Who this is for — Readers who want to understand what happens after matching, why a trade and its final transfer are not the same event, and which entity records or administers the assets.
A trade establishes that two parties have entered into an agreement. Post-trade processing takes that agreement towards completion. Within this chain, clearing, settlement and custody perform different tasks. They may be offered by related organisations, but they do not become the same function.
In plain language — Clearing establishes what each party must deliver and manages the exposures; settlement carries out the transfer; custody maintains records and services the assets after the transfer.
The three functions
| Function | Main question | Operational result |
|---|---|---|
| Clearing | Which positions and obligations result from the trades? | Obligations calculated, and possibly netted and secured |
| Settlement | Have securities and money been transferred according to the instructions? | Delivery and payment completed within the applicable system |
| Custody | Who records, safeguards and administers the held assets? | Positions recorded and asset-servicing functions performed |
The sequence is not identical in every market. Some contracts are cleared by a central counterparty; others remain bilateral. Some instruments provide for delivery, others for cash settlement of a difference. Cycles, deadlines, currencies, entities and the legal notion of finality depend on the applicable rules.
Clearing: positions, netting and risk
EMIR defines clearing as the process of establishing positions, including the calculation of net obligations, and ensuring that financial instruments, cash or both are available to secure the exposures. Netting can reduce the number or gross value of transfers to be settled, but it does not eliminate every risk.
When a central counterparty (CCP) is involved, it interposes itself between the counterparties and becomes the buyer to every seller and the seller to every buyer, according to the EMIR definition. The CCP manages counterparty risk through participation rules, margins, collateral, default procedures and other resources established by its framework. “Cleared” does not mean risk-free: it concentrates and transforms exposures that must be governed by a resilient infrastructure.
Not every trade passes through a CCP. In bilateral relationships, the counterparty's credit quality, contractual agreements, collateral and reconciliation procedures remain central.
Settlement: transferring securities and payment
Settlement is the final discharge of the agreed obligations: for a securities transaction, it normally entails transfer of the securities and the corresponding payment. The time at which the trade executes and its settlement date may differ. The cycle must not be assumed: it varies by instrument, market and jurisdiction.
The delivery versus payment (DvP) principle coordinates delivery of the securities with payment, reducing the risk that one leg is transferred without the other. The ECB describes TARGET2-Securities (T2S) as a platform on which securities and cash can be exchanged simultaneously; settlement takes place in central-bank money on a DvP basis through securities accounts at a central securities depository and dedicated cash accounts at a national central bank.
A settlement fail means that an expected delivery has not been completed by the applicable deadline. It may result from unavailable securities or cash, unmatched instructions, operational problems or other constraints. By itself, it proves neither manipulation nor insolvency, but it creates risks, costs and management procedures specified by the system.
Custody: recordkeeping and administration
Custody concerns the safekeeping and administration of assets and their associated rights. It may include recording positions, reconciliations, collecting proceeds, managing corporate actions, providing information and processing voting instructions. A central securities depository (CSD), a custodian bank, an intermediary and a sub-custodian occupy different levels of the chain.
An investor may appear directly in the relevant register or hold an interest through omnibus accounts or a chain of intermediaries. Protection in an insolvency, segregation and exercisable rights depend on the account structure and applicable law. Custody does not guarantee market value, issuer solvency or the instrument's liquidity.
The Principles for Financial Market Infrastructures address CSDs, settlement systems, CCPs and custody risk separately. Principle 16 requires an infrastructure to safeguard its own assets and those of its participants and to minimise the risk of loss or delay in access.
Risks that should not be confused
- Counterparty risk: a party or participant fails to perform.
- Principal risk: one leg is transferred without receipt of the other.
- Liquidity risk: cash or assets are unavailable when required.
- Operational risk: systems, data, people or communications prevent the process.
- Legal and finality risk: rights, segregation or irrevocability are unclear.
- Custody risk: loss, misuse, inadequate recordkeeping or delayed access to assets.
To identify an exposure, ask who executes, who clears, who settles, where the accounts are held and which entity provides custody services. The platform's commercial name does not automatically answer all these questions.
Sources
- European Securities and Markets Authority, EMIR, Article 2 — Definitions — definitions of CCP, clearing, clearing member and counterparty risk.
- European Central Bank, What is T2S? — settlement of securities and cash, delivery versus payment, and accounts at CSDs and central banks.
- CPSS-IOSCO, Principles for financial market infrastructures, April 2012 — international standards for CCPs, CSDs and settlement systems; finality, DvP and custody risk.