SEC-MRD Opinion No. 02 RE : Delivery versus Payment (DVP) - HSBC

SECURITIESAND EXCHANGE COMMISSION Tel: (632) 584-2016 Email: mrd@sec.gov.ph SECBuilding,EDSA,EastGreenhills Mandaluyong City, Metro Manila Republic of the Philippines

Market Regulation Department

SEC MRD Opinion No. 2 Series of 2008

October 8. 2008

3058 Fifth Avenue West HSBC Centre Bonifacio Global City, Taguig City Fax: 581-8181 THE HONGKONGAND SHANGHAIBANKCORP

Attention: Atty. JoseGerman Licup, SVP, Legal & Compliance

SUBJECT: Delivery versus Payment (DVP)

Gentlemen:

regard to your government securities transactions achieve delivery versus payment settlement procedures of your bank with qualified institutional buyers (QIBs) with (DVP), and hence compliant with SEC Memorandum Circular No. 14, series of 2006, otherwise known as the Rules Governing the Over-the-Counter (OTC) Market. This refers to your request for opinion on the issue whether or not the

trade shall be delivery versus payment (DVP) scheme". "the clearing and settlement arrangement in the exchange of assets subject of the In particuiar, you cited Section 20 (B) of the OTC Rules which requires that

In reply, herein below is our response to your query:

different settlement systems in the domestic equities and fixed income markets. achieving DVP in securities transactions. We also discussed extensively the Opinion No.1 dated 28 July 2008, we described the different approaches of This is not the first time our office is addressing this issue. In SEC-MRD

steps. .First, the confirmation of the terms of trade by the market participants The process of clearing and settling securities trade includes several key

confirmation process which is known as clearance. Third, the final transfer of securities (delivery) in exchange for the finai transfer of funds (payment) in order to settle the obligations which is known as settlement. Second, the calculation of the obligations of the counterparties resulting from the

thatensures that delivery occurs if and only if payment occurs. It is a procedure by of DVP system is to ensure that counterparties are not exposed to principal risk, that is, the risk that the seller of a security could deliver hut not receive payment or which the buyer's payment for securities is due at the time of delivery. The purpose that the buyer of a security could make payment but not receive delivery. /crss. Delivery Versus Payment in Securities Setttement Systems (B1S, Septcmher 1992)) A.DVP system is a securities settlement system that provides a mechanism

and securities. When a central securities depository does not itself provide cash accounts for settlement, it first blocks the underlying securities in the account of the seller or his custodian. It then requests transfer of funds from the buyer to the seller in the settlement bank. The securities are delivered to the buyer or his custodian if and only if the central securities depository receives confirmation of settlement of the cash leg from the settlement bank. /cpss, Recommcndations For Secarities Sctlenten Syatcms(I31S November 200) Strictly speaking. DVP does not require simultaneous final transfers of funds

your bank relative to your GS transactions with QIBclients achieve DVP. Based on your letter and manual of procedures, your bank's settlement procedures can be described in general as follows: In your request, you seek confirmation that the settlement procedures by.

amount against the counterparty's deposit account with HSBC funded either by Settlement (RTGS); or (2) check payment via earmarking of the cash settlement amount against existing Effects Not Cleared (ENC) credit facility granted by HSBC HSBC's Treasury front-office and QIB representative are recorded in HSBC terminal. Payment settlement of the transaction on settlement date can be through any of the foilowing methods: (1) cash payment via debit of the cash settlement existing balances or by 'credit of remittance received through Real Time Gross Treasury Trading System (TREATS) and concurrently reported via the PDEX FI Fortransactions where the bank sells GS, sell trades concluded between the

to the counterparty.

transaction, the cash settlement amount is earmarked and exclusively held for settlement of the transaction, using the hold maintenance function of the HSBC Universal Banking (HUB) Front End system (HFE). It is only when the securities Securities (RoSS) from the bank's RoSS account to the QIB's RoSS account or that of its third party custodian, pursuant to the confirmation received by HSBC from the BTr RoSS that the transaction has been posted in the RoSS,is the earmarking lifted and the funds so earmarked are debited from the account of the counterparty and received by HSBCas payment for the securities. sold are ready for transfer in the Bureau of the Treasury's (BTr) Register of Scripless In both of the above instances, pending settlement of the securities leg of the

Iifted. earmarking against the counterparty's deposit account is lifted and the funds so payment is returned to the counterparty and the earmarking of the ENC line is earmarked become available for the counterparty's disposal/use, or (b) the check In the event that the securities settlement fails for any reason: i(a) the

counterparty's deposit account with HSBC; or (2) remittance of payment via RTCS HSBC's Treasury front-office and QIB representative are recorded in TREATS and (1) cash payment by the bank via credit of the cash settlement anount into the to the counterparty's bank other than HSBC concurrently reported via the PDEX FI terminal. Payment settlement by the Bank of the transaction on settlement date can be through any of the following methods: For transactions where the bank buys GS, buy trades concluded between the

case of payment via RTGS, payment is earmarked by temporarily crediting the HSBC, pending settlement of the securities leg of the transaction, the cash for settlement of the transaction, using the HFEhold maintenance function. In the counterparty's deposit account with HSBCpending settlement of the securities leg of the transaction. Clients who do not have existing deposit accounts with the bank will be documented with a client agreement settlement amount is earmarked in favor of the counterparty and exclusively held will be required to open an account for settlement purposes prior to trading. This In the case of payment via credit to the counterparty's deposit account with

the QIB's or its custodian's RoSS account to the HSBC's RoSS account based on the other than HSBC, as payment for the securities. confirmation'received by HSBC from BTr RoSS, is the earmarking lifted and the funds become freely available for the disposition of the counterparty. In the case of RTGS payment, the freely available funds are debited from the counterparty's deposit account with HSBC and then sent to the counterparty's designated bank, It is only when the securities sold are ready for transfer in the BTrRoSS, from

earmarking against the client's deposit account is lifted and the funds so earmarked are debited, or (b) the RTGSremittance instruction is cancelled, and the funds revert to the bank. In the unlikely event that the securities settlement fails for any reason: (a) the

on a per deal basis and will not involve netting or off- setting of transactions. Under the above transactions, whether buy or sell, settlement will be done

paid. Thus, in our view, the settlement arrangements described in your letter and earlier mentioned, DVP does not require simultaneous final transfers of funds and securities. It is essential though that the securities are delivered to the buyer or his custodian if and only if it is confirmed that the cash aspect of the transaction is manual of procedures achieve DVP. effected only when payment occurs or assured within the settlement cycle. As These procedures and safeguards ensure that each transfer of securities is

binding upon the Commission in other cases whether of similar or dissimilar particular issue raised therein and shall not be used in the nature of a standing rule Circumstances. (SHcMemorandum Cirttar No. I5(2003) on the facts you disclosed and described in the query and relevant solely to the It is understood though that the foregoing opinion is rendered based solely

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transactions with QIBs be made part of your records and that the same shall be disclosed to your counterparties and form part of the client agreement. Finally,you are directed that the detailed manual of procedures for Gs

For your guidance.

Very truly yours.

VICENTEGRACIANO P. FELIZMENIO JR. Officer in Charge

Paid: OR # 0211630, September 23, 2008 Filing Fee: P5.000.00