gtcs

®

Fund/SERV

SELLSELL

SELL

BUY

BUY

SELLSELLSELL

SELLBUY BUY BUY

BUY

A

Security

SETTLINGBANK

Report

Tracking a TradeThere’s 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, munici-

pal, and corporate bond transactions in

the United States are settled within three

business days—the 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.

Investor places an order to buy or sell

with a broker/dealer.

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

After the transaction is matched, or

locked-in, between buying and selling

firms, the market’s automated system

sends trade information to NSCC.

In the case of equity transac-

tions, 99.9% are

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.

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 transfers securities

electronically from the selling

firm’s account to NSCC’s account at

DTC, and then from NSCC’s account

to the buying firm’s account.

Firms instruct their settling

banks to send funds to, or receive

funds from, DTC to complete

the transaction.

MAKING A TRADE

T (TRADE DATE)

T+1

T+2

T+3

INVESTORS

FIRMS

EXCHANGES & MARKETS

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, legally binding them to complete the transaction.

NSCC

DTC

13

12

GUIDE TO CLEARANCE & SETTLEMENT GUIDE TO CLEARANCE & SETTLEMENT

• Matching and Netting

• OTC Derivatives

• Trade Settlement • Stocks

• Reducing Risk • Mutual Funds

• Bonds• MBS

• Custody

VIRGINIA B. MORRIS AND STUART Z. GOLDSTEIN

An Introduction to DTCC

G U I D E T O C L E A R A N C E & S E T T L E M E N Tis an overview of The Depository Trust & Clearing Corporation (DTCC), whose sophis t icated infrastructure and risk management systems provide essential services to US and global capital markets. The guide explains clearing, netting, and settling—the 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.

Lightbulb Press, Inc.www.lightbulbpress.com

[email protected] Phone: 212-485-8800

www.lightbulbfinancial.comLatest guides • Popular articles • Bookstore

©2012 by Lightbulb Press, Inc. All Rights Reserved. ©2009 by Lightbulb Press, Inc. All Rights Reserved.

Welcome 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, you’ve never heard of DTCC? Well, maybe that’s because we’ve done our job so well, quietly behind the scenes.

Since the 1970s, the efficiencies and low costs associated with DTCC’s centralized infrastructure are credited with attracting the flow of investment capital to the US—that 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 you’ll read in this guide, DTCC links all mutual funds to all banks, broker/dealers and financial planners, which gives investors unlimited choice.

You’ll also learn about DTCC’s 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 par-ticipants—and taxpayers—from 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. DonahueChairman and CEOThe 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

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

20 Up and Running

22 Streamlining the Markets

24 Trading Mutual Funds

26 Insurance and

Retirement Services

28 An Infrastructure for

OTC Derivatives

30 A Global Financial Market

32 Glossary


Introducing DTCCThe Depository Trust & Clearing Corporation plays a central role in the capital markets.

equivalent of the US annual gross domes-tic 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.

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 com-panies and creation of new ones.

One organization plays a leading role in keeping this transaction pipe-line flowing smoothly and efficiently. It does so by processing all the trans-fers of money and securities between buyers and sellers.

Because this company, The Depository Trust & Clearing Corporation (DTCC), through its subsidiaries, processes enormous volumes of transactions—more than 30 billion a year—its costs per trans-action 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, DTCC’s array of post-trade processing services helps make the United States an attractive mar-ket for investors at home and abroad.

MARKet scoPeTrading volumes of stocks and fixed-income instruments, including US government securities, mortgage-backed 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 transac-tions 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

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

seRVInG tHe InDUstRYDTCC is a utility for the financial services industry.• DTCCusesasophisticatedinfra-

structureofphysicalequipment, softwareprograms,andrisk managementsystemstodeliveressentialservices,includingtradematching,clearing,netting,and settlingsecuritiestransactions.

• DTCCisownedbyitsusers— broker/dealers,banks,investmentmanagers,andotherthirdpartieswhomarketfinancialproducts and services.

GUIDe to cLeARAnce & settLeMent

2©2009 by Lightbulb Press, Inc. All Rights Reserved.

cUttInG costsAs a utility for the financial services indus-try, 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

rebates and discounts returns excess to customers.

One DTCC subsidiary, the National Securities Clearing Corporation (NSCC), reports that clearing each side of an equity trade—once for the seller and once for the buyer—in the United States costs an average of three-tenths of a cent ($0.003), regardless of the number of shares being traded. That’s 100 times cheaper than the cost of clearing a comparable trade in Europe.

In addition—and perhaps even more important—by 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 custom-ers can use for other investment purposes.

It’s A GLoBAL MARKetCapital 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 per-ception that the US economy is stable and that the dollar, despite its up and downs, is sound. But there’s 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, bal-ance-sheet netting, and cost savings that are available to US members.

Since 2008, DTCC has been pro-viding 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.

• DTCCusersareknownasparticipants,customers,ormembers.Eachfull participantisalsoanownerbecause itisrequiredtopurchasesharesintheorganization.ParticipantswhousealimitednumberofDTCCservicesareconsideredmembersbutnotowners.

• DTCCismarket-neutral,whichmeansitacceptstransactionsfrommultipletradingplatformsonanondiscrimina-torybasis.Itcurrentlysupportsmorethan50,includingtheNewYorkStockExchange(NYSE)andNasdaq.

• DTCCoperatesonanat-costbasis.

DeFInInG tHe teRMsCentral counterparty (CCP) is an entitythatinterposesitselfasthebuyertoeverysellerandthesellertoeverybuyertoguaranteeatradewillcompleteeven ifanoriginalpartytothetrade—eitherthebuyerortheseller—goesbankrupt or otherwise defaults. Clearing and settlement is a processthatfinalizesatradebytransferringownershipofthetradedassetand thecashtopayforit.Custodyishavingpossessionofcertifi-catesthatrepresentownership,whethertheyareinphysicalorelectronicform.Nettingisaprocessofreducingthenumberoftradeobligationsthatrequirefinancialsettlementbyoffsetting purchasesagainstsales.



Streamlining Clearance and SettlementPost-trade processing wasn’t 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 bro-kers who had bought stocks and bonds and returning with the checks to pay for them.

Meanwhile, back-office clerks at bro-kerage companies processed the extensive paperwork required to settle each trans-action and transfer ownership on the firms’ books. In fact, a single securities transfer could involve as many as 33 dif-ferent forms. The result was an increasing backlog of undelivered certificates and accounting discrepancies, totaling hun-dreds of millions of dollars at some firms.

tHe PAPeR cRUncHIn 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

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 60’s and 70’s 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 that’s in use today.

A neW eRA oF settLeMentThe 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 com-munity for streamlining and automating securities transfers, a group consisting of New York’s clearing house banks, the NYSE, the American Stock Exchange (Amex), and the National Association

1940 1950

cLeARInG UP A PAPeR cRIsIs

1946TheSECsettlementtimeincreasedfromtwodaysto four.

1968Sharevolumepeakedat21.4million—SECincreasedsettlement timetofivedaysandNYSEclosed on Wednesdays.

tHe Go-Go YeARsThroughoutthefirsthalfof1968,newtradingvolumerecordsweresetalmostdaily,peakingatabout21.4millionsharesonJune13.But,puttingthosenumbersinperspec-tive,they’retinycomparedtothe4.8billionshares

onaveragethatclearedeachdayin2008.



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

market—formed the Banking and Securities Industry

Committee (BASIC). The collaboration ultimately resulted in the creation of The Depository Trust Company (DTC) in 1973.

Jointly owned by key industry players, DTC’s 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 computer-ized book-entry system.

consoLIDAtInG FoRcesWhile eliminating the industry’s 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-

CUSIPIDentItY PRoBLeMsPartoftheinefficiencyinclearanceandsettlementwasthechallengeof identifyingsecuritieseasilyandaccurately,eitherbylookingatthemorusing theirtickersymbols.

Toresolvetheproblem,theCommittee on Uniform Security Identification Procedures (CUSIP)oftheAmericanBankersAssociation(ABA)createdauniversalcodingsystem.Since1967,allstocksandgovernment,corporate,andmunicipalbondsregisteredintheUnitedStatesandCanadahavebeenassignedauniquenine-characterCUSIPnumberidentifyingthecompany orissuerandthetypeofsecurity.TheCUSIPserviceisownedbytheABAandadministeredbyStandard&Poor’sFinancialServices,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 com-pleted 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 process-ing 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.

A ReGULAtoRY noteDTC, NSCC, and the Fixed Income Clearing Corporation (FICC) are registered clearing agencies and self- regulatory 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.

1960 1970 1980

cLeARInG UP A PAPeR cRIsIs

1968TheNationalClearingCorporation (NCC) was created to clear OTC transactions.

1969 Morethan100firmsdefaulted whenthemarketdropped.

1973 TheDepositoryTrustCompany(DTC)wascreatedtoimmobilizestockcertificates,andtheswitchwasmade toanelectronicbook-entrysystem.

1976 Creation of theNationalSecurities ClearingCorporation(NSCC).

1975TheSecuritiesActAmendment createdtheNationalMarketSystem (NMS) andtheBankingandSecuritiesIndustryCommittee(BASIC)wasformed.



GENERAL INC.

CCPCCP

N S C C

GENERAL INC.

Building a SystemThe structure of clearance and settlement rests on the foundation that was established in 1973.

Today, NSCC and DTC—now wholly owned subsidiaries of DTCC—clear 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, it’s important to recognize that what’s T for one transaction

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

FUnGIBLe secURItIesInvestorscanbuyandsellsecurities,suchassharesofstockorcorporatebonds,becausethesecuritiesarefungible,orinterchangeable,inthesamewayone$20billhasexactlythesamevalueasanyother$20bill.

tAKInG ResPonsIBILItYOne of the major questions in any finan-cial transaction is whether the person or organization on the other side of the deal—the buyer if you’re selling or the seller if you’re buying—will live up to the terms of the bargain. This potential default, known as counterparty risk, is serious enough when the agreement is between indi-viduals.

But it can be even more problematic if the agreement depends on a financial institu-tion, such as a brokerage firm,

which may be the counterparty to millions of trades that occur in various market-places 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 counter-party (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 secu-

rities or make the payment the firm

owes. For exam-ple, 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.



Demater ial i zer

0 1 0 0 1 1GENERAL INC.

contRoLLInG tHe FLoWIn the same legislation that established the National Market System, Congress recommended immobiliza-tion, 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 and registered in its nominee name, Cede & Co., also known as street name. On DTC’s books, shares of those securities are recorded in the brokerage firm’s name. But at your brokerage firm, your name is on the firm’s books as the beneficial owner of the securities.

So, for example, when you sell shares of stock, the ownership of the shares is transferred electronically from your broker’s DTC account to the DTC account

tIMe to DeMAteRIALIZeTheglobalgoalofeliminatingpapercertificateshasbeenunderwayfordecadeswithmixedsuccess.Somecountrieshavegonesofarastodictatethewaycertificateslook,hopingthatdullgraypiecesofpaperwillbelessattractivetoinvestorsthantheelaboratelydesignedandoftenbeautifulcertificatesofthepast.

of the broker whose client purchased the shares. The firms’ records are then updated to reflect the change, and the confirmation notice sent to you is proof you sold the shares and of the amount you received for the sale. The buyer receives a similar confirmation notice

detailing the shares purchased and the amount paid.

Only a small number of investors continue

to hold paper cer-tificates—affecting just one-tenth of one percent (0.001) of all equity trades each day.

eLIMInAtInG PAPeR entIReLYThe 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 retrieval have been put in place, owner-ship records are increasingly strictly electronic. Issuers simply don’t 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 sys-tem. Similarly, mutual funds, US Treasury securities, commercial paper, and other financial products are issued only in elec-tronic form.

Dematerialization appears to be the future of equities trading as well. Since 2008, all stocks listed on US exchanges must be eligible for the Direct Registration System (DRS). This system allows registered owners to hold securities on the books of the issuers or the issuers’ transfer agents in book- entry form, rather than in the form of paper stock certificates.



99.9% of all equity trades are locked in

NSCCClearance

BUYORDER

SELLORDER

BUYORDER

100SHARES

OFNRQ

100SHARES

OFNRQ

100 SHARES

OFNRQ

SELLORDER

BUYORDER

100SHARES

OFNRQ

100 SHARES

OFNRQ

Investor

FIRMA

FIRMB

Clients place orders

FIRMA

SELLSELL

SELL

SELLSELLSELL

SELL

BUY

BUY BUY BUYBUY

BUY

99% of trading obligations areeliminated through netting

Financial obligationsare netted to a single

dollar amounteach day

NSCC

MAtcHInG

nettInG

Matching and NettingThe 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 don’t require the exchange of money.

MAtcHInG tHe DetAILsMatching, 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.

Here’s 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 firm—say Firm B—fills the order in its trading system in response to a cli-ent’s 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 elec-tronically 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 communi-cation electronically to the trading firms. This communication legally commits the firms to complete the deal.

eXcePtIons to tHe RULeIn today’s 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 firm’s information doesn’t match the selling firm’s, 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.



99.9% of all equity trades are locked in

NSCCClearance

BUYORDER

SELLORDER

BUYORDER

100SHARES

OFNRQ

100SHARES

OFNRQ

100 SHARES

OFNRQ

SELLORDER

BUYORDER

100SHARES

OFNRQ

100 SHARES

OFNRQ

Investor

FIRMA

FIRMB

Clients place orders

FIRMA

SELLSELL

SELL

SELLSELLSELL

SELL

BUY

BUY BUY BUYBUY

BUY

99% of trading obligations areeliminated through netting

Financial obligationsare netted to a single

dollar amounteach day

NSCC

nettInG

firm’s position either as net seller—when that firm’s clients have sold more shares of a particular security than they purchased—or as net buyer—when the firm’s clients bought more shares of a security than they sold.

These positions of net seller and net buyer are determined through netting, the process of automatically offsetting the firm’s buy orders on an individual security against its corresponding sell orders for that security. The net buys and sells are determined by matching CUSIPs—each security’s 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 their trades. For example, suppose that Firm A had 100 clients buying and selling shares of stock NRQ. Through netting, the vast majority of these trades may cancel each other out by offsetting shares bought against shares sold.

Though it’s conceivable for a firm’s trades in a particular security to net out perfectly, it isn’t very likely. So, at the end of the day, NSCC may alert Firm A that it is a net seller of 500 shares of NRQ and must deliver those shares to settle its obligation.

sells can be netted together. This process is known as multilateral netting.

Netting financial obligations—the money that must change hands—is even easier. All money owed to or from a partic-ular firm for its trading activity is netted to a single dollar amount each day by NSCC.

What that means is that any firm that ends the day with a net debit needs to have only enough money on hand to cover its net financial obligation. That is always less than the actual value of its transactions.

nettInGThroughnetting,DTCC’sclearingagencysubsidiariesareabletoreducethetotalnumberoftradeobligationsrequiringfinancialsettlement.Oftherecord$315trillioninequitysecurities transactionsprocessedin2008,NSCCnetteddown99%.So only$2.9trillionrequiredanexchangeofsecuritiesorcash.

NettingalsosignificantlyreducesindustryriskandhelpsDTCCcustomersoptimizecapitalbyfreeinguptrillionsofdollarsthattheycanuseforotherinvestmentpurposes.Thatincreased liquidityisasignificantadvantageofthecentralizedclearanceandsettlementsystemthat’safeatureofUScapitalmarkets.

DIstILLInG tHe nUMBeRsOn 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 counter-party to all trades. So no matter how many different firms Firm A traded with on a particular security, all of those buys and



T+3

T+4T+3 cont.

DTCNet

SellerNSCC

Hey, now it’s time to

settle up.

I don’t have that much time

on hand.

I’ll take what is

available.Report

DTC

LendingFirm

That’sall they’ve

got.I can

lend youwhat you

need.

I canborrowthe rest.

Stock BorrowProgram

Stock Borrow

Program

SELLORDER BUYORDER

NSCC

NetSeller FTD

FTD SEC

You must deliver

tomorrow.

CNS

NSCC

OK, here’s your final net

amount due.Report

NetSeller

NetBuyer

This is just whatI expected.

Me too.Report

DTC

NSCCSettling

Bank

Done, and done.

Except I havea net debit, so

I owe some cash.

$ $

I don’thave that

much stockon hand.

Getting SettledEvery day is T+3 for a new group of transactions.

The pieces all come together on the settlement date (T+3) when a securities transaction is finalized. It’s the day when the money is exchanged and the ownership changes.

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 what’s available in the firm’s account with the trust company in order to transfer ownership.

PARtIcIPAnt FIRMsThebroker/dealerswhoareamongthemorethan300participantsintransactionshandledthroughtheNSCCsystemarecalledself-clearingfirms.Inthisrole,theymayclearandsettletransactionsfortheirownfirms.AparticipantthatisaclearingfirmcanclearandsettleforitsownfirmandforotherbrokeragefirmsthatarenotNSCCmembers.

Someclearingfirmsalsoproviderecord-keepingandcustodyservicesfortheclientaccountsofotherbroker/dealers,knownasintroducingfirms,thatdon’tdotheirownclearing.Allclientassets,mostofwhichexistaselectronicrecords,mustbekeptsegregatedfromtheclearingfirm’sownassets.

BeHInD tHe scenesSettlement doesn’t just happen. But NSCC and DTC have established a process to ensure that it does.

On T+2, NSCC commu-nicates to financial firms what their final cash and securities obligations are. It also sends an electronic report to DTC describing

DeLIVeRY PRoBLeMsIf a firm doesn’t provide securities that are due on T+3, it is still obligated to make delivery. Through NSCC’s 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. That’s 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

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.



T+3

T+4T+3 cont.

DTCNet

SellerNSCC

Hey, now it’s time to

settle up.

I don’t have that much time

on hand.

I’ll take what is

available.Report

DTC

LendingFirm

That’sall they’ve

got.I can

lend youwhat you

need.

I canborrowthe rest.

Stock BorrowProgram

Stock Borrow

Program

SELLORDER BUYORDER

NSCC

NetSeller FTD

FTD SEC

You must deliver

tomorrow.

CNS

NSCC

OK, here’s your final net

amount due.Report

NetSeller

NetBuyer

This is just whatI expected.

Me too.Report

DTC

NSCCSettling

Bank

Done, and done.

Except I havea net debit, so

I owe some cash.

$ $

I don’thave that

much stockon hand.

teMPoRARY LoAnsIf 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

lending business activity is done outside of NSCC.

However, on occasion, firms may still find them-selves without enough securities to cover their delivery obligations. In these situations, NSCC’s automated Stock Borrow Program goes into effect.

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 broker’s legal obligation to eventually deliver the securities.

NSCC doesn’t charge for the service, which was created in the 1980s to keep the settlement system func-tioning and to help complete more trades on T+3.

PAYInG tHe BILLThe final stage of settlement is moving the money from buyer to seller, a process that occurs in parallel with transferring owner-ship 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 don’t 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 indi-vidual 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 pay-ment through the Federal Reserve Bank’s Fedwire system. This process automates and streamlines what used to involve the delivery of physical checks to complete

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 & coSecuritiesthatDTCholdsinitsdepositoryare registeredinthenomineeorstreetnameof Cede&Co,whichoriginatesfromanacronym forCEntralDEpository.Changingownership recordsforthesesecuritiescanbedone efficientlyusingbook-entryaccountingmethodswherenocertificatesactuallychangehands.



A

Security

SETTLINGBANK


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, munici-pal, and corporate bond transactions in the United States are settled within three business days—the 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.

Investorplacesanordertobuyorsellwithabroker/dealer.

Broker/dealerfirmsends the order to anexchangeormarketfor execution.

DTC transfers securities electronicallyfromthesellingfirm’saccounttoNSCC’saccountatDTC,andthenfromNSCC’saccounttothebuyingfirm’saccount.

Firmsinstructtheirsettlingbankstosendfundsto,orreceivefundsfrom,DTCtocomplete the transaction.

MAKInG A tRADe

t+3

INVESTORS

FIRMS

EXCHANGES & MARKETS



Security

Report

Afterthetransactionismatched,orlocked-in,betweenbuyingandsellingfirms,themarket’sautomatedsystemsendstradeinformationtoNSCC.

Inthecaseofequitytransac-tions,99.9%are

AtmidnightbetweenT+1andT+2,NSCCstepsinascentralcounterparty(CCP)tothetrade.Atthispoint,NSCCassumesresponsibilitytomakethetradewholeshouldeitherthebuyingorsellingfirmbeunabletofulfillitsendoftheobligation.

NSCCissuesatradesummarytothebuyingandsellingfirms,indicating netmoneyandnetsecuritiesowed forsettlement.

NSCCsendsinstructionstoDTC detailingnetpositionstobesettled.

t (tRADe DAte)

t+1

t+2

senttoNSCCaslocked-intrades,whichmeansthatthemarketplacecomparedthematthetimeofexecution,confirmingalldetails,includingsharequantity,

price,andsecurity.NSCCconfirms

trade details with participatingfirms,legallybinding themtocomplete the transaction.

NSCC

DTC



DVPMBsD ccPGsD

Settling DebtsA lot happens under the US government’s fixed-income umbrella.

The Fixed Income Clearing Corporation (FICC) automates clearing, netting, and settling trades in US government securities in the secondary market—the world’s largest and most liquid fixed-income market.

sMootHInG tHe FLoWUsing 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 settle-ment 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 what’s known as a delivery vs. payment (DVP) system.

Using multilateral netting, GSD calculates each participant’s daily cash settlement obligation, aggregating all net positions to a single dollar value. In 2008, for example, GSD netted average daily

2000 2010

A BRIeF tIMeLIne

1994MortgageBackedSecuritiesClearingCorporation(MBSCC) movedtoNewYorkandaffiliatedwithNSCC.

1986NationalSecuritiesClearingCorporation(NSCC)formedtheGovernmentSecuritiesClearingCorporation(GSCC).

2002GSCCandMBSCCbecamepartoftheDepositoryTrust&ClearingCorporation(DTCC).

2003DTCCmergedthetwo companiesintoanewsubsidiary,FixedIncomeClearing Corporation(FICC).

19901980

Through its Government Securities Division (GSD), FICC handles the clearing 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 non-mortgage government agencies, such as the Tennessee Valley Authority (TVA) and the Import-Export Bank.

A second division, the Mortgage-Backed Securities Division (MBSD), clears and settles secondary market transactions in mortgage-backed securi-ties 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.



RttM RePoGcFcash obligations of $4.1 trillion down to $1 trillion, creating enormous efficiencies in trade settlement.

AUctIon tAKeDoWnTo 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 settle-ment obligations and the securities are delivered to the purchasers as they arrive in the GSD accounts at the clearing banks from the Federal Reserve.

MAnAGInG RIsKAs 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 member’s default, GSD requires all participants to contribute to

GettInG A tRIMWhen securities are used as collateral inmarginaccounts,theircurrentvaluesmaybereducedbyacertainpercentagetoprotectagainstpotentialfutureloss.Thediscountisdescribedas a haircut.

a margin account, depositing either cash or eligible securities.

As trades reach GSD, they are matched and confirmed by its Real-Time Trade Matching (RTTM) system. Buyers and sellers receive immediate notification, making their obligation to complete the trade legal and binding.

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 indi-vidual securities. And it

collaborates with futures clearing organizations, in a process called cross-margining, to keep track of participants’ credit

exposure—and thus potential vulner-ability to default—across fixed-income markets.

BUYInG BAcK tHe FARMMeasured 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.

General collateral finance (GCF) repos create even more short-term liquid-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 it’s made before the underlying assets can be deliv-ered. In fact, dealers can wait to allocate specific securities to a transaction until after the end-of-day netting.



Clearing MBSSettling transactions in mortgage-backed securities is big business.

The Mortgage-Backed Securities Division (MBSD) of the Fixed Income Clearing Corporation (FICC) is the only centralized clearing facility for the $60 trillion market in mortgage-backed securities (MBS).

These securities are issued by US government corporations and agencies,

including Ginnie Mae, and the government sponsored enterprises (GSEs) Fannie Mae and Freddie Mac. The division doesn’t clear MBS offered by nongovernment organizations.

Like FICC’s 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 MoneYOne 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

before they create a problem that would interfere with timely settlement.

Similarly, by employing multilateral netting to reduce the number of secu-

settLeMent cYcLesSIFMAissuesa12-monthMBSsettlementcycle.EachclassofMBSsettlesonceamonthonapredeterminedday.Forexample,all15-yearClassAFannieMaeMBSmightsettleonJune15,andall30-yearClassCGinnieMaeMBSmightsettleonJune19.Thefollowingmonth,theproductswill settleinthesameorder,thoughtheactualsettlementdateswillvary.

rities that must be delivered and the amount of money that must change hands to settle the day’s transactions, MBSD reduces post-trade costs and frees up capi-tal that can be used for other purposes.

tHe MoRtGAGe MARKetTransactions in mortgage-backed securi-ties 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 settle-ment—a 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 nine-digit identifying code, that identifies the terms—including the maturity date and coupon rate—of the hundreds of securi-ties that are eligible for inclusion.

Mortgage-backed securities have an extended settlement schedule that concludes over four days.



JUst WHAt Is An MBs?Mortgage-backedsecurities(MBS)are createdbybundlingagroupofsimilar mortgagesinto apackage thatcanbe divided into slices and sold to investors.

This approach works because mort-gages 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 that’s 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.

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.

tYInG UP tHe enDsThrough 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 MBSD’s 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.

Under MBSD’s future CCP operation, however, members will send pool instructs to MBSD’s 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 FICC’s clearing banks, with FICC as the counterparty. Trade participants also deliver or receive the mortgage pools that didn’t net and settle these obligations directly with each other rather than with FICC.

MAnAGInG MBs RIsKThe 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 require-ments 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 credit- worthiness, along with other risk factors.

Mortgage-backed securities have an extended settlement schedule that concludes over four days.



DTCCDTCC

NSCC

DTC FICC

Managing RiskRunning 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 you’re responsible for clearing and settling billions of dollars of equity and fixed-income transactions every busi-ness day. In that case, risk management is at the heart of the job. A large part of DTCC’s 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 dis-ruptions that can occur, evaluating the damage they could cause, and identifying effective ways to protect against them.

WHAt DAnGeRs LURK?Among the known risks that DTCC faces, two especially demand constant vigilance:

• On the financial front, participant 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.

A cAse In PoIntLehmanBrothers,formerlyoneoftheworld’slargestinvestmentbanksandaprincipaluserofDTCC’sservices,declaredbankruptcyinSeptember2008.Whenit did,thefirmexposedthefinancialservices industry,marketparticipants—andtaxpayers—toover$500billionworthofopentradeobligationsinvariousmarketsand asset classes.

DTCCwasabletoliquidateallofLehman’sopenpositionsinaboutsixweekswithnoimpacttotheindustryandwithoutanylosstotheclearingfundoruseofitslinesofcredit.DTCC’srigorousrisk-manage-mentprocess,includingsimulationexercisesthattestedhowtohandlejustsuchamelt-downonlymonthsbeforeithappened,wereinstrumentalinthesuccessfuloutcome.

Inaddition,becauseDTCChadaccuraterecords of the value of unsettled credit de-faultswapsintheLehmanportfolio—closerto$6billionthanthe$400billionitwasrumored—DTCCwasabletocalmfearsthatthe entire financial industry was threatened.

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

MeMBeRsHIP ReQUIReMentsFor DTCC, managing risk means being selective. To become a full member and be able to clear and settle transactions through any of DTCC’s three subsidiaries—NSCC, FICC, or DTC—prospective participants must satisfy stringent membership requirements.



DTCCDTCC

S.S. CLEARING FUNDS.S. CLEARING FUND

Members are also subject to an ongoing surveillance program designed to detect anything out of the ordinary, including a concentra-tion of trading positions in certain securities. Members may be asked for more collateral if trading pat-terns suggest an increased risk to the clearing corporation.

In the event that a DTCC sub-sidiary ceases to act for a member, DTCC notifies other participants and the SEC and acts to close out the pending trades.

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

MUtUALIZAtIon oF RIsKOne 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 collateral—generally a mix of cash and securities—in a clearing

no RIsK UnMAPPeDWhenyourbusinessismanagingrisk,youlookbothforwardandbackward.Tobe preparedforanyunwelcomesurprises, DTCCriskmanagementteamsusescenarioplanningexercisestosimulatefinancial meltdownstheyhopewillneverhappen andtestpotentialresponsesforcontainingthe situation if they should.

Throughoutitshistory,DTCC’sclearing corporationhasneverhadalosstoitsmem-bers’clearingfundsfromafirmfailure.And,sincemorethan35participatingfirmshavefailedinjustoverthreedecades,that’sampleevidencethatDTCChasthenecessaryexpertiseandexperienceinthisarea.

fund. This fund provides a pool of resources that protects all participating parties in the event of a firm’s failure. The idea is that through a mutualization of risk, the industry can mitigate loss from closing out a defaulting member’s pending positions.

There’s a minimum deposit into the clearing fund for each firm, and some firms, if they’re considered over-leveraged, must deposit more. The amount that’s 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 sub-sidiary, 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.


19©2009 by Lightbulb Press, Inc. All Rights Reserved. ©2009 by Lightbulb Press, Inc. All Rights Reserved.

Up and RunningSuccess often depends on the ability to make the complex routine.

The sophisticated hardware and software that automate the clearance and settle-ment 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 trad-ing accelerates and the volume mushrooms, advances in technol-ogy 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 con-stant innovation and upgrading.

BoostInG cAPAcItYDTCC and its subsidiaries have responded to the demands of escalating trade volumes by regu-larly 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 trade- processing capability. In 2009, for exam-ple, 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 NSCC’s system won’t be overwhelmed by unpredictable spikes in trading volume that are typical by-products of financial crises and economic turmoil. In the tur-bulent 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 transac-tions, representing 19.3 billion shares.

WHen ReDUnDAncY Is sMARtExtraordinary events—such as power outages,

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

DTCC has established rigorous business-continuity 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 settle-ment isn’t interrupted if transaction records are lost or computers can’t 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 minute’s worth—or less—of 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.

secURe DAtA tRAnsMIssIons AnD IncReAseD tRADe VoLUMe



cMMILatein2008,DTCCwasappraisedataCapabilityMaturityModel®Integration(CMMI®)Level3acrossitsentireenterprise.CMMI,aninternationallyrecognizedassessmentfromtheSoftwareEngineeringInstitute(SEI)ofCarnegieMellonUniversity,isameasureofexcellenceinimprovingorganizationalprocesses.IncombinationwithDTCC’s softwaresecurityprogram,CMMILevel3providesa highlydisciplinedapproachtoembedandenforcesoft- waresecuritycontrols.ItworkswhetheritiscustomcodewrittenbyDTCCdevelopersorsoftwarepurchasedofftheshelfandadaptedforuse.

tHe BLAcKoUtLateintheafternoonofAugust14,2003,a massivepowerblackoutleaptfromClevelandto DetroittoTorontotoNewYorkinseconds,affecting 50millionpeople.

ButDTCC,withmultipleoperatingsites,back-uppowergenerators,andcontingencyproceduresinplace,continuednormalprocessing.OneofDTCC’sremote operatinglocationstookleadresponsibilityforsettle-mentoperations,andoneofitsremotedatacenterssteppedintomanagedataprocessingoperations.

DTCC also maintains operating centers in multiple locations in the United States and overseas, which are separate from its data centers. Those operating centers are designed to handle physical activities supporting clearance, settlement, processing of income and dividend payments, and responding to corporate actions.

stAYInG connecteDA secure, redundant communi-cations network to carry data, voice, and Internet is vital to keeping trade and settlement information flowing between customers and DTCC’s 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 disrup-tion 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 cAPtUReHigh-speed electronic transmis-sion is an essential component of DTCC’s business continuity planning because it makes possible the replication and storage of data at its multiple data centers. Synchronous—or simultaneous—transmission works smoothly over distances

of up to 70 miles. The data travels along a network of fiber optic cables, moving as a continuous stream between open connections. Errors that may creep in can be readily corrected.

Before 2003, the only way to move data across greater distances was asyn-chronously, where small packets of data literally hop across a telecomm network.

The problem, however, was that you could lose up to a two-hour window of data, which was not acceptable. In 2003, DTCC began working with EMC Corporation to bring innovation to asynchronous communication, transferring large amounts of accurate data over 1,000 miles and closing the potential loss of data to under 30 seconds.

secURe DAtA tRAnsMIssIons AnD IncReAseD tRADe VoLUMe



CeDe& Co.

Streamlining the MarketsDTC has a part to play in every stage of a security’s lifecycle.

The Depository Trust Company (DTC) was created in 1973 to streamline the set-tlement of securities transactions in the US capital markets. To get the job done, DTC took custody of and immobilized millions of paper certificates and devel-oped an electronic book-entry system to record the changes in ownership.

Today, DTC not only ensures the seamless settlement of retail and insti-tutional 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 pay-ment 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 with-drawn from custody.

PResent At cReAtIonThe once paper-intensive task of bringing new securities issues to market has been streamlined by DTC’s underwriting ser-vices. Underwriters can submit, in real time, the extensive documentation that’s required, distribute both primary and secondary offerings, and settle transac-tions electronically.

DTC’s 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,

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

connectInG WItH cLIentsThe dividends and interest that investors expect to receive from their equity and debt securities is one of the major reasons they’re willing to put their money into the capital markets. DTC plays a major role in facilitating these payments when they’re made on issues held in DTC’s nominee name of Cede & Co. DTC also coordinates tax-withholding information where applicable.

Dividends owed to the beneficial own-ers 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 cor-porate actions to broker/dealers whose clients are affected. Typically, corporate actions include tender offers, rights offers,

KeePInG BUsYIn2008,DTCsettledtransactionsvalued atalmost$455trillionandprocessed 316.6millionbook-entrydeliveries.

Dtc



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

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, pro-viding 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. Omgeo’s 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.

convertible security conversions, war-rants, mergers, and redemption notices on municipal and corporate bonds.

on tHe BooKsThrough its Direct Registration System (DRS), DTC likewise serves registered owners of equities who:

• 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

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 DTC’s 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 own-ership with the issuer’s 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 tRADesA retail transaction—also known as a broker-to-broker or streetside trade—may 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:

• Institutional investor, such as a mu-tual fund, pension fund, hedge fund,

DTC,asacentralsecuritiesdepository,holdscustodyof85%to90%ofallsecuritiesintheUnitedStatesandservicesthoseassetsforfinancialfirmsonbehalfofinvestors.


23©2009 by Lightbulb Press, Inc. All Rights Reserved. ©2009 by Lightbulb Press, Inc. All Rights Reserved.

FIRMFIRMFIRMFIRM

FUNDFUNDFUNDFUND

BEFORE Fund/SERV

Trading Mutual FundsIt 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 labor intensive. Here’s what happened if you told your broker to buy shares of ABC Fund:

1. Your broker con-tacted 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.

2. Next, ABC Fund and your broker com-municated 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 way—manual-ly—and often one order at a time.

cReAtIon oF FUnD/seRVWhile the industry continued to grow, by the 1980s the manual nature of the pro-

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 grow—and 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 build-ing a series of proprietary networks to provide those links was cost-prohibitive.

WHo Does FUnD/seRV seRVe?Fund/SERVhandlestransactionsin conventionalpooledinvestments,including open-andclosed-endmutualfunds.ArelatedproductfromNSCC,theAlternativeInvestmentProducts(AIP)suiteofserviceshandlestransactionsinalternativeproductsincludinghedgefunds,fundsofhedgefunds,privateequityrealestateinvestmenttrusts(REITs),andlimitedpartnerships.



FIRMFIRMFIRMFIRM

FUNDFUNDFUNDFUND

Fund/SERV

AFTER Fund/SERV

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 con-sortium 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.

That’s 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 FLoWInGFund/SERV acts as a central hub for mutual fund transactions, linking all trad-ing parties—mutual funds and the broker/dealers and banks who market their prod-ucts—automating 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-

firms or rejects the order through Fund/SERV, which then relays that confirmation or rejection back to your broker almost imme-diately. Selling your shares of ABC Fund is handled the same way.

When a transaction 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 there’s 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 cHoIceReducing time and errors is just part of the Fund/SERV story. From an investor standpoint, Fund/SERV has created virtu-ally 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 there’s no centralized system, and a single cross-border transaction can be as much as €50.

ALL tHRoUGH tHe nIGHt (AnD DAY)BrokerscanentermutualfundordersthroughFund/SERVatanypointbetween2amand

midnightEST,MondaythroughFriday.Fundcompaniescanelecttoreceive thoseordersinrealtime,astheyenterthesystem,justonceaday,orin batchesatpredeterminedintervalsthroughoutthe22-hourtimeframe.



VariableAnnuityMutualFund

MutualFund

VariableAnnuity Variable

AnnuityMutualFund

VariableAnnuity

VariableAnnuity

VariableAnnuity

VariableAnnuityVariable

Annuity

MutualFund Mutual

Fund

MutualFund

MutualFund

Insurance and Retirement ServicesAutomated 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 pres-ents both an opportunity and a challenge for two segments of the financial services industry: the companies that create retire-ment products, and the firms that market those products to their retail clients.

The opportunity is the nearly $15 tril-lion invested in retirement accounts that must be refocused from asset accumula-tion to providing income. The continuing challenge is how to reach these account holders with attractive, competitive prod-ucts that offer the same level of automated efficiency and transparency that charac-terizes buying and selling assets such as stocks, bonds and mutual funds.

stReAMLInInG tHe sYsteMMutual funds have evolved as a major force for investors to build and preserve assets in the US financial markets in large part because NSCC’s automated Fund/SERV system makes transactions quick, accu-rate, and inexpensive, linking funds with the broker/dealers, banks, and financial planners who market these products.

That’s 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

WHeRe tHe Assets AReAtyear-end2008,mutualfundsaccountedfor22%ofUSretirementassetsand annuitiesheld12%,withthebalanceinotherfinancialproductsmanagedby pensionfunds,insurancecompanies,banks,andbrokeragefirms.

have been mired in a traditional paper-intensive, manual sales and service model.

A transaction that in other financial sectors takes place in seconds can take significantly longer for an insurance product. What’s more, many of the distri-bution parties have yet to be electronically linked to be able to sell and service these products, communicate essential informa-tion, 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 neeDFor 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

Baby boomers have nearly $15 trillion invested inretirement accounts.



VariableAnnuityMutualFund

MutualFund

VariableAnnuity Variable

AnnuityMutualFund

VariableAnnuity

VariableAnnuity

VariableAnnuity

VariableAnnuityVariable

Annuity

MutualFund Mutual

Fund

MutualFund

MutualFund

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

MInIMIZInG RIsKBy 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 pro-cessing, 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 service—and offer investors more product transparency and competi-tive choice in meeting their investment and retirement goals.

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 cus-tomizable elements of product innovation.

MonItoRInG AnD RePoRtInGTo help the industry manage its responsi-bilities 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 report-ing 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.

MoVInG on AnD RoLLInG oVeR Wheninvestorsswitchbrokeragefirms,which theydoforavarietyofreasons,theyunder- standablywanttomovealltheirassets— stocks,bonds,mutualfunds,andannuities— totheirnewaccount,withminimalhassleandnomistakes.

Inthe1980s,transferringmutualfundsandannuities,whichinvolvesupdatingregistrationsonthebooksofthefunds,insurancecompa-nies,orbrokeragefirms,wasmorecomplicatedanderror-pronethanmovingindividualsecuri-ties.Theresultingdelayswereasourceoffrictionnotonlybetweenfirmsandmutualfundorinsurancecompanies,butalsobetweenfirmsandtheirfrustrated clients.

To solve theseproblems,

NSCCexpandedACATS(AutomatedCustomerAccountsTransferService),thesystemcreatedin1985tospeedthetransferofequityandbondpositionsinabrokerageaccountfromonefirmtoanother.In1989,ACATS-Fund/SERVeffectivelystandardizedandautomatedtheprocesswhenclientsmovedtheiraccountsfromonebrokeragefirmtoanother.Buildingonthissuccess,in2005,ACATS-IPSsimilarlypairedtheInsuranceProcessingService(IPS)withACATStostandardizeandautomate accounttransfersinvolvingannuities.

Transfer of Retirement Assets (ToRA) is a related service that facilitates the transferofIRAassetsfromafund-sponsoredIRAtoanotherfund.

BUsIness BY tHe nUMBeRsFund/SERVcurrentlycompletes—ona dailybasis—anaverageof800,000 mutualfundtransactionsworthbillions ofdollarsthatareheldinmillionsof accountsmaintainedatover1,000fund companiesandintermediaryfirms.

In2008,NSCCprocessed 73.4millioninsuranceapplications, premiums,andcommissionsvaluedat

$29.6billion—anincreaseof42%over theprioryear.

800000OVER 1000TRILLIONS

DAILY AVG.TRANSACTIONS

FUNDCOMPANIES

Fund/SERV

TOTALVALUE

ToRAACATS-IPS

ACATS-Fund/SERV



Deriv/SERV

An Infrastructure for OTC DerivativesDTCC 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 com-modities 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, institu-tional investors, sovereign wealth funds, and hedge funds may use them to diver-sify portfolios, protect against volatility, interest rate or currency movements, and create capital.

tHe PAPeR cHAseTrading 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 trans-actions. For example, a deal worked out between a US bank and a British dealer on

an underlying asset traded in Japan might report the details of the transaction in an inconsistent manner. This lack of stan-dardization resulted in frequent errors, delays, and significant operational risks.

A centRALIZeD soLUtIonIn 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 central-ized 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 pro-vides payment services for these contracts,

BIG BUsInessThemarketforOTCderivativesisamong thefastestgrowinginthefinancial industry.Attheendof2008,thenational value—orcashvalueoftheunderlyingassets—stoodat$684trillionforall outstandingOTCderivativecontracts.



Deriv/SERV

$

$

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 install-ments to sellers. Payouts are triggered by what are known as credit events.

nAMe tHAt DeRIVAtIVeMost 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 be-fore a particular date in the future. While futures are standardized, ex-change-listed contracts, forwards are customized contracts negotiated in the OTC market.

• Options are agreements that give 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 stan-dard options are negotiated in the OTC market.

• Swaps are negotiated agreements to exchange one thing, such as cash flow or credit risk, for another. For example,

seRVInG tHe MARKetRecently,DTCChaspartneredwithanotherfinancialinformationservicescompany,Markit,toextendmatchingandconfirma-tionbenefitstoawideruserbase,andacrossamorediverserangeoffinancialinstruments.Thenewcompany,MarkitSERV,launchedinSeptember2009,combinestheDeriv/SERVandMarkitWiretradeconfirma-tionplatformstocoverderivativesinallmajorassetclassesincludingcredit,interestrates,equities,andcommodities.

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 eVentsA credit event occurs when an entity on whichaCDScontractiswrittendefaultsonitsdebt,throughbankruptcy,forinstance,oragovernmenttakeover.RecentcrediteventsthatmadethenewsincludedthefailureofinvestmentbankLehmanBrothers,theUSgovernmenttakeoverofmortgagelendersFannieMaeandFreddieMac,andthebank-ruptciesofGeneralMotorsandChrysler.

%



DC

MiFIDBest

Execution

A Global Financial MarketToday’s 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 markets—operated at cost and developed, owned, and governed by the firms that are the primary users.

from the fragmented infrastructure, but not from the high costs of cross-border trading.

PAVInG tHe WAY FoR coMPetItIonThe European Union (EU), a partnership of 27 countries, has recognized the benefits of integrating its financial markets. In fact, the EU’s 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.

Best eXecUtIonAnother major step towards market inte-gration 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 coun-tries. It mandates that investment firms guarantee best execution—or the best possible trade result—for 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 the trade at the best

DTCC

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 cross-border 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 country’s 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 oPPoRtUnItIesInresponsetogrowinginterestamongnon-USfinancialcompaniestoclearandset-tletheirtradesdirectlyinUSmarkets,DTCChasrecentlyenactedchangestoadmitthesefirmsasfullmembersofDTCC’ssubsidiariesDTC,NSCC,andboththemortgage-backedandgovernmentsecuritiesdivisionsofFICC.



TradeRepository

Global Corporate Actions Loan/SERVEuroCCP

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 imple-mentation, 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 EU’s emerging integrated investment environment.

Dtcc In eURoPeAs Europe’s 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 post- trade processing.

Leveraging its expertise in consoli-dating and streamlining US post-trade systems, DTCC is playing a key role in shaping the new pan-European clearance

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 Europe’s post-trade infrastructure, EuroCCP provides low-cost clearance and settlement for a growing list of trading venues, including MTFs and—in the future—exchanges. 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 2010.

sYnDIcAteD LoAnsSyndicatedloansarecomplexstructures involvingmultiplelendersforeachborrower,withanagentbankactingastheliaison,trans-mittinginformationamongparties.Marketparticipantsbuyandsellthesesyndicatedloansinasecondarymarket,andeachtimeatradeoccurs,theagentisresponsibleforupdatingtheownershiprecords.

In2008,DTCCcreatedtheLoan/SERVReconciliationandMessagingservicestoboostefficiencies,helpingtoautomateandstream-linethisverymanualandriskybusinessofsyndicatedcommercialloanprocessing.

In2009,morethan80leadingfund managersandthe1,300investmentfunds theyoverseeparticipatedinthesyndicated loanmarketandwerelinkedtoLoan/SERV.

1100110011ThelanguageofinternationalbusinessisnotEnglish,French,German,orJapanese,butbinarycode.Likewise,DTCC’stechnologyis acommondenominatorthatextendsthereachoflow-costandreliableinvestmentservicingsolutionstocustomersnomatterwherethey’relocated.

GLoBAL coRPoRAte

ActIonsWithoperationsinNewYork,

London,andShanghai,DTCC’sGlobalCorporateAction(GCA)

ValidationServicefollowsthesun,providinground-the-clockcoverage

tosimplifyandreducethecostofcommunicatinginformationabout

corporateactionsonequityandfixed-incomesecuritiesthataretradedinEurope,theAmericas,

andtheAsia-Pacificregion.Theseservicesareprovided

byitssubsidiary,DTCCSolutionsLLC.



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.

Book-entry describes the automated accounting system that transfers ownership of securities electronically from the selling broker’s account at The Depository Trust Company (DTC) to the buying broker’s 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 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 participant’s pending trades, reducing losses to its counterparties.

Continuous Net Settlement (CNS) is a fully automated netting system the National Securities Clearing Corporation (NSCC) uses to reduce the total number of trade obliga-tions that require financial settlement.

Custody means having possession of certifi-cates that represent ownership of securities, whether those certificates are in physical or electronic form.

Dematerialization is the process of elimi-nating paper certificates from the securities processing cycle and replacing them with electronic records.

Margin requirement is the minimum 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.

Market risk encompasses the factors 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.

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-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 party’s 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 name, is the name in which immobilized securities are registered with the issuer’s 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 broker-age firm’s books, they are assigned to the accounts of their beneficial owners.

Operational risk includes the risks posed internally by an organization’s infrastructure or policies and externally by natural events, malfunctions, or deliberate attacks.

Repurchase agreement is a fixed-income 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 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 Reserve’s Fedwire system.

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.

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.

32

G LossARY


sPecIAL tHAnKsDTCC: 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.comISBN: 978-1933569-98-7No 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.

LIGHtBULB PRessProject Team

Design Director Dave WilderArt Director Kara W. HatchEditors Sophie Forrester, Sarah Hickey, Mavis MorrisProduction Thomas F. Trojan

AUtHoRsAUtHoRs

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 firm’s 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.

VIRGInIA B. MoRRIs is the editorial director of Lightbulb Press. She over-sees 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 she’s 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 Investor’s Guide to Trading Options, A Woman’s Guide to Investing, Guide to Understanding Exchange Traded Funds, An Advisor’s 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.


®

Fund/SERV

SELLSELL

SELL

BUY

BUY

SELLSELLSELL

SELLBUY BUY BUY

BUY

A

Security

SETTLINGBANK

Report


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, munici-

pal, and corporate bond transactions in

the United States are settled within three

business days—the 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.

Investor places an order to buy or sell

with a broker/dealer.

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

After the transaction is matched, or

locked-in, between buying and selling

firms, the market’s automated system

sends trade information to NSCC.

In the case of equity transac-

tions, 99.9% are

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.

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 transfers securities

electronically from the selling

firm’s account to NSCC’s account at

DTC, and then from NSCC’s account

to the buying firm’s account.

Firms instruct their settling

banks to send funds to, or receive

funds from, DTC to complete

the transaction.

MAKING A TRADE

T (TRADE DATE)

T+1

T+2

T+3

INVESTORS

FIRMS

EXCHANGES & MARKETS

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, legally binding them to complete the transaction.

NSCC

DTC

13

12

GUIDE TO CLEARANCE & SETTLEMENT GUIDE TO CLEARANCE & SETTLEMENT

• Matching and Netting

• OTC Derivatives

• Trade Settlement • Stocks

• Reducing Risk • Mutual Funds

• Bonds• MBS

• Custody

VIRGINIA B. MORRIS ANd STUART Z. GOLdSTEIN

An Introduction to DTCC

G U I d E T O C L E A R A N C E & S E T T L E M E N Tis an overview of The Depository Trust & Clearing Corporation (DTCC), whose sophis t icated infrastructure and risk management systems provide essential services to US and global capital markets. The guide explains clearing, netting, and settling—the 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.

Lightbulb Press, Inc.www.lightbulbpress.com

[email protected] Phone: 212-485-8800

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©2012 by Lightbulb Press, Inc. All Rights Reserved. ©2012 by Lightbulb Press, Inc. All Rights Reserved.

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