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An Introduction to DTCC

B SELL BUY UY BUY SELL SELL


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Matching and Netting Custody Trade Settlement

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Stocks Bonds
Fund/

OTC Derivatives

MBS

S E RV

Reducing Risk
V I R G I N I A B. M O R R I S
AND

Mutual Funds
STUART Z. GOLDSTEIN

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2009 by Lightbulb Press, Inc. All Rights Reserved.

elcome to a behind-the-scenes look at the extensive post-trade processing that underpins the global financial marketplace. As the primary infrastructure organization serving the capital markets in the US, The Depository Trust & Clearing Corporation (DTCC) brings a unique perspective on safety, soundness, risk mitigation and transparency to the financial services industry. Oh, youve never heard of DTCC? Well, maybe thats because weve done our job so well, quietly behind the scenes. Since the 1970s, the efficiencies and low costs associated with DTCCs centralized infrastructure are credited with attracting the flow of investment capital to the USthat helps fuel our economy. At its core, DTCC is a huge high-volume data processing business involving the safe and efficient transfer of securities ownership and settlement of trillions of dollars in trade obligations every day for financial firms who do business around the world. Beyond that, as youll read in this guide, DTCC links all mutual funds to all banks, broker/dealers and financial planners, which gives investors unlimited choice. Youll also learn about DTCCs long and proud history in helping to bring order, certainty and stability to the financial community in times of crisis. You might even say we were born of crisis. Our two oldest subsidiaries were created in the 1970s, when the manual and paper-intensive process forced our stock exchanges to close down one day a week to catch up with growing trading volumes. In each decade since, we have played a central role behind the scenes in helping protect and mitigate risk for our members and to safeguard the integrity of the US financial system. Most recently, during the financial crisis in 2008, we protected market participantsand taxpayersfrom more than $500 billion in potential losses following the collapse of Lehman Brothers. We are also now working with financial firms and regulators to bring a new level of transparency to the over-the-counter derivatives market. We hope this guide will shed more light on the growing importance of DTCC and the role we play, as we work in tandem with our members, the industry and global regulators to help accomplish our shared vision of greater transparency, risk mitigation, increased efficiencies and resiliency in the changing world of financial services.

Donald F. Donahue Chairman and CEO The Depository Trust & Clearing Corporation

2009 by Lightbulb Press, Inc. All Rights Reserved.

c o n t e n t s
2 Introducing DTCC 4 Streamlining Clearance 20 Up and Running 22 Streamlining the Markets 24 Trading Mutual Funds 26 Insurance and

and Settlement
6 Building a System 8 Matching and Netting 10 Getting Settled 12 Tracking a Trade 14 Settling Debts 16 Clearing MBS 18 Managing Risk

Retirement Services
28 An Infrastructure for

OTC Derivatives
30 A Global Financial Market 32 Glossary

2009 by Lightbulb Press, Inc. All Rights Reserved.

GUIDe to cLeARAnce & settLeMent

Introducing DTCC
The Depository Trust & Clearing Corporation plays a central role in the capital markets.
Every business day in the United States, investors execute hundreds of millions of securities transactions exchanging money for shares of stock, bonds, mutual funds, and other financial instruments. These transactions generate pools of capital that fund many kinds of business and government activities, including expansion of existing companies and creation of new ones. One organization plays a leading role in keeping this transaction pipeline flowing smoothly and efficiently. It does so by processing all the transfers of money and securities between buyers and sellers. Because this company, The Depository Trust & Clearing Corporation (DTCC), through its subsidiaries, processes enormous volumes of transactionsmore than 30 billion a yearits costs per transaction are very low. And, because DTCC guarantees the completion of every stock and bond transaction processed through its systems, it reduces risks for investors and for the entire financial system. In short, DTCCs array of posttrade processing services helps make the United States an attractive market for investors at home and abroad.
MARKet scoPe

Every three days DTCC processes the equivalent of the US annual gross domestic product.

seRVInG tHe InDUstRY

Trading volumes of stocks and fixedincome instruments, including US government securities, mortgagebacked securities, and corporate and municipal bonds, in US markets dwarf those in other markets around the world. For example, in a single day more than 19.3 billion shares of stock can be traded across equity markets in the United States, in contrast to 1.5 billion shares traded across European markets. In 2008, DTCC settled transactions in stocks, exchange traded funds, mutual funds, corporate and municipal bonds, and US Treasury issues valued at $1.88 quadrillion. To put that number in perspective, every three days DTCC processes the
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DTCC is a utility for the financial services industry. DTCC uses a sophisticated infrastructure of physical equipment, software programs, and risk management systems to deliver essential services, including trade matching, clearing, netting, and settling securities transactions. DTCC is owned by its users broker/dealers, banks, investment managers, and other third parties who market financial products and services.

equivalent of the US annual gross domestic product. DTCC also provides various services, including custody, to owners of 3.5 million securities issues registered in the United States and 100 other countries and territories.

2009 by Lightbulb Press, Inc. All Rights Reserved.

GUIDe to cLeARAnce & settLeMent


DeFInInG tHe teRMs

Central counterparty (CCP) is an entity that interposes itself as the buyer to every seller and the seller to every buyer to guarantee a trade will complete even if an original party to the tradeeither the buyer or the sellergoes bankrupt or otherwise defaults. Clearing and settlement is a process that finalizes a trade by transferring ownership of the traded asset and the cash to pay for it. Custody is having possession of certificates that represent ownership, whether they are in physical or electronic form. Netting is a process of reducing the number of trade obligations that require financial settlement by offsetting purchases against sales.

rebates and discounts returns excess to customers. One DTCC subsidiary, the National Securities Clearing Corporation (NSCC), reports that clearing each side of an equity tradeonce for the seller and once for the buyerin the United States costs an average of three-tenths of a cent ($0.003), regardless of the number of shares being traded. Thats 100 times cheaper than the cost of clearing a comparable trade in Europe. In additionand perhaps even more importantby netting down or reducing the total number of customer trading obligations that require the exchange of money for settlement, NSCC and another DTCC subsidiary, the Fixed Income Clearing Corporation (FICC), help to minimize risk and free up trillions of dollars of capital each year that their customers can use for other investment purposes.
Its A GLoBAL MARKet

DTCC users are known as participants, customers, or members. Each full participant is also an owner because it is required to purchase shares in the organization. Participants who use a limited number of DTCC services are considered members but not owners. DTCC is market-neutral, which means it accepts transactions from multiple trading platforms on a nondiscriminatory basis. It currently supports more than 50, including the New York Stock Exchange (NYSE) and Nasdaq. DTCC operates on an at-cost basis.

cUttInG costs

As a utility for the financial services industry, DTCC is able to leverage economies of scale and a critical mass of trading volume over time to reduce the transaction fees it charges. And, if transaction fees exceed costs in a given month or year, a system of

Capital flows to the markets where price is most competitive, risk is best managed, and efficiency is greatest. International investment in US securities reflects, in part, the perception that the US economy is stable and that the dollar, despite its up and downs, is sound. But theres ample evidence that overseas investors are drawn to US markets because the US financial system is more efficient, more liquid, and operates at lower cost than other markets worldwide. Non-US financial companies were recently approved to become full members of three DTCC subsidiaries, enabling them to directly clear and settle trades executed in both US and non-US markets. What they seek in becoming members is the same high-quality risk management, balance-sheet netting, and cost savings that are available to US members. Since 2008, DTCC has been providing those services and economies directly to European markets through its London-based EuroCCP subsidiary. In addition, another DTCC subsidiary, The Depository Trust Company (DTC), maintains cross-border depository relationships with a number of countries and is in the process of establishing others.
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GUIDe to cLeARAnce & settLeMent

Streamlining Clearance and Settlement


Post-trade processing wasnt always the streamlined process it is today.
Before the era of high-speed digital networks and electronic recordkeeping, virtually all securities transfers were conducted using paper certificates and paper checks. The end of the trading day involved a mass migration of papers, as hundreds of Wall Street messengers raced on foot throughout the financial district hand-delivering the certificates to the brokers who had bought stocks and bonds and returning with the checks to pay for them. Meanwhile, back-office clerks at brokerage companies processed the extensive paperwork required to settle each transaction and transfer ownership on the firms books. In fact, a single securities transfer could involve as many as 33 different forms. The result was an increasing backlog of undelivered certificates and accounting discrepancies, totaling hundreds of millions of dollars at some firms. In the early 1960s, so much paper was changing hands that the Securities and Exchange Commission (SEC) increased the time permitted between the execution of a trade and the settlement date to five days from four. It had been two before 1946. And, to give firms a chance to catch up with paperwork, the New York Stock Exchange (NYSE) began shutting its doors every Wednesday and closing early on other days of the week. Even more problematic, this manually intensive process was not only rife with errors but strained the US capital markets
tHe Go-Go YeARs tHe PAPeR cRUncH

to their breaking point and threatened their ability to raise capital. Though less infamous than the crash of 1929, the dot.com bubble, or the credit crisis that began in 2008, the paperwork crisis of the 60s and 70s presented one of the biggest challenges the US securities markets ever faced. In response, Congress charged the SEC with investigating and addressing the underlying causes. The laws that emerged profoundly shaped the clearance and settlement process thats in use today.
A neW eRA oF settLeMent

The Securities Act Amendment of 1975 eliminated fixed brokerage commissions and ushered in the National Market System (NMS) to foster greater transparency, efficiency, and competition in US capital markets, including the process of clearance and settlement. To rally support in the financial community for streamlining and automating securities transfers, a group consisting of New Yorks clearing house banks, the NYSE, the American Stock Exchange (Amex), and the National Association

Throughout the first half of 1968, new trading volume records were set almost daily, peaking at about 21.4 million shares on June 13. But, putting those numbers in perspective, theyre tiny compared to the 4.8 billion shares on average that cleared each day in 2008.
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cLeARInG UP A PAPeR
1946 The SEC settlement

time increased from two days to four.


1950

1940

1968 Share volume peaked at 21.4

millionSEC increased settlement time to five days and NYSE closed on Wednesdays.

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GUIDe to cLeARAnce & settLeMent


Part of the inefficiency in clearance and settlement was the challenge of identifying securities easily and accurately, either by looking at them or using their ticker symbols. To resolve the problem, the Committee on Uniform Security Identification Procedures (CUSIP) of the American Bankers Association (ABA) created a universal coding system. Since 1967, all stocks and government, corporate, and municipal bonds registered in the United States and Canada have been assigned a unique nine-character CUSIP number identifying the company or issuer and the type of security. The CUSIP service is owned by the ABA and administered by Standard & Poors Financial Services, LLC.
tainty that the trading parties would settle the trade in a timely fashion. In 1976, the NYSE, Amex, and the NASD agreed to merge their clearing organizations to create greater efficiency and to guarantee trades would be completed even if an individual brokerage firm went out of business. This newly combined organization was called the National Securities Clearing Corporation (NSCC). Its mission was to ensure the marketplaces had the processing capacity, trade guarantees, and risk management to avoid any disruption of the trading markets. Equally important, NSCC was to ensure safety and soundness of the system by broadly applying a process called multilateral netting. Using this technique, buy and sell positions within and among brokerage firms could be offset, requiring far fewer deliveries and settlement payments and reducing risk and financial exposure for the industry as a whole. DTC, NSCC, and the Fixed Income Clearing Corporation (FICC) are registered clearing agencies and selfregulatory organizations (SROs) that oversee their participants and abide by rules that must be approved by the SEC. DTC, a limited purpose trust company, is also a member of the Federal Reserve system and regulated by the New York State Banking Department.
A ReGULAtoRY note IDentItY PRoBLeMs

Banking and Securities Industry Committee (BASIC). The collaboration ultimately resulted in the creation of The Depository Trust Company (DTC) in

of Securities Dealers (NASD)at that time the self-regulatory organization of the over-the-counter marketformed the

CUSIP
certificates, and the switch was made to an electronic book-entry system.
1970 1973 The Depository Trust Company (DTC) was created to immobilize stock 1976 Creation of the National Securities Clearing Corporation (NSCC). 1980

1973. Jointly owned by key industry players, DTCs mission was to help eliminate the reliance on paper stock certificates, which was a major obstacle to efficient trade settlement. At DTC, stock certificates were immobilized, or held at a central location, with changes of ownership recorded electronically using a computerized book-entry system.
consoLIDAtInG FoRces

While eliminating the industrys reliance on the physical delivery of thousands of paper stock certificates was critical to solving the paperwork crisis, the US capital markets also needed a more efficient process for clearing and settling transactions executed on the stock exchanges and over-the-counter market. On the floor of an exchange, brokers on each side of a trade wrote paper tickets and runners literally ran the tickets to the back room where data entry clerks entered information into computers. This process was highly inefficient and fraught with errors. Most important, there was no cer-

cRIsIs
to clear OTC transactions.
1960 1968 The National Clearing Corporation (NCC) was created

1969 More than 100 firms defaulted

when the market dropped.

1975 The Securities Act Amendment created the National Market System (NMS) and the Banking and Securities Industry Committee (BASIC) was formed.
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GUIDe to cLeARAnce & settLeMent

Building a System
The structure of clearance and settlement rests on the foundation that was established in 1973.
Today, NSCC and DTCnow wholly owned subsidiaries of DTCCclear and settle virtually all broker-to-broker securities transactions in the United States. Their work begins on the day a trade is executed, called T for trade date, and ends three days later on T+3, when the buyer officially becomes the owner and the seller has received payment. But since trading is ongoing, its important to recognize that whats T for one transaction
tAKInG ResPonsIBILItY

is T+1 for a transaction completed a day earlier and T+2 for one completed the day before that. To understand how the system works, it helps to start with three key features considered essential to efficient trade completion:

Role of the central counterparty Immobilization of paper certificates Dematerialization, or the creation of
noncertificate shares which may be the counterparty to millions of trades that occur in various marketplaces each day. If the financial firm fails to pay for the securities its clients bought, or to deliver those its clients sold, the entire system could falter. These counterparty risks are greatly reduced by the trade guarantee that NSCC offers. NSCC acts as the central counterparty (CCP) to all trades it has received and reported back to the brokerage firm. In that role, at midnight between T+1 and T+2, NSCC becomes the buyer for every seller and the seller for every buyer for these trades. NSCC essentially guarantees that if a firm goes out of business, it will deliver the securities or make the payment the firm owes. For example, if a trade is executed on Monday and will settle Thursday, NSCC becomes the counterparty to the trade at midnight between Tuesday and Wednesday. NSCC has recently proposed that its guarantee move to the trade date, as soon as the details of the trade are validated. The earlier trades are guaranteed by NSCC, the less counterparty risk exists.

One of the major questions in any financial transaction is whether the person or organization on the other side of the dealthe buyer if youre selling or the seller if youre buyingwill live up to the terms of the bargain. This potential default, known as counterparty risk, is serious enough when the agreement is between individuals. But it can be even more problematic if the agreement depends on a financial institution, such as a brokerage firm,

FUnGIBLe secURItIes

Investors can buy and sell securities, such as shares of stock or corporate bonds, because the securities are fungible, or interchangeable, in the same way one $20 bill has exactly the same value as any other $20 bill.

2009 by Lightbulb Press, Inc. All Rights Reserved.

GUIDe to cLeARAnce & settLeMent


contRoLLInG tHe FLoW

In the same legislation that established the National Market System, Congress recommended immobilization, which essentially streamlined the multi-step process during which (1) the seller endorsed and delivered the certificate to a broker, (2) the selling broker delivered the certificate to DTC, (3) DTC delivered the certificate to the transfer agent, (4) the transfer agent issued a new certificate in the name of the new owner, and (5) the buying broker provided that certificate to the new owner. With immobilization, transfers are handled electronically through a book-entry accounting system. The immobilized securities are all held by DTC to hold and registered in its nominee name, Cede paper cer& Co., also known as street name. On DTCs books, shares of those securities are tificates affecting just recorded in the brokerage firms name. one-tenth of one percent But at your brokerage firm, your name is (0.001) of all equity trades on the firms books as the each day. beneficial owner of the securities. So, for example, when you sell shares of stock, the ownership of the shares eLIMInAtInG PAPeR is transferred electronically from your entIReLY brokers DTC account to the DTC account The concept of dematerialization, or the elimination of paper certificates, was introduced in the 1970s before it seemed a practicable solution. But as technology has evolved and safeguards for data GENERAL IN retrieval have been put in place, ownership records are increasingly strictly electronic. Issuers simply dont create certificates at all. Few new corporate or municipal bond certificates have been issued in the United States since 1983, when the bearer-bond system was converted to a book-entry sysof the broker whose client purchased tem. Similarly, mutual funds, US Treasury the shares. The firms records are then securities, commercial paper, and other updated to reflect the change, and the financial products are issued only in elecconfirmation notice sent to you is proof tronic form. you sold the shares and of the amount Dematerialization appears to be you received for the sale. The buyer the future of equities trading as well. receives a similar confirmation notice Since 2008, all stocks listed on US detailing the shares exchanges must be eligible for the purchased and the Direct Registration System (DRS). amount paid. This system allows registered owners to Only a small number hold securities on the books of the issuers of investors continue or the issuers transfer agents in bookentry form, rather than in the form of paper stock certificates.
tIMe to DeMAteRIALIZe

The global goal of eliminating paper certificates has been underway for decades with mixed success. Some countries have gone so far as to dictate the way certificates look, hoping that dull gray pieces of paper will be less attractive to investors than the elaborately designed and often beautiful certificates of the past.
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GUIDe to cLeARAnce & settLeMent

Matching and Netting


The principle behind matching and netting is that less money means less risk.
Matching and netting are key elements in clearing and settling securities transactions. NSCC uses a fully automated accounting system called Continuous Net Settlement (CNS), which plays a central role in helping to reduce the total number of trade obligations that require financial settlement. Currently, on an average day, 99% of all trade obligations that occur in US equity markets dont require the exchange of money. Matching, or comparing the details of a transaction, is the first, essential step in ensuring that securities and the money to pay for them will be exchanged within the required three-day timeframe. In an equity trade, for example, the brokerage firm that places a buy or sell order and the contra firm that fills it must agree on the name of the stock, the price per share, and the number of shares that have been exchanged. Heres how it works: If you give your broker at Firm A an order to buy 100 shares of NRQ stock, your broker will enter an order to buy 100 shares. Another firmsay Firm Bfills the order in its trading system in response to a clients instruction to sell NRQ. Its books will show a reciprocal order to sell 100 shares of NRQ stock. (You should note, though, that the process of filling orders is handled differently on the various trading platforms and that firms can satisfy a trade from their own inventory of securities. But however the transaction is handled, the broker handling it must ensure the investor gets the best price available.) As the final step in the trade, the buy order is automatically matched electronically against the sell order at the marketplace or exchange. If the details agree, the order is complete, or locked in, and sent from the trading venue to NSCC. NSCC then confirms receipt of the details of the transaction by sending a communication electronically to the trading firms. This communication legally commits the firms to complete the deal.
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MAtcHInG
100 SHARES OF BUY NRQ ORDER
eXcePtIons to tHe RULe

MAtcHInG tHe DetAILs

In todays highly automated trading environment, 99.9% of all equity trades are matched before they arrive at NSCC. Where there is an unmatched trade, because the buying firms information doesnt match the selling firms, the firms must resolve the discrepancies before the trade can be cleared. Misunderstandings may occur for a number of reasons. For example, the firms may not agree on the price or the size of the order. Once the differences are resolved, the matched order goes on to NSCC for clearing and settlement following the standard procedure.

nettInG
FIRM A

B SELL BUY UY BUY SELL SELL

SE LL

BU

Clients place orders


SE LL
BUY

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LL

99% of trading obligations are eliminated through netting

GUIDe to cLeARAnce & settLeMent


DIstILLInG tHe nUMBeRs

On T+2, or two days after the trade date (T), NSCC provides each participating broker/dealer with a summary of all of its securities transactions to be settled the following day. The report also shows the

What makes netting of trades possible is that NSCC legally becomes the counterparty to all trades. So no matter how many different firms Firm A traded with on a particular security, all of those buys and

100 SHARES OF BUY ORDER NRQ

100 SHARES OF SELL NRQ ORDER

firms position either as net sellerwhen 100 100 that firms clients have sold more shares of a SHARES SHARES particular security than they OF OF BUY SELL purchasedor as net buyer NRQ NRQ ORDER ORDER when the firms clients bought more shares of a security than they sold. 99.9% of all equity These positions of net seller trades are locked in and net buyer are determined through netting, the process of automatically offsetting the firms buy orders on an individual security against its corresponding sell orders for that security. The net buys and sells are determined by matching CUSIPseach securitys unique identifying code. The goal of netting is to minimize the number and value of the transactions that must take place between firms to settle sells can be netted together. This process their trades. For example, suppose that is known as multilateral netting. Firm A had 100 clients buying and selling shares of stock NRQ. Through netting, the Netting financial obligationsthe vast majority of these trades may cancel money that must change handsis even each other out by offsetting shares bought easier. All money owed to or from a particagainst shares sold. ular firm for its trading activity is netted to Though its conceivable for a firms a single dollar amount each day by NSCC. trades in a particular security to net out What that means is that any firm perfectly, it isnt very likely. So, at the that ends the day with a net debit needs end of the day, NSCC may alert Firm A to have only enough money on hand to that it is a net seller of 500 shares of NRQ cover its net financial obligation. That and must deliver those shares to settle is always less than the actual value of its obligation. its transactions.
nettInG

Financial obligations are netted to a single dollar amount each day

Through netting, DTCCs clearing agency subsidiaries are able to reduce the total number of trade obligations requiring financial settlement. Of the record $315 trillion in equity securities transactions processed in 2008, NSCC netted down 99%. So only $2.9 trillion required an exchange of securities or cash. Netting also significantly reduces industry risk and helps DTCC customers optimize capital by freeing up trillions of dollars that they can use for other investment purposes. That increased liquidity is a significant advantage of the centralized clearance and settlement system thats a feature of US capital markets.
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GUIDe to cLeARAnce & settLeMent

Getting Settled
Every day is T+3 for a new group of transactions.
The pieces all come together on the settle-

T+3
Net Seller

when a securities transaction is finalized. Its the day when the money is exchanged and the ownership changes.

ment date (T+3)

Hey, now its time to settle up.

I dont have that much time on hand.

NSCC

rt Repo DTC

Ill take what is available.

BeHInD tHe scenes

T+4
Net Seller
T F D

Settlement doesnt just happen. But NSCC and DTC have established a process to ensure that it does. On T+2, NSCC communicates to financial firms what their final cash and securities obligations are. It also sends an electronic report to DTC describing

the securities that are changing hands, the amounts that are due, and the brokerage accounts that need to be updated to reflect changes in ownership. When securities are due from a brokerage firm as the net seller, DTC can see whats available in the firms account with the trust company in order to transfer ownership.

I dont have that much stock on hand.

FTD

You must deliver tomorrow.


CNS

SEC

If a firm doesnt provide securities that are due on T+3, it is still obligated to make delivery. Through NSCCs Continuous Net Settlement (CNS) system, the shares are included in the batch of trades scheduled for settlement on the following day. Through a process called marking to market, the settlement price of the undelivered security is updated to match the current market price, and NSCC collects additional collateral to cover that increase in price, if necessary. Thats done to minimize the increased risk of delivery not being made at what could be a higher price. A firm with an outstanding obligation to deliver may obtain the securities it owes in one of several ways. For example, the firm may purchase the securities, borrow them, or securities that have been on loan may be returned. The firm uses these securities to settle existing obligations first. Under current SEC rules (Rule 204), all fails to deliver (FTD) must be closed by the morning of the day following T+3, with only a few exceptions. The SEC and the
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DeLIVeRY PRoBLeMs

self-regulatory bodies where the trades occur, such as the NYSE and Nasdaq, have the authority to force a resolution for those exceptions. In addition, firms that are owed stock always have the opportunity to buy-in. This means they can buy the same security from another firm, charging the first seller for any difference in price they must pay for the purchase.
PARtIcIPAnt FIRMs

The broker/dealers who are among the more than 300 participants in transactions handled through the NSCC system are called self-clearing firms. In this role, they may clear and settle transactions for their own firms. A participant that is a clearing firm can clear and settle for its own firm and for other brokerage firms that are not NSCC members. Some clearing firms also provide recordkeeping and custody services for the client accounts of other broker/dealers, known as introducing firms, that dont do their own clearing. All client assets, most of which exist as electronic records, must be kept segregated from the clearing firms own assets.

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GUIDe to cLeARAnce & settLeMent


Thats all theyve got.

I can borrow the rest.

NSCC

DTC

SELL R ORDE

BUY ORDER
lending business activity is done outside of NSCC. However, on occasion, firms may still find themselves without enough securities to cover their delivery obligations. In these situations, NSCCs automated Stock Borrow Program goes into effect.

I can lend you what you need.

Borrow Stock ram Prog

Lending Firm

Stock Borrow Program


This voluntary program allows NSCC to borrow securities from the inventory of other firms at DTC to complete the delivery of securities for settlement purposes. This short-term loan does not take away the selling brokers legal obligation to eventually deliver the securities. NSCC doesnt charge for the service, which was created in the 1980s to keep the settlement system functioning and to help complete more trades on T+3.

teMPoRARY LoAns

If firms do not have an adequate supply of securities to fulfill their delivery obligations, they are likely to try and borrow securities from other brokers for a fee. This formal securities

T+3 cont.
OK, heres your final net amount due.
Report
This is just what I expected.

NSCC

Net Seller

Except I have a net debit, so I owe some cash.


Net Buyer
Done, and done.

t Repor

Me too.

The final stage of settlement is moving the money from buyer to seller, a process that occurs in parallel with transferring ownership of the securities. It is initiated when DTC posts the final net amount due from participants late in the afternoon of T+3. The obligations dont come as a surprise. NSCC and DTC jointly provide all participants and their settling banks with reports throughout the day listing net debit and net credit amounts for individual participants, as well as a net-net figure for each settling bank. Each participant firm is required to select a settling bank to handle the electronic payment or receipt of payment through the Federal Reserve Banks Fedwire system. This process automates and streamlines what used to involve the delivery of physical checks to complete
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PAYInG tHe BILL

DTC

Settling Bank

NSCC

settlement. In fact, many financial firms use the same settling bank, which allows NSCC and DTC to net the total amount being handled by any one settling bank for all the participant firms using that bank.
ceDe & co

Securities that DTC holds in its depository are registered in the nominee or street name of Cede & Co, which originates from an acronym for CEntral DEpository. Changing ownership records for these securities can be done efficiently using book-entry accounting methods where no certificates actually change hands.
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GUIDe to cLeARAnce & settLeMent

Tracking a Trade
Theres a lot more to settling a trade than meets the eye.
The National Securities Clearing Corporation (NSCC) and The Depository Trust Company (DTC) facilitate orderly

transfer of more than 100 million equity transactions, on average, every trading day. More than 99.9% of all equity, municipal, and corporate bond transactions in the United States are settled within three business daysthe timetable mandated by the Securities and Exchange Commission (SEC) to ensure the stability and efficiency

of the financial markets. This settlement cycle begins the first business day after the trade is executed. So, if you bought a stock on Friday morning, T+1 would occur the following Monday, and T+3 would occur on Wednesday.

MAKInG A tRADe
Investor places an order to buy or sell with a broker/dealer.

INVESTORS

Broker/dealer firm sends the order to an exchange or market for execution.

EXCHANGES & MARKETS

A
FIRMS

t+3
DTC transfers securities electronically from the selling firms account to NSCCs account at DTC, and then from NSCCs account to the buying firms account. Firms instruct their settling banks to send funds to, or receive funds from, DTC to complete the transaction.

SETTLING BANK

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GUIDe to cLeARAnce & settLeMent

t (tRADe DAte)
After the transaction is matched, or locked-in, between buying and selling firms, the markets automated system sends trade information to NSCC. In the case of equity transactions, 99.9% are sent to NSCC as locked-in trades, which means that the marketplace compared them at the time of execution, confirming all details, including share quantity, price, and security. NSCC confirms trade details with participating firms, NSCC legally binding them to complete the transaction.

t+1
At midnight between T+1 and T+2, NSCC steps in as central counterparty (CCP) to the trade. At this point, NSCC assumes responsibility to make the trade whole should either the buying or selling firm be unable to fulfill its end of the obligation.

t+2
NSCC issues a trade summary to the buying and selling firms, indicating net money and net securities owed for settlement. NSCC sends instructions to DTC detailing net positions to be settled.

DTC

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GUIDe to cLeARAnce & settLeMent

Settling Debts
A lot happens under the US governments fixed-income umbrella.
The Fixed Income Clearing Corporation (FICC) automates clearing, netting, and settling trades in US government securities in the secondary marketthe worlds largest and most liquid fixed-income market.

GsD MBsD ccP DVP


and netting of trades in securities issued by the US government. These include US Treasury bonds, notes, bills, Treasury Inflation-Protection Securities (TIPS), and Treasury zero-coupon issues, all of which settle by law on T+1, or one day after the trade date. GSD also clears trades in securities issued by nonmortgage government agencies, such as the Tennessee Valley Authority (TVA) and the Import-Export Bank. A second division, the MortgageBacked Securities Division (MBSD), clears and settles secondary market transactions in mortgage-backed securities issued by US government corporations, agencies, or sponsored enterprises. These instruments are known as pass-through securities because the payments on the mortgages making up the securities are passed through to the holders of the securities. Through its Government Securities Division (GSD), FICC handles the clearing Using its automated comparison and netting services, GSD determines a net credit or debit trading position for each participant in each government security after the fixed-income market closes on the trade date (T). GSD then relays settlement obligations to all participants and their clearing banks by midnight between T and T+1. On T+1, the two FICC clearing banks, JP Morgan Chase and the Bank of New York Mellon, transfer the securities from seller to buyer in a continuous book-entry process. As securities are received before the 3 pm deadline, they are immediately dispatched to a buyer who has paid for them, using whats known as a delivery vs. payment (DVP) system. Using multilateral netting, GSD calculates each participants daily cash settlement obligation, aggregating all net positions to a single dollar value. In 2008, for example, GSD netted average daily
sMootHInG tHe FLoW

A BRIeF tIMeLIne
1986 National Securities Clearing Corporation

(NSCC) formed the Government Securities Clearing Corporation (GSCC).


1990

2002 GSCC and MBSCC became

part of the Depository Trust & Clearing Corporation (DTCC).

1980

2000

2010

1994 Mortgage Backed Securities

Clearing Corporation (MBSCC) moved to New York and affiliated with NSCC.

2003 DTCC merged the two

companies into a new subsidiary, Fixed Income Clearing Corporation (FICC).

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14

GUIDe to cLeARAnce & settLeMent


a margin account, depositing either cash or eligible securities. When securities are used as collateral As trades reach GSD, they are matched and in margin accounts, their current confirmed by its Real-Time Trade Matching values may be reduced by a certain (RTTM) system. Buyers and sellers receive percentage to protect against potential immediate notification, making their obligation future loss. The discount is described to complete the trade legal and binding. as a haircut. In addition, RTTM helps to reduce the risk of failed trades. The program allows participants to make immediate adjustments to a trade so they can address any discrepancies. And the automated process that RTTM initiates ensures collection and payment of netted cash settlement obligations. GSD also continuously monitors trading activity and adjusts margin requirements. Among other things, it looks at customers open positions in individual securities. And it collaborates with futures clearing organizations, in a process called cross-margining, to keep track of participants credit exposureand thus potential vulnercash obligations of $4.1 trillion down to ability to defaultacross fixed-income $1 trillion, creating enormous efficiencies markets. in trade settlement.
GettInG A tRIM AUctIon tAKeDoWn

RttM GcF RePo


To finance the public debt, the US Treasury sells bills, notes, bonds, and other financial instruments to institutional and individual investors through public auctions. Through its Auction Takedown service, GSD is able to reduce the costs and risks of settling these transactions. It does so by automatically netting the purchases that its customers have made at the auctions with their other trading activity in the secondary market. Because of the lag between auction and issue dates, net positions created by the auction are forward-settling transactions for which special margin requirements apply. On the issue date, net positions are replaced with settlement obligations and the securities are delivered to the purchasers as they arrive in the GSD accounts at the clearing banks from the Federal Reserve. As a frontline defense against risk, GSD acts as a central counterparty (CCP), serving as buyer to every seller and seller to every buyer, guaranteeing that all matched trades will be settled even if one party defaults. To manage the potential risk of a clearing members default, GSD requires all participants to contribute to
MAnAGInG RIsK

BUYInG BAcK tHe FARM

Measured by dollar volume, repurchase agreements, called repos, are the biggest component of the government fixed-income market. Repos are popular because they offer secured financing on favorable terms, thereby providing vital market liquidity in the vicinity of $3 trillion a day. Using a repo, broker/dealers and other financial services firms sell securities for immediate cash and simultaneously agree to repurchase the same or similar securities at a specific future date at an agreed-upon price. Through a reverse repo, firms that have a cash surplus can earn short-term interest by lending money and holding the security as collateral. The repurchase price includes the interest earned on the deal. ity at lower cost. These repos allow dealers to trade generic CUSIPs identified by rate, term, and type of underlying asset without having to settle each trade as its made before the underlying assets can be delivered. In fact, dealers can wait to allocate specific securities to a transaction until after the end-of-day netting.
General collateral finance (GCF) repos create even more short-term liquid-

2009 by Lightbulb Press, Inc. All Rights Reserved.

15

GUIDe to cLeARAnce & settLeMent

Clearing MBS
Settling transactions in mortgage-backed securities is big business.
The Mortgage-Backed Securities Division (MBSD) of the Fixed Income Clearing Corporation (FICC) is the

settLeMent cYcLes

SIFMA issues a 12-month MBS settlement cycle. Each class of MBS settles once a month on a predetermined day. For example, all 15-year Class A Fannie Mae MBS might settle on June 15, and all 30-year Class C Ginnie Mae MBS might settle on June 19. The following month, the products will settle in the same order, though the actual settlement dates will vary.
before they create a problem that would interfere with timely settlement. Similarly, by employing multilateral netting to reduce the number of secu-

only centralized clearing facility for the $60 trillion market in mortgage-backed securities (MBS). These securities are issued by US government corporations and agencies,

Mortgage-backed securities have an extended

including Ginnie Mae, and the government sponsored enterprises (GSEs) Fannie Mae and Freddie Mac. The division doesnt clear MBS offered by nongovernment organizations. Like FICCs Government Securities Division (GSD), which clears and settles transactions in US Treasury issues, MBSD uses the automated Real-Time Trade Matching (RTTM) system to compare transactions that clearing members submit for settlement and to generate confirmations that establish the members contractual obligation to complete the trades. Once MBSD begins operating as a central counterparty (CCP), projected to launch in late 2009, it will guarantee the settlement of all matched trades if one of the parties to the trade defaults.
sAVInG tIMe AnD MoneY

rities that must be delivered and the amount of money that must change hands to settle the days transactions, MBSD reduces post-trade costs and frees up capital that can be used for other purposes. Transactions in mortgage-backed securities and Treasury issues differ in a number of ways. MBS transactions settle over time periods as long as 90 days from the trade date, a much longer period than trade day plus one (T+1) that applies to government securities. In addition, the majority of MBS transactions are done on a TBA, or to-be-announced, basis. Contracts do not specify which mortgages will be included in the trade until 48 hours prior to settlementa concept that was introduced to bring more liquidity to the market. Until the final pool is assembled, the contract is identified by a generic CUSIP, or ninedigit identifying code, that identifies the termsincluding the maturity date and coupon rateof the hundreds of securities that are eligible for inclusion.
tHe MoRtGAGe MARKet

One benefit of real-time clearing is reduced risk and increased efficiency, in part because RTTM provides tools that members use to detect and correct errors
16

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GUIDe to cLeARAnce & settLeMent


This approach works because mortgages of the same class are assumed to be fungible, or interchangeable, and to carry equivalent risk. The classes themselves are defined by SIFMA, the Securities Industry and Financial Markets Association. Another unique feature of an MBS trade is that once it is matched and confirmed, one side of the trade can be assigned to a third party, something thats not permitted with any other security. The result is that one of the original parties to the trade can get out of the deal, and the obligation to deliver or receive the underlying mortgages lies with someone else. Under MBSDs future CCP operation, however, members will send pool instructs to MBSDs pool netting system for bilateral matching and netting against the submissions from their counterparties. FICC will then step in as the CCP to settle all the qualifying net pool obligations. Then, on settlement day (SD), the participating firms settle their net pool obligations through FICCs clearing banks, with FICC as the counterparty. Trade participants also deliver or receive the mortgage pools that didnt net and settle these obligations directly with each other rather than with FICC.

d settlement schedule that concludes over four days.

Trades are often assigned, for example, when the buyer no longer wants the mortgages, sometimes because the MBS was purchased to hedge a portfolio or the buyer was speculating on the direction of the market. Through its settlement balance order system, MBSD nets all to-be-announced (TBA) contracts three days before their settlement date (SD-3). This process reduces the number of mortgage pools that must be delivered by more than 90%. Two days before settlement (SD-2), sellers must begin submitting information on the pools they will deliver. They use MBSDs real-time Electronic Pool Notification (EPN) service, which reduces potential failures that might result from incomplete or inaccurate information. EPN also reduces the time and cost involved in settlement. In the last 24 hours before settlement, pool submissions must be completed so the pools themselves can be netted.
tYInG UP tHe enDs

MAnAGInG MBs RIsK

The complexity of MBS products and the length of the settlement process increase the risk that one of the parties to a trade may default. In response, FICC continually assesses and updates collateral requirements for participating members. Changes to collateral requirements may reflect volatility in the mortgage market, potential changes in interest rates, mortgage prepayment rates, and default rates, as well as the members individual trade obligations and creditworthiness, along with other risk factors.
JUst WHAt Is An MBs?

Mortgage-backed securities (MBS) are created by bundling a group of similar mortgages into a package that can be divided into slices and sold to investors.
17

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GUIDe to cLeARAnce & settLeMent

Managing Risk
Running a tight ship depends on anticipating problems and having solutions at hand.
When the sun is shining, it may seem foolish to worry about the next storm except if youre responsible for clearing and settling billions of dollars of equity and fixed-income transactions every business day. In that case, risk management is at the heart of the job. A large part of DTCCs mission is to protect the safety and soundness of the US capital market system. This includes ensuring it has the capacity to handle unpredictable spikes in trading volume and protecting the system against the risk that could result from the activities of a single trading firm. For DTCC, risk management means anticipating unthinkable, unknowable, and unimaginable threats. It also means being prepared for more ordinary disruptions that can occur, evaluating the damage they could cause, and identifying effective ways to protect against them.
WHAt DAnGeRs LURK? A cAse In PoInt

Among the known risks that DTCC faces, two especially demand constant vigilance:

On the financial front, participant

Lehman Brothers, formerly one of the worlds largest investment banks and a principal user of DTCCs services, declared bankruptcy in September 2008. When it did, the firm exposed the financial services industry, market participantsand taxpayersto over $500 billion worth of open trade obligations in various markets and asset classes. DTCC was able to liquidate all of Lehmans open positions in about six weeks with no impact to the industry and without any loss to the clearing fund or use of its lines of credit. DTCCs rigorous risk-management process, including simulation exercises that tested how to handle just such a meltdown only months before it happened, were instrumental in the successful outcome. In addition, because DTCC had accurate records of the value of unsettled credit default swaps in the Lehman portfoliocloser to $6 billion than the $400 billion it was rumoredDTCC was able to calm fears that the entire financial industry was threatened.

firms might be unable to meet their trading obligations.

On the technological front, the auto-

mated systems might be overwhelmed by a surge in volume or disrupted by natural disasters or terrorism.

MeMBeRsHIP ReQUIReMents

For DTCC, managing risk means being selective. To become a full member and be able to clear and settle transactions through any of DTCCs three subsidiariesNSCC, FICC, or DTC prospective participants must satisfy stringent membership requirements.

Among other things, this includes having an established business history, sufficient technology, and adequate financial resources. Each firm has a minimum net capital requirement, which is based on the organizations business, its credit rating, the services it wants to access, and, in the case of a broker/dealer, whether it clears for other firms.

N S C C
18

D TC

FICC

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GUIDe to cLeARAnce & settLeMent

FUND UND S.S. CL EAR ING F .S CL EARING S

If left unchecked, either of these risks could undermine trade settlement and confidence in trading markets.
MUtUALIZAtIon oF RIsK

One specific challenge to clearance and settlement is the possibility that a participant might fail to deliver securities or payments. For example, what happens if a member firm declares bankruptcy in the middle of a settlement cycle, when several days worth of trades are in the system but before money and securities have changed hands? And what happens if not just one firm, but several firms, collapse within a short time? To safeguard against this possibility, which would have a cascading, crippling effect on all of the firms trading partners, all NSCC and FICC participating members must deposit collateralgenerally a mix of cash and securitiesin a clearing

fund. This fund provides a pool of resources that protects all participating parties in the event of a firms failure. The idea is that through a mutualization of risk, the industry can mitigate loss from closing out a defaulting members pending positions. Theres a minimum deposit into the clearing fund for each firm, and some firms, if theyre considered over-leveraged, must deposit more. The amount thats required, known as the margin, is calculated at least daily. DTC members have a similar obligation to make deposits of collateral. Collateral that DTCC subsidiaries require is held in an interest-paying reserve account. If a firm stops using the services of a subsidiary, the margin is returned. As additional liquidity protection, DTCC itself maintains a fund of retained earnings plus multibillion dollar lines of credit with a consortium of banks.

DTCC
Members are also subject to an ongoing surveillance program designed to detect anything out of the ordinary, including a concentration of trading positions in certain securities. Members may be asked for more collateral if trading patterns suggest an increased risk to the clearing corporation. In the event that a DTCC subsidiary ceases to act for a member, DTCC notifies other participants and the SEC and acts to close out the pending trades.
no RIsK UnMAPPeD

When your business is managing risk, you look both forward and backward. To be prepared for any unwelcome surprises, DTCC risk management teams use scenario planning exercises to simulate financial meltdowns they hope will never happen and test potential responses for containing the situation if they should. Throughout its history, DTCCs clearing corporation has never had a loss to its members clearing funds from a firm failure. And, since more than 35 participating firms have failed in just over three decades, thats ample evidence that DTCC has the necessary expertise and experience in this area.
19

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GUIDe to cLeARAnce & settLeMent

Up and Running
Success often depends on the ability to make the complex routine.
The sophisticated hardware and software that automate the clearance and settlement process also make it efficient and effective. But this technology poses potential systemic risks of its own, quite distinct from the disruption of bankruptcy, illiquidity, or fraud that are widely recognized as primary threats to the financial system. As the pace of securities trading accelerates and the volume mushrooms, advances in technology make that speed and volume possible. But the data generated must be instantly accessible and error free. And communications among the parties must be secure and uninterrupted. Keeping these interlocking systems fully functional is an ongoing responsibility that requires regular stress testing of current capacity as well as constant innovation and upgrading.
BoostInG cAPAcItY

hurricanes, cyber-attacks, even terrorists assaultspose a different threat from spikes in trading volume. Yet both put technological capacity and resilience to the test. To prepare for any eventuality,

secU Re DAtA AnD IncReAseD

DTCC and its subsidiaries have responded to the demands of escalating trade volumes by regularly upgrading their capacity to clear and settle transactions on schedule, no matter how many there are. NSCC regularly monitors volume trends and increases its daily tradeprocessing capability. In 2009, for example, the push was from 500 million to 850 million transactions a day, which is more than three times the average daily volume of equity, corporate bond, and municipal bond transactions combined. This excess capacity ensures that NSCCs system wont be overwhelmed by unpredictable spikes in trading volume that are typical by-products of financial crises and economic turmoil. In the turbulent autumn of 2008, for example, there was a surge in the number of daily equity transactions, peaking on October 10 at an unprecedented 209.4 million transactions, representing 19.3 billion shares.
WHen ReDUnDAncY Is sMARt

Extraordinary events such as power outages,


20

DTCC has established rigorous businesscontinuity policies and procedures to keep all aspects of its operations running at all times. The key to these safeguards is rapid capture and automated replication of data and services. To ensure that clearance and settlement isnt interrupted if transaction records are lost or computers cant communicate, DTCC has established a network of fully redundant back-up data centers in the United States. If necessary, any one of these data centers could take control of the system and manage the recovery. If all the data centers in the same region were to shut down simultaneously, only a minutes worthor lessof the most recent information could be lost, at least temporarily. In that event, DTCC and its customers would work together to recover and replicate the missing data.

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GUIDe to cLeARAnce & settLeMent


Late in the afternoon of August 14, 2003, a massive power blackout leapt from Cleveland to Detroit to Toronto to New York in seconds, affecting 50 million people. But DTCC, with multiple operating sites, back-up power generators, and contingency procedures in place, continued normal processing. One of DTCCs remote operating locations took lead responsibility for settlement operations, and one of its remote data centers stepped in to manage data processing operations.
tHe BLAcKoUt stAYInG connecteD

t R A n sMIssIons tRADe VoLUMe

A secure, redundant communications network to carry data, voice, and Internet is vital to keeping trade and settlement information flowing between customers and DTCCs subsidiaries. That network must continue to work, even in the face of an internal failure or an external emergency. In fact, a communications system that functions throughout a disruption is critical to averting a potential crisis. To eliminate the risk of a communications breakdown, DTCC has relationships with multiple telecommunications companies. These relationships allow DTCC to maintain a web of contacts with customers through a self-healing telecomm network. If communication is disrupted, the network will automatically re-route the communication through an alternate path.
GoInG FARtHeR FAsteR on DAtA cAPtURe

High-speed electronic transmission is an essential component of DTCCs business continuity planning because it makes possible the replication and storage of data at its multiple data centers. Synchronousor simultaneoustransmission works smoothly over distances of up to 70 miles. The data travels along DTCC also maintains operating a network of fiber optic cables, moving centers in multiple locations in the as a continuous stream between open United States and overseas, which are connections. Errors that may creep in separate from its data centers. Those can be readily corrected. operating centers are designed to handle Before 2003, the only way to move physical activities supporting clearance, data across greater distances was asynsettlement, processing of income and chronously, where small packets of data dividend payments, and responding to literally hop across a telecomm network. corporate actions. The problem, however, was that you could lose cMMI up to a two-hour window Late in 2008, DTCC was appraised at a Capability Maturity of data, which was not Model Integration (CMMI) Level 3 across its entire acceptable. In 2003, enterprise. CMMI, an internationally recognized assessment DTCC began working with from the Software Engineering Institute (SEI) of Carnegie EMC Corporation to bring Mellon University, is a measure of excellence in improving innovation to asynchronous organizational processes. In combination with DTCCs communication, transferring software security program, CMMI Level 3 provides a large amounts of accurate highly disciplined approach to embed and enforce softdata over 1,000 miles and ware security controls. It works whether it is custom code closing the potential loss of written by DTCC developers or software purchased off the data to under 30 seconds.

shelf and adapted for use.

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21

GUIDe to cLeARAnce & settLeMent

Streamlining the Markets


DTC has a part to play in every stage of a securitys lifecycle.
was created in 1973 to streamline the settlement of securities transactions in the US capital markets. To get the job done, DTC took custody of and immobilized millions of paper certificates and developed an electronic book-entry system to record the changes in ownership. Today, DTC not only ensures the seamless settlement of retail and institutional trades. It is directly involved in everything that occurs during the lifecycle of a security. When a company decides to go public, DTC supports the underwriting process that brings the new issue to market. DTC provides a service for announcing, collecting, allocating, and reporting payment of dividends and interest. It also offers a proxy service that, among other things, uses electronic communications to simplify investor participation. In addition, DTC is party to corporate reorganizations and other events when companies change names, securities must be surrendered, or securities are withdrawn from custody.
PResent At cReAtIon

The Depository Trust Company (DTC)

or traded rapidly for a profit, is reported to the lead underwriter for investigation.
connectInG WItH cLIents

The once paper-intensive task of bringing new securities issues to market has been streamlined by DTCs underwriting services. Underwriters can submit, in real time, the extensive documentation thats required, distribute both primary and secondary offerings, and settle transactions electronically. DTCs IPO Tracking Service follows the movement of newly issued shares as participant firms deliver orders. This helps ensure a stable market environment during the launch of a new stock. Any data suggesting that an issue is being flipped,

The dividends and interest that investors expect to receive from their equity and debt securities is one of the major reasons theyre willing to put their money into the capital markets. DTC plays a major role in facilitating these payments when theyre made on issues held in DTCs nominee name of Cede & Co. DTC also coordinates tax-withholding information where applicable. Dividends owed to the beneficial owners of stocks, as well as interest payments and repayment of principal on bonds, are credited by the issuer, through its paying agent, to DTC. Then the payments are distributed to the appropriate brokerage firms and banks for allocation to client accounts. Dividends may be directed into a dividend reinvestment program (DRIP). DTC also disseminates news of corporate actions to broker/dealers whose clients are affected. Typically, corporate actions include tender offers, rights offers,

KeePInG BUsY

In 2008, DTC settled transactions valued at almost $455 trillion and processed 316.6 million book-entry deliveries.

Dtc
22
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GUIDe to cLeARAnce & settLeMent


convertible security conversions, warrants, mergers, and redemption notices on municipal and corporate bonds. Through its Direct Registration System (DRS), DTC likewise serves registered owners of equities who:
on tHe BooKs

Prefer to hold stocks in their own

names in book-entry form with the issuer or its transfer agent Want to be able to trade stocks easily

bank trust department, or insurance company Investment manager who makes the trading decisions Buying and selling brokers who act on behalf of the investment managers Marketplace where the trade is completed Custodian banks which handle payments for the trade

In the past, investors who sold stocks held in their own name had to endorse and deliver the certificates to their brokers within the three-day settlement window. But through DTCs electronic transfer system, registered owners wishing to sell can request that stock be moved directly to their broker/dealers for execution. Buyers of newly purchased securities can also use the system to register their ownership with the issuers transfer agent. An immediate benefit of DRS is that it accommodates investor preferences while essentially eliminating the cost and risk of moving paper securities. Perhaps even more significant, DRS helps move the industry one step closer toward the global goal of abolishing physical certificates.
InstItUtIonAL tRADes

A retail transactionalso known as a broker-to-broker or streetside trademay involve as few as 100 shares of stock or a small number of bonds. In contrast, an institutional transaction may involve the purchase or sale of a minimum of 10,000 shares or $100,000 in bonds. The parties involved in an institutional trade include the:

To help maintain confidentiality and avoid triggering a major impact in the marketplace, the buying broker either arranges a trade for the entire block or breaks it into a number of pieces. The trade may even be executed over several days. DTC is responsible for completing settlement of institutional trades, which includes the receipt of payment and the transfer of securities ownership in its book-entry system. The money settlement systems of DTC and NSCC are unified, providing customers with one consolidated, end-of-day netted payment obligation for both DTC and NSCC trades. Omgeo, a joint venture of DTCC and Thomson Reuters, acts as a central communications hub and provides trade management services for institutional activity through its links with investment managers, broker/dealers, and custodians. Omgeos systems communicate details of the trade, including how large orders of securities should be allocated to different custodians and accounts, affirmation of instructions by investment managers, and confirmation by the custodian banks and broker/dealers.

Institutional investor, such as a mu-

tual fund, pension fund, hedge fund,

DTC, as a central securities depository, holds custody of 85% to 90% of all securities in the United States and services those assets for financial firms on behalf of investors.

2009 by Lightbulb Press, Inc. All Rights Reserved.

23

GUIDe to cLeARAnce & settLeMent

Trading Mutual Funds


It takes a streamlined and flexible infrastructure to handle the volume and diversity of mutual fund transactions.
Between 1924, when the first mutual funds were introduced in the United States, and 1986, the process of selling them was largely manual and FIRM labor intensive. Heres what happened if you told your broker to buy shares of ABC Fund: 1. Your broker contacted ABC Fund to give the order and waited for confirmation, which might come over the phone, through the mail, or, in the later years, by fax. D 2. Next, ABC Fund FUN and your broker communicated via mail the details required for the purchase and, when they agreed on the details, your broker sent payment to the fund to complete the purchase. 3. The fund entered the shares you owned on its books and then sent a written statement confirming the registration of your account. If you wanted to sell, orders were relayed, confirmed, and repurchased by the fund in much the same waymanuallyand often one order at a time.
cReAtIon oF FUnD/seRV

BEFORE Fund/SERV
FIRM FIRM FIRM

FUN

FUN

FUN

While the industry continued to grow, by the 1980s the manual nature of the proWHo Does FUnD/seRV seRVe?

Fund/SERV handles transactions in conventional pooled investments, including open- and closed-end mutual funds. A related product from NSCC, the Alternative Investment Products (AIP) suite of services handles transactions in alternative products including hedge funds, funds of hedge funds, private equity real estate investment trusts (REITs), and limited partnerships.

cess prevented funds from offering a wider range of choices to investors, and the lack of automation limited the ability of banks, broker/dealers, and financial planners to sell funds. These problems became even more pressing to resolve with the introduction of new investment products, such as individual retirement accounts (IRAs), and the increasing popularity of defined contribution plans, especially 401(k)s. As investors grew more sophisticated, with a greater understanding of investment and savings strategies, their demand for choice and greater access to financial products also increased. In 1978, for example, investors had about $55 billion invested in some 500 mutual funds. A little more than a decade later, there was over $1 trillion spread across 2,900 funds. However, serious questions remained about whether the mutual fund industry could continue to growand meet investor demand. There were a growing number of fund companies and financial intermediaries, including banks and trust companies, broker/dealers, financial advisers, investment managers, and others. But few were individually linked as trading partners, and the cost of building a series of proprietary networks to provide those links was cost-prohibitive.

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GUIDe to cLeARAnce & settLeMent


ALL tHRoUGH tHe nIGHt (AnD DAY)

Brokers can enter mutual fund orders through Fund/SERV at any point between 2 am and midnight EST, Monday through Friday. Fund companies can elect to receive those orders in realtime, as they enter the system, just once a day, or in batches at predetermined intervals throughout the 22-hour timeframe.

AFTER Fund/SERV
FIRM FIRM FIRM FIRM

Fund/

S E RV

FUN

FUN

FUN

Eventually, the industry asked the National Securities Clearing Corporation (NSCC) to help find a solution, based on its success in automating the processing of equity transactions. Working closely with the Investment Company Institute (ICI), the National Association of Securities Dealers (NASD), and a consortium of mutual fund companies and broker/dealers, NSCC created a viable solution. In 1986, NSCC launched Fund/ SERV, an acronym for Fund Settlement, Entry, Registration, and Verification. Thats the centralized processing system that has been credited with facilitating the growth of the industry and through which the vast majority of mutual fund transactions in the United States are processed today.
KeePInG InFoRMAtIon FLoWInG

firms or rejects the order through Fund/ SERV, which then relays that confirmation or rejection back to your broker almost immediately. Selling your shares of ABC Fund is handled the same way. When a transaction ND FU is confirmed, Fund/ SERV generates the financial details, helps settle the money that is owed or that is to be paid, and provides a settlement summary to both trading parties. Unless theres a correction or cancellation, the registration of the new mutual fund account is finalized. The Fund/SERV system is also built for flexibility. For instance, the time it takes for transactions to settle may differ based on the fund type. While money market funds typically settle on T or T+1, equity funds generally settle on T+3.
eXPAnDInG InVestoR cHoIce

Fund/SERV acts as a central hub for mutual fund transactions, linking all trading partiesmutual funds and the broker/ dealers and banks who market their productsautomating key steps from initial order to final money settlement. Say, for example, you tell your broker to buy shares of ABC Fund. Your broker relays your order to ABC Fund through Fund/SERV. ABC Fund then either con-

Reducing time and errors is just part of the Fund/SERV story. From an investor standpoint, Fund/SERV has created virtually unlimited choice among thousands of funds sold in the United States. This is in sharp contrast to Europe, where investors are often more limited in the choice of funds available from distributors. The cost of processing and settling mutual fund trades is also significantly cheaper than it was. Through Fund/SERV, fees continue to come down, dropping from $0.47 per transaction before 1986 to the current $0.05 per transaction. This is even more attractive when compared to similar trades in Europe, where theres no centralized system, and a single crossborder transaction can be as much as 50.

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25

GUIDe to cLeARAnce & settLeMent

Insurance and Retirement Services


Automated systems smooth the bumps in the road that can slow down product delivery.
More than 78 million baby boomers are now reaching retirement, and that presents both an opportunity and a challenge for two segments of the financial services industry: the companies that create retirement products, and the firms that market those products to their retail clients. The opportunity is the nearly $15 trillion invested in retirement accounts that must be refocused from asset accumulation to providing income. The continuing challenge is how to reach these account holders with attractive, competitive products that offer the same level of automated efficiency and transparency that characterizes buying and selling assets such as stocks, bonds and mutual funds. Mutual funds have evolved as a major force for investors to build and preserve assets in the US financial markets in large part because NSCCs automated Fund/SERV system makes transactions quick, accurate, and inexpensive, linking funds with the broker/dealers, banks, and financial planners who market these products. Thats not yet the case for variable annuities, which often have mutual funds as their underlying asset. Despite the role these investments can play as an asset accumulation and income payout tool for the increasing ranks of retired people, annuities and other insurance products
stReAMLInInG tHe sYsteM

have been mired in a traditional paperintensive, manual sales and service model. A transaction that in other financial sectors takes place in seconds can take significantly longer for an insurance product. Whats more, many of the distribution parties have yet to be electronically linked to be able to sell and service these products, communicate essential information, or manage payouts. The lengthy sales lifecycle coupled with a lack of automation have proven to be significant obstacles to growth in this industry.
MeetInG tHe neeD

For more than a decade, DTCC, through its NSCC subsidiary, has been working with the insurance industry to develop solutions that can automate, standardize, and centralize the multiple transactions, money settlements, and information exchanges that characterize these complex products throughout their lengthy lifecycle. Complete electronic processing has streamlined the sales process for agent and client by automating transactions prior to and after the sale of an annuity from initial application to premium and commission settlement. The ultimate goal is to build a scalable system that meets customer expectations
WHeRe tHe Assets ARe

Baby boomers have nearly $15 trillion invested in retirement accounts.

At year-end 2008, mutual funds accounted for 22% of US retirement assets and annuities held 12%, with the balance in other financial products managed by pension funds, insurance companies, banks, and brokerage firms.

Varia bl Annu e ity

Variable Annuity

Mutual Fund

Variable Annuity

Mutual Fund

Mutual Fund

Variab Annuit

ble uity
26

Mutual Fund

Variable Annuity

Mutual Fund

le Variab nnuity A

Variab le Annuit y

Mutual Fund

2009 by Lightbulb Press, Inc. All Rights Reserved.

GUIDe to cLeARAnce & settLeMent


MoVInG on AnD RoLLInG oVeR

When investors switch brokerage firms, which they do for a variety of reasons, they understandably want to move all their assets stocks, bonds, mutual funds, and annuities to their new account, with minimal hassle and no mistakes. In the 1980s, transferring mutual funds and annuities, which involves updating registrations on the books of the funds, insurance companies, or brokerage firms, was more complicated and error-prone than moving individual securities. The resulting delays were a source of friction not only between firms and mutual fund or insurance companies, but also between firms and their frustrated clients. ACATSTo solve Fund/SER these problems, V
and regulatory requirements for greater transparency, accountability, access, and efficiency in the purchase, administration, and payout processes for annuities. At the same time, the electronic capability must support the personalized nature of insurance service and the customizable elements of product innovation.
MonItoRInG AnD RePoRtInG

NSCC expanded ACATS (Automated Customer Accounts Transfer Service), the system created in 1985 to speed the transfer of equity and bond positions in a brokerage account from one firm to another. In 1989, ACATS-Fund/ SERV effectively standardized and automated the process when clients moved their accounts from one brokerage firm to another. Building on this success, in 2005, ACATS-IPS similarly paired the Insurance Processing Service (IPS) with ACATS to standardize and automate account transfers involving annuities. transfer of IRA assets from a fund-sponsored IRA to another fund.
Transfer of Retirement Assets (ToRA) is a related service that facilitates the

ACATSIPS

ToRA

As new distribution channels open beyond the carriers traditional agent network, NSCC is offering these distribution firms easier access to the automated solutions necessary to provide the retirement sector with better insurance products and service.
MInIMIZInG RIsK

To help the industry manage its responsibilities under a complex array of federal and individual state regulations that govern annuity sales and service, NSCC also provides asset value and transaction information. These monitoring and reporting solutions create greater transparency for customers, distribution firms, carriers, and regulators. The ability to confirm transactions or underlying asset values immediately in a contract gives financial firms and their clients the ability to make investment decisions based on timely data, while providing regulators a reliable audit trail to ensure compliance.
BUsIness BY tHe nUMBeRs

By automating linkages between trading parties and providing services to support the full lifecycle of mutual fund and annuities, NSCC has helped the industry grow while reducing errors, improving processing efficiency, reducing operation risk, lowering the cost of transaction processing, and easing regulatory compliance. But most important, NSCC has helped the broker/dealers, banks, and third party financial planners who market these investment products enhance their customer serviceand offer investors more product transparency and competitive choice in meeting their investment and retirement goals.

ble ty

Fund/SERV currently completeson a daily basisan average of 800,000 mutual fund transactions worth billions of dollars that are held in millions of accounts maintained at over 1,000 fund companies and intermediary firms. In 2008, NSCC processed 73.4 million insurance applications, premiums, and commissions valued at

$29.6 billionan increase of 42% over the prior year.

Fund/SERV
DAILY AVG. TRANSACTIONS FUND COMPANIES TOTAL VALUE

Mutual Fund
2009 by Lightbulb Press, Inc. All Rights Reserved.

GUIDe to cLeARAnce & settLeMent

An Infrastructure for OTC Derivatives


DTCC is paving the way for a centralized, automated environment for the over-the-counter derivatives market.
Derivatives are financial contracts whose value is linked to an underlying asset or market index. The assets that underlie derivatives contracts range from securities such as stocks or bonds to physical commodities such as pork bellies or barrels of oil. Some derivatives are traded on exchanges while others are privately negotiated contracts between two parties. The latter are known as over-the-counter (OTC) derivatives. Exchange-traded derivatives, which are regulated, have standardized terms. Unregulated OTC derivatives, in contrast, can be customized and tailored to the needs of the counterparties that negotiate them. OTC derivatives serve a number of financial purposes. For example, large corporations, investment banks, institutional investors, sovereign wealth funds, and hedge funds may use them to diversify portfolios, protect against volatility, interest rate or currency movements, and create capital.
tHe PAPeR cHAse

Deriv/ SERV

an underlying asset traded in Japan might report the details of the transaction in an inconsistent manner. This lack of standardization resulted in frequent errors, delays, and significant operational risks. In 2003, DTCC launched the Deriv/SERV family of services to help standardize, automate, and reduce operational risks in the global market for OTC credit default swaps (CDS), one of the fastest growing types of derivatives. While Deriv/SERV does not act as a central counterparty, its family of services automates matching and confirmation, asset servicing, and centralized settlement in multiple currencies. Because of the high volume of trading activity, the high risks of processing CDS trades manually, and the large exposures represented by outstanding contracts, this market also needed a central, automated registry to keep track of CDS contracts worldwide. To fill that need, DTCC created the Trade Information Warehouse in November 2006. The Warehouse centralizes OTC credit derivatives contracts and eliminates the risks, inefficiencies, and uncertainties that arise from incomplete documentation. This comprehensive database serves as the repository for all legally binding OTC credit derivatives contracts. The Warehouse services the contracts in its database, including processing amendments, assignments, and early terminations throughout their terms, which often last several years. It also provides payment services for these contracts,
A centRALIZeD soLUtIon

Trading in OTC derivatives was historically paper intensive and manual, with the details of each contract usually worked out over the phone, by fax, or by email. Because these tailor-made contracts are often negotiated across national borders and regulatory jurisdictions, there was little standardization in the legal documentation for executing these transactions. For example, a deal worked out between a US bank and a British dealer on
BIG BUsIness

The market for OTC derivatives is among the fastest growing in the financial industry. At the end of 2008, the national valueor cash value of the underlying assetsstood at $684 trillion for all outstanding OTC derivative contracts.
28

2009 by Lightbulb Press, Inc. All Rights Reserved.

GUIDe to cLeARAnce & settLeMent

seRVInG tHe MARKet

including calculation of payment amounts, netting of offsetting payment obligations to reduce the number of payments required, and, in partnership with CLS Bank International, central settlement of these obligations in multiple currencies. Payments on CDS contracts occur when they are negotiated and when buyers of credit protection pay quarterly installments to sellers. Payouts are triggered by what are known as credit events.
nAMe tHAt DeRIVAtIVe

Recently, DTCC has partnered with another financial information services company, Markit, to extend matching and confirmation benefits to a wider user base, and across a more diverse range of financial instruments. The new company, MarkitSERV, launched in September 2009, combines the Deriv/SERV and Markit Wire trade confirmation platforms to cover derivatives in all major asset classes including credit, interest rates, equities, and commodities.

Most derivative contracts are variations of a few basic types:

Forwards and futures are agree-

ments to buy or sell an asset at a specified price on or before a particular date in the future. While futures are standardized, exchange-listed contracts, forwards are customized contracts negotiated in the OTC market. the holder the right to buy or sell an asset at a specified price during a predetermined period of time. While many options described as plain vanilla trade on organized exchanges, other less standard options are negotiated in the OTC market.

in a typical interest rate swap, the parties might agree to exchange interest earned at a variable rate for interest earned at a fixed rate on the same principal. In a credit default swap, one party buys credit protection from another, transferring default risk from buyer to seller. Swaps may also be written on currency exchange rates, commodities, and other assets. More complex derivatives are created by combining aspects of these three basic types. For instance, a swaption gives its holder the right, but not the obligation, to enter into an underlying swap by a predetermined date in the future.
cReDIt eVents

Options are agreements that give

Swaps are negotiated agreements to

exchange one thing, such as cash flow or credit risk, for another. For example,

A credit event occurs when an entity on which a CDS contract is written defaults on its debt, through bankruptcy, for instance, or a government takeover. Recent credit events that made the news included the failure of investment bank Lehman Brothers, the US government takeover of mortgage lenders Fannie Mae and Freddie Mac, and the bankruptcies of General Motors and Chrysler.
29

2009 by Lightbulb Press, Inc. All Rights Reserved.

GUIDe to cLeARAnce & settLeMent

A Global Financial Market


Todays securities industry operates across the world.
What were once regional markets, and more recently national markets, have become global markets. Cross-border capital flows and cross-border investments are now the norm rather than the exception. As markets expand, individuals and institutions need a broader range of investment servicing solutions that can reach beyond geographical borders, yet are still reflective of local marketsoperated at cost and developed, owned, and governed by the firms that are the primary users.

D T CC

DC

from the fragmented infrastructure, but not from the high costs of crossborder trading. Unlike the US financial markets, in which the mechanisms for clearance and settlement are highly centralized, each European nation traditionally has had its own securities exchange and post-trade environment. As a result, the rules and infrastructure for executing, clearing, and settling investment transactions differ significantly from one country to another. This fragmentation discouraged crossborder investing and severely impeded the growth and competitiveness of the European markets. For example, a retail investor in Europe would incur much higher costs to participate in the markets of another European country than in his or her home country. Each transaction had to be cleared and settled according to the other countrys rules and processes. Institutional investors often avoided dealing with the different processes by appointing a global custodian that, in turn, hired local custodians in each market. This arrangement created multiple links in the settlement chain and was inherently expensive. The investors were shielded
MeMBeRsHIP oPPoRtUnItIes PAVInG tHe WAY FoR coMPetItIon

The European Union (EU), a partnership of 27 countries, has recognized the benefits of integrating its financial markets. In fact, the EUs core objectives have included the creation of a single European market and the development of a pan-European economy that can rival that of the United States and other global markets. The introduction of the euro in 1999 was a momentous step that the economies of Europe took in that direction. And, in 2000, the national stock exchanges of Belgium, France, and the Netherlands merged to create the first European exchange that transcended national borders, Euronext. Another major step towards market integration came with the implementation of the Markets in Financial Instruments Directive, or MiFID, in late 2007. This EU law is designed to ensure competition among trading venues in various EU countries. It mandates that investment firms guarantee best executionor the best possible trade resultfor their clients. In effect, this edict obligated investment firms to send an order to the venue that could meet a number of criteria, such as executing Best Execution the trade at the best
Best eXecUtIon

In response to growing interest among non-US financial companies to clear and settle their trades directly in US markets, DTCC has recently enacted changes to admit these firms as full members of DTCCs subsidiaries DTC, NSCC, and both the mortgage-backed and government securities divisions of FICC.
30

MiFID

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sYnDIcAteD LoAns

Syndicated loans are complex structures involving multiple lenders for each borrower, with an agent bank acting as the liaison, transmitting information among parties. Market participants buy and sell these syndicated loans in a secondary market, and each time a trade occurs, the agent is responsible for updating the ownership records.

In 2008, DTCC created the Loan/SERV Reconciliation and Messaging services to boost efficiencies, helping to automate and streamline this very manual and risky business of syndicated commercial loan processing. In 2009, more than 80 leading fund managers and the 1,300 investment funds they oversee participated in the syndicated loan market and were linked to Loan/SERV.

EuroCCP Global Corporate Loan/SERV Trade Actions Repository

price, at the highest speed, for the lowest cost, and with the greatest likelihood of a successful settlement. Even in the short time since its implementation, MiFID has had a profound impact on the European markets. In the past, trading was concentrated on the national exchanges. Today, best execution has paved the way for competition and innovation within the EUs emerging integrated investment environment. As Europes traditional national exchanges compete for market share with new, nimble, technology-driven trading platforms, called multilateral trading facilities (MTFs), there is also growing competition among new clearing platforms focused on reducing the costs of posttrade processing. Leveraging its expertise in consolidating and streamlining US post-trade systems, DTCC is playing a key role in shaping the new pan-European clearance
1100110011 Dtcc In eURoPe

and settlement landscape. In August 2008, DTCC launched a pan-European clearing subsidiary based in London, called European Central Counterparty Limited (EuroCCP). Created to bring operating efficiency, robust risk management, and economies of scale in integrating Europes post-trade infrastructure, EuroCCP provides low-cost clearance and settlement for a growing list of trading venues, including MTFs andin the futureexchanges. Among these currently are Turquoise, NYSE Arca Europe, SmartPool, and Pipeline. EuroCCP expects to be clearing for the NASDAQ OMX Nordic exchanges of Copenhagen, Helsinki, and Stockholm by the first quarter of GLoBAL 2010. coRPoRAte

The language of international business is not English, French, German, or Japanese, but binary code. Likewise, DTCCs technology is a common denominator that extends the reach of low-cost and reliable investment servicing solutions to customers no matter where theyre located.

With operations in New York, London, and Shanghai, DTCCs Global Corporate Action (GCA) Validation Service follows the sun, providing round-the-clock coverage to simplify and reduce the cost of communicating information about corporate actions on equity and fixed-income securities that are traded in Europe, the Americas, and the Asia-Pacific region. These services are provided by its subsidiary, DTCC Solutions LLC.
31

ActIons

2009 by Lightbulb Press, Inc. All Rights Reserved.

GLossARY
Beneficial owner is an investor who has purchased and owns a security, even though the title is held in nominee name (also known as street name) for safety and convenience. The beneficial owner receives the dividends or interest the security pays, has the right to sell it, and, in the case of stock, is entitled to vote on certain corporate matters. Multilateral netting is a process through which buy and sell positions are offset within a brokerage firm, no matter who it traded with, to reduce the number of securities that must be delivered. Financial obligations are also netted within and among brokerage firms to reduce the size of settlement payments that must be made. Mutualization of risk means that all par-

accounting system that transfers ownership of securities electronically from the selling brokers account at The Depository Trust Company (DTC) to the buying brokers DTC account when the transaction is settled. With book-entry accounting, no physical certificates change hands.
Central counterparty (CCP) is an entity that interposes itself as the buyer to every selling brokerage firm and the seller to every buying brokerage firm to guarantee a trade will complete even if the original buyer or seller defaults. Clearing fund is a pool of collateral

Book-entry describes the automated

ties who clear and settle trades through a DTCC subsidiary agree to share the potential losses that might result if the subsidiary had to tap the resources of its clearing fund in the event of one trading partys default.

Netting is a process of reducing the number of trade obligations that require transfer of securities and financial settlement by offsetting purchases against sales. Nominee name, also known as street

made up of cash and securities that brokerage firms, banks, and others that clear transactions through The Depository Trust & Clearing Corporation (DTCC) subsidiaries must deposit to participate. The resources can be used to close out a defaulting participants pending trades, reducing losses to its counterparties.

name, is the name in which immobilized securities are registered with the issuers transfer agent if they are not registered to the beneficial owner. Securities held at DTC are registered in its nominee name, Cede & Co, and recorded on its books in the name of the brokerage firm through which they were purchased. On the brokerage firms books, they are assigned to the accounts of their beneficial owners.

Operational risk includes the risks posed

Continuous Net Settlement (CNS) is a fully automated netting system the National Securities Clearing Corporation (NSCC) uses to reduce the total number of trade obligations that require financial settlement. Custody means having possession of certifi-

internally by an organizations infrastructure or policies and externally by natural events, malfunctions, or deliberate attacks.

Repurchase agreement is a fixed-income

cates that represent ownership of securities, whether those certificates are in physical or electronic form.

product. One party to the agreement sells securities to another and simultaneously agrees to buy back the same or similar securities at a specific future date at an agreed-upon price.

Settling bank handles the electronic

nating paper certificates from the securities processing cycle and replacing them with electronic records.
Margin requirement is the minimum

Dematerialization is the process of elimi-

payment or receipt of funds associated with netted securities transactions for the financial firms that have selected the bank to act on their behalf. Payments move through the Federal Reserves Fedwire system.

amount of collateral in cash and securities that a DTCC participant must have on deposit in a clearing fund at a particular moment. Margin requirements are calculated at least daily. that individually or in combination have the potential to drive a securities market lower, reducing the value of the issues trading in that market. Among these factors are falling profits, increasing interest rates, illiquidity, fraud, political unrest, and currency fluctuations.
32

Systemic risk is the possibility that an

entire inter-related system of institutions or structures could be crippled or even collapse if one of the key components of that system failed.

Market risk encompasses the factors

Trade Information Warehouse is a centralized electronic infrastructure and database for retaining the terms, handling the post-trade processing, and serving as a repository for over-the-counter (OTC) credit derivatives contracts. The Trade Information Warehouse is a service offering of DTCC Deriv/SERV LLC, a wholly-owned subsidiary of DTCC.

2009 by Lightbulb Press, Inc. All Rights Reserved.

AUtHoRs
VIRGInIA B. MoRRIs is the editorial director of Lightbulb Press. She oversees the development of a wide range of consumer content on investing, personal finance, and the financial markets for print and interactive media. She serves as a consultant for financial literacy and consumer education organizations for both adults and young people, and shes a frequent guest speaker on financial radio and television programs, as well as at national conferences. Virginia is the author of more than a dozen books on financial subjects, including the Guide to Understanding Money and Investing, An Investors Guide to Trading Options, A Womans Guide to Investing, Guide to Understanding Exchange Traded Funds, An Advisors Guide to Behavioral Finance, Your Guide to Understanding Investing, Saving for Retirement, and Guide to Understanding Direct Investing. Her articles appear in a wide variety of magazines and on corporate websites.

stUARt Z. GoLDsteIn is Managing Director of Corporate Communications and has been chief spokesperson for The Depository Trust & Clearing Corporation (DTCC) since its creation in 1999, and for its National Securities Clearing Corporation subsidiary since 1992. He is responsible for overseeing the firms media relations program, crisis management, executive communications, public affairs activities, internal communications and corporate Web strategy.
He is an accomplished writer and has published numerous articles on trends in the field of corporate communications and is a frequent newspaper op-ed contributor on public policy issues. Most recently, he has served as editor of Clearing the Way, a special purpose magazine distributed globally on market infrastructure issues.

LIGHtBULB PRess Project Team Design Director Dave Wilder Art Director Kara W. Hatch Editors Sophie Forrester, Sarah Hickey, Mavis Morris Production Thomas F. Trojan sPecIAL tHAnKs

DTCC: Michael C. Bodson, Scot Halvorsen, Ed Fanning, Mark Vercruysse, Crystal Levy-Bueno, Stephen Letzler
2009 BY LIGHtBULB PRess, Inc. ALL RIGHts ReseRVeD.

Lightbulb Press, Inc., 37 West 28th Street, New York, NY 10001 Tel. 212-485-8800, www.lightbulbpress.com ISBN: 978-1933569-98-7 No part of this book may be reproduced, stored, or transmitted by any means, including electronic, mechanical, photocopying, recording, or otherwise, without written permission from the publisher, except for brief quotes used in a review. While great care was taken in the preparation of this book, the author and publisher disclaim any legal responsibility for any errors or omissions, and they disclaim any liability for losses or damages incurred through the use of the information in the book. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that neither the author nor the publisher is engaged in rendering financial, legal, accounting, or other professional service. If legal advice, financial advice, or other expert assistance is required, the services of a competent professional person should be sought.

2009 by Lightbulb Press, Inc. All Rights Reserved.

GUIdE

TO

CLEARANCE

&

SETTLEMENT

is an overview of The Depository Trust & Clearing Corporation ( D T C C ) , w h o s e s o p h i s t i c a t e d i n f r a s t r u c t u re a n d r i s k management systems provide essential services to US and global capital markets. The guide explains clearing, netting, and settlingthe essential elements of post-trade processing and the role of a central counterparty in ensuring completion of equity and fixed-income transactions. It looks, as well, at the increasing number of solutions DTCC provides for financial firms at home and around the world.
LEM ENT RAN CE & SETT GUI DE TO CLEA LEM ENT RAN CE & SETT GUI DE TO CLEA

Tracking a Tragde than meets the eye. a trade


Theres a lot more to settlin

T (TRADE DATE)
, or After the transaction is matchedselling and locked-in, between buying d system firms, the markets automate NSCC. sends trade information to In the case of equity transactions, 99.9% are

This settlement of the financial markets. day after s Clearing The National Securitie cycle begins the first business bought a and The Depository So, if you Corporation (NSCC) the trade is executed. T+1 would occur facilitate orderly Trust Company (DTC) stock on Friday morning, T+3 would 100 million equity and transfer of more than the following Monday, every trading day. transactions, on average, occur on Wednesday. equity, municiMore than 99.9% of all transactions in pal, and corporate bond settled within three the United States are e mandated by business daysthe timetabl Commission e the Securities and Exchang and efficiency (SEC) to ensure the stability

which sent to NSCC as locked-in trades, compared means that the marketplace confirming n, them at the time of executio quantity, all details, including share price, and security. NSCC confirms trade details with participating firms, NSCC legally binding them to complete the transaction.

DE MAKING A TRA
Investor places an order to with a broker/dealer. buy or sell

T+1
T+2, NSCC steps in as At midnight between T+1 and trade. At this point, to the central counterparty (CCP) to make the trade whole NSCC assumes responsibility or selling firm be unable to should either the buying n. fulfill its end of the obligatio

INVESTORS

Broker/dealer firm sends the order to an exchange or market for execution.

EXCHANGES & MARKETS

A
FIRMS

T+2
to the NSCC issues a trade summary g buying and selling firms, indicatin owed net money and net securities for settlement. instructions to DTC NSCC sends settled. detailing net positions to be

Report

T+3
DTC transfers securities electronically from the selling at firms account to NSCCs account account DTC, and then from NSCCs to the buying firms account. Firms instruct their settling receive banks to send funds to, or funds from, DTC to complete the transaction.

DTC

SETTLING BANK

13

12

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