In the stock market, there is always a buyer and a seller. So, when a person buys a certain number of shares, there is another trader who sells the shares. This trade is settled only when the buyer receives the shares and the seller receives the money.
Let’s see in detail how the process takes place
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There are three phases in a secondary market transaction:
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In the stock market, a large number of trades occur simultaneously. The stock exchanges use an electronic order matching system to match ‘buy’ and ‘sell’ orders from different traders. This way, each trade is executed.
For instance, imagine that stock ‘X’ is trading in the stock market.[sc name=”new” ][/sc]
The buy and sell orders for this stock are as follows:
Here the costliest buy prices are matched against the cheapest available sell prices, and whenever the buy price is less than or equal to the best available sell price a match is done. This of course also depends on the respective quantities available in the market across buys and sells and is known as market depth.
So even if a particular price may result in a match, if there is not enough quantity available at the seller side at that price, the buy order will still not be fully traded.
The market depth is created by brokerages who collect orders from different investors and pass it on to the stock exchanges, most likely to be the two most popular exchanges in India — the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE). In this process, brokerages act as the intermediary between the investor and the stock exchange.
Once two orders match and a trade is executed, the clearing process takes place. Clearing is the identification of what security is owed to the buyer and how much money is owed to the seller. The entire process is managed by ‘clearing houses’. These are independent entities.[sc name=”ads1″ ][/sc]
For example, imagine that there are two traders: Ramesh and Suresh.
However, in the real market scenario, traders tend to conduct multiple transactions. As a result, the clearing house identifies all the transactions and the net amount or net securities owed to the trader are calculated.
The next step is to fulfil the financial obligations identified in the clearing step. This involves the transaction settlement for the buyers and sellers.
So once the buyer receives the security and the seller receives the payment, the transaction is settled.
Types of settlements in the stock market[sc name=”ads2″ ][/sc]
There are two types of settlements in equity investment that you will come across and they are as follows –
- Spot settlement
This type of settlement is carried out immediately following the rolling settlement principle of T+2.
- Forward settlement
This settlement is applicable when you agree to settle the trade later at a future date which could be T+5 or T+7.
What is rolling settlement?
A rolling settlement is one in which the trade is settled in the days following the trade. Trades are settled in T+2 days with this sort of settlement, which indicates that deals are closed after the second working day. Sunday, Saturday, Bank holidays, and exchange holidays are not included in this time frame. So, if a trade is made on a Tuesday, it will be closed on a Thursday. Similarly, if you buy a stock on Friday, you must pay the broker that day, but the shares will be deposited in your account the following Tuesday. You become the shareholder of record on the day that your trades are settled.[sc name=”ads2″ ][/sc]
For dividend-seeking investors, the equity settlement day is important. If the buyer wants to collect a dividend from the company, he must settle the trade for a profit before the record date.
Rolling settlement rules in BSE
- In the Bombay Stock Exchange (BSE), the shares are all settled in T+2 days.
- Government securities and fixed income securities for retail investors are also closed in T+2 days.
- Pay-in and pay-out when you buy or sell securities are executed on the same day of the trade.
- The securities are deposited by the client within one working day after the BSE completes the pay-out of the funds and securities.
Settlement cycle on the NSE[sc name=”new” ][/sc]
The cycle for rolling equity settlements on the National Stock Exchange (NSE) is as follows:
|Rolling Settlement Trading||T|
|Clearing Including Custodial Confirmation and Delivery Generation||T+1|
|Settlement Through Securities and Funds Pay-In and Pay-Out||T+2|
|Post Settlement Auction||T+2|
|Reporting for Bad Deliveries||T+4|
|Pay-In-Pay-Out of Rectified Bad Deliveries||T+6|
|Re-Reporting of Bad Deliveries||T+8|
|Closing of Re-Bad Deliveries||T+9|
Participants Involved in the Process
- Clearing Corporation
Clearing corporation is one of the major participants involved in clearing and settlement process in stock market. The responsibility for clearing and settlement of trade executed at the stock exchange lies on the National Securities Clearing Corporation Limited (NSCCL). It is also in charge of risk management and is obligated for meeting all settlement regardless of the member defaults.
- Clearing Members/Custodians
They are another participant in the clearing and settlement process in Indian stock market. When trading members place deals in the stock exchange, the same is moved to NSCCL, which transfers them to the clearing members. The clearing member is in charge of determining the position of share to suit the trade.
- Clearing banks
Clearing banks are responsible for the settlement of funds. There are 13 clearing banks, and each clearing member needs to open a clearing account with either one of them. In case of a pay-out, clearing members receive funds in the clearing account and in case of pay-in they need to make funds available.
There are two depositories in India – National Securities Depository Limited (NSDL) and Central Depository Services Limited (CDSL). These two depositories hold your Demat account, and clearing members also need to maintain a clearing pool account with them.
Clearing members need to transfer the securities to the clearing pool account they hold with the depositories on the date of settlement.
- Professional Clearing Members
These are special category members appointed by the NSCCL. However, note that they are not allowed to trade, and they can only clear and settle trades executed for their clients. Professional clearing members generally constitute banks, custodians and so on.
How Trades are Cleared and Settled in the Stock Market?
- The stock exchange transfers the details of every trade to the clearing corporation on the T day when trade is executed
- The clearing corporation confirms with the clearing members before they close the trade. Once they receive confirmation, they determine the obligations of the clearing member
- After the details are confirmed the clearing banks must have sufficient funds, and depositories should make the shares available
- The clearing corporations get funds and securities from clearing banks and depositories for purchase and sale transactions respectively.
- In the case of the purchase transaction, the clearing member receives securities and in the case of sale transaction, the clearing member receives money in the clearing account.
A Diagram for Clearing & Settlement Process
A trade in the stock market takes place in an instant. But for that to happen smoothly and efficiently, all these processes take place in the background. And knowing the whole process may help you understand how the stock market works better.