Day 5-Date Understanding Trade Settlement

Overview Trade Settlement

The evolution of finance and commerce as a whole has pushed the world economies to a new high. With the advent
of trading of financial instruments and multiplier effect into action, the monetary growth has been multiple folds
over the past few decades.
Let’s get deeper into what exactly is trade settlement and how does it function. Trade settlement is a transaction
method wherein the securities in trade are transferred into the buyer’s account and the monetary value of the security
is deposited into the seller’s account post a trade execution.
The securities traded are financial like bonds, stock futures, or other financial instruments of value. The date when
an order is placed is known as trade day whereas the transferring of security and cash takes place on the settlement
day.
The trade settlement in the trade life cycle process is a part of a bigger whole which we call the trade settlement
period.
The trade settlement period incorporates the whole time taken to complete the trade, starting from execution to
settlement of the trade.
Types of Trade Settlement
During trading of financial securities, the time period for settlement of trades, trade capture is set as per the contract.
The general time frame differs as per the types of securities. Equity securities are settled on T + 2 days, here ‘T’ is
the trade date. Other securities such as commodities, currencies, or derivatives are traded at the mark to market, the
settlement for a mark to market is at T + 2 days.
The classification of Trade settlement can be done into 3 types:
• Normal/ Rolling Settlement
• Trade-to-Trade Settlement
• Auction
Rolling Settlement
In this type of trade settlement, securities are settled on successive dates based on the settlement period in the
contract and the day when the trade was executed. So let’s take a trade contract period with T + 2 days settlement
time, here if a trade is placed on Monday and another trade is placed on Tuesday, the trade on Monday will be
settled on Wednesday and the trade executed on Tuesday will be settled on Thursday (successively).
This is different from the account settlement method wherein the trade executed within a given time period is all
settled at once.
Trade-to-Trade Settlement
In the Asset allocation, Trade to Trade Settlement method, intraday trading in prohibited for securities falling in this
segment.

In this type of settlement method, the trader is required to accept the delivery of the security when bought and
provide the monetary value, while selling the trader has to deliver the securities and the monetary value of the same
will be provided to the trader for the securities traded. In short, shares are traded only for delivery.
Auction
Any trade involves at least two parties to the transaction, in the trading of financial securities, on one side we have
the buyer of the security on the other side we have the seller of the financial security. The auction takes place when
the selling party of the transaction or trade fails to deliver within the given time period on the agreement of selling
the security for the said or agreed upon the monetary value of the security. It’s a kind of penalty for the investor’s
carelessness while trading.
In this case of failure, the broker of the selling party will try to purchase the security in a buy-in-auction market, the
sum of the auction price along with the penalty and brokerage charges has to be paid by the defaulter (the selling
party). The settlement of the action is done on T+3 days given the broker tries and purchases the share in the auction
market on T + 2 days.

Pre-matching
A transfer of securities, both in DTC and in FED, is initiated by a single delivery instruction. As a consequence,
there is no matching of delivery and receipt instructions on the U.S. market in DTC or FED.

However, for transactions settled in DTC against payment, DTC provides an affirmation process which is equivalent
to a matching facility. Provided that both sets of instructions match, the custodian will electronically affirm the
broker's confirmation on the ID system. Affirmed ID confirmations will result in an automated settlement in DTC's
books, with no need for the delivering party (that is, the broker or the custodian as the case may be) to input
additional separate delivery instructions.

In addition, DTC has launched a “Settlement Matching” initiative whereby certain deliveries are subject to approval
by the receiving party before settlement.

Settlement cycles

The settlement cycle in the US is T+2 for equities, corporate bonds, municipal bonds, unit investment trusst
(UIT) and T+0 or T+1 for Money Market Instruments and Government Securities.

Settlement flow
Both against and free of payment settlement are supported by DTC and Fedwire Securities Services.

DTC settlement

For DVP settlement, securities and cash provisionally settle simultaneously during the day. The delivery and receipt
of securities and cash are effective upon booking on the DTC account. Securities and funds are available for
additional settlement, but cash is only available for withdrawal until net end of day cash settlement through the
Fedwire system.

Fedwire Securities settlement

Transactions are affected via book entry simultaneously throughout settlement date.

Cash settlement

For settlement in DTC and NSCC, the cash settlement is performed at the end of the processing day, on a net basis.

For settlement in Fedwire Securities, the cash settlement is performed transaction by transaction during the day.

In both cases, central bank money is used to settle the cash transaction.

Settlement finality
Delivery of securities or cash may be reversed by the buyer/recipient. There is no limitation on the reversal time
frame. However, most securities reversals (referred to as the "Don't Know" - DK procedure) take place on settlement
day.

Under the DTC “Settlement Matching” initiative, certain deliveries are now subject to approval by the receiving
party before settlement, using the DTC RAD function. Once approved and settled in DTC, the transaction can no
longer be “DK'ed” by the receiving party.

Deliveries that are subject to RAD approval are as follows:

• All against-payment deliveries with a countervalue above USD 0.01;

• Free of payment deliveries on DTC-eligible Money Market Instruments (MMIs).

Note: Although these transactions can no longer be DK'ed, DTC still allows receiving counterparties to request a
return of a previously settled position after the initial settlement, but, contrary to DK, such return request is subject
to the prior approval of the original delivering counterparty.

Registration

Book-entry securities held in DTC are registered in the nominee’s name of DTC, Cede & Co., and held in the
account of the broker or custodian that is the DTC member.

Physical registered securities must be forwarded to the corporation's transfer agent to change the evidence of
ownership on the legal records of the issuing corporation.

The issuing corporation generally appoints a transfer agent, a bank or trust company to perform the registration.
Some large corporations perform this function themselves. Transfer agents must complete a transfer according to
rules set forth by the SEC. For most securities, the re-registration should be processed within three business days
after receipt.

Nominee registrations are used by banks, brokers, mutual funds and other financial institutions to minimise re-
registration of securities and speed the delivery and settlement process.

Stamp duty

Stamp duty is not applicable in the U.S. market.

Penalties

Buy-ins

Rules and procedures for buy-ins vary according to the type of market, security and settlement system in which the
failing trade is processed. We therefore recommend to refer to each institution’s rules and regulations.

TMPG Fails Charge Trading Practice

The Treasury Market Practices Group (TMPG) and the Securities Industry and Financial Markets Association
(SIFMA) have published a Trading Practice to provide a standard procedure that market participants may elect to
use to assess and pay "fails charges" for certain delivery failures in the market for U.S. Treasury securities.

The purpose is to preserve and enhance the efficiency and operational integrity of the marketplace for Treasuries by
reducing the incidence of delivery failures.
Securities lending and repo market

Securities financing/lending is a common practice in the U.S. market. The terms of the loan is governed by a
"Securities Lending Agreement". Under U.S. law, the borrower must provide the lender with collateral in the form
of cash, government securities or a letter of credit. As payment for the loan, the parties negotiate a fee, quoted as an
annualized percentage of the value of the loaned securities.

Repurchase agreements are also widely used in the U.S.A. Foreign investors can participate in the local repo market
without restrictions.

Thank you

Naveen