Trade Clearing and Settlement in Stock Markets

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Clearing and settlement is a post trade activity.

Clearing Agencies ensure trading members meet their fund/security obligations. It acts as a legal counter party to all trades and guarantees settlement for all members. The original trade between the two parties is cancelled and clearing corporation acts as counter party to both the parties, thus manages risk and guarantees settlement to both the parties. This process is called novation.

It determines fund/security obligations and arranges for pay-in of the same. It collects and maintains margins, processes for shortages in funds and securities. It takes help of clearing members, clearing banks, custodians and depositories to settle the trades.

The settlement cycle in India is T+2 days i.e. Trade + 2 days. T+2 means the transactions done on the Trade day, will be settled by exchange of money and securities on the second business day (excluding Saturday, Sundays, Bank and Exchange Trading Holidays). Pay-in and Pay-out for securities settlement is done on a T+2 basis.

The following is the summary of trading and settlement process in India.

Investors place orders from their trading terminals.
Broker houses validate the orders and routes them to the exchange (BSE or NSE depending on the client’s choice)
Order matching at the exchange.
Trade confirmation to the investors through the brokers.
Trade details are sent to Clearing Corporation from the Exchange.
Clearing Corporation notifies the trade details to clearing Members/Custodians who confirm back. Based on the confirmation, Clearing Corporation determines obligations.
Download of obligation and pay-in advice of funds/securities by Clearing Corporation.
Clearing Corporation gives instructions to clearing banks to make funds available by pay-in time.
Clearing Corporation gives instructions to depositories to make securities available by pay-in-time.
Pay-in of securities: Clearing Corporation advises depository to debit pool account of custodians/Clearing members and credit its (Clearing Corporation’s) account and depository does the same.
Pay-in of funds: Clearing Corporation advises Clearing Banks to debit account of Custodians/Clearing members and credit its account and clearing bank does the same.
Payout of securities: Clearing Corporation advises depository to credit pool accounts of custodians/Clearing members and debit its account and depository does the same.
Payout of funds: Clearing Corporation advises Clearing Banks to credit account of custodians/ Clearing members and debit its account and clearing bank does the same. Note: Clearing members for buy order and sell order are different and Clearing Corporation acts as a link here.
Depository informs custodians/Clearing members through Depository Participants about pay-in and pay-out of securities.
Clearing Banks inform custodians/Clearing members about pay-in and pay-out of funds.
In case of buy order by normal investors Clearing members instruct his DP to credit the client’s account and debit its account. The money will be debited (Total settled amount – margins paid at the time of trade) from the client’s account.
In case of sell order by normal investors Clearing members instruct his DP to debit the client’s account and credit its account. The money will be credited to the client’s account.

In case of trades by mutual fund houses the custodians act as clearing members.

Please note that a clearing member is the brokerage firm which acts as a trading member and clearing member of clearing agency where as custodians are only clearing members. Even if the clients don’t meet their obligations clearing members are required to meet their obligations to the clearing corporations.

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Sathish Emmadi

Sathish Emmadi is a co-founder & editor at Lastbull.com. He is presently working in IT for one of the world’s top mutual fund companies. Handled multiple projects in BFSI (Banking,Financial Services and Insurance) domain. An Engineering Graduate from NITW.