Chapter 4
Equity clearing and settlement
When an investor purchases a share in a company they have acquired
a stake in the equity of that company. Through the share purchase
they are buying partial ownership in the issuing company. The
number of shares owned by the investor in proportion to the total
number of shares outstanding determines the extent of the ownership
an investor has in a company. For the private investor this is likely to
be a very small percentage, but the larger funds can often have
reasonably significant holdings. Not all equity-related instruments
give the buyer ownership and it is very important to understand not
only the equity shares characteristics but also those of the various
other types of instruments.
A share may offer the following ‘rights’ to investors:
The right to vote in company matters.
The right to have access to company books and records
(accounting and record keeping).
The pre-emptive right (or right of first refusal). This means
that if the company issues new securities, the current holders may
have the right to purchase additional shares to maintain their
proportional ownership of the company. This offer to the original
holder is generally given before the offer is made to the public.
The right to share in the company’s profits through dividend
These basic rights are important in terms of settlement as they will
have actions associated with them, for instance corporate actions in
respect of rights issues, dividends, etc. Within the realm of equity
securities are various classes of equity instruments such as ordinary
shares, preference shares, etc. Foreign markets will support equities,
which may be similar to some of the above but with different
terminology. For example:
USA – Common Stock/Preferred Stock
France – Action Ordinaire (Ordinary Share)
Germany – Stamm-Aktie (Ordinary Share)
Japan – Futsu Kabushiki (Ordinary Share)
We need to consider the different characteristics of each of the classes
of equity instruments, starting with the most common type, the
ordinary share, as shown in Table 4.1.
Issuing and trading equities
When a corporate entity offers its shares to the public for the first
time, it is said to be going public. This ‘Offer for Sale’ (or Initial
Public Offering – IPO) will be underwritten by investment banks or
brokers. A prospectus containing information on the issuer, the terms
of the issue, the management structure and any other important
aspects of the issuer is prepared. The issue itself will either be placed
among clients of the brokers (institutional investors) or advertised to
the general public through the publication of mini-prospectuses and
application forms in the financial press and elsewhere.
Any shares which are not bought by the public will be taken up by the
underwriters who will take the shares onto their own books or sell
them on to their own clients. On the other hand, issues that are
initially oversubscribed will be distributed on a scaled-down basis.
One of the consequences of an oversubscription is that the share price
will rise to a premium over the issue price when it starts trading in the
secondary market.
Clearing, Settlement and Custody54
Table 4.1 Classes of equities
Class Characteristics
Ordinary shares represent partial ownership in a
corporation. Characteristically shareholders will have the
right to vote in the election of the board of directors.
They will also have the pre-emptive right to purchase any
additional shares sold by the company and to receive a
dividend, but only if the directors decide to issue a
This dividend payment will generally be received when a
dividend is declared but only after preferred shareholders
have been paid.
In addition, if the company is liquidated, (un)secured
creditors, bondholders, and preferred shareholders have a
prior claim to the company’s assets before the common
Preference shares also represent ownership in a
corporation. Characteristically shareholders will:
Generally have no voting rights.
Generally receive dividends before the ordinary
The dividend is frequently fixed as a percentage of the
share’s stated value. However, the dividend is not
guaranteed. If the company does not post strong earnings,
the directors can omit the preferred dividend.
A cumulative feature may be attached to a preference
share, which states that all dividends in arrears must be
paid to holders at some point in time prior to any
dividends paid to common shareholders.
Participating preference shares may benefit from an
increased level of dividends if the company does well.
Redeemable preference shares have a fixed repayment
date and may be entitled to more than their nominal
capital amount (face value).
Equity clearing and settlement 55

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