
[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]                         


[[Page 28539]]

=======================================================================
-----------------------------------------------------------------------

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.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ Securities Exchange Act Release No. 57461 (March 10, 2008), 
73 FR 14294.
---------------------------------------------------------------------------

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

[[Page 28540]]

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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

(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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

(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

[[Page 28541]]

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.
---------------------------------------------------------------------------

    \5\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------

    \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).
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \7\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Florence E. Harmon,
Deputy Secretary.
[FR Doc. E8-10968 Filed 5-15-08; 8:45 am]

BILLING CODE 8010-01-P
