by Edward C. Kelleher
The Depository Trust Company (DTC) is helping boost efficiencies and reduce risk in the bond market by alerting its customers about partial calls of municipal and corporate bonds twice each day -- in the morning and afternoon -- in addition to the current end-of-day notification.
A partial call of a bond occurs when the issuer chooses to retire part of its debt and pay back both principal and accrued interest to some bondholders before the bond reaches maturity. When this occurs, the issuer must ensure that the called amount is distributed randomly and impartially across the entire bondholder base, which is done through a series of lotteries.
Thousands of lotteries
When a partial call occurs - and they do thousands of times a month - DTC conducts a lottery to see which of its customers will be affected by the call. Once customers are notified, they in turn conduct their own lotteries to see which bondholders will receive early payment for surrendering their securities.
Under the old process, DTC sent out one lottery result file at end of day, usually around 5 p.m. ET, alerting firms and telling them how their positions would be affected by the size of the call. Customers conducted their own lottery the next day.
"By notifying DTC customers twice during the day - at 8 a.m. and 3 p.m. - we’re providing them with a much wider window to conduct their lotteries and notify their bondholders," said Daniel Thieke, DTCC vice president, Asset Services. The new intraday files are optional. "This will help our customers boost efficiencies and better serve their clients," Thieke added.
"We are pleased to have been selected by the DTC to work with them during the pilot stage of this new notification process, which will now become widely available and benefit the entire industry," said Karl Baker, senior director, National Financial Services LLC. "Receiving notification of bond calls more frequently from the DTC - now three times a day - enables us to deliver even faster notification to customers who hold bonds that are being called."
With the new schedule, firms are no longer waiting to receive one file overnight, and they can conduct random lotteries and notify investors as soon as possible about the recall. This reduces both monetary and reputational risk for a firm.
"Under the previous system, the time lapse between the DTC lottery and notification to the end investor could create problems," said Thieke. "Bondholders may have chosen to sell a security without knowing that it was being called. They would find themselves short when they learned about the call, and would have to find a way to buy back the security, often at a higher price than they sold it at. When this happens, bondholders come back to the firm and ask, ‘Why didn’t you tell me about the call?’
"The new lottery files will help avoid situations like this and, in many instances, firms can notify their customers the same day they receive the lottery file. This will boost customer satisfaction as well as reduce the risk of anyone losing money because of later notification."
Municipals vs. corporates,/strong>
In 2010, DTC conducted more than 80,000 lotteries for partial calls involving more than $57 billion. The vast majority of the lotteries were for municipal bonds - more than 72,000 compared to just over 8,000 for corporate calls. @