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1.3.4 Clearing System

Learn about the clearing system used in the Canadian securities market, including the role of CDS Clearing and Depository Services, the netting process, and key roles of an investment dealer.

The Clearing System

During a trading day, exchange members act as both buyers and sellers of many listed stocks. Rather than each member making a separate settlement with another member on each trade during the course of a trading day, a designated central clearing system handles the daily settlement process between members.

In Canada, securities are cleared through CDS Clearing and Depository Services (CDS). Although CDS is not considered a financial intermediary, it is a valued partner to dealers operating in the securities market, providing reliable clearing services. CDS operates CDSX, the facility for the clearing and settlement of trades in equity and debt securities in Canada and for various cross-border transactions. Marketplaces such as the Toronto Stock Exchange (TSX), the TSX Venture Exchange, and alternative trading systems report trades to CDSX. Over-the-counter trades are also reported to CDS by participants in the system. Participants with access to the clearing and settlement system primarily include banks, investment dealers, and trust companies.

Netting Process

The central clearing system uses a process called netting to establish and confirm a credit or debit position balance, in the form of cash or security, for each dealer member.

The netting process involves the following steps:

  1. Compile each firm’s clearing settlement sheets from their trading activity.
  2. Confirm each member’s securities or cash obligations.
  3. Inform each member of the net securities or funds they must deliver to settle their account.

In this way, the number of securities and the amount of cash that needs to change hands among various members each day is substantially reduced.

Here is a visual representation of the netting process:

      graph TD;
	    A[Trades Executed] --> B[Trades Reported to CDSX];
	    B --> C[Netting Process];
	    C --> D[Compile Settlement Sheets];
	    D --> E[Confirm Obligations];
	    E --> F[Inform Members of Net Deliveries];
	    F --> G[Settle Accounts];

Key Roles of an Investment Dealer

Principal vs Agent

An investment dealer can act in one of two primary roles:

  • Principal: The dealer buys and sells securities for its own account, taking on the risk and potential profit or loss from the transactions.
  • Agent: The dealer facilitates transactions on behalf of a client, acting as an intermediary and earning a commission for the services provided.

Glossary

  • Clearing System: A mechanism through which trades are confirmed, settled, and cleared by centralized entities to ensure smooth and efficient market operations.
  • CDS Clearing and Depository Services (CDS): The organization responsible for the clearing and settlement of securities trades in Canada.
  • CDSX: The clearing and settlement platform operated by CDS.
  • Netting: A method of reducing the number of transactions required to settle trades by offsetting obligations among market participants.

Frequently Asked Questions (FAQs)

Q1: What is the role of CDS Clearing and Depository Services?

A1: CDS Clearing and Depository Services (CDS) is responsible for the efficient clearing and settlement of trades in equity and debt securities in Canada. It operates the CDSX platform where trades are cleared and settled.

Q2: What is netting in the context of the clearing system?

A2: Netting is a process by which the central clearing system offsets and consolidates multiple trade obligations to reduce the number of transactions and amounts of securities and cash that need to change hands, simplifying settlement.

Q3: Who are the typical participants having access to the clearing system?

A3: Typical participants include banks, investment dealers, and trust companies that are involved in the securities market.

Key Takeaways

  1. The clearing system centralizes the settlement of trades to streamline transactions between exchange members.
  2. CDS Clearing and Depository Services administers the central clearing system in Canada via the CDSX platform.
  3. The netting process reduces the complexity and volume of settlements by offsetting trade obligations.
  4. Investment dealers can operate either as principals or agents in the marketplace.

By understanding these foundational elements, you’ll be better equipped to navigate the clearing and settlement processes within the Canadian securities market.


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markdown ## Which organization is responsible for the clearing and settlement of trades in equity and debt securities in Canada? - [ ] Investment Industry Regulatory Organization of Canada (IIROC) - [x] CDS Clearing and Depository Services (CDS) - [ ] Canadian Securities Administrators (CSA) - [ ] Financial Consumer Agency of Canada (FCAC) > **Explanation:** CDS Clearing and Depository Services is the organization responsible for the clearing and settlement of trades in Canada. ## What is the main function of the central clearing system in the securities market? - [x] To handle the daily settlement process between exchange members - [ ] To act as a financial intermediary - [ ] To perform fundamental analysis of stocks - [ ] To execute trades on behalf of investors > **Explanation:** The central clearing system handles the daily settlement process between exchange members, using netting to minimize the amount of securities and cash that need to be exchanged. ## Which system does CDS operate for clearing and settlement? - [ ] TSX Alpha Exchange - [x] CDSX - [ ] IIROC - [ ] CSA National Systems > **Explanation:** CDS operates the CDSX, which is the facility for the clearing and settlement of trades in Canada. ## What is the process called that establishes and confirms a credit or debit position balance for each dealer member? - [ ] Clearing - [ ] Settlement - [ ] Margining - [x] Netting > **Explanation:** The process is called netting, which helps establish and confirm credit or debit position balances for dealer members. ## What types of trades are reported to CDSX? - [x] Trades from marketplaces like the Toronto Stock Exchange (TSX) and alternative trading systems - [ ] International trades only - [ ] Only retail trades - [ ] Trades that require manual reporting > **Explanation:** CDSX receives reports of trades from marketplaces like the TSX, TSX Venture Exchange, and alternative trading systems, as well as over-the-counter trades reported by participants. ## Who primarily has access to the clearing and settlement system? - [x] Banks, investment dealers, and trust companies - [ ] Retail investors - [ ] Individuals - [ ] Regulatory bodies > **Explanation:** The primary participants with access to the clearing and settlement system include banks, investment dealers, and trust companies. ## What significant benefit does the netting process provide in the clearing system? - [ ] Increases the number of transactions during a trading day - [ ] Adds complexity to the settlement process - [x] Substantially reduces the number of securities and amount of cash that must change hands daily - [ ] Provides real-time trading data to retail investors > **Explanation:** Netting significantly reduces the number of securities and the amount of cash that must change hands among members daily. ## Is CDS considered a financial intermediary? - [ ] Yes, it is a financial intermediary by definition - [x] No, it is not considered a financial intermediary - [ ] Only during certain transactions - [ ] It's unclear > **Explanation:** CDS is not considered a financial intermediary, even though it provides critical clearing services. ## What additional role does the central clearing system play apart from clearing? - [ ] Provides brokerage services to retail investors - [ ] Conducts financial advisory - [x] Facilitates cross-border transactions - [ ] Issues new securities > **Explanation:** Apart from clearing and settlement, the CDSX also facilitates various cross-border transactions. ## The clearing system simplifies the settlement process by: - [x] Using netting to balance accounts, minimizing cash and securities transfers - [ ] Requiring individual settlements for each trade - [ ] Handling only cash settlements - [ ] Operating only within a single market > **Explanation:** By using netting to balance accounts, the clearing system minimizes the number of cash and security transfers between members.

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