Custody and Central Securities Depositories Flashcards
What is settlement?
Transfer or ownership from seller to buyer & transfer of cash.
Contains two parts: Clearing and Settlement
What is clearing?
The calculation of obligation.
The securities to be transferred & money to be paid
What is cash on delivery?
Goods must be paid for at delivery or else they will be returned
What is delivery versus payment
Securities are only delivered after payment has been made
What is the US settlement cycle, and who is responsible for the system?
T+1 as of May 2024
Depository Trust & Clearing Corporation (DTCC)
What is the settlement cycle in the UK
Who is responsible for it?
T+1 for Gilts
T+2 for Equities and Corporates
CREST
What is the settlement cycle in Japan
Who is responsible for it?
T+2 for Corporates and Equities
T+1 for JGBs
Japan Securities Depository Centre (JADSEC)
How does crest work for international stocks?
CREST places stocks at a local depository. E.g. Clearstream for Germany or the DTCC for US equities.
What is a clearing house?
What is it vital to doing and how?
An institution which settles and clears transactions.
Vital to minimising counterparty risk via novation
What is novation?
The process by which the clearing house turns one contract into two
In both contracts the clearing house becomes the central counterparty to both parties
Why do clearing houses require margin and collateral?
As the counterparty to all transactions - market failure is contingent on their capitalisation
Give 4 acceptable forms of margin:
1) Cash (confirmed by bank certificates)
2) Short Term Govt Securities
3) Stock in the clearing corporation
4) Letter of credit issued by an approved bank
What is initial margin?
Posted at the beginning of the trade - covers the maximum daily price fluctuations
What is variation margin?
Clearing house requires more margin to cover price moves
Via direct debit within an hour
This lets the clearing house maintain control over margins and minimise risk
How has the role of the clearing house has expanded over time?
1) Transaction Process
2) Post-trade management
3) Management of collateral
4) Final settlement (delivery of good or payment to seller)
5) Risk Management
6) Guarentee performance of contracts
Who is the major UK clearing house?
London Clearing House (LCH ltd)
Who are the major European clearing houses?
EuroCCP
ICE Clear Europe (Supervised by BoE)
EUREX (German)
EMIR recognises ICE and EUREX as CCPs
What does a Central Securities Depository do? (CSD / ICSD)
1) Custody of Assets
2) Settlement of Securities
3) Track ownership
4) Secure storage
How many CSDs do each countries have?
Generally one who is assoicated with the domestic stock exchange
They are often heavily regulated
What is an ICSD
Provides settlement / custody services for international securities
What are the primary functions of a CSD?
1) Immobilisation (placing physical assets / certificates at a central depository)
2) Safekeeping - Dematerialising, etc.
3) Deposit and Withdrawal
4) Corporate Action Processing (voting, buybacks, take up rights etc.)
5) Pleding
What is a custodian?
An organisation responsible for ensuring that a client’s assets are fully protected at all times.
What services does a custodian provide?
1) Safekeeping
2) Arranging Delivery
3) Collect dividend income and interest
4) Monitor entitlements (e.g. corporate actions)
5) Manage Tax
6) Register securities
7) Provide Market Info
What are the 4 options when making custody arrangements?
1) Global Custodian - full range of markets
2) Regional Custodian - multiple markets in one region
3) Local Custodian - one market
4) CSD / ICSD
Give an example of a global custodian and how they work?
Network of local custodians - e.g. Citi have over 100
Can also use external agents as “sub-custodians”
Who can be a sub-custodian
The global custodians own branch
Local agent bank
Regional Provider
What is a local custodian?
Banks which specialise in providing custody to their home market
Experts / specialits in their market
Dying breed compared to global custodians
When are local custodians particuarly attractive?
1) When practices differ greatly from global standards
2) Relationship between custodian / regulatory authorities leaves it well positioned.
Give 5 advantages of local custodians:
1) Country Specialists
2) Act as “eyes and ears” of the global custodian
3) Regular dealings with regulators and politicians - can improve efficiency
4) Expert knowledge of practices, culture and language
5) May offer opportunities for reciprocal business
Give 3 disadvantages of local custodians:
1) Credit Rating not up to requirement
2) Cannot offer the same discount that regional can
3) Tech / Service may lag behind regional custodians
What is a regional custodian?
Give two examples of large regional custodians:
Provides custodian services across multiple markets in a region
HSBC & Stan Chart
What are the advantages of a regional custodian:
1) Higher credit rating than local
2) Can learn from experience in one market to another
3) Can offer discounts to global custodians using many of its markets
4) benefit from economies of scale
5) Tech / service better than locals
6) Size of firm and its clients can exert pressure on regulators
Give 3 disadvantages of regional custodians:
1) Less well attuned to local market practice and culture
2) Due to spread of clients - each client may not receive the level of attention a local custodian could offer
3) Lack the customer base/track record of local custodians
What 3 ways do crypto custodians differ from traditional custodians?
1) Security - tougher security measures needed like cold storage, biometrics
2) Regulation - lack of regulation
3) Transparency - Due to the complex nature of crypto, more transparency is required to ensure customers are aware of the actions of the custodian
Aside from this, broadstrokes they are similar to traditional custodians
What is cold storage?
Storing an investor’s private key offline
Who are the major users of Crypto custodians?
Hedge Funds, Governments and institutional investors
What is laid out in a custody agreement?
1) How the assets are held, protected and segergated
2) The responsibilities and obligations of the custodian
3) Define actions that require instruction and which do not (also allow 3rd parties e.g. managers to give instruction)
4) Reporting obligations
5) Standards of Service / Care
6) Contingency to cope with failure
What is a sub-custody agreement, what two things are included?
An agreement between a global custodian and a firm they employ to act as a sub-custodian
1) Responsibilities of the sub-custodian
2) How assets will be held and kept seperate
What is a service level agreement and what is included in one?
An agreement of the standard of service required
1) Record Keeping
2) Market Knowledge
3) Stock Lending and Borrowing
4) Communication
5) Processing corporate actions
What is the process of selecting a custodian?
1) RFI
2) RFP
3) Further interview / investigation after RFP screening
What does a RFP include?
1) Background information
2) capacity of IT / Staff / Systems
3) Track record / experience
4) Recent Losses
5) Credit Worthiness
It is effectively a large survey to filter out candidates - its an early stage of the process
What legislation largely effects custodians?
Pension regulation e.g. UK Pension Act
Why does pension legislation affect custodians?
Pension trustees are responsible for appointing custodians. Trustees are liable for civil penalties
What standards must pension trustees adhere to?
1) Demonstrate familiarity with the structure / aim of pension scheme
2) Must have appropriate training and skill
3) Monitor and review tasks they delegate to third parties
4) Loyalty demands means trustees must act in best interest of members
5) Avoid undue risk
