CHAPTER 3
CLEARING, SETTLEMENT
AND LEGAL FRAMEWORK
30 MIN. COMMERCE BY NITIN SIR
{Telegram channel :- https://t.me/FMM30MINCOMMERCEBYNITINSIR/2)
• TOPIC:- CLEARING AND SETTLEMENT
• After a trade happens, it needs to be finalized. In India's stock market, this process has
seen big changes in the past decade. They've started using advanced technology, created
clearing corporations to handle risks, made settlements quicker, moved to digital securities,
and improved risk management.
• Before January 2002, trades were settled in batches covering multiple days. For instance,
trades from Monday to Friday were settled together, and only the net amounts were
exchanged.
Then they switched to T+2 ROLLING SETTLEMENT. Here, trades are settled two days after they happen.
• Example: you buy stocks on Monday. With T+2, the trade will be finalized and the stocks transferred to
you by Wednesday.
•
• TOPIC:- SETTLEMENT AGENCIES
• 1. Clearing Corporation (NSCCL): Handles Post-trade Activities like clearing and
settlement. It ensures trades are completed, manages risks, and guarantees settlement.
• For example, NSCCL ensures that when you buy stocks, you receive them and when you
sell, you get paid.
• 2. Clearing Members: These members settle their obligations determined by NSCCL. They
need to Have Funds Or Securities Ready in designated accounts for settlement.
• 3. Custodians: They safeguard Proof Of Ownership of assets like share certificates. Custodians settle
trades assigned by trading members. For instance, if you buy stocks through a broker, a custodian ensures
you receive them.
• 4. Clearing Banks: They Facilitate Funds Settlement between clearing members and NSCCL. Clearing
banks offer services like real-time gross settlement (RTGS) and electronic funds transfer (EFT).
• 5. Depositories: These Hold Investors' Securities In Electronic Form. If you have a demat account, you're
the beneficiary owner.
• TOPIC:- FUNCTIONS OF CLEARING BANK
• 1. Branch Network: Provide branches in major cities to serve traders and
clearing members.
• 2. Automation: Offer high-tech services like Real-Time Gross Settlement (RTGS)
and Electronic Funds Transfer (EFT).
• 3. Special Facilities:
• (I) Dedicated branches for clearing services
• (II) Software to connect with the clearing corporation
• (III) Real-time access to account information.
• 4. Value-added Services: Free funds transfer between cities for members.
• 5. Working Capital: Offer funds for daily business operations.
• 6. Depository Participant Services: Act as a link between investors and the depository.
• 7. Capital Market Services: Offer additional services related to the stock market.
• NSE Trading Platform: The National Stock Exchange (NSE) provides a platform
where trading members buy and sell securities.
• NSCCL Role: The National Securities Clearing Corporation Ltd. (NSCCL) calculates
the money and securities each trading member must pay or receive after trading.
• Novation: NSCCL becomes the legal party responsible for settling all trades. This
means it ensures that trades are completed, even if a member defaults.
• Member Defaults: If a trading member fails to meet their obligations (like paying
money or delivering shares), NSCCL immediately stops them from trading and starts
recovering the owed amount.
• Member Defaults: If a trading member fails to meet their obligations (like paying money or delivering
shares), NSCCL immediately stops them from trading and starts recovering the owed amount.
• Example:
Suppose Member A sells 100 shares of Company X to Member B. After the trade, if Member A fails to
deliver the shares, NSCCL will still ensure that Member B receives the shares. NSCCL will then take
action against Member A to recover the shares or money.
• TOPIC:- CLEARING PROCESS
• Example: If Member A has bought 50 shares and sold 30 shares of Company X on a trading day, NSCCL
will calculate that Member A has a net obligation to receive 20 shares.
• 1. Determining Obligations: NSCCL calculates what each member needs to pay or receive (funds or
securities) on the settlement date. It acts as a middle party between traders and nets their positions.
• 2. Receiving Trades: At the end of each trading day, NSCCL receives details of completed trades from NSE
and determines the total obligations of each Clearing Member (CM).
• 3. Electronic Transfer: NSCCL sends this information electronically to Clearing Members, which means
all trades during a period are settled together.
• 4. Netting: A process called "multilateral netting" is used to figure out the net settlement for each
Clearing Member—whether they need to deliver or receive securities or funds.
• 5. Delivery Assignment: NSCCL allocates the delivery and receipt obligations between members to
finalize who owes what and who receives what.
• TOPIC:- SETTLEMENT PROCESS
• TOPIC:- SETTLEMENT CYCLE FOR DEMATERIALISED SECURITIES
• Normal Market: Trades done each trading day are settled two days later (T+2 basis).
• For instance, if you buy stocks on Monday, you'll receive them in your demat account by Wednesday.
• Inter Institutional Deals: Trades in this segment are for institutional investors only. Settlement happens
on a T+2 rolling basis, where transactions must be in demat mode.
• For example, if an institution buys stocks on Monday, they receive them in their demat account by
Wednesday.
TOPIC:- SECURITY SETTLEMENT PROCESS
Example Scenario:
Member A (seller) has a trade obligation to deliver 1,000 shares of Company Z to Member B (buyer) on the
pay-in day (T+2 day).
The trade involves dematerialized securities, meaning the shares are in electronic form.
1. Downloading of Securities Obligations:
After the trading day ends, NSCCL calculates the securities obligations for each member and notifies both
Member A and Member B of their responsibilities:
Member A must deliver 1,000 shares.
Member B must pay for these shares.
2. Delivery of Securities (Pay-In Day):
On the pay-in day, Member A needs to ensure the 1,000 shares of Company Z are available in their
depository pool account (either in NSDL or CDSL).
Suppose Member A uses NSDL. By 10:30 AM, they must instruct NSDL to transfer these shares from their pool
account to the NSCCL settlement account.
Member B doesn't need to do anything for receiving shares; they will receive the securities automatically once
the settlement is processed.
3. Handling in Depositories (NSDL vs. CDSL):
In NSDL, the member gives direct instructions to move the shares from their pool account to the NSCCL
settlement account.
In CDSL, this transfer is based on a settlement ID provided by NSCCL, and the member has to ensure the
correct balance is available for each settlement.
TOPIC:- DIRECT PAYOUT TO INVESTORS
• It is a system where securities are directly credited to the client's account after a transaction. The
NSCCL manages this process by coordinating with clearing members (i.e., brokers).
• Example:
• Investor X buys 500 shares of Company Y through Broker A on Monday (T Day). The settlement
follows the T+2 cycle, meaning pay-in/pay-out happens on Wednesday (T+2 day).
• Process:
• 1. Broker A prepares the file for NSCCL, including Investor X’s beneficiary account details in NSDL.
• This file contains information about the shares and settlement number and is submitted before 9:30
AM on the pay-out day (Wednesday).
• 2. NSCCL validates the file and ensures that all records are correct. If everything is in order, NSCCL
sends the payout instructions to NSDL.
• 3. On Wednesday, NSDL credits the 500 shares directly to Investor X’s Demat account based on the
payout instructions.
• 4. If Broker A didn’t provide the account details for Investor X or there was an error in the information:
• The 500 shares would be credited to Broker A's pool account instead.
• Broker A would then need to manually transfer the shares to Investor X once the issue is resolved.
• Alternate Situation:
• If Investor X hadn’t paid the dues to Broker A for the transaction, Broker A might not release the
shares directly to Investor X’s account. Instead, the shares would remain in the broker’s pool account
until the payment is cleared.
• TOPIC:- PROBLEMS PERTAINING TO SECURITIES SETTLEMENT
• 1. SHORT DELIVERIES
• 2. BAD DELIVERIES:
• 3. COMPANY OBJECTIONS:
• 1. SHORT DELIVERIES:- Short deliveries occur when a broker, custodian, or clearing corporation delivers
fewer securities than agreed upon.
• Example: If a broker was supposed to deliver 100 shares to another broker but only delivers 80 shares.
• For the securities that can't be delivered, an equivalent amount is calculated based on the closing price
of the previous day. This amount is called valuation debit.
NOTE;- This issue can happen in both physical and dematerialized settlements.
• 2. BAD DELIVERIES:- Bad deliveries refer to securities deliveries that are defective or incorrect.
• Imagine a broker named Broker A agrees to deliver 100 shares of a company to another broker, Broker
B, through physical settlement. Broker A sends the share certificates and documents to Broker B.
• Upon receiving the documents, Broker B notices that the share certificates are damaged or the
signature on the transfer form does not match the one on record. This makes the delivery defective or
incorrect—called a bad delivery.
• These bad deliveries must be reported to the clearing corporation within two days of receiving the
documents.
The delivering member has two days to fix the issue. If not rectified, the securities go for auction on
the next day.
This problem occurs only in physical settlements.
• 3. COMPANY OBJECTIONS: Definition: Company objections occur when documents for securities
transfer are rejected.
• Example: Documents returned due to incomplete information or signature discrepancies.
• The selling clearing member (CM) is responsible for fixing the problem within a scheduled timeframe.
The receiving CM can raise an objection if documents are incorrect. The selling CM has 7 days to
withdraw invalid objections.
If the documents are not fixed within 21 days, a buying-in auction is conducted by the National
Securities Clearing Corporation (NSCCL).
• TOPIC:- FUND SETTLEMENT
• 1. CLEARING ACCOUNT: Definition: Clearing members maintain an exclusive account with designated
clearing banks for settlement operations.
• Example: A brokerage firm maintains a clearing account with HDFC Bank for settling its financial
obligations.
• 2. CHANGE IN CLEARING BANK: Definition: Procedure for shifting a clearing account from one
designated bank to another.
• Example: A brokerage firm decides to switch its clearing account from ICICI Bank to Axis Bank.
• Procedure: Member requests a change, obtains a no objection certificate (NOC) from the existing bank,
and informs NSCCL for issuance of a letter to the new bank.
• 3. SETTLEMENT OF FUNDS: Definition: Process of fulfilling financial obligations for various settlements.
• Example: A brokerage firm is required to deposit funds in its clearing account to cover its obligations
for a particular settlement.
• 4. FUNDS SHORTAGES: Definition: Trading restrictions imposed in case of insufficient funds.
• Example: If a brokerage firm fails to deposit sufficient funds in its clearing account by the pay-in day.
• Procedure: Trading is halted until the shortfall is resolved as per established norms.
• 5. PENAL CHARGES: Penalties imposed on members for various violations.
• Example: A brokerage firm incurs penalties for failing to meet its funds or securities deliverable
obligations.
• Procedure: Penalties are levied for non-compliance with rules, such as margin shortages or client code
modifications.
• TOPIC:- SHORTAGES HANDLING
• VALUATION DEBIT:
• On the securities pay-in day, the National Securities Clearing Corporation Limited (NSCCL) identifies any short
deliveries (when a clearing member fails to deliver the required securities).
• The clearing member is charged (debited) an amount equal to the value of the securities they failed to deliver,
based on the valuation price (the closing price on the day before the pay-in day). This is known as a valuation
debit.
• A valuation debit is also applied when a clearing member delivers securities that are defective or incorrect (bad
delivery).
• Valuation Price for Failure to Deliver (Regular Market and Limited Physical Market Deals):
• If a clearing member fails to deliver securities on the settlement day, the valuation price is the closing
price of those securities on the last trading day before the pay-in day (the day when the securities are
supposed to be delivered).
• Valuation Price for Bad Deliveries (Regular Market and Limited Physical Market Deals):
• If there is a bad delivery (e.g., incorrect or defective securities), the valuation price is the closing price
of the securities on the last trading day before the bad delivery rectification day (the day when the
member has to correct the delivery).
• TOPIC:- CLOSE OUT PROCEDURES
• When securities aren't delivered or rectified, the NSE uses a close-out process.
• This means that the receiving member is compensated by crediting an amount based on certain pricing
rules.
• TOPIC:- VALUATION PRICE
• 1. Regular Market:
• Failure to Deliver: The price is the highest price from the start of the trading period until the closing
out day or 20% above the closing price on auction day, whichever is higher.
• Non-rectified Bad Delivery: The price is the highest price until the closing out day or 20% above the
closing price on auction day, whichever is higher.
• Non-rectified Company Objections: The price is 20% above the closing price on auction day.
• 2. Limited Physical Market:
• Failure to Deliver: The close-out price is 20% over the actual trade price.
• Non-rectified Bad Delivery: The close-out price is 10% over the trade price.
• Non-rectified Company Objections: The price is 20% above the closing price of the regular market.
• 3. Auction Market:
• Auction Non-Delivery: The price is the highest price until the closing out day or 20% above the closing
price on auction day.
• Auction Bad Delivery: The price is the highest price until the closing out day or 10% above the closing
price on auction day.
• 4. Rebad Delivery (Bad delivery reported again after rectification):
• Regular Market: The price is the highest price until the closing out day or 10% above the auction day
closing price.
• Limited Physical Deals: The close-out price is 10% over the actual trade price.
• 5. Company Objection Reported as Bad Delivery:
• The close-out price is 10% above the closing price on auction day.
• 6. Deleted Securities (Securities no longer traded on the exchange):
• The price is the average trade price over the last 26 weeks plus 20%.
• 7. Bonds:
• Failure to Deliver / Non-rectified Bad Delivery: The close-out price is the highest price or 5% above the
auction day closing price.
• Non-rectified Company Objection: The close-out price is 5% above the auction day closing price.
• TOPIC:- RISKS IN SECURITIES SETTLEMENT
• 1. Counterparty Risk:
This occurs when one party in the transaction fails to meet their obligations. It has two main
components:
• (a) Replacement Cost Risk:
• This happens if one party defaults before settlement.
• For example, if the price of the security has changed from the time of the original transaction to the
replacement, the buyer or seller could lose money.
• This risk is reduced by shortening the time between transaction and settlement.
• (b) Principal Risk:
• This risk arises if one party fulfills their obligation (delivering securities or making payment), but the
counterparty does not.
• For example, the seller delivers the securities, but the buyer does not pay, or vice versa.
• Delivery vs. Payment (DvP) systems help mitigate this risk by ensuring payment is made only when
delivery is confirmed.
• Liquidity Risk: This occurs when one party delays settlement, forcing the other to borrow funds or
securities temporarily.
• Third Party Risk: This arises when a third party, like a clearing bank or custodian, fails to perform their
duties, disrupting the settlement process.
TOPIC:- CATEGORIZATION OF NEWLY LISTED SECURITIES
1. Initial Categorization (First Month)
Market Capitalization Assessment:
Suppose ABC Technologies Ltd. has a market capitalization of ₹500 crores. In the stock market, there are three
groups based on market capitalization:
Group I: Comprises securities with a market capitalization of over ₹400 crores.
Group II: Comprises securities with a market capitalization between ₹200 crores to ₹400 crores.
Group III: Comprises securities with a market capitalization below ₹200 crores.
Initial Placement: Since ABC Technologies Ltd. has a market capitalization of ₹500 crores, it falls into Group I
because it exceeds the market capitalization of 80% of the securities in that group.
2. Monthly Review (After One Month) : After one month, during the monthly review, the stock exchange
evaluates ABC Technologies Ltd. based on its trading frequency and impact cost.
Let’s say: Trading Frequency: The security was traded on 25 out of 30 days.
Impact Cost: The impact cost was calculated at 0.8%.
Re-categorization: Since ABC Technologies Ltd. was frequently traded and has a low impact cost, it remains in
Group I.
3. Corporate Actions and ISIN Changes
Corporate Action Scenario: After a few months, ABC Technologies Ltd. decides to change its business structure
and issues a new set of shares, resulting in a new ISIN. The new ISIN is INE123XYZ456 for the newly issued
shares.
New Categorization: The new ISIN is treated as a newly listed security. During the initial categorization, the new
shares are assessed based on their market capitalization. Let’s assume:
The new shares of ABC Technologies Ltd. have a market capitalization of ₹550 crores. Given this market cap, the
new shares would also be categorized in Group I for the first month.
TOPIC:- CROSS MARGINING
Cross margining allows clients to offset positions in different segments, reducing the overall margin requirement
based on the premise that losses in one position can be mitigated by gains in another. This strategy lowers the
overall risk for traders.
Example of Cross Margining
Scenario: Client Portfolio: Buy Position: 100 shares of Security A at ₹50 in the capital market.
Short Position: 100 shares of Security A at ₹55 in the stock futures market.
TOPIC:- MARGIN SHORTFALL
If there is a margin shortfall:
Trading Restrictions: If a trader does not have enough margin (money), they cannot place new trades until they
deposit the required amount. This helps avoid further financial risk.
Penalties: A penalty fee is charged for not having enough margin. The penalty depends on how much is missing
and how often it happens.
Example: Trader A needs ₹200,000 for their trades but only has ₹180,000. There's a ₹20,000 shortfall.
Until Trader A adds the missing ₹20,000, they can’t trade. A penalty of ₹6 (0.03% of ₹20,000) may be charged
for the first day of shortfall. This keeps trading fair and reduces risk.
TOPIC:- LEVY OF MARGIN FOR INSTITUTIONAL DEAL
1. Identifying Institutional Trades: When a trade is made for an institution, a special code is used to mark it as
an institutional transaction.
2. Custodial Confirmation: If the institution’s custodian (the person managing their securities) confirms the
trade, it's considered an institutional deal. If the custodian doesn't confirm it, the trade is treated like a regular
transaction, and margins are charged to the broker who made the trade.
3. Using the "INST" Code: Brokers can also use an "INST" code to identify institutional trades when placing
orders for their clients.
4. Who Pays the Margin: If the custodian confirms the trade, they pay the margin (security deposit). If the
custodian rejects or doesn't accept the trade, the broker who made the trade pays the margin.
5. Margin Calculation: The margin is calculated for each institutional client and collected from the custodian or
the broker based on the trade's status.
Example: Broker A places a trade for Institutional Client B using a special code.
If Custodian C (managing B's funds) confirms the trade, they pay the margin.
If Custodian C doesn’t confirm it, Broker A has to pay the margin instead.
This process ensures that the correct party pays the margin depending on the confirmation status of the
institutional deal.
TOPIC:- ONLINE MONITORING AND SURVEILLANCE SYSTEM
The exchange has implemented an online monitoring and surveillance system that tracks members' exposure
on a real-time basis. Here's how it works:
1. Alerts on Exposure Levels: The system sends alerts to both the member and NSCCL when exposure levels
reach specific thresholds: 70%, 85%, 90%, 95%, and 100% of the allowable limits. This helps in ensuring members
don’t exceed their limits, allowing NSCCL to monitor positions closely and take proactive actions if needed.
2. Price and Volume Alerts: The system generates alerts if there are unusual movements in the price or volume
of securities, especially when they deviate from historical trends. The exchange maintains detailed databases to
track these trends, and alerts are investigated if necessary.
3. Rumor Tracking: Rumors in print media are monitored, and if they seem to affect the price of securities,
companies involved are contacted for verification. The results are then shared with members and the public.
TOPIC:- OFFLINE MONITORING
Offline surveillance focuses on inspections and investigations to ensure compliance with the exchange's rules
and regulations. This includes:
Inspections of Trading Members: Regular inspections are carried out to verify that members are conducting
their business in compliance with the exchange’s rules.
These inspections are intended to ensure that investor interests are protected and that no malpractice is
occurring.
Through these monitoring systems, the exchange can maintain market integrity, identify unusual activity, and
take appropriate action when necessary.
TOPIC:- INDEX BASED MARKET WIDE CIRCUIT BREAKERS / PRICE BAND FOR SECURITIES
The market-wide circuit breaker system is designed to curb excessive volatility in the stock market. It applies
when the index moves significantly (either upward or downward) by set percentages—10%, 15%, and 20%.
Here’s how it works:
Circuit Breaker Levels:
The breakers are triggered when the Nifty 50 or Sensex hits the 10%, 15%, or 20% movement threshold,
whichever occurs first. Once triggered, trading is halted across all equity and equity derivatives markets in the
country.
These halts are coordinated across exchanges to bring stability to the market.
The goal is to provide a cooling-off period during extreme market fluctuations, allowing traders to reassess
market conditions and preventing panic-driven trading.
TOPIC:- SETTLEMENT GUARANTEE MECHANISM
The Settlement Guarantee Fund (SGF) is like a safety net for the stock exchange. Its main purpose is to make
sure that all trades are settled, even if one of the members involved in the trade cannot pay or fulfill their
obligations. Here's an example to explain it in simple terms:
Example:
Imagine you're at a big market where people buy and sell things every day. In this market, there are many sellers,
and sometimes, one of them might not be able to deliver what they promised. To protect everyone, the market
has set up a special fund (the SGF). If one seller cannot provide the goods, the market uses this fund to cover
the loss so that buyers still receive what they expected.
Similarly, in the stock market:
If a trading member fails to pay what they owe or can't complete a trade, the SGF steps in and covers the missing
amount, ensuring that the trade is settled as planned. This gives all the other traders confidence that their trades
will go through smoothly, even if one person defaults.
TOPIC:- INTERNATIONAL SECURITIES IDENTIFICATION NUMBER
• The International Securities Identification Number (ISIN) is a unique code used to identify securities, such
as shares and bonds, globally. In India, the Securities and Exchange Board of India (SEBI) has assigned
the responsibility of issuing ISINs to the National Securities Depository Limited (NSDL).
• ISIN Numbering System:
• The ISIN is a 12-character alphanumeric code.
• The first two characters represent the country code, which is "IN" for India.
• The third character represents the issuer types
• The next 4 characters (fourth to seventh character) represent company.
• The next two characters (the eight and ninth characters) represent security type for a given issuer.
• The next two characters are serially issued.
SEBI (PROHIBITION OF INSIDER TRADING) REGULATIONS, 2015 SIMPLIFIED:
• What is Insider Trading?
• Insider trading happens when someone buys or sells stocks using secret information about a company
that could affect its stock prices if made public.
• Purpose:
• To prevent unfair practices and protect investors from being cheated due to secret information.
• Key Definitions:
• Dealing in securities: Buying, selling, or agreeing to buy or sell stocks.
• Insider: Someone connected to a company who might know confidential information.
• Connected Person: Anyone related to the company who could access inside information.
• Price Sensitive Information: Info that, if known to the public, could significantly affect a company's stock
price.
• Unpublished Information: Information not shared with the public by the company.
• Example: If a company's executive buys its stocks because they know the company will announce a big
profit soon, it's insider trading.
• Conclusion:
• These rules aim to keep the stock market fair by stopping insiders from using secret info to their
advantage.
• QUESTION:- What Does SEBI ((Prohibition of Fraudulent and Unfair Trade Practices relating to the
Securities Market) Regulations, 2003 regulate?
• ANSWER:- The SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to the Securities
Market) Regulations, 2003 empower SEBI to investigate cases of market manipulation and fraudulent or
unfair trade practices.
• FRAUD: Fraud includes any like knowingly misrepresenting the truth, making false promises, recklessly
making true or false statements, or engaging in any act declared fraudulent by law.
• 2. DEALING IN SECURITIES: Dealing in securities includes buying, selling, subscribing to securities, or
engaging in any transaction related to securities, whether as a principal, agent, or intermediary as
defined under the SEBI Act.
• NOTE: These regulations aim to maintain the integrity and fairness of the securities market by
prohibiting fraudulent and unfair practices. They ensure that investors are not misled or deceived and
that market transactions are conducted transparently and in accordance with the law.
