CREST Settlement Flow

CREST - SETTLEMENT - Anurag Singh

INTRODUCTION TO CREST CREST is the Central Securities Depository for the U.K., Republic of Ireland, Isle of Man and Jersey equities and UK gilts It was established in 1993 and operation started in 1996 CREST joined Euroclear group in September 2002 It is established as a Recognised Clearing House under the Financial Services and Markets Act

CREST RELATIONSHIPS CREST distinguishes users from other participants Users have the technical capability of connecting to CREST via an electronic communications network Participants are those who have formal relationship with CREST, whether or not they operated they operate the technology that enables communication with the system

CREST-COMPANIES For any company to settle their shares through CREST need to get the following formalities done: A board resolution need to be passed and the share holders need to be informed Each company need to ensure that its registrar has signed a service level agreement with CREST and is able to communicate directly with CREST From the day the company’s securities are eligible to settle through CREST, its shareholders are able to maintain holdings in dematerialised accounts Company may choose to select few of its less frequently traded class of other securities as ineligible for CREST settlement

MAINTAINING DETAILS OF SECURITIES Maintains details of eligible securities, residuals and transaction reporting only securities Registrar of the company notifies CREST that the security is CREST eligible, the details are created in CREST The above created details is available for viewing and is in status ‘New’ Transactions can be placed for these securities but these are still ineligible to settle When all the conditions and formalities are over at CREST, the security is enabled for settlement by CREST system controller CREST can disable a security for reason like failed reconciliation, bad delivery etc. Transactions on disable securities will not be allowed to settle, though new transactions can be fed

CREST - INVESTOR Investors have following options of holding securities in CREST Dematerialise holdings and participate directly as a CREST member or a sponsor member – his name is in registrar and is the legal owner of the shares Retaining paper certificates outside CREST Maintaining his holding in a nominee company, either in dematerialised or certificated form : nominee company becomes the legal owner and investor is the beneficiary owner

CREST- OTHER CSDS CREST has cross-border links with other central securities depositories and thus allow UK investors to hold and transfer certain international securities through CREST

CREST OPERATIONS Maintain details of members and their account structures Book keeping Authenticating and seeking to match electronic settlement instructions from CREST participants Settling transactions, maintaining the obligations Providing information to registrars and payment banks Providing information to LCH and its clearing members for SETS trades Support to SLB, CA, claims calculation and settlements Providing information to system regulators Calculation & collection of applicable transfer tax for the Inland revenue & Irish Revenue commissioners Reconciling balances with registrars Providing support for settlement of certificated securities

USERS Have technical ability to send and receive electronic messages on behalf of members and other participants Users contract with network providers for the connection to CREST (like with SWIFT Securenet Limited) The ability to communicate with CREST is provided by gateway, which is a computer running software that enables communication between user’s office and CREST User may use the connectivity only for his own use or as a service to other participants

MEMBERS, SPONSORED MEMBERS AND PERSONAL MEMBERS Members are those participants who have stock accounts and has his name on the company register Sponsored Members are those who hold securities in CREST and have their name in the company register, but don’t directly communicate with CREST If the sponsor member is an individual, he is termed as Personal Member Member need be in: A contract with a payment bank per currency Contract with a user in case of sponsored members) or should be a user Accepts the terms and obligations of CREST service

PAYMENT BANKS Payment banks are CREST participants who hold cash accounts with the Bank of England and facilitate payment in respect of transactions settling through CREST. Payment arrangements are formalised by payment bank contract with: Each CREST member or sponsored member who is a client of the bank Each other payment bank in that currency CREST

REGISTRARS Registrar is the department or organisation appointed by a company to maintain the legal record of registered shareholders – the register Registrar need to maintain two registers: CREST holdings (dematerialised) Non-CREST holdings (paper certificates) For UK registered securities, following need to be maintained: Issuer register (comprising certificated holdings) Operator Register (comprising electronic holdings in CREST) At the end of each day, full record of shareholders need to be formed by combining issuer register and operator register Note: Receiving Agent is an organisation appointed by a company to assist in administering a stock event.

REGULATORS AND THE INLAND REVENUE Regulators of CREST participants e.g. FSA, have access to view all systems data relating to their regulates. CREST calculates and collects stamp duty reserve tax (SDRT), on behalf of the Inland Revenue and Stamp Duty on behalf of the Irish Revenue Commissioners.

CENTRAL COUNTERPARTY (CCP) LCH acts as CCP for trades generated through Stock Exchange Electronic Trading System (LSE – SETS) CCP has both full member and clearing member functionality

CLEARING MEMBERS Clearing members are allowed to view their open positions related to SETS They also have membership with LCH

OTHER PARTICIPANTS Information Provider: Organisations which provide information to CREST to have a connection via a network, feeding data to CREST for internal use and for distribution to CREST members & other participants. CSDs: Central Securities Depositories are participants who maintain link with CREST for cross border settlement, moving securities to and from settlement systems outside the UK Product Providers: Organisations which provide collective instruments, including unit trusts and open ended investment companies (OEICs), which want to use CREST as a settlement facility

MEMBER ACCOUNT STRUCTURE User Sponsored Member Member Sponsored Member Sponsored Member Default Member Account Member Account 1 Member Account n Available Deposit Link

MEMBER ACCOUNT STRUCTURE Member can have one or more accounts On registration of the Member, a default account gets registered for the member – which has no account id Each additional member account has an alphanumeric designation & is created on Member’s request For additional accounts, annual fee is charged

TRANSACTION TYPES DEL – Deliveries OAT – Own Account Transfers MTM – Complex (Many to Many) Deliveries DBV – Delivery By Value DBR – DBV Returns DBI – DBV Interest Payment ADJ – System Controller’s Adjustment CLA – Claims, or benefit claims RES – Residual Settlement INT – Interest Payment STR – Strip Request RCN – Strip Reconstitution Request STD – Stock Deposits STW – Stock Withdrawal BDR – Bad Delivery Reversal BWR – Bad Withdrawal Reversal REG – Registrars Adjustment Transaction

TRANSACTION TYPES – CONTD. RPO – Repo Transaction RPR – Repo Returns RPS – Repo Substitution SCR – Self Collateralising Repo SLO – Stock Loans SLD – Stock Loan Revaluations SLR – Stock Loan Returns STP – Stamp Duty Payments TFE – Transfer From Escrow TTE – Transfer To Escrow ESA – Escrow Account Adjustment USE – Unmatched Stock Event Transaction XDL – Cross-Border Delivery XDC – Cross-Border Delivery Confirmation XDR – Cross-Border Delivery Reverse

MATCHING OF SETTLEMENT INSTRUCTION Process of matching input made, or treated as being made, independently by both principal participants to the delivery, before transaction can proceed to settlement In case the member has opted for Central Sponsor Services, with respect to EDS and DEL transactions, CREST will automatically generate the instruction on behalf of them and there is no need for the member to send the instruction CREST requires perfect matching and doesn’t include any degree of tolerance other than in relation to consideration

CLEARING SUPPORT For a member to become ‘CCP’ Participant or a CREST central sponsor for a particular trading system or clearing service, CREST needs sound legal basis for: the formation of contracts to be settled through the central sponsor services to be provided by the applicant the performance of such contracts by way of net settlement the taking of action in respect of such contracts where they remain unsettled by reason of the default of a participant in the trading system or clearing service the respective rights and obligations in relation to corporate events affecting securities the subject of, and under, such contracts; and the relationship between a clearing member and a non-clearing member in respect of such contracts

TOLERANCE MATCHING This functionality enables CREST to amend the consideration of a transaction within specified parameters in order to achieve a match The maximum adjustment for each settlement currency is: Sterling - £ 10.00 US Dollar - $15.00 Euro - €15.00 Tolerance Matching is applied to following transactions: Deliveries (DEL) Residuals (RES) Stock Loans (SLO) Tolerance Matching doesn’t apply to cash-only DEL transactions, non-settling transactions and DEL transaction created as central sponsor transactions Members may opt in/out for tolerance matching. By default it is ‘opted out’ Tolerance Adjustments Logic: If neither participants have opted for central tolerance, there is no tolerance adjustment If one of the two participants have opted for central tolerance, the transaction input of the stock giver will be opted in will always have his transaction input adjusted If both the participants have opted for central tolerance, the transaction input of the stock giver is considered true if it lies within the tolerance band and the taker of the stock’s input is adjusted Notification that the transaction has been centrally adjusted is achieved by means of a specific party transaction status. Only the participant whose input has been amended will be notified by the user file change mechanism.

AMENDMENT OF SETTLEMENT INSTRUCTIONS CREST allows amendment of non-matching fields in a delivery, complex delivery, stock loan, residual, repo transaction, DBV instruction or cross-border delivery (when receiving UK/Irish Security) Members are allowed to amend the data input by themselves but not the ones input by the counterparty member Non-matching fields in matched deliveries can be amended in any transaction state between matched and settled Matching fields generally cannot be amended at anytime with exception for rollover and early return features of the repo transaction In case of single input transactions, Non-core fields can be amended anytime before settlement Amendment of core fields requires deletion of transaction and re-input No fields can be deleted after settlement It is not possible to amend a member account of a transaction if the Settlement Netting Type Field has been set to ‘G’ signifying that it is matched grossed transaction eligible for netting Similarly if member account is amended in a transaction which is not set for netting to a account which is set for netting, the transaction is not reassessed for netting and settled on a gross basis

DELETION OF SETTLEMENT INSTRUCTION A transaction can be deleted if Matching transaction is not yet matched Single input transaction before settlement Matched transactions can be deleted only by matched deletion Deletion cannot occur after settlement has taken place Cross-border transfers cannot be deleted once the transferor CSD has instructed the receiving CSD Transactions are centrally deleted if they remain unmatched for more than 30 business days Following transaction types are eligible for deletion: claims, or benefit claims, DBV returns, deliveries, interest payments, complex (or ‘many-to-many’) deliveries, own account transfers, strip reconstitution request, residual transactions, repo transactions, repo returns, repo substitutions, stock loan revaluations, stock loans, stock loan returns, stock deposits, strip requests, stock withdrawals, transfers from escrow, transfers to escrow, unmatched stock event transactions, cross border deliveries

SETTLEMENT QUEUE A queue is a list of similar transactions that are ready to settle, ordered in the sequence in which CREST has attempted to settle them Transactions are queued on the basis of following factors: SCR eligible securities will have the highest priority in comparison to other securities Random Security Number: In order to avoid favouring of one security to another, CREST assigns a random number to each security every day and instruction will be sequenced based on this number starting with highest Stock Debit Priority: Priority set by stock debit party will be used to determine sequence For cash only transaction, priority set by cash debit party will be used for settlement For DVP transaction, priority given on cash side will not effect settlement sequence Intended settlement date: Transaction will be sequenced by intended settlement date, starting with the oldest first Value: Transaction will be sequenced by value in descending order, starting with the highest value

ENQUIRY FACILITY CREST supports enquiry to access: Members’ stock and cash balances and positions Settlement banks’ cash and stock balance Member Transactions Account structure CREST IPA relationship enquiry and issuer ISIN enquiry System data Operational data

DELIVERY TRANSACTIONS Delivery/Own Account Transfer

DELIVERIES/OWN ACCOUNT TRANSFERS The Deliveries can be of following type: Delivery against Payment Delivery free of Payment Payment only Delivery transaction can be either gross or net OAT enables members to transfer securities between its own member accounts OAT require single input of instruction Only stocks in Account’s available or deposit link balance can be transferred OAT are always free of payment

CLIENT RELATIONSHIP HANDLED OUTSIDE CREST Broker’s Nominee (Sponsored Member) CCP (Member) Principal (Member) Stock Stock Settlement Instruction Settlement Instruction SETS - Trade a/c 1 a/c 1 a/c a/c Broker Principal Investor

BACK-TO-BACK DELIVERY Market Maker (Member) Broker’s Nominee (Sponsored Member) Investor B Sponsored (Member) Stock Stock Settlement Instruction Settlement Instruction Trade a/c 1 a/c 1 a/c Market Maker Broker Investor a/c 1 a/c 1

INVESTOR’S HOLDING MAINTAINED BY CUSTODIAN Market Maker (Member) Broker’s Nominee (Sponsored Member) Custodian (Member) Stock Stock Settlement Instruction Settlement Instruction Trade a/c 1 a/c 1 a/c Market Maker Broker Investor a/c 1 a/c 1 Custodian

OVERVIEW Stock Loan and Collateral results in the transfer of full legal ownership of the stock involved The loaned stock is registered into the name of the borrower On settlement of original transaction, CREST automatically creates the reciprocal transaction to enable the stock to be returned to the original owner The original owner, although no longer the legal owner, retains an interest over any benefits distributed on that stock

INPUT OF STOCK Settlement Instruction Settlement Instruction Settlement Instruction

SETTLEMENT OF A STOCK LOAN Create payment Obligations Lender’s Bank Intermediary Bank Borrower’s Bank Registrar Stock Stock Cash Cash SLO1 - Settled SLO2 - Settled SLR1 - Created SLR2 - Created RURs for SLO1 & SLO2 Create payment Obligations Lender’s Account Intermediary’s Account Borrower’s Account CMA CMA CMA

SETTLEMENT OF A STOCK LOAN RETURNS Lender’s Bank Intermediary Bank Borrower’s Bank Registrar Stock Stock Cash Cash SLR1 - Settled SLR2 - Settled RURs for SLR1 & SLR2 Create payment Obligations Create payment Obligations Intermediary Member Borrowing Member Raise priority of SLR1 Raise priority of SLR2 Lender’s Account Intermediary’s Account Borrower’s Account CMA CMA CMA

STOCK LOAN REVALUATION TRANSACTIONS(SLD) Stock Price Rises Stock Price Falls

COLLATERAL PROVISION CREST members can arrange overnight cash loans from another member in exchange for securities held as collateral To support the same CREST assembles a package of securities to a specified value and transfers it to the lender It is known as Delivery By Value (DBVs) These are generally used by Market Makers The DBVs can be used in conjunction to collateralised stock loan or even independently The term of DBVs is only from one business day to the next, so revaluation is unnecessary. Even if the loan gets extended a new DBV instructions have to be input each day

SETTLEMENT OF COLLATERAL PROVISIONS DBV Settlement DBR Settlement

OVERVIEW CREST members can hold and settle transactions in a range of domestic and international securities registered in countries where CREST has cross border links with the overseas central securities depository (CSD) Communication between each system is via SWIFT Legal Basis of Ownership and Transfer Each CSD with which CREST has a link has a UK nominee who is a participant in CREST (type CSD), allowing it to hold UK stock electronically on behalf of its participants. Thus the participants in the overseas CSD are able to be the beneficial owners of the UK stock Similarly, CREST will maintain a special-purpose nominee in each country with which it has links for holding and transferring stock on behalf of CREST members

OVERVIEW – CONTD. CREST Depository Interests (CDIs) CREST as a nominee maintains holdings of overseas securities in accounts with CSDs CREST issues depository interests in UK for the above holdings and credits them to appropriate member accounts in CREST CREST maintains a separate register for above mentioned holdings CDIs can be used as collateral and transferred in the same way as normal securities CDIS have limitations like It cannot be held in certificated form There is no SDRT liability in respect of the transfer of CDIs CREST charges custody fees for holding CDIs

TYPES OF X-BORDER TRANSACTIONS X-Border Unmatched Delivery Input (XDL) and Reversal (XDR) Enhanced DEL Transaction type

XDL & XDR XDL Member Generated XDL XDL is created on receiving an instruction from the CREST member delivering stock The instruction is similar to a delivery instruction but is a free of cash instruction The instruction carries fields for identifying the receiving participant in overseas CSD CREST generated XDL XDL can be generated as a result of SWIFT message from a linked CSD, where linked CSD’s participant wishes to deliver to a CREST participant Upon receipt of the message, CREST creates the an XDL and attempts it in next settlement cycle, if settlement fails CREST deletes the XDL & sends rejection message to linked CSD XDR CREST generates an XDR in case a CREST member is delivering stock to linked CSD’s participant If the linked CSD fails to deliver the stock to its participant, XDR settles resulting in movement of securities back from linked CSD to the CREST member

ENHANCED DEL TRANSACTION TYPE This is used in the case of transfers via link to Euroclear Frankfurt or Swiss Stock Exchange or virt-x, the DEL transaction is used Instruction is input a day before settlement day CREST blocks the stock and cash in the account On settlement in overseas, CREST settles the transaction

RECEIVE OVERSEAS STOCK ACROSS FOP LINK Linked CSD 1 2 3 4 CREST Member XDL CSD Participant CSD sends a swift message to CREST On successfully accepting the message, CREST generates XDL Transfer of security takes place and a CDI is created CREST sends a settlement confirmation

DELIVERING OVERSEAS STOCK ACROSS FOP LINK Linked CSD 3 1 4 – Negative REG 2 CREST Member CSD Participant CREST Member inputs a transaction for delivering overseas stock, CREST generates XDL, transfers stock from Member to CSD CREST sends a SWIFT message to Linked CSD for transfer Linked CSD sends a settlement confirmation CREST generated negative registrar’s adjustment (REG) to remove CDI from system XDL

DELIVERING UK STOCK ACROSS FOP LINK Linked CSD 5 1 6 4 Registrar 2 - RUR 3 CREST Member CSD Participant CREST Member inputs a transaction for delivering overseas stock, CREST generates XDL, transfers stock from Member to CSD CREST generates RUR and sends to Registrar CREST receives confirmation from Registrar CREST sends the transfer request to linked CSD as SWIFT message Linked CSD sends a settlement confirmation CREST generated a XDC and moves the stock from reserve balance to available balance XDL R A XDC

RECEIVING UK STOCK ACROSS FOP LINK Linked CSD 1 2 6 Registrar 4 - RUR 5 3 CREST Member CSD Participant Linked CSD sends a SWIFT message as transfer instruction CREST on successfully accepting message creates an XDL which is unmatched and alleged to CREST Member CREST Member instructs an XDL to match the one created by CREST, once matched CREST transfers stock from available balance of linked CSD to member available balance CREST sends RUR to Registrar Registrar confirms RUR CREST sends settlement confirmation to linked CSD XDL CREST Member

OVERVIEW Reconciliation will happen between following entities CREST and Registrars CREST and Members, via Users Purpose of Reconciliation Meet Regulatory requirement Ensure Integrity of overall system operation Also for Members To monitor settlement activity Detect & prevent any fraudulent activity arising from unauthorised instructions

CREST & REGISTRARS RECONCILIATION Registrar sends a file transfer message to CREST CREST compares the same with its book for legal record of holdings If there is any discrepancy, the security will be disabled, & no transaction will be settled till the discrepancy is resolved Reconcile schedule – Daily reconciliation of total holdings per security held in the system Daily reconciliation of the accounts whose balances are changed Periodic full reconciliation of all stock accounts

CREST & MEMBER RECONCILIATION Open Positions & Item Reconciliation Open transaction details Open stock & cash positions Unmatched Transaction request Stock Balance Reconciliation Settled Cash Reconciliation Stamp (SDRT) Reconciliation Reconciliation Involving Stock Deposits and Withdrawals

CREST Settlement Flow

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CREST Settlement Flow