Many of these phrases and terms used within the securities industry can be related to those used in the outside world. But it is important to understand the meaning of the components of a trade in order to understand their impact on trade agreement and its life cycle.
These are following terminology widely used in the securities industry:
- Trade date: The date the parties involved in the trade agreed to trade. It is also known as date of trade execution.
- Operation: The type and direction of the trade, e.g. buy or sell, lend or borrow.
- Quantity: The number of units of the goods being exchanged.
- Goods: The specific goods being exchanged. This is in which STOs (Securities trading organisations) invests. It is also referred to as securities or instruments.
- Price: The price of each unit being exchanged.
- Supplier: The entity with whom the trade has been executed (the deliverer of goods and the receiver of cash). The party with whom the trade is conducted is also known as the counter party, whether buying or selling, lending or borrowing.
- Delivery date: The agreed intended date of delivery of goods by the supplier and payment of cash by the buyer. It is also known as value date or contractual settlement date.
- Cash due: The cash value of the trade due to be paid to the supplier upon delivery of the goods.
- Required location of goods: From the buyer’s perspective, the desired storage location of the goods.
- Cash to be paid from: From the buyer’s perspective, the specific bank from which payment is to be made.
Apart from these, we have another few important terms of trading that we should understand to know that, how the trading operations work under the hood.
Role of custodian in trading: To describe the custodian term. Lets take an example. An STO based in Stockholm may choose to invest in a Japanese security. There may be nothing to prevent the Stockholm-based STO taking delivery of the securities in Stockholm. However, from an efficiency and cost perspective STOs typically require delivery to occur in the normal place of issue and delivery of the securities, in this example Tokyo. The alternative is that securities would be delivered from Tokyo to Stockholm, with lengthy delivery time-frames and the costs (e.g. insurance) of such a delivery to be considered. In this case, the seller likely to demand payment for the securities before the securities leave the seller’s possession. If the buyer agrees to this arrangement, he would be taking a risk of being without both securities and cash an unacceptable risk to most STOs.
In order to minimize this risk and to exchange securities and cash in the most efficient manner for all securities in which they invest, STOs typically utilize local agents to exchange securities and cash on their behalf. These local agents are often referred to as custodians. Securities are held within a custodian securities account (also known as a depot account) and cash is held within a custodian cash account (also known as a nostro account).
Settlement of Trade: The exchange of securities and cash is known as settlement within the securities industry. The act of settlement should be viewed as no different from buying or selling goods in one’s personal life. For instance, most people hesitate to pay the purchase cost of a car without taking delivery of the car at the same time. Conversely, most people would not feel happy about handing over a car that they were selling without receiving the buyer’s cash at the same time. The risk, applicable to both buyer and seller, is that at one point in time they may be in possession of neither asset, whether goods or cash.
STOs are typically very risk averse and they try to avoid these situations whenever possible. The most efficient and risk-free method of settlement is known as Delivery versus Payment (DvP). Where simultaneous exchange of securities and cash is effected between buyer and seller (through their custodians), the seller not being required to deliver securities until the buyer pays the cash and the buyer not being required to pay cash until the seller delivers the securities. To ensuring that both parties are protected.
In next blog, I will explain you about the securities market place. So stay tune.
Happy Learning !!!
Book: Securities Operations: A Guide to Trade and Position Management by Michael Simmons