Once you have bought or sold shares, the transaction is complete only when you have got the shares you purchased, or received money for the shares you sold. This is called settlement in stock market parlance.The stock exchanges have a complex mechanism in place to ensure that every trade is properly matched, and shares are received or delivered properly. There are basically three tasks that are performed in the process of buying and selling of securities. They are:
Trading basically deals with placing an order and its execution. Clearing deals with the determination of obligations in terms of funds and securities. Settlement means that the trade will be completed and for trades on the BSE the settlement agent is called as ‘Clearing House (CH)’ while on the NSE it is termed the ‘National Securities Clearing Corporation (NSCCL)’. In case of a shortfall of securities, an auction is called for to sort out the difference.
The clearing and settlement mechanism in the Indian securities’ market has witnessed several innovations. The stock exchanges in India were earlier following a system of account period settlement for cash market transactions and then the T+2 rolling settlement was introduced for all the securities. The members receive the funds / securities in accordance with the pay-in / pay-out schedules notified by the respective exchanges. The trades are settled irrespective of default by any member and the exchange follows up with the defaulting member subsequently for recovery of his or her dues to the exchange.
Two depositories viz., the National Securities Depositories (NSDL) and the Central Depositories Services (CDSL) provide electronic transfer of securities and more than 99 per cent of the turnover is settled in dematerialised form. The members / custodians make available the required securities in their pool accounts with depository participants (DPs) by the prescribed pay-in time for securities. The depository transfers the securities from the pool accounts of members / custodians to As per the schedule determined by the clearing agency, the securities are transferred on the pay-out day by the depository from the settlement account of the clearing agency to the pool accounts of members / custodians. The pay-in and pay-out of securities is put into effect on the same day for all settlements. Select banks have been empanelled by the clearing agencies for the electronic transfer of funds. The members are required to maintain accounts with any of these banks.
The members are informed electronically of their pay-in obligations of funds. The members make available the required funds in their accounts with clearing banks by the prescribed pay-in day. The clearing agency forwards the funds’ obligations files to the clearing banks which, in turn, debit the accounts of members and credit the account of the clearing agency. In some cases, the clearing agency runs an electronic file to debit members’ accounts with clearing banks and credit its own account. On the payout day, funds are transferred by the clearing banks from the account of the clearing agency to the accounts of members as per the members’ obligations. In the T+2 rolling settlement, the pay-in and pay-out of funds as well as securities take place within two working days after the date of trade.
WHAT ARE SETTLEMENT AGENCIES?
A clearing corporation, with the help of clearing members, custodians, clearing banks and depositories, settles the trades executed on exchanges. It performs the following tasks:
- Clears all trades.
- Determines obligations of members.
- Arranges for pay-in of funds and securities.
- Arranges for pay-out of funds and securities.
- Assumes the counter-party risk of each member and guarantees financial settlement.
- It also undertakes settlement of transactions on other stock exchanges like the, Over the Counter Exchange of India.
In India, the clearing corporation for the NSE is the NSCCL and for the BSE it is BOI Share Holding. The NSCCL, a wholly-owned subsidiary of the NSE, was incorporated in August 1995. It is responsible for the post-trade activities of the NSE. The clearing and settlement operations of the BSE are managed by a company called BOI Share Holding, which is a subsidiary of the Bank of India and the BSE and is known as a clearing house. All settlements for securities are through the clearing house on a delivery versus payment (DVP) basis.
Clearing Members :
Clearing members (CMs) are the members of the clearing houses/clearing corporations who facilitate settlement of trades done on the stock exchanges. He/she could be a broker or a custodian registered with the SEBI since he/ she is an important intermediary in the capital market and an essential link in the depository system. The CM’s main activity is to facilitate pay-in/pay-out of securities to / from stock exchanges/clearing house/ clearing corporations either on their own behalf or on behalf of their clients. The securities which are due for delivery can be delivered directly from the client’s account (depending on whether the exchange provides this facility) or through CMs to the stock exchanges / clearing house / clearing corporation account.
Similarly, pay-out of securities can be delivered directly to the client’s account on the basis of information given to a clearing house by the CM or to the CM’s account. In the capital market segment all the trading members of the exchange are the clearing members of the clearing corporation. However, please note that in the case of trades done in the future and option market, clearing members can be a separate entity as compared to trading members as the volume of trades done in this segment is huge.
Custodians : A custodian is a clearing member but not a trading member. He /she settles trades assigned to him/her by the trading members. He/she is required to confirm whether he/she is going to settle a particular trade or not.
Clearing Banks : Clearing banks act as a link between the clearing members and the NSCCL for the settlement of funds, i.e., pay-in and pay-out of funds. Every clearing member gets an account opened with a clearing bank for this purpose only. A clearing bank works on the instructions of the clearing member. A clearing member after defining the obligations in terms of funds informs the clearing bank about the obligations to be fulfilled. The clearing bank makes the funds available required on the pay-out day to meet the obligations on time.
Depositories : The earlier settlement system followed by the Indian stock exchanges was very inefficient as it was unable to take care of the transfer of securities in a speedy manner. Since the securities were in the form of physical certificates their quick movement was again difficult. This led to settlement delays, theft, forgery, mutilation and bad deliveries and also to added costs. To wipe out these problems, the Depositories Act 1996 was passed. It was formed with the purpose of ensuring free transferability of securities with speed, accuracy and security. It has been able to do so by:
- Making securities of public limited companies freely transferable, subject to certain exceptions.
- Dematerialising the securities in the depository mode.
- Providing for maintenance of ownership records in a book entry form.
At present, in India, there are two depositories viz., the National Securities Depository (NSDL) and the Central Depository Services (India) (CDSL) which are registered with the SEBI. A clearing member /custodian opens a securities pool account (demat) with a depository participant of these depositories to make the securities available in the account on the settlement day. As per the instructions, the depository transfers the securities electronically.
National Securities Depository (NSDL) NSDL, the first and the largest depository in India, was established in August 1996. NSDL has been promoted by the Industrial Development Bank of India (IDBI), Unit Trust of India (UTI) and National Stock Exchange of India (NSE). As on January 18, 2010, they have crossed 1 crore active investor accounts.
Central Depository Services (I) (CDSL) : CDSL has been promoted by the Bombay Stock Exchange and the Bank of India. It was formed in February 1999. Both the depositories have a network of depository participants (DPs) which are further electronically connected to their clients. So, DPs act as a link between the depositories and the clients. CDSL was promoted by the Bombay Stock Exchange (BSE) jointly with leading banks such as the State Bank of India, Bank of India, Bank of Baroda, HDFC Bank, Standard Chartered Bank, Union Bank of India, Bank of Maharashtra, Canara DS Bank & The Calcutta Stock Exchange.