While investors are usually well aware of the process of buying and selling stocks or bonds, the world of post-trade often escapes their attention, if they consider it at all. However, the steps that unfold after a transaction is executed on an exchange
or electronic platform hold great significance in ensuring the security of investors and, on a broader scale, safeguarding the integrity of the global capital markets.

The primary goal of every trade is to be executed at the optimal price and settled with minimal risk and cost. The trade life cycle is often divided into two main phases: pre-trade activities and post-trade activities. Pre-trade activities include steps
occurring before order execution.

Post-trade processing refers to the activities after a financial trade is completed, primarily focusing on verifying transaction details, gaining approval from both the buyer and seller, updating ownership records, and coordinating the transfer of securities
and cash. This process is particularly crucial in non-standardised markets like over-the-counter (OTC) markets. 

In this article, we’ll take a closer look at the most important steps in the post-trade phase. But before we proceed, let’s make a quick recap of some fundamental trading terms we’ll use further on.

Trading Terms

Trading is the dynamic activity of buying and selling securities or other financial instruments.

Clearing follows the trade and manages the actions between the trade date and the settlement date. This process can be formal through a CCP (Central Counterparty) clearing house or informal directly between the buyer and seller. In CCP clearing, the CCP
assumes the role of the buyer to the seller and vice versa, transferring counterparty risk from the actual parties to the CCP. 

Settlement is an essential step in the post-trade process where the buyer receives the purchased securities, and the seller obtains corresponding cash. Banks and brokers, acting as investors’ intermediaries, play a role in settling trades of securities in
book entry form and providing access to CSDs. 

Custody and Asset services include the safekeeping of assets by intermediary banks, brokers, and CSDs on behalf of investors. They also include asset servicing functions such as income collection, corporate action processing, tax reclamation, and proxy voting
amasevisi.

Post Trade Processes

Post-trade processes are the activities conducted after the execution of a trade. They include clearing, settlement (which involves processes like affirmation, confirmation, allocation, and matching), custody, asset servicing, and related activities such
as collateralisation. 

The above-listed services are provided by financial market infrastructures such as Central Counterparties (CCPs), Clearing Houses, Central Securities Depositories (CSDs), as well as intermediating banks, including custodians and brokers.

Clearing

Clearing is the preliminary stage in the fund delivery process, kicking off when an individual or business initiates a wire transfer. During clearing, payment instructions are transmitted from the sender’s bank to an interbank clearing network such as CHIPS.
Unlike settlement networks, which focus on the actual transfer of funds, clearing networks like CHIPS primarily facilitate the reconciliation and routing of payment instructions between banks. 

Notably, clearing networks allow transactions to be netted, reducing costs compared to real-time settlement systems. While clearing ensures the accuracy and availability of funds for transfer, it does not involve the direct movement of funds between banks.
Instead, clearing concludes once the recipient’s bank deposits the wire amount into the recipient’s account using reserve funds, effectively confirming the completion of the clearing process.

Risk Mitigation with CCPs

CCPs play a crucial role in risk mitigation. They require eligible members to pay membership fees and contribute to a default fund, serving as a base layer of capital for extreme circumstances. Margin, or collateral, is requested daily or immediately in
volatile markets. In the event of a member defaulting, the CCP uses the collected funds to close out open positions. CCPs provide anonymity in stock exchange trades, serving as the legal counterparty to both parties, reducing the need for them to know each
other’s financial affairs.

Netting Function

CCPs offer netting, reducing exposure by consolidating multiple trades into a single transaction. For instance, if a counterparty buys and sells the same securities, the CCP nets these transactions, decreasing the total number of securities to be received
or delivered and mitigating risk.

Ukuhlala

Settlement marks the culmination of the fund delivery process, distinct from the preceding clearing phase. Following clearing, settlement can commence either immediately or at a later stage. Most payment systems, such as CHIPS, typically initiate settlement
by sending a final settlement wire at the end of the business day. Unlike clearing, which primarily involves transmitting payment instructions and confirming fund availability, settlement involves the actual transfer of funds between banks. In the case of
USD transactions, settlement often occurs through systems like Fedwire.

It is a crucial step in the post-trade process where buyers receive securities, and sellers receive cash in exchange for securities. This process, occurring two or three business days after the trade date, involves the use of electronic Delivery versus Payment
(DvP) to prevent either party from holding both securities and cash.

Investors typically use banks as custodians for holding securities and cash in safekeeping accounts. Settlement involves the transfer of securities and cash between the custodians of the buyer and seller. In cases where different custodians are involved,
coordination is required between the banks of the trading counterparties.

Custodian banks are interconnected through Securities Settlement Systems (SSSs), operated by Central Securities Depositories (CSDs). SSSs facilitate the technical interaction and processing efficiency for settlement. Matching, a crucial process before settlement,
ensures the correct pairing of instructions from buyer and seller custodians by considering various elements such as trade date, settlement date, and counterparty bank details.

Post-trade activities do not distinguish between trades executed in regulated markets or on a bilateral basis. There is always a transfer of securities and payment of cash, and accurate settlement instructions are vital for the smooth execution of different
types of transactions, regardless of how the trade is executed.

The Differences between Settlement and Clearing

Clearing and settlement processes in banking differ primarily in their functions and timing. Clearing determines the commitments of funds, while settlement involves the final reconciliation of accounts between banks. In clearing, funds may move between accounts
within the same bank, while settlement involves interbank fund transfers. 

Central banks often oversee settlement systems, facilitating direct money movement between banks’ accounts. Timing-wise, clearing occurs rapidly, usually within minutes, while settlement offers more flexibility, allowing banks to exchange funds immediately
after clearing or at a later time. Understanding these distinctions enables banks to make informed decisions regarding liquidity management. For instance, if speed is crucial, using real-time settlement systems like Fedwire is preferable, whereas if cost is
a priority, opting for systems like CHIPS may be more financially prudent.

Post Trade Process Step-by-Step

Now let us look at the post-trade process step-by-step. After orders are placed and executed by fund managers through their brokers, the affirmation and confirmation processes take place followed by clearing and settlement. 

Affirmation and Confirmation (Back Office Function)

– Institutions enlist custodians for clearing and settlement activities, particularly when involved in international trading.

– Fund managers may initially place orders without specific fund allocations, deciding on allocations later in the day.

– The broker sends trade confirmations to the institution, and fund managers allocate shares to specific funds.

– Custodians receive details from both the broker and institution, affirming trade accuracy through verification processes.

Clearing and Settlement (Back Office Function)

– Trades are cleared and settled within T+2 days, meaning trade allocations occur in investors’ demat accounts two days after the trade date.

– Clearing corporations calculate obligations for funds (buy transactions) and securities (sell transactions).

– Clearing members maintain accounts with designated banks and the depository, ensuring sufficient balances for fund obligations and stock holdings.

– Clearing members fulfil obligations, leading to the settlement of stocks and funds in investors’ demat accounts.

T+2 and Securities Settlement Timelines

In 2017 the settlement period for stocks and other assets was reduced to T+2 by the SEC. Clearing involves reconciling purchases and sales, validating funds, recording transfers, and ensuring security delivery. Non-cleared trades pose settlement risks and
may result in accounting errors. 

Post-trade services have gained prominence due to new regulations, derivatives standardisation, and increased processing complexity, offering firms opportunities to outstrip competitors. 

The SEC proposed shortening stock trade clearing time to T+1, with a potential further reduction to same-day settlement (T+0) in Spring 2022, aiming for implementation in Q1 2024. Settlement dates, occurring one to three days after the trade date, accommodate
post-trade processing, clearing, and settlement. Legacy systems contribute to this delay. Canada and Mexico are also following suit with this move. 

It must be mentioned that though most stocks, ETFs, corporate bonds, and municipal bonds settle T+2, listed options and government securities settle T+1. Certificates of deposit (CDs) and commercial paper settle T+0.

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• Source: https://www.finextra.com/blogposting/25962/what-do-post-trade-investment-operations-entail?utm_medium=rssfinextra&utm_source=finextrablogs