Depository Trust and Clearing Corporation

The difference matters because a trade does not settle instantly. Between the time a trade is executed and the time it settles, either side could fail to perform. The buyer could be unable to pay, or the seller could be unable to deliver. That exposure is called counterparty risk, and the clearing and settlement system exists in large part to reduce it.

The Depository Trust and Clearing Corporation

DTCC is a holding company. It was created in 1999 when DTC and NSCC formed a holding company. The SEC's annual report for that year described the arrangement this way: certain functions of both entities would move to the holding company, while DTC and NSCC would continue to operate as separate clearing agencies. That structure remains. DTCC sits above its subsidiaries, and the subsidiaries are the entities that actually clear and settle.

DTCC is user-owned and governed by its users, who are often called participants. DTCC's own materials describe these participants as including banks and broker-dealers, the same institutions that rely on its services. DTCC describes itself as a market-neutral industry utility. It is not an exchange, and it does not set the prices at which securities trade.

DTCC operates three subsidiaries that its own materials describe as systemically important. The first is DTC. The second is NSCC. The third is the Fixed Income Clearing Corporation, or FICC, which serves the fixed income markets. This entry focuses on DTC and NSCC because they are the two that handle trades in equities and in corporate and municipal bonds.

Why the System Exists

The system is the product of a crisis. In the 1960s the securities industry faced what became known as the paperwork crisis, because securities were evidenced by paper certificates that had to be moved physically between firms. DTC was created in 1973 in response to that crisis, and NSCC began operations in 1976.

The industry's solution had two parts. The first was immobilization, which means pooling securities in the vault of a central depository so that certificates no longer need to travel from firm to firm. The second was dematerialization, which means replacing physical certificates with electronic records of ownership on the books of the depository. Together these changes allowed ownership to change hands by a bookkeeping entry rather than by the delivery of paper.

The National Securities Clearing Corporation

NSCC provides clearing services and acts as a central counterparty for broker-to-broker trades. The SEC describes a central counterparty as an entity that interposes itself between the counterparties to securities transactions, acting functionally as the buyer to every seller and the seller to every buyer. In practice that means that after NSCC accepts a trade, each of the two firms that made the trade has NSCC, rather than the other firm, as its counterparty.

NSCC does this through a process called novation. Once a transaction has passed the required checks and is accepted into the system, it reaches the point where NSCC's trade guarantee applies, and NSCC becomes the legal counterparty to each side. The guarantee is about completion of the trade. It does not promise that a security will rise in value. It addresses the risk that one firm fails to perform its side of a trade that has already been accepted.

NSCC's best-known service is Continuous Net Settlement, or CNS. Under CNS, eligible NSCC members use the system to net, clear and settle securities transactions. NSCC consolidates the trades of a member in an eligible security into a single long or short position per security. CNS handles broker-to-broker trades in equities, corporate bonds, municipal bonds and unit investment trusts.

A hypothetical shows the effect of netting. Suppose a broker-dealer buys ten thousand shares of a stock from several counterparties during the day and sells seven thousand shares of the same stock to several others. Without netting, the firm would have to settle each of those trades separately. With netting, the firm's position in that stock reduces to a single net position of three thousand shares to receive. This illustration does not describe any actual firm or trade.

Netting reduces the number of deliveries and payments that have to be made, and it reduces the cost of settlement. Because the central counterparty stands behind accepted trades, it also reduces the number of separate relationships that each firm has to monitor for credit risk.

The Depository Trust Company

DTC is a central securities depository. DTCC describes DTC as the central place where securities positions are held in the United States. Securities that are eligible for DTC's services are held there, and ownership moves between participants by book entry, which means an electronic entry in the depository's records rather than a delivery of a certificate. DTC also settles the financial obligations that NSCC has cleared.

DTC holds securities in the name of its nominee, Cede & Co. This is the arrangement that makes the pooled system work. Instead of reissuing certificates each time a security changes hands, the transfer agent's record stays in the nominee's name, and DTC's records show which participant is entitled to how much. A later section explains the mechanics.

The participants in DTC are financial institutions. Investors typically do not deal with DTC directly. They hold securities through a brokerage firm, and the brokerage firm holds them through DTC. That layered arrangement is why shares held in a brokerage account are commonly said to be held in street name.

Who Uses the System

The firms that use these services are the institutions at the center of the securities business. Eligible NSCC members use Continuous Net Settlement to net, clear and settle their transactions, and DTC's participants are financial institutions that hold securities through the depository. DTCC's own materials list banks and broker-dealers among the participants that own and govern the company.

An individual investor is not a member of NSCC or a participant in DTC. A retail customer reaches the system through a brokerage firm. When that firm trades with another firm, whether it acts as a broker for a customer or as a dealer for its own account, the transaction is a broker-to-broker trade of the kind NSCC clears. The customer sees only the confirmation and the later change in the account. The clearing and settlement work happens between the firms and the DTCC subsidiaries.

How a Central Counterparty Reduces Risk

It helps to compare the system with the alternative. Without a central counterparty, every trade is a separate promise between two firms. Each firm has to decide how much it trusts every other firm it trades with, and a failure by one firm can leave several others unable to complete their own trades. With a central counterparty, each firm's trade is with NSCC. DTCC's description of CNS says that NSCC becomes the legal counterparty to each trade, ensuring completion even in the event of default.

Netting adds a second layer of protection by reducing the amount that has to move. DTCC's description of CNS states that daily netting significantly reduces volume and cost by consolidating eligible trades into a single long and short position per security. Fewer deliveries mean fewer chances for a delivery to fail, and fewer payments mean less money in transit. NSCC also provides centralized counterparty and risk management services to the members that use CNS.

How a Trade Moves Through the System

The sequence for a typical equity trade can be described in stages. First, a customer places an order with a broker-dealer, and the order is executed. The execution creates a trade between two firms. Second, the trade is submitted for clearing. NSCC accepts the trade, becomes the central counterparty, and nets the firm's obligations with those of its other trades in the same security. Third, on the settlement date, the netted positions are settled. Securities move between participants' accounts at DTC by book entry, and payment moves in the opposite direction. Finally, each broker-dealer updates its own records to reflect the customer's ownership.

The roles divide cleanly. NSCC deals with the question of who owes what to whom. DTC deals with where the securities are and how they move. DTCC sits over both as the holding company. In everyday speech people sometimes use DTCC to refer to all of it, but the three names are not interchangeable.

A Trade Followed From Start to Finish

The following hypothetical follows one trade through the system. It does not describe any actual firm or trade.

On a Monday, a customer of Firm A places an order to buy two hundred shares of a listed stock. Firm A executes the order against a customer of Firm B, who is selling the same two hundred shares. The trade is now a transaction between Firm A and Firm B. Neither customer has received the shares or the cash yet.

The trade is then submitted for clearing. NSCC accepts it and, through novation, becomes the counterparty to both firms. Firm A's purchase is combined with Firm A's other activity in the same stock that day, and Firm B's sale is combined with Firm B's other activity. If Firm A bought a total of seven hundred shares and sold three hundred during the day, Firm A's net obligation is to receive four hundred shares. If Firm B only sold, its net obligation is to deliver the shares it sold.

Under the T+1 cycle, settlement takes place on the next business day, which in this example is Tuesday. At DTC the shares move from Firm B's account to Firm A's account by book entry, and payment moves the other way. The shares are never delivered as a paper certificate. Firm A then records the shares in its customer's account, and Firm B removes them from its customer's account. The customer who bought the shares holds them through Firm A, which holds them through DTC.

Immobilization, Dematerialization and Street Name

The two ideas behind the system are worth restating, because they explain why a modern investor rarely sees a certificate. Immobilization means that securities are pooled in a central depository such as DTC rather than moving from firm to firm in paper form. Dematerialization goes a step further. It substitutes electronic records of book-entry securities on the books of the depository for the physical certificates themselves.

Under DTC's FAST program, the transfer agent for an issue keeps a single balance certificate registered in the depository's nominee name, Cede & Co. The transfer agent is the company that keeps the issuer's records of who owns its securities. When participants buy and sell, DTC's records change and the balance on that single certificate is adjusted. The practical effect is that shares held through brokerage accounts are commonly registered on the issuer's books in the nominee's name, while the beneficial owner is recorded on the books of the investor's brokerage firm. The shorthand for that arrangement is street name.

FINRA Rules That Connect Member Firms to the System

FINRA's Uniform Practice Code, in the FINRA Rule 11000 series, sets standards for how member firms settle trades with one another, and several of its rules assume that settlement runs through a depository.

FINRA Rule 11310, titled Book-Entry Settlement, requires that a member use the facilities of a securities depository for the book-entry settlement of all transactions in depository eligible securities with another member. For these purposes the rule defines a securities depository as a securities depository registered as a clearing agency under Section 17A of the Exchange Act. Depository eligible securities are those that are part of an issue eligible for deposit at a securities depository and are eligible for book-entry transfer at the depository when the transaction settles.

FINRA Rule 11320, titled Dates of Delivery, sets the delivery timing. For a regular way transaction, delivery is to be made at the office of the purchaser on, but not before, the first business day following the date of the transaction. This is the FINRA counterpart to the federal settlement cycle described below.

Other Delivery Timing Under FINRA Rule 11320

FINRA Rule 11320 covers more than regular way trades. A cash transaction calls for delivery on the day of the transaction. A seller's option transaction lets the seller choose when to deliver within the period the parties set, so that delivery may be made on the date the option expires or earlier on advance notice. Regular way delivery, on the first business day following the date of the transaction, is the standard cycle. These variations show that the settlement date is not always the same for every trade, even though the standard cycle is one business day.

The Settlement Cycle

The length of time between trade date and settlement date has shortened over the years as technology improved. DTCC's own history notes that DTCC and DTC led the industry in moving the United States equity settlement cycle from five business days after the trade date to three. The most recent change came with the move from two business days to one.

SEC Rule 15c6-1 was amended to shorten the standard settlement cycle for securities transactions from T+2 to T+1, and the compliance date was May 28, 2024. Under T+1, a transaction in most securities settles one business day after the trade date. The SEC's guidance notes that some categories of transactions are treated differently, and that parties can expressly agree at the time of a transaction to settle on a longer cycle in limited circumstances.

A shorter cycle reduces the time during which counterparty risk exists, because the period between execution and settlement is shorter. It also means that the processing steps described above, including matching, netting and settlement, have to be completed more quickly.

Regulation of Clearing Agencies

DTC, NSCC and FICC are registered clearing agencies. The SEC describes a clearing agency as an entity broadly defined in Section 3(a)(23)(A) of the Exchange Act that performs functions such as acting as a central counterparty or as a central securities depository. The two functions map onto the two companies discussed here. NSCC is a central counterparty, and DTC is a central securities depository.

Section 17A of the Securities Exchange Act of 1934 and SEC Rule 17Ab2-1 require an entity to register with the Commission, or obtain an exemption from registration, before performing the functions of a clearing agency. Registered clearing agencies are also self-regulatory organizations. Changes to their rules are filed with the SEC, and DTCC publishes the rule filings of its subsidiaries.

Other clearing agencies serve other markets. The Options Clearing Corporation, for example, clears exchange-listed options. A reader who sees the term clearing agency should therefore remember that DTC and NSCC are two examples and not the only ones.

DTCC, NSCC, DTC and FICC at a Glance

DTCC is the holding company that sits above the others. It is owned and governed by its users, and its subsidiaries are the registered clearing agencies. NSCC is the clearing agency that acts as central counterparty for broker-to-broker trades in equities, corporate bonds, municipal bonds and unit investment trusts, and that nets those trades through CNS. DTC is the clearing agency that serves as the central securities depository, holding securities in the name of its nominee and moving them by book entry. FICC is the subsidiary that serves the fixed income markets.

When a question refers to clearing, think of NSCC. When a question refers to where securities are held and how they move on settlement day, think of DTC. When a question refers to the parent or to the industry utility as a whole, think of DTCC.

Why the Distinctions Matter

Securities professionals use the names DTCC, NSCC and DTC in conversation, in training and in compliance work, and the right name tells the listener which function is meant. A statement that a trade has been cleared refers to NSCC. A statement that a security is held at the depository or that a settlement was made by book entry refers to DTC. A statement about an industry utility, its owners or its governance refers to DTCC.

The distinctions also help when reading rules. FINRA Rule 11310 refers to a securities depository registered as a clearing agency, which is the function DTC performs. SEC Rule 15c6-1 sets the standard settlement cycle for most securities transactions. Neither rule is a description of a single company. Each describes a function, and the DTCC subsidiaries are the best-known examples of the entities that perform it.

Common Misunderstandings

One misunderstanding is that DTCC is a government agency. It is a user-owned industry utility, and it is regulated through its subsidiaries by the SEC.

A second is that DTCC, NSCC and DTC are three names for the same thing. DTCC is the holding company. NSCC clears and acts as the central counterparty. DTC holds securities and settles. FICC is a separate subsidiary for the fixed income markets.

A third is that the guarantee protects the value of an investment. The trade guarantee concerns completion of an accepted trade. It does not protect an investor from a loss caused by a falling price.

A fourth is that an investor's shares are registered in the investor's own name on the issuer's books. When securities are held through a brokerage firm and a depository, the registered owner on the issuer's books is commonly the depository's nominee, and the investor's interest is recorded on the books of the brokerage firm.

Key Points

DTCC is the holding company, formed in 1999. It is user-owned and has three subsidiaries that it describes as systemically important: DTC, NSCC and FICC.

NSCC clears trades and acts as a central counterparty. Through novation it becomes the legal counterparty to accepted trades, and through Continuous Net Settlement it nets a member's activity in each eligible security into a single position.

DTC is the central securities depository. It holds securities in the name of its nominee, Cede & Co., moves them between participants by book entry, and settles the obligations that NSCC has cleared.

FINRA Rule 11310 requires members to use a securities depository for book-entry settlement of depository eligible securities with other members, and FINRA Rule 11320 sets regular way delivery at the first business day after the transaction. Under SEC Rule 15c6-1, the standard settlement cycle became T+1 with a compliance date of May 28, 2024.

DTC, NSCC and FICC are registered clearing agencies under Section 17A of the Securities Exchange Act of 1934.