Proposed Business Model

Transcription

1 T+2 Settlement Cycle Proposed Business Model 9 th January 2017

2 Contents 1. Introduction Definitions Structure Settlement Cycle Pre-order checks Custody Controls Pre-settlement and failed trades chains identification DvP Settlement Fails Management Short Selling Securities Borrowing and Lending Corporate Actions Murabaha Transfers Tradable Rights Table of figures Figure 1: Market Structure... 6 Figure 2: Market Structure (Independent Custody Model)... 7 Figure 3: Transaction Workflow... 9 Figure 4: Rejection Workflow Figure 5: Settlement Workflow Figure 6: Fails Management Overview Figure 7: Short Selling Workflow Figure 8: SBL Initiation Figure 9: SBL Return Figure 10: SBL Return Figure 11: Corporate Actions Figure 12: Murabaha Workflow Figure 13: Tradable Rights Workflow Business Model Overview v1.3.5 Page 2 of 39

3 Disclaimer This document is developed for awareness purposes only. While Tadawul intends to follow the Model explained hereunder, nothing in this document shall be construed to impose any obligation on the part of Tadawul. This document does not constitute a basis for legal reference nor is it intended as advertisement material or an invitation to invest. Further, upon implementation, Tadawul may, at its sole discretion, make changes, additions and/or deletions to this document due to technical, legal or other reasons without incurring any liability on its part. Business Model Overview v1.3.5 Page 3 of 39

4 1. Introduction The purpose of this document is to describe the business model ( the Model ) which will be implemented by Tadawul during the first half of The Model is based on infrastructures: Tadawul, SDC, SAMA and participates: Trading/Custody Members, Settlement Members. Key model components include: Migration to T+2 settlement cycle Improvement of Custody Controls Introduction of DvP settlement Introduction of Covered Short selling Introduction of Securities Borrowing and Lending (SBL) 2. Definitions Available Securities securities available for carrying out transactions which shall include securities which have been purchased but not yet settled to client accounts. BIS DvP Model 2 a DvP settlement mechanism where final transfer of securities from the seller to the buyer (delivery) occurring on a gross (trade by trade) basis, but final transfer of cash from the buyer to the seller (payment) occurring on net basis. Borrowing Agent a Custody Member appointed by borrower for conducting SBL transactions. Custody Member Authorized Person (AP); a member of SDC providing custody services for investors. AP that is a Custody Member can, but doesn t have to be an Exchange Member at the same time. Depository System Equator, IT system used by SDC for facilitation of clearing, settlement, safekeeping and registry functions. Delivery versus Payment (DvP) a securities settlement mechanism that links a securities transfer and a funds transfer in such a way as to ensure that delivery occurs if and only if the corresponding payment occurs. Business Model Overview v1.3.5 Page 4 of 39

5 Exchange Member Authorized Person (AP); a member of exchange providing trading services for investors. AP that is an Exchange Member has to be a Custody Member at the same time. Execution Broker an Exchange Member providing trading services in respect of transactions in deposited securities custody services for which are provided by another legal entity - Independent Custody Member. Independent Custody Member - a Custody Member providing custody services if trading services are provided by Execution Broker (please see Execution Broker). Lending Agent - a Custody Member appointed by lender for conducting SBL transactions. Saudi Arabian Monetary Agency (SAMA) - central bank of Saudi Arabia. Saudi Arabian Riyal Interbank Express (SARIE) - national RTGS payment system operated by SAMA that facilities cash settlement for SDC. Saudi Stock Exchange (Tadawul) a stock exchange in Saudi Arabia. Securities Depository Center (SDC) Central Securities Depository (CSD) of Saudi Arabia, performs securities settlement and cash netting, performs safekeeping and registry functions. SDC operates end beneficial accounts. Securities Borrowing and Lending (SBL) a collateralized loan of securities from one party (lender) of transaction to another (borrower). SBL is conducted in order to cover failed settlement, facilitate short selling or other activities. Settlement Limit - a cash limit as determined by the relevant Settlement Member for each Custody Member from time to time Settlement Member a bank nominated by Custody Member to facilitate cash settlement for this Custody Member; sets Settlement limit. Trading System X-Stream INET, IT system used by Tadawul for facilitating trading functions. Tadawulaty is a suite of services offered by Tadawul in cooperation with the Authorized Persons. It encompasses a bundle of financial services targeted at the different segments of investors as well as issuers. Business Model Overview v1.3.5 Page 5 of 39

6 3. Structure The Model is built on the current market structure and will not introduce significant structural changes to it. The current market structure is the following: Figure 1: Market Structure If client is using Independent Custody Model, i.e. separate Exchange and Custody Members, the market structure is the following: Business Model Overview v1.3.5 Page 6 of 39

7 Figure 2: Market Structure (Independent Custody Model) Business Model Overview v1.3.5 Page 7 of 39

8 4. Settlement Cycle 4.1. Overview Under the Model, settlement cycle is differed to T+2, therefore, settlement of cash and securities is conducted two business days after the trading. However, purchasing and selling powers are granted immediately i.e. expected cash proceeds from executed but not yet settled trades could be used for prospective purchases and purchased securities could be sold before settlement (please refer to the section 5 Pre-order for more details). T+2 settlement cycle as described in the Model would be used for all on-exchange and offexchange trades 1 for all securities traded at Tadawul, namely: Equities Sukuks & Bonds ETFs Tradable Rights REITs T+2 model (where purchasing and selling powers are granted only upon settlement) which is currently used for some asset classes such as Sukuks & Bonds and some Equities (distressed companies) will be no longer be used. Time window between trading and settlement could be used by custodian to confirm trades with clients and submit rejections to SDC accordingly (valid for Independent Custody Model only) Transaction workflow Under the Model workflow of the transactions is the following: 1 Settlement cycle for special buy-in trades is T+0 or T+1 (please refer to the section 9 Fails Management for more details). Business Model Overview v1.3.5 Page 8 of 39

9 Figure 3: Transaction Workflow # Action Description Timing 1 Pre-order checks 2 Order Placement 3 Trade execution 4 Custodian Rejections Exchange Member performs all necessary checks and sends order to the Trading System. Before placing an order into the order book, Trading System checks 2 it: for buy orders - against Adjusted Settlement Limit (ASL), for sell orders against Available Securities. If amount of ASL/Available securities is not sufficient system rejects the order. If order is not rejected at pre-order checks stage, it is placed into the order book. As soon as order is matched with another order, trade executes. Independent Custody Member can reject any trade executed on behalf of its clients. T+0; during trading hours T+0; during trading hours T+0; during trading hours From moment of trade execution until cut-off 2 All other current checks in the Trading System, including Ownership Limits, will be maintained. Business Model Overview v1.3.5 Page 9 of 39

10 5 Rejections Management Broker executed a trade which then has been rejected ought to perform necessary actions (find cash or securities) to ensure settlement of the rejected trade. 6 Pre-Settlement SDC identifies trades which would fail to settle due to the lack of securities and subsequent trades (failed trade chain) and rolls over settlement of such chain to the next business day. time - T+2 11:00 a.m. From moment of trade rejection until presettlement at T+2 1:00 p.m. T+2 1:00 p.m. 7 Settlement SDC conducts DvP Settlement of the trades. T+2 2:00 p.m. 8 Fails From T+3 Management until T+6 Broker/SDC conducts various types of fails management to ensure settlement of the failed trades. Business Model Overview v1.3.5 Page 10 of 39

11 5. Pre-order Checks 5.1. Prefunding Cash Prefunding Cash prefunding requirement is maintained for Natural Persons. For other investor types cash prefunding requirement is to be defined by the corresponding Member. As in the current model, cash prefunding requirements are checked by the corresponding Exchange Member, not by the Trading System Securities Prefunding Securities prefunding requirement is maintained for all investors, however, purchased but not settled securities could be utilized for onward sell trades. As in the current model, securities prefunding requirements are checked by the Trading System System Checks Available Securities Before placing a sell order into the order book, Trading System checks it against quantity of securities available. If quantity is not enough, then the order is rejected by the Trading System. Such checks are conducted at account (i.e. individual investor) level. Available securities are the securities that an investor will ultimately have on his or her account, i.e. securities currently held by the investor plus securities purchased, but not yet settled minus securities sold, but not yet settled. More precisely: Available Securities= Inventory + Securities Pending-in Securities Pending-out Securities blocked for active sell orders Securities blocked for failed trade chains Where: Inventory securities balance of investor s account, free of pledge or other restrictions; Securities Pending-in - securities bought by the investor but not yet settled; Business Model Overview v1.3.5 Page 11 of 39

12 Securities Pending-out - securities sold by the investor but not yet settled; Securities blocked for active sell orders total volume of active sell orders; Securities blocked for failed trade chains pending-in securities blocked as a result of failed trade chain identification (please refer to the section 7 Pre-Settlement and Failed Trade Chains Identification for more details). Available securities are checked on the account level and recalculated after any action affecting one of the components e.g. sell order placement Available Inventory In cases where settlement/transfer of security takes place earlier than the relevant settlement cycle (i.e. immediate, T+0 or T+1) in order to prevent potential settlement fails, Depository System checks not available securities, but available inventory. Available inventory is actual securities on the investor s account that are not reserved for any sell trade or order. More precisely: Available Inventory=Inventory Securities Pending-out Securities blocked for active sell orders Cases where available inventory is checked instead of available securities are the following: Free of Payment (FOP) transfer of securities (excluding Murabaha transfers) Securities Borrowing and Lending Buy-in trades Adjusted Settlement Limit Before placing a buy order into the order book, Trading System checks it against Adjusted Settlement Limit (ASL). If ASL is not enough, the order is rejected by the Trading System e.g. if ASL is non-positive, no buy order will be accepted. Such check is conducted on Custody Member level. For the trades conducted under ICM, ASL of Independent Custody Member is utilized. ASL is a total purchasing power of a Custody Member i.e. it is a Settlement Limit set by Settlement Member plus expected incoming funds from sell trades minus expected outgoing funds for buy trades and subscriptions and funds blocked for rejected sell trades. ASL is a rolling limit i.e. includes all unsettled trades for all settlement dates. More precisely: Business Model Overview v1.3.5 Page 12 of 39

13 ASL=Settlement Limit + Funds Pending-in - Funds Pending-out Funds blocked for active buy orders Funds blocked for rejected sell trades Where: Settlement Limit limit set by the corresponding Settlement Member; can be adjusted by Settlement Member anytime intraday via Depository System. Funds Pending-in value of unsettled sell trades 3 with any settlement date (on-exchange and off-exchange trades). Funds Pending-out value of unsettled buy trades with any settlement date (on-exchange and off-exchange trades) and value of unsettled tradable right subscriptions Funds blocked for active buy orders value of active buy orders Funds blocked for rejected sell trades (for Execution Brokers only) value of the rejected sell trades. Since rejected sell trades are generally not covered by securities i.e. could fail to settle, value of such trades is not added but subtracted from ASL. This field is applicable only for Custody Members that act as Execution Brokers Daily recalculation of ASL ASL is based on the value of unsettled trades, therefore, in addition to recalculation after every order/trade, it is also recalculated after every settlement to exclude the value of settled trades. In order not to intervene with trading activities, such adjustment is always conducted after the trading hours. In order to allow Members to foresee necessity to adjust the Settlement Limit, Depository System allows Member to see their expected ASL at specified date e.g. ASL as of tomorrow excluding trades which will settle today Negative ASL ASL could become negative due to the following reasons: After settlement (since settled trades are excluded) Upon rejection (for Execution Broker) 3 Excluding rejected sell trades i.e. trades which could fail to settle Business Model Overview v1.3.5 Page 13 of 39

14 If ASL is negative, as explained in the section before, Member will not be able to place any buy orders. Negative ASL could be resolved by either of the following: Executing sell trades Increase of Settlement Limit by the Settlement Member (could be done intraday) NIN ASL Independent Custody Members could (but not obliged to) set a special Settlement Limit on a client level. If such limit is set, the order will first be checked against the Member ASL and then against client s NIN ASL. Logic of calculation of NIN ASL is similar to ASL, however it s not a rolling limit i.e. does not include trades from the previous days (refreshed every day to be equal to the NIN Settlement Limit). NIN ASL = NIN Settlement Limit + Daily Funds Pending-in Daily Funds Pending-out Funds blocked for active buy orders Where: NIN Settlement Limit limit set by Independent Custody Member for its client; can be adjusted by Custody Member anytime intraday via Depository System. Daily Funds Pending-in value of sell trades conducted by the client during the current trading session (on-exchange and off-exchange trades). Daily Funds Pending-out value of buy trades conducted by the client during the current trading session (on-exchange and off-exchange trades) and value of tradable right subscriptions executed during current operational day. Funds Blocked For Active Buy Orders value of active buy orders of the client. Business Model Overview v1.3.5 Page 14 of 39

15 6. Custody Controls 6.1. Overview Currently Independent Custody Member can open the following types of accounts for investor: Custody account an account only for safekeeping; cannot be used for trading/settlement purposes; Access account an account for trading/settlement; could also be used for safekeeping. In order to make securities from Custody account available for trading, custodian has to transfer them into the Access account, prior a sell order could be placed into the Trading System. The Model introduces two important enhancements to the custody controls available under ICM: Multiply override accounts 4 Trade rejections Above-mentioned enhancements make usage of Custody accounts obsolete, however this functionality is retained in the Depository System Multiple Override Accounts Under the Model, Independent Custody Member can open several Access accounts and restrict trading from such accounts to the specific Execution Broker(s). Allocation of the same account to the multiple Execution Brokers is permissible. If Execution Broker is not assigned to the account, it is notable to place an order on behalf of this account (the order is rejected by the Trading System). 4 Multiple override account will be available before the migration to T+2. Business Model Overview v1.3.5 Page 15 of 39

16 6.3. Trade Rejections Overview Trade rejections are available only for the trades executed on behalf of clients using Independent Custody Model and could be made only by Independent Custody Member for its clients. There is no trade confirmation functionality in the Depository System, only trade rejections are possible. All trades that are not rejected until the cut-off time, which is 11:00 a.m. T+2, are treated as confirmed and will be settled from clients accounts. All rejections are final and cannot be reversed or canceled, neither by Independent Custody Member nor by Execution Broker. Responsibility for the settlement of rejected trades lies completely with the Execution Broker. If the trade is rejected, SDC cannot put any claim on client s assets e.g. a force sells on the client s securities. All rejected trades are placed to (and settled from) a special principle account of the corresponding Execution Broker Rejection Account. Rejection Account cannot be used for trading activities apart from the fails management activities (please refer to the section 9 Fails Management for more details). If rejection of the buy trade leads to a shortage of securities on client s account (i.e. negative amount of Available Securities), Independent Custody Member has to reject corresponding sell trade(s) to resolve the shortage (i.e. make amount of Available Securities non-negative) Rejection workflow Figure 4: Rejection Workflow Business Model Overview v1.3.5 Page 16 of 39

17 # Action Timing 1 Execution Broker conducts a trade at the Trading During trading hours at T+0 System 2 Independent Custody Member can see trades in Depository System real time or in the end of day report Immediately upon execution/end of day T+0 3 Client rejects or does not confirm the trade From trade execution until cut-off time specified by Independent Custody Member 4 Independent Custody Member rejects the trade From trade execution and until 11:00 a.m. T+2 5 Broker is notified about rejection via FIX message Immediately upon rejection input 6 Rejection is executed i.e. trade is transferred from client s account under Independent Custody Member to the Broker s Rejection account; Available Securities, Available Inventory and ASL are recalculated. During the rejection batch, which is not earlier than 30 minutes, but not later than 60 minutes after the rejection (during trading hours) Batch Processing Rejections are processed in batches. Batches run every 30 minutes and include all rejections which were input into the Depository System at least 30 minutes before the batch start. For example, a rejection received at 10:29 is executed during the batch at 11:00, at 10:31 at 11:30. This is done to give the Execution Broker time to prepare for the rejection (since it will affect its ASL) Rejection Input Process Rejections should be input by Independent Custody Member manually via Depository System. Independent Custody Member could reject individual trades (exchange executions). However, search of the trades is conducted by account, settlement date, and order number. Independent Custody Member can choose particular trades from the search output or reject all at once. Partial rejection (i.e. rejection of the part of the trade) is not possible. Business Model Overview v1.3.5 Page 17 of 39

18 7. Pre-Settlement and Failed Trade Chains Identification 7.1. Trades Failed to Settle Since all orders are checked by the Trading System for securities prefunding requirements, normally sell trades cannot fail to settle. However, if the sell trade has been rejected by the Independent Custody Member, Execution Broker may not be able to find securities to cover such trade until the pre-settlement time and therefore will fail to settle. This is the only possible cause for a trade to fail to settle at the first place. However, since settlement is conducted according to BIS DvP Model 2, i.e. net cash and gross securities, a failed trade might cause consecutive trades to fail (e.g. a rejected buy trade could cause a failure of the consecutive sell trade). Such trades are also considered as failed but treated differently (please refer to the section 9 Fails Management for more details). Depository System always tries to settle trade against Inventory i.e. even if sell trade is preceded by the buy trade which failed to settle, but amount of Inventory is sufficient, such sell trade will be settled. Execution Broker has to have securities on its Rejection Account at pre-settlement time which is at 1:00 p.m. on T+2, otherwise sell trades will be considered as failed. Partial settlement is allowed only during Cash Substitution, therefore in all other cases if there is not enough securities to settle the whole trade, such trade will fail to settle in full. If a trade fails to settle at a Record Date of a corporate action, market claim is generated or trade transformation is conducted (please refer to the section 12 Corporate Actions for more details) Pre-settlement Before processing the actual settlement, SDC conducts a pre-settlement run. During the presettlement, SDC identifies trades which will fail to settle at upcoming settlement run due to the shortage of securities (rejected sell trades) or due to the failure of settlement of the preceding trade. Such trades form a failed trade chain. The failed trade chain is rolled over for the next day settlement and is subject to fails management process (please refer to the section 9 Fails Management for more details). During the pre-settlement, only trades with intended settlement date of current day or earlier are considered; i.e. trades with intended settlement date in the future are not considered (the failed trade chain is potentially incomplete). Business Model Overview v1.3.5 Page 18 of 39

19 7.3. Failed Trade Chains At the end of the day, SDC identifies trades with intended settlement date in the future which will fail because settlement of the trade(s) identified at pre-settlement has failed. Such trades are added to the failed trade chain and failed trade chain is considered as complete. Failed trade chain has the following links: First link: failed seller an Execution Broker who has not covered the rejected sell trade in time. Intermediate links (if any) Investors who failed (or will fail) to settle sell trades because of the first link or other intermediate link. Last links: end-buyer(s) investors who haven t received (or will not receive) purchased securities because of the first link or intermediate link. As soon as full chain is identified, end buyer(s) is restricted from selling securities, which are expected to be received from failed trade, until the failed trade chain is resolved. This is done in order to prevent failed trade chain to grow. For example: Trade #1: ABC sells 100 securities to DEF (rejected sell trade); Trade #2: DEF sells 100 securities to GHI; If ABC fails to find securities for settlement, then: Failed Seller is ABC; Intermediate link is DEF; End-buyer is GHI; GHI cannot sell 100 securities he/she is expecting to receive from Trade #2. Business Model Overview v1.3.5 Page 19 of 39

20 8. DvP Settlement 8.1. Overview Settlement is conducted according to BIS DvP Model 2 gross settlement of securities, net settlement of funds. Gross settlement of securities is conducted on trade-by-trade basis between the accounts of beneficial owners in SDC. Net settlement of funds is conducted as cash transfers between Settlement Members and SDC account in SAMA. Such cash transfer is net for each Settlement Member i.e. cash settlement of all trades of Custody Member(s) that uses this Settlement Member, is netted into a single debit or credit. In compliance with the Principle of DvP, delivery of securities occurs if and only if the corresponding payment occurs. In order to ensure that there is no securities shortages, settlement is always preceded by pre-settlement Settlement workflow Figure 5: Settlement Workflow Business Model Overview v1.3.5 Page 20 of 39

21 # Action Timing 1 SDC calculates net cash debits or credits for each Settlement Member. 14:00 One Settlement Member could either have a net debit or net credit, not both. 2 SDC instructs SAMA to debit accounts of the corresponding 14:00 Settlement Members in SARIE and credit SDC account. 3 SDC initiates securities settlement. Securities settlement is conducted 14:15 on the gross basis - trade-by-trade transfers between the beneficial owner accounts in SDC. 4 SDC instructs SAMA to debit SDC account and credit accounts of the corresponding Settlement Members in SARIE. 14:15 (in parallel with #3) 9. Fails Management 9.1. Overview In order to prevent settlement of rejected sell trades to fail or resolve failed settlement, Execution Broker or SDC could/will conduct variety types of fails management. Such activities could be categorized as follows: Type Description Timing Pre-fail Management Optional Fails Management Mandatory Fails Management Activities which could be conducted by the Execution Broker before rejected sell trade fails to settle Activities which could be conducted by the Execution Broker after the trade settlement has failed Activates conducted by SDC to ensure settlement of failed trades From T+0 until T+2 From T+3 until T+4 From T+5 until T+6 Business Model Overview v1.3.5 Page 21 of 39

22 Late Settlement Fee 5 Fee for every day of settlement delay The following figure shows the overview of the types of fails management: Figure 6: Fails Management Overview The following sections provide explanations of each type of the fails management. 5 Despite Late Settlement Fee is not particularly a type of fails management i.e. it cannot resolve the fail by itself, Late Settlement Fee is an important part of the settlement discipline, it encourages participants to settle in time, and therefore considered in this section. Business Model Overview v1.3.5 Page 22 of 39

23 9.2. Transfer from Principle Account In order to cover shortage of securities, Execution Broker can transfer such securities from its principle (proprietary trading) account to its Rejection Account using same NIN FOP transfer. This operation could be conducted at any time until the end of day T+4. Transfer is subject to normal FOP transfer fee, no special fee is charged Securities Borrowing Execution Broker can borrow needed securities via SBL functionality. Standard processes and standard SBL fees are applied. This operation could be conducted at any time until end of day T Buy from The Open Market Execution Broker can buy needed securities from the open market. Standard processes and standard fees are applied. This operation could be conducted at any time until the end of trading session T+3 i.e. trade should settle before or at T+5. However, if purchase is conducted after T+0, than corresponding sell trade will still fail to settle at T+2 and will settle two business days after the purchase. Therefore, only buying from the open market at T+0 is considered as pre-fails management, while from T+1 to T+3 as optional fails management Optional Buy-in Overview Optional buy-in is a special type of trade. The buy side account of buy-in trade could be only an Execution Broker s rejection account with (potential) shortage of securities i.e. sell trades failed (or expected to fail) to settle. The sell side account of the buy-in trade could be a principle account of another Exchange Member or client s account of this or another Exchange Member. Sell side account cannot be an account belonging to a client using Independent Custody Model. Buy-in trade is checked (from the sell side) against Available Inventory, not Available Securities i.e. seller has to have securities inventory in order to be able to conduct such trade. Business Model Overview v1.3.5 Page 23 of 39

24 Buy-in trades are negotiated bilaterally between participants. Tadawul provides a special functionality in Tadawulaty system, which allows Execution Broker to request interest (RFI) for buy-in from other Exchange Members. However, usage of this system is optional, failing Execution Broker may opt for finding counterparties by itself. Buy-in trades are manually input by failing Execution Broker in Depository System and should be approved by the counterparty (similar to the current process of off-exchange trades input). Input of buy-in trade is possible only after pseudo pre-settlement at 11:30 a.m. and until actual pre-settlement at 1:00 p.m. (for same day settlement) or the end of day (for next day settlement). Amount of securities purchased via buy-in trade(s) cannot exceed the shortage of these securities on the rejection account, it however may be less. Settlement of buy-in trades is conducted during the normal settlement run, cash side is netted with other trades: If buy-in is conducted at T+1 i.e. one day before the intended settlement date of the rejected trade, then settlement of the buy-in trade is conducted next business day. If buy-in is conducted at T+2, T+3, T+4 i.e. on or after the intended settlement date of the rejected trade, then settlement of the buy-in trade is at the same day. Buy-in trade are subject to normal trading fee. No admin fee is charged. Any Process Time Any For buy-in at T+1: from 11:30 and until 16:00 For buy-in at T+2, 3 and 4: from 11:30 and until 13:00 For buy-in at T+1: 14:00 (next business day) Action T+1 to T+4 Failing Participant to request interest for buy-in in Tadawulaty (Security, Quantity, optionally: Price) Participants to agree on trade details Failing participant to enter the transaction and seller to approve Buy-in trades together with the trades from corresponding failed trade chain are settled during the normal settlement run. Business Model Overview v1.3.5 Page 24 of 39

25 For buy-in at T+2, 3 and 4: 14:00 (same day) 9.6. Late Confirmation Transfer Rejections are irrevocable, however if client provides late confirmation for the trade (until T+4), Execution Broker and client (via Independent Custody Member) can facilitate an FOP transfer to rectify the rejection. Cash transfer should be conducted bilaterally outside of the Depository System. Cash transfer should be conducted by the value of original transaction and all interest claims, fees and penalties should be explicitly mentioned. In order to facilitate such transfer, party holding securities (Execution Broker in case of buy trade rejection and Independent Custody Member in case of sell rejection) should send a special request to SDC specifying accounts for transfer and providing evidence for the purpose of such transfer (the rejected trade details). Transfer could be conducted only between the account of the client from which the original trade has been conducted and Execution Broker Rejection account for the amount of the original trade. Late settlement fee (for the number of days the trade has failed to settle) is charged from the Execution Broker, who in turn could charge it from the client. Independent Custody Member should submit a report on periodical basis of all such transfers including the cash leg (explicitly specifying amount of interest claims, fees, penalties, etc. claimed) and original rejected trades Mandatory Buy-in Overview Mandatory Buy-in is an auction conducted by SDC on behalf of the failing Execution Broker at T+5 (i.e. 3 days after the intended settlement date of the failed trade). The auction is conducted with a fixed price where offers are prioritized by volume the largest volume has the highest priority. This allows to minimize number of buy-in trades. If two offers have the same volume, they are prioritized by the time of receipt (First In First Fulfilled). Offer with a volume bigger than requested buy-in volume is assumed to have the requested volume. Buy-in price is 110% of the last day reference price adjusted for corporate actions. Business Model Overview v1.3.5 Page 25 of 39

26 Since buy-in trades are special cum i.e. have corporate action proceeds attached even if conducted on or after the ex-date, but before or on record date (please refer to the section 12 Corporate Actions for more details), reference price is adjusted in the following way. If buy-in is conducted at the ex-date: Adjusted reference price = last day reference price as it was i.e. without any adjustments If buy-in is conducted at the record date and corporate action is not tradable rights issuance: Adjusted reference price = Where: Last Day Reference Price adjustment factor + Dividend per share Reference Price a closing price of the securities calculated in accordance with Tadawul s methodology: Volume Weighted Average Price for the equities, Last Normal Price for other securities; not adjusted for corporate actions; Adjustment factor the multiplier applied by Tadawul for adjustment of the price in Trading System at Ex-date for securities corporate actions such as splits or bonus shares; Dividend per share a value of the cash dividend per share; zero if no cash dividends. For example: Price of security is 100 (and not changing); corporate action is a 1:1 bonus shares issuance; Buy-in is conducted at the record date. At the ex-date: Tadawul will adjust the price in the Trading System by multiplying it by 0.5; New price = 100*0.5 = 50. At the record date: Adjusted reference price = 50/0.5+0=100; Buy-in price=110%*100=110. Business Model Overview v1.3.5 Page 26 of 39

27 9.8. Cash Substitution Overview If mandatory buy-in was not fully successful i.e. there are still some unsettled trades with intended settlement date of T+2, SDC conducts a cash substitution 6. Cash substitution is a method of settlement where securities obligations are substituted with cash obligations, i.e. as if end-buyer sold securities to the failed seller at the Cash Substitution Price Late Settlement Fees In case of the failed settlement, SDC charges a late settlement fee for every day of delay i.e. for each day from T+2 (intended settlement date) and until successful settlement or T+5 (cash substitution), whichever comes first. For each failed trade chain, Late Settlement Fee is charged to the failed seller (the first link of the chain) and distributed to the end-buyers (the last links of the chain). The fee is charged based on the trade value and distribution is made pro rata by the amount of the shares of end-buyers trades. For example: if SAR 1000 is charged from the failed seller and there are two end-buyers: A with the trade for 8 securities and B with the trade for 2 securities. Than A will receive SAR 800 and B will receive SAR 200. Administrative fee is additionally charged from the failed seller for the late settlement fee management. 10. Short Selling Overview Covered short selling is allowed for investors other than Natural Persons. However, investor has to borrow securities and have them settled on its account before selling short. 6 For the Tradable Rights cash substitution is also initiated for all trades that remain unsettled two business days after the end of the Tradable Right trading period. Business Model Overview v1.3.5 Page 27 of 39

28 Short selling could only be conducted from specially designated accounts - Short Selling Accounts. Short Selling Accounts could only be used for short selling related activities including borrowing securities, short selling, buying back and returning the securities loan. Ordinary trading from such accounts is prohibited Workflow Figure 7: Short Selling Workflow # Action 1 Investor originates securities borrowing transaction 2 Investor receives securities from the borrowing transactions 3 Investor conducts short sell trade 4 Investor buys securities back 5 Investor returns securities to the lender Business Model Overview v1.3.5 Page 28 of 39

29 11. Securities Borrowing and Lending Overview Origination Securities Borrowing and Lending activities are handled completely bilaterally where SDC only facilitates an FOP transfer of securities based on instructions from counterparties. Securities Borrowing and Lending transactions are originated outside of the exchange and negotiations are taking place bi-laterally. However, SDC provides Tadawulaty platform that allows to initiate a request for interest (RFI) for borrowing or lending securities. There are two types of SBL transactions available: Fixed term where date of return is predefined; Open-ended where return occurs by request of borrower or lender subject to notice period. SBL transactions cannot last more than one year i.e. should be returned and rebooked every year. SBL transaction could be conducted for the following purposes: Short Selling; through a designated short selling account Failed Settlement; through an Execution Broker rejection account ETF creation Relending 7 (lending a security, which has been borrowed) Other purposes specified by SDC Facilitation In order to initiate SBL transaction, Lending Agent needs to input transaction into the Depository System and Borrowing Agent needs to approve it. As soon as approval is received, SBL transaction is settled immediately by FOP transfer from lender s account to borrower s account. 7 Security could be relent only once Business Model Overview v1.3.5 Page 29 of 39

30 SDC does not initiate automatic return of securities nor process notifications for return (such actions should be handled bilaterally). In order to facilitate a return for SBL transaction, Borrowing Agent needs to input return instruction into the Depository System and Lending Agent needs to approve it. As soon as approval is received, SBL transaction is settled immediately by FOP transfer from borrower s account to the lender s account. Initiation and return requests are checked against Available Inventory (not Available Securities) i.e. lender/borrower should have securities inventory (settled securities) in order to perform such transactions. Action with SBL transaction should always be requested by party that holds the securities at the moment of time i.e. Initiation of SBL transaction in the system is requested by Lending Agent, while return by Borrowing Agent Eligible Participants SBL activities are prohibited for Natural Persons. Borrower/Lender (end investors) has to appoint Borrowing/Lending Agent a Custody Member who would facilitate SBL transaction for the investor. Borrowing/Lending Agent could also act as borrowers/lenders i.e. proprietary SBL transaction SBL Agreement Borrower and Lender have to sign an SBL Agreement and define key aspects of their SBL activities: such as notification periods, corporate actions handling, rules governing failure to return and default, etc. SDC may require Agents to lodge SBL Market Agreement with SDC Collateral and Fails Management Collateral management activities for SBL (including marking-to-market) are conducted bilaterally (or via a third party). SDC does not act as principle for SBL transactions and is not be accountable for any risks. In the case of failure to return securities, SDC is not responsible for any fails management as it will be handled completely between Borrower and Lender through their agents. However, if SBL transaction is terminated without return of securities, Borrowing and Lending Agents must terminate SBL transaction in the Depository System by filing a request to the SDC Business Model Overview v1.3.5 Page 30 of 39

31 stating a mutual consent (or consent of liquidator, court order, etc.) and justification of the reason to terminate without return of securities Corporate Actions SBL transaction is a transfer of legal ownership, therefore lender is not eligible for corporate actions entitlements and loses its voting rights. SBL Agreement should specify process of manufacturing of corporate action s proceeds and recalling securities for voting purposes. SBL transactions are transformed by SDC in case of a corporate event in form of bonus shares issuance, split, consolidation or capital decrease (please refer to the section 12 Corporate Actions for more details). Dividends, tradable rights, compensation payments for any lost fractions (if any), etc. should be handled bilaterally Ownership Limits For the purpose of ownership limits (e.g. Foreign Ownership Limit) calculation, lent securities are considered as owned by both lender and borrower. Therefore, return of lent securities cannot lead to the breach the ownership limits Process Initiation Figure 8: SBL Initiation # Action Business Model Overview v1.3.5 Page 31 of 39

32 1 Borrower and lender negotiate SBL transaction bilaterally 2 Lending Agent inputs request for a loan into the Depository System 3 Borrowing Agent approves the request 4 SDC immediately transfers loaned securities from the lender s account to the borrower s account on FOP basis; SBL transaction is created in the system * Initial and day-to-day management of collateral is conducted bilaterally between borrower and lender (or through a third party) Return Figure 9: SBL Return # Action 1 Borrower or lender to request return with appropriate notice period (to be defined in SBL Agreement) or at the expiry date of fixed term SBL transaction (bilaterally) 2 Borrowing Agent inputs request for return of the loan into the Depository System 3 Lending Agent approves the request 4 SDC immediately transfers loaned securities from the borrower s account to the lender s account on FOP basis; original SBL transaction is deemed closed Business Model Overview v1.3.5 Page 32 of 39

33 * Return of the collateral is managed bilaterally between borrower and lender (or through third party) Termination without return Figure 10: SBL termination # Action 1 Termination without return event occurs (to be specified in the SBL Agreement), e.g. default of a counterparty, inability to find securities, etc. 2 Counterparties to submit to SDC an official request to terminate without return the loan stipulating the reason for the termination without return and showing consent of both parties for termination (or liquidator consent or court order, etc.) 3 Original SBL transaction is deemed terminated * All claims to be handled bilaterally Business Model Overview v1.3.5 Page 33 of 39

34 12. Corporate Actions Key dates Due to the transition to the deferred settlement cycle and therefore introduction of a time period between the trading and the settlement, the corporate actions framework is amended. Issuer s sharebook is defined based on the settled positions i.e. based on securities inventory on investors accounts. Such sharebooks (at different points of time) are used for defining the list of investors eligible for attending General Meetings and for corporate actions entitlements. Moreover, a new key date is introduced, which is an Ex-dividend date (Exdate). The following chart explains the key dates for the corporate actions: Figure 11: Corporate Actions Key Dates Definition Timing Announcement Day Issuer announces General Meeting (GM) and key dates At least 10 calendar days before GM Business Model Overview v1.3.5 Page 34 of 39

35 Eligibility for GM Investors registered in issuer s sharebook at the end of the day (inventory i.e. settled position) are eligible to attend GM and vote General Meeting date General Meeting (GM) Eligible investors attend GM Ex-Dividend Date Record Date Security starts to trade at market opening without CA s proceeds attached. Security price is adjusted by the Exchange for securities corporate actions (splits, bonus shares, rights issuance). Exchange does not adjust price in case of cash dividends Investors registered in the issuer s sharebook at the end of the day (inventory i.e. settled position) are eligible to receive CA s proceeds One business day before the record date Two business days after GM Payment Date (securities) Securities dividends are credited to the investors accounts Record Date Payment Date (cash) Cash dividends are paid by the issuer. SDC is not involved into the process of cash dividends distribution Within 15 calendar days after the Record Date Business Model Overview v1.3.5 Page 35 of 39

36 12.2. Market Claims and Trade Transformations Sharebook is defined on settled position, therefore the buyer who was supposed to receive corporate actions proceeds (securities were purchased before the ex-date) would not receive them if settlement of the trade fails. However, SDC will generate market claim or perform a trade transformation in order to enable buyer to receive corporate actions proceeds. Administrative fee is charged from the failed seller [first link] for the trade transformations or market claims generation Bonus Shares, Splits, Consolidations, Capital Reductions All trades that fail to settle at the record date of corporate action, which is bonus shares issuance, split, consolidation or capital reduction, are transformed. Transformation is conducted by adjusting the volume (number of the traded securities) of the trade according to the corporate event description. Value (cash amount) of the trade remains unchanged and price is adjusted in accordance to the new volume. All SBL transactions at the record date of corporate action, which is bonus shares issuance, split, consolidation or capital reduction, are transformed as well. Transformation is conducted by adjusting the loan volume (number of lent securities) according to the corporate event description Cash Dividends, Tradable Right Issuance In case of cash dividends, lost corporate action proceeds are handled via market claims. The market claim is generated between a buyer and a seller of every trade failed to settle at the record date. Such claims are communicated to the relative Custody Members in a form of special report Voting Rights No market claim, transformation or compensation is conducted for the voting rights. Business Model Overview v1.3.5 Page 36 of 39

37 13. Murabaha Transfers Overview Murabaha is a special type of transfers designed for Sharia compliant loans. In order to facilitate Murabaha, lender of cash buys securities and transfers them to the borrower`s account, then borrower, almost immediately, sells the securities and receives money. In order to make such activities possible, special transfer is designed, called as a Murabaha transfer. Unlike normal FOP transfers, Murabaha transfers could be made from Available Securities (not from Available Inventory) i.e. the lender is able to transfer purchased but not settled securities. Murabaha transfers could only be made from special Murabaha accounts and only between the accounts under the same Custody Member. Murabaha Transfer is executed immediately but settlement of corresponding trades follows the standard T+2 settlement cycle. Therefore, money for the sell trade will be settled only in two days after the trade. However, since cash is settled on the net basis, net settlement of cash for the whole Murabaha transaction is only the difference between the value of lender s buy and borrower s sell trade Workflow Figure 12: Murabaha Workflow Business Model Overview v1.3.5 Page 37 of 39

38 Step Action Time 1 Lender of cash buys securities from the market using Murabaha account. Any time 2 Custody Member requests Murabaha transfer Immediately 3 SDC transfers purchased but not settled securities Immediately 4 Borrower sells securities on the market Immediately 5 SDC settles the difference between values of buy and sell trades (securities settlement is effectively 0) T+2 14:00 Business Model Overview v1.3.5 Page 38 of 39

39 14. Tradable Rights Overview Tradable rights are distributed based on the sharebook generated by the same principle as for the cash dividends. Subscription is based on settled position, i.e. Available Inventory is checked before subscription request is accepted. In other words, buyer can subscribe only after trade is settled. Therefore, in order to allow at least one day for subscription, trading period for tradable rights is three days shorter than the subscription period. Moreover, SDC checks it against Custody Member ASL before accepting subscription (please refer to the section 5 Pre-order for more details). As soon as tradable right is subscribed, it is blocked, i.e. cannot be sold or transferred. Settlement of the subscription amounts handled in two business days after submission of the subscription request. Subscription is irrevocable, however subscription can we cancelled within the day of the subscription request submission. Fails Management for Tradable Rights follows the same rules as for the other securities (please refer to the section 9 Fails Management for more details). However, all trades that remain unsettled two business days after the end of trading period are cash compensated Workflow Figure 13: Tradable Rights Workflow Business Model Overview v1.3.5 Page 39 of 39