concept. More particularly, what is the probable effect of requiring new and higher rates or return on capital or increased interdepository charges ?"
No unforeseen problems of substance have been encountered. Some foreseen procedural problems remain to be resolved—and will be such as the handling of dividends, proxies, withdrawal of nominee certificates, etc., where the internal procedures for the handling of such matters now differ among depository operations.
As to “requiring new and higher rates of return on capital or increased interdepository charges”, it is contemplated that beyond a nominal rate of return on shareholders' investment, depositories' charges to users would be scaled to cover depository costs.
Our committee appreciates your interest in this effort and the opportunity to tell you of our continuing progress. We will continue to keep your Committee informed. Sincerely,
JOHN H. PERKINS, Chairman.
NATIONAL CLEARING CORPORATION,
Washington, D.C., November 17, 1972. Mr. JOSEPH P. CORIACI, Second Vice President, Continental Bank, Chicago, Ill.
DEAR JOE: The Subcommittee on Insurance and Protection is pleased to present to the National Coordinating Group the findings of its study and its recommendations.
APPROACH AND FINDINGS
The Subcommittee analyzed insurance and protection for certificate depositories from a nationwide point of view. It followed the guideline prescribed by the National Coordinating Group of “a nationwide system of interrelated regional depositories independently operated by the private sector.”
The work program of the Subcommittee included visits to Central Certificate Service, Inc. in New York and the Pacific Securities Depository in San Francisco. Also, Midwest Stock Exchange Clearing Corporation personnel discussed with the Subcommittee plans to provide adequate depository capacity within its continuous net settlement system, operated in Chicago. Each of these companies already has embarked upon a program of reorganization as a limited purpose trust company. Although it cannot be precisely determined when such reorganization will be affected, estimates of 3 to 6 months appear reasonable. The Subcommittee was given to assume that following trust company formation by each, the three entites will develop “systems interfaces” through the use of reciprocal accounts, and that this will then be the basis for the establishment of the network contemplated by the National Group. Presently, coverage for CCS includes a $50 million broker's blanket bond, $25 million excess transit insurance, and a $5 million lost instrument premium bond. The Midwest and Pacific Coast both have broker's blanket bonds of $20 million.
The study addressed these four points set forth in my letter to you dated September 1, 1972:
1. Investigate the concept of individual depository coverage versus a single “umbrella” concept.
2. Educate the insurance underwriters on a national basis as to the reduction in risk in a depository environment versus the risk in a physical delivery system.
3. Explore the co-insurance concept advanced by BASIC's Herman Bevis in his March 15, 1972 paper.
4. Analyze the risk in the depository environment versus risk in a physical delivery system.
From an insurer's point of view, risk of type would be the same whether securities are in a depository environment or in a physical delivery system. As a matter of fact, the severity of losses would if anything be significantly greater in a depository environment because of the concentration of securities. However, the frequency of losses—therefore the risk of loss-obviously should be less, which should bear favorably in obtaining insurance.
The Subcommittee believes that insurance can be obtained at a fair cost. Limits are unknown at this time. It believes that certain marketing techniques such as the “layering” of insurance should keep the cost down to a reasonable level. Because of the catastrophic nature of the risk, a participation by the depositories in any premium reduction program because of favorable past experience (as mentioned by Herman Bevis in connection with co-insurance) is unlikely to be obtained. However, future premiums might be reduced based upon such experience.
The Subcommittee further believes that certain functions such as maintaining large aggregate values of securities positions in custody, handling money settlement, and withdrawing certificates in nominee form (even though withdrawal by transfer would be preferable for insurance purposes) are primary characteristics of existing depository operations. They will govern insurance coverage, not vice versa, and will be viewed by the insurers accordingly.
Jumbo certificates have bee considered by some as a means of reducing the possibility of loss. While this may well be true, the size of the certificate must be limited to ensure that the insurance industry can legally respond to the loss of such a certificate.
RECOMMENDATIONS Because of the different stages of development of the three organizations and their varying services, procedures, controls, and membership requirements, and since at this time their operations do not yet interface, the Subcommittee recognizes that the recommendations which follow are by definition premature.
1. Existing coverage, of course, must remain in force until interfaces through reciprocal accounts have been completed.
2. At that time, the following plan should be implemented, and the existing programs of individual depositories cancelled :
(a) A primary underlying program should be purchased by each individual depository in a specified amount (suggest less than $5 million) and on a standardized form to be developed, which must be used by all depositories.
(b) An excess "umbrella” program covering all depositories for a catastrophic limit of coverage should be written on the same standardized form for as much coverage as is economically feasible within the market capability of the insurance industry. The premium for such a policy would be
allocated to each depository on a basis yet to be determined. 3. This program should be negotiated in advance of the actual time interfaces commence. It should if possible cover agents of depositories as well as the depositories themselves.
4. Other traditional coverages, such as third party liabilities, workmen's compensation, and property damage should be purchased by each depository. EDP insurance also should be individually considered, with special attention to loss prevention. (Reference should be made to National Fire Protection Bulletin No. 75 for guidance in protecting a data processing facility.) It is assumed that sufficient limits will be maintained for each type of insurance purchased by each depository.
5. Each depository should submit a synopsis of its overall program to the other depositories for annual review. The Subcommittee also would be pleased to review each depository's insurance program.
Errors between depositories should be readjustable and therefore need not require errors and omissions coverage (which is costly and perhaps could not be obtained in sufficient amount in any event).
In connection with the program outlined above, the Subcommittee wishes to point out that adequacy of security and controls will be judged heavily and the size of jumbo certificates duly considered by the insurers when they determine the extent and cost of coverage. It is suggested that each jumbo certificate be limited to the total amount of coverage.
Although insurance underwriters probably have been exposed to the securities depository concept to a point where they acknowledge the benefits of depositories, immobilization of certificates, book-entry methods of accounting, etc., they should in the future be educated through formal educational programs developed by the depositories. Presentations should be made to leading underwriters including their senior executives. (The Subcommittee would be glad to assist in arrangements.) Such a program should outline the benefits which would result from a viable depository system and should accomplish two objectives :
1. Indicate the confidence which members of the insurance industry can have in depositing their own securities, and
2. Indirectly change insurance company attitudes toward writing the blanket bond of individual financial institutions.
It was a privilege to serve the National Coordinating Group. If recommendations presented herein are accepted, the Subcommittee would undertake to manuscript the form for primary and excess coverage, as discussed above. It would present the form to underwriters and determine market capacity and pricing.
(Chicago); Byrne Davis, Marsh & McLennan, Inc. (San Fran-
REPORT AND RECOMMENDATIONS CONCERNING A FINANCIAL INDUSTRY NUMBER
SYSTEM (FINS) Background
In July 1970, the Security Imprinting and Processing (SIP) Task Force sponsored by The American Bankers Association issued its Final Report and Recommendations. Among other things, SIP called for the adoption of FINS by the banking and securities industries. The CIP FINS recommendation is Exhibit I. In short, FINS, which was developed by the CUSIP Technical Subcommittee between 1968 and 1970, would provide a unique number for every financial institution involved in securities processing.
Also in July 1970, the BASIC Task Force distributed approximately 100 copies of the FINS recommendation within the banking and securities industry soliciting comments. Seventeen replies were received. These generally agreed with the theory of FINS but saw no use for it then and would have trouble justifying the change from whatever numbering system they were using.