APPENDIX III-BANK WIRE

In addition to the FRS Wire Network, discussed above, instructions for the transfer of funds can be handled with the Bank Wire. The Bank Wire is a switching network connecting over 230 banks, as shown below. This network switch is based on a four character alphabetic code (NXXX for New York banks, CXXX for Chicago banks, etc.) but the messages are not formatted in any standard as FRS messages are. Bank Wire is managed by banks in Chicago and New York, but an Ad Hoc Committee is now considering broader ownership of this network.

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APPENDIX IV-CLEARING HOUSE INTERBANK PAYMENTS SYSTEM (CHIPS)

In 1970, the New York Clearing House Association (NYCHA) installed an automated clearing house through which international payments could be switched by means of a central computer located at the NYCHA. This system, referred to as the Clearing House Interbank Payments System, or CHIPS, has been expanded from the nine participating NYCHA banks to include one new NYCHA member and five Edge Act and foreign agency banks. In addition, forty other banks involved in international transactions participate through a Paper Exchange Payment System, or PEPS, with transactions printed centrally at NYCHA. PEPS may be viewed as an interim or "staging" phase for these forty organizations. When the switching computer system at NYCHA is expanded in 1974 to allow installation of terminals at the PEPS participants' locations, they will become part of CHIPS.

The CHIPS system determines the net position of each participating bank daily. The following morning at the 10:00 a.m. exchange, the NYCHA bank receives a credit or debit to its balance account on deposit at the Federal Reserve Bank of New York similar to the method of settling the exchange of checks.

This CHIPS capability conceivably can be expanded when the new computer switch is installed in early 1974 to include securities transactions. However, at present, it does not seem that this system has sufficient capacity to handle securities transactions in addition to its present volume. The NYCHA recently had a Funds Settlement Committee analyzing the feasibility of international payments being settled in funds valued today rather than funds valued tomorrow in an attempt to aid the Federal Reserve System in removing uncollected funds from the payment mechanism. This committee had three subcommittees concerned with Operations, Credit and Money Market.

This group has concluded that settlement should continue to be based on funds valued tomorrow because of operating limitations of the payment mechanism to effect transactions under limited times. In addition, there are severe credit problems caused by the settlement in good funds and the difficulty of unraveling erroneous transactions settled in funds valued today or cash. On a funds valued tomorrow basis, error conditions are corrected in funds valued today, so that the beneficiary of the transaction does not suffer a loss.

While solutions to all the problems mentioned regarding international payments being settled in funds valued today seem to be technically feasible, the benefit of settling transactions on a value today basis does not appear to be worth the severe peak demand it places on the payment mechanism.

Mr. Moss. We will now hear from our next witness. Mr. Bevis?

STATEMENT OF HERMAN W. BEVIS

Mr. BEVIS. Yes, Mr. Chairman, I will speak next.

Mr. Chairman, gentlemen, I appreciate the opportunity again to appear before you on behalf of BASIC to discuss legislation having to do with securities depositories. As has been noted, I am accompanied by Hamilton F. Potter, Jr., of Sullivan and Cromwell, counsel to BASIC.

Under date of May 11, 1973, we submitted a "Memorandum of Comment" containing our views, which we still hold, on title IV of H.R. 5050. This memorandum is attached as an appendix; a supplement updates it as to some of the figures and more important recent developments. [See p. 1876.] All my comments are confined to provisions of title IV concerning securities depositories. I offer no comments, pro or con, with regard to provisions having to do with clearing agencies, transfer agents, and other matters covered by title IV.

A PRIMARY ROLE FOR BANK REGULATORY AGENCIES TO ASSURE SAFETY FIRST

I believe that additional legislation is not needed for regulation of bank depositories at this time. However, if we assume that such legislation is to be enacted, we are concerned that title IV provides no realistic steps to inspire confidence that the securities and funds in depositories will be carefully safeguarded.

We believe that a securities transaction processing bill should have two objectives: (1) the prompt and accurate processing and settlement of securities transactions and (2) the financial and physical integrity of the processing institutions so as to assure that they will be able to answer for funds and securities on deposit or in process of settlement. Our concern is that if there is to be legislation it should make clear that the first objective should not be achieved at the expense of the second.

Title IV gives the SEC sole jurisdiction over a depository's registration, rulemaking, examination, and enforcement. It directly refers to bank regulatory agencies only twice and those instances almost have the appearace of afterthoughts. In section 17A (p) (1), if the appropriate bank regulatory agency so requests, it shall receive a copy of an SEC report on its examination of a bank depository; and section 17A (p) (2) provides that the SEC shall consult and cooperate with the agencies on mutual regulatory needs and responsibilities. That is all.

Mr. Chairman, banks and other non-broker-dealer fiduciary financial institutions, whose participation in any nationwide system of depositories is essential, want "safety first" as the regulatory cornerstone before they relinquish possession of assets they hold for others. They consider that "safety first" as a regulatory matter is something to be addressed before the event; the approach should be preventive and precautionary rather than remedial. To them, this means that depositories should not only look like banks and act like banks, but be regulated like banks.

I think the Congress should recognize this desire for assurance of safety-I believe the Congress shares it-and, if it is decided there

should be legislation, should select the Federal Reserve Board as the prime Federal regulator for depositories chartered as member banks in view of its experience, capacity, and philosophy in regulation where safety and financial integrity come first, especially in the areas of safeguards, protection of securities and funds and related matters such as access.

Having referred to the Federal Reserve Board, I should like to comment at this point on a position regarding rulemaking taken in a letter from the Vice Chairman of the Board to Senator Williams in connection with S. 2058. In that letter, the Board calls for "concurrence of the appropriate bank supervisory agency prior to the adoption of any rule by the SEC applying to any clearing agency (depository) which is a bank." Mr. Solomon referred to this earlier and quoted it. This arrangement should meet the oft-expressed desire by both committees of the Congress and the SEC that the latter have the coordinating role for systems to process the Nation's securities transactions. At the same time, the Board would have the opportunity to see that factors important in its supervision of bank depositories had been appropriately covered in depository rules.

Balancing the considerations of prompt and accurate processing of securities transactions, and of safety of the system may not always be easy. Consider, for example, the following hypothetical illustrations:

1. Depositories A, B, and C each receive applications from newly organized depository D to become a participant. D urges A, B, and C also to become participants in it so as to expand immobilization of certificates and the book-entry system.

A, B, and C, after reviewing D's operations, safeguards, and financial resources, believe that they would incur financial risks in crossparticipation with D until it has completed a shakedown period or can show that its operations meet what they consider appropriate

standards.

Expanding the modern system for processing and settling securities transactions argues that depository D become a member of the system quickly; safeguarding securities and funds suggests delay until depository D meets the higher standards.

2. If some participants typically want immediate transfer to others by book-entry of the securities they deposit and any of the deposited securities are rejected by the transfer agents as reportedly lost or stolen, the depository could suffer a loss if the participants do not have other securities of the same issue on deposit to cover the transactions and are unable to redeem the rejected securities.

The depository could protect itself from this risk with a rule that such participants would not receive credit for deposited securities— and, hence, be unable to redeliver them—until they had cleared transfer. Such a rule would slow deliveries for these participants and increase fails. Yet, a depository must limit its risk exposure. The two conflicting objectives must be sensibly balanced.

Broadly stated, the regulatory structure of an integrated national depository system should not invite the possibility that a rulemaker, primarily "market oriented," might require a depository to increase its capacity to handle larger volumes of transactions at the price of an unwise increased risk to participants stemming from operational

inability, financial difficulty, or disreputable practices of persons involved in the overall system.

Title IV of H.R. 5050 is far from what we consider necessary to promote the development of securities depositories in alleviation of the country's securities transaction processing problem. It does not, as I have said, give recognition to the principle that operational expansion is not to be achieved at the expense of adequate safeguards. We attempted to point up the substantially different approach that we consider advisable in a model bill attached to our May 11, 1973, memorandum of comment.

That memorandum also dealt, at pages 14-19, with three specific areas in H.R. 5050 that we feel should be revised, under the headings "Access," "Disciplinary Relationships," and "Management Participation." We continue to hold the views expressed there.

We would stress "access" particularly, since the quality of participants has a close relationship to the safety of securities and funds in a depository. Before one makes just about every registered brokerdealer in the United States eligible to join depositories, for example, it seems to me that he should consider the implications to a depository of the SIPC 1972 annual report. Pages 56-57 contain 40 illustrative examples of reasons for failures of broker-dealer firms. In 13 of the 40, fraud was indicated, and in 11 of the 40 variations of the term "inept management" appeared. While a depository's screening might well not keep out all of such firms who apply, it should not be precluded from trying on the basis of such criteria as, for example, the honesty and integrity of the applicants or their operational capacity or business experience. Rejection of an application should, of course, always be subject to review by the appropriate regulatory authority.

THE "SYSTEMS CONCEPT" IN ONE AGENCY REGULATION

I recognize the symmetry envisioned in holding one Government agency entirely responsible for all securities handling matters, and of giving that agency all authority over that area. I recognize also the appearance of complexity when two agencies are given authority and responsibility as to different aspects of a securities depository's organization and operations.

Joint regulation of depositories by the SEC and the Federal Reserve Board will not conform to a theoretical systems concept. However, I believe that it would produce a more realistic and effective pattern of regulation with regard to securities depositories than title IV of H.R. 5050 and experience shows not all symmetrical approaches inexorably lead straight to the desired result. As you know, the approach of joint regulation is not without precedent. Mr. Solomon mentioned one illustration. Another is that the Federal Reserve Board at present drafts credit regulations governing the securities industry, which are enforced by the SEC. Existing expertise and capacity should be plied; this is all that BASIC has proposed.

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Mr. Chairman, we believe that the bill that recently passed the Senate, S. 2058, goes far in equating the two desirable objectives of (a) safeguarding of depository securities and funds and (b) facilitating the prompt and accurate processing of securities transactions. If there is to be legislation regulating securities depositories, we would