The back-end system of securities can also be called a clearing system in a sense. Looking at securities trading markets around the world, there are various trading methods, including lively manual bidding, advanced and fast computer automatic matching, and expert trading systems that combine manual and computer trading. The different trading methods have formed the characteristics of each market. However, measuring whether a market is mature and whether the trading method is effective is not the only criterion. It should also include factors such as the quality of listed companies, the quality of investors, market efficiency, risk level, and the clearing and registration system. Whether the clearing and registration system is advanced and effective, and whether it can match the trading system, is a key issue. An efficient and forward-looking clearing and settlement system can provide development space and direction for the overall securities market. Imagine that a transaction is completed in seconds, but it takes a week for the transfer of ownership, which would impact the operation of the entire securities market. Such a market model is unimaginable. The history of the development of global securities markets tells us that a mature securities market not only requires a fair and efficient trading system, legal system, and market participants, but also a mature clearing and registration system, and even advanced development.
The foundation of the Japanese securities clearing and settlement system is "people" and "stocks," which constitute the basis of all data and are called upon in every step of the system's operation. The heart of the back-end clearing and settlement system for securities is "transaction settlement." Transaction settlement is the beginning of the back-end system and the trigger. Without transaction settlement, there is no clearing and settlement. The result of transaction calculation becomes the raw data for both the clearing system and the settlement system, making it the most crucial and important part of the entire system. If an error occurs and the system continues to run, it will result in widespread data inconsistency in the entire system. Even with data recovery, it may be difficult to recover within a short period of time due to the wide scope involved. The result of the clearing and settlement system is "money" and "goods," namely clearing and settlement. Once the money and goods (i.e., stocks) in each account are calculated, the back-end clearing and settlement can be said to have successfully completed its mission. As for various types of documents and document printing and sending, although they are also important, compared to clearing and settlement, they can be taken care of with a sigh of relief.
Figure 1: Overview of the Japanese Clearing and Settlement System
Figure 2: Business Process Diagram of Stock Exchange, Clearing Organization, Settlement Organization, and Custodian Organization
Clearing Organization#
The main functions of a clearing organization are debt assumption, netting, settlement instruction, and settlement guarantee.
Debt Assumption#
When a securities transaction is concluded, the seller incurs the obligation to deliver the securities and receive the payment, while the buyer incurs the obligation to pay and receive the securities. The clearing organization assumes the debts arising between the seller and the buyer, acquires corresponding claims, and becomes the party to the rights and obligations of the debts incurred by the seller and the buyer in the transaction. By assuming the debt, the clearing organization replaces the counterparty in settlement, allowing each clearing participant to conduct transactions without considering the credit risk of the counterparty. Furthermore, the centralization of the counterparty in settlement allows for the streamlining of settlement operations among clearing participants.
Netting#
Settlement of transactions cleared by the clearing organization is not done individually for each sale or purchase, but rather, for securities, the quantities of sales and purchases are offset on a per-security basis, and for funds, the quantities are offset across securities, all with the same settlement date.
Settlement Instruction#
Based on the executed data in the market, the clearing organization performs netting calculations, determines the settlement quantities for each clearing participant, notifies each clearing participant of the settlement quantities, and issues settlement instructions to the settlement institution (depending on the settlement method, clearing participants may issue settlement instructions based on notifications from the clearing organization). For settlement of stocks and other securities using the Securities Transfer and Clearing Corporation, delivery of securities and settlement of funds are linked, enabling DVP settlement that eliminates principal risk.
Settlement Guarantee#
For securities transactions concluded in the market, the clearing organization assumes the debts and becomes the party to the rights and obligations of the debts incurred by the seller and the buyer. Therefore, even if a clearing participant causes a settlement default, the clearing organization has an obligation to fulfill the settlement with other clearing participants. By guaranteeing settlement, the clearing organization allows market participants to trade with confidence. The Japan Securities Clearing Corporation has established a settlement guarantee system that follows the principle of self-responsibility while also providing mutual guarantees as a last resort. In the event of losses caused by a clearing participant's settlement default, the losses are covered by the clearing fund deposited by the defaulting participant. If there is a shortfall, other clearing participants may be asked to share the burden, ensuring mutual guarantee.
Settlement Institution#
Japan Securities Depository Center, Inc.#
Japan Securities Depository Center, Inc. operates a transfer system based on the "Law on Transfer of Corporate Bonds and Stocks" as a transfer institution for stocks, convertible bonds with stock acquisition rights (CB), beneficiary rights of investment trusts (ETF), and investment units of real estate investment trusts (REIT). The delivery of securities for ordinary transactions of securities in the Tokyo Stock Exchange is made through transfers between accounts of securities companies at the Japan Securities Depository Center and accounts at the Japan Securities Clearing Corporation on the fourth business day from the trade date. The delivery between customers and securities companies is made by opening accounts for customers at securities companies and transferring between those accounts.
Figure 3: Business Process Diagram of Clearing Organizations and Settlement Organizations
