Institutions: The activity of institutional customers is
growing rapidly. These customers will almost always em-
ploy banks as custodians. The current relatively rigid pro-
cedures required to make deliveries for these customers are
a major problem. This component of the market could be
served best, from an overall point of view, through devel-
opment of a means whereby security ownership records
can be transferred nationwide by a wire system, with
central control and record-keeping. The fact that a rela-
tively small number of banks are used by institutions for
the large majority of such securities storage makes this
approach both technically feasible and potentially desir-
able on an economic basis.

The customer market, therefore, appears to be stratified, with a number of transfer, delivery and custodian arrangements desirable to meet the needs of the end customers in a socially desirable fashion. The primary change required is the development of a centrally controlled wire system for transferring ownership records of some components of the institutional market (and some of the larger personal holdings).

B. THE WIRE SYSTEM DECISION

The subject of moving securities by wire has received repeated attention over many years. The legal and institutional barriers to a system are enormous and will take many years to overcome. It seems unlikely that the institutional market could be converted entirely in less than several decades. However, some components (such as bank managed portfolios, or mutual funds, which are subject to fewer and more uniform legal requirements than other institutions) would be far easier to convert than others.

In a separate technical appendix, we present a preliminary design for a securities movement system. We believe this preliminary design furnishes a reasonable basis for starting serious consideration of the problems that will be encountered. The intent of the design is to provide a stimulus for potential participants to begin the open discussions necessary to start action on a serious development program.

C. SECURITIES MOVEMENT SYSTEM FEATURES

Securities movement operations will be based on a wire network that connects participating banks with the Banking Module. As was mentioned earlier, a variety of legal changes will be needed before most institutions can employ such a system to receive and store securities. Once this has been accomplished, the most critical factor for success of the system will be that of gaining broad acceptance; the individual banks and institutions being served will employ the system only when they have complete faith in the security and integrity of the Banking Module and the wire network.

To develop this faith, it will be important to have a transition phase during which procedures can be tested in an environment where complete backup is available, both to ensure adequate safety in operations and to permit the new system to be run in parallel with existing procedures. This could be done initially by making deliveries by wire, but following rapidly with a paper, non-negotiable turn-around document. Once the system has been proven to the satisfaction of users, the unnecessary paper can be eliminated.

Aside from the operation of the wire network, there are two main elements to the securities movement system: system entry and withdrawal of certificates, and transfers between the Banking and Broker Module.

1. Entry and Withdrawal

Certificates will be entered and withdrawn by procedures which essentially parallel current methods. The Custodian will have full responsibility for these activities and will continuously adjust his records to reflect entries and withdrawals. Both the Custodian and the Banking or Broker records will be checked, prior to withdrawals, to ensure that adequate security positions exist. All transactions will be given a system audit number, which can be correlated with individual participant records through a user-oriented identification number.

2. Inter-Module Transfers

Inter-module transfers in our design are characterized by:

These mechanisms will offer participants a means for rapidly developing the reports and audit controls necessary to promptly identify and trace any errors arising in connection with system operations.

As will be described later the basic movement system will be batch oriented for reasons of security and integrity. However, console entries can be employed in real time for actions such as position inquiries. They can also be used for intra-modular activities (such as transferring securities from one broker to another in the Broker Module) or for initiating relatively slow operations (such as withdrawal of certificates). In the latter case, a degree of safety is provided by the fact that an activity report can be checked before the transaction is completed.

Other real time entries can be considered but, in general, we believe that relatively irreversible transactions should be entered in real time only at the user's risk; with the present state-of-the-art, we have inadequate knowledge to ensure protection of console entry activities from fraud or theft.

D. BANK OPERATIONS IN THE SYSTEM

The Banking Module will operate the wire network for moving security ownership records. Other securities handling aspects of the Banking Module will closely parallel the Broker Module, but should be subject to constraints and record-keeping as decided by the banking community. The full scale of operations for this module cannot be estimated at present. For example, if a sufficient volume of securities movements in Bank Module nominee name is generated, it may become appropriate to conduct a Bank Module clearing run, but this decision must await system experience.

As in the case of brokers, relatively large clerical savings should become possible for the banks. For example, banks that operate as transfer agents now must perform far more certificate operations than will be necessary with our proposed system. Data from one of the main clearing banks in New York indicate that, on the average, over three certificates currently must be received and re-issued per trade conducted on the NYSE floor. For the fraction of transactions which can be covered in the future by bookkeeping entries (whether involving formal transfers or not), these operations can be largely eliminated.

In similar fashion, many custodial costs can be reduced. The majority of certificates held by the Custodian probably can be stored in less space and lower cost space than is now required; bank custodial costs will be reduced both by this action and by the lower activity levels which should result from the system. Charges for the bookkeeping and movement operations conducted by the banks can provide a stream of income.

In the long run, the wire network may serve to encourage development of more economical means for providing a variety of services. Some possibilities include: increased data processing services for correspondents, interbank deposits, credit information transmission, splitting of loan requests and credit card system data transmission, etc. More important, there is the possibility of developing a considerable market among individual share owners, through providing custodial services that currently are economical only for large holders of securities. The relative ease of movement of securities through the wire system can encourage such activity, particularly if a user charge is imposed for receipt of paper certificates (simply reflecting the extra costs involved in that process).

The full development and evaluation of a list of potential Bank Module activities requires much further study, but it seems clear that a wide range of opportunities exists to achieve economy of scale and to expand the set of services banks can offer to their customers.

VI. NEXT STEPS - A PATTERN FOR GROWTH

A. GENERAL PROGRAM

The approach we are recommending for developing a securities handling system involves five broad areas of work:

Development of overall system organization.

Development of a Broker Module, which represents a
logical extension and expansion of services already
being offered by the Exchange to its members and
other participants.

Development of a wire network system, under
banking community control, for the efficient transfer
and delivery of securities to certain categories of
customers.

Development of a set of organizational relationships,
which, over the long term, will provide a set of
interface mechanisms for dealing efficiently with
systems developed for other securities markets.

Preparation of a plan for developing and imple-
menting the integrated system.

1. System Organization

While a functional system organization has been proposed, many important characteristics have not been studied yet. In particular, appropriate mechanisms for sharing ownership and control of the three basic modules among prospective participants must be developed, within the constraint that the Custodian Module have authority commensurate with its responsibility for overall system integrity.

2. The NYSE Broker Module

With the exception of the collateral loan function (which is almost ready for implementation in CCS) the development of the Broker Module