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Revision as of 17:53, 18 July 2006 by Epeefleche (talk | contribs) (→Immobilisation)(diff) ← Previous revision | Latest revision (diff) | Newer revision → (diff)Settlement (of securities) is the process whereby securities or interests in securities are delivered, usually against payment, to fulfill contractual obligations, such as those arising under securities trades.
Settlement involves the delivery of securities to perform contractual delivery oligations. It usually also involves the corresponding payment of the purchase price. Usually settlement is preceded by trading, which involves entering into contracts of sale and purchase.
Although settlement is becoming quicker, in many markets a number of business days still elapse between trading and settlement. A number of risks arise for the parties during the settlement interval, which are managed by the process of clearing, which follows trading and precedes settlement. Clearing involves modifying those contractual obligations so as to facilitate settlement, usually by netting and novation.
Nature of settlement
Settlement involves the delivery of securities from one party to another. Delivery usually takes place against payment, but some are made without a corresponding payment. Examples would be the delivery of securities collateral against a loan of securities, and a delivery made pursuant to a margin call.
Traditional settlement
Traditionally, securities settlement has involved the physical movement of paper instruments, or certificates and transfer forms. Payment was usually made by check. It was also risky, inasmuch as paper instruments, certificates and transfer forms were relatively easy to lose, steal and forge. (see indirect holding system) In the 1970s, the United States markets experienced what has become known as "the paper crunch," as settlement delays threatened to disrupt the operations of the securities markets. This led to the formation of the Depository Trust Company (DTC). In the United Kingdom, the weakness of paper-based settlement was exposed by a programme of privatisation of nationalised industries in the 1980s, and the Big Bang of 1986 led to an explosion in the volume of trades, and settlement delays became significant. In the market crash of 1987, many investors sought to limit their losses by selling their securities, but found that the failure of timely settlement left them exposed.
Electronic settlement
The electronic settlement system came about largely as a result of Clearance and Settlement Systems in the World's Securities Markets, a major report in 1989 by the Washington-based think tank, the Group of Thirty. This report made nine recommendations with a view to achieving more efficient settlement.
In an electronic settlement system, electronic settlement takes place between participants. If a non-participant wishes to settle its interests, it must do so through a participant acting as a custodian. The interests of participants are recorded by credit entries in securities accounts maintained in their names by the operator of the system. It permits both quick and efficient settlement by removing the need for paperwork, and the synchronisation of the delivery of securities with the payment of a corresponding cash sum (called delivery versus payment, or DVP).
The recent development of electronic securities trading has brought about settlement pressures akin to the paper crunch of the 1970s and 1980s, rendering the need for further efficiencies urgent.
Legal significance
After the trade and before settlement, the rights of the purchase are contractual and therefore personal. Because they are merely personal, her rights are at risk in the event of the insolvency of the vendor. After settlement, the purchaser owns securities and her rights are proprietary. Settlement is the delivery of securities to complete trades. It involves upgrading personal rights into property rights and thus protects market participants from the risk of the default of their counterparties.
Immobilisation and dematerialisation
Immobilisation and dematerialisation are the two broad models for electronic settlement. Both were identified by the influential report by the Group of Thirty in 1989.
Immobilisation
Immobilisation entails the use of securities in paper form and the use of depositaries, which are electronically linked to a settlement system. Securities (either constituted by paper instruments or represented by paper certificates) are immobilised in the sense that they are held by the depositary at all times. In the historic transition from paper-based to electronic practice, immoblisation often serves as a transitional phase prior to dematerialisation.
An example of a national immobilisation system is the Central Moneymarkets Office (CMO) in London. The Depository Trust Company in New York is the largest immobilizer of securities in the world. Euroclear and Clearstream Banking, Luxembourg are two important examples of international immobilisation systems. Both originally settled eurobonds, but now a wide range of international securities are settled through them including many types of sovereign debt and equity securities.
Dematerialisation
Dematerialisation involves dispensing of paper instruments and certificates altogether. Dematerialised securities exist only in the form of electronic records. The legal impact of dematerialisation differs in relation to bearer and registered securities respectively.
Direct and indirect holding systems
In a direct holding system, participants hold the underlying securities directly. The settlement system does not stand in the chain of ownership, but merely serves as a conduit for communications of participants to issuers.