The Paperwork Crisis

In U.S. markets, the push for dematerialization?for getting rid of paper certificates?had its origins in what came to be called "the paperwork crisis" of the late 1960s. The crisis developed in the securities industry because clerks were swamped with so many paper stock certificates that they simply couldn't process them fast enough. At that time, brokers still exchanged paper certificates and checks for each trade, sending hundreds of messengers scurrying through Wall Street and in other trading centers clutching bags of checks and securities.

What prompted the growing mountains of paper was a surge in trading on the New York Stock Exchange, where trading sometimes reached 12 million shares daily. At these volumes, brokers became buried in paperwork, and concern about risk was growing in Congress, the Securities and Exchange Commission and other quarters.

Drowning in Certificates

The crisis became so severe that, in order to help reduce the backlog, the exchanges closed entirely every Wednesday, shortened trading hours on the other days, and extended settlement to T5?trade day plus five days?from the T+4 practice in place at the time. Eventually, by making use of the new computers and data processing tools that were beginning to come into the market, the industry developed several distinct approaches to solve the paperwork problem.

One Solution: Immobilize

The first solution was to immobilize physical stock certificates by maintaining them in a central location or depository, and to record changes of ownership by using "book-entry" accounting methods. As a result, no certificates actually had to change hands. Initially, this was done by the New York Stock Exchange and its Central Certificate Service. But the industry wanted to create a separate entity to do this, and that led to the creation of DTCC's depository subsidiary, the Depository Trust Company, in 1973.

Today, DTCC's depository maintains custody of some 2.5 million different securities valued at more than $28 trillion, including international securities from more than 100 other countries. Each day, many of these securities are traded over and over again, but the trades are recorded by the depository's book-entry accounting system so that no paper certificates have to change hands.

A Second Solution

Meanwhile, led by the U.S. Treasury Department, other parts of the securities industry began exploring another approach for avoiding the costs and risks involved in creating and storing paper certificates. What the Treasury Department began to do in the 1980s, instead of having its securities immobilized, was to dematerialize its new issues of bonds and notes. This means the securities were issued electronically without any paper involved. Trades are recorded by book entry, just as they are for nearly all securities, but there aren't any paper securities to immobilize because the securities are all paperless.

Today, most of the securities issued in U.S. markets, including municipal and corporate bonds, U.S. government notes and bonds, mortgage-backed securities, commercial paper and other securities are offered to individual or institutional investors in paperless form. They are dematerialized. (Many markets throughout the world, in fact, no longer use paper securities at all.)

Dematerialization

Starting in the mid 1990s, the securities industry began to take this same approach?dematerialization?to equities, which are the common stock of publicly traded companies. The industry created the Direct Registration System or DRS, which enables companies to issue their stock and register ownership electronically on their own books or on those of their transfer agent. Today, some 1,000 companies participate in DRS, which is administered by DTCC.

Many other companies, however, have not yet taken advantage of DRS, in part because many of them are incorporated in states which only recently repealed laws requiring the issuance of paper stock certificates. With the change in state laws, the expectation is that use of DRS will rise sharply. Ultimately, then, it appears that almost all securities in U.S. markets will be dematerialized. They will be issued and traded electronically, and the longstanding problem of lost or stolen stock certificates will finally be laid to rest.