1. Core Functions in Clearing, Settlement and
Custody: Europe
Market participants
There are various Market participants who are involved in the settlement process:
Institutional investors are basically banks, insurance companies, mutual and
pension funds. The central banks are in charge of maintaining the national payment
system for interbank payments, as well as providing clearing and settlement services
for government securities.
Broker/Dealers undertake the primary role in intermediating securities market
trade, through matching at the stock exchanges surplus units willing to acquire
securities to those willing to dispose.
Custodians are responsible for safekeeping and administrative services related to
the holding and transfer of securities on the behalf of their clients. Because individual
investors are not deemed to hold an account on the CSD, where securities are kept,
custodians which have direct access to the CSD monitor the receipt of dividends,
interest payment, corporate actions, apart from payments and delivery of securities in
a transaction. Global custodians are active in different markets worldwide through
establishment of sub-custodian relationships. Global custodians concentrate more in
institutional investors (e.g. mutual and pension funds) and private banks.
Local agents used to be the most common option for settlement of equities.
International investors used to access to the local CSD using the channels of a local
agent, customarily a local bank, even if they had presence in the market. Local agents
have competence in the legal and taxation system of the local market, and they offer
indirect access to the local settlement system without the burden of attending to
requisites of funds, technology and soundness.
Clearinghouse (CH) is a department of an exchange or a separate entity which
provides services related to clearing and settlement of transactions and payments.
In many cases, CH acts as a Central Counterparty (CCP) reducing the credit risk
associated with securities transactions. A CCP interposes itself to the both legal parts
of the transaction, becoming the buyer and the seller of every security. Additionally, it
offers two advantages:
• Multilateral netting that reduces the costs of cross-border transaction
• Effective collateral management, which is achieved with the concentration of
required collateral in a single entity
Central Securities Depository (CSD) holds and administers mobilized or
immobilized securities. Under the CSD, there is no physical delivery of shares.
Instead, the CSD uses a simple book entry system to keep track of the movement
of shares arising from trades. Moreover, it manages the provision of dividends
and interest payment services, as well as the settlement process. An International

2. Central Securities Depository (ICSD) clears and settles international securities or
cross-border transactions through direct access to the local CSD or through indirect
access – partnership with a local agent. ICSDs attend wholesale financial clients (e.g.
investment banks). ICSDs - Euroclear, Clearstream and SIS-Sega - offer a great web
of direct and indirect access to CSDs in more than 120 countries. The ICSD specific
advantage has been associated with the settlement of eurobond, since it was created
specifically for this purpose. Nevertheless, ICSDs have become increasingly active in
the settlement of government bonds and equities, as well.
Settlement value chain
The value chain can be broken down into three main functions:
o Clearing
o Settlement
o Custody
Clearing of securities transaction involves the calculation of mutual obligations
of market participants, and determines what each counterpart should expect to
receive. Clearing houses, central securities depositories (CSD) or international
central securities depositories (ICSD) are the providers of clearance. Securities and
funds must be respectively provided by the custodians or, in some cases, by the
brokers, before the settlement time. The securities traded are blocked (cannot be
traded) at the depository until settlement date. Meanwhile, the investor authorizes his
custodian to receive securities and deliver payment. CSDs clear the instructions of
securities and payment transfers either on a gross or net basis. Multilateral netting is
usually employed by clearinghouses acting as central counterparties, because netting
reduces the liquidity needed by the system, as well as the volume of transactions and
payments.
A system must be developed in a way to minimize the risks involved on securities
transactions, and it must still offer lower costs, which do not hinder the intention
to acquire or dispose securities. Gaining access in this local market by a foreign
investor involves costs in establishing relationship with a local agent, which financial
institutions are ready to pass them over to the investor.
Settlement is regarded to the exchange of a security for its payment. In most
developed financial markets, few participants actually hold physical certificates for
the publicly traded securities they own. Rather, ownership is tracked electronically
through a book-entry system maintained by a CSD. Ownership transfer occurs on
the system’s records of the depository, while cash side of the transaction is usually
affected through a banking payment system. The custodian of the buyer orders debit
the account held at the central bank, while the custodian of the seller make securities
traded available for delivery against payment. In most markets settlement ranges from
T+1 to T+3.
In order to understand the settlement of securities, we have to analyse the settlement
in 3 different contexts atleast:
a. Domestic Equity settlement

3. b. Cross border Equity settlement
c. Euro bond settlement
Domestic Equity transaction
An example for domestic equity transaction: The investor initiates the trade
through his usual broker (1). The broker (1) will seek a counterpart broker (2) on the
local stock exchange. If the facility is available, the trade may be novated to a CCP.
The investor will use his custodian (B) to interact with the national settlement system
and the national cash clearing system, typically the central bank.
The details of the transaction are as follows:
· Step 1: The transaction begins with the investor wishing to invest in a
domestic equity. He contacts his broker (1) with an order to buy.
· Step 2: The broker (1) finds another broker (2) matching his order on the
stock exchange.
· Step 3: The matched instruction transferring the equity from Broker (2) to
Broker (1) may be sent to the CCP, if available, and is then sent on to the
settlement system.
· Step 4: The investor forwards confirmation of the trade to his custodian (B),
Broker (1) instructs delivery of equity to (B).
· Step 5: The custodian (B) confirms receipt of equity from Broker (1) and
instructs delivery of cash.
· Step 6: The transaction is settled with the payment leg conducted via the
central bank.
Fig 1: Domestic Equity Settlement (Source: Giovannini Report 1)

4. Cross Border Trade
A “cross-border securities transaction” involves market participants buying and
selling securities on non-domestic markets and/or undertaking transactions with
counterparties in other countries.
In order to settle a transaction in a particular security, both counterparties must have
access to systems where it is possible to deliver and receive that security. Thus, the
distinctive feature of a cross-border settlement relative to a domestic settlement is
that it involves gaining access to a settlement system in another country and/or the
interaction of different settlement systems.
Fig 1: Channels of Cross Border Settlement (Source: HWWA, 2004)
In settling a cross-border securities transaction, the counterparties have 5 options.
These are:
• To have direct access to a national CSD in the country where the
security is issued (Not widely used). Non-resident institutional traders
will often establish local branches or subsidiaries to acquire direct
access.
• To avail of the services of a local agent, which is normally a financial
institution with membership of the national CSD in the country where
the security is issued (Most commonly used). Local agents can also
offer this service to CSDs or ICSDs (so-called indirect links).
• To use ICSDs, which were originally established to settle for the
Eurobond market but have broadened their range of activities
substantially over time. These links are either direct or through local
agents. This facility is enhanced by the provision of intra-day securities
lending, which facilitates the settlement of back-to-back trades without
the additional costs associated with pre-positioning securities or
accepting the delayed availability of securities.
• To use a global custodian, which also provides customers with a single
access point to national CSDs in various countries via a network of
sub-custodians in the countries concerned (Preferred option for

5. trading in securities). These sub custodians can be local branches or
subsidiaries of the global custodian or can be local agents.
• To use a bilateral link between CSDs, which is the most recently
available but probably the least used option by non-residents due to
expense involved.
Cross Border Equity transaction
An example of a cross-border equity transaction: In this example, the actors
involved in a cross-border equity transaction are the investor who initiates the trade
via his usual local broker (A) and settle it through his local custodian (B). In this
example all three of the actors are located in the same country. As the equity trade
takes place in a foreign country, local broker (A) will use a foreign-country broker
(1), who will seek a counterpart broker (2) on the foreign-country stock exchange. If
the facility is available, the trade may be novated to a CCP. The local broker (A) will
need a foreign-country custodian (Y) and a foreign-country cash clearer. The local
custodian (B) will need a foreign country custodian (X) as well and yet another cash
clearer. The national central bank of the foreign country may be involved in the cash
leg of the trade settlement.
The details of the transaction are as follows:
· Step1: The transaction begins with the investor wishing to invest in a foreign
equity. He will contact his local broker (A) with an order to buy.
· Step 2: Local broker (A) will forward the investor’s order to his
correspondent foreign-country broker (1).
· Step 3: The foreign-country broker (1) finds another foreign country broker
(2) matching his order on the foreign-country stock exchange. The matched
instruction may be sent to the CCP.
· Step 4: All agents receive and forward confirmation of the investor’s order,
while the instruction transferring the equity from (2) to (1) is usually sent
automatically to the foreign-country CSD.
· Step 5: Local broker (A) instructs his foreign-country custodian (Y) to
receive the equity from the foreign-country broker (1) and to deliver it to
foreign-country custodian (X); the margin transfer (and foreign exchange
conversion) from Broker A to the foreign-country CSD are conducted via
the foreign-country cash clearer of local broker (A) and the foreign-country
cash clearing system; the investor instructs his local custodian (B) to receive
the equity from the foreign-country custodian (Y) of his local broker (A) and
transfers the necessary funds for payment to his local custodian (B).
· Step 6: The local custodian (B) instructs its foreign-country custodian (X) to
receive the equity from the foreign-country custodian (Y) of the local broker
(A). The transfer of the investor’s funds for payment is made from the local
custodian (B) to its foreign-country cash clearer.
· Step 7: Foreign-country broker (1) receives the equity from foreign-country
broker (2); then, foreign-country broker (1) delivers it to foreign-country
custodian (Y), who delivers it to foreign-country custodian (X) – all within the
settlement system of the foreign country CSD; the foreign-country cash clearer
of local broker (A) transfers funds for payment to the foreign-country CSD,

6. while the foreign-country cash clearer of the local custodian (B) transfers the
investors funds to the foreign-country cash-clearer of local broker (A).
· Step 8: The payment leg of the transaction is conducted via the foreign-
country central bank.
· Step 9: Confirmation is then sent to all actors and equity transaction is
booked (credit/debit) between foreign-country custodian (X) and local
custodian (B) and between local custodian (B) and the investor.
Fig 1: Cross Border Equity Settlement (Source: Giovannini Report 1)
Euro Bond transaction
An example for Euro Bond transaction: The actors involved are the investor who
initiates the trade through his usual broker (1). The broker (1) will seek a counterpart
broker (2) to conduct an over-the-counter (OTC) transaction. The transaction is settled
in an ICSD, with the payment leg conducted via the investor’s cash correspondent and
the cash correspondent bank network.
The details of the transaction are as follows:
· Step 1: The transaction begins with the investor wishing to invest in a
Eurobond. He contacts his broker (1) with an order to buy.
· Step 2: The broker (1) finds another broker (2) matching his order and
purchases the Eurobond in an OTC transaction
· Step 3: Broker (1) confirms the terms of the trade with the investor and calls
for a margin payment.
· Step 4: Broker (1) sends instructions to the ICSD to receive the Eurobond
from Broker (2) and deliver it to the investor. The investor sends instruction
to ICSD to receive the Eurobond from Broker (1), while instructing his cash
correspondent to transfer the funds to the cash correspondent network. (Broker
(2) sends the same instructions in reverse.)
· Step 5: The transaction is settled in the ICSD, with the payment leg
conducted via the cash correspondent network.

7. Fig 1: Eurobond Settlement (Source: Giovannini Report 1)
Conclusion
The clearing and settlement processes are essential features of a smoothly functioning
securities market. Clearing and settlement can be achieved in different ways and can
involve several intermediaries in addition to the buyer and seller. A cross-border
securities transaction normally involves a greater number of actors than a domestic
transaction. The increased risks due to intermediaries that are associated with cross-
border clearing and settlement imply additional costs to the ultimate investor.