Module II·Article III·~4 min read
Depository and Custody: Asset Safekeeping and Accounting
Clearing, Settlement, and Custody
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The system of safekeeping and accounting of securities
The depository system ensures the secure safekeeping of securities, the accounting of ownership rights, and the processing of corporate actions. Understanding the custody chain is critically important for investors and professionals working with client assets.
Central Securities Depositories (CSD)
A Central Securities Depository (CSD) is an organization that provides centralized accounting of securities and their transfer between owners. The CSD maintains a “master register” of ownership, eliminating the need for physical movement of paper certificates. The functions of a CSD include: notary function — official accounting of issued securities; settlement function — the transfer of securities between accounts; safekeeping — keeping records of ownership. Modern CSDs operate in a dematerialized environment — securities exist solely as electronic records.
Examples of CSDs: DTCC (Depository Trust Company) in the USA, Euroclear and Clearstream in Europe, CREST in the United Kingdom, NSD (National Settlement Depository) in Russia. International CSDs (ICSDs) — Euroclear and Clearstream — specialize in cross-border settlement.
Tiered custody structure
The custody chain describes the chain of safekeeping from the ultimate beneficial owner to the CSD. A typical structure: the CSD at the top holds records for its participants (custodian banks); custodian banks hold assets for clients (investment managers, asset owners); beneficial owners are the final owners.
Omnibus accounts: a custodian can hold assets of many clients in a single account at the CSD (commingled). This is operationally efficient but creates risks in the event of custodian bankruptcy — distinct segregation of client assets is necessary.
Nominee holding: formally, the securities are registered in the name of a nominee (custodian), not the beneficial owner. This is standard practice but creates legal complexity regarding the rights of the beneficial owner.
Custodian banks
Custodian banks are financial institutions specializing in the safekeeping and administration of assets for institutional clients. The largest global custodians are: BNY Mellon, State Street, JPMorgan, Citibank, Northern Trust.
Custodian services include: safekeeping (asset storage), settlement (trade settlements), income collection (collection of dividends and interest), corporate actions (processing of issuer events), tax reclaim (refund of withheld taxes), reporting (client reporting).
Sub-custody: a global custodian uses a network of local custodians in various countries to access local CSDs and markets. Selection and monitoring of sub-custodians is a critical element of operational due diligence.
Ownership rights and registers
Share register — the official list of the owners of the company’s shares. In different jurisdictions, register structures can vary: in some countries, the register is maintained by the issuer or its agent; in others, by the CSD.
Beneficial ownership: a distinction is made between the legal owner (the registered owner, typically the nominee) and the beneficial owner (the real owner with economic rights). Disclosure of beneficial ownership is regulated by securities law to prevent covert accumulation of stakes.
Shareholder identification: issuers are interested in knowing their real shareholders. The European directive SRD II obliges intermediaries to disclose information about beneficial owners upon request of the issuer.
Corporate actions
Processing corporate actions is a most important function of the custody chain. Action types include: mandatory (dividends, splits, reverse splits), voluntary (tender offers, rights), mandatory with options (choice between cash and stock dividend).
Lifecycle of a corporate action: announcement → ex-date (the ex-dividend date for trading) → record date (the date the owners are determined) → payment date (the payment/execution date). The custody chain must process every stage correctly.
Proxy voting: the custody chain ensures the implementation of the voting rights of beneficial owners. Custodians forward voting instructions up the chain to the issuer or its agent. Automation of proxy voting improves participation rates, but problems remain with timeliness and accuracy.
Custody risks
Counterparty risk: the risk of custodian bankruptcy. Client assets must be segregated from the custodian’s own assets and protected in the event of bankruptcy. Regulatory regimes set requirements for segregation, but practical protection depends on the jurisdiction.
Operational risk: errors in settlement, corporate actions, or reconciliation can lead to financial losses. Robust controls, automation, and reconciliation are key mitigants.
Cross-border risk: holding assets through a chain of sub-custodians in different jurisdictions creates legal, operational, and repatriation risks. Sanctions, capital controls, and political risks are additional factors for emerging markets.
Securities lending
Securities lending is the temporary transfer of securities from lender (owner) to borrower with an obligation to return. Custodians often act as agents in securities lending, generating additional income for clients.
Borrowers use borrowed securities for: short selling (selling for subsequent repurchase at a lower price), covering fails, market making, hedging, and collateral transformation. The lender receives a fee and retains economic exposure (dividends through manufactured payment).
Collateralization: the borrower provides collateral (usually >100% of the value of the borrowed securities) to protect the lender. Collateral may consist of cash or securities. Daily mark-to-market ensures the adequacy of collateral.
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