Clearing and Trade Settlement Process in Indian Stock Market

Buyers and sellers are the two main participants involved in the securities market. To buy/sell shares or other securities, both parties need to have a Demat account with a regulated broker registered under the Securities and Exchange Board of India (SEBI).

Also, for any trade to settle in the stock market, a buyer must have a seller ready to sell shares. Likewise, a seller needs a buyer prepared to buy shares.

The stock exchange is responsible for matching the best buy order with the best sell order. Stock exchanges use an electronic matching system to find buyers and sellers. After the two entities get paired, the securities and funds are verified by clearing corporations and credited to the respective accounts of buyers and sellers. It is known as the clearing and settlement process.

How does the Clearing and Trade Settlement Process work?

The clearing and settlement process is a three-step process that takes into account trade executions, order confirmations of buyers and sellers, and stock exchange transfers like mutual funds.

The entire clearing and settlement process emphasizes that buyers receive their securities on time and sellers receive their funds on time. Both the buyer and the seller can safely buy and sell securities such as mutual funds or shares and settle trades in the Indian stock market, thanks to the clearing members and market regulators.

Trade execution

Anyone who wants to place a buy/sell order in the stock market must have a Demat account. Once your trading account is open, you are ready to place an order. Trade execution refers to the day when you buy or sell stocks. The day when you execute your trade is known as T day.

After buyers and sellers place orders, stock exchanges match the best buy order with the best sell order and vice versa.

Clearing

Although buyers and sellers execute their trades on the T day, neither buyers nor sellers receive shares or funds into their accounts instantly. Instead, it takes time to verify and settle the order – a task for which clearing members are responsible.

In the clearing process, the clearing house entities such as depositories, a clearing firm, clearing banks and corporations, members & custodians—confirm funds and securities from both ends and initiate transactions.

Here, the account of both the traders is updated. The clearing process involves multiple transactions and takes place on T+1 days.

Settlement

Settlement is the final step where securities get transferred from the seller’s Demat account and credited into the trading account of the individual who bought them. And the funds get transacted from the buyer’s trading account to the Demat account of the person who sold securities.

Even though T day is when the actual transaction happened, the final settlement gets completed after T+2 days.

The final transaction is now quicker than it used to be when trading used in the physical format. Back then, it used to take five days to settle the trade. But since the computerization, the settlement period for securities in the Indian stock market has been reduced to T+2 days.

To fully comprehend what the clearing and settlement process looks like, let’s discuss the two scenarios in detail.

T day: the day you execute your order

Suppose you decide to buy ten stocks of Tata Steel at 1240 on a Friday. Thus, the total amount you spent buying these stocks adds to INR 12,400. However, when you execute this order, you also have to pay charged additional charges applied by your broker along with INR 12,400.

These charges may include security transaction charges, transaction charges, GST, SEBI, and other charges as per your broker.

The total amount will get deducted from your Demat account once you place this order. However, your trading account will not reflect the purchased stocks yet. But you will receive a copy of a contract note, a legal agreement of the trade, which will contain information regarding your order and all the break-up charges.

Please Note: Traders should save all the related documents carefully for future reference.

T+1 day: the next day after you place your order.

Because you executed your trade on Friday, the T+1 day will be two days after because weekends do not come under the successive settlement process. Therefore, on T+1 day, i.e., Monday, the stock exchange receives the money and additional charges.

Although the stocks you bought do not show in your account yet, you owe the right to sell them. It is called “Buy Today, Sell Tomorrow.” Some also refer to this selling as “Acquire Today, Sell Tomorrow.” It is a risky move, and you should avoid doing it because you intend to sell stocks that you do not owe yet.

So, traders should avoid selling stocks on T+1 days, especially if they are trading illiquid stocks.

T+2: The day when the trade settles

The second day after T day is T+2 day (Tuesday). On this day, the actual exchange takes place. Ten shares of Tata Steel will get credited into the buyer’s Demat account. The collected money will be reflected in the broker’s account and transferred into the seller’s Demat account.

The buyer’s account will reflect shares on T+2 day, indicating that you own those ten shares. Overall, the trade is settled in three days, although the money gets debited from your account the day you place your order.

Day T: the day when you sell your shares

Suppose you want to sell ten shares of Tata steel @1240. The day you sell your shares is the T day. After selling your shares, your broker will immediately block access to them. But no money will be credited into your trading account.

Day T+1: the day broker gives shares to the stock exchange

T+1 is the next day after you place you execute your seller order. On this day, the broker hands over the shares to the stock exchange, verifying the money that needs to be credited into the seller account. At the same time, the stock exchange also verifies the buyer from whose account the money will be debited. This again is completed with the help of an electronic matching system. Before that, however, it used to take five days to settle a trade because of heavy paperwork.

Day T+2: The day you receive your funds (minus the deductions)

On the T+2 day, the money is transferred from the buyer’s account and credited into your broker’s, which will credit into your account. It involves other charges. Sellers receive their funds after all the deductions have been removed.

Rolling settlement and cycle

Rolling settlement is a type of trade settlement in which a trade is settled in consecutive days. The period of settlement is T+2 days. The purpose of rolling settlement is to credit the account of buyers and sellers quickly rather than waiting for a specific date or day.

For instance, if you purchase a stock on 1st January, then by 3rd January, your trade will get settled. Earlier, NSE followed the weekly settlement process, and all securities were processed on Thursdays.

However, the rolling settlement doesn’t count government holidays, weekends, and bank & stock exchange holidays in the settlement process. So, for instance, if you purchase stocks on 4th January, Friday, then you would receive them on Tuesday.

The majority of stocks settle on a rolling basis on the second business day following their execution (T+2).

Market Timings for Clearing and Settlement

T (Trade Execution )

9:15 a.m to 3:30 p.m: Buy/sell stocks or securities.

T+1( confirmation and clearing of trades)

By 11 a.m: Confirmation of all traders.

By 1:30 p.m: Processing of files to brokers, custodians, and other clearing members

T+2 (Final credits)

By 11 a.m: Pay-in of securities and funds.

By 1:30 p.m: Pay-outs of securities and funds.

Settlement Cycle on the NSE

The National Stock Exchange follows a T+2 day rolling settlement. However, other activities take place beyond T+2, which are listed below.

Rolling Settlement Trading: T
Clearing and delivery generation: T+1
Settlement of Securities And Funds, i.e., Pay-In And Pay-Out: T+2
Post Settlement Auction: T+2
Auction Settlement: T+3
Reporting For Bad Deliveries: T+4
Pay-In-Pay-Out Of Rectified Bad Deliveries: T+6
Re-Reporting Of Bad Deliveries: T+8
Terminating Of Re-Bad Deliveries and funds pay-in & pay-out: T+9

Overview of Stock Market Participants in the Process

To guarantee the settlement process, National Securities Clearing Corporation Limited (NSCCL) NSCCL acts as a subsidiary Of NSE. The main objective of this body is to bring and sustain confidence in the clearing and settlement of securities. NSCCL also fosters and facilitates short, consistent settlement cycles.

The Role of NSCCL

Clearing of all trades
Assigning obligations to members
Fixing pay-in of securities and funds
Fixing pay-out for securities and funds
Checking each member’s counterparty risk and ensuring financial settlement.
Transaction settlements on the alternative stock market exchanges

NSCCL is partnered with other agencies like depositaries, custodians, professional clearing members, and clearing banks to clear and settle trades. Here’s a gist of the functions of each of these agencies.

Depository

Depositories act as special organisations that facilitate the electronic transfer of securities in a dematerialised format. Depositories hold securities and ensure easy transfer through a book entry rather than files or certificates. As a bank holds funds for you, a depository holds securities for you.

It is not your task to open an account with a depository. Instead, depository participants, which are depositories’ agents, undertake this function. National Securities Depository Limited (NSDL) and Central Depositories Services Limited (CDSL) are the two depositories operating in India.

Professional Clearing Members

Professional clearing members (PCMs) are banks, custodians, etc., which clear and settle trades executed for their clients. They don’t trade for them. Their functions may resemble that of custodians.

Clearing Banks

The primary purpose of a clearing bank is to complete pay-ins and pay-outs. They act as a link between the clearing members and the NSCCL. To complete the settlement of funds, each clearing member opens an account with the clearing bank.

A clearing member instructs the clearing banks regarding the terms of funds. It is also the job of the clearing bank to provide funds on the pay-out day.

Custodians

The job of custodians is to keep securities safe. Custodians hold the documentary proof of securities and their ownership. In NSCCL, a custodian acts only as a clearing member, not a trading member. However, without the permission of NSCCL, a custodian can’t settle trades. Custodians include banks, large corporations, and foreign investors.

How are trades cleared and settled?

On the T day, the stock exchanges collect all the trade information and transfer it to the clearing corporation. Further, the corporation tells the details about the trade to clearing members and custodians. Finally, such a clearing firm can accept or reject to settle the order.

If approved, the clearing firm sends a list of obligations to the clearing banks and other members. After all clearing members receive details and obligations, they follow as per their roles.

Clearing banks ensures the availability of funds, and depositories ensure the availability of securities. For easy transfer of securities and funds, the clearing member or the buyer’s broker opens a clearing pool account and transfers the respective amount into the clearing bank.

The clearing member/broker of the seller opens a depository pool account and therein deposits the respective shares. The transfer of the funds takes place from the buyer’s clearing bank to the seller’s clearing bank.

The transfer of shares takes place from the seller’s depository pool account to the buyer’s depository pool account. Eventually, the amount is credited into the seller’s Demat account, and the shares are distributed to the buyer’s Demat account.

Clearing Corporation

A clearinghouse/corporation is a financial institution that acts as an intermediary between buyers and sellers. Its goal is to run things smoothly, from buyers receiving their securities to sellers receiving their funds. It keeps up the interests of both parties in check. The top clearing houses in India are:

Indian Clearing Corporation
Indian International Clearing Corporation (IFSC) Limited
Metropolitan Clearing Corporation of India Limited
National Commodity Clearing Corporation Limited
Multi Commodity Exchange Clearing Corporation Limited
NSE IFSC Clearing Corporation Limited
National Securities Clearing Corporation Limited (NSCCL)

Conclusion

Although the settlement process occurs in the back-end, you should know the behind process as an investor or trader. A clearing and settlement process takes T+3 days to reflect shares or funds into your trading account.

With the help of a clearing firm & other clearinghouse members, NSE ensures that the clearing and settlement process runs smoothly. There are multiple ways SEBI ensures that trades get settled.

Recently, many market participants requested to change the trade settlement cycle to T+1 day, which means the settlement process will take two days to complete.

SEBI decided to consider this newly purposed settlement period and has discussed the matter with institutions such as stock exchanges, clearing firms, and depositors. However, many market participants have questioned the impact on settlement operation. At the same time, market players believe the new cycle will market the market more efficiently and guard investors’ interest. For any of that, you have to wait and find out.

Disclaimer: Please read all the investment-related documents carefully before investing in securities.