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Facts About Exchange Traded Funds (ETF)

  • ETFs trade on an exchange as an equity
  • NSCC’s ETF process automates the creation and redemption of ETF securities
  • NSCC reports, clears and settles ETFs and its underlining securities through its creation/redemption process
  • ETF processing also includes a nightly distribution of domestic, foreign and fixed income portfolio information
  • Participants can customize portfolios by excluding specific securities substituting them with their cash value
  • ETFs can also be created/redeemed against cash (in lieu of securities) when the underlying securities are not NSCC or DTC eligible. For example, Leveraged and Commodity based ETFs that contain futures and swap contracts
  • NSCC also clears and settles ETF’s trades in the domestic secondary market

Benefits

  • Provides a nightly Portfolio Composition File of each ETF and a Web browser GUI that pertains to the ETF for the following trading day
  • Supplies an instruction detail file containing the details for each create and redeem
  • Reduces manual deliveries
  • Provides clearance and settlement of the ETF, as well as the underlying components, through NSCC’s CNS and Non-CNS settlement process and any relevant cash amounts. The underlying components, the ETF and the cash amounts (minus the transaction fee) are guaranteed by NSCC
  • Clients can create or redeem an ETF on T+2 or T+1 (next day) basis
  • Capacity to create or redeem a customized portfolio with cash in lieu of securities
  • Able to create or redeem a portfolio against cash or through the exchange of securities

ETF Flow (How the Service Works)

  • On T- 1, participants receive a Portfolio Composition report/file listing the securities in each ETF. The file also contains the estimated cash amount in each portfolio. Trades eligible for cash creates and redeems show a cash creation amount on the portfolio composition file
  • On Trade Date (T) a participant places a creation/redemption order through the distributor. After receiving the order from the distributor, the agent bank transmits an instruction file for the creates or redeems to NSCC
  • On the night of T, NSCC sends an Instruction Detail File showing the details of the creates and redeems to participants with activity. This report serves as the contract for the create/redeem activity
  • Both the components and the ETF are processed through DTCC’s normal equity clearance and settlement systems
  • Cash amounts for the transaction fees are sent directly to money settlement and are settled under a unique NSCC settlement codes. For standard portfolio’s it is a code 54; for custom portfolio’s it is a code 55

Facts About CNS®

  • CNS is an accounting and balancing system that enables continuous net settlements
  • Each day NSCC identifies trades that were matched through its trade capture and reporting system and stages them for settlement
  • System generates reports of security, money positions and related information
  • CNS provides clearance for equities, corporate bonds, UIT’s and municipal bonds that are eligible at DTC

Benefits

  • CNS nets participants security obligations on a daily basis to one net long or short position for each CUSIP
  • NSCC becomes the contra side of each netted obligation and guarantees its settlement
  • Each day CNS settles one net position per issue with each contra party - NSCC

How the Service Works

  • T-1
    • On the evening of T-1 the ETF agent bank (sometimes referred to as an Index Receipt Agent) sends NSCC a portfolio composition file for each ETF for the following trade day
    • The portfolio composition file displays the individual securities and the weightings that make up one ETF basket for the following trade day. For many ETFs one basket equals 50,000 shares
    • The portfolio composition file also includes cash amounts in the fund for each basket unit
          For example, 50,000 ETF shares =

          10 IBM shares

          40 MRK shares

          30 CSCO shares

          . . .

          And cash amount
    • NSCC distributes the portfolio composition files on T-1 to members, non-members and the listing exchanges
  • T
    • On Trade Date the agent bank’s authorized participant instructs the distributor and or the agent bank they want to create (or redeem) an ETF basket
    • The agent bank sends NSCC the ETF creation instructions on behalf of the authorized participant
    • On the night of T, NSCC generates the following transactions (for a redemption it is reversed) for the agent bank and its authorized participant for settlement on T+2
    • Agent Bank: - 50,000 ETF shares (deliver - short) + Components (receive - long)
    • Authorized Participant: + 50,000 ETF shares (receive - long) - Components (deliver - short)
    • NSCC assigns the closing price on T to each of the components to determine their contract value
    • NSCC then totals the contract values of all of the components along with the cash amount provided by the ETF agent, which pertains to accrued dividends and fund fees and assigns that amount to the contractual value for the 50,000 ETF shares. If all securities settle on settlement date the only money that settles through CNS (code 82) is the cash amount
    • The transaction fee is sent directly to money settlement and collected through a unique money settlement code on T+2. For standard portfolio’s it is a code 54; for custom standard portfolio’s it is a code 55
  • T+1
    • On T+1, NSCC reports the details of creates/redeems that were received
    • Once the create/redeem for an eligible security is reported to NSCC, the transaction is eligible for processing through CNS
    • The status and movements of these securities are reported through various reports
    • Cash amounts for dividends and fees are sent directly to money settlement and are collected through a unique money settlement code on T+2
  • T+2
    • On T+2, the authorized participant delivers the underlying components to CNS who, in turn, delivers them to the agent bank
    • The agent bank delivers the 50,000 ETF shares to CNS who, in turn, delivers them to the authorized participants. These deliveries are made through DTC book entry with CNS
    • When all securities settle there is no CNS ‘mark to market’ payment. The only money changing hands is the cash payment for the transaction fee and the difference between the value of the components and the cash amount and the ETF which is sent directly to money settlement. If not all securities settle, CNS will mark to the market the securities that are failing based upon the primary markets closing price for the components and the ETF
    • CNS automatic delivery process occurs in two cycles: the night and the day cycle
    • Daily money settlement is based on the value of all settled trades plus or minus mark-to-the-market calculations for all open CNS positions and relevant cash amounts
    • For any trades that are not completed on settlement day, CNS will mark the open position to the market and the open position will then become part of the next business days netting/settling process

Additional Services Information

  • Exemptions which are negative instructions sent to NSCC to indicate short positions that should not be automatically taken from participants DTC account. Separate exemptions exist for one day settling items
  • Priorities which are standing instructions set by participants to NSCC to control the delivery of securities of CNS long positions to their DTC accounts. ETF agents are High-High priority for the CNS night cycle and CNS day cycle allocations
  • Processing Reorganizations
    • Reorganizations – both mandatory and voluntary are processed at NSCC. The typical corporate action on ETFs is a regular or reverse stock split. A new CUSIP is usually assigned to the ETF but the trading symbol does not change. Components can also undergo a corporate action such as a regular or reverse split, cash dividend, spin-off or liquidation.
    • Information about these events is available through a series of reports and notices that show activity under way in various CNS subaccounts
    • NSCC allows protection on voluntaries when a participant has a long (failing) position with CNS
  • Processing Dividends
    • Accounting of dividends is based primarily on a participants closing position on the record date
    • Cash and Stock dividends, spinoffs and other type of distributions are reported to the participant on the morning after record date
    • On payable date the appropriate debit or credit is applied to the participants CNS Sub account
  • Processing Buy-Ins
    • Issue an intent buy-in to CNS once a security has failed
    • CNS retransmits the buy-in to the participant or those that owe shares to CNS

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