we're going to try and understand the
business process flow of securities as
they are traded
uh cleared and settled in today's
financial markets place and in order to
do this this diagram
summarizes the
important players and their roles
within this context
let's
have a look here on the left where we
have a
an investor
who wants to buy securities from the
marketplace
now their order is placed onto the
exchange via an intermediary and this
intermediary is
called a broker
the broker is a special
entity that is authorized by the
exchange to buy and sell securities on
behalf of others and on behalf of itself
there are strict requirements to become
a broker
and there are all kinds of compliance to
ensure that the broker is performing a
a good role for on behalf of the
investors
so once the order is placed onto the
market via the broker
the exchange receives the
the the buy order similarly it receives
sell orders onto the exchange in the
same manner and throughout the day the
exchange will be holding
lists of buy and sell
of different quantities of securities at
different target prices and throughout
the day it will
attempt to perform automatic matching
based on price
product uh quantity and so on and so
forth now when it finds a match it will
send back an order confirmation of the
details back to the broker and
at this point the broker will forward
those details back to the investor now
this whole process
uh is
normally conducted in the front office
and is a
termed trade execution
so this whole cycle is the trade
execution cycle
now once the exchange has confirmed the
trade
it also
works hand in hand with the
clearinghouse
and the clearinghouse is a special
institution
that is introduced into the settlement
cycle in order to safeguard the
interests of buyer and seller it
effectively guarantees the trade on
behalf of the buyer and seller and it
becomes materially important for much
larger quantities of trades where you
may have
billions and billions of pounds that are
being exchanged and are at risk at the
same time
so the clearinghouse
at this moment in time actually
takes ownership of the trade and splits
the trade into two separate trade legs
one leg
is a buyer to the seller and the other
leg is a seller to the buyer
and by doing this it legally transfers
the title of the shares for that period
of time
to the clearing house
this is purely to become a guarantor
for the safety of the investors
now
um whilst the clear the the tactical
term by the way is novation
um it's taking ownership of uh the the
the trade um
uh um
for a period of time
now
throughout the trading day there are a
number of trades that are coming through
from the exchange and the clearinghouse
is responsible for performing netting
now netting is where
a number of trades with the same
counterparty in the in the same product
can be grouped together
and
netted into a single transaction rather
than multiple
so whilst it's performing the netting at
the end of the day it will create one
net figure for the settlement
obligations
of that counterparty and it will send
those settlement obligations through
to the counterparty's
um
nominated custodian or nostro agent if
it's
for cash settlement
now that concludes the responsibilities
of the clearinghouse and the exchange
and at this point
the
uh the investor
will have a
trade which is locked in
in other words it has been matched it's
been confirmed on the exchange and it
requires settlement and settlement is
normally t plus two
so it has a um two days in which to pay
for the securities
now the safest way for payment of
securities is delivery versus payment
and this ensures that there is
simultaneous payment of security in
return for cash
now
at this point
the
clearing agent has already had
instructions from
the clearinghouse notifying it of
pending settlement and now all it's
waiting for is for the investor to
submit their formal instruction to
settle this transaction
and when this happens uh the payment
must match the payment that is made at
the custodian and the nostra and when
this matches there is transfer of cash
from the custodian or the nostril agent
for security and the clearinghouse
formally deregisters the buyer and
re-registers the seller and that way the
uh security is kept in electronic
bookkeeping form at the depository and
that pretty much concludes the full
settlement lifecycle it starts off with
the investor
taking a view on the market and placing
an order onto the market via an
intermediary otherwise known as the
broker
and
the exchange performs a matching
execution and settlement finding the
best price on the market for that
particular product
and then the clearing which involves uh
ensuring that there is the correct
computation
according to netting
and ensuring that settlement becomes the
final part of the chain
the final part then the investor makes a
payment to the nostro the custodian and
this completes the chain
of settlement
now
we'll take a look in subsequent
tutorials how
this would actually happen in practice
with the
use of an efficient elements system or
settlements engine