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Part I – Securities Settlement

Trade-for-Trade Settlement

Trade-for-Trade Settlement requires that the brokerage firm delivers or receives traded securities directly to or from the firm with which the trade was executed. For example – Firm A buys 200 shares of IBM from Firm B. On settlement date, Firm B delivers 200 shares of IBM to Firm A. In turn, Firm A renders payment to Firm B for the delivered securities.

Securities transactions are subject to Trade-for-Trade settlement under the following conditions:

  1. The trade is compared Ex-Clearing
  2. The security traded is a fixed income security and one - or both - of the trading firms is not a CNS clearing firm

Ex-Clearing

Ex-Clearing is a manual comparison process that is performed by the brokerage firm’s Purchase and Sales Department when the traded security does not meet the eligibility standards of the designated clearing corp.

On settlement date, the firm’s Settlement area will create a Fail Record on the firm’s accounting books and records to represent the open receivable or deliverable. The Settlements area will ‘set-up’ a Fail-to-Deliver for securities sold and a Fail-to-Receive for securities purchased.

The transaction is concluded when the selling firm delivers the sold securities to the buying firm, and the buying firm pays the selling firm for the delivered securities. At such time, the open fail record is removed from the firm’s books and records. The ultimate removal of the open receivable or deliverable is referred to as a "Clean-Up".

Fixed Income Trade-for-Trade Settlement

Certain Fixed Income securities transactions are settled via Trade-for-Trade Settlement even though the particular security traded is eligible for Net Settlement via CNS. This occurs when one - or both – of the participants are not members of CNS.

Fixed Income Trade-for-Trade Settlement transactions require a special "Trade-for-Trade" comparison generated by the designated clearing corp. The trade details submitted by the buy firm and sell firm for comparison must specifically designate the transaction as Trade-for-Trade. This designation is a key trade element. No comparison will result unless both sides agree on the Trade-for-Trade designation.

Successful matches on a specific trade record result when both the buy side firm and the sell side firm submit matching trade records to NSCC. The successful match results in a Trade-for-Trade comparison or trade contract.

On settlement date, the NSCC will generate a Deliver Balance Order to the selling firm. The Deliver Balance Order is an official instruction to deliver the traded securities to the buy side firm. The Deliver Balance Order also specifies the net amount to be received by the delivering firm in settlement of the transaction.

Also on settlement date, the NSCC will generate a Receive Balance Order to the buying firm. The Receive Balance Order is an official instruction to receive the traded securities from the sell side firm. The Receive Balance Order also specifies the net amount to be paid by the receiving firm in settlement of the transaction.

Net Settlement

Net Settlement is a process through which a brokerage firm consolidates all of its trading activity in a particular security for a given settlement date, and makes one aggregate settlement transaction. Net Settlement reduces the need for trade-for-trade settlement and is the catalyst for the automation of the trade settlement process.

Net Settlement streamlines the settlement process by reducing the number of security movements between brokerage firms saving both time and resources.

Unless otherwise specified at the time of the trade – ie. Fixed Income Trade-for-Trade Settlement – the vast majority of securities that are eligible for trade comparison through the NSCC - or another designated clearing organization - are also eligible for the Net Settlement Process.

How Net Settlement Works:

The NSCC or another designated clearing organization forwards the details for all compared trades to the NSCC’s Settlement System for Net Settlement processing. The Net Settlement System consolidates all submitted trading activity and determines which firms are Net Buyers and which firms are Net Sellers.

A firm is a net buyer of securities if it purchased more of an eligible security than it sold on a given day. A net buyer would have a short (-) "Settlement Position", because the purchased shares/bonds must be received from the street.

Conversely, a firm is a net seller of securities if it sold more of an eligible security than it bought on a given day. A net seller would have a long (+) "Settlement Position", because the sold shares/bonds must be delivered to the street.

For example, consider the following trading activity:

TRADING ACTIVITY

  1. Firm 1 Sells 10,000 shares of XYZ Co. to Firm 3
  2. Firm 3 Sells 5,000 shares of XYZ Co. to Firm 6
  3. Firm 3 Sells 2,000 shares of XYZ Co. to Firm 8
  4. Firm 8 Sells 1,000 shares of XYZ Co. to Firm 1

See Exhibit 1 for DAY 1 TRADING ACTIVITY

Based on the trading activity presented:

  1. Firm 1 is a Net Seller of 9,000 shares of XYZ Co.
  2. Firm 3 is a Net Buyer of 3,000 shares of XYZ Co.
  3. Firm 6 is a Net Buyer of 5,000 shares of XYZ Co.
  4. Firm 8 is a Net Buyer of 1,000 shares of XYZ Co.

On settlement date, all Net Sellers receive instructions from the NSCC - or another designated settlement system - to deliver the net quantity of securities sold. Net Buyers receive instructions from the NSCC - or another designated settlement system - to receive the net quantity of securities purchased.

It is very important to note that the actual movement of securities resulting from a Net Settlement transaction is not necessarily between the two originating firms.

For example, the following settlement instructions would be generated for the trading activity presented above:

  1. Firm 1 Delivers 3,000 shares of XYZ Co. to Firm 3
  2. Firm 1 Delivers 5,000 shares of XYZ Co. to Firm 6
  3. Firm 1 Delivers 1,000 shares of XYZ Co. to Firm 8

Or

  1. Firm 3 Receives 3,000 shares of XYZ Co. to Firm 1
  2. Firm 6 Receives 5,000 shares of XYZ Co. to Firm 1
  3. Firm 8 Receives 1,000 shares of XYZ Co. to Firm 1

Note the following:

  1. Through Net Settlement the four trades are settled with only three security movements
  2. Firm 1 delivers shares to Firm 6 even though no trade was executed between Firm 1 and Firm 6
  3. Firm 1 delivers 1,000 shares to Firm 8 even though Firm 1 actually bought 1,000 shares from Firm 8

Net Settlement is accomplished by one of two methods:

  1. Non-CNS
  2. CNS

Non-CNS Net Settlement

Non-CNS Net Settlement occurs when a security is eligible for automated trade comparison via the NSCC – or another designated clearing house – but not eligible for settlement via CNS – Continuous Net Settlement.

Trade Contracts are designated as Non-CNS at the time of comparison. This designation is assigned by the NSCC and is determined at the security level. The resulting trade contract is referred to as a Non-CNS Compared Trade.

Upon successful comparison, the Clearing Corp. submits the Non-CNS Compared Trade to the trade settlement system. All trading activity is consolidated and trade settlement instructions are generated.

The trade settlement instruction generated for a Non-CNS security is called a Balance Order. A Deliver Balance Order is issued to a firm that is a net seller of securities. Conversely, a Receive Balance Order is issued to a firm that is a net buyer of securities. Click here to see an example of a Balance Order.

Again, it is important to note that the generation of Deliver and Receive Balance Orders, and the subsequent movement of securities resulting from Net Settlement, is not directly linked to the actual trade activity which occurred on trade date.

Please consider the original example:

TRADING ACTIVITY

  1. Firm 1 Sells 10,000 shares of XYZ Co. to Firm 3
  2. Firm 3 Sells 5,000 shares of XYZ Co. to Firm 6
  3. Firm 3 Sells 2,000 shares of XYZ Co. to Firm 8
  4. Firm 8 Sells 1,000 shares of XYZ Co. to Firm 1

See Exhibit 1 for DAY 1 TRADING ACTIVITY

Recall that based on the trading activity presented:

  1. Firm 1 is a Net Seller of 9,000 shares of XYZ Co.
  2. Firm 3 is a Net Buyer of 3,000 shares of XYZ Co.
  3. Firm 6 is a Net Buyer of 5,000 shares of XYZ Co.
  4. Firm 8 is a Net Buyer of 1,000 shares of XYZ Co.

Based on this trading activity the following Balance Orders would be generated by the NSCC:

  1. Firm 1 receives a Deliver Balance Order to deliver 3,000 shares of XYZ Co. to Firm 3
  2. Firm 1 receives a Deliver Balance Order to deliver 5,000 shares of XYZ Co. to Firm 6
  3. Firm 1 receives a Deliver Balance Order to deliver 1,000 shares of XYZ Co. to Firm 8

and

  1. Firm 3 receives a Receive Balance Order to receive 3,000 shares of XYZ Co. from Firm 1
  2. Firm 6 receives a Receive Balance Order to receive 5,000 shares of XYZ Co. from Firm 1
  3. Firm 8 receives a Receive Balance Order to receive 1,000 shares of XYZ Co. from Firm 1

On settlement date:

  1. Firm 1 Delivers 3,000 shares of XYZ Co. to Firm 3
  2. Firm 1 Delivers 5,000 shares of XYZ Co. to Firm 6
  3. Firm 1 Delivers 1,000 shares of XYZ Co. to Firm 8

CNS - Continuous Net Settlement

CNS is an NSCC Net Settlement system. CNS enables the brokerage firm to consolidate (net) all of its trading activity – for each eligible security traded – into one net settlement transaction. The system differs from that for Non-CNS Net Settlement in the following ways:

  1. No Balance Orders are generated
  2. Firms deliver/receive securities directly to/from CNS
  3. The Net Settlement Process is continuous

Balance Orders are not generated for trades settling through CNS. Member firms instead receive a Compared Trades Summary – which details all settlement transactions received by CNS - from all sources - for a specific settlement date, and the net quantity to be received or delivered for that day’s activity.

The settlement process is streamlined, because the brokerage firm needs only to settle one net transaction directly with CNS. This eliminates the need for the brokerage firm to settle each individual trade with each of its numerous trading counterparts.

On settlement date, the brokerage firm will either deliver shares/bonds to (the firm was a net seller) or receive shares/bonds from (the firm was a net buyer) CNS. The quantity of shares/bonds the brokerage firm must deliver or receive from CNS is referred to as the firm’s CNS Position. A long CNS Position indicates that the firm must deliver securities to CNS. A short CNS Position indicates that the firm must receive securities from CNS.

It is important to understand that CNS serves as a conduit to facilitate the settlement process between its member firms. Member firms settle through CNS, not with CNS. On any given settlement date, the total shares/bonds owed to CNS must equal the total shares/bonds owed from CNS. At no time does CNS have an ownership interest in the securities it receives and delivers. As soon as CNS receives securities from net sellers those securities are automatically delivered to the firms that are net buyers.

Net Settlement

As with Non-CNS Net Settlement, the CNS settlement process also determines the firm’s net settlement position. A firm is a net buyer if it purchased more of a CNS eligible security than it sold on a given day. A net buyer would have a short CNS Position, because the purchased shares/bonds must be received from CNS.

Conversely, a firm is a net seller if it sold more of a CNS eligible security than it bought on a given day. A net seller would have a long CNS Position, because the sold shares/bonds must be delivered to CNS.

For example, consider the following trading activity:

DAY 1 TRADING ACTIVITY

  1. Firm 1 Sells 10,000 shares of XYZ Co. to Firm 3
  2. Firm 3 Sells 5,000 shares of XYZ Co. to Firm 6
  3. Firm 3 Sells 2,000 shares of XYZ Co. to Firm 8
  4. Firm 8 Sells 1,000 shares of XYZ Co. to Firm 1

See Exhibit 1 for DAY 1 TRADING ACTIVITY

DAY 1 CNS POSITIONS

  1. Firm 1 is a net seller of 9,000 shares of XYZ Co. and has a long CNS Position of 9,000 shares
  2. Firm 3 is a net buyer of 3,000 shares of XYZ Co. and has a short CNS Position of 3,000 shares
  3. Firm 6 is a net buyer of 5,000 shares of XYZ Co. and has a short CNS Position of 5,000 shares
  4. Firm 8 is a net buyer of 1,000 shares of XYZ Co. and has a short CNS Position of 1,000 shares

DAY 1 SETTLEMENT ACTIVITY

  1. Firm 1 Delivers 9,000 shares of XYZ Co. to CNS
  2. Firm 3 Receives 3,000 shares of XYZ Co. from CNS
  3. Firm 6 Receives 5,000 shares of XYZ Co. from CNS
  4. Firm 8 Receives 1,000 shares of XYZ Co. from CNS

See Exhibit 2 for DAY 1 SETTLEMENT ACTIVITY

Continuous Net Settlement

The most important feature of the CNS net settlement process is that it is continuous.

Due to mitigating factors such as Customer Protection Rules, Fed Requirements and Unsettled Trade Activity, a brokerage firm with a long CNS Position does not always have sufficient Excess shares/bonds available to fully satisfy - settle (deliver securities) - its long CNS Position. As a result, the firm sometimes carries forward its long CNS Position – in part or in total - to the next business day.

Similarly, as a result of firms with long CNS Positions being unable to fully satisfy their obligations to CNS, firms with short CNS Positions do not always receive sufficient shares from CNS to satisfy their open receivable. As a result, those firms might carry forward a short CNS Position – in part or in total - to the next business day.

The CNS process is continuous because it takes a firm’s prior CNS Position into consideration in conjunction with the firm’s new net trading activity when determining the firm’s new CNS Position.

Under Continuous Net Settlement the determination of whether a firm is a net buyer or seller of securities begins with the firm’s prior day closing CNS Position. The firm’s prior day closing position is netted with the current day’s net trading activity to determine the firm’s new CNS Position.

For Example assume the following trading activity:

DAY 1 TRADING ACTIVITY

  1. Firm 1 Sells 10,000 shares of XYZ Co. to Firm 3
  2. Firm 3 Sells 5,000 shares of XYZ Co. to Firm 6
  3. Firm 3 Sells 2,000 shares of XYZ Co. to Firm 8
  4. Firm 8 Sells 1,000 shares of XYZ Co. to Firm 1

See Exhibit 1 for DAY 1 TRADING ACTIVITY

DAY 1 CNS POSITIONS

  1. Firm 1 is a net seller of 9,000 shares of XYZ Co. and has a long CNS Position of 9,000 shares
  2. Firm 3 is a net buyer of 3,000 shares of XYZ Co. and has a short CNS Position of 3,000 shares
  3. Firm 6 is a net buyer of 5,000 shares of XYZ Co. and has a short CNS Position of 5,000 shares
  4. Firm 8 is a net buyer of 1,000 shares of XYZ Co. and has a short CNS Position of 1,000 shares

Now, consider the following modified Day 1 Settlement Activity:

DAY 1 SETTLEMENT ACTIVITY

  1. Firm 1 Delivers 8,000 shares of XYZ Co. to CNS
  2. Firm 3 Receives 3,000 shares of XYZ Co. from CNS
  3. Firm 6 Receives 5,000 shares of XYZ Co. from CNS

See Exhibit 3 for the new DAY 1 SETTLEMENT ACTIVITY

The following CNS Position remain at the close of business for Settlement Date 1:

  1. Firm 1 has a long CNS Position of 1,000 shares of XYZ Co.
  2. Firm 8 has a short CNS Position of 1,000 shares of XYZ Co.

DAY 2 TRADING ACTIVITY

  1. Firm 8 sells 500 shares of XYZ Co. to Firm 7
  2. Firm 7 sells 500 shares of XYZ Co. to Firm 1

See Exhibit 4 for DAY 2 TRADING ACTIVITY

DAY 2 CNS POSITIONS

Firm 8 is a net seller of 500 shares of XYZ Co. and has net short CNS Position of 500 shares

Opening Position

-1,000

Net Activity

+ 500

New Position

- 500

Firm 1 is a net buyer of 500 shares of XYZ Co. and has a net long CNS Position of 500 shares

Opening Position

+1,000

Net Activity

- 500

New Position

+ 500

See Exhibit 5 for DAY 2 CNS POSITIONS AND SETTLEMENT ACTIVITY





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