In this article, you will learn everything about stock clearing & settlement process.
Understand in detail about the stock clearing process & settlement process, types of settlement process, entities involved in the entire process & more.
About Stock Clearing & Settlement
When you purchase or sell stocks, the trading process happens online. If you are working on purchase transactions, then money will be debited from your account and you will get the shares.
For sale transactions, shares have to be taken from the Demat account and the selling price is credited back to the bank account.
The process is not quick and to make sure there is minimal risk for the trader, the regulators have come up with a trading cycle.
This cycle is called the Stock Clearing and Settlement process. This article discusses the basics of clearing and settlement.
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Stock Clearing Process
In the stock market, the investment process takes place in three steps, namely – Trading, Clearing, and Settlement. The clearing is a process through which the financial transactions are settled.
Bilateral clearing facilitates all the legal steps to guarantee a successful transaction for the parties involved in the transaction to follow.
A third-party is present in the central clearing process. The third party is what we call the clearing house.
When buyers and sellers carry out the trade, they take the front seat. The third-party acts as the middleman between the buyers and the sellers.
They agree and make the transaction transparent. It is their responsibility to ensure that all the concerned parties uphold their contractual obligation.
They abide by strict compliance with all trade legislation and exchange commitments.
Clearing houses aggregate the transactions of each of their members and calculate the transactions of transferable securities for the trading day.
The trades which do not undergo this process can have serious settlement risks.
Governments around the world are now encouraging, or even demanding, central clearing so that they can assess the systemic risk that their financial institutions are placing on economies, especially in the trading of derivatives.
The best means of holding records so that the financial risks to the economy can be properly measured is Central clearing.
In the stock market, investors play the position of buyers as well as sellers. They work on buying or selling their shares.
A settlement is a term applicable for exchange of payment to the seller and securities being transferred to the buyer in a trade.
It is considered as the final step in the life cycle of Security Transaction.
A rolling settlement interval of T+2 is what the Indian stock market follows. It is a process of setting the security trades on a successive period based on a particular date.
This date is when the original trade is made, i.e. the one happening today will have a settlement date after one business day.
It is a two-way mechanism that is the final step of every transaction. The process is complete after this method.
The settlement is complete once the buyer receives their share while the seller receives his credit by the end of T+2 day.
The broker deals with the transfer process here too. While the official agreement starts on the day of exchange, all the final ownership for the transfer takes place on that day.
A total of five days is a must when this procedure is in physical format. This makes the settlement date T+5, but it is T+2 since the digital age.
On the spot settlement is the form of settlement where the funds are exchanged immediately and the usual T+2 is the pattern followed.
Thus, the transaction which took place on Wednesday will be settled by Friday that is by the second working day.
There is one more settlement that is referred to as the forward settlement where the two parties concerned, decide on the day the settlement must take place.
It can be T+5 or t+9 and so on.
Entities involved in Stock Clearing and Settlement Process
There are different items involved in this whole process of clearance and settlement.
Initially, shares were kept in a physical certificate format, but in the post computerized period, they are stored in electronic form.
The purchasing and sale of shares include a Demat account where the shares are stored. Hence, it is also necessary to have a Demat account.
SEBI has come up with a different framework to ensure a good output and optimize its authority over Demat accounts by building depositories.
The depository is very helpful for an investor if they want to purchase or sell securities.
National Securities Depository Limited (NSDL) and Central Depository Services Limited (CDSL) are the two depositories in India.
Clearing Corporation receives the funding and securities from the clearing banks and depositories for the transactions and trading accordingly.
There is a professional clearing member appointed by the NSCCL. Even though they are restricted to trade, they have the authority to clear and settle the trades.
The clearing corporation is designed to manage the confirmation, settlement, and distribution of shares.
Their function is central to this entire process. If two investors agree to carry out a transaction, they ease the entire buying and selling process.
It is their responsibility to ensure that the settlement cycles do not prolong. It also ensures the transaction attracts no significant threats and risks further.
They participate at every stage and act as a protective shield for all the secondary market transactions with effective risk management systems.
The clearing corporation ensures that their task is completed by passing each trade to a clearing member or custodian.
Their main obligation is to make sure that all the funds and shares are available on the day of T+2. They clear the trade by ensuring pay-in and pay-outs of securities and funds to the clearing banks.
They are responsible for the safety of customers’ assets. On behalf of other trading participants, they settle trades.
A trading member may delegate a specific trade for settlement to a custodian. The custodian settles the transaction further.
Then there are the clearing banks. Here, the transfer and movement of money happen.
SEBI has established a list of 13 designated clearing banks that aid in the settlement of funds. Each clearing member must make sure that they have a clearing account in any one of these banks.
Some of these banks include the HDFC bank, ICICI bank, Axis bank, Stock holding and Corporation of India Ltd, and State bank of India.
Stock Clearing – Conclusion
This article discusses the basics of clearing and settlement process in stock markets and if you are an investor, you need to have an insight over this process to get a grip on the execution and settlement of trade.
This process must be in sync to make sure the stock market functions happen smoothly.
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