Chapter 7: Clearing and Settlement Flashcards
What is post-settlement?
Management of failed transactions and the subsequent accounting of trades
How are trades matched that are conducted via order book?
Auto-matched, matching engine is integrated into the technology
What is clearing/clearance?
Defines the obligations held by the buyer and the seller in the trade
When does clearing introduce credit risk?
When trades are cleared bilaterally, outside a CCP
What is LCH?
A multi-asset clearing house
What is LCH’s CCP service for equities called?
EquityClear
What is the NSCC and FICC?
Subsidiaries of DTCC (Depository Trust and Clearing Corp)
NSCC - National Securities Clearing Corp
FICC - Fixed Income Clearing Corp
What are the 3 models defined by the BIS for DvP settlement?
Model 1
Trades settle
What is Model 1 as defined by the BIS for DvP settlement?
Trades settle on a gross (trade-by-trade) basis with a final simultaneous exchange of securities and funds between buyer and seller
e.g. CREST
What is Model 2 as defined by the BIS for DvP settlement?
Systems settle securities transfers intraday throughout the processing cycle
Funds settle on a net basis, with the final transfer occuring at the end of the processing cycle
What is Model 3 as defined by the BIS for DvP settlement?
Securities and funds settle on a net basis with final transfers occurring at the end of the processing cycle
What is the limitations of Model 1?
Funding, hard to predict the largest debit balance intraday
Can be based on securities availability
E.g. if we don’t have gilts to deliver we don’t get the cash which is used to settle other things
What does CREST give LSE members that trade frequently traded listed company share trades the option to do?
Settle with LCH’s EquityClear CCP
What is an example of a member firm using a LCH as a CCP when trading a single security?
To illustrate this, if a firm has 20 orders executed in the same security through the Stock Exchange Electronic Trading Service (SETS), it could choose to either settle 20 trades with LCH ltd (settling on a gross basis), or choose to have all 20 trades netted so that the firm just settles a single transaction with LCH ltd (settling on a net basis).
Where are securities and fund accounts usually held for Model 2 settlement?
Securities - in the system
Funds - another entity, e.g. commercial/central bank
Funds settle end of processing cycle
What is the benefit of Model 2?
Settle funds on a net basis, reduces frequency of transactions that fail due to insufficient funds
What is the risks of Model 2?
Counterparty risk, don’t receive cash
What is utilised to reduce Model 2 counterparty risk?
Assured payment system, irrevocable commitment from the buyer’s bank to make payment to the seller’s bank at the end of the processing cycle
What is the most popular settlement model?
Model 2
Why is Model 2 popular?
Easiest to realise liquidity efficiencies
How are securities transferred in Model 3?
Book entry
What is the advantage of Model 3?
Reduces funding and security requirements
Everything is netted once/several times a day
What is the risk with Model 3?
Can create large liquidity exposures if a participant fails to settle a large net
What are the 3 types of custodian?
- Appointing a local custodian in each market in which they invest - direct custody arrangements
- Appointing a global custodian
- Settle trades and hold cash/securities directly in a CSD/ICSD
Why did the term global custody come into usage?
ERISA - Employee Retirement Income Security Act
What did ERISA - Employee Retirement Income Security Act mandate?
That pension funds could not act as the custodians of the assets held in their own funds. Had to be held in the safekeeping of another bank. Only US banks.
Who are the two largest global custodians?
BNY Mellon
State Street
What is a sub-custodian?
Employed by a global custodian as its local agent to provide settlement and custody services on behalf of clients in foreign market.
E.g. BNP
What is local custodian?
Provide sub-custody in their home market, local market specialists
E.g. Bank Hap
What is a regional custodian?
Offers regional custody, e.g. HSBC in Asia
What is a nominee shareholder?
Nominee that holds shares on behalf of the beneficial owner
What is the reasoning behind choosing a nominee shareholder?
Reduces administrative burden, safe custody
Quicker processing times
What is a pooled nominee?
Omnibus/Commingled
Clients are grouped together
What is a designated nominee?
Numbered accounts
Nominee name includes unique identifies for each client
E.g. JPMCC Account 1, JPMCC Account 2
What is a sole nominee?
Single nominee name used for client
Why would an investor choose designated (dividends)
Some investors require dividends to be mandated to a specific bank account, no possible with Omnibus
What is a corporate nominee?
Issuing company provides a facility for smaller shareholders to hold their shares under one corporate nominee
How can a corporate nominee be related to a halfway house between pooled and designated nominee?
Whilst single entry on the register, the issuing company will have visibility on the individual holdings that make up the nominee
Can forward dividend payments to individual shareholders
What is the cost of an individual registration?
Fairly minimal, relative to overall custody and securities lending charges
What is record date?
The date which a copy of the shareholders register is taken. These will be paid the next dividend. EOD
What is the ex-dividend date?
Business day before record date. Typically thursday
How long from record day does a company pay dividend?
30 days
What is the ex-dividend period?
Period between ex-dividend date up to dividend payment date.
Between what dates are shares traded without dividend right?
Ex-dividend date (day before record date) and Dividend payment date
How does settlement periods affect dividends?
If record date is Friday, and a security is T+2, this will have to be traded by Wednesday in order to appear on the register.
When is a share traded cum-dividend?
All dates but the ex-dividend period
What is a special cum-trade?
Special arrangement where during ex-dividend date the buyer does receive the next dividend
When can a special cum-trade be executd?
Up to and before the payment date. Not on or after the payment date.
During ex-dividend period
What is a special ex trade?
Bought during cum-dividend period but does not receive the dividend
When is special ex possible?
In the 10 business days prior to the ex-date
Why would a buyer do special ex/cum trade?
Usually tax reasons
Dividends are subject to income tax
What is continuous linked settlement?
The process where large banks manage FX settlement among themselves
Who manages CLS? (Continuous Linked Settlement)
CLS Group Holdings
Who regulates CLS? (Continuous Linked Settlement)
Federal Reserve Board of New York
How does CLS settle transactions?
On a PvP (payment-versus-payment) bassi.
What is Herstatt risk?
Settlement risk in FX where swaps are not paid simultaneously
How were FX transactions settled prior to CLS?
Two separate payment legs
What caused the introduction of CLS?
26 June 1974 - German Regulators put Bankhaus Herstatt into liquidation
Had received FX payments in the dat but had not yet made any payments
Could not make payments, banks that had paid in were left short
How does CLS work?
Payment from one party is only made if there is a payment coming in the opposite direction
Why was Central European Time window chosen for CLS?
To allow an overlap for all global markets
What time zone does CLS operate in?
7am-Midday CET (Central European Time)
Which banks pay using CLS?
Central banks
What is distributed ledger technology?
Replacement of a centralised ledger with a decentralised network of computers all holding copies of exactly the same ledger
How are changes done to a distributed ledger?
By consensus from ‘nodes’
What is securities driven and cash driven motivations in stock lending?
Securities Driven
Firms borrow to facilitate operations
Cash Driven
Firms lends to increase returns
How are securities lending fees usually quoted?
Annualised percentage of the value of the loaned securities
What does it mean for a fee to be quoted as a rebate?
If cash collateral is agreed, the lender will earn interest that accrues on the cash - and will rebate an agreed rate of interest to the borrower.
When do short positions have to be declared?
In Europe, %s of total share capital
>0.1% - declared to Regulator
>0.5% - declared to public
What is a haircut?
The amount that the collateral exceeds the market value of the borrowed assets
What does SBLI stand for?
Stock Borrowing and Lending Intermediary
What do SBLIs do?
Act an intermediary between those who want to lend (pension funds) and those who want to borrow (hedge funds)
Why would a custodian bank offer an SBLI service?
Custodian banks often run as a loss-making activity.
SBLI supplements income
What is a manufactured dividend?
Dividend or coupons passed back to the lender
What does a lender need to do in order to vote?
Recall the shares
What is the GMSLA?
Global Master Securities Lending Agreement
Market standard agreement for securities lending
What is the difference between Stock Lending and Repo?
Stock Lender charges fee to the borrower
Repo counterparty pays or receives rate of interest
What is the variation margin?
The pre-agreed band that collateral value may be before a margin payment is madde.