Global financial market infrastructure kingpin, the Depositary Trust & Clearing Corporation (DTCC) has pulled back the curtain on the opaque inner-workings of the securities trading business in a back-story blockbuster released this month.
Likely destined to remain a cult classic rather a hit summer read, the updated DTCC ‘Guide to Clearance & Settlement’ follows the story of a neglected back-office process and its journey from paper-based obscurity to the digital centre of the financial world.
Financial markets have come a long way since the DTCC predecessor entity first formed in 1973 with share trading, in particular, now a favourite retail pastime instead of the largely professional occupation of 50 years ago.
However, as DTCC chief, Michael Bodson, explains in the introduction, while “investors are very familiar with the mechanics of buying and selling stocks or bonds, the world of post-trade processing remains a mystery to most people—if they think about it at all”.
“But what happens after a transaction is executed on an exchange or electronic platform is essential to safeguarding your investments and, more broadly, protecting the integrity of the global capital markets,” Bodson says.
The DTCC guide spares little detail in filling the post-trade investor knowledge gap through tightly-packed text and multiple flow diagrams tracking the route of orders and money through the financial system as bonds, shares, mortgage-backed securities, managed funds, derivatives and other securities change hands at almost light-speed pace today.
“With the growing prominence of fintech, or the integration of technology in banking and financial services, in recent years,
DTCC is now leading the industry into the digitization era by exploring ways to turn traditional and physical interactions, communications, business functions, and models into digital ones,” the guide says.
Markets haven’t quite ditched the paper legacy, though, with DTCC nominee company, Cede & Co, still holding vast quantities of physical share certificates in its massive underground storerooms, for example.
“Over the years, the industry has made significant progress eliminating paper certificates, a process known as dematerialization,” the DTCC publication says.
“However, existing inventory of physical securities still remains, primarily in the equity markets.”
In 2012, DTCC almost lost 1.7 million paper share certificates after ‘superstorm Sandy’ swept through New York, flooding the firm’s main securities vault with contaminated water.
Facing a real dematerialisation crisis, DTCC embarked on a paper rescue mission that saw the sodden certificates snap-frozen before being trucked across the country for specialist vaporisation and radiation treatment.
“The $1 trillion vault recovery effort took six months of 10-hour shifts, six days a week, but in the end 99.9% of the certificates were recovered and restored,” the guide says.
Perhaps the vault address of 55 Water Street should’ve been a red flag to the DTCC risk management team.
Despite pushing ahead with further digital upgrades and back-office automation (including a targeted move to ‘T+1’ settlement for US shares by next year), DTCC owes a lot to paper.
Prior to 1946, US stocks actually settled in two days but rising participation and market complexity saw the back-office sign-off process gradually increase, hitting five days in the early 1960s as “so much paper was changing hands”.
“Though less infamous than the crash of 1929, the dot.com bubble, or the credit crisis that began in 2008, the paperwork crisis of the 1960’s and 1970’s presented one of the biggest challenges the US securities markets ever faced,” the guide says.
The paper shock also underwrote the creation of DTCC, an industry-owned organisation charged with sorting out the administrative mess.
‘Guide to Clearance & Settlement’ is available online, as a PDF or, for the purists, as hard copy.