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 Part II – Movement of Funds The settlement of funds during the trade settlement process follows a flow similar to the movement of securities. The process differs depending on the trade settlement method employed. Trade-for-Trade Settlement - Money Settlement When firms compare securities transactions for trade-for-trade settlement, both Ex-Clearing and Fixed Income Trade-for-Trade Settlement, the dollar amount settled is the original contract amount. The original contract amount is the "Principal Amount" of the trade plus any accrued interest. The principal amount is calculated by multiplying the quantity of securities traded by the agreed upon execution price. For example: Firm A sells 100 shares of XYZ Co. to Firm B @ $15 per share to settle on a trade-for-trade basis. The settlement amount of this transaction is the contract or principal amount, which is $1,500.
For interest paying Fixed Income securities, the value of any contracted accrued interest is also included in the settlement amount. For example: Firm A sells 1 XYZ Co. bond to Firm B @ par. The trade contract includes $20 of accrued interest. The settlement amount of this transaction is $1,020.
On settlement date, Firm A would deliver the securities to Firm B and would receive the above contract amounts in settlement of the transactions. Net Settlement – Money Settlement When traded securities are eligible for Net Settlement, the settlement amount is not equal to the original contract amount. Instead, the traded securities are adjusted to market value prior to settlement. This adjustment to market value is processed on the evening prior to settlement date, and uses the stock’s closing price from that day’s activity as the new market value. Firm’s settle on the adjusted amount, and receive a "Mark to the Market Adjustment" from the clearing corp. in the daily NSCC settlement figures. The Mark to the Market Adjustment amount is the difference between the current market value and the original contract amount. For example, assume that Firm 1 sells 100 shares of XYZ Co. to Firm 2 at a price of $15 per share. The contract amount is calculated as follows:
Now, assume that the market value of XYZ Co. increases to $18 per share at the close of business on the evening prior to settlement date. The settlement amount is calculated as follows:
Trade-for-Trade Net Settlement vs. Continuous Net Settlement Money Settlement - Trade-for-Trade Net Settlement On settlement date, the NSCC will issue Firm 1 a Deliver Balance Order for 100 shares of XYZ Co. with a settlement amount of $1,800. The NSCC will issue Firm 2 a Receive Balance Order for 100 shares of XYZ Co. with a settlement amount of $1,800. However, the original trade was executed at a price of $15 per share, not $18 per share. Therefore, upon settlement, Firm 1 receives – and Firm 2 pays - $300 too much in settlement of this trade. To compensate the firms for this difference, NSCC generates a monetary adjustment in the amount of the difference between the Contract Amount and the Settlement Amount. This adjustment is classified as a Mark to the Market Adjustment and is calculated as follows:
Therefore, on settlement date, NSCC will charge Firm 1 $300 by processing a debit Mark to the Market Adjustment. Firm 2 will receive a credit Mark to the Market Adjustment for $300 from NSCC. As a result, both firms will settle a net amount of $1,500 with NSCC for the trade of 100 shares of XYZ Co. @ $15 per share.
Money Settlement - Continuous Net Settment The money settlement for CNS eligible securities is very similar to that for Trade-for-Trade Net Settlement. The primary differences between Trade-for-Trade Net Settlement and Continuous Net Settlement are:
On settlement date, Firm 1 will receive a credit of $1,800 in its CNS Settlement Amount in settlement of the sale of 100 XYZ Co. to Firm 2. Similarly, Firm 2 will be charged with a debit of $1,800 in its CNS Settlement Amount. However, the original trade was executed at a price of $15 per share, not $18 per share. Therefore, Firm 1 received $300 too much from CNS in settlement of this trade and Firm 2 paid $300 too much to CNS in settlement of this trade. To compensate the firms for this difference, CNS generates a monetary adjustment in the amount of the difference between the Contract Amount and the Settlement Amount. This adjustment is classified as a Mark to the Market Adjustment and is calculated as follows:
Therefore, on settlement date, CNS will charge Firm 1 $300 by processing a debit Mark to the Market Adjustment. Firm 2 will receive a credit Mark to the Market Adjustment for $300 from CNS. As a result, both firms will settle a net amount of $1,500 with CNS for the trade of 100 shares of XYZ Co. @ $15 per share.
Continuous Mark to the Market CNS adjusts all positions to market value at the close of business each day. Assume from the previous example that Firm 1 did not deliver 100 shares of XYZ Co. to CNS on settlement date. The following CNS positions are open at the close of business on settlement date: Firm 1 – Long 100 XYZ Co. Firm 2 – Short 100 XYZ Co. Further assume that the closing market value of XYZ Co. is $17 per share. The new Net Market Value is $1700:
A Mark to the Market Adjustment of $100 will be applied against the open CNS position for both Firm 1 and Firm 2. Firm 1 will be debited $100 and Firm 2 will be credited $100. This process will be completed at the close of business each day until the CNS Positions are cleaned-up. |
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