Clearing, settlement and custody · RiskAtoms Academy

By the end you will be able to

1Trace a trade from execution, through clearing and settlement, to custody.
2Explain how a CCP clears trades, and how netting shrinks what must be settled.
3Explain delivery versus payment and the settlement risk it removes.
4Describe what a central securities depository and a custodian do.

Why it matters

When you tap “buy” in a trading app, the shares are not yours yet. You own a promise. Turning that promise into ownership takes a chain of firms most investors never hear of, and every link in it can fail.

Core explanation

After the trade: from promise to ownership

Buying a coffee is simple: you pay and get the coffee at once. Buying shares is different. At the moment of execution, buyer and seller agree a price, but nothing has changed hands. The two have swapped promises: one to pay, one to deliver. Three more stages turn those promises into reality.

Clearing works out exactly who owes what to whom and manages the risk that someone fails before paying. For most exchange trades, a central counterparty (CCP) takes over the trade by novation, becoming the buyer to the seller and the seller to the buyer. It collects margin from both.
Settlement is the swap itself: securities go to the buyer and cash to the seller. It happens at a central securities depository (CSD), which holds the official record of who owns what. Settlement is done delivery versus payment (DvP): both legs move together, or neither does.
Custody begins once the shares are yours. A custodian bank holds them for you, collects dividends, passes on votes and handles events such as share splits.

Settlement does not happen the moment you trade. It happens on a set day, written T+1 or T+2: the trade date plus one or two business days. US shares moved from T+2 to T+1 in May 2024, and the EU and UK plan to follow in October 2027. Step through each stage and watch which firms are involved.

Step throughThe life of a share trade

1 / 6

InvestorBrokerExchangeCCPCSDCustodian

Order

The investor tells a broker to buy 200 shares. The broker checks the investor has the money and sends the order to the exchange.

What moves: An instruction
What can go wrong: A mistyped order (a 'fat finger'): operational risk.

Why clearing nets

Busy firms trade the same share with each other many times a day, buying and selling. Settling every trade separately would move far more shares and cash than needed. A CCP adds up each firm's trades into one net figure. This is netting. Compare the two ways below.

ExploreFive trades, settled two ways

Firms A, B and C trade one share with each other during the day, all at €50.00.

B→ 1,000 shares →A€50,000 back
C→ 800 shares →B€40,000 back
A→ 600 shares →C€30,000 back
C→ 400 shares →A€20,000 back
A→ 300 shares →B€15,000 back

Deliveries: 5
Shares moved: 3,100
Cash moved: €155,000

Netting cuts cost and risk: there are fewer things to go wrong, and much less cash is needed during the day. It also means that if a firm fails, the CCP faces one net position, not dozens of trades.

Who keeps the records

In the US, the Depository Trust Company (DTC, part of DTCC) is the CSD for most shares and corporate bonds. In Europe, Euroclear and Clearstream run national and international CSDs, and CREST, operated by Euroclear UK & International, settles UK shares. Large custodians include BNY, State Street and JP Morgan.

Sort itWhich stage is this?

0 of 6 right

An exchange matches your buy order with a seller's order at €12.40.
The CCP becomes the buyer to the seller and the seller to the buyer.
Shares move to the buyer's account at the CSD as cash moves to the seller.
A bank collects a dividend on a client's shares and credits it to her account.
A firm's 40 trades in one share are combined into a single delivery.
A bank forwards voting papers for a company's annual meeting to its client.

Worked example

Following one purchase and one day's netting

An investor in Chicago buys 200 shares of a US company at $150 through a broker, on a Monday that is a normal business day. US shares settle T+1. Then we look at the netting from the explorer above. Try each step before revealing it.

From trade to ownership

Step 1 of 6

1
Trade date (T)
The order executes on Monday at $150. The investor owes 200 × $150 = $30,000. The seller owes 200 shares. The price is fixed, but nothing has moved.

Regulatory lens

CCPs and CSDs are held to international standards, the CPMI-IOSCO Principles for Financial Market Infrastructures (2012). In the EU, the Central Securities Depositories Regulation (CSDR) adds settlement discipline, including cash penalties for trades that fail to settle on time. Client assets held by brokers and custodians must be kept separate from the firm's own, under rules such as the UK's client assets rules (CASS) and the US Customer Protection Rule.

Looking ahead: CCPs and other market utilities are the subject of L1.2.07, and margin and collateral of L1.7.11.

Sparks

SparkThe paperwork crisis

In 1968, trading volumes on Wall Street outgrew the back offices that moved paper share certificates by hand. Unsettled trades piled up, and the New York Stock Exchange closed on Wednesdays for part of that year to let firms catch up. The crisis led to central depositories, so that ownership could be recorded electronically instead of by moving paper.

SparkHerstatt risk

On 26 June 1974 German regulators closed Bankhaus Herstatt in the middle of the day. Banks that had already paid it Deutsche Marks in Europe never received the dollars due later in New York. Settlement risk across time zones is still called Herstatt risk, and the episode helped prompt the creation of the Basel Committee on Banking Supervision later that year.

Key takeaways

A trade passes through execution, clearing, settlement and custody. At execution only promises are swapped.
In clearing, a CCP becomes the buyer to every seller and the seller to every buyer, collects margin, and nets trades.
Netting turns many trades into one delivery per firm, cutting the shares and cash that must move.
Settlement happens at a CSD on a set day (T+1 for US shares since May 2024), using delivery versus payment.
Custodians hold securities for their owners, collect income, handle corporate actions and keep client assets separate.

Reaction

Check what stuck

Glossary

Execution: The moment a buy order and a sell order are matched and the price is fixed.
Clearing: Everything between execution and settlement: confirming the trade, working out who owes what, and managing the risk that someone fails.
Central counterparty (CCP): Central counterparty: a firm that becomes the buyer to every seller and the seller to every buyer.
Novation: Replacing one contract with new ones: the CCP replaces the original buyer-seller trade with two trades, one with each side.
Netting: Combining many trades into one net amount per firm, so only the difference has to move.
Margin: Collateral posted with a CCP or counterparty to cover losses if a firm defaults.
Settlement: The actual exchange of securities for cash, after which ownership has changed.
Delivery versus payment: Delivery versus payment: securities and cash move at the same moment, or neither moves.
Central securities depository (CSD): Central securities depository: the institution that keeps the official record of who owns securities and moves them on settlement.
Custody: Holding and looking after securities for an owner: safe keeping, collecting income and handling corporate actions.
Custodian: A bank that provides custody for investors.
T+1: Shorthand for the settlement date: T is the trade date and T+1 is one business day later.

Deep Dives & Origins

Deep Dives

Norman, P., Plumbers and Visionaries: Securities Settlement and Europe's Financial Market, Wiley, 2007. Intermediate, history.
CPMI-IOSCO, Principles for Financial Market Infrastructures, Bank for International Settlements, April 2012. Advanced.

Origins

CPMI-IOSCO, Principles for Financial Market Infrastructures, BIS, April 2012.
US Securities and Exchange Commission, final rule shortening the settlement cycle to T+1, February 2023.
Regulation (EU) No 909/2014 (the Central Securities Depositories Regulation).
Norman, P., Plumbers and Visionaries, Wiley, 2007.
Basel Committee on Banking Supervision, history of the Basel Committee.

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