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Debt securities trading in the capital markets involves several steps before the electronic transfer of ownership from one owner to another finishes. For ownership to pass from the seller to the buyer, a “clearing” and “settlement” process must occur. The terms “clearing” and “settlement” are often used interchangeably. However, they represent distinct processes.

Steps Involved in Clearing and Settlement

Once the parties execute a securities trade, the clearing and settlement processes begins. This involves several sequential actions:

• Confirmation: A confirmation of a sale of securities in a specified amount at a given price between the buyer and seller.
• Clearing: The buyer and the seller receive documentation to establish their obligations. The clearing process occurs before settlement begins.
• Settlement: The settlement process involves the delivery of securities from the seller to the buyer and the delivery of funds from the buyer to the seller. While clearing and settlement can occur on the same day, the timing may be longer depending on the complexity of the transaction.
• Payment: Payment occurs through the Federal Reserve’s Fedwire system. The system assigns a reference number to confirm the receipt of funds.
• Delivery: DTC’s electronic book-entry system delivers and credits the appropriate account.

Depository Trust Company (DTC)

The Depository Trust Company, or DTC, is one the largest securities depositories in the world. The DTC facilitates the clearing and settlement of securities transactions. It does this by maintaining a “book-entry” system. This is an electronic method of recordkeeping, as opposed to issuing physical security certificates.

Companies that are DTC eligible have access to Fast Automated Securities Transfer (FAST) processing. This service enables companies, security holders, brokers, and other parties to electronically move securities between DTC participants in an expedited manner.

The DTC also acts as a custodian and holds physical security certificates on behalf of brokers, dealers, and banks. The DTC designates Cede & Company as the custodial nominee for DTC. Debt securities are represented by the issuance of global notes, usually registered in the name of Cede & Company as nominee for DTC.

The DTC is a subsidiary of The Depository Trust & Clearing Corporation (DTCC), a securities holding company. Not all securities are eligible to settle through DTC. In order to be a DTC participant, a company, broker, bank, or other entity must have an account with DTC.

Euroclear and Clearstream

In Europe, the two largest clearing systems are Euroclear and Clearstream. Similar to the DTC in the United States, Euroclear and Clearstream provide settlement services for securities. Both services operate electronic book-entry transfer systems. This eliminates the need for physical certificates.

A series of steps facilitate cross-market deals between DTC and Euroclear or Clearstream participants. The settlement process generally takes longer for cross-market trading.

Trading Mechanics of Clearing and Settling Debt Securities

There are two methods of transferring securities between brokers/dealers and the DTC—the Deposit/Withdrawal At Custodian (DWAC) process and the Direct Registry System (DRS). Both use the FAST system. The electronic format of securities transfers provides investors with efficiency and cost savings.

Both systems enable the holding of securities “on the books” of a transfer agent. A transfer agent is usually a trust company or bank that records transactions and maintains the financial records of investors. In other words, they act as an intermediary between the company’s registrar and investors.

The Deposit/Withdrawal At Custodian (DWAC) provides investors with efficiency and cost savings. As an electronic system for the transfer of shares, the DWAC process minimizes time lags. Because the DWAC process does not involve the transfer of physical certificates, the settlement process is accelerated.

The Direct Registry System (DRS) also allows investors to hold their securities in book entry form with a transfer agent. This allows the seamless clearing and settling of shares in electronic form. The main distinguishing factor is that DWAC deposits require a Medallion Guaranteed Stock Power while DRS deposits are paperless. This is a special certification stamp on a share certificate that confirms its authenticity. This medallion signature guarantee can be waived under certain circumstances.

In order for a company to have its securities settle through the DTC, it must have a letter of representations on file. A letter of representations is a standardized agreement that outlines the terms under which the DTC will act as depository for the company.