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The Basics Of The CSD Industry

Investors may be aware that the Johannesburg Stock Exchange (JSE) provides a platform for the buying and selling of shares. A stockbroker (licensed by the JSE), acting on behalf of an investor (whether buying or selling), strikes a deal with another stockbroker using the trading platform provided by the JSE. But what happens then? How do the shares get moved from the seller’s name to the buyer’s name? How do they exchange cash in return for the shares?

This is done behind the scenes by Strate (South Africa’s Central Securities Depository) with the help of specific organisations that have been given the authority to act as CSD Participants. Therefore, it is important for investors to know how Strate works when investing in shares.

A Central Securities Depository (CSD) is an organisation tasked with keeping the records of ownership for financial instruments (which are securities such as shares / equities, bonds, warrants and money market investments). These records are safely kept in electronic form by Strate and this allows the daily transfer of ownership from seller to buyer to take place easily and efficiently. This process is broadly referred to as settlement.

Once a deal has been struck by the brokers using the trading system(s) provided by the JSE, the JSE sends the trade details to Strate which then forwards them to the CSD Participant(s). Strate then oversees the settlement process by verifying that the seller does indeed have the shares available to sell (which is checked by the CSD Participant) and the buyer has the cash available to pay for them. Once these details have been confirmed, Strate ensures that settlement takes place on due date by transferring the financial instrument from the sellers account to that of the buyer. Strate also ensures that the cash due by the buyer is transferred via the South African Reserve Bank into the bank account of the seller at the same time.

This electronic process is extremely efficient and safe compared to what used to be done in the previous paper-based environment. Historically, shares changed hands manually through the exchange of paper share certificates. The process was filled with administrative burdens, fraudulent certificates, theft and long settlement delays. Today the transfer of ownership takes a maximum of three business days to complete.

The previous paper-based records were ‘dematerialised’ (converted to an electronic record) after Strate was created in 1998. Today, Strate uses its world-class IT infrastructure and technology to do the electronic settlement efficiently and effectively, eliminating the risks that the investors used to face in the paper-based environment. Even though some investors still hold on to their paper share certificates, over 98% of the value in the market has been dematerialised through the stockbroker and / or CSD Participant (e.g. a bank, Computershare, etc.) network.

Back in the day when the market consisted of paper records, the backlog of paperwork meant that the company’s share register was never 100% up-to-date. As a result, when dividends were declared and paid, payment was often made to the incorrect shareholder because the payments were made to the investor whose name appeared on the register. Both the investor and listed company would then need to go through the costly and administratively intense claims process to rectify the situation.

Today, the company issuing the shares (issuer) always knows who their investors are and can be assured that the correct person and/or entity is paid their dividend on time and that they are fully informed of upcoming annual general meetings. This also helps to ensure that investors are able to exercise their voting rights at these meetings. This is a stark contrast to the inefficiencies brought about by the paper-based environment.

In South African law, Strate’s record is regarded as the legal record of ownership.

Investors often ask: “What happens if Strate’s computers crash?” With risk management top of mind, Strate has committed to ensuring its services are provided in a secure and controlled environment. Strate has highly sophisticated Disaster Recovery facilities in place, with several sites that it can use to ensure that it continues to fulfil its duties at all times. Strate ensures that the integrity of the South African market infrastructure and the record of share ownership are not compromised and that it continues to operate a world-class system regardless of the potential disruption. Mechanisms are in place to make sure that disruptions are kept to a minimum and that recovery from disruptions can be effected with a minimum delay – without any impact on the market.

As mentioned earlier, although more than 98% of paper share certificates (by value) have been transferred to an electronic record of ownership, there are still investors who choose to hold securities in paper form, keeping them in their safe or under a mattress. This is risky as certificates may get lost, stolen or even destroyed (for example, in a fire or a flood).

One example of this is the devastation caused by Hurricane Sandy in the United States in late 2012. The Depository Trust & Clearing Corporation (DTCC) in New York suffered “significant water damage” to its buildings. It went through a lengthy process of recovering about 1.3 million water-soaked securities that were stored in a 10,000-square-foot underground vault.

The DTCC says only a ‘very small percentage’ of the $39.5 trillion of stocks and bonds that its depository stores could have been damaged.

Another concern relating to paper certificates lies in the need to be able to prove that you are the true owner of the investment. This is a real problem when you have misplaced the certificate or when it has been damaged through fire or flood. If the owner is deceased, it has often been found that the executor of his/her estate was not even aware of the investment (or could not find a certificate) in order to prove ownership. The electronic record of ownership at the CSD has changed all this and has eliminated the risks associated with having to holding paper securities, which helps the family (and the executor) to manage your affairs should you pass away.

Holding shares electronically is far more safe and secure and it also means they can be sold immediately. For South Africa, dematerialising securities through the best CSD system available enhances the country's profile as an investment destination. Before Strate was created, there were less than 4 000 trades a day on the stock exchange. Today there are over 120 000 trades a day, showing the growth, advances and efficiencies that have been brought to the market.

Since its inception, Strate has used international benchmarks to ensure that, as a South African Financial Market Infrastructure, it provides world-class post-trade services to the market. These are not only limited to keeping a record of the ownership of shares, but also help to make all of the other aspects of managing these investments easier and less risky.