Magazine article Government Finance Review

Same-Day Funds Settlement on Municipal Bonds: New Principal and Income Cash Transfer Deadlines

Magazine article Government Finance Review

Same-Day Funds Settlement on Municipal Bonds: New Principal and Income Cash Transfer Deadlines

Article excerpt

Funds transfers on municipal bond payment dates are commonly viewed by public debt managers as a back-office function that comes to the attention of senior finance officers only on rare instances when "something goes wrong." Even at such times - for example, when the wire transfer system fails - paying agents have been willing to remit funds on behalf of issuers, comforted by the ultimate remedy of a "clawback" of monies from the Depository Trust Company (DTC) and ultimately from securities firms and dealers, if necessary. However, the full implementation of the technologies of paperless municipal bonds and same-day funds settlement is bringing funds transfer mechanics more into the spotlight and necessitating that issuers develop more fail-safe procedures in cooperation with their paying agents.

"Clawback" refers to the DTC policy which makes it possible for paying agents to be made whole for payments made on behalf of issuers in instances when the issuer ultimately fails to make payment itself. Uncertainty as to whether this remedy will be denied to paying agents at some point in the future is the crux of a dialog which has developed between DTC, its participants (as defined below), The Bond Market Association, the paying agent community, and issuers. If the right to "clawback" is repealed in the future, paying agents will have no alternative but to be much more reluctant to make payments on behalf of issuers during the inevitable intra-day periods when funds may be in transit from the issuer but where there is no way for the paying agent to know this for certain.

The transition to same-day settlement dates back to a Group of Thirty (G-30) set of recommendations to the U.S. financial industry in 1988. The G-30 is an independent, nonpartisan, nonprofit organization established in 1978 to deepen understanding of international economic and financial issues, to explore the international repercussions of decisions taken in public and private sectors, and to examine choices then available to policy makers. The 1988 G-30 recommendations were aimed at a) reducing risk and funding requirements, b) promoting payment finality and payment consistency across instruments, and c) improving trade processing efficiencies in the U.S. securities industry. In support of the visions set forth by those recommendations, and as part of the U.S. Working Committee's G-30 Clearance and Settlement Project, industry guidelines were published in 1993 requiring, as of January 1, 1995, that all new issues be made depository-eligible and structured so that all associated payments of principal and income (P&I) to depositories (consisting of dividends, interest, reorganization, and redemption payments) be paid in same-day funds on payment date. In May 1995, a major change in the securities marketplace occurred, as the settlement period for trades was accelerated from five days to three days. Conversion to same-day funds settlement occurred on February 22, 1996.

Payment Cut-off Times and Clawbacks

To implement these changes, it was necessary to mandate adherence to defined timetables for all issuer payments on corporate as well as municipal instruments. In 1993, a fixed cut-off time for receipt of P&I payments by all depositaries was established as 2:30 p.m. ET on payable date. In 1997, DTC revised its Operational Arrangements and Letters of Representation to require that all payments be remitted by issuers to paying agents or their intermediaries by 1 p.m. ET on payable date, or earlier if required by the paying agent, to guarantee receipt of same-day funds at DTC by 2:30 p.m. ET on payable date. The revised Operational Arrangements, which set forth all necessary guidelines for an issue to become eligible for DTC, became effective January 1, 1998. Letters of Representation are signed by issuers as their agreement to comply with Operational Arrangements, which contain the payment guidelines.

Depository processing of P&I payments require the timely receipt of funds from issuers or their agents, supported by automated details to allow for accurate allocations to the banks, brokers, and broker/dealers that are DTC participants (the Participants). …

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