1. CISI – Financial Products, Markets & Services
Topic – Equities
(4.1.11, and ) Trading and Settlement

2. Trading Clearing Settlement
Process overview
Before an investor finally owns or relinquishes securities, there is a 3-stage process they must go through:
Trading
Investors need to find a buyer or seller for securities they want to relinquish or own
The obligations of the buyer and seller to a trade are defined and legally formalised. It establishes what each of the counterparties expects to receive when the trade is settled and defines the obligations each must fulfil, in terms of delivering securities or funds, for the trade to settle successfully.
Clearing
The ownership of a security is transferred from seller to buyer in exchange for the equivalent value in cash. Ideally, these two transfers should occur simultaneously.
Settlement

3. Trading Trading (buying and selling) shares and bonds is done either:
On-exchange
Off-exchange
On-exchange
Off-exchange
Takes place through a recognised stock exchange, using a trading system
Takes place directly between market counterparties away from an exchange. Also known as
“Over the Counter”
Quote driven system
Order driven
system OR

4. Trading on-exchange – Quote Driven
Quote driven system
e.g. NASDAQ or SEAQ
Market makers:
Work throughout the trading day
Provide continuous two-way (bid and offer) prices for particular securities
A trading system employing market makers
Make a profit through the price spread
Perform their function regardless of market conditions
Provide liquidity to a market which may have dried up without them

5. Trading on-exchange – Order Driven
Order driven system
matches buyers and sellers by
Electronic Order Book
e.g. LSE’s SETS
Auction Process
e.g. NYSE floor OR
Both match buyers and sellers in strict chronological order:
By Price then
By the quantity of shares being traded

6. Trading on-exchange – Order Driven - SETS
The London Stock Exchange’s main trading platform is SETS, which is used to trade shares that are contained within the FTSE All Share Index.
LSE member firms
(Investment banks and brokers)
‘Deep’ Order Book
This is used for liquid stock e.g. Vodafone
the term ‘deep’ implies that there are lots of orders waiting to be dealt on either side.
These firms input orders for themselves or on behalf of client into SETS via computer terminals
SETS system
WITH
Electronic Order Book
Integrated market makers
Orders added to one of 3 lists in the system
Buy
queue
sell
queue
Executed
immediately
Investors who add their order to these queues are prepared to hold out for the price they want
Here, investors trade against the queue of buyers (if they are selling) or against the sellers’ queue (if they are buying).

7. Other trading systems on the LSE
The London Stock Exchange does not just use SETS. Due to the varying liquidity of shares and the need to trade fixed interest securities (corporate and government bonds), alternative systems are used:
SETSqx
SEAQ
ORB
Trading Systems
Stock Exchange Automated Quotation
For fixed interest securities and AIM stocks not traded on SETS or SETSqx
One of the last examples of quote-driven equity trading systems along with the NASDAQ
SETS - quotes and crosses
Not all shares are liquid enough to trade via SETS.
SETSqx is for shares where the volume of shares traded is low.
It combines periodic auctions with quotes from market makers
Order Book for Retail Bonds
Offers continuous two-way pricing
Used for trading in UK gilts and retail-size corporate bonds

8. Trading Clearing Settlement
Process overview
Before an investor finally owns or relinquishes securities, there is a 3-stage process they must go through:
Trading
Investors need to find a buyer or seller for securities they want to relinquish or own
The obligations of the buyer and seller to a trade are defined and legally formalised. It establishes what each of the counterparties expects to receive when the trade is settled and defines the obligations each must fulfil, in terms of delivering securities or funds, for the trade to settle successfully.
Clearing
The ownership of a security is transferred from seller to buyer in exchange for the equivalent value in cash. Ideally, these two transfers should occur simultaneously.
Settlement

9. Trading Clearing Settlement
Process overview
Before an investor finally owns or relinquishes securities, there is a 3-stage process they must go through:
Trading
Investors need to find a buyer or seller for securities they want to relinquish or own
The obligations of the buyer and seller to a trade are defined and legally formalised. It establishes what each of the counterparties expects to receive when the trade is settled and defines the obligations each must fulfil, in terms of delivering securities or funds, for the trade to settle successfully.
Clearing
The ownership of a security is transferred from seller to buyer in exchange for the equivalent value in cash. Ideally, these two transfers should occur simultaneously. (Delivery versus Payment or DvP)
Settlement

10. Methods of Holding Title
Before exploring how purchases and sales of shares are settled – ie, how the seller gets his money and the buyer gets her shares.
It is important to consider how ownership of a share is evidenced.
Shares can be issued in either registered or bearer form, with the former (registered) being a lot more common than the latter (bearer).

11. Holding shares in registered form Methods of Holding Title
Holding title - How do you show that you own particular shares?
Holding shares in registered form
The investor’s name is recorded on the company share register, and, often they are issued with a share certificate.
Many companies have ‘dematerialised’ their shares (They do not use physical share certificates) and use electronic records of ownership.
This is known as issuing shares on a non-certified basis.
Methods of Holding Title
(Evidencing share ownership)
Holding bearer shares
The person who physically holds the share certificate is the owner or ‘bearer’.
Ownership passes through transfer of the certificate to the new owner.
Risky – the certificate could be lost and so could the investment.
Provides opportunity for money laundering and tax evasion.

12. ‘Immobilised’ Often have no register Authorised depositaries
Settlement – Registered and Bearer Shares
Shares in registered form
Bearer Shares
UK Companies
Often have no register
Required to keep and maintain a
Authorised depositaries
Share register
They are usually kept safe in authorised depositories.
These can be international organisations like Euroclear, or country based depositories like Singapore’s central depository.
a record of all current shareholders in that company, and how many shares they each hold.
Company registrar
Bearer shares kept in this way are said to be
‘Immobilised’
keeps and maintains the company share register - might be an employee of the or a specialist firm of registrars
‘Certificated settlement’
Historically, when selling these shares, the seller sent their share certificate and a stock transfer form, providing details of the new owner, to the company registrar. The registrar would delete the seller’s name and insert the name of the buyer into the register. The registrar then issued a new certificate to the buyer.
An electronic register is also kept by CREST so that trades can be settled electronically.

13. Shares in registered form
Settlement – Registered and Bearer Shares
Shares in registered form
Bearer Shares
Over the past decade most UK settlement has moved to a paperless, dematerialised (or uncertificated) form of settlement through a system called CREST.
Certificated settlement is cumbersome and inefficient
Some investors still hold physical share certificates and they have been unable to benefit from shorter settlement periods.
Settlement of these trades usually takes place at:
This allows all of the paperwork to be completed. As part of the changes to settlement periods, there are separate proposals to phase out the use of paper share certificates.
European markets to move to a standardised T+2 settlement period:
This reduction in the settlement period is intended to harmonise practices across Europe and help to reduce risk
T + 2
T + 10