1. Certificate for Introduction to Securities & Investment (Cert.ISI) Unit 1  Registered versus bearer  Role of Euroclear  Uncertificated transfers  Settlement participants 28cis Lesson 28:  How equity trades are settled

2. Methods of Holding Title Securities that are represented in paper (physical) form are called certificated securities. They may be bearer or registered.  Registered form Many years ago, it was customary for the name of the owner to be written on the share certificate With registered shares, possession of the certificate is not proof of ownership: ownership must be recorded on the company’s share register  The investor’s name is recorded on the share register

3. Bearer Shares The alternative to holding shares in registered form is to hold bearer shares  Risks of bearer shares  Not only is there a price risk associated with owning shares, but bearer shares have the additional risk of losing the certificate o The owner can lose the entire investment Because of the risks, bearer shares are relatively rare – and in the UK, very rare  Opportunities for money laundering  Bearer shares are regarded unfavourably by the regulatory authorities because they make it easier to launder money or evade tax o Money laundering is used by tax evaders, terrorists and corrupt politicians to disguise the sources and uses of their ill-gotten wealth  Bearer form  The person who holds, (or is the “bearer” of) the shares is the owner o Ownership passes by transfer of the share certificate to the new owner

4. Share Registration With very few exceptions, UK listed companies are required to maintain a share register, This is a record of all current shareholders of the company and the number of shares they each hold  The share register is kept and maintained by the company registrar.  The registrar might be an employee of the company, or  An employee of a specialist firm of registrars According to the Unclaimed Assets Register, around £3bn is owed to UK investors from shares and dividends – money that has been forgotten from old share certificates left in the bottom of drawers.

5. Bearer Shares Bearer shares are usually “immobilised” in central depositories authorised by the regulators  Authorised depositories can be international organisations, e.g.  Euroclear  Authorised depositories can be country-based registries, e.g.  Singapore’s central depository CENTRAL DEPOSITORY

6. Share Settlement  the share register must be updated to record the name of the buyer  the remaining number of shares owned by the seller must be updated  the broker is usually paid commission for completing the transaction  the proceeds of the sale must be paid to the seller of the shares When a shareholder sells some shares in a company, an administrative process known as “settlement” must be completed: When a fund manager buys a share, he /she may decide to allocate the share to several different funds under his / her management, e.g.  Purchase of 50m BP at 450p  10 million allocated to Kent County Council Pension Fund  20 million to English Teachers Pension Fund  20 million to Universities Superannuation Scheme

7. Share Settlement (cont.) In the days when shareholders were given certificates, a seller would send the certificate and a stock transfer form (with details of the new owner) to the company registrar Upon receipt of these documents, the registrar would delete the seller’s name from the register and replace it with the name of the new buyer  The registrar would then issue a new certificate to the buyer  This process was known as “certificated settlement” because it required the issue of a new share certificate

8. Increasingly, companies issue shares on a non-certificated basis Non-Certificated Shares Non-certificated shares exist only as an electronic entry in the register  Most of the online broker services will only deal with non-certificated shares.

9. The Move Towards Paperless Settlement Over the past 10-15 years, most UK settlement has moved to a paperless, “dematerialised” (i.e. non-certificated) form of settlement through a system called CREST CREST is the central securities depository for UK and Irish equities  It is a computer-based system which started operating in 1996  It replaced the Stock Exchange’s Talisman system  In September 2002, CREST merged with Euroclear  It is now owned by Euroclear UK and Ireland

10. CREST  Share-holdings are non-certificated  Share certificates are not required as evidence of transfer of ownership  There is real time matching of trades  Buyers and sellers and matched instantly The key features of CREST are:  Settlement of transactions takes place in multiple currencies  Electronic transfer of title takes place upon settlement  Settlement creates guaranteed obligations to pay cash outside CREST  Coverage includes shares, corporate and government bonds  This also includes other securities held in registered form  CREST will also handle corporate actions like dividends and rights issues

11. Electronic Transfer of Title (ETT) Under UK law, title to an asset normally has to be evidenced by a written instrument However, the Companies Act gives the Treasury the power to make regulations allowing ownership of securities to be evidenced or transferred without a written instrument  Without these exemptions, an electronic, uncertificated share settlement systems like CREST would be unable to function

12. Electronic Transfer of Title (ETT)  In 2001 further regulations eliminated the interval between settlement in CREST and transfer of legal title by entry on the share register  Legal title was now able to be transferred at the point of electronic settlement  This is known as Electronic Transfer of Title, or ETT The Uncertified Securities Regulations 1995 created the legal framework that allowed the CREST settlement system to function

13. CREST Structure  Shares of different companies are held within the member’s account  These are allocated to separate securities accounts o These securities accounts distinguish between money deposited to settle outstanding transactions and money deposited to facilitate transfer of certificated shares Each CREST member has a participant ID and at least one member account ID  CREST users communicate with CREST only through their chosen network  They do not communicate directly with one another  CREST users input their instructions and receive information via one of three electronic networks  Syntegra  Swift  LSE

14. Holding Securities in CREST Direct member  The direct member’s name will appear on the issuing company’s register  Each member has a stock account containing records of its securities  Direct members are permitted to hold more than one stock account o This is useful if the member has several underlying clients  Each member appoints a CREST payment bank to pay out and receive moneys in respect of CREST transactions Shares in CREST are held in in one of the following three ways: Sponsored member  The sponsored member’s name will appear on the issuing company’s register  Sponsored members are usually private investors  A direct member sponsors their membership and provides the link to CREST o Sponsors are usually brokers, fund managers or custodian firms who charge a fee for this service  A sponsored member is also required to appoint a CREST payment bank Custodian  The beneficial owner appoints a nominee, who is a direct member of CREST  The nominee (usually a broker or fund manager) holds the securities on behalf of the shareholder through a specially designated stock account  The nominee company’s name appears on the share register

15. Payment Banks and Cash Memorandum Accounts  CREST maintains one of more Cash Memorandum Accounts (CMAs) for each member  The CMA can be denominated in sterling, euros, or US dollars  The CMA is basically an electronic transaction ledger which shows the net balance of payments made and received at any time during the course of the settlement day CREST members are required to appoint a CREST payment bank to receive and receive moneys in respect of settlements in CREST  Settlement is instantaneous  Payments are made between settlement banks on their central accounts at the Bank of England as they occur

16. Transfers and registers of title  The Operator Register of Securities  Maintained by CREST Under the CREST system, the register of securities comprises two parts:  The Issuer Register of Securities  Maintained by the issuing company’s Registrar When any transfer of title occurs in CREST, the CREST system will send to the Issuer a Register Update Request (RUR)  The RUR requires the issuing company to update its register of uncertificated securities  This is a duplicate of the CREST register but it enables the issuer to keep track of the owners of both its uncertificated and certificated shares

17. Settlement in CREST Sell details Buy details Selling Member Buying Member CREST Stage 1: Trade Matching  The buying and selling members input instructions to CREST detailing the terms of the agreed trade  CREST authenticates these instructions to check they match  If the input data from both members is identical, CREST creates a matching transaction

18. Settlement in CREST (cont.) Sell details Buy details Selling Member Buying Member Buying Member’s AC Selling Member’s AC CREST Stock Stage 2: Stock settlement  On the intended settlement date, CREST checks that:  the buying member has the funds  the selling member has sufficient shares in its share account  the buyer’s CREST settlement bank has sufficient liquidity with the Bank of England to settle the transaction  If all is in order, CREST moves the stock from the selling member’s account to the buying member’s account

19. Settlement in CREST (cont.) Sell details Buy details Selling Member Buying Member Selling Member’s CMA Buying Member’s AC Selling Member’s AC CREST Buying Member’s CMA Stock Cash Stage 3: Cash settlement  CREST credits the CMA of the selling member and debits the CMA of the buying member  This simultaneously generates an obligation on the buying member’s settlement bank in favour of the Bank of England  The selling member’s bank receives that payment in Bank of England funds immediately upon the debit of the purchase price from the buying member’s CMA

20. Settlement in CREST (cont.) Sell details Buy details Selling Member Buying Member Bank account transfers Issuer register updated Selling Member’s CMA Buying Member’s AC Selling Member’s AC CREST Register updated Buying Member’s CMA Stock Cash Stage 4: Register update  CREST automatically updates its Operator Register of Securities to effect the transfer of shares to the buying member  Legal title passes at this point – ETT  This prompts the simultaneous generation by the CREST system of an RUR, requiring the issuer to amend its record of uncertificated shares

21. Settlement in CREST (cont.) Sell details Buy details Selling Member Buying Member Bank account transfers Issuer register updated Selling Member’s CMA Buying Member’s AC Selling Member’s AC CREST Register updated Buying Member’s CMA Stock Cash In fact, Stages 2,3 and 4 occur simultaneously

22. What if the securities are held in certificated form?  Deposit at one of four regional CREST counters  The relevant share certificates  A CREST transfer form If a member of CREST sells securities in certificated form, the member must:  Input an electronic CREST record The transfer form and certificates are processed and transferred by CREST to the relevant company registrar  The registrar checks the documents and deletes the securities from the register  The registrar credits the CREST account of the buyer in electronic form Buyers can also specify delivery in certificated form:  When the seller receives the funds, the seller instructs CREST to instruct the issuer’s registrar to produce as certificate in the name of the buyer