adminThe benefits of a Centralised Securities Depository can best be understood in comparison with a bank. A CSD is an organisation where the securities (shares) of a shareholder are held in the electronic form just like a bank holds its customers’ cash. This is done at the request of the shareholder through the medium of a Depository Participant (DP).
This is similar to a bank where depositors have accounts in different currencies (shares). The balances in these accounts are increased or reduced as the depositors buy or sell shares respectively.
Transactions on the depositors’ (investors) accounts are done through intermediaries called depository participants. Thus depositors do not deal directly with the CSD but access CSD services through custodians, brokers and transfer secretaries. Perhaps brokers are the most well known of the three classes of participants but all combine to form the value chain in capital markets.
Electronic transaction of securities eliminates the problems and delays arising out of a paper based system. Typically, paper based systems are plagued by issues of security — theft, misplacement and destruction from the elements — fire, water and old age. Keeping valuable assets requires investment in security and just like it is better to entrust your cash with a bank with secure facilities, investors can also delegate the security issues to the CSD.
Paper based systems are also characterised by efficiency constraints in that it takes time and humans to move them from one place to another. In the early 1600s for example it would take weeks for a British investor who bought shares on the Amsterdam stock exchange to receive his shares. In addition humans are prone to mistakes and thus paper based system would impose significant efficiency constraints in a capital market.
When a share deal is confirmed between a buyer and seller, a process of transferring those shares into the name of the new owner takes place, on receipt of the money from the buyer. This transfer is facilitated by the transfer secretary who is an agent of the company that issued the shares originally.
The transfer process involves sending the share certificates that have been sold to the transfer secretary who cancels the old share (in the name of the original owner who has now sold), and issuing out a new share certificate in the name of the new owner – the buyer.
In a CSD this process is reduced to a book entry where shares are subtracted (debited) from the seller’s account and added (credited) to the buyer’s account, after the money has been transferred from the buyer’s account to the seller’s account. Thus the efficiency and security benefits are obvious from the investor’s and transfer secretary’s perspective.
Such efficiency gains help boost stock market activity and it is easy to appreciate the benefits if we include foreign investors who can trade from anywhere in the world. The exchange of money and shares is known as clearing and settlement and stock markets speak of settlement cycles in terms of days. Currently in Zimbabwe the settlement cycle is five working days, that is, if shares are sold and bought today, the exchange will be complete in five days.
With the introduction of the CSD, this cycle is expected to be reduced.
Although the ideal would be the same day, it would require very expensive and complex systems and procedures such that most markets have settled for three days. This is mainly to give time to deal with exceptions from the intended flow if activities.
In their role as agents for issuers (companies that issue stock), transfer secretaries are also responsible for effecting what are called corporate actions. Perhaps the most well known is dividend payout where the company decides to share out the profit earned in a trading period among the shareholders.
The profit is typically declared per share and thus an investor in that company will get a dividend amount that is proportional to the number of shares he holds. It is easy to see the level of effort involved in computing and distributing dividend payout in a paper based system where thousands of investors are involved.
CSDs have come to the rescue in this regard in that the software can automate the computation and distribution of dividends as well as applying the appropriate tax rules. This is another significant source of work because of the need to apply the tax law provisions which vary between local and foreign investors, thresholds etc. Other corporate actions include complex financial transactions such as share splits, consolidations, mergers, swaps etc.
Brokers are market participants involved in the actual trading — price and quantity — at the stock exchange. By law, Brokers have to be licenced to provide this service in a market. This is to ensure professionalism and make the market a safe ecosystem. Typically brokers must ensure that funds are available before they make a buy commitment at the stock exchange. Similarly they must ensure the shares exist before making a sell commitment.
In a paper based system the brokers will ask the selling investor to bring the shares and once a deal in confirmed, the shares will be forwarded to the transfer secretary after confirming that the funds have been received (settlement). This is called Delivery vs Payment (DvP). In a CSD the investor’s shares are blocked or reserved on the system until transferred or until the trade is cancelled.
Because banks have secure storage places (vaults), they were the natural providers of safe keeping services (custody) for shares. Despite the emergence of CSDs, investors still use custodians to manage their investment portfolios and thus the custodians maintain records of the clients’ dealings in different shares.
The same activity is carried out on the CSD system and it is the Custodian’s duty to release shares for selling and receive shares that have been bought.
It is therefore clear that the CSD is in essence a secure and efficient platform where capital market participants execute their different roles in the value chain. If this model is extended to the rest of the world, using the power of ICT, then the world indeed becomes a global market.
The writers Nyasha Mukura and Campbell Musiwa can be contacted on [email protected] and [email protected] respectively.
Online Reporter