Have you ever wondered what happens behind the scenes after you place a buy or sell order for stocks? The process that facilitates the transfer of shares and funds between the involved parties is called trade settlement.
Understanding this mechanism can help investors better grasp the timeline and parties involved in completing a transaction.
Read on as we break down the types of settlements, the settlement cycle, the roles of clearing corporations and members, and more.
What is a trade settlement?
Trade settlement is the last step in the trading and settlement process that starts with selecting a broker or sub-broker.
Whether on the stock exchange or the secondary market, a transaction has two sides (buyer and seller). A trade goes through clearing and settlement following this transaction.
Once both parties have received the securities and the payment, the transaction is finalised. The settlement date is when the final ownership transfer happens, whereas the transaction day is when the official transaction happens.
So, in simple terms, the securities trading and settlement process means transferring securities into a buyer’s account and funds into a seller’s account after trading shares, bonds, futures contracts, or any other securities.
What is a rolling settlement?
Rolling settlement runs on a T+2 settlement cycle (meaning trade day plus two days), specifically on a rolling basis. It refers to the exchange of funds and securities within two business days of the trading date.
Types of trade settlement
- Spot settlement: A spot settlement is a type of trade settlement that takes place almost immediately after the execution of a trade.
- Forward settlement: This settlement is used for trades settled later, say T+5 or T+7.
What is the trade settlement cycle and settlement date?
The day the ownership of the security eventually passes is known as the settlement date.
Typically, T+2 is the date of settlement in the Indian financial markets. The letter ‘T’ represents the transaction date, which is static and never changes. The date of the final settlement is not always specific. In most cases, T+2 is the settlement day.
A settlement cycle, on the other hand, is the time a trade needs to finish the settlement process to meet the contract’s terms. When it comes to equity, the settlement cycle is T+2. In contrast, derivatives have a settlement cycle of T+1.
However, this cycle does not include weekends, holidays, and NSE and BSE holidays.
Parties involved in the trade settlement process
- Clearing corporation
The National Securities Clearing Corporation Limited (NSCCL) oversees the clearing and settlement of stock market transactions. Furthermore, it handles risk management and pays for settlements regardless of whether a member is in default.
- Clearing member
Trading members deliver their transactions to NSCCL, which transfers them to the clearing members. After the transaction is done, the clearing member chooses the optimal share position to go with it. Share positions are the number of shares a trader or investor holds in a specific stock or portfolio.
- Clearing banks
Clearing banks are in charge of settling money. In the case of a pay-out, clearing members receive cash in the clearing account; when it comes to a pay-in, they are required to make funds accessible.
- Professional clearing members
These people are part of the specialised group at NSCCL. They are not allowed to trade themselves, so their function is restricted to clearing and settling transactions on behalf of their customers. Professional clearing members often include financial institutions like banks and custodians.
Trade confirmation and settlement process in the Indian stock market
- The stock exchange notifies the clearing company of all transactions on the T-day after completion.
- The clearing members check with the clearing company before the transaction is closed. Upon getting confirmation, they determine the responsibilities of the clearing member.
- After the details are confirmed, the depositories release the shares, and clearing companies must have sufficient funds.
- For buying and selling transactions, clearing companies receive funds and assets from depositories and clearing banks.
- After a buy, the clearing member gets the corresponding securities. After a sale, they get the money in the clearing account.
Understanding settlement violations
A settlement violation happens when an investor’s account does not have enough settled funds to pay the trade, even if the purchase has been finalised.
In that case, the broker may sell the asset and the investor is penalised for any loss that may take place if the security’s market value drops. Moreover, in some cases, the broker may also charge a fee for a settlement violation.
Conclusion
In conclusion, trade settlement ensures the smooth completion of buy and sell orders. Knowing the settlement process can help investors set the right expectations and avoid violations.
FAQs
A bad delivery is a situation where a seller fails to deliver the shares on the settlement day due to reasons such as a mismatch of signatures, physical damage, or wrong transfer deeds. A bad delivery can result in penalties, auctions, or the close-out of the trade.
Yes, you can sell your stock before the date of settlement, but you have to deliver the shares on the settlement day. It is considered a violation to liquidate a trade before settlement has been paid for it.
Pay-in is the process of transferring the shares from the seller’s demat account to the broker’s account and then to the clearing corporation. Pay-out is the process of transferring the shares from the clearing corporation to the broker’s account and then to the buyer’s demat account.
Trade-to-trade settlement is where shares can only be bought or sold on a delivery basis. The shares bought on a trade day have to be paid for and received in the demat account, and the shares sold have to be delivered from the demat account.
An auction in a settlement is a process where the stock exchange buys the shares from the market on behalf of the buyer who did not receive the shares due to short delivery or bad delivery by the seller.
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