[Federal Register: May 16, 2008 (Volume 73, Number 96)]
[Notices]
[Page 28539-28541]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr16my08-127]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-57813; File No. SR-NSCC-2007-12]
Self-Regulatory Organizations; National Securities Clearing
Corporation; Order Granting Approval of a Proposed Rule Change To
Provide a New Alternative Investments Products Service
May 12, 2008.
I. Introduction
On July 17, 2007, National Securities Clearing Corporation
(``NSCC'') filed with the Securities and Exchange Commission
(``Commission'') and on February 19, 2008, amended proposed rule change
SR-NSCC-2007-12 pursuant to section 19(b)(1) of the Securities Exchange
Act of 1934 (``Act'').\1\ Notice of the proposal was published in the
Federal Register on March 17, 2008.\2\ No comment letters were
received. For the reasons discussed below, the Commission is approving
the proposed rule change.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ Securities Exchange Act Release No. 57461 (March 10, 2008),
73 FR 14294.
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II. Description
NSCC is establishing a new Alternative Investment Products service
(``AIP Service''), a processing platform for alternative investment
products such as hedge funds, funds of hedge funds, commodities pools,
managed futures, and real estate investment trusts (``REITs'').
(1) Summary of AIP Service
The AIP Service will provide for processing of information relating
to transactions in alternative investment products and for settlement
of related payments (``AIP Payments''). It will facilitate, among other
things, processing activities such as subscriptions and redemptions,
distributions, position reporting, and account maintenance. Activities
that will be supported by the AIP Service are more fully described
below in the section titled ``Scope of AIP Service.''
Settlement of AIP Payments through NSCC will be done on a prefunded
basis. NSCC will simply pass-through AIP Payments from AIP members to
the contraside AIP members without netting or without guaranteeing
payment in the event of contraside default. NSCC will not be liable to
make payment to an AIP member in the event of a default in payment by
the contraside AIP member. Settlement of AIP Payments (``AIP
Settlement'') will be segregated from all other money settlements at
NSCC. NSCC will have no exposure to credit risk as a result of the
operation of the AIP Settlement. AIP Settlement is more fully described
below in the section titled ``AIP Settlement.''
Participation in the AIP Service will be governed by NSCC's Rules
and procedures applicable to the AIP Service. Each user of the AIP
Service (``AIP Member'') will be required to enter into an AIP
membership agreement with NSCC that will govern its use of the AIP
Service. Entities eligible for membership will include entities subject
to regulation under U.S. federal or state laws such as registered
broker-dealers, investment advisers, banks, and insurance companies.
Because of the unique processing and distribution features of
alternative investment products and because NSCC will have no exposure
to the credit risk of AIP Members and will have no liability to make
payments in the event of an AIP Member's AIP Settlement default,
entities that are not required to register under applicable U.S.
federal or state law and entities organized under applicable law
outside of the U.S. will also be eligible to become AIP Members.
Membership in the AIP Service is more fully described below in the
section titled ``AIP Members.''
NSCC developed the concept and functionality for the AIP Service at
the request of and in consultation with industry participants, many of
which were NSCC members using other NSCC services. Some of these
interested parties committed to become pilot subscribers to the
proposed AIP Service and committed to assist NSCC in funding the launch
of the AIP Service. These parties are more fully described below in the
section titled ``AIP Pilot Group.''
(2) Alternative Investment Products
Alternative investment products are typically illiquid, pooled
investment products that are exempt from registration under the
Security Act of 1933 and the Investment Company Act of 1940 and that
are offered through private placements to high net worth individuals
and institutional investors such as pension funds.
Alternative investment products may be placed and held by an end
investor through a direct relationship with the issuer or manufacturer
of an alternative investment product (called the ``AIP Manufacturer''
for purposes of NSCC Rules) or through an entity acting on behalf of an
issuer or manufacturer. They may also be placed and held through a
distribution channel such as a registered broker-dealer that
facilitates transactions as a processing contraparty to the AIP
Manufacturer (called the ``AIP Distributor'' for purposes of NSCC
Rules). Alternative investment products are not generally traded in the
secondary market. In this respect, the distribution for alternative
investment products is similar to the distribution of mutual funds on
NSCC's Fund/SERV system. Alternative investment products have
processing characteristics and risk profiles that differ from those of
mutual funds, and those differences have been taken into account and
reflected in the functionality of the AIP Service and in NSCC Rules and
procedures.
Increasingly, investors and their advisers are including
alternative investment products as part of their portfolios. The
alternative investment products market currently represents over $1
trillion in assets and continues to grow. Despite the large asset base,
processing remains extremely manual using methods such as delivery of
hard-copy documents, transmission of information by fax, e-mail
messages and spreadsheets, and telephone calls. The lack of automation
and standardized, centralized processing is inefficient, prolongs
transaction processing time, results in high costs per transaction, and
increases the likelihood of errors--factors that increase in importance
as the volume of transactions in alternative investment products
continues to increase as it has in recent years.
(3) AIP Pilot Group
Accordingly, several industry participants (many of which were
members of NSCC) approached NSCC to explore whether NSCC could bring
automation and standardization to the alternative investment product
market analogous to that which NSCC's Mutual Fund Services has provided
to the mutual fund market. Mutual funds and alternative investment
products frequently share similar distribution channels and are
frequently both included in an investor's portfolio for which a
financial intermediary consolidates asset reporting and servicing.
NSCC solicited its members to assess industry interest. A pilot
group of interested broker-dealers, alternative product manufacturers,
and fund administrators was formed to determine the feasibility of NSCC
providing such a service and if feasible to assist in the development
of the business requirements and functional specifications for such a
service. Some members of the pilot group committed to assist in the
costs of development of such a service through payment of a
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fixed amount that would be applied to their respective usage fees when
the service was in production. Consistent with this commitment to
support the costs developing and implementing the service, NSCC agreed
to consult with the members of the pilot group in refining and
enhancing the necessary functionality for the service. The
functionality for the initial scope of the AIP Service is described
below in the section titled ``Scope of AIP Service.''
(4) Eligible AIP Products
Alternative investment products that can be processed through
NSCC's AIP Service (``Eligible AIP Products'') will initially include
the types of products referenced above (i.e., hedge funds, funds of
hedge funds, commodities pools, managed futures, and REITs). Additional
products could be added in the initial phase or from time to time as
requested by industry participants and as approved by NSCC.\3\ Eligible
AIP Products may include those registered with the Commission and those
not required to be registered. When an AIP Manufacturer submits an
alternative investment product for processing through the AIP Service,
pursuant to NSCC rules and procedures, it represents and warrants to
NSCC that the offer and sale of the investment product complies with
applicable law.
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\3\ Due to the nature of alternative investment products, NSCC
retains the right to refuse to process a specific product or type of
product through the AIP Service or to require that a product or type
of product no longer be processed through the AIP service if NSCC
deems it to be in the interests of NSCC and its members to do so.
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(5) AIP Members
The following types of entities will be eligible to become AIP
Manufacturers or AIP Distributors:
(i) A broker-dealer registered under the Exchange Act or a non-US
broker-dealer subject to regulation by the appropriate financial
services regulator in its home jurisdiction;
(ii) A bank or trust company under supervision of federal or state
banking authorities or a non-US bank subject to regulation in its home
jurisdiction;
(iii) An investment company registered under the Investment Company
Act or an issuer (structured as a fund or other pooled investment
vehicle) that is not required to register thereunder;
(iv) An investment adviser as defined under the Investment Advisers
Act of 1940 regardless of whether it is registered under the Investment
Advisors Act or is exempt from registration;
(v) A commodity pool operator or commodity trading advisor as
defined in the Commodity Exchange Act regardless of whether the
commodity pool operator or commodity trading advisor is registered
pursuant to the Commodity Exchange Act or is exempt from registration
thereunder;
(vi) An insurance company regulated under state insurance law or a
non-US insurance company subject to regulation by the appropriate
insurance regulator in its home jurisdiction;
(vii) An AIP Manufacturer that is an entity engaged under contract
to provide administrative services to one or more Eligible AIP
Products; or
(viii) An entity that does not qualify as one of the above entities
but that has demonstrated to the Board of Directors of NSCC that its
business and capabilities are such that it could reasonably expect
material benefit from direct access to the AIP Service.
Because AIP Settlement will be prefunded and because NSCC will be
insulated from exposure to the credit risk of AIP Members and will have
no liability to make payments in the event of an AIP Member's AIP
Settlement default, there are no financial requirements for
participation in the AIP Service. Members will be required to meet
NSCC's operational requirements and general standards applicable to
competency for membership and to meet such other requirements as NSCC
may establish from time to time.\4\
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\4\ NSCC's general standards applicable to competency are
designed to screen for any action or condition of an applicant or
member that could in the judgment of NSCC present undue risk to NSCC
or its members.
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(6) Scope of AIP Services
The AIP Service will support communication of information and
settlement of AIP Payments between AIP Manufacturers and the AIP
Distributors in order to facilitate the processing of subscriptions and
purchases, tenders and redemptions, dividends and distributions,
commissions and fees, position reporting, product information, account
maintenance, automated transmission of imaged documents, and such other
actions as NSCC may determine from time to time. The AIP Service will
provide AIP Members with the ability to transmit data in connection
with transactions whether the payments are made outside of NSCC or
through the AIP Service.
As with all NSCC services, NSCC will not be responsible for the
completeness or accuracy of data transmitted through the AIP Services
or for any errors, omissions, or delays which may occur in the absence
of gross negligence on the part of NSCC.
Fees for the use of the AIP Service have not yet been established
and will be the subject of a subsequent proposed rule change filed
under section 19(b)(3)(A) of the Act if this proposed rule filing is
approved.
(7) AIP Settlement
AIP Settlement will be in same day funds over fedwire and will be
segregated from all other settlement payments at NSCC. Unless otherwise
provided by NSCC, AIP Members will be required to appoint a settling
bank (``AIP Settling Bank'') for purposes of settlement similar to NSCC
settlement procedures for its other money settlements.
NSCC will maintain credit balances and debit balances for each AIP
Member to which NSCC will post gross credits and gross debits for
settlement on the date designated for settlement by the AIP Member
(``Settlement Date''). AIP Settlement will be on a gross bais meaning
that the credit balance of an AIP Member will not be netted against its
debit balance. If NSCC does not receive funds from an AIP Member in the
amount of the debit balance by the requisite time on the Settlement
Date, NSCC will reduce the corresponding settlement credit balances of
the AIP Members that are the contrasides to the AIP Member that did not
pay its gross debit balance. Nonpayment of a debit balance will not be
deemed a payment default under NSCC Rules, but NSCC may establish fees
for late payment or nonpayment and may establish a threshold number of
instances of late payment or nonpayment which would result in other
sanctions, including NSCC's ceasing to act for such an AIP Member.
After receipt of an AIP Member's debit balance from the AIP
Member's AIP Settling Bank on Settlement Date, NSCC will transfer to
the AIP Settling Bank(s) of the contraside AIP Member(s) the settlement
credit balance(s). NSCC's payment will include gross credit balances
which may have been reduced to reflect the reversal of any credits with
respect to debit balance amounts that were not paid by a contraside AIP
Member.
Use of NSCC's AIP Service will provide the alternative investment
product industry with the ability to process transactions and to settle
funds on a centralized, fully redundant platform that will provide more
robust business continuity in the event of interruption to processing
on a primary system, better audit trails on
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transactions, lower costs, and fewer errors and delays than is
currently the case.
Settlement on the basis of gross debits and gross credits without
offsets insulates NSCC from any financial risks associated with
Eligible AIP Products and AIP Members. Because NSCC's obligation to pay
a credit balance will be conditioned upon receipt by NSCC of the debit
balance from the contraside AIP Member, NSCC will not bear the risk
that an AIP Member may default at settlement.
(8) AIP Document Transmission
The AIP Service will automate the transmission of imaged hard-copy
documents (``paper workflow'') between AIP Manufacturers and AIP
Distributors. The alternative investment industry has a number of
investment instruments that are private or are traded outside of the
normal processes and that require the exchange of documentation. It is
not untypical for the parties to exchange up to forty pages of hard-
copy documents. Subaccount documentation is typically sent for both
initial and subsequent subscriptions, depending on the requirements of
the alternative investment product, and for tender offers. The paper
workflow component of the AIP Service will allow parties to scan and to
convert documents to a file format such as portable document format
(``PDF'') file for transmission with or without a pending transaction
message.
(9) Proposed Changes to NSCC Rules
A new Rule 53, ``Alternative Investment Product Services and
Members,'' will be added to NSCC's Rules, and additional confirming
changes will be made elsewhere throughout NSCC's Rules as needed to
provide consistency with the new Rule 53.
III. Discussion
Section 17A(b)(3)(F) of the Act requires, among other things, that
the rules of a clearing agency be designed to remove impediments to and
to perfect the mechanism of a national system for prompt and accurate
clearance and settlement of securities transactions.\5\ By facilitating
the transmission of standardized information for alternative investment
products on a centralized communications platform and by automating
money settlements through a centralized facility in the same day funds,
the AIP Service will provide increased efficiencies and reduced risks
that are typically associated with the current alternative investment
products processing. As such, the proposed changes will help remove
impediments to and perfect the mechanism of a national system for the
prompt and accurate clearance and settlement of securities
transactions.
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\5\ 15 U.S.C. 78q-1(b)(3)(F).
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IV. Conclusion
On the basis of the foregoing, the Commission finds that the
proposed rule change is consistent with the requirements of the Act and
in particular section 17A of the Act and the rules and regulations
thereunder.\6\
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\6\ In approving the proposed rule change, the Commission
considered the proposal's impact on efficiency, competition, and
capital formation. 15 U.S.C. 78c(f).
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It is therefore ordered, pursuant to section 19(b)(2) of the Act,
that the proposed rule change (File No. SR-NSCC-2007-12) be and hereby
is approved.
For the Commission by the Division of Trading and Markets,
pursuant to delegated authority.\7\
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\7\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E8-10968 Filed 5-15-08; 8:45 am]
BILLING CODE 8010-01-P