Since the trading of securities is presently feasible only when the seller owns the securities to be traded, the buyer is assured that the purchased securities will be delivered to him/her within a given period of time (for the securities currently traded at Tehran Stock Exchange, this period is one working day). However, it is likely that the buyer or the buyer's agent fail to pay the price of the purchased securities within the 'set time'; and the seller is not assured to receive the price of the sold securities within the 'set time'; The delay in payment of the due amount causes problem for the creditor in particular and the whole market in general, because CSDI as a clearing house has to postpone the process of settlement and payment to the creditors till payment of all the debtors is complete. (Once all funds due from the members whose purchases exceed their sales are received, then the clearing house pays the funds due to the members whose sales exceeds their purchases. In the process of settlement, the clearing house carries out the task of netting offsetting the obligations of the members, i.e. the members with both purchase and sale transactions shall settle only the difference). In advanced markets, the clearing houses usually act as guarantor as well, in the sense that the clearing house guarantees the obligations of the trading parties against each other. They actually act as seller before the buyer and as buyer before the seller as far as the obligations arising from the transactions is concerned. Although the Iranian capital market has set as its goad to guarantee the full settlement of the transactions, this crucial goal has to be implemented and achieved through a step-by-step process. Central Securities Depository of Iran (CSDI), as the clearing house of Tehran Stock Exchange and the Iranian OTC exchanges, has recently designed and launched the new service of Settlement Guarantee Fund (SGF) as the first step towards achieving the aforementioned goal. Taking the advantage of this newly established service, the traders can to a large extent be assured of the fact that in case a party fails to honor the trade settlement obligations within the set time, the clearing house will be able to fulfill the obligations of the defaulting member within the set time.
Members of the clearing house are entities that possess the financial and operational capabilities specifically required by the clearing house. Such entities are selected by the clearing house in such a way as to be capable of fulfilling the crucial task of clearing and settlement in the capital market through the clearing house in the most appropriately. As already mentioned, clearing and settlement is the last step in finalizing the transactions carried out in the capital market. Without this last step, the market loses its credibility and integrity. CSDI is currently compiling the rules of admitting the members by the clearing house. Till then, all the brokerage firms active in Tehran Stock Exchange and the Iranian OTC exchanges are considered as clearing members. As the directs users of the services offered by the clearing house, the clearing members shall contribute to SGF and provide a deposit based on the relations representing the risks involved in their clearing activity Thus SGF is a pool of funds contributed by the clearing members (currently brokerage firms) proportionate to their clearing activities. These funds are used in case of a member's default (failure to honor the trade settlement obligation in due time which is temporarily and generally less than one day as evidenced by the historical data), in an attempt to avoid a disruption in the settlement process. By establishment of this fund, the clearing house will be able to temporarily compensate any deficit in due settlement of transactions by withdrawing the funds deposited in SGF.
The funds required by the Settlement Guarantee Fund (SGF) and the contributions of the clearing members are revised and necessary adjustments are effected on quarterly or mid-term basis at the discretion of the clearing house. The SGF's funds are determined on the basis of the credit worthiness of the clearing members during the preceding quarter so as to enable the clearing house to cover the default in a specified percentage of the cases. Due to the expertise of the clearing house, such specified percentage is determined by the clearing house. The details will be dealt with in the next section. In view of the fact that SGF is not an independent legal entity, its assets are kept in separate accounts (where the collateral deposits of each member is distinguishable). Although SGF provides liquidity for the settlement process and the contributions are preferably in cash, arrangements have been anticipated to invest the SGF's funds in the securities with guaranteed profit or in the form of bank term deposits (the interest of which will be credited to the accounts of the members proportionately and the accounts are adjusted accordingly on quarterly basis when the SGF's funds are updated) in an attempt to avoid the stagnancy of the funds. The SGF's funds are thus kept in the forms other than cash. Therefore, provisions have been made to utilize such investment as collateral to obtain cash facilities (at interest rates lower than that of the investment).
The estimation of the SGF's funds is of particular significance, because insufficient sources will render the Settlement Guarantee Fund inefficient in covering the risk due to the default of the clearing members, while the excess thereof causes the blockage of the funds of the clearing members. A careful and accurate assessment of the liability of the members and the estimation of the risks eventually led to the designing of the following formula:
SGF = Dp% x A
where (p) is the level of the services provided by the clearing house to cover the default risk, which is announced by the clearing house periodically. This value which is presented in percentage represents the readiness of the clearing house to cover the default of the clearing members under the existing circumstances. On the basis of the level of service provided by the clearing house, the funds of SGF which are sufficient to cover the default of the clearing members in p percent of the cases (Dp) is obtained from the historical data of the previous terms.
If the clearing house decides to cover the default of more than one member or the default of one member for several days in a row simultaneously, then the factor (A) is used for this purpose. Thus by affecting the factor (A) the clearing house will be in a position to cover the default of A number of day-member at a maximum liability for Dp. Once the funds required by SGF are estimated, the clearing members will contribute on the basis of a percentage of the frequency of their activity. This is obtained from the following formula:
Dp and Dip are defined in the following table. This table contains the data regarding the liability of the clearing members (currently the brokerage firms at Tehran Stock Exchange and the Iranian OTC exchanges) during a presumed quarter. For instance, the first member (broker) owes 200 units of a given currency to the clearing house in Day 1. Non-existence of a figure in the box corresponding to Day 2 means that the first broker is creditor. In the same order, the ith broker owes Dit units on the tth day.
If all the values in the foregoing table are demonstrated on an axis, the following figure is obtained: Considering a service level of 95 percent to be provided by the clearing house, the value of 500 units of a given currency is obtained. In other words, 500 units of a given currency available to SGF, it will be able to cover the probable default of the clearing members in 95 percent of the cases (net liability frequency). In this example, the variable p or the level of the clearing house's service has been set at 95 percent and Dp=500 has been obtained from the data of the previous quarter. Dip for each clearing member (each row in the table) is calculated on the mentioned basis which indicates the frequency of the clearing activity of the same member on the basis of which shall contribute to the SGF's funds. The advantage of these formulas is that the sources of SGF are determined on the basis of p% of the lowest level of the members' activity, and the clearing members contribute to SGF on proportionate to the lowest p% of their clearing activity. Consequently, the higher values that mainly concern the major transactions and have their own settlement and guarantee method are excluded from this cycle.
Various arrangements have been designed to recover the utilized funds from the defaulting members. These arrangements include cash fines, prohibiting the defaulting member from purchase transactions and legal actions initiated by the CSDI against the defaulting member.