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LIFE CYCLE OF A SECURITY explores the role of central securities depositories in the United States and global capital markets, with a particular focus on the part The Depository Trust Company (DTC) plays in launching new securities issues and providing the essential services that security issuers require. The guide explains the process of creating and distributing stocks and bonds in the primary and secondary markets, the details of clearing and settling retail and institutional transactions, and the sophisticated infrastructure that enables the seamless payment of dividends and interest, smooth management of tender offers and other corporate actions, and essential risk protection in an increasingly global environment.

SECu RITY LIFE CYCLE OF A SECu RITY LIFE CYCLE OF A

WHAT’S AN If trading volume between countries INTERNATIONAL CSD? justifies it, CSDs are frequently linked There are currently two International electronically, and have accounts with Central Securities Depositories (ICSDs), both Central Securities Depositories each other, so that securities can be located in Europe: Clearstream Banking in The certificate stops here. moved electronically between them. In Luxembourg and Euroclear Bank in Belgium. most cases, payment for those securities Initially created to accommodate the shares that an issuing corporation offers is usually handled between the trading expanding market in Eurobonds—bonds In the quest to attract capital and make firms’ settlement banks rather than for sale in one or more countries in addi- issued in a different currency and sold in their economies more vibrant, most tion to its home market. This approach through the CSD, though some CSDs a different country than that of the issuer, countries with active capital markets allows the corporation, working with a are equipped to handle both transfer and generally outside of the regulation of have central securities depositories local depositary bank, to raise capital in and payment. any single country—these depositories now (CSDs) to provide the custody and the target market. also provide recordkeeping and settlement recordkeeping services that enable the When these securities are traded in the SPOTLIGHT ON DTC services for a wide range of domestic and electronic transfer of ownership when The Depository Trust Company (DTC) was internationally traded securities by working United States, they’re known as American investors buy and sell securities and Depositary Receipts (ADRs) and may be created in 1973 to transform the settle- with a number of domestic CSDs around initiate settlement. With CSDs, settling immobilized at DTC or held in electronic ment process for securities transactions. the world. In the mid-1960s, when the predecessor the huge volume of securities traded form. Investors buy ADRs through a broker every day in the world’s capital markets as they do any US security, and enjoy the to DTC, the Central Securities Service, is fast, cost effective, and secure. same benefits and face the same risks. began operations, the paper-based trading or holding them in custody in a central system in the United States had become location. That central location was Like stockholders, ADR holders are - CROSS-BORDER SETTLEMENT entitled to all dividends paid on the under overly cumbersome and was bogged down DTC, now the largest central securities by the increasing transaction volume. In addition to the services they provide lying investment and to any capital gains depository in the world. domestically, CSDs also handle cross- they realize by selling their receipt for Before DTC, when a corporation Today, DTC acts as a CSD for virtu- border settlement and may hold securi- went public or a bond was issued, each more than they paid for it. DTC processes ally all US municipal securities, as well ties issued in countries other than the dividends for most ADR issues and purchaser received an elaborately as the vast majority of equities and their own. allocates the payments to the participants designed, and often quite beautiful, corporate bonds issued in the United Those securities may include whose clients own the receipts. paper certificate in his or her name that States. In addition to its recordkeeping receipts, or certificates, representing detailed the issuer’s name, the date of and custody services, it provides a num- issue, the number of shares, the par value, ber of asset processing services. For ownership records electronically. Some CSDs record and, after 1967, a unique identifying example, it settles institutional trades THE MANY ROLES OF A CSD the names of the beneficial owners and others the CUSIP number. In general, the basic functions of CSDs directly, manages all phases of a secu- names of only their member firms. To sell, the owner endorsed and rity’s life cycle, and offers underwriting, worldwide include: Settlement services. Very few CSDs are CSDs delivered the certificate to a broker, interest, dividend, and corporate action Custody and recordkeeping. able to complete cash settlement by themselves. immobilized who delivered it to the buyer’s broker services, including reorganization provide safekeeping for securities Generally, CSD members instruct a settlement in exchange for payment. Before the in their vaults and electronic ownership records - processing and tender offers for . Using bank or the country’s central bank to meet their purchaser could receive proof of owner for those that are dematerialized securities it holds in its custody. payment obligations, receive payments due them, ship, a new certificate had to be issued. There is no requirement that book-entry accounting methods, a CSD updates or both, for processing through the CSD. The solution to this bottleneck was to equities or bonds be held at DTC to record changes of ownership electroni- trade. But increasingly, many broker- Immobilization cally, using a computerized book-entry age firms and issuers want to take Securities Dematerialization system that eliminated the exchange of advantage of the efficiencies and • Clearance • Custody paper certificates by immobilizing them, cost benefits that DTC’s electronic book-entry system offers. Since 1999, DTC and National Securities Clearing Corporation (NSCC) have been subsidiaries of Book - entry and Settlement the Depository Trust & Clearing System processing dividend Corporation (DTCC), the world’s most and interest pay- efficient and cost effective post-trade Other services. The range of services ments, announcing, reporting, and clearance and settlement organization. a CSD provides varies from country to country, facilitating corporate action events, such as and many expand and create new offerings on a tender offers and reorganizations, and facilitating continual basis. Examples of additional services the deposit and withdrawal of securities. 5 include a role in underwriting new securities, 4 • The Global Market central securities depository • Central Securities Depository www.lightbulbfinancial.com • Creating Stock Latest guides • Popular articles • Bookstore • Corporate Actions Lightbulb Press, Inc. www.lightbulbpress.com [email protected] Phone: 212-485-8800

ISBN 978-0982907528 5 0 6 9 5 • Fixed Income Issues

• Managing Risk

9 780982 907528 VIRGINIA B. MORRIS AND STUART Z. GOLDSTEIN

©2012 by Lightbulb Press, Inc. All Rights Reserved. ©2010 by Lightbulb Press, Inc. All Rights Reserved. Welcome to the life cycle of a security. This publication looks at the activities that underpin securities post-trade processing and ensure safety, soundness and risk mitigation in the global financial marketplace. It focuses on key steps involved in the safe and efficient transfer of securities ownership and settlement of trillions of dollars in trade obligations every day for the financial services industry. As the primary infrastructure organization serving the capital markets in the US, The Depository Trust & Clearing Corporation (DTCC), through its subsidiaries, helps automate, centralize, standardize and streamline processes critical to the security and reliability of these markets. One of our principal subsidiaries, The Depository Trust Company (DTC), is the world’s largest central securities depository (CSD) and is also the first stop for almost all new US securities. CSDs like DTC play a continuing critical role in the increasingly global and electronic future of capital markets throughout the world with DTC providing custody and asset servicing for more than 3.6 million securities issues from the US and 121 other countries and territories, valued at $33.9 trillion. In 2009, DTCC settled nearly $1.48 quadrillion in securities transactions. For all the changes in today’s fast-moving financial markets, one thing that never changes is DTCC’s primary mission. It is, first and foremost, to protect and mitigate risk for customers and investors. And, throughout our history, our story has been one of successfully responding to crisis. In fact, DTC was created in response to the manual, paper-intensive crisis of the 1970s, which actually caused the stock exchanges to shut down one day a week as they scrambled to catch up with what were then considered to be soaring equity trade volumes. In each crisis since then—including 9/11 and the financial crisis of 2008 and the collapse of Lehman Brothers—DTCC has stepped up to help protect our members and help to safeguard the integrity of the US and global financial system. This booklet is intended as a companion piece to the Guide to Clearance & Settlement, published earlier by Lightbulb Press and DTCC. Combined, we believe these publications offer a broad overview of how capital markets work and the role DTCC plays, working with our members, global regulators and the industry to bring safety, reliability, and transparency to the financial services world.

Donald F. Donahue Chairman and CEO The Depository Trust & Clearing Corporation

2 The Capital Markets 20 Retiring a Stock 4 Central Securities Depositories 22 Fixed Income Issues 6 Creating Stock 24 Fixed Income Services 8 Clearance and Settlement 26 Money Market Instruments 10 Holding Stock 28 Managing Risk 12 Corporate Actions 30 Paying Taxes 14 Dividend Payments 32 The Global Market 16 Voluntary Tenders 34 Glossary 18 Corporate Reorganizations

Capital markets exist where the exchange of capital—typically in the form of money or property—takes place in what’s known as the primary market between those interested in acquiring capital—through an initial public offering (IPO), secondary stock offering, or bond issue—and those interested in purchasing equity or debt. In general, those seeking capital are companies and governments who want funding for projects or for expansions. Those that provide capital are investors, either individuals or institutions, CENTRAL SECURITIES DEPOSITORY that believe they will make a profit through investing in these companies or governments.

SECONDARY MARKET TRADING While raising capital is important, no capital market would survive without a secondary market where previously issued securities are bought and sold. In fact, this ability to trade in the secondary market is what keeps the primary market active. That’s because investors can be relatively confident that if they decide to invest in a new company or venture, there will be investors in the secondary market ship changed hands, when dividends or willing to buy their securities should interest was paid, or when the company they decide to sell. changed its name or merged with another Further, the interaction of demand company. for investments and willingness to But as trading volume grew and the sell helps keep the markets liquid, variety of securities expanded, the paper- which means that investors can trade based, labor-intensive processing became investments relatively easily. It also a huge and expensive burden. The solution helps bring in more capital. For example, was the development of central securities new capital flows into the securities mar- depositories, or CSDs. ket when investors choose to reinvest their Rather than firms or issuers having earnings in the market instead of spending to deliver, reregister, and reissue them elsewhere. individual certificates with every trade or every time a stock split, the CSDs immo- DEVELOPMENT OF THE CSD bilized, or secured, the certificates in a For several hundred years, organized secu- single location. rities markets operated in much the same This meant they could assume respon- way as they always had. Investors placed sibility for servicing those securities. their orders through brokerage firms, and When the stock was split or the issuer paid those brokers handled the exchange of dividends or interest, the CSD handled securities and cash or checks required to updating the records and making pay- finalize a trade. Securities issuers dealt ments. CSDs also facilitated the task of directly with their investors when owner- reregistering ownership of the securities

Advances in technology and an increase in not only the volume but the pace of securities trading have gone hand-in-hand. But the dependence on technology presents a challenge as well. The electronic systems must continue to function seamlessly so that the data generated by trading is instantly accessible and error free. Parties to the transactions must be able to count on secure and constant communication. To ensure there are no interruptions despite the risks from external events or internal failures, a number of CSDs, including The Depository Trust Company (DTC) in the United States, have established networks of fully redundant data and operations centers. Any one of the data centers or any one of the operations centers, which are separated from each other by thousands of miles in some cases, has the capacity to take over CENTRAL SECURITIES DEPOSITORY responsibility for all aspects of the recordkeeping and services that are the responsibility of the CSD. The key is the reliable and rapid capture and automated replication of data as trades occur. As CSDs around the globe are increasingly interconnected, technology is also at the forefront. Binary code, which is the international language of business, extends the reach of low-cost and reliable investment services to benefit issuers, brokerage firms, banks, and investors worldwide.

DEMATERIALIZATION The current move toward dematerialization, or eliminating paper certificates and replacing them with electronic records as they were being traded each day, using as evidence of securities ownership, is an electronic book-entry system. Most of another example of the dynamic nature the paper certificates remained untouched of the capital markets. When this goal in the depository. That sped is fully implemented, securities will be up the process, made it less risky, and issued only in electronic form, and the helped lower the costs of investing. need for physical custody of paper CSDs will continue to play a critical certificates will be phased out. role in the global capital markets. The Twenty-five countries across Europe, ways in which they are growing and Asia, Africa, and the Americas have expanding to serve investors and financial completely eliminated paper certificates, services firms in processing securities and many more have begun the process of through their life cycles are changing the dematerialization. Virtually all municipal face of capital markets around the world. bonds issued in the United States are dematerialized, as are mutual funds THE IMPACT OF TECHNOLOGY and US government securities, with the Demand for more efficiency in the capital exception of some US savings bonds. markets, which resulted in the creation US equities and corporate bonds still of CSDs, corresponded with the advent of exist in physical form. But with changes increasingly sophisticated hardware and in the law in recent years, a growing software that made electronic record- number of public companies have moved keeping, automated trade settlement, and to dematerialize their securities and no electronic payment systems possible. longer issue paper certificates.

Central Securities Depositories The certificate stops here.

In the quest to attract capital and make shares that an issuing corporation offers their economies more vibrant, most for sale in one or more countries in addi- countries with active capital markets tion to its home market. This approach have central securities depositories allows the corporation, working with a (CSDs) to provide the custody and local depositary bank, to raise capital in recordkeeping services that enable the the target market. electronic transfer of ownership when When these securities are traded in the investors buy and sell securities and United States, they’re known as American initiate settlement. With CSDs, settling Depositary Receipts (ADRs) and may be the huge volume of securities traded immobilized at DTC or held in electronic every day in the world’s capital markets form. Investors buy ADRs through a broker is fast, cost effective, and secure. as they do any US security, and enjoy the same benefits and face the same risks. CROSS-BORDER SETTLEMENT Like stockholders, ADR holders are In addition to the services they provide entitled to all dividends paid on the under- domestically, CSDs also handle cross- lying investment and to any capital gains border settlement and may hold securi- they realize by selling their receipt for ties issued in countries other than more than they paid for it. DTC processes their own. the dividends for most ADR issues and Those securities may include allocates the payments to the participants receipts, or certificates, representing whose clients own the receipts.

THE MANY ROLES OF A CSD ownership records electronically. Some CSDs record In general, the basic functions of CSDs the names of the beneficial owners and others the worldwide include: names of only their member firms. Custody and recordkeeping. CSDs Settlement services. Very few CSDs are provide safekeeping for securities immobilized able to complete cash settlement by themselves. in their vaults and electronic ownership records Generally, CSD members instruct a settlement for those that are dematerialized. Using bank or the country’s central bank to meet their book-entry accounting methods, a CSD updates payment obligations, receive payments due them, or both, for processing through the CSD. Immobilization Securities Dematerialization

processing dividend Book - entry Other services. The range of services and interest pay- a CSD provides varies from country to country, ments, announcing, reporting, and System and many expand and create new offerings on a facilitating corporate action events, such as continual basis. Examples of additional services tender offers and reorganizations, and facilitating include a role in underwriting new securities, the deposit and withdrawal of securities.

central securities depository life cycle of a security

If trading volume between countries WHAT’S AN justifies it, CSDs are frequently linked INTERNATIONAL CSD? electronically, and have accounts with There are currently two International each other, so that securities can be Central Securities Depositories (ICSDs), both moved electronically between them. In located in Europe: Clearstream Banking in most cases, payment for those securities Luxembourg and Euroclear Bank in Belgium. is usually handled between the trading Initially created to accommodate the firms’ settlement banks rather than expanding market in Eurobonds—bonds through the CSD, though some CSDs issued in a different currency and sold in are equipped to handle both transfer a different country than that of the issuer, and payment. and generally outside of the regulation of any single country—these depositories now SPOTLIGHT ON DTC also provide recordkeeping and settlement The Depository Trust Company (DTC) was services for a wide range of domestic and created in 1973 to transform the settle- internationally traded securities by working ment process for securities transactions. with a number of domestic CSDs around In the mid-1960s, when the predecessor the world. to DTC, the Central Securities Service, began operations, the paper-based trading system in the United States had become or holding them in custody in a central overly cumbersome and was bogged down location. That central location was by the increasing transaction volume. DTC, now the largest central securities Before DTC, when a corporation depository in the world. went public or a bond was issued, each Today, DTC acts as a CSD for virtu- purchaser received an elaborately ally all US municipal securities, as well designed, and often quite beautiful, as the vast majority of equities and paper certificate in his or her name that corporate bonds issued in the United detailed the issuer’s name, the date of States. In addition to its recordkeeping issue, the number of shares, the par value, and custody services, it provides a num- and, after 1967, a unique identifying ber of asset processing services. For CUSIP number. example, it settles institutional trades To sell, the owner endorsed and directly, manages all phases of a secu- delivered the certificate to a broker, rity’s life cycle, and offers underwriting, who delivered it to the buyer’s broker interest, dividend, and corporate action in exchange for payment. Before the services, including reorganization purchaser could receive proof of owner- processing and tender offers for ship, a new certificate had to be issued. securities it holds in its custody. The solution to this bottleneck was to There is no requirement that record changes of ownership electroni- equities or bonds be held at DTC to cally, using a computerized book-entry trade. But increasingly, many broker- system that eliminated the exchange of age firms and issuers want to take paper certificates by immobilizing them, advantage of the efficiencies and cost benefits that DTC’s electronic book-entry system offers. Since 1999, DTC and National Securities Clearing Corporation (NSCC) have been subsidiaries of the Depository Trust & Clearing Book - entry Corporation (DTCC), the world’s most System efficient and cost effective post-trade clearance and settlement organization.

central securities depository life cycle of a security Creating Stock A Company IPO Issuing new stock takes the 11 coordinated effort of A many players. Company + Underwriting Firm Privately held companies go public when they issue stock through an initial public offering (IPO). When a company goes 22 public, outside investors may purchase Preliminary shares and become part owners of Prospectus the company. SHARE 44 PRICE Institutional Firms’ A company may choose to do an IPO Investors AND for a number of reasons. Usually, it’s to 33 PRICE Clients gain access to outside capital so that it can expand or improve upon its business A Compa AHEAD operations or to be better able to compete ny Road S against companies providing similar how DTC Secondary products or services in the marketplace. Markets

INITIAL PUBLIC OFFERING 11 The IPO process begins when a to issue, as well as a price range within company that wishes to go public contacts which the lead underwriter believes the one or more , underwriting firms shares should be sold—though both may typically the investment banking divi- change when the issue is and the sion of a broker/dealer, to act as lead priced terms of the issue are finalized. A prospec- underwriter for the new issue. The lead tus may be revised and refiled with the underwriter assumes most of the respon- SEC and other regulators as the document sibility for managing the IPO process, is reviewed. A final prospectus must be including: filed with the SEC after the transaction • Creating and filing the prospectus has been priced. • Selecting and managing the syndicate, a group of other investment banks that PRICING THE ISSUE help distribute the issue to investors 33 The next step is a road show—a whom they identify two- to four-week marketing effort the • Marketing the new issue lead underwriter uses to gauge and garner • Distributing shares to investors and interest in the new issue. Interest, which sending money to the issuer is quantified by the number of shares a • Maintaining initial price stability in prospective investor would be willing to the market purchase at a particular price, is recorded A Company PRICE in an order book. Road Show AHEAD PREPARING THE ISSUE Based on this investor reaction, the 22 The most common underwriting lead underwriter makes a determination agreement is known as a firm commit- about what it believes the size and price of ment. The lead underwriter and other the offering should be. members of the syndicate assume the risk For example, say Private Company A by buying the new shares from the issuing wants to issue 10 million shares, and, company and selling them to investors. based on economic and other factors Lawyers, accountants, and other agents related to the issuer, the lead underwriter are also part of launching a new issue. believes each share should be priced at The process officially kicks off when between $10 and $12 dollars. the lead underwriter and company work If on the road show, however, the together to create a preliminary issue is oversubscribed—which means prospectus, which is filed with the that investors are willing to purchase Securities and Exchange Commission more than the 10 million shares, 50 or (SEC). 60 million, for example—the lead under- The preliminary prospectus provides writer will revise the original offering. detailed financial and operating models For this issue, the lead underwriter might for the company and includes the total propose that the company issue 12 mil- number of new shares the company wishes lion, instead of 10 million, shares at $14 a

A Company IPO FULL DISCLOSURE GETTING PAID 11 While the SEC requires that all important The underwriting fees, called the gross information, including risks, be disclosed, spread, are typically 7% of the value of the A it does not make a determination on a issue, or the total number of shares being Company Underwriting security’s value. Analyzing how valuable issued times the share price. The gross + the stock is, and whether it will be a good spread is split among the members of the Firm fit in your investment portfolio, is up to you, syndicate, with the largest share going to the as the investor, and your advisers. lead underwriter. 22 Preliminary Prospectus SHARE 44 PRICE Institutional Firms’ Investors AND 33 PRICE Clients A Company AHEAD R oad Show DTC Secondary Markets

share because it believes there is enough USING DTC’S SYSTEMS demand. If, on the other hand, the issue The IPO process, once highly manual and is undersubscribed, the lead underwriter paper intensive, has been streamlined and may downsize or reprice the offering. automated by DTC’s underwriting services. Using DTC’s system, underwriters can sub- DISTRIBUTING THE SHARES mit all required documentation to make 44 While it’s possible for individuals the new issue eligible to be held at DTC, to invest in an IPO, it’s not always easy to as well as electronically distribute IPO do so. Since the syndicate is in charge of shares and settle all transactions associ- selling the new issue, its members identify ated with this new issue. their best and largest clients, which tend DTC primarily accomplishes distribu- to be institutional investors, such as pen- tion through a system called UWSOURCE. sion and mutual funds, as well as their It allows participant firms to keep firms’ wealthiest clients. These investors constant track of any changes or are generally believed to be best able to documentation provided, including purchase a large block of shares and to pricing changes. handle the risk if the new issue doesn’t Underwriters can also keep track of perform as expected in its early days securities as issues are distributed to A Companyof trading. PRICE investors through DTC’s electronic IPO Road OnceShow the number ofAHEAD shares being Tracking Service. Being able to monitor issued is finalized, the lead underwriter the movement of shares helps to ensure uses DTC’s underwriting services to make that a transaction runs smoothly. the securities depository eligible, distribute the shares efficiently to the syndicate SECONDARY ISSUES members’ investors, and collect payment. A company that has already gone On closing day, the lead underwriter sends public may decide to issue more shares the cash raised by the IPO to the issuing through a secondary offering to raise company. additional capital. The sale of shares to initial investors However, a corporation generally issues is typically referred to as the primary new shares only if its share price is high. market distribution. Once the new stock That’s because adding to the number of begins trading in the secondary market, outstanding shares dilutes the value of the generally the day following the IPO, the shares investors currently own. To avoid share price can fluctuate above or below this, companies may instead decide to the IPO price based on what investors are issue bonds, convertible bonds, which can willing to pay or accept for the new stock. be converted to company To stabilize the price in early trading, the stock after a certain amount of time, or lead manager often agrees to step in and preferred shares, which are hybrid equity buy shares. and fixed-income investments.

When a new stock begins to trade, SETTLING UP transactions are handled through the Trades are finalized on T+3, thesettle - automated and streamlined systems of ment date. NSCC sends final instructions two subsidiaries of The Depository Trust & for settlement to the firms, and DTC com- Clearing Corporation (DTCC), NSCC and municates their net credit or net debit DTC, just as the billions of other trades status to both firms and theirsettling are processed each year. banks, which handle the payment or receipt of payments on behalf of firms RETAIL TRADES through the Federal Reserve NSCC and DTC clear and Bank’s elec- settle nearly all retail, Customer Customer or broker-to-broker, AIL TRA securities transactions Sells ETA DES Buys in the United States R S on a strict schedule. For equity transac- 100 100 tions, the process Shares Shares begins the day the CHA NGES trade is made, or T for Broker EX Broker short. The transaction is settled three business days later on T+3, C when the buyer receives credit for the NS C purchased shares and the seller receives T TIN the payment due. NE G To help ensure the process is smooth and efficient and to reduce the risk of Financial Financial having to cope with the ripple effect of a Institution failed transaction, NSCC becomes the cen- Institution tral counterparty (CCP) to all M T trades at midnight between T+1 and T+2, inimum Broker Minimum D C acting as seller for every buyer and buyer 10,000 10,000 for every seller to guarantee a trade will Shares Shares complete even if an original party to the trade goes bankrupt or similarly defaults. I Without that guarantee, thousands of NS L trades other firms had made with a firm STI NA that goes out of business would have to be ITU TIO unwound. This means the trades would T be considered not to have taken place tronic Fedwire system. RA DES and would have to be re-executed at a Payment is completed and changes new price with some other firm. But with in ownership are recorded electroni- the NSCC guarantee, which mitigates the cally through DTC’s book-entry accounting risk of default and counterparty exposure, system. that’s not an issue. INSTITUTIONAL TRADES Institutional trades differ somewhat MANAGING TRADES from retail transactions. These block DTC’s Inventory Management transactions often involve a minimum of System (IMS) enables participants to 10,000 shares and sometimes 100,000 or monitor the clearance and settlement status more. They’re handled by a single broker of their trades by settlement dates. They can and typically have a limited number of also control the order in which transactions trading partners. For example, $800,000 are processed on T+3 by authorizing the of a $1 million transaction may be able settlement process or holding back certain to be executed in a single large block. trades in the settlement cycle. In such cases, settlement goes directly through DTC.

segments if it can’t find an institutional NETTING buyer for most or all of the lot. Or, it may Through netting—the automatic process choose to disguise the fact that it’s selling of offsetting a firm’s buy orders for a or purchasing a large position. In these particular security against its sell orders cases, the smaller trades may flow through for that security—NSCC is able to reduce NSCC for clearing and then to DTC. the total number of trades that require Institutional trades differ from broker- an exchange of money by 98% each to-broker transactions in that institutional trading day. trades generally are not netted, but are In addition, at the end of each trading handled on a trade-for-trade basis, which day, netting consolidates the amounts due means a direct exchange of securities and from and owed to a firm across all the cash between firms and the custodian different securities it has traded to a single bank. However, DTC, with the introduc- net debit or a net credit. tion of its ID Net service, has begun to allow brokers to net their institutional transactions with their other transactions to reduce Customer Customer securities movement while AIL TRA still retaining the trade-for- Sells ETA DES Buys trade settlement between R S the firm and the custodian bank. This allows 100 100 the banks to maintain their fiduciary Shares Shares CHA NGES responsibility to Broker EX Broker pay for only those trades where all C the shares are delivered, while at NS C the same time providing the benefits of T TIN netting to the brokers. NE G Although institutional trade shares move separately and are not netted with Financial Financial other trades, firms handling both retail and institutional trades receive one Institution Institution consolidated cash payment obligation each M day, helping to reduce risk and keep clear- T inimum Broker Minimum ance and settlement as efficient D C 10,000 10,000 as possible. Shares Shares I FUNGIBLE SECURITIES NS L When you deposit a dollar in the bank, you’re STI NA entitled to withdraw the value of one dollar ITU TIO from the bank at a future date. However, T you aren’t likely to get back the exact same RA DES To complete the institu- dollar bill you put in. But, it doesn’t matter tional trade, DTC updates the since the one you do receive has the same record of stock ownership, first from the value as the one you had earlier. accounts of the custodian banks holding Securities are similarly fungible, or in- the securities to the broker’s account at terchangeable. When you hold shares in street DTC, and then to the accounts of the cus- name, you are the beneficial owner and have todian banks of the firm buying the shares. all the rights and risks associated with own- Similarly, it transfers the money from the ing stock, but you don’t hold shares directly. buyer’s custodian banks’ accounts to the Instead, your security position is recorded on broker’s account, and then through to the the books of your brokerage firm, and the custodian banks securities are immobilized in DTC’s custody of the selling institutional firm, all and registered in its nominee name, Cede & electronically. A number of different Co., an acronym for CEntral DEpository. custodian banks and accounts can be When you buy or sell your position, that a part of a single institutional trade position changes hands electronically through worth tens of millions of dollars. DTC’s book-entry accounting system, but the Sometimes, however, the broker may securities remain in DTC custody. need to execute a large trade in smaller

The way you hold stock determines what proxies, and the way any dividends are happens when you buy and sell, as well as paid. You have three choices: how you receive investor communications, • Street name including annual reports and voting • Direct registration • Physical certificate

IN STREET NAME Between 85% and 90% of all equities and corporate and municipal bonds that have which show the security’s value and divi- been issued in paper form in the United dends the issuer has paid that have been States are immobilized by DTC. The shares credited to the beneficial owner’s account. are registered with their issuers or the issuers’ transfer agents in DTC’s nominee THROUGH DIRECT name, Cede & Co., also known as street REGISTRATION name. If you purchase shares and want to hold When you hold your shares this way, them electronically in your own name your name is listed on your brokerage rather than in street name, in many firm’s books as the beneficial owner of the cases you can do so through the direct securities. Your brokerage firm’s name is registration system (DRS). That system listed in DTC’s ownership records. And allows you to register your name and DTC’s nominee name is actually listed address, as the owner of the securities, as the registered owner of the stock with directly on the issuer’s books or the books the issuer’s transfer agent. But, while the of the issuer’s transfer agent. Investors securities are registered in the name Cede who use direct registration receive a & Co., DTC merely holds them as record statement from the transfer agent provid- owner—you are always the beneficial, or ing proof of ownership instead of a stock actual, owner of the securities. This means certificate. This moves the market towards you’re entitled to all the benefits—and the goal of dematerialization, or the risks—associated with owning the stock. elimination of paper certificates. When you sell stock you hold in The issuer or transfer agent sends all street name, the shares are debited investor information, dividends, and other electronically from your broker’s account corporate communications, including at DTC and credited to the DTC account proxy materials, directly to you. of the brokerage firm whose client bought If you want to sell your shares at the shares. Your brokerage firm updates market or a limit price, however, the its books to reflect the sale from your securities must usually be transferred account, and the buyer’s brokerage firm electronically from your account with the updates the buyer’s account to reflect issuer or its transfer agent to your broker/ the purchase. But the physical certificate dealer through DTC. While you can sell doesn’t have to be changed, since Cede shares directly from your DRS account, & Co. continues to be the sole registered transfer agents cannot provide a current owner of the shares. price or limit price. Both you and the buyer receive electronic confirmations that detail the FAST TRANSACTIONS number of shares and the price of your Transfer agents who are eligible to use the transactions. In addition, as long as the DRS system must also register to become buyer holds the shares, his or her broker- members of DTC’s Fast Automated age firm provides proxy materials and Securities Transfer—FAST—program. regular account statements, FAST transfer agents maintain the out-

ONE BIG CERTIFICATE A corporation issuing a new security may give DTC custody of a certificate for the total number of shares in the offering. Such issues are referred to as book-entry only (BEO) and essentially require street-name ownership, eliminating any individual physical certificates or physical processing.

number of shares held in DTC’s nominee name daily.

WITH PAPER CERTIFICATES If you still hold a paper certificate and choose to sell your shares, you have three days to deliver the certificate to your broker, who will generally forward it to DTC. The certificate will be deposited into the broker’s DTC account and registered in the name Cede & Co. so the ownership changes can be made electronically. Similarly, if you purchase shares and want IDENTIFYING SECURITIES a physical certificate, those shares are Regardless of how shares are held, all withdrawn from DTC’s account by the stocks—as well as government, municipal, transfer agent and registered in your name and corporate debt registered in the United and address. States and Canada—are issued a unique However, there is likely to be a fee nine-character sequence that identifies for issuing the certificate. Most, but not the issuer and type of security. The all, brokerage firms and transfer agents Committee on Uniform Security charge their clients a fee for delivering a Identification Procedures (CUSIP) physical certificate. In some cases, a firm of the American Bankers Association (ABA) may refuse requests for a physical cer- created this universal coding system in 1967 tificate. In other cases, a certificate may to make it easier to organize and manage simply not be available, as more and more issues of securities. public companies have chosen to stop issu- The first six digits of the CUSIP number ing physical certificates altogether. identify the issuer. The next two, which may There is risk in holding paper be numbers in the case of equity securities certificates, which today represent or letters in the case of fixed-income just one-tenth of one percent of daily investments, identify the issue. The last digit trading volume. They may be lost, is a check digit, which helps the computer damaged, or stolen, which can delay ensure that the CUSIP entered was correct. your ability to transfer them. Also, if The CUSIP service is owned by ABA and missing shares must be replaced, there administered by Standard & Poor’s Financial is a fee that must be paid to buy insurance Services. Other numbering systems exist to cover the possibility that the lost or for international securities, with the most stolen certificate is accepted and must common being ISIN, or International be honored. Securities Identification Numbers.

ISSUE SECURITY POSITION REPORTS CUSIP 842587 10 7 If most securities are registered in street name, how does an issuer know ISSUER CHECK DIGIT who owns its securities? Transfer agents have the names of shareholders who hold certificates. For street name standing electronic balances for all DTCC shares, issuers and their agents can positions and communicate with DTC request from DTC a list of the banks each day, receiving information about the or brokers holding shares on a specific trades completed that day that involve date using DTC’s Security Position the deposit or withdrawal of physical Reports (SPRs). The banks or brokers certificates or direct registration posi- can then contact the shareholders tions. This program enables the transfer about company events. agent and DTC to update and balance the

A corporate action is an event that pro- duces a corporate restructuring, and, very A BIG PIECE OF THE PIE often, affects the value of the company’s Corporate actions in the United States securities. Some of these actions have a account for about 50% of all corporate financial impact, directly or indirectly, actions announced globally. on the company’s shareholders. One example of direct financial impact is any change in the company’s Other corporate actions, like renaming dividend payments that results from the company, generally have no financial an action. The same would be true for impact on its shareholders. bondholders if there were a change in the There are about one hundred types repayment of company debt. Alternatively, of corporate actions, also known as a two-for-one stock split resulting in twice corporate events, which can affect a as many shares as each shareholder had security. Some of the most common before is an example of an indirect include dividend payments, interest financial impact. payments, voluntary tender offers, It’s indirect because, while the split corporate reorganizations, rights itself does not directly affect the total offers, convertible securities, warrants, value of the stock holding (since the price and redemption of municipal and of the shares are adjusted to account corporate bonds. for the change in number of shares outstanding), market reactions to the split HANDLING PAYMENTS may drive the stock price up or down. DTC handles certain essential aspects of corporate action processing. For example, payments generated by certain TYPES OF actions flow from the initiating corpo- CORPORATE ACTIONS rations or their paying agents to the registered owner, Cede & Co., the nomi- • Dividend payments nee registration for DTC. DTC, in turn, Interest payments electronically credits the accounts of the • appropriate brokers or banks, which pass • Voluntary tender offers the payments along to clients. Corporate reorganizations Making sure corporate action proceeds • are collected and allocated in a timely • Rights offers and efficient way is a giant processing Convertible securities task for the depository because it must • deal with thousands of agents around the • Warrants world. For high-volume agents, DTC has • Redemption on municipal and developed direct, automated communica- corporate bonds tion lines to facilitate seamless electronic instruction and payment processing.

COR DTC XBRL XBRL ERROR PORA MA A PRO N RISK CT T UA IO E CES L NS SING

C orporate Manu Action Pro al cessing s life cycle of a security

WHAT’S AT STAKE intent and content of corporate events. When significant events occur in the life However, even with DTCC’s service, firms of a security, they’re announced to share- feel the need to confirm and check their holders and others in a press release, an interpretation of prospectuses and other SEC filing, or both, generating a flurry documents that can often run to hundreds of activity. of pages. Financial data vendors, such as Bloomberg, Thomson Reuters, and CHANGING THE GAME Dow Jones, gather the corporate action DTC is currently undertaking a major information from the announcing com- initiative to re-engineer its technology panies and pass it along to investors, and the way it handles corporate actions stakeholders, and other financial data to address the imbalance between the processors. These hundreds of market amount of information that’s created participants collect, interpret, enter, and and the market’s ability to analyze and re-enter data, as communications from manage that information effectively. many sources move through multiple One major step is to modernize its channels and into the hands of tens of systems to a single, integrated platform thousands of investors. capable of handling all corporate actions As the volume and complexity of processing, from underwriting to bank- corporate actions increase, the risks of ruptcy, for both US and international error and delay are magnified with every securities. manual entry along the announcement Another major innovation is the chain. The cost of processing corporate introduction of a technology called actions and the risk exposure to errors XBRL (eXtensible Business Reporting is estimated in the hundreds of millions Language) for corporate actions annually for the financial services announcements. The goal is to replace industry alone. the paper corporate action documents that issuers currently send out with A BETTER WAY documents that contain electronic data DTCC, through its Global Corporate tags in XBRL that can feed DTC’s and Action (GCA) Validation Service collects other financial firms’ systems directly and validates corporate action informa- without the need to interpret and rekey tion—an enormous flood of faxes, phone the information. calls, messages, emails, and media reports Using XBRL messages to electroni- that follow corporate action announce- cally disseminate corporate actions data ments—not only for US securities, but directly from issuers will greatly reduce for securities in more than 160 countries the cost of corporate actions while also around the world. reducing the risk and speeding the In this way, DTCC helps minimize announcements to investors. Instead of risk and the need for individual firms spending millions to ensure they have to interpret or determine the correct the right data and right interpretation of an action, firms can simply pass the announcement information directly through to investors automatically and electronically.

GLOBAL CORPORATE ACTIONS With operations in New York, London, and Shanghai, the GCA Validation Service provides round-the- clock coverage to simplify and reduce the cost of communicating information about corporate actions on equity and fixed income securities that are traded across the globe.

COR DTC XBRL XBRL ERROR PORA MA A PRO N RISK CT T UA IO E CES L NS SING

C orporate Manu Action Pro al cessing s life cycle of a security Dividend Payments Dividends are part of the return shareholders realize on their investment.

Corporations that realize a profit may Cede & Co. For international securities, choose to pay their shareholders a DTC also coordinates tax-withholding dividend, or share of the earnings, re- information where it’s applicable. invest the earnings in the business, or both. In the United States, dividends IT STARTS WITH A PROFIT are most commonly declared and paid If a corporation’s board of directors elects quarterly, usually in cash. to distribute a dividend, it announces that The dividend you’re entitled to decision publicly through a press release may be credited to your account at your on what’s known as the declaration date. brokerage firm, you may receive a check, The board also announces the record or, if the corporation offers a dividend date, or the date by which an investor reinvestment program (DRIP), you must be registered as a shareholder in may choose to automatically reinvest your order to receive the dividend income and a dividends to buy additional shares of the payment date, or the day when the divi- corporation. If you hold your shares dend payment will be made. in certificate form, you generally receive When the issuer notifies the exchange a check for the amount from the issuer where the issue trades about the upcom- or the bank that acts as the issuer’s ing distribution, the exchange declares the paying agent. ex-date—the first day the issue will trade DTC plays a major role in facilitating without the dividend. It’s normally two these payments when they’re made on business days prior to the record date. issues held in DTC’s nominee name of

HOW THE PROCESS WORKS Here’s an overview of the way DTC distributes dividends:

• As soon as rate or price information is available, DTC calculates cash or stock distributions for each dividend announcement.

Corporation Declaration Record Dividends Date Date Payment Ex-date Date

• DTC doesn’t handle tracking and distributing of dividends for the small percentage of US securities not in its custody. In these cases, dividends are paid directly by the issuer’s paying agent.

TAX FACTS Dividend payments are taxable unless the investment is owned through a tax-deferred account, such as an employer sponsored retirement plan or individual retirement account (IRA). However, dividend payments on most US and many international stocks are considered qualifying dividends. That means dividend payments are taxed at the lower long-term capital gains rate, provided the investor has owned the stock the required length of time, rather than at the ordinary income rate.

MAKING THE ANNOUNCEMENT bank, to transfer to DTC the dividends DTC captures and monitors all dividend owed to the beneficial owners of stocks payment information for the stocks it held in its nominee name of Cede & Co. holds in custody and distributes this The transaction is handled electronically, information to its participants, primarily using Fedwire. major brokerage firms and banks. Its Using its records of holdings of the sources include trustees, industry stock on the record date, DTC distributes vendors, exchanges, regulatory agencies, payment to the appropriate brokerage paying or remarketing agents, transfer firms and banks. They, in turn, allocate the agents, corporations, and participants. payments to their client accounts. In addition, DTC updates each member The centralized, totally electronic pro- firm’s stock ownership records after cessing that DTC’s automated Dividend trading ends each day, so it has a record Service provides makes the process of of each firm’s daily holdings, including the making millions of payments each year number of shares. These records are par- highly efficient. Paying agents don’t have ticularly critical for the record date of any to cut thousands of individual checks to dividend payment. shareholders, and broker/dealers and Prior to the dividend’s payment date, banks don’t have to deal with thousands DTC distributes information on the divi- of paying agents representing the corpora- dend payment to participant banks and tions who owe dividend payments to the broker/dealers electronically, allowing firms’ clients. It also helps to ensure that them to compare their records with DTC’s. the payments are made on schedule and The announcement includes record date, reduces the cost by eliminating the need payable date, settlement date, stock rate, for other agencies to act as middlemen. and cash rate. The Dividend Service similarly handles dividends paid on shares issued by corpo- payING DIVIDENDs rations based outside the United States On the payment date, the corporation that are eligible to be held at DTC but declaring a dividend, also known as the are instead held in its custody with local issuer, uses a paying agent, generally a custodians or depositories.

• DTC processes dividend allocations throughout Any funds received after 3 p.m. on the the day as they are received. DTC allocates payment date are allocated the following practically 100% of the funds it receives morning. Funds that are received after from issuers or their paying agents by 3 p.m. the payment date are allocated when Eastern Time on the dividend payment date. they’re received.

Share- holders DTC Dividends Brokers

• Sometimes, however, dividends may be paid • If a client, through its brokerage firm or as additional shares. In that case, each bank, has given instructions to reinvest the affected participant’s DTC position in the dividends via DTC’s dividend reinvestment security is increased by the number of shares program (DRIP), money will not be allocated declared in the distribution. Those participants, to DTC by the issuer or its paying agent. in turn, allocate the appropriate number of Instead, the dividend will be used to purchase shares to the accounts of clients who own the additional securities, which will be forwarded security. Typically, cash is paid in lieu of to DTC to be credited to the bank’s or broker/ fractional shares. dealer’s account.

A tender offer is a voluntary corporate acquirer’s bid for shares. Friendly tender action. It’s an open offer to purchase some offers are negotiated between the corpora- or all of the stock shareholders own in a tion and the third party. Hostile tender target company by a certain date and time offers involve an unsolicited—and rather than buying shares in the stock unwelcome—third-party bid. market. Often, it’s a third party—typically Whether the tender offer is friendly or another corporation, a wealthy individual, hostile, any person or corporation seeking or group of investors—trying to acquire to acquire more than five percent of the control of the target company. However, voting class of a company’s stock in this issuers can also use voluntary tenders to way must file a Tender Offer Statement buy back their own security. required by Regulation 14D-1 with the Tender offers can be classified as Securities and Exchange Commission friendly or hostile, depending on how (SEC), and notify the target company willing the management of the target com- and the exchange on which the target pany is to participate in the prospective company is listed.

FOLLOWING A PATTERN Some tender offers succeed and others fail. Some are resolved quickly while others drag on. But they’re all handled in essentially the same way, with DTC facilitating the process because it holds a majority of the shares that will be tendered in its nominee name, Cede & Co. In addition, because of DTC’s centralized, automated book-entry system, changes in securities ownership can be made accurately and efficiently.

INITiATION DATA SHARING A tender offer begins when an individual Tender agents or information agents or entity makes an offer to acquire a block of debt working for the offering party send an information or equity securities by a set date and at a set price. announcement or offering circular outlining the Generally speaking, voluntary tenders involve details of the tender offer to DTC, certificate share- purchasing equity securities, while exchange offers holders, and the public. involve offering one security for another, and may involve exchanging debt for equity, one equity for another equity, or new debt for old debt.

3rd PARTY Circulars DTC Tender O Offer FFER $ AGENTS $ Target Co. Shares

Tendered Securities Tender Agent’s Account

DELIVERY OF SECURITIES Security DTC generally can deliver the tendered notice from brokers on shares their customers securities to the tender agent on a somewhat want to tender, balance all tendered positions, and delayed delivery date, not the tender expiration complete submission of any late instructions. date. This allows the depository time to receive

SETTING A PRICE MAKING ARRANGEMENTS During a tender offer, the soliciting Because of risks inherent in tender bidder may offer cash or other securities offers, such as moving stock prices, an in exchange for the shareholders’ stock. offer has a very specific expiration date. To make the transaction more attractive, DTC requires a contract with the tender the potential acquirer usually offers to pay offer agent committing it to transaction a premium over the current market price details, including the precise expiration of the target company’s shares. While the date, before DTC announces the tender bidder’s offer price is fixed, it is usually offer to its participants. contingent on shareholders tendering, In the past, letters of transmittal or selling, a pre-established number of were required in order to process tender shares. offers, as they indicated a commitment When a tender offer is announced, to transfer the physical certificates to you and other shareholders who choose be tendered. Now that the majority of to participate have a limited amount of domestic securities are held at DTC, all time to accept. If you hold your shares of this information can be communicated in street name, you typically notify your electronically through DTC’s system. broker/dealer that you plan to tender, and Letters of transmittal are still sent to the broker/dealer notifies DTC. If enough any shareholder who holds physical shareholders accept the offer, the transac- certificates directly, of course. tion with participating shareholders moves forward.

ANNOUNCEMENT DTCC creates an account on behalf of the DTC announces the details of the tender agent to hold tendered shares that participant offer to its participants, including banks, broker/ firms have submitted on behalf of their customers. dealers, and other parties holding securities on When DTC receives a participant’s instructions, DTC’s books on behalf of their investors. DTC transfers the shares held on its books from the participant’s account into the agent’s account. TENDER After submitting tender instructions, a participant After relaying information of the tender cannot sell or otherwise access the tendered offer to its participants, DTC plays a key role as securities unless the tender is changed materially, an intermediary in the automated tender process, completed, or abandoned. taking instructions from broker/dealers whose Certificate holders deal directly with the client shareholders choose to participate, or tender tender agent to tender their shares. their shares.

TARGET COMPANY OK BROKER/ to O tender FFDEALERSER

6 EXPIRATION AND Instructions 6 ENTITLEMENTS new securities, if any. The participants adjust the When a tender offer expires, and the entity appropriate client accounts to reflect the payment. making the offer chooses to accept the shares Any shareholder who tendered shares held in cer- tendered, the tender agent pays what are known tificate form is paid directly by the tender agent. as the entitlements to DTC for shares it holds in In the event that not enough shares are its nominee name. Entitlements can take three tendered, it is up to the entity making the tender forms in tender offers: cash, new securities, or offer to revoke the offer, which can be done at a combination of cash and new securities. any time. Securities are then released from the DTC forwards the cash to its respective par- agent’s account and returned to the accounts of ticipants and credits their DTC accounts with the participants who have submitted instructions.

A corporate reorganization is a type of have taken place over that security’s corporate action that can occur during a lifetime. The first six characters in any security’s life cycle. In a reorganization, a CUSIP represent the issuer or company, company may make changes to its legal or and those don’t change, though the operational structures, or it may restruc- remaining elements do. ture its ownership. Companies usually elect to reorganize HANDLING their business following some major REORGANIZATIONS change or problem, such as a bankruptcy, DTC’s Reorganization Service provides that has caused or may eventually cause all reorganization participants, including the company financial harm. For that shareholders, with information about reason, the goal of reorganization is usu- various reorganization activities from ally the same: to improve a company’s efficiency, organization, and profitability.

MANDATORY vs. VOLUNTARY Reorganizations can be mandatory or voluntary. A company’s board of directors initiates mandatory reorganizations and, as a shareholder, your participation is required. On the other hand, in a voluntary reorganization, you and other shareholders have the right to decide if you would like to participate. A stock split is a common mandatory reorganization. In a two-for-one stock split, a company doubles the number of outstanding shares and typically halves the price. For example, if you own 100 shares of a stock selling at $50 a share for a total value of $5,000, and the company’s directors authorize a two-for-one split, you would own 200 shares initially priced at $25, with the same total value of $5,000. the initial announcement until the action Other examples of mandatory reorganiza- is finalized. tions include changing a company’s name DTC facilitates announcements of and selling an entire company when reorganization events by making infor- insiders who hold the bulk of the shares mation it gathers from various sources have agreed to the sale. available within what are known as Alternatively, a tender offer is an reorganization announcements. These example of a voluntary reorganization. announcements also provide In a voluntary tender offer, a third party participants with updates on what’s makes an open offer to purchase all or happening as events unfold. For example, some of the shareholders’ stock in a announcements for voluntary corporate particular company, by a certain date actions contain the offer type, expiration and time. date, rates, terms and conditions, and other elements of the corporate action. CUSIP CHANGES Announcements for mandatory corporate When a corporate event occurs, the actions typically include the meeting date, CUSIPs, or unique nine-character rates, and agent. sequences that identify the company’s In addition, DTC may also be respon- equity and debt securities, often must be sible for processing the reorganizations changed. The existing CUSIP sequences themselves. DTC executes mandatory disappear and aren’t reused. reorganization transactions based on the However, each nine-character details of the company’s reorganization sequence tells the story of changes that announcement. For example, in the case

KEEP IT SIMPLE DTC’s Reorganization Service helps simplify communications and DTC processing for corporate reorganization events. Using it, DTC participants, including banks and broker/dealers, and other third parties who

market financial products and services can receive, view, and track: • Information about pending reorganization events • Distributions related to reorganization allocations • Tender offer and exchange offer announcements and instructions • Announcements and activities related to mandatory reorganizations being processed on behalf of shareholders • Announcements related to consent solicitations and bankruptcies

CHILLING OUT DTC may at times place temporary of a two-for-one stock split, DTC auto- or permanent restrictions on certain matically executes the split by crediting transactions, such as deposits or with- broker/dealers whose clients own the drawals of certificates. Such a restriction stock with double the original number is known as a chill. of outstanding shares. Based on that For example, DTC may impose change, each broker/dealer is responsible a temporary chill that restricts the for changing the number of shares in book-entry movement of securities, the account of each client affected by effectively closing the books and the split. stabilizing existing positions until a DTC plays a slightly different role merger or other reorganization has in voluntary reorganization events. For been completed. A permanent chill example, in the case of a tender offer, DTC could be imposed when an equity has creates an account to hold shares that been dematerialized by the issuer. In you and other shareholders have tendered that case, a chill would end all physical through your brokers until the buyer certificate processing except deposits. decides to finalize the purchase That way, no new certificates would and pays the cash or stock it offered. ever be issued. In all reorganization events, DTC Chills are also placed when, among utilizes its book-entry system so that other things, regulators take certain ownership records are secure, and, when actions, or when there are questions appropriate, securities can be safely and about whether unregistered securities easily surrendered and the appropriate have been illegally issued. payments made.

There are a number of reasons that trading in a particular stock may end. For example, any time a stock’s CUSIP changes—after a corporate reorganization, such as a name change, or other corporate action, such as a merger—new stock is issued to reflect the change, and the original stock is retired. Other times, a stock disappears from With Chapter 11 bankruptcy the goal the marketplace because it has lost all is paying off creditors, becoming profitable its value. If a stock you own becomes again, and emerging as a totally worthless, you’re experiencing first stronger entity. During the rebuilding hand the primary risk of investing: You period the corporation’s managers may can potentially lose all of the money you still run day-to-day business operations, invested in this stock. If you find yourself and the company’s stock may continue in this position, the only real comfort is to trade. that there may be tax strategies you can You may discover, however, it has been use to help soften the loss, as long as you delisted by the New York Stock Exchange follow the rules and the stock you’re (NYSE) or Nasdaq, which have strict holding qualifies. listing requirements, including price- per-share floors, but continues to trade A BAD END in the less restrictive over-the-counter Stock is at risk of being worthless if the market, on either the OTC Bulletin Board company that issued it is insolvent and (OTCBB) or Pink Sheets. If you have seeks bankruptcy protection. Whether its trouble tracking it down, you may want fate is sealed or resuscitation is possible to call your broker or the company that depends largely on the type of bankruptcy issued the stock to find out if and where the issuer enters. it’s trading. Chapter 7 bankruptcy forces a Even if the issuer successfully emerges company to shut down operations com- from bankruptcy, your stock may not pletely and liquidate, or sell off, its assets regain its value. The company may have to help pay its debts. In these situations, canceled its existing shares and, as part its stock becomes worthless, is no longer of its reorganization plan, when it’s again traded, and you generally lose whatever profitable, issue new common stock under you invested. a different ticker symbol—an abbreviation used to identify a stock that is being traded. NO CRYSTAL BALL In some cases, you may be able to It’s hard to predict the long-term perfor- exchange your old shares for new ones— mance of a stock at the time it’s issued or though you’ll generally receive fewer the number of years it will continue to trade. shares that are worth less than the shares Most stocks go through cycles of growth and you originally owned. In this case, as in decline that reflect the pattern of the overall any reorganization, the old shares are market. Some do better than their peers worthless and no longer trade. and others fail, sometimes because changes in technology or taste make the company’s FINDING VALUE IN products or services obsolete, and sometimes WORTHLESS STOCK when poor management decisions drive the If stock you own becomes worthless, you company out of business. may be able to take a tax deduction for its cost basis—or what you paid for the shares. You must claim the loss in the year the stock became valueless, but you have up to seven years to file an amended return (IRS Form 1040-X) and claim the deduction.

REPORTING WORTHLESS SECURITIES If you believe you may be holding worthless stock, you can call your local Internal Revenue Service (IRS) office or There are some restrictions, 800-829-1040 for information about how however, about when you can do a to report worthless securities and claim a tax-loss sale, so it pays to discuss your deduction for your loss. options with your tax adviser or other professional.

Part of the reason you’re given so much THE FATE OF time to file an amended return is because WORTHLESS SECURITIES it can be difficult to satisfy the IRS that DTC participants who hold worthless secu- the stock you hold is worthless. Even if a rities in nominee name may delete them stock is trading for pennies a share, it may from their accounts by moving them to not qualify. The IRS generally considers DTC’s Position Removal (PREM) stock worthless if: system. Alternately, DTC may move securities to the PREM system after The issuer is insolvent, or has • notifying affected participants that the gone through an identifiable event, worthless securities will be deleted from such as terminating its business their accounts. operations or selling substantially all of When a company has been inactive or its assets insolvent for at least six years, DTC may • It’s improbable that the stock’s value move the deleted shares from PREM to will ever increase its Destruction of Non-Transferable , where Certain other factors related to the Securities Certificates Program • the certificates are destroyed. issuer and investor apply Before destroying a certificate, DTC creates a digital image of the security and NEAR-WORTHLESS STOCK keeps an electronic record of its existence. If you own stock that is nearly, but not Although it is unlikely, if the security’s technically, worthless, you may be able value ever recovers, DTC can then use the to do a and use your loss to tax-loss sale digital image to return the position to par- offset any capital gains you may have for ticipants’ accounts by the year. working with the company’s transfer In order to claim the loss, you must agent. But, by destroying the certificate, sell the shares you own. You may be able DTC eliminates the cost and risks asso- to do so in the secondary market. But, if ciated with holding and maintaining there are no bids from other investors, you certificates from insolvent and otherwise can generally ask your broker to buy them inactive companies. from you—generally for up to $1 for your entire position in the stock.

The life cycle of a corporate DTC facilitates the creation, distribution, or municipal bond has an issue date, a fixed term, and and settlement of new bond issues, through a maturity date, when it’s retired and ceases to exist. its Underwriting Services program The issuer sets when interest payments on a bond will be made and the interest rate it will pay. If the bond has any special features, such as whether it’s callable—or redeemable by the issuer— before its maturity date, or whether it’s convertible, which means investors may be able to exchange it for company stock under certain circumstances, those are ISSUING CORPORATES made clear when the bond Corporate bonds are launched much as is issued as well. equities are. The process begins when the company hires a firm, typically an investment bank, as lead underwriter. The lead under- A SHORT HISTORY writer assembles a group of other investment Until 1982, bonds were issued with a banks to work with it to distribute the issue. sheet of coupons attached. These bearer The job of the lead underwriter involves: bonds had no record of ownership, on the certificate itself or on the issuer’s • Filing a prospectus and other required offer- books. So if a certificate was lost or ing documents with the Securities stolen, the person in possession could and Exchange Commission (SEC) claim interest and principal payments. • Working with DTC to make the To claim your interest, you clipped security eligible for book-entry a coupon and mailed it to the paying creation, distribution, settlement, agent. That’s the origin of the terms and other depository services coupon, which means the interest a bond pays, and coupon rate, which • Marketing the issue to institutional means interest rate. And those terms investors in what’s known as a road show persist, though the issuance of bonds • Pricing the issue based on investor with coupons attached does not. There interest and the bond’s rating are, however, long-term coupon bonds issued and still outstanding from before • Distributing the issue to its clients 1982. The vast majority of bearer bonds and clients of the syndicate members in the United States are held at DTC, and A corporation does one thing very staff at DTC clip and mail in the coupons differently before issuing new debt than it on behalf of the beneficial owners. does before an initial public offering (IPO) of Starting in the 1980s, most coupon stock. It seeks a credit rating for the bond from bonds that could be converted to one of the major credit reporting agencies. registered bonds were converted. This Municipalities seek a rating for new debt issues meant that the bondholder’s name was as well. printed on the certificate and recorded A rating is important from the issuer’s in the issuer’s books. Interest was paid perspective because it helps determine the by check or electronically via Fedwire. interest rate it must pay to attract investors. Today, all bonds are issued in registered And it’s important to investors as an indication format, and the only coupon bonds of credit quality—essentially the likelihood the remaining are close to maturity. bond issuer will default, or fail to meet its obligations.

KEEPING TRACK positions of a CUSIP reflect the nature of the Fixed income instruments are given unique security being issued, and if the issue is a fixed nine-digit CUSIP identifiers just as equities are. income security, letters are assigned to those What distinguishes the two types is their use of positions. If the issue is an equity, the positions letters and numbers. The seventh and eighth are usually numbers.

DTC facilitates the creation, distribution, Using NIIDS, underwriters send and settlement of new bond issues, through new-issue information electronically to its Underwriting Services program DTC, as well as any follow-up adjusted information. Once DTC has all the required reporting information, it sends the data to information vendors, dealers, and other market participants so they can match, confirm, and report trades in a timely and ISSUING MUNICIPALS accurate fashion. Municipalities may issue bonds in one of DTC distributes updates in a real-time two ways. The first, known as a negotiated electronic format until settlement day. arrangement, is similar to the equity or Once the newly issued bonds are corporate bond issuance process—the in the marketplace, all secondary municipality hires an investment bank to market transactions are cleared and underwrite the issue. settled through DTC for institutional Using the second approach, known transactions and through DTC and NSCC as a competitive bid, the municipality is for broker-to-broker transactions. obligated to select as lead underwriter the bank that will cost the issuer least. If A WORD ON the bond will be repaid with tax revenues, TREASURY SECURITIES as general obligation (GO) bonds are, the The US Treasury issues its own bonds, law usually requires competitive bidding notes, and bills through the Bureau of to help ensure the bonds are issued at the Public Debt. Though historically they were lowest possible cost. issued as physical certificates, today the Treasury market is completely AT YOUR SERVICE dematerialized. Your name, as the owner DTC facilitates the creation, distribution, of any Treasury securities, is recorded and settlement of new bond issues, electronically in book-entry form on the as it does new equity issues, through books of the Federal Reserve Bank, its Underwriting Services program. To which is the depository for these issues. improve the reporting of trades and The Fixed Income Clearing Corporation price transparency of the newly issued (FICC), also a subsidiary of DTCC, handles municipal bonds, the Municipal Securities clearing, netting, and settlement for trans- Rulemaking Board (MSRB) requires lead actions in these managers to distribute new issue informa- securities in the secondary market tion through DTC’s New Issue Information through its Government Services Division Dissemination Service (NIIDS). (Congress (GSD) and two clearing banks, Bank of created MSRB in 1975 to oversee the issu- New York Mellon and JPMorgan Chase. ance and trading of municipal securities.) The issues are created electronically, recorded in book-entry form, and, at the JOINING THE CLUB time of sale, distributed from the accounts To have access to DTC settlement services, a of the underwriter firm to the accounts of bank, broker/dealer, or other financial services the DTC participants whose clients have organization must be a full member of DTC. That purchased the offering. requires satisfying initial membership requirements and meeting its continuing obligations.

DTC plays a role in both the ordinary securities through its Reorg Deposit and not-so-ordinary events in a bond’s Service. Before DTC implemented this life—from making interest payments to service, participants had to meet strict facilitating bond calls and dealing with deadlines to be able to process a call corporate takeovers—that can take place transaction at DTC. If they missed the before it reaches maturity. cut-off date, the transaction had to go through a transfer agent outside of DTC. PAYING INTEREST Today, through the Reorg Deposit When bonds are held at DTC in book- program, participants may deposit any entry form, the issuer, its paying agent, DTC-eligible securities that are subject to or its trustee transfers interest payments a full or partial call at any time after the to DTC as the registered holder of the announcement. In return, they’re credited issue in its nominee name of Cede & Co. with the principal and any interest that On the payable date, DTC credits this may be due, plus a premium, or supple- interest to its participants’ accounts so mental payment in excess of par value, that these brokerage firms and banks can if the issuer chooses to pay one. allocate interest to the accounts of their However, to ensure that investors clients who are the beneficial owners of receive payment on the redemption date, the bonds. the issuer’s paying agent must receive the For the limited number of bearer called bonds at least five days before the bonds still in circulation, DTC’s Coupon call redemption date. If a deposit arrives Collection Service (CCS) provides within the five-day window, or later, inves- participants with a central location for tors will be paid only after DTC receives submitting payment requests and collect- the distribution from the paying agent. ing the interest due to their clients. CCS allows participants to avoid MAKING dealing with individual municipalities and PARTIAL CALLS paying agents that would otherwise make Partial calls may the process cumbersome and error prone. be made: • By self-selection, BOND FULL AND PARTIAL CALLS allowing investors Some bond agreements include a to surrender bonds provision that allows the corporation until the quota or municipality to redeem the issue’s is met value, either in full or in part, before its maturity date. To activate a call option, • On a pro-rata BOND the issuer notifies DTC that a call will be basis, where all made and the date on which it will occur. bondholders must If a full call is announced, DTC chills redeem a certain the security at the close of business on percentage of the day before the payable date so that their holding no further trading can occur. Through an However, to accommodate its par- • impartial lottery to ticipants, DTC allows deposits of chilled choose randomly selected investors who must cash in their bonds If the lottery system is used, two lotteries are held. The first, which takes Reorg Deposit place at DTC, determines which participants will be affected by the call. The second occurs at the selected participant firms to determine which individual investors must tender their holdings.

WHAT HAPPENS WHEN redeeming them or by selling them in the A BOND MATURES secondary market—rather than holding A bond’s life cycle typically ends when them until maturity and the issue is redeemed and bondholders are risking loss of market value or default. repaid the principal they invested. Defaults. One of the first indicators Forty-five days before that a firm is in financial trouble is a the bond’s maturity date, default on an interest payment or DTC’s corporate action scheduled redemption. When DTC is announcement system aware of the default, it updates its automatically generates announcement by deleting the distribu- and sends a redemption tion rate and noting the default. payment announcement DTC also updates its internal to participants. When the systems to prevent any future maturity date arrives announcements from being and the issuer generated until they are autho- transfers funds to rized by the issuer or its paying DTC, payments agent. However, trading in the are automatically security remains open as there’s transferred via typically a market for defaulted DTC’s book-entry bonds. And, if a future accounting system payment is made, to its participants’ DTC pays as directed accounts. Those by the issuer or the payments are, in paying agent. turn, credited to In general, bondholders have better the relevant client accounts by the firms. odds of recovering some of the value of Once the payments have been their investment than stockholders do allocated, DTC removes the position if a company enters bankruptcy. That’s from its participants’ accounts, but keeps because creditors are paid before a a record of the bond, including when it company’s equity investors. However, matured and the payments that were the fate of a bond depends on the type made to investors, for at least seven years. of bankruptcy the company enters and how or if it recovers. Other ways to end In Chapter 11 bankruptcy, in some The end of a bond’s life cycle isn’t always cases, investors receive a new bond, business as usual. But there are DTC company stock, or a combination in systems in place to help handle special exchange for the bond they currently own. events, such as corporate takeovers In Chapter 7 and bankruptcy. bankruptcy, Corporate takeovers. In a corporate when a takeover, what happens to the bonds inves- company ends tors hold depends on the terms of the operations, bond agreement. If there is a change of the amount control provision in the agreement, inves- investors receive tors may tender their bonds. In exchange, depends on the the issuer will either pay par value or assets the com- a slight premium to par, as well as any pany has left to accrued interest. distribute and the type of bond they hold. Otherwise, and in cases where For instance, secured creditors are paid investors decide not to tender their bonds, before unsecured creditors. the purchasing company assumes the debt DTC typically receives a disclosure of the target company, and statement and ballots that describe investors continue to receive interest the reorganization plan for the security and principal payments in accordance and publishes the event through its with the original bond agreement. Reorg Inquiry for Participants (RIPS) However, since existing bonds may system. If the plan is approved and be downgraded depending on the provides for new entitlements for security circumstances of holders, DTC announces this through the the takeover, inves- same system, and, when it has received tors may be more those entitlements, allocates them likely to sell their to participants. bonds—either by BOND 25 ©2010 by Lightbulb Press, Inc. All Rights Reserved. BOND

BOND life cycle of a security Money Market Instruments Short-term borrowing is a big-time business.

Corporations issue bonds to raise money • Bankers’ acceptances for long-term projects, but often use • Institutional certificates of deposit (CDs) money market instruments (MMIs) for • Medium-term notes short-term financing. One of the most • Tax-exempt notes popular MMIs is commercial paper (CP)— • Deposit notes short-term commercial debt with maturi- Even though they are actually debt ties ranging from overnight to 270 days. instruments, MMIs are considered Other MMIs include: part of the asset class known as cash equivalents since they are liquid securities considered to have limited market risk because of their short terms and to be nearly free of credit—or default—risk based on the issuer’s reputation. To keep the MMI market as liquid as possible and to handle the high volume of trades that take place every day, DTC offers an automated system to handle the entire MMI life cycle—from issuance to redemption—that expedites processing while minimizing risks.

INVESTOR’S CUSTODIAN

BROKER $ $ $ $ $ NOTES

MEDIUM DEPOSIT TERM

Issuer Dealer Placed Placed TAX- EXEMPT

TYPES OF Commercial MMI Paper Institutional COMMERCIAL PAPER CP INVESTORS CD Commercial paper can be either CP and other MMIs are sold almost exclusively to secured or unsecured. Secured—or institutional investors, the majority of which are: asset-backed—paper is backed by Money market mutual funds specific assets the issuing company • owns. Unsecured CP is backed solely • Commercial bank trust departments by the issuer’s promise to pay. How- • Financial corporations, such as ever, both secured and unsecured life insurance companies CP are considered high-quality, safe Securities dealers securities because of the financial • reputation of the issuers and the high • Private and government pension funds credit ratings they receive from the Investors interested in purchasing CP who major credit rating agencies. aren’t members of DTC must have an account at either a broker/dealer or custodian bank. INVESTOR’S IPA CUSTODIAN ISSUER DTC IPA 26 DTC ©2010 by Lightbulb Press, Inc. All Rights Reserved. life cycle of a security

ISSUING COMMERCIAL PAPER efficient as possible while keeping risk to Commercial paper can be either directly a minimum. or dealer issued. Directly issued CP is To do that, DTC compensates for risk offered for sale by the issuing company inherent in these securities by assessing itself, while dealer-issued CP is placed variable discount levels to the market with investors by a broker/dealer the prices of MMIs. The level of the discount company hires. The broker/dealer can act assessed is based on the strength of as a distributor for the issuer by helping the ratings the issuer’s securities have to place the new issue through a relation- received from the rating agencies, such as ship with the institutional investors. S&P and Moody’s, and the days to maturity Regardless of how the security is of the MMI. The less creditworthy the distributed, all issuers use issuing issuer is deemed, the higher the discount and paying agents (IPAs)—in the assessed, and the greater the collateral CP market, these are commercial banks that is required. that must be members of DTC—to carry out the issuance and settlement HANDLING MATURITY transactions associated with selling and DTC initiates the book-entry transfer of redeeming CP. The issuer authorizes its the maturing securities from the investors’ IPA to enter issuance instructions into custodian accounts to the designated IPAs’ DTC’s system as well as to pay investors accounts beginning at approximately 1 at redemption through DTC’s book-entry a.m. the day the paper is to mature. The accounting system. All transactions are IPA has until 3 p.m. that day to refuse to processed electronically, since all CP is pay. A refusal to pay would occur if the held in book-entry form. issuer defaults on its payment to the IPA for any net payments due. At about 3:10 MAINTAINING p.m., all CP that is ready for redemption is LIQUidITY settled and any that is not is dropped from Because such the day’s settlement queue. a high volume In instances where the issuer fails of CP is issued to pay the IPA, DTC communicates the and redeemed default to its participants and unwinds, every day, DTC or reverses, all of the transactions in the INVESTOR’S must ensure that issuer’s paper that have been processed CUSTODIAN processing is as that day, and blocks the issuance of any new securities. BROKER $ $ $ $ $ NOTES

MEDIUM DEPOSIT TERM

Issuer Dealer Placed Placed TAX- EXEMPT

THE ROLLOVER Commercial Paper Institutional MARKET CD What makes CP and all MMIs unique among the securities DTC issuers typically fund the redemption of processes is what happens at redemption. maturing CP with the proceeds from their Issuers have two options when their new issues. CP reaches maturity. Just prior to the So, for example, if a company issues maturity date, the issuer may wire cash CP on Monday to mature on Tuesday and to its IPA to fund the redemption, and also plans to issue new CP on Tuesday, it the issuer’s account is credited and the uses the proceeds from Tuesday’s sale to position closed. fund the redemption of Monday’s issue. However, since the CP market is so Then, when Tuesday’s CP is ready for short term—most issues have maturities redemption on Wednesday, the company of seven days or less—and because repeats the process. This common practice companies generally issue new CP as givesINVESTOR’S the CP market its nickname: soon as their outstanding CP matures, IPA theCUSTODIAN rollover market. ISSUER DTC IPA 27 DTC ©2010 by Lightbulb Press, Inc. All Rights Reserved. life cycle of a security Managing Risk Protecting against risk provides certainty and safety in the capital markets.

If you invest, you’re reminded frequently of the risks you face. Stock prices can drop. Companies can stop paying dividends. Interest rates can go up, reducing A RISK OVERVIEW the market value of existing bonds. Debt There are risks in clearance and issuers can default. And, if you’re wise, settlement, the chief components you employ a number of investment of post-trade processing. strategies to help control the negative consequences those risks could have on your portfolio. There are other risks when you invest that you’re less likely to think about, but DTC also encounters risks in providing asset DTCC does, specifically through its clear- services for the 3.6 million securities in the depos- ing subsidiaries NSCC and FICC, and its itory, specifically collecting and allocating timely depository and settlement subsidiary DTC. payments of cash and/or stock entitlements—the These risks include the possibility that dividends, interest, principal, redemption, and a transaction you authorize won’t settle— maturity payments due to beneficial owners. that when you buy you won’t end up with the security you want or when you sell you won’t end up with the money that’s due that they must deposit enough securities you—or that dividends, interest, or prin- so that their combined discounted value cipal that you’re owed won’t be paid. equals the collateral requirement. What this overcollateralization means for AVOIDING A MELTDOWN DTC is that if the market as a whole or the To ensure that all transactions can be price of a single security or sector falls completed in the event a participant firm significantly during the trading day, the fails, all of DTCC’s clearing subsidiaries collateral in a participant’s account should maintain risk margining and collateral still be adequate to cover a default. programs. DTC maintains a Collateral NSCC and DTC require a minimum Monitor and a net debit cap. deposit for each firm, calculated daily, and The Collateral some firms may be required to deposit CIP RTI ANT Monitor has two PA S more during the day if they seem to pose components: cash $ greater liquidity risk.

and securities. DTC Minimum This collateral could be converted to requires every par- Deposit cash to cover what an insolvent firm owed ticipant to maintain if it defaulted on its obligations for the an account called trades already in the settlement cycle. the participants’ FUND Beyond that, DTC also maintains a large fund that holds only line of credit with a number of banks cash. The Collateral Monitor also requires to provide another line of protection participant firms to put up securities if necessary. as necessary, along with the cash in the participants’ fund, to cover settlement GETTING SETTLED obligations, and DTC tracks each partici- As a defense against DTC pant’s collateral account value throughout the threat that a participant the trading day. firm will not be able to meet Securities used as col- its obligation lateral are given to pay what it owes to a haircut. This means settle its transactions, DTC discounts the DTC imposes a net debit securities, reducing their cap, which serves as a value by 2% to 100% of liquidity control. the previous day’s clos- The cap is the highest amount a ing price. participant is permitted to owe DTC in What the haircut a business day. It’s comparable to the means for participants is credit limit on your credit card, but is

$ life cycle of a security

Counterparty risk is Operational risk is the down. It’s also possible the possibility that a par- potential that DTCC’s systems that a surge in trading ticipant firm—a broker/ could fail, either as a result of volume could over- dealer, bank, or other internal malfunction or external whelm operations. financial institution—will threats, such as natural events or fail and be unable to live even deliberate attacks, or that Systemic risk is up to its side of the deal. a participant’s systems could shut the possibility that an inter-related system of financial institutions In this case, the issuer or the issuer’s paying agent may not provide could be crippled or DTC with the required cash or enough information—such as the identifying collapse if one or more CUSIP number for the security with interest or dividends due—to make the of the key components payment on schedule. To reduce its exposure to default, DTC has developed failed. Loss of liquidity rules and procedures that allocate only those entitlements that are paid on would be a primary time and are correctly identified. reason.

unique and dynamic for each firm based SETTLEMENT: RAIN OR SHINE on the amount in its collateral account at As part of the critical infrastructure of the DTC and the level of its trading activity. United States, DTC is legally required to Any transaction that would result have its systems, processes, and functions in a participant’s exceeding its net debit up and running within two hours of any cap is recycled, or held in a pending disaster. So, while it’s possible that a trade account, until a credit from another settlement could be delayed, there has transaction, a payment, or other cash infu- never been an instance where DTC failed sion increases the firm’s account to complete daily settlement during more balance. At that point, the settlement than 35 years of operation. process can go forward. To ensure this continues to be the case, DTC has developed sophisticated data INSTITUTIONAL TRADES processing and communications systems When a transaction is institutional rather to streamline and expedite the settlement than retail—that is, the parties involved process with the use of straight-through in clearing the trade are a participant bro- processing (STP) whenever possible. kerage firm and various participant banks DTCC’s systems are deliberately acting as agents for an institutional redundant and cover DTC and all other investor rather than two brokerage DTCC subsidiaries to ensure that firms—DTC alone handles clearance processing can continue at alternate and settlement. Those trades do not go locations if there is a problem anywhere in through NSCC, DTCC’s clearing firm for the system. broker-to-broker trades. If there’s an unscheduled closing of The depository never assumes the exchanges, clearance and settlement the role of central counterparty continue normally on the regular sched- (CCP) in these trades, as NSCC does ule. But if the closing is more extensive, in retail trades. Instead, DTC offers a involving the Fedwire system of the different kind of protection to reduce Federal Reserve Bank of New York or settlement risk. other banking systems required for money Any trade that cannot be completed exchange—as might be the case for the returns to status quo ante, or the way funeral of a former US president—some things were before the deal was initiated. automated processes continue but Any securities or payments that have settlement itself is delayed until the next already been exchanged are returned business day. to the original owner. It’s as if the trade never occurred.

When you purchase securities issued by • Domestic Tax Reporting Service pro- a non-US company, you may owe taxes vides participants with income on income you receive from your invest- classification information they ment to the country where the company is need for accurate tax reporting headquartered, just as you do on income from US securities. Most countries tax the FINDING TAX RELIEF dividends or interest that securities pay, When dividends or interest are paid on the capital gains realized from selling the your non-US investments, the issuer’s securities at a profit, and often both. paying agent usually withholds the tax In most cases, taxes are withheld when that’s due and deposits it with the local payments are made to investors outside tax authority. What’s at issue is the tax the country, unless there are tax agree- rate that applies, specifically if it is the ments in place between the country of statutory rate or a lower rate. In this con- investment and the investor’s home coun- text the statutory, or legally established, try. Such agreements, called tax treaties, rate is generally the maximum rate the reduce the tax rate to the more favorable country charges on investment income. treaty rate. A lower withholding rate may apply if the investor is a resident of a country that AT YOUR SERVICE has a tax treaty with the country where DTC, through its family of tax services the security was issued or is considered products, both simplifies and expedites a resident for tax purposes. In other cases, what can be a major stumbling block to local legislation may international investing: meeting tax obli- entitle investors from gations without paying more than is legally other countries to required. a lower rate. These services benefit DTC participants, and through them the individual and institutional investors for whom the participants act as agents. They also benefit the securities’ issuers in the sense that making tax matters easier makes the securities more appealing to international investors and so attracts more capital. • TaxRelief enables participants to obtain the appropriate rate of withholding tax at the time an income payment is made—known as relief at source—or expedited tax refunds when relief at source is not available • TaxInfo provides a centralized source of information to help participants identify the lowest tax withholding rates available to specific clients • US Tax Withholding aids non-US financial institutions holding US securities at DTC in complying with non-resident alien tax withholding rules

DTC works with issuers, paying agents, and tax authorities of various countries to determine the lowest withholding tax rate for qualifying beneficial owners of the types of securities that are DTC eligible. This avoids their having to file a post-payable claim, which is a manually intensive process that can be expensive and error US TAX prone. WITHHOLDING Through its TaxRelief product, DTC can SERVICES help provide this relief in one of Tax withholding can also be two ways: a challenge for non-US financial institutions holding US securities With tax relief, the income • at-source on behalf of non-US citizens or resident payment and refund are handled simul- aliens. If those securities are in DTC taneously in one transaction custody, the depository, through its US • With quick conditional refunds, the Tax Withholding Service, acts as the refund is paid separately through DTC’s withholding agent for direct non-US cash settlement system after participants and those with qualified the dividend has been paid intermediary status from the Internal Revenue Service (IRS). THE NEED TO KNOW DTC works to simplify the often- Because income tax rules are complicated complicated tax-withholding process in and constantly changing around the world, at least four major ways: and different tax treaties offer tax relief Aiding participants in complying to different categories of investors, taking • with US non-resident alien tax with- full advantage of the tax relief that’s avail- holding rules able can be difficult. To help participants readily identify the tax • Assisting participants in obtaining the rates applicable to a variety of clients lowest possible US withholding rates holding non-US securities, DTC provides for their customers TaxInfo, a country-specific document Coordinating a range of tax with- library containing international tax with- • holding remittance processes on holding rates and relief entitlements for behalf of the participants select markets. Among the topics each document cov- • Facilitating claims for over- ers are the definitions of beneficial owners payment and accelerating the eligible for favorable tax repayment process treatment under different tax treaties, As part of this service, DTC also pays the tax withholding rates for various dividends, net of the appropriate withhold- investor types, and other relevant ing tax, on the payment date, provides a eligibility criteria. settlement statement, and remits the tax that’s been withheld to the IRS.

DOMESTIC TAX REPORTING SERVICE Through its Domestic Tax Reporting Service, DTC accumulates important tax reporting information across various security types for financial institutions. This centralized resource for year-end tax information makes it easier for participants to utilize the correct tax classifications during year-end reporting. This, in turn, ensures that investors get the information they need to file their annual taxes correctly.

Financial firms have been striving to systems to play a critical and growing role make it easy for individuals and institu- in investors’ being able to access global tions to invest anywhere in a world that markets. One of the key technology increasingly has focused on raising capital developments is the increasing use of as a key element for economic growth. common International Organization In order to assist these firms in for Standards (ISO) communication providing global services, infrastructure formats for various types of messages organizations like CSDs have needed to and from customer firms, other to make significant changes in their depositories, and exchanges. operations. For example, DTCC is leading an For example, as dematerialization effort to get securities issuers to adopt becomes more common, CSDs have had eXtensible Business Reporting Language to work out ways for non-citizens of their (XBRL) when announcing corporate countries to hold securities electronically. actions, a move designed to create a straight-through process for corporate International Message actions, initially in the United States and Standards later, globally. XBRL will allow issuers There’s parallel pressure to adapt tech- to electronically tag data in documents, nology to operate on a worldwide stage, making it possible to extract key elements across borders and without barriers. and flow them directly into ISO 20022 Increasingly, in response, DTCC and other formats being developed by the global infrastructure organizations have financial industry. CSD taken significant steps to modify their CSD CSD CSD CSD CSD CSD

CSD

CSD on Ware formati house Trade In DTCC CSD

CSD CSD CSD

ACSDA foster the exchange of ideas and communications Regional associations have also been formed by between CSDs in the Americas, and represents the CSDs for broader interaction and information Americas to other industry organizations. sharing on a regular basis. DTCC was a founding member in 1999 of the Americas Central Securities New Infrastructures Depositories Association (ACSDA), composed of DTCC has also taken a leading role in developing 25 CSDs from the Americas. ACSDA works to new post-trade infrastructures for alternative market classes. It was the first to develop a matching and confirmation service for over-the- counter credit default swaps contracts in 2003,

Electronic Links Through a DVP system, security pay- One of the main ways to achieve some ment and delivery are done at the same degree of interoperability is by establish- time. The securities are transferred from ing electronic links between depositories seller to buyer in a book-entry process at where there is significant volume. the end of the day, with a corresponding For example, collaboration between exchange of payment recorded when the DTC in the United States and other CSDs buyer’s securities are dispatched. worldwide has facilitated clearance and Delivery free of payment, on settlement of US securities traded abroad. the other hand, allows the electronic In addition, DTC holds book-entry posi- movement of shares between DTCC’s tions representing securities issued by US depository and other CSDs abroad, non-US entities on behalf of its US par- but there is no money payment connected ticipants in its accounts at depositories in with the movement. Payment for these other countries. For example, if a client traded shares is handled outside the of brokerage firm A, a DTC participant, respective securities’ settlement systems, purchased shares of stock X issued by a directly between the buying and company headquartered in the United selling firms. Kingdom, DTC would hold those shares in CSDs are also working to encourage its account in the UK CSD. increased information sharing and These links between DTC and other cooperation globally. DTCC has signed CSDs worldwide allow electronic move- memoranda of understanding (MOUs) ment of securities in place of expensive, with a number of central securities time-consuming movement of physical depositories and clearing organizations certificates. In some cases, these links can around the world covering information handle full delivery versus exchanges and joint work on projects. payment (DVP) settlement. In others, In at least one case, DTCC has taken a trade settlement takes place through a direct equity stake in Chile’s depository as delivery free of payment system. part of a way to encourage international cooperation and development of joint CSD CSD CSD services in Latin America. CSD CSD CSD CSD

CSD

DTCC CSD

CSD CSD CSD

and the first to develop a global repository for for OTC derivatives trades has proven so those instruments to store all the details of the successful that the International Swaps and swap contracts. Now called the Trade Information Derivatives Association (ISDA) and the industry Warehouse, the repository not only reports on have supported the concept for other OTC deriva- credit default swaps trading and volume to the tives classes, issuing and awarding to TriOptima public and regulators globally. It also provides key a contract for developing a repository for global asset servicing functions, such as payment recon- OTC interest rate derivatives and another to DTCC ciliation, central settlement and processing for a repository for OTC equity derivatives. Both of credit events, and successor events. repositories are now in operation, providing trad- The concept of a global central repository ing data to the industry and regulators globally.

Beneficial owner is an investor who capital. The maturities of CP range from owns a security even though the title is overnight to 270 days. held in the nominee name—also known is an event that as street name—of a central securities Corporate action may impact the value of a company’s depository, such as DTC. The beneficial securities and generally has a direct or owner receives the dividends or interest indirect effect on its shareholders and the security pays, has the right to sell the bondholders. Among the range of possible security, and, in the case of stock, is enti- corporate actions, some of the most com- tled to vote on certain corporate matters. mon are dividend or interest payments, Block trade is a securities transaction stock splits, tender offers, rights offerings, that typically involves the sale or pur- securities conversions, warrants, and chase of 10,000 or more shares of stock corporate reorganizations. or $200,000 or more in bonds in a single holds assets, including order. Typically institutional rather than Custodian bank individual securities and American retail investors make block trades. Depositary Receipts (ADRs), for institu- Book-entry describes the accounting tional investors, corporations, and wealthy system that enables DTC to transfer individuals. The custodian also collects ownership records for securities held investment income generated by client in its nominee name of Cede & Co. assets, provides corporate communica- electronically from the selling broker’s tions to its clients, and participates in account to the buying broker’s account the settlement of securities transactions when the transaction is settled. With on their behalf. book-entry accounting, no physical means having possession of securities change hands. Custody assets, including securities, that exist in Call is an issuer’s election to exercise either physical or electronic form. a right to redeem a security before its occurs when an institution or maturity date. In a full call, an entire Default individual obligated to make a payment issue is redeemed, while a partial call or deliver an asset fails to do so on time affects only a portion of the issue. The call and in full. Default may be the result of provision, if it is included, and the first inability or unwillingness to pay. date on which it can occur, are specified in the bond agreement, or deed of trust. Dematerialization is the process of eliminating paper certificates from the is an entity Central counterparty (CCP) securities processing cycle and replacing that interposes itself as the buyer to every them with electronic records. selling brokerage firm and the seller to every buying brokerage firm to guarantee Direct registration means holding a secu- that a trade will eventually settle even if rity directly by having ownership recorded the original buying or selling brokerage electronically on the books of firm defaults. the issuer or the issuer’s transfer agent. Central securities depository (CSD) Dividend reinvestment program is an organization that has custody of (DRIP) allows investors to channel divi- immobilized securities issued in certifi- dends directly into purchases of additional cate form and dematerialized securities shares of the security on which the earn- issued in electronic rather than certificate ings were paid. The income isn’t paid out form. The CSD provides a portfolio of to the shareholder, but taxes are due on services relating to those securities on the reinvested amounts unless the security behalf of its participants. is held in a tax-advantaged account. Clearance is one step in the post-trade DTC eligible describes financial assets process that finalizes the transfer of that qualify to be held at DTC and traded security ownership. It involves confirming and serviced through its electronic book the details of the transaction and, when entry system. Among the requirements, a central counterparty such as NSCC is the issue must meet the definition of involved, guaranteeing that the trade financial asset established by the Uniform will settle even if one of the original Commercial Code, meet or be exempt from parties defaults. certain SEC requirements under securities laws, and have a CUSIP number. Commercial paper (CP) is a form of money market instrument that is short- Immobilization occurs when securities term corporate debt issued by companies certificates are placed in the custody of that are believed to pose limited risk a central securities depository to reduce of default and need a regular source of the movement of physical securities.

Ownership records for immobilized acceptances, and institutional certificates securities are updated electronically of deposit. Most MMIs have terms of using a book-entry system, first at the 270 days or less because those with CSD and then at the participant firms longer maturities must be registered whose clients are the beneficial owners. with the Securities and Exchange Commission (SEC). Infrastructure organization is a firm whose mission is to support affiliated Net debit cap is the highest amount a organizations and improve their capacity DTC participant is allowed to owe the to deliver effective services by identifying depository in a business day. The amount and developing the necessary resources, is determined separately for each firm, creating compatible systems, ensuring based on the collateral it has on deposit effective communication, and and how much trading it is doing. mitigating risk. Nominee name, also known as street Initial public offering (IPO) allows a name, is the name in which immobilized corporation to raise money in the capital securities are registered with the issuer markets by making its shares available or the issuer’s transfer agent. Securities to the investing public for the first time. held at DTC are registered in its nominee In most cases, the corporation works name of Cede & Co. and recorded on its with the investment banking division of a books in the name of the brokerage firm brokerage firm, which facilitates the deal, that represents the beneficial owner. On underwrites the offering, and, working the brokerage firm’s books, the securities with a syndicate of other banks, distrib- are assigned to the accounts of their utes the shares at a set price, primarily to beneficial owners. institutional investors or wealthy individu- are the bro- als. The issuer receives the proceeds of Participant organizations ker/dealers, banks, investment managers, the sale, minus the underwriter’s fee. The and other financial firms who are mem- securities are generally made eligible at bers of clearing agencies, such as DTCC’s DTC for book-entry transfer. subsidiaries, DTC, NSCC, and FICC. is a securities Institutional transaction is a collateral account trade in which an organization, such as a Participants’ fund that each DTC participant must maintain mutual fund, hedge fund, pension fund, to cover the risk it poses as a result of or endowment, purchases or sells a large settlement activity in the DTC system and block of stocks, bonds, or other securities. to provide DTC with a source of liquidity Issuer is the corporation or government for the settlement of transactions. The body that offers a security—such as a required deposit, which is all cash, is cal- stock or bond—for sale to the public or culated daily. through a private placement. Paying agent is an institution, nor- Issuing and paying agent (IPA) acts mally a bank, authorized by an issuer to as an agent for an issuer of money market pay the principal plus premium, if any, instruments to handle the financial and interest on any debt securities or transactions associated with selling and dividends on equities on behalf of the redeeming these securities. In this con- issuer. If the security is in DTC custody, text, an IPA is a commercial bank that the paying agent authorizes an electronic must also be a DTC participant. money transfer to the depository, which distributes the income to those partici- describes the ease with which Liquidity pants whose clients hold the security. If an asset can be converted to cash. the security is held in certificate form Securities that are easily converted to or through direct registration, the pay- cash may be described as highly liquid ing agent sends a check to the holder or and those that aren’t easily converted authorizes an electronic transfer of the as illiquid. amount due. is the day the term of a Maturity date is the day on which a bond, money market instrument, or other Payment date dividend or other entitlement to holders debt security ends. Repayment of principal is paid. The issuing company’s board of and the final interest payment are due at directors announces the payment date at maturity, although the security may be the same time it announces the dividend. rolled over with a new maturity date. is the date by which an Record date Money market instruments (MMIs) investor must own a stock in order to be are short-term, high-grade debt securi- eligible to receive an upcoming dividend. ties including commercial paper, bankers The issuing company’s board of directors

announces the record date at the same Settlement date is the date on which a time it announces the dividend. securities transaction becomes final, with the seller’s broker delivering the security , or record holder, is the Record owner and the buyer’s broker delivering payment. individual or institution whose name is Different securities can have different recorded as the holder of record on the settlement dates. For example, with US books of the security’s issuer. The record stocks and municipal or corporate bonds, holder is not necessarily the beneficial the settlement date is three business days owner. That is the case when Cede & Co. after the trade date, or T+3. With US gov- is the record owner of immobilized and ernment securities, it’s one day after the dematerialized securities in the custody of trade date, or T+1. Different countries DTC, while individuals and institutions are can have different settlement periods. the beneficial owners. handles the electronic pay- is the process of repaying a Settling bank Redemption ment or receipt of funds associated with debt obligation, either at the maturity date netted securities transactions for or before. Early redemption is handled by the financial firms that have selected the calling some or all of the issue. bank to act on their behalf. Payments Reorganization is a corporate action that in the United States move through the may result in changes to the company’s Federal Reserve’s Fedwire system and legal, operational, or ownership struc- are irrevocable. tures. These changes are generally made

to address a problem, improve Straight-through processing (STP) describes an automated communications efficiency, organization, and profitability, environment in which data are entered or increase the market price of the once and forwarded electronically through corporation’s stock. every phase of a securities transaction Retail transaction is a securities trade from trade to settlement, never having that involves two brokerage firms, one to be re-entered. This reduces errors and representing the buyer and the other speeds up processing. representing the seller. Retail trades are is a group of investment banks cleared, netted, and settled through two Syndicate or brokerage firms assembled by the DTCC subsidiaries, NSCC and DTC. lead underwriter of a security offering to Secondary market includes the underwrite, or distribute, a new stock or exchanges, trading rooms, and electronic bond issue to investors that the syndicate’s networks where securities transactions members identify. involving buyers and sellers take place is an offer to purchase some following an initial distribution of stock Tender offer or all of the outstanding stock that inves- in an IPO or the issuance of a bond. tors hold in a target company at a certain Securities’ issuers receive no proceeds price by a certain date. The bidder may from these trades, as they do when the offer cash or other securities as payment, securities are sold for the first time. provided that a sufficient number of share- Security is a stock, bond, or other invest- holders agree to sell. ment product issued by a corporation or is a commercial bank government as a means of raising capital Transfer agent or other financial organization retained by offering investors something of value in by a corporation to maintain records of exchange for cash. For example, purchas- ownership for its securities issues and ing stock gives the buyer an ownership send out proxy materials and other corpo- share in the issuing corporation while a rate communications to owners of record. bond represents a debt owed to the holder. In some cases, the issuer acts as its own Settlement is the post-trade process that transfer agent. finalizes the exchange of and payment for is the investment banking securities that have been traded. When Underwriter division of a broker/dealer that works with these securities are dematerialized or corporations or municipalities who want immobilized in a CSD, such as DTC, the to issue stock or bonds to raise capital. change in ownership is recorded electroni- The underwriter creates and files the cally on the books of the brokerage firms prospectus, assembles a syndicate to assist whose clients authorized the trade. No with distribution, markets the new issue, certificates change hands. Financial set- distributes it and sends money to the tlement is handled by electronic transfer issuer, and initially maintains price stabil- between the accounts that the buying and ity in the market as the new issue begins selling firms maintain at DTC. to trade. For its efforts, the underwriter receives a fee. 36 ©2010 by Lightbulb Press, Inc. All Rights Reserved. authors

Virginia B. Morris is the editorial director of Lightbulb Press. She over- sees the development of a wide range of consumer content on investing, personal finance, and the financial markets for print and interactive media. She serves as a consultant for financial literacy and consumer education organizations for both adults and young people, and she’s a frequent guest speaker on financial radio and television programs, as well as at national conferences. Virginia is the author of more than a dozen books on financial subjects, including Guide to Clearance & Settlement, Guide to Understanding Money and Investing, An Investor’s Guide to Trading Options, A Woman’s Guide to Investing, Guide to Understanding Exchange Traded Funds, An Advisor’s Guide to Behavioral Finance, Your Guide to Understanding Investing, Saving for Retirement, and Guide to Understanding Direct Investing. Her articles appear in a wide variety of magazines and on corporate websites.

STUART Z. GOLDSTEIN is Managing Director of Corporate Communications and has been chief spokesperson for The Depository Trust & Clearing Corporation (DTCC) since its creation in 1999, and for its National Securities Clearing Corporation subsidiary since 1992. He is responsible for overseeing the firm’s media relations program, crisis management, executive communications, public affairs activities, internal communications and corporate Web strategy. Stuart is the co-author of the companion Guide to Clearance & Settlement. He is an accomplished writer and has published numerous articles on trends in the field of corporate communications and is a frequent newspaper op-ed contributor on public policy issues. Most recently, he has served as editor of Clearing the Way, a special purpose magazine distributed globally on market infrastructure issues.

Executive Editor Stephen Letzer Stephen is currently a Director of Corporate Communications for The Depository Trust & Clearing Corporation (DTCC) in New York and has been with the company 14 years, supporting its core clearing and settlement businesses. Prior to that he has worked in the defense industry, for the American Stock Exchange, and was a journalist for several years.

Lightbulb Press Project Team Design Director Dave Wilder Art Director Kara W. Hatch Editors Debbie DiVito, Mavis Morris Production Mercedes Lopez, Thomas F. Trojan

SPECIAL THANKS DTCC: Peter Gleeson, James Femia, Javette Laremont, Robert Hensey, Isaac Montal, John Petrofsky, Gregory Kalina, Cheryl Lambert, Eric Miller, Patrick Kirby, Dan Thieke, Kurt Holweger, Edward C. Kelleher, Michael Scholl Sarah Hickey DeLucia

©2010 by Lightbulb Press, Inc. all rights reserved. Lightbulb Press, Inc., 37 West 28th Street, New York, NY 10001 Tel. 212-485-8800, www.lightbulbpress.com ISBN: 978-0982907528 No part of this book may be reproduced, stored, or transmitted by any means, including electronic, mechanical, photocopying, recording, or otherwise, without written permission from the publisher, except for brief quotes used in a review. While great care was taken in the preparation of this book, the author and publisher disclaim any legal responsibility for any errors or omissions, and they disclaim any liability for losses or damages incurred through the use of the information in the book. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that neither the author nor the publisher is engaged in rendering financial, legal, accounting, or other professional service. If legal advice, financial advice, or other expert assistance is required, the services of a competent professional person should be sought.

A SECu RITY LIFE CYCLE OF A SECu RITY LIFE CYCLE OF

WHAT’S AN If trading volume between countries INTERNATIONAL CSD? justifies it, CSDs are frequently linked There are currently two International electronically, and have accounts with Central Securities Depositories (ICSDs), both Central Securities Depositories each other, so that securities can be located in Europe: Clearstream Banking in The certificate stops here. moved electronically between them. In Luxembourg and Euroclear Bank in Belgium. most cases, payment for those securities Initially created to accommodate the shares that an issuing corporation offers is usually handled between the trading expanding market in Eurobonds—bonds In the quest to attract capital and make - firms’ settlement banks rather than for sale in one or more countries in addi issued in a different currency and sold in their economies more vibrant, most tion to its home market. This approach through the CSD, though some CSDs a different country than that of the issuer, countries with active capital markets allows the corporation, working with a are equipped to handle both transfer and generally outside of the regulation of have central securities depositories local depositary bank, to raise capital in and payment. any single country—these depositories now (CSDs) to provide the custody and the target market. also provide recordkeeping and settlement recordkeeping services that enable the When these securities are traded in the SPOTLIGHT ON DTC services for a wide range of domestic and electronic transfer of ownership when The Depository Trust Company (DTC) was internationally traded securities by working United States, they’re known as American - investors buy and sell securities and Depositary Receipts (ADRs) and may be created in 1973 to transform the settle with a number of domestic CSDs around initiate settlement. With CSDs, settling immobilized at DTC or held in electronic ment process for securities transactions. the world. In the mid-1960s, when the predecessor the huge volume of securities traded form. Investors buy ADRs through a broker every day in the world’s capital markets as they do any US security, and enjoy the to DTC, the Central Securities Service, is fast, cost effective, and secure. same benefits and face the same risks. began operations, the paper-based trading or holding them in custody in a central system in the United States had become location. That central location was Like stockholders, ADR holders are - CROSS-BORDER SETTLEMENT entitled to all dividends paid on the under overly cumbersome and was bogged down DTC, now the largest central securities by the increasing transaction volume. In addition to the services they provide lying investment and to any capital gains depository in the world. Before DTC, when a corporation domestically, CSDs also handle cross- - they realize by selling their receipt for Today, DTC acts as a CSD for virtu- border settlement and may hold securi went public or a bond was issued, each more than they paid for it. DTC processes ally all US municipal securities, as well ties issued in countries other than the dividends for most ADR issues and purchaser received an elaborately as the vast majority of equities and their own. allocates the payments to the participants designed, and often quite beautiful, corporate bonds issued in the United Those securities may include paper certificate in his or her name that whose clients own the receipts. States. In addition to its recordkeeping- receipts, or certificates, representing detailed the issuer’s name, the date of and custody services, it provides a num issue, the number of shares, the par value, ber of asset processing services. For ownership records electronically. Some CSDs record and, after 1967, a unique identifying example, it settles institutional trades THE MANY ROLES OF A CSD the names of the beneficial owners and others the CUSIP number. In general, the basic functions of CSDs directly, manages all phases of a secu- names of only their member firms. To sell, the owner endorsed and rity’s life cycle, and offers underwriting, worldwide include: Settlement services. Very few CSDs are CSDs delivered the certificate to a broker, interest, dividend, and corporate action Custody and recordkeeping. able to complete cash settlement by themselves. immobilized who delivered it to the buyer’s broker services, including reorganization provide safekeeping for securities Generally, CSD members instruct a settlement in exchange for payment. Before the in their vaults and electronic ownership records - processing and tender offers for . Using bank or the country’s central bank to meet their purchaser could receive proof of owner for those that are dematerialized securities it holds in its custody. payment obligations, receive payments due them, ship, a new certificate had to be issued. There is no requirement that book-entry accounting methods, a CSD updates or both, for processing through the CSD. The solution to this bottleneck was to equities or bonds be held at DTC to record changes of ownership electroni- trade. But increasingly, many broker- Immobilization cally, using a computerized book-entry age firms and issuers want to take Securities Dematerialization system that eliminated the exchange of advantage of the efficiencies and • Clearance • Custody paper certificates by immobilizing them, cost benefits that DTC’s electronic book-entry system offers. Since 1999, DTC and National Securities Clearing Corporation (NSCC) have been subsidiaries of Book - entry and Settlement the Depository Trust & Clearing System processing dividend Corporation (DTCC), the world’s most and interest pay- efficient and cost effective post-trade Other services. The range of services ments, announcing, reporting, and clearance and settlement organization. a CSD provides varies from country to country, facilitating corporate action events, such as and many expand and create new offerings on a tender offers and reorganizations, and facilitating continual basis. Examples of additional services the deposit and withdrawal of securities. 5 include a role in underwriting new securities, 4 • The Global Market central securities depository • Central Securities Depository www.lightbulbfinancial.com • Creating Stock Latest guides • Popular articles • Bookstore • Corporate Actions Lightbulb Press, Inc. www.lightbulbpress.com [email protected] Phone: 212-485-8800

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