The Indian stock market trades go through a life cycle, which is a three-step process:
What is trading? When a trader/investor purchases or sells a share in the stock market, it creates a legally binding agreement between the trader and exchange to transfer the ownership of the share against the price agreed on in the trading system.
What is clearing in the stock market? It is the process to ensure the smooth transfer of ownership and money to the respective parties. The process consists of posting sufficient margin and proper recording of the transactions to ensure the transfer of the ownership title.
What is a settlement in the stock market? The final step in the life cycle of exchange-traded securities is where the buyer receives the shares in their Demat account and the seller gets the agreed-upon money in their account.
Parties to clearing and settlement:
Investor/Trader: Investors/traders are the primary participants of the stock market. A buyer identifies the stocks to buy today and initiates contact with the trader. These stocks that a buyer wishes to purchase are owned by someone who wishes to sell the same. Both buyer and seller execute their trade at a price on the exchange, and henceforth the clearing and settlement process starts.
Broker: A broker facilitates the buying and selling activities for the clients by acting as their agent with the depository and the exchange. The broker ensures the flow of funds from the client to exchange and the share title to the client in return.
Exchange: A stock exchange is a platform where all the trading activity takes place. The exchange is a facilitator for maintaining a counterparty risk-free environment of transaction and acts as a buyer to the seller and as a seller to the buyer.
Depository: National Securities Depository Limited (NSDL) and Central Depository Services Limited (CDSL) are the two depositories in India. They hold the trading participant’s shares in dematerialized form. All the ownership records of securities are stored with depositories.
Clearer: When a buyer/seller initiates a transaction, there is a legally binding agreement created between the trader and the exchange. Clearer is the entity that performs confirmation, settlement, and delivery of shares on the exchange’s behalf. This ensures a counterparty risk mitigation and efficient handling of the trade life cycle.
Clearing banks: The banks identified by respective exchanges and approved by the Securities and Exchange Board of India (SEBI) are known as clearing banks. All the clearing members need to have an account with such clearing banks. Clearing banks ensure proper settlement of the monetary part of the transactions; all the clearing members are required to maintain sufficient funding to fulfill their financial obligation against the transaction.
Custodian or clearing agents: Custodians hold a pooled clearing account with a depository. They are kept apprised with all the trading activity and transactions. The main purpose of the custodian is to ensure the availability of shares and funds for final settlement on T+2 days.
Settlement procedure in the stock market
There is a fixed timeline for settlement, which depends on the instruments that are traded. The settlement cycle of the Indian stock market is as follows:
T+2 Settlement: For all equity transactions, the T+2 settlement cycle is followed.
T+1: Derivatives/Currency/Commodities use the T+1 Settlement cycle to fulfill the mark to the market requirement of the respective exchanges.
Only exchange working days are used for the purpose of the settlement cycle.
Types of settlement:
Normal Settlement/ Spot Settlement: Based on the rolling settlement, trades are settled on the T+2 method on the settlement cycle.
Forward Settlement: When trades are settled between the parties at an agreed later date.
What is Rolling Settlement? Rolling settlement is the process where trades are settled after a predefined number of days of trade execution. In Indian stock exchanges, all transactions are settled on a T+2 rolling settlement cycle. It means that net open positions of the transaction’s day will be settled after two business days.
| Day | Activity | NSE | BSE |
| T | Rolling Settlement Trading | Transaction | Transaction |
| T+1 | Clearing | Confirmation by Custodians | Confirmation by Custodians |
| T+2 | Settlement | Pay in and payout of shares and funds.
Auction |
Pay in and payout of Shares and funds. |
| T+3 | Post Settlement | Auction pay in and payout | Auction pay in and payout |
| T+4 | Bad delivery reporting | ||
| T+6 | Bad delivery pay in and payout | ||
| T+8 | Bad delivery reporting of T+6 | ||
| T+9 | Closing of bad deliveries |
Auction: On T+2-day, exchange matches pay in securities and any shortage in the same is managed through an auction. The buyer has the rightful title of the shares, and they get the acquisition through an auction if there are any shortages.
Bad deliveries: Indian stock exchanges have clearly defined regulations and compliances. A bad delivery is when the transfer of shares to the acquirer fails due to some nonconformity in compliance.
Clearing and settlement process
- Trade-in initiated by buyer and seller respectively at their ends
- Exchange updates all the transaction details to be clearer on the same date
- Clearer sends the details of the transaction to clearing agents and custodians for confirmations
- Clearer determines the obligations of both clearing agents and custodians and informs them to fulfill their contract in terms of shares and funds
- Clearer sends the details of the transactions to clearing agents and custodians for confirmations
- Clearer determines the obligations of both clearing agents and custodians and informs them to fulfill their contract in terms of shares and funds
- Transfer of funds from clearing bank and transfer of shares to depository pool account happens and all the exchange charges are debited. On this day, trade activity is regarded as cleared for final settlement
- On T+2 day, the buyer gets the share in their demat account and the seller gets the credit of funds. In case of any differences, the exchange performs its shortage handling mechanism
Importance of settlement
For the smooth functioning of the stock market, efficiently working clearing and settlement mechanisms are imperative. Normally, an investor or trader doing any trade activity has no idea of the intricacies involved in the overall process of settling the trades. An effective settlement system ensures the faith of market participants in the stock market.
