[Federal Register Volume 73, Number 110 (Friday, June 6, 2008)]
[Notices]
[Pages 32373-32376]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E8-12667]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-57901; File Nos. SR-DTC-2007-14 and SR-NSCC-2007-14]


Self-Regulatory Organizations; the Depository Trust Company and 
National Securities Clearing Corporation; Order Approving Proposed Rule 
Changes, as Amended, To Provide for the Settlement of Institutional 
Transactions in Conjunction With Each Other Through a Service Called ID 
Net

June 2, 2008.

I. Introduction

    October 15, 2007, The Depository Trust Company (``DTC'') and the 
National Securities Clearing Corporation (``NSCC'') each filed with the 
Securities and Exchange Commission (``Commission'') and on December 20, 
2007, and on February 25, 2008, each amended their proposed rule 
changes pursuant to Section 19(b)(1) of the Securities Exchange Act of 
1934 (``Act'').\1\ Notice of the proposal was published in the Federal 
Register on April 2, 2008.\2\ The Commission received no comment 
letters in response to the proposed rule changes. For the reasons 
discussed below, the

[[Page 32374]]

Commission is approving the proposed rule changes, as amended.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ Securities Exchange Act Release No. 57573 (March 27, 2008), 
73 FR 18019 (SR-DTC-2007-14 and SR-NSCC-2007-14).
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II. Description

1. Background

    Unlike exchange trades and most prime broker trades, most 
institutional delivery (``ID'') transactions do not currently flow 
through NSCC's Continuous Net Settlement system (``CNS'').\3\ Rather, 
these institutional transactions are processed and settled at DTC. The 
ID Net Service will allow subscribers to the service to net all 
eligible affirmed institutional transactions at DTC against their CNS 
transactions at NSCC.
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    \3\ NSCC's CNS is an automated accounting and securities 
settlement system that centralizes and nets the settlement of 
compared and recorded securities transactions and maintains an 
orderly flow of security and money balances. CNS provides clearance 
for equities, corporate bonds, unit investment trusts, and municipal 
bonds that are eligible for book-entry transfer at DTC.
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    The ID Net Service will accept affirmed institutional transactions 
that are eligible for the ID Net Service from clearing agencies 
registered pursuant to Section 17A of the Act, other entities (such as 
Omgeo Matching Services--US LLC) which have obtained an exemption from 
clearing agency registration from the Commission, and Qualified 
Vendors, as defined in the rules of the New York Stock Exchange, the 
National Association of Securities Dealers, or other self-regulatory 
organizations (entities with exemptions from clearing agency 
registration or Qualified Vendor are collectively referred to as 
``Affirming Agencies''), and net the broker-dealer side of such 
transaction with the broker-dealer's CNS obligations.
    Eligibility for the ID Net Service will require that a broker-
dealer be an NSCC Member eligible for CNS processing and a DTC 
Participant (``ID Net Firm'') and that a bank be a DTC Participant 
(``ID Net Bank'') (collectively ``ID Net Subscribers''). In addition, 
eligibility for ID Net Service processing will be based on the 
underlying security being processed, the type of transaction submitted 
for processing, and the timing of affirmation. Participation in the ID 
Net Service will be voluntary and will be governed by the rules and 
procedures applicable to the ID Net Service as described below. All ID 
Net Subscribers will be required to enter into separate ID Net 
Subscriber agreements with NSCC and/or DTC, as applicable, governing 
their use of the ID Net Service.

2. Current Processing

    A typical ID transaction is currently processed as follows. An 
Investment Manager, acting on behalf of its Institutional client, 
executes a transaction with Firm A. The Investment Manager, or a 
Custodian acting on its behalf, and Firm A submit the transaction data 
to an Affirming Agency (for example, Omgeo) for confirmation/
affirmation. Once affirmed, the Affirming Agency's automated systems 
transmit settlement instructions for the matched transaction to DTC's 
Inventory Management System (``IMS'') to be processed. These ID 
transactions are not netted, rather they are settled on a trade-for-
trade basis at DTC.

3. Proposed Service

    In order to extend netting benefits and efficiencies to 
institutional transactions, NSCC will extend its clearance and 
settlement functionalities to net the broker-dealer's side of 
institutional transactions with the broker-dealer's broker-to-broker 
activity that is eligible for processing through NSCC's CNS service.
    Most equity securities that are currently eligible for CNS 
processing will be eligible for ID Net Service processing. However, ID 
Net Services will initially exclude the following: (1) Corporate and 
municipal bonds and unit investment trust issues; (2) new issue 
securities in their first day of IPO trading; (3) securities that are 
IPO tracked since the use of omnibus accounts will bypass the tracking 
system; (4) trades in issues that are currently undergoing a mandatory 
or voluntary reorganization; (5) trades in securities with a CNS buy-
in; and (6) trades in securities appearing on the Commission's 
Regulation SHO list.\4\
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    \4\ NSCC has determined that certain security types may have a 
relatively high rate of delivery failure or may disrupt normal 
processing of transactions in the ID Net Service. Such securities 
will initially be excluded from the service; however, as experience 
with the service grows, the status of such securities may be 
reevaluated.
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    To facilitate the processing of ID Net Service transactions, two 
new securities accounts will be established by NSCC at DTC on behalf of 
all ID Net Firms that have elected to use the ID Net Service--the ``ID 
Netting Subscriber Deliver Account'' and the ``ID Netting Subscriber 
Receive Account'' (collectively referred to as the ``ID Netting 
Subscriber Accounts''). NSCC will be the owner of both accounts and 
will act as agent for the ID Net Firms. NSCC will process ID Net 
Service transactions through these accounts on behalf of participating 
ID Net Firms. While NSCC will direct transactions through these 
accounts on behalf of the ID Net Firms, the ID Net Firms, not NSCC, 
will be responsible for satisfying applicable DTC risk management 
controls and Participant Fund requirements for their activity in the ID 
Netting Subscriber Accounts.
    The ID Netting Subscriber Deliver Account will be maintained for 
all ID Net Firms receiving ID Net Eligible Securities from an ID Net 
Bank. The ID Netting Member Receive Account will be maintained for all 
ID Net Firms receiving ID Net Eligible Securities from CNS that are 
bound for delivery by that ID Net Firm to an ID Net Bank.\5\
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    \5\ ID Net Firms will not have the ability to direct 
transactions to either ID Netting Subscriber Account. All ID Net 
Firm positions in either the ID Netting Subscriber Deliver Account 
or the ID Netting Subscriber Receive Account will be recorded 
separately by NSCC and in no event will securities positions of one 
ID Net Firm be attributed to another ID Net Firm.
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    With the establishment of these two new ID Netting accounts, ID Net 
Service transactions will be processed as follows. Upon affirmation, 
the Affirming Agency will check that the transaction is eligible for ID 
Net Service processing. If the transaction qualifies, the Affirming 
Agency prior to submitting that affirmed transaction to IMS will flag 
the transaction by populating the delivery instructions third party 
field with the account number of the ID Netting Subscriber.
    IMS will facilitate the delivery of the securities, subject to 
DTC's risk management controls, to the ID Netting Subscriber Deliver 
Account. On the night of trade date plus two (``T+2''), the ID Net 
Firm's CNS position, if any, will be updated for the quantity and value 
of the ID Net Service transaction and an open obligation in the ID 
Netting Subscriber Deliver Account will be created.
    For transactions in which the ID Net Firm is delivering securities 
to an ID Net Bank, on the night of T+2, the ID Net Firm's CNS position, 
if any, will be updated for the quantity and value of the ID Net 
Service transaction and an open obligation in the ID Netting Subscriber 
Receive Account will be created. Once the securities are credited to 
the ID Netting Subscriber Receive Account, the securities will be 
delivered, subject to DTC's Risk Management controls, to the ID Net 
Bank's account.
    ID Net Service transactions not completed for any reason, including 
due to a party's failure to deliver or pass DTC's risk management 
controls, by 11:30 a.m. on settlement date will be ``dropped'' from ID 
Net Service and instead will be settled trade-for-trade between the 
original counterparties at DTC as if the transaction had not been 
included in the ID Net Service.

[[Page 32375]]

4. Eligibility Requirements

    Eligibility is based on the participants, the underlying security, 
the type of trade, and the timing of the affirmation as follows: (1) 
The broker-dealer must be both an NSCC Member and a DTC Participant; 
(2) The custodian bank must be a DTC Participant; (3) The broker-dealer 
and the custodian bank must both elect to participate in the ID Net 
Service; and (4) The security must be an equity security eligible for 
CNS. The following securities will not be eligible for the ID Net 
Service: (1) Corporate and municipal bonds; (2) unit investment trust 
issues; (3) new issue securities in their first day of trading; (4) 
securities that are IPO tracked since the use of omnibus accounts will 
bypass the tracking system; (5) securities that are undergoing a 
mandatory or voluntary reorganization; (6) securities with a pending 
CNS buy-in; and (7) Regulation SHO securities.\6\ The trade must be 
affirmed before 9 p.m. on trade date plus one (``T+1''), and the trade 
must be ``regular-way'' (i.e., scheduled for T+3 settlement).
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    \6\ Supra note 4.
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    After a transaction has been affirmed and deemed eligible for the 
ID Net Service, DTC will monitor the ID Net Service transaction's 
eligibility up until approximately 8 p.m. on the night of T+2. If the 
transaction becomes ineligible for any reason, the transaction will be 
exited from the ID Net Service processing and will be settled on a 
trade-for-trade basis between the ID Net Firm and the ID Net Bank 
outside of the ID Net Service at DTC.

5. Settlement

    Upon receipt of the affirmation of an eligible trade from the 
Affirming Agency, DTC's IMS System will automate the following: (1) For 
bank deliveries, IMS will move the ``original clearing broker'' from 
the ``receiver's field'' to the ``third party field'' of the ID 
delivery instruction and will replace it with a with the ID Netting 
Subscriber Delivery Account and (2) For bank receives, IMS will move 
the ``original clearing broker'' from the ``deliverer's field'' to the 
``third party field'' of the ID delivery instruction and will replace 
it with the ID Netting Subscriber Receive Account.
    Custodian banks will still be able to exempt or authorize ID 
deliveries in IMS before the night cycle as they do today; and trades 
that are eligible for ID Net Service but which are still in a pending 
state by 11:30 a.m. on settlement date will revert to trade-for-trade 
settlement versus the original clearing participant and will not settle 
as part of ID Net Service. Accordingly, if the bank subsequently 
authorizes the delivery, it will be sent to the original clearing 
broker instead of to the ID Netting Subscriber Deliver Account.
    ID Net Firms will still be able to exempt or cancel an ID delivery 
in IMS as they do today, but they will be limited to instructions 
transmitted through DTC's Participant Terminal Service and Participant 
Browser Service (PTS/PBS) and only on a trade-by-trade basis. 
Deliveries from the ID Netting Subscriber Receive Account will be 
attempted in random order until approximately 10 a.m. on settlement 
date. After that time, the system will attempt to complete any of the 
deliveries up until 11:30 a.m. in settlement value order with highest 
value first. ID Net Service transactions not completed for any reason 
by 11:30 a.m. due to a party's failure to deliver or pass DTC risk 
controls on settlement date will be exited from the ID Net Service and 
instead will settle trade-for-trade versus the original clearing 
broker. Deliveries that do not complete will be available for immediate 
reintroduction from the original clearing broker's account through a 
new IMS function at 11:30 a.m. Brokers can then create a profile to 
have these deliveries await authorization or to be processed 
immediately.
    If an ID Net Bank reclaims a transaction from the ID Netting 
Subscriber Receive Account, the reclaim will be processed against the 
applicable ID Net Firm and not against the ID Netting Subscriber 
Receive Account.

6. DTC Risk Management Control Updates

    In order to protect DTC from having a failure exported from NSCC, 
updates to DTC's participants' net debit caps and collateral monitors 
will be necessary. A new ID Net Service collateral monitor and net 
debit cap balance will be recorded for each ID Net Firm. The ID Net 
Service collateral monitor will record the net balance of collateral 
generated for all transactions processed through the ID Net Service. If 
the balance of collateral generated by all ID Net Service receives and 
delivers is positive, the ID Net Firm's collateral monitor will not be 
increased by that amount. However, if an ID Net Service transaction 
requires collateral, the system will use the ID Net Service collateral 
surplus for that ID Net Firm before attempting to use other collateral 
from that ID Net Firm. If there is insufficient ID Net Service 
collateral for that broker, the system will look to the ID Net Firm's 
excess collateral in its account.
    Similar to collateral, the system will create a new ID Net Service 
settlement balance for each ID Net Firm. When this balance is a net 
credit from deliveries on the ID Net Firm's behalf through the ID 
Netting Subscriber Receive Account, it will only be used to offset 
incoming ID Net Services receives to the ID Netting Subscriber Deliver 
Account. If there is an insufficient ID Net Service credit to absorb 
the debit of the ID Net Service delivery to the ID Netting Subscriber 
Deliver Account for the ID Net Firm, the system will create an ID Net 
Service debit that will effectively treat the ID Net Service debit as a 
reduction of the ID Net Firm's net debit cap. The ID Net Service debit 
will only be used for net debit cap calculation purposes and will not 
represent a participant's actual settlement balance.\7\ If the broker 
has insufficient collateral or net debit cap, the transaction will pend 
until 11:30 a.m. on settlement date.\8\
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    \7\ Currently, brokers receive market value credit for 
deliveries to CNS if the security is received versus payment (RVP) 
or collateral value (collateral value is market value less the DTC 
haircut) if the delivery to CNS was from securities in their start 
of day position or received for free. With respect to the ID Net 
Service, the system will no longer identify if a delivery came from 
a broker's RVP securities or not, and as such, the system will 
assume the delivery came from a broker's start of day position.
    Likewise, to the extent that ID Net Firms have a net credit for 
their ID deliveries today, an ID Net Firm's settlement balance is 
reduced. Since these credits will no longer be generated from the ID 
Net Firm's account, it may require the need to fund DTC intraday to 
prevent net debit cap blockage.
    \8\ As an example of how DTC risk controls will be applied to ID 
Net Subscribers, assume that Investment Manager A sells 10 shares of 
Common Stock X using ID Net Firm B (a broker). If B sells the shares 
on an exchange for $20, and the trade is affirmed and the shares are 
delivered by A's Custodian Bank C, then C will receive a credit in 
DTC for $20 and the ID Netting Subscriber Deliver Account (owned by 
NSCC as agent for B) will have a DTC debit of $20. In this case, B's 
net debit cap will be reduced by $20 and its collateral monitor is 
reduced by the net of the $20 debit and the collateral value of the 
securities (e.g., with a 10 percent haircut the collateral value 
will be $18), or $2. When the ID Netting Subscriber Deliver Account 
delivers the shares to CNS, it receives a credit for $20. This 
credit is offset with the DTC debit of $20 at end-of-day. 
Additionally, assume A then buys 10 shares of Commons Stock Y 
through B at $30. On the night of T+2, CNS will deliver the shares 
to the ID Netting Subscriber Receive Account and that account will 
be debited in CNS for $30. C will then receive 10 shares of Y from 
the ID Netting Subscriber Receive Account. C receives a debit in DTC 
for $30 and the ID Netting Subscriber Receive Account is credited at 
DTC for $30. B's account has its DTC net debit cap increased by $20 
to offset the previous decrease of $20 (for the sale of Common Stock 
X) (and not $30 since the net of the ID Net receive relating to the 
sale of Common Stock X above of $20 and the delivery of Common Stock 
Y for $30 is a $10 credit and B's net debit cap is decremented only 
when the net balance is a debit. C will not receive a net credit, 
but will receive an offset of previous ID Net debits with ID Net 
credits) and the same for its collateral monitor which is increased 
only up to the amount it was debited for ID Net transactions (absent 
its participation in the ID Net service, B will have received a $3 
credit to the collateral monitor which equals the net of the $30 
credit and the collateral value of the securities $27 ($30 market 
value less a 10% haircut)). In this case, B will only receive a 
collateral credit of $2, but the ID Net credit balance of $1 will be 
registered to absorb future ID Net receives that have a collateral 
deficiency. If C was at its net debit cap or collateral monitor 
limit due to other receives, the ID Net transaction will recycle or 
pend in the system until the deficiency can be satisfied or until 
11:30 a.m., when it will drop out of ID Net.

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[[Page 32376]]

7. NSCC Clearing Fund Offset and Mark-to-Market

    ID Net Service transactions will be used to offset the balance of 
any other CNS transactions and the ``net'' of those transactions will 
be used for purposes of determining NSCC Clearing Fund obligations 
pursuant to NSCC's current procedures with a revised mark-to-market 
calculation applicable to ID Net Firms. The revised mark-to-market 
calculation for ID Net Firms will be based on (x) the current CNS mark-
to-market component (which will exclude ID Net transactions) and (y) a 
mark-to-market component calculated with respect to ID Net Service-
related positions. However, any positive value derived from either (x) 
or (y) will be set to zero.\9\
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    \9\ Similar to the existing CNS mark-to-market component, the 
new ID Net Service mark-to-market component applicable to ID Net 
Service transactions will equal the net of each day's difference 
between the contract price of the Member's net positions relating to 
ID Net Service activity and the current market price for such 
positions.
    For example, if an ID Net Firm has a ``regular'' mark-to-market 
debit of $500,000 and an ID Net Service mark-to-market debit of 
$100,000, then these debits will be added together and the ID Net 
Firm's total mark-to-market obligation will equal a debit of 
$600,000. However, if that same ID Net Firm's ID Net mark-to-market 
calculation results in a credit of $100,000, then the value of that 
credit will be set to zero, and therefore the total mark-to-market 
will equal a debit $500,000 (i.e., the amount of the broker's 
regular mark-to-market debit).
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8. Prioritization

    In order to reduce the potential number and value of fails in the 
ID Net Service, deliveries from CNS to the ID Netting Subscriber 
Receive Account will be given a higher delivery priority pursuant to 
the allocation algorithm set forth in NSCC's Procedure VII (CNS 
Accounting Operation) than other CNS deliveries with the exception of 
buy-in deliveries, corporate action deliveries, and deliveries of 
component securities of index receipts.\10\ NSCC is also modifying this 
Procedure to clarify that deliveries of the component securities for 
index receipts shall have the same priority as deliveries to the ID 
Netting Subscriber Receive Account.
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    \10\ Currently, institutional deliveries processed through the 
DTC system from ID Net Firms to banks may be prioritized by ID Net 
Firms through IMS and/or through exempting their deliveries to CNS 
in order to ensure that available inventory will be used for such 
deliveries. Including these transactions in the proposed service 
allows for the ``automation'' of such prioritization through the CNS 
Accounting Operation.
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    Any ID Net transactions that cannot be completed will be exited 
from the ID Net Service and instead will settle trade-for-trade between 
the ID Net Firm and the ID Net Bank (the original counterparties) at 
DTC.

9. DTC Fees

    ID Net Banks and ID Net Firms will be charged a reduced DTC ID Net 
Service fee of $0.025 for each completed delivery and receive processed 
versus the ID delivery or receive fee of $0.05. For deliveries that are 
exited from the ID Net Service, there will not be a ``drop'' fee 
charged. For ID Net Service deliveries cancelled by ID Net Firms from 
the ID Netting Subscriber Receive Account, the $0.45 ``pend cancel'' 
fee will be charged. For ID Net Service deliveries to and from CNS on 
behalf of the ID Net Firms, no fee will be charged.

10. NSCC Rulebook Changes

    Under the proposed rule change, a new Rule 65 and Procedure XVI 
(both titled ``ID Net Service'') will be added to NSCC's Rules, and 
additional conforming changes will be made elsewhere throughout NSCC's 
Rules to provide consistency with the new Rule 65. These additional 
changes include the following:
(a) Rule 3 (Lists To Be Maintained)
    A subsection will be added to Rule 3 to provide that NSCC will 
maintain a list of Eligible ID Net Securities and may from time to time 
add or delete applicable CNS Securities from the list.
(b) Procedure VII (CNS Accounting Operation)
    Procedure VII will be revised to incorporate the processing of 
transactions in Eligible ID Net Securities into the CNS Accounting 
Operation. The revisions will also reflect: (i) That Member's will not 
be able to exempt deliveries from an ID Netting Subscriber Account, 
(ii) the prioritization of ID Net Service deliveries and deliveries of 
the component securities of index receipts in the CNS allocation 
algorithm behind deliveries associated with reorganizations and buy-
ins, and (iii) that ID Net Service transactions will be recorded on the 
Miscellaneous Activity Report on the night of T+2 and removals of such 
transactions from the ID Net Service will also be recorded on that 
report.
(c) Procedure XV (Clearing Fund Formula and Other Matters)
    Procedure XV will be revised to indicate the exclusion of ID Net 
Service transactions from the ID offset process for the purposes of 
calculating the volatility component of a subscriber's Clearing Fund 
requirement. In addition language will be revised and added with 
respect to the calculation of mark-to-market to reflect the changes to 
the formula as described above.

III. Discussion

    Section 19(b) of the Act directs the Commission to approve a 
proposed rule change of a self-regulatory organization if it finds that 
such proposed rule change is consistent with the requirements of the 
Act and the rules and regulations thereunder applicable to such 
organization. Section 17A(b)(3)(F) of the Act requires that the rules 
of a clearing agency be designed to promote the prompt and accurate 
clearance and settlement of securities transactions.\11\ DTC and NSCC's 
proposed rule changes should promote the prompt and accurate clearance 
and settlement of securities transactions by leveraging the 
capabilities of the DTC and NSCC systems to provide for more 
streamlined securities deliveries and extend netting benefits and 
efficiencies to ID transactions.
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    \11\ 15 U.S.C. 78q-1(b)(3)(F).
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IV. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposed rule changes are consistent with the requirements of the Act 
and in particular Section 17A of the Act and the rules and regulations 
thereunder. In approving the proposed rule changes, the Commission 
considered the proposals' impact on efficiency, competition, and 
capital formation.\12\
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    \12\ 15 U.S.C. 78c(f).
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    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that the proposed rule changes (File Nos. SR-DTC-2007-14 and SR-NSCC-
2007-14), as amended, be and hereby are approved.

    For the Commission by the Division of Trading and Markets, 
pursuant to delegated authority.\13\
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    \13\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Acting Secretary.
 [FR Doc. E8-12667 Filed 6-5-08; 8:45 am]
BILLING CODE 8010-01-P