Clearing and Settling Facility and Corporate Debt Trades

Four short rules decide where an over-the-counter trade actually clears. Three cover the FINRA facilities a trader reports through, the ADF rule and the two TRF rules, and the fourth covers corporate debt. They read almost identically, and the small differences between them are the tested part.

How Must an Alternative Display Facility Trade Clear and Settle?

The Alternative Display Facility (ADF) clearance and settlement rule binds a member. That member shall clear and settle transactions effected on the ADF in ADF-eligible securities that are eligible for net settlement, through the facilities of a registered clearing agency that uses a continuous net settlement system.

The rule then names three ways to satisfy that requirement.

• Direct participation in such a clearing agency
• Use of direct clearing services
• Entry into a correspondent clearing arrangement with another member that clears trades through such an agency

The ADF definitions supply the security type. An ADF-eligible security means a national market system (NMS) stock as Regulation NMS definitions define it, and an NMS stock is any NMS security other than an option.

The rule prints a paragraph number for that definition which, in the current Regulation NMS, holds the definition of a manual quotation instead, while the NMS stock definition sits in a different paragraph. Read the term as the NMS stock definition it names.

One escape exists. Notwithstanding that requirement, transactions in ADF-eligible securities may be settled "ex-clearing" provided that both parties to the transaction agree.

Exam Tip: Gotchas

• The ADF duty carries a net-settlement qualifier the facility rules do not. It reaches ADF-eligible securities that are eligible for net settlement, so a security outside net settlement is outside the sentence.
• The correspondent route has a condition on the other member. The arrangement must be with another member that clears trades through such an agency, so a correspondent outside a registered clearing agency does not satisfy the rule.

How Must a Trade Reporting Facility Trade Clear and Settle?

Two rules cover the Trade Reporting Facilities, one for the FINRA/Nasdaq facilities and one for the FINRA/NYSE facility, and their operative text is identical. Each binds a Trade Reporting Facility (TRF) Participant rather than a member generally.

That participant shall clear and settle transactions in designated securities through the facilities of a registered clearing agency that uses a continuous net settlement system. The requirement may be satisfied by the same three routes: direct participation, use of direct clearing services, or entry into a correspondent clearing arrangement with another member that clears trades through such an agency.

The TRF definitions supply the security type on both sides. Designated securities means all NMS stocks as Regulation NMS definitions define them, so these rules carry no net-settlement qualifier of their own.

Each rule carries the same escape. Notwithstanding the requirement, transactions in designated securities may be settled "ex-clearing" provided that both parties to the transaction agree. Trade reporting itself is covered in the unit on reporting trades to the designated reporting facility.

Exam Tip: Gotchas

• The two facility rules bind different actors from the ADF rule. The ADF rule binds a member. The facility rules bind a Trade Reporting Facility Participant, which is why a firm's status matters before the duty attaches.
• Ex-clearing settlement needs agreement from both sides. One party's election is not enough under any of these rules, so a scenario where only the seller wants ex-clearing does not reach it.

When Must a Corporate Debt Trade Clear Through a Registered Clearing Agency?

The corporate debt clearance rule reaches a narrower population. Each member or its agent that is a participant in a registered clearing agency, for purposes of clearing over-the-counter securities transactions, shall use the facilities of a registered clearing agency for the clearance of eligible transactions between members in corporate debt securities.

One case falls outside it by its own terms. The requirement does not apply to a transaction between members whose accounts are carried by a carrying member that clears and settles the transaction through book-keeping transfers between the parties' accounts at that carrying member.

A second route out is discretionary. FINRA may exempt any transaction or class of transactions in corporate debt securities from the requirement.

Exam Tip: Gotchas

• The corporate debt duty attaches only to a clearing agency participant. It binds each member or its agent that is a participant in a registered clearing agency for clearing over-the-counter transactions, rather than every member that trades corporate debt.
• The carrying-member exception depends on how the trade settles. Both parties' accounts must sit with the carrying member and that member must clear and settle the trade by book-keeping transfers between those accounts.

What Should You Check on Exam Day?

• Name the actor the rule binds. The ADF rule binds a member, the two facility rules bind a Trade Reporting Facility Participant, and the corporate debt rule binds a clearing agency participant.
• Check whether the security is eligible for net settlement before applying the ADF duty; the facility rules carry no such qualifier.
• Confirm the correspondent clearing route runs through another member that itself clears through a registered clearing agency.
• Treat ex-clearing settlement as available only where both parties to the transaction agree.
• On corporate debt, ask whether one carrying member holds both accounts and clears and settles by book-keeping transfer. That is the only self-executing exception; FINRA may separately exempt a transaction or class of transactions.