Custody-Only Trading

What Is Custody-Only Trading?

Custody-only trading is a system wherein shares must be registered to the holder by name (and not that of an owner's broker or custodian) and must be traded in physical form (e.g., paper stock certificates).

The adoption of custody-only trading requires any purchase or transfer of stock to be put through the responsible company's transfer agent. The transfer agent cancels the shares received from the seller and issues another share certificate for an equivalent number of shares to the buyer. While custody-only trading is a bulky cycle, a few companies carry out it to counter "naked" short selling.

Understanding Custody-Only Trading

While conventional short selling includes the sale of borrowed stock, "naked" short selling alludes to short sales by traders who have no expectation of borrowing and afterward selling the stock. Rather, they essentially resort to short selling without borrowing the stock or guaranteeing that it very well may be borrowed, thereby driving down the price of the stock sharply. Since custody-only trading requires purchase and sales of physical shares only, there is no stock for short-sellers to borrow or profess to borrow, thereby putting naked shorting down. In 2008, the SEC restricted "harmful" naked short selling in the United States.

For certain types of investors, similar to a hedge fund or a buy-and-hold investor, they might like to hold investment securities that are not subject to the speculative expectations of short-sellers. Custody-only seems OK since it restricts examiners from driving security prices around inconsistently with naked short sales.

In reality however, naked shorting is certainly not a major problem on by far most of listed stocks. In spite of the fact that, it very well might be even more a problem for stocks that trade over-the-counter (OTC) or aren't listed on a major exchange. These are commonly small companies or penny stocks that are now exceptionally speculative in nature.

Drawbacks of Custody-Only Trading

The greatest drawback of custody-only trading is that it theoretically forfeits some level of liquidity and productivity. It takes more work to buy and sell shares. Investors with a specific strategy might find this downside is compensated for by the denial against naked short selling.

Another issue emerges in light of the fact that custody-only securities are not eligible for Depository Trust Company (DTC) nominee registration or for DTC book-entry services. Be that as it may, DTC considers the deposit of securities under various techniques; these apply to particular asset classes, for example, client registered custodial assets, restricted shares, private positions, and limited partnership interests.

The Depository Trust Company (DTC) is the world's biggest securities depository. Established in 1973, it is a trust company that gives safekeeping through electronic recordkeeping of securities balances. It likewise acts as a clearinghouse to process and settle trades in corporate and municipal securities.

Illustration of Custody Only Trading

In a commonplace stock transaction made through an online brokerage account, the transaction is dealt with electronically. Share certificates can be mentioned, at a cost, yet are not consequently given to the stock buyer. All things being equal, the ownership of the shares is followed and recorded electronically by the DTC.

At the point when somebody purchases custody-only shares, which are definitely more uncommon than shares that can be traded electronically, share certificates are produced in the buyer's name. The share certificates that were in the seller's name are canceled.

On the off chance that the owner of the shares wishes to sell them, they must contact the transfer agent who will work with the creation of new share certificates in the new owner's name, and cancel the prior owner's certificates.

Features

• Custody-only trading curbs naked short-selling, yet this comes to the detriment of liquidity and proficiency since it requires more work and investment to buy or sell shares.
• Custody-only trading happens when shares are traded in physical form and in a registered owner's own name.
• At the point when shares are purchased, a stock certificate is made with the owner's name. At the point when shares are sold to another buyer, the former stock certificates are canceled and new ones are issued to the buyer.