The Trade Life Cycle Explained

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Execution is the transaction whereby the seller agrees to sell and the buyer agrees to buy a security in a legally enforceable transaction. Thereafter, all the processes that lead up to settlement is referred to as clearing, such as recording the transaction. Settlement is the actual exchange of money, or some other value, for the securities.

Clearing is the process of updating the accounts of the trading parties and arranging for the transfer of money and securities. There are 2 types of clearing: In bilateral clearingthe parties to the transaction undergo the steps legally necessary to settle the transaction.

Central clearing uses a third-party — usually a clearinghouse — to clear trades. Clearinghouses are generally used by the members who own a stake in the clearinghouse.

Members are generally broker-dealers. Only members may directly use the services of the clearinghouse; retail customers and other brokerages gain access by having difference between trading broker and clearing brokerage with member firms. The member firms have financial responsibility to the clearinghouse for the transactions that are cleared.

It difference between trading broker and clearing brokerage the responsibility of the member firms to ensure that the securities are available for transfer and that sufficient margin is posted or payments are made by the customers of the firms; otherwise, the member firms will have to make up for any shortfalls.

If a member firm becomes financially insolvent, only then will difference between trading broker and clearing brokerage clearinghouse make up for any shortcomings in the transaction.

For transferable securities, the clearinghouse aggregates the trades from each of its members and nets out the transactions for the trading day. At the end of the trading day, only net payments and securities are exchanged between the members of the clearinghouse.

For options and futures and other types of cleared derivatives, the clearinghouse acts as a counterparty to both the buyer and the seller, so that transactions can be guaranteed, thereby virtually eliminating counterparty risk.

Additionally, the clearinghouse records all transactions by its members, providing useful statistics, as well as allowing regulatory oversight of the transactions. Settlement is the actual exchange of money and securities between the parties of a trade on the settlement date after agreeing earlier on the trade.

Most settlement of securities trading nowadays is done electronically. In futuressettlement refers to the mark-to-market of accounts using the final closing price for the day. A futures settlement may result in a margin call if there are insufficient funds to cover the new closing price. Modern day settlement and clearing evolved as a solution to the paper difference between trading broker and clearing brokerage of securities trading as more and more stock and bond certificates were being traded in the 's and 's, and payments were still made with paper checks.

Brokers and dealers either had to use messengers or the mail to send certificates and checks to settle the trades, which posed a huge risk and incurred high transaction costs. At this time, the exchanges closed on Wednesday and took 5 business days to settle trades so difference between trading broker and clearing brokerage the paperwork could get done. The 1 st solution to this problem was to hold the certificates at a central depository — sometimes referred to as certificate immobilization —and record change of ownership with a book-entry accounting system that was eventually done electronically.

In Europe, Euroclear and Clearstream are the major central depositories. The process of eliminating difference between trading broker and clearing brokerage certificates entirely is sometimes referred to as dematerialization. A further improvement was multilateral nettingwhich further reduced the number of transactions. Brokers have accounts at central depositories, such as the DTCC, which acts as a counterparty to every trade. So instead of sending payments and difference between trading broker and clearing brokerage for each transaction, trades and payments were simply aggregated over the course of the day for each member broker, then were settled at the end of the day by transferring the net difference in securities and funds from 1 account at the depository to another.

For example, if a broker bought shares of Microsoft for a customer and sold 50 shares of Microsoft for another customer, then the broker's net position is the accumulation of 50 shares of Microsoft, which would be recorded at the end of the market day.

Likewise, only 50 shares of Microsoft would be transferred to the broker's account, since this is the net difference of buying shares and selling 50 shares. Nowadays, governments around the world are promoting, or even requiring, central clearing, so that they can assess the systemic risk being imposed upon economies by their financial institutions, especially in the trading of derivatives, as was witnessed in the recent credit crisis ofwhen governments had to bail out many financial institutions because of a possible domino effect if a major institution would fail.

Central clearing is the best means of maintaining records so that financial risks to the economy can be better assessed.

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Ever wondered how on Earth all the different components and stages of a trade fit together? We start with our investors. The investor informs the broker firm and their custodian a financial institution — usually a bank — which looks after their assets for safekeeping of the security they would like to buy, and at what price — either the market price or lower.

This is called a buy order. A couple more jargon nuggets for you here: A market order is an order to buy or sell at the market prices. From this point, the order is fed down to the risk management experts in the middle office of the organisation. Amongst other things they will check the client placing the order has sufficient stocks to pay for the security and the limits.

When an order is accepted and validated by the risk management team, the broker firm sends it to the Stock Exchange…. They will also put in a sell order to their broker, stating the security they have to make available on the market and the market price how much they want to sell it for.

The sell order goes through all of the necessary risk management procedures in the middle office on this side as well. All being well, it then shoots off to the exchange too…. Once the beautiful moment of a perfect match happens…. A trade is born! In order to proceed further, confirmation is necessary. The broker on each side of the trade has checked that their client agrees with details and conditions: The exchange will also send these details to the custodian who will relay this information to the broker for confirmation.

Once the trade has been confirmed by the brokers and as long as each party agrees with the details and conditions, the back office team gets to work, and the clearing house comes into play…. On the settlement date the sell side must have transferred their security and the buy side must have transferred the money for their purchase. Finally, the glorious settlement date arrives: Back office staff are responsible for ensuring that these payments are made on time and documented and reported in the correct manner.

The buy side will transfer cash for the security via the clearing house, and likewise the sell side will hand over their security. At the end of each trade day the clearing house will provide reports on settled trades to exchanges and custodians. Like what you're reading? Thinking of getting to a career in Finance? What is your full name? All being well, it then shoots off to the exchange too… Stage six: Once the beautiful moment of a perfect match happens… Stage seven: Once the trade has been confirmed by the brokers and as long as each party agrees with the details and conditions, the back office team gets to work, and the clearing house comes into play… Stage nine: This is a digital high five.

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