Compliance Report ISSA Recommendations 2000

ISSA - International Securtities Services Association

Compliance to the ISSA Recommendations 2000

Market: U.S.A.

Status: December 28, 2001

Recommendation 1
Recommendation 2
Recommendation 3
Recommendation 4

Recommendation 5
Recommendation 6
Recommendation 7
Recommendation 8

Market selection

Recommendation 8

Local laws and regulations should ensure that there is segregation of client assets from the principal assets of their custodian; and no possible claim on client assets in the event of custodian bankruptcy or a similar event. Regulators and markets, to further improve investor protection, should work:

to ensure clarity on the applicable law on cross border transactions
to seek international agreement on a legally enforceable definition of finality in a securities transaction
to ensure that local law fully protects the rights of beneficial owners
to strengthen securities laws both to secure the rights of the pledgee and the protection accorded to client assets held in Securities Systems.

1. Under local rules and regulations, what are the segregation requirements for keeping client assets and custodian assets in the depository? All custodians are required to segregate principal and client assets on their books. There is no regulatory requirement for such segregation to be undertaken at the depository level although the functionality exists. At depository level the custodian has the ability to segregate client assets at entity level, investor level or fund level.

2. How are clients' assets protected in the event of insolvency of a custodian or depository? DTC segregates assets of participants and its own assets. In the event of default, US law would protect the investor against claims from an administrator of their agent as long as the relevant accounts were clearly segregated from the principal activities of the insolvent party. Protection for client assets is governed by the Uniform Commercial Code (UCC). Whenever a Bank holds securities for a customer pursuant to a Custodian Agreement, the Bank is a "financial intermediary" with respect to such securities, under the Uniform Commercial Code. If the Bank should ever become insolvent, the respective Superintendent of Banks and the Federal Deposit Insurance Corporation as liquidators and receiver, respectively, would be required to turn over promptly to the Bank's customer any property held in the customer's custodian account.

3. Does local law recognise the existence of beneficial owners who may differ from the legal owner of a security? The concept of beneficial owner and fiduciary responsibility is clearly enshrined within US law.

4. Does local law clearly define the point of time when a settlement, both for the security and the cash involved, achieves finality and thus cannot be unwound? DTCC: DTCC has clear legal authority to transfer title to securities. Title is not final within DTCC until all end of day cash obligations have been fulfilled.

FED: FRB has the power to change title to securities without prejudice based on the respective Rules and Regulations of the FED, as approved by FRB's participants. As per the FRB's operating guide, title is final and irrevocable immediately as the FRB system moves title and cash simultaneously.

5. Does a pledgee have an absolute right to realise their security at all times? Yes, under rules established by the SEC.

6. Does the depository have loss sharing provisions in its rules, and how would these be applied? DTCC: There are default protections in the form of a participant's fund, based on participants' average monthly holding and daily volume, which currently stands at US$400 million. In the event that a participant's failure exceeded its contribution to the fund, DTC would draw on other participants on a pro-rata basis. In addition, DTC sets debit caps for participants, and maintains bank credit lines of US$1 billion, which have not been drawn. DTC will ultimately institute unwind procedures on LIFO basis to meet the obligations of the defaulting party. DTCC retains the right to assess members a proportional amount (based on size) in case of participant default. Although there are no loss sharing provisions for participants in the banking system, the FedWire System has liquidity and credit is readily available from the Federal Reserve Bank.

FED: The FRB system has strong default protections, including instantaneous good title for good value, trade by trade settlement, and liquidity/credit availability at the Fed.

1.	Under local rules and regulations, what are the segregation requirements for keeping client assets and custodian assets in the depository?	All custodians are required to segregate principal and client assets on their books. There is no regulatory requirement for such segregation to be undertaken at the depository level although the functionality exists. At depository level the custodian has the ability to segregate client assets at entity level, investor level or fund level.
2.	How are clients' assets protected in the event of insolvency of a custodian or depository?	DTC segregates assets of participants and its own assets. In the event of default, US law would protect the investor against claims from an administrator of their agent as long as the relevant accounts were clearly segregated from the principal activities of the insolvent party. Protection for client assets is governed by the Uniform Commercial Code (UCC). Whenever a Bank holds securities for a customer pursuant to a Custodian Agreement, the Bank is a "financial intermediary" with respect to such securities, under the Uniform Commercial Code. If the Bank should ever become insolvent, the respective Superintendent of Banks and the Federal Deposit Insurance Corporation as liquidators and receiver, respectively, would be required to turn over promptly to the Bank's customer any property held in the customer's custodian account.
3.	Does local law recognise the existence of beneficial owners who may differ from the legal owner of a security?	The concept of beneficial owner and fiduciary responsibility is clearly enshrined within US law.
4.	Does local law clearly define the point of time when a settlement, both for the security and the cash involved, achieves finality and thus cannot be unwound?	DTCC: DTCC has clear legal authority to transfer title to securities. Title is not final within DTCC until all end of day cash obligations have been fulfilled. FED: FRB has the power to change title to securities without prejudice based on the respective Rules and Regulations of the FED, as approved by FRB's participants. As per the FRB's operating guide, title is final and irrevocable immediately as the FRB system moves title and cash simultaneously.
5.	Does a pledgee have an absolute right to realise their security at all times?	Yes, under rules established by the SEC.
6.	Does the depository have loss sharing provisions in its rules, and how would these be applied?	DTCC: There are default protections in the form of a participant's fund, based on participants' average monthly holding and daily volume, which currently stands at US$400 million. In the event that a participant's failure exceeded its contribution to the fund, DTC would draw on other participants on a pro-rata basis. In addition, DTC sets debit caps for participants, and maintains bank credit lines of US$1 billion, which have not been drawn. DTC will ultimately institute unwind procedures on LIFO basis to meet the obligations of the defaulting party. DTCC retains the right to assess members a proportional amount (based on size) in case of participant default. Although there are no loss sharing provisions for participants in the banking system, the FedWire System has liquidity and credit is readily available from the Federal Reserve Bank. FED: The FRB system has strong default protections, including instantaneous good title for good value, trade by trade settlement, and liquidity/credit availability at the Fed.