1.3.4 Clearing System

The Clearing System

During a trading day, exchange members act as both buyers and sellers of many listed stocks. Rather than each member making a separate settlement with another member on each trade during the course of a trading day, a designated central clearing system handles the daily settlement process between members.

In Canada, securities are cleared through CDS Clearing and Depository Services (CDS). Although CDS is not considered a financial intermediary, it is a valued partner to dealers operating in the securities market, providing reliable clearing services. CDS operates CDSX, the facility for the clearing and settlement of trades in equity and debt securities in Canada and for various cross-border transactions. Marketplaces such as the Toronto Stock Exchange (TSX), the TSX Venture Exchange, and alternative trading systems report trades to CDSX. Over-the-counter trades are also reported to CDS by participants in the system. Participants with access to the clearing and settlement system primarily include banks, investment dealers, and trust companies.

Netting Process

The central clearing system uses a process called netting to establish and confirm a credit or debit position balance, in the form of cash or security, for each dealer member.

The netting process involves the following steps:

1. Compile each firm’s clearing settlement sheets from their trading activity.
2. Confirm each member’s securities or cash obligations.
3. Inform each member of the net securities or funds they must deliver to settle their account.

In this way, the number of securities and the amount of cash that needs to change hands among various members each day is substantially reduced.

Here is a visual representation of the netting process:

      graph TD;
	    A[Trades Executed] --> B[Trades Reported to CDSX];
	    B --> C[Netting Process];
	    C --> D[Compile Settlement Sheets];
	    D --> E[Confirm Obligations];
	    E --> F[Inform Members of Net Deliveries];
	    F --> G[Settle Accounts];

Key Roles of an Investment Dealer

Principal vs Agent

An investment dealer can act in one of two primary roles:

• Principal: The dealer buys and sells securities for its own account, taking on the risk and potential profit or loss from the transactions.
• Agent: The dealer facilitates transactions on behalf of a client, acting as an intermediary and earning a commission for the services provided.

Glossary

• Clearing System: A mechanism through which trades are confirmed, settled, and cleared by centralized entities to ensure smooth and efficient market operations.
• CDS Clearing and Depository Services (CDS): The organization responsible for the clearing and settlement of securities trades in Canada.
• CDSX: The clearing and settlement platform operated by CDS.
• Netting: A method of reducing the number of transactions required to settle trades by offsetting obligations among market participants.

Frequently Asked Questions (FAQs)

Q1: What is the role of CDS Clearing and Depository Services?

A1: CDS Clearing and Depository Services (CDS) is responsible for the efficient clearing and settlement of trades in equity and debt securities in Canada. It operates the CDSX platform where trades are cleared and settled.

Q2: What is netting in the context of the clearing system?

A2: Netting is a process by which the central clearing system offsets and consolidates multiple trade obligations to reduce the number of transactions and amounts of securities and cash that need to change hands, simplifying settlement.

Q3: Who are the typical participants having access to the clearing system?

A3: Typical participants include banks, investment dealers, and trust companies that are involved in the securities market.

Key Takeaways

1. The clearing system centralizes the settlement of trades to streamline transactions between exchange members.
2. CDS Clearing and Depository Services administers the central clearing system in Canada via the CDSX platform.
3. The netting process reduces the complexity and volume of settlements by offsetting trade obligations.
4. Investment dealers can operate either as principals or agents in the marketplace.

By understanding these foundational elements, you’ll be better equipped to navigate the clearing and settlement processes within the Canadian securities market.