1. MEMBERSHIP STANDARDS

Each Clearing and depository Facility¹ ("Facility") must have express minimum standards for member access to its core services.

Both the Facility and its participants have a legitimate need to restrict Facility membership to protect their own creditworthiness. Important criteria for membership include financial integrity, proven operational skills, and high ethical standards. By adopting objective standards to evaluate potential members, Facilities can strike a balance between protecting their membership and permitting fair and open access to their services. The following are reasonable requirements for members of Facilities.

Members should be subject to supervision or regulation by a governmental authority or self-regulatory authority subject to governmental oversight. Such supervision will provide monitoring of the member's financial condition.

¹ In the United States, clearance and settlement functions are divided between separate entities. One entity, the clearing corporation, provides clearance services such as trade comparisons (agreement on trade terms and the contract's existence), continuous net settlement accounting (the netting of each participant's daily purchases and sales to obtain a daily net receive or deliver obligation), and trade for trade accounting (the accounting for each participant's daily purchases separately). A different entity, the securities depository, provides settlement services including custody (with the immobilization of stock certificates) and the transfer of stock ownership by bookentry settlement. An alternative to immobilization of stock certificates is dematerialization where positions in a security are reflected only on electronic books and records and no certificates exist.

The Group of Thirty, a private sector group that studied the state of clearance and settlement in the world's principal securities markets, issued a report in 1988 recommending that: (1) trade comparison between direct market participants should occur by the day following the date of execution; (2) indirect market participants should be members of a trade comparison system which achieves positive affirmation of trade details; (3) each country should have an effective and fully developed central securities depository; (4) each country should implement a netting system; (5) a delivery versus payment system should be employed as the method for settling all securities transactions; (6) countries should adopt a same-day funds payment method for settlement of securities transactions; (7) a rolling settlement system should be adopted by all markets so that final settlement occurs on the third day after the date of execution; (8) securities lending and borrowing should be encouraged as a method of expediting the settlement of securities transactions; and (9) each country should adopt the standards for securities numbering and messages developed by the International Standards Organization. Group of Thirty, New York and London, Clearance and Settlement in the World's Securities Markets (March 1989); See also International Organization of Securities Commissions, Clearing and Settlement in Emerging Markets - A Blueprint 109-112 (October 1992). Efforts are underway in most countries to comply with the Group of Thirty recommendations.

Members should maintain minimum liquid capital sufficient to meet their payment obligations as they come due. The amount of liquidity required may be determined with reference to the size of the member's positions and, in the case of Facilities that mark positions to market, to the magnitude of potential changes in the positions' values.

Members should maintain adequate systems of internal accounting controls to foster customer and counterparty confidence that the members will meet their delivery and payment obligations on a timely basis.

2 FINANCIAL AND OPERATIONAL CAPACITY

Facilities should have sufficient financial and operational capacities.

Facilities that have adequate financial capacity can limit liquidity pressures that result from participant defaults and ensure that even if defaults occur, settlement will be completed on schedule. Likewise, adequate operational capacity can prevent liquidity problems and reduce credit risks resulting from delayed settlement of transactions.

Specifically Facilities should have sufficient capital or liquidity resources (bank credit lines, member guarantee funds, margin, retained earnings, and/or member assessment powers) to meet their ordinary and contingent liabilities. Minimum capital levels may differ among Facilities based on the level of exposure to member default (e.g., in general, net capital levels for securities clearinghouses are lower than those for futures clearinghouses). The capital resources should be in cash or highly liquid securities and should be limited in the purposes for which they may be used. Member contributions should be based on a non-discriminatory formula universally applied.

Facilities also should have an affirmative obligation to safeguard funds and securities in their possession or control. Facilities should protect against the possibility of theft, destruction, or loss of securities or funds and the unauthorized modification, disclosure, or destruction of data.

Each Facility should have systems for monitoring members' financing condition and obligations to the Facility. Such monitoring should be increased for any firm whose ratings decline. Monitoring a member's financial condition can provide early notice of concentration risks and the effects of high volatility on individual members. Monitoring also will enable the Facility to take early corrective action.

3. REGULATORY FRAMEWORK

A regulatory framework for the operation of Facilities should be established.

Each Facility should be subject to direct governmental oversight or self-regulation subject to governmental oversight, including periodic examinations (depending on the stage of market development, it may be appropriate to permit the establishment of only a single clearing and depository organization). If there are multiple Facilities in a clearance and settlement system, close cooperation between them is essential. In addition, the transfer agent or any other entity performing the registrar function should be regulated with respect to turn around time and recordkeeping requirements. In particular, timely registration of the transfer of securities is essential for market liquidity.

Facilities should be obligated to monitor information about the financial and operational condition of participants in multiple markets and to share that information with entities in those markets. Linked entities should notify each other when a common participant's financial or operational condition is impaired. Monitoring participants' positions in all markets will provide Facilities with more information with which to assess liquidity, systemic and credit risks. There may be resistance, however, to sharing certain types of information and, therefore, confidentiality must be assured. Information sharing also may require more advanced technology to make use of the information provided.

An efficient clearance and settlement system also requires coordination among the stock and derivative markets. The lack of integrated clearance and settlement among derivative and cash market products increases systemic risk.²

4. ISSUANCE OF GUIDELINES

Facilities should issue clear guidelines, rules, and procedures.

The terms on which members can obtain access to the Facility's services and the circumstances under which a member's access to those services can or will be revoked should be publicly disclosed. The Facility's rules should avoid unfairly discriminating among members in the admission to or use of the system.

The Facility should establish measures designed to assure that the Facility and its members can meet their financial obligations on a timely basis (e.g., margin or collateral deposit requirements, or secure bank credit lines).

The Facility should establish measures to reduce the risk of non settlement. The longer the time period between the execution and settlement of a trade, the greater the risk of default. Several advisory committees, including the Group of Thirty, have recommended a settlement date of three days after the execution date of a trade. Also, settlement by book-entry between financial intermediaries and between financial intermediaries and their institutional clients increases the efficiency of the street side settlement process while decreasing the risks and costs involved in transferring securities. Therefore, all new issues coming to market should be made eligible for depository processing, thereby reducing the need for manually transferring securities certificates.

The Facility should state what actions it will take in the event of a member's default or insolvency, and the likely disposition of pending trades, open commitments, payment obligations, and delivery or receive obligations.

The Facility should disclose the respective rights and obligations of members to the Facility, defining the extent to which the Facility may assess members to fund or allocate losses incurred by the Facility in the event of a member default or insolvency.

5. SYSTEM CAPACITY

Facilities must maintain adequate systems capacity to process reasonably anticipated volume, including projected peak volume demands and must be capable of protecting against reasonably anticipated internal or external threats to the integrity of their operations.

Facilities should use automated systems that permit electronic processing of data, payments, and securities deliveries. During times of high trading volume, technology often is essential to efficient clearance and settlement. The elimination of physical delivery of stock certificates is essential to automating clearance and settlement systems because physical movement of certificates to transfer ownership is inefficient. The risk of automated system down-time may be reduced by duplication of power supplies and other essential components. Back-up precautions must be taken so that participants can have confidence in the integrity of the systems.

Facilities should establish formal current and future capacity estimates for their automated systems to ensure that their automated systems have the capacity to accommodate adequately current and reasonably anticipated processing levels and to respond to localized emergency conditions. Future capacity estimates should be based on projected volume figures and possible increased message traffic resulting from planned modifications to existing systems or the introduction of new systems.

Facilities should conduct periodic capacity stress tests to determine the behavior of automated systems under a variety of simulated conditions. The periodic test of system capacities will help identify potential weak points and reduce the risk of operational failure. The tests should be based on generally accepted standards, subject to regulatory approval.

Facilities should conduct independent annual reviews to assess whether their automated systems can perform adequately at their current and future estimated capacity levels and whether these systems have adequate protection against physical threats. Appropriate areas for independent review include whether: (1) current and future capacity estimates are accurate; (2) the automated systems can perform at estimated capacity levels; (3) planned system enhancements realistically will accommodate future capacity requirements; (4) contingency protocols are well designed and likely to be effective; and (5) automated systems are vulnerable to systems integrity failure. In addition, the independent reviews should make recommendations to address any deficiencies found in the areas listed above.