THE SECURITIES CLEARING AND SETTLEMENT SYSTEM

Information Systems in the Securities Market

CLEARING AND SETTLEMENT OF SECURITIES

As with any marketplace, an action recognizable to all parties involved is necessary for finalizing a transaction.

An efficient system is required as there are many parties involved, and high volumes of trade in the securities industry.

In simple terms, clearing and settlement is the process of exchanging the seller’s shares for the buyer’s cash.

PARTICIPANTS IN THE CLEARING AND SETTLEMENT OF SECURITIES Regulatory authorities: the Central Bank and securities

regulators. They sometimes provide C&S for government securities

Brokers: undertake the primary intermediary role in securities trading. They are Central Depository Agents (CDAs)

The Central Securities Depository (CSD): provide facilities for holding securities

The Exchange: facilitate transmission of trading information to the CSD

The Clearing Agent: carries out procedures of matching, confirmation, calculation of obligations prior to settlement. Usually the CSD

The Settlement Agent: determines the settlement positions and monitors the exchange of securities and payments. Usually a bank, or the broker.

The lifecycle of a securities transaction involves three phases: 1. Trade execution, 2. Trade clearance3. Trade settlement

PAPER-BASED TRADING AND SETTLEMENT A share certificate is a certificate issued by a

company certifying that on the date the certificate is issued a certain person is the registered owner of shares in the company.

The key information contained in the certificate is the name and address of the shareholder, the number of shares held, the class of shares and the amount paid on those shares.

DISADVANTAGES OF SHARE CERTIFICATES

The share certificate system requires handling of huge volumes of paper leading to increased costs and inefficiencies.

Risk exposure of the investor also increases due to this trading in paper. Some of these risks are: Delay in transfer of shares. Possibility of forgery on various documents leading to

bad deliveries, legal disputes etc. Possibility of theft of share certificates. Prevalence of fake certificates in the market. Mutilation or loss of share certificates in transit. The physical form of holding and trading in securities

also acts as a bottleneck for the brokering community in capital market operations.

IMMOBILISATION

Immobilisation or is a process whereby securities are converted into electronic data and stored in computers by a Depository.

Share certificates are surrendered, the physical paper is cancelled, and an investor’s depository account is created, and credited with the value of the security.

This ‘depository’ is usually referred to as a Central Depository System (CDS)

Dematerialisation vs. ImmobilisationImmobilisation

equivalent to withdrawal and central holding of securities certificates, which are still recognized as prima facie evidence of ownership

Dematerialisation physical certificates no longer exist, and if they

do they are no longer recognized as legal evidence of ownership. Comes after immobilisation

THE CENTRAL DEPOSITORY SYSTEM

The CDS is an Electronic Book Entry System to record and maintain securities and to register their transfer.

In a CDS, ownership is changed without physical movements of securities or execution of transfer deeds.

The CDS is a computer system that facilitates holding of securities in electronic accounts and facilitate faster and easier processing of transactions for NSE securities (shares and bonds) (www.cma.or.ke)

The CDS is electronically linked to brokers (Central Depository Agents) via a satellite link through Very Small Aperture Terminals (VSATs).

BENEFITS OF IMMOBILISATION AND DEMAT

Transacting the depository way has several advantages over the traditional system of transacting using share certificates. Faster safer and easier trading in securities. One

does not have to wait for the issue of paper certificates before they can trade again as the shares are credited to the CDS account T+x days after the date of trade.

The era of too much paperwork was eliminated by the CDS since delivery, clearing and settlements are all carried out electronically.

There is a drastic reduction in the number of transaction days. Previously, the physical movement of certificates meant that it took even weeks to complete a transaction depending on the variables at play. With the CDS, it takes a maximum of five days after transaction to get paid, if you are a seller, or receive your shares, if you are a buyer.

The CDS has boosted market efficiency and reduced transaction as well as operational costs. It has eliminated problems associated with the use of certificates such as loss of certificates, delays in acquiring certificates, mutilation, and costs involved in the issuing of certificates.

BENEFITS OF IMMOBILISATION AND DEMAT CONTD

CDS IN KENYA The CDS system in Kenya became operational in 2004 The CDS is managed by Central Depository & Settlement

Corporation Limited (CDSC), an associate company of the NSE

Securities settlement is completed on the 5th day (T+5 cycle)

Settlement may delay due to inadequate banking systems

A guarantee fund is maintained to reduce the risk of default due to illiquidity or insolvency of a participant. This fund is made up of pre-set stockbroker contributions, and an ongoing levy paid by investors through their brokers.

Challenges of implementing the CDS in Kenya Inadequate legal and regulatory framework.Correct corporate and market structure: The

relationship between it and the risk makers/bearers and other market players needs to be clearly defined.

Correct strategy: immediate demat? T+1 settlement? Immobilise the entire market at once? Cultural issues to consider.

Good corporate governance Infrastructural support

CDS IN KENYA CONTD