One, Two, Three: DTCC Tries Eliminating Paper Certificates
No more paper certificates.
That's what The Depository Trust & Clearing Corp. (DTCC), the New York-based umbrella organization for clearing and settling U.S. securities transactions, wants to see happen in the U.S. market by 2018 at the latest.
It's a process that has already occurred in many European and Asia-Pacific countries such as France, Switzerland and Australia leaving the U.S. behind the curve. But apparently not for long.
DTCC is seeking industry feedback by September 1 to begin a three-pronged approach in 2013 to further eliminate paper certificates. Highlighted in a white paper, the "dematerialization campaign" involves reducing the volume of certificates that are sent by broker-dealers to DTCC for processing and eventually eliminating DTCC’s centralized processing of physical deposits of certificates altogether by 2015. It also means making recommendations on the primary issuance of securities that will eventually eliminate the need for physical certificate processing and reduce the number of certificates already stored in DTCC's vaults. DTCC is holding a whopping 1.7 million of them.
Dematerialization is a blanket term that refers to the process of replacing paper-certificates representing ownership of shares in U.S. equities with book-entry securities held in electronic form; they are blips on a computer screen. Immobilization achieves the same goal but through less sophisticated means; certificates are held in a central location and change in ownership of shares takes place through bookkeeping entries.
The US has already cut down the number of certificates in circulation as more securities are issued without certificates and issuers taking advantage of a direct registration system operated by DTCC which allows investors to hold statements instead of certificates to evidence share ownership. But there are plenty of certificates left in circulation.
No one will estimate just how many. At the very least it's expensive and risky for both DTCC and its participants to handle all that paper, says Dan Thieke, managing director at DTCC. For one, DTCC and financial firms have to securely store the certificates, insure them when making delivery to their counterparties and bear the costs of replacement when lost or stolen. It could easily come to over $100 million a year. Electronic records eliminate that risk and because statements have no intrinsic value, so if one is lost or stolen it can be issued at a fraction of the cost.
The following are the highlights of the DTCCC's "dematerialization program" found in its white paper entitled: "Strengthening U.S. Financial Markets: A Proposal to Fully Dematerialize Physical Securities Eliminating the Costs and Risks They Incur." A full copy of the document can be found on the Thought Leadership section of DTCC's website www.dtcc.com. 1- Traditional Physical Transactions: Of the three tracks cited in the dematerialization program, this will be the most challenging to implement, says Thieke, because it involves changes that effect the direct handling of certificates broker-dealers and banks send to DTCC for immobilization in its Deposit Automation Management (DAM) service. Those certificates are re-registered in the name of the financial firm and require switching to DTCC's nominee name Cede & Co. "It would have the most number of players involved in amending their procedures-- DTCC; transfer agents, and broker dealers," says Thieke who said costs could not be determined until DTCC and the securities industry come up with an answer.
DTCC proposes that in 2013 it offer one of three options of which the most impactful -- in terms of reduced cost and risk -- is having broker-dealers and banks send certificates directly to transfer agents with corresponding instructions to deposit those securities into their DTCC account; that scenario removes DTCC from handing the physical certificates. In a second or modified version of DAM, deposits of certificates to DTCC could be credited to a bank or broker-dealer's account as "provisional" for several days (until the certificates clear transfer) before being finalized and credited on the books of DTCC. By extending the timetable for completing a deposit of a certificate, DTCC says it can reduce its cost base and ultimate fees it charges broker-dealers and banks. The third option calls for banks and broker-dealers to continue to use the current DAM process subject to higher fees.
2- New Issues: DTCC receives an estimated 50,000 new certificates each year to store, mainly for municipal bonds and retail certificates of deposit. One way to reduce the number is for DTCC, to offer an e-cert program to accept retail certificates of deposit in electronic form. Yet another is to allow issuers to send electronic images of certificates in so-called book-entry only shares -- typically corporate or municipal debt -- to be stored in an electronic vault. "While investors don't receive paper certificates, DTCC still has to store a jumbo certificate and transfer ownership of shares in electronic form by crediting or debiting the immobilized certificate," explains Thieke.
3- Existing DTCC Vault Inventory: One way to reduce the number of certificates in DTCC's vault is to reduce the number of years non-transferable issues must be stored from six to four years before they can be destroyed. These non-transferable securities, most of which are low-priced equities and are no longer serviced by a transfer agent, are often categorized as “distressed assets”.
DTCC is also considering resurrecting an old idea -- a direct registration system for restricted securities through which investors would hold statements instead of certificates to evidence ownership of shares. Under that scenario, the DTCC would allow transfer agents to record all of the investors information about their assets while broker-dealers control the accounts and underlying shares for purposes of monitoring the restriction window. However, as DTCC notes, the idea would require additional funding and addressing broker-dealers' concerns over "good control" of the securities in case they are ever used as collateral. "Good control" implies that broker-dealers have the same access to the securities as they would if they were held at the firms' offices.
Written by Chris Kentouris, Editor-in-chief (Chris can be contacted through Chris.Kentouris@hotmail.com)
