CUNA Comment Letter

Interagency White Paper on Structural Change in the Settlement of Government Securities: Issues and Options

August 12, 2002

Ms. Jennifer J. Johnson, Secretary
Board of Governors of the Federal Reserve System
20th Street and Constitution Avenue, NW
Washington, D.C. 20551

RE: Interagency White Paper on Structural Change in the Settlement of Government Securities: Issues and Options

Dear Mr. Katz:

The Credit Union National Association (CUNA) appreciates the opportunity to comment on a white paper titled "Structural Change in the Settlement of Government Securities: Issues and Options" (White Paper). The Board of Governors of the Federal Reserve (Federal Reserve) and the Securities and Exchange Commission (collectively, "the agencies") have presented this paper to the public to generate discussion. CUNA, a national trade association, represents more than 90 percent of the nation's 10,300 state and federal credit unions.

The white paper identifies alternative utility types and different assessment criteria for evaluating these utilities. The alternative utility models mentioned are: an industry-owned depository and settlement entity that contracts with a commercial bank for the provision of most services; a private, limited-purpose bank that furnishes the operational support itself; and a public utility for which the Federal Reserve provides depository and settlement services.

The agencies asked if there were additional alternative utility types or additional vulnerabilities in the current system that should have been explored. CUNA believes that the agencies have explored all feasible utility models. CUNA does believe, however, that the agencies may want to explore explicitly the geographic vulnerability posed by having both banks that provide settlement services for government securities located in New York.

CUNA believes that the evaluation criteria listed in the white paper are all relevant; however, more consideration could be given to the high cost of entering into, and competing in, this business. A new entrant would need substantial financial resources to acquire the personnel, systems, physical infrastructure, and financing necessary to operate the utility. As a result, the initial investment for an industry utility would likely be a minimum of several million dollars. In addition, obtaining committed lines of credit would add substantially to the cost of entry. A utility would probably need $100 to $200 billion in intraday credit to be a serious competitor as a clearing facility. The utility would likely obtain the committed lines of credit from the banks investing in and using the utility; however, additional guarantees from the Federal Reserve might be necessary if the entire amount of required credit is not available from the banking industry. Any new entrant would face a major challenge finding this initial capital and competing with the two clearing banks that are well entrenched in the industry. In order to compete against its well-established competitors, a new entrant may have to offer lower prices initially. All of these costs and the pressure of competition may be prohibitive to all, except for the Federal Reserve.

The agencies asked for comments regarding how a utility could be motivated to improve its services. CUNA does not believe that concerns about efficiency, innovation, and competition can be addressed entirely through governance. Competition usually promotes efficiency and innovation. In a highly competitive industry, increasing market share, maintaining pricing power, and continuing product innovation are generally critical objectives for companies. Without competition, the reasons for attaining these objectives are less compelling.

The agencies asked about the feasibility of separating "core clearing", which includes the settling of trades and providing of intraday credit from "tri-party repo service", which includes overnight and term financing through tri-party repurchase agreements. CUNA believes that it is not feasible to separate the provision of core clearing from the provision of tri-party repo service. We believe clearing banks gain operational efficiencies from providing both core clearing and tri-party services. A utility that offers only one of these services would not have the benefit of these efficiencies. As a result, the utility would either price its services higher than a "full service" bank or price its services to compete with the "full service" bank, which would make it difficult for the utility to be profitable.

The agencies also asked specific questions regarding the structure of a privately owned facility. CUNA believes the users of such a facility should own it; however, there should be government oversight to ensure compliance with industry rules and regulations. The utility's board of directors should be chosen from a mix that includes its owners and disinterested parties, which would be similar to most corporate boards. The utility also should be a registered clearing agency based on the services it provides.

The agencies request recommendations for pursuing the goals of the White Paper. CUNA believes that the agencies should use the input from the comments to re-evaluate the proposed alternative structures and review the feasibility of any new structures suggested by respondents. This information should be disseminated to the public for review and additional comment, if necessary. The agencies should also establish a task force to participate in a decision-making process. The task force should include representatives from organizations that provide and receive securities settlement and tri-party repo services.

If you have any further questions, please contact CUNA's Senior Vice President and Associate General Counsel Mary Dunn or me at (202) 638-5777.

Sincerely, Michelle Q. Profit Assistant General Counsel