This article is written by Jayant Saxena, pursuing a Certificate Course in Capital Markets, Securities Laws, Insider Trading and SEBI Litigation from LawSikho.
When we speak of trade in the market, investors are willing to purchase and sell shares, and then there is a duty imposed on them to transfer shares and the amount to the opposite party. This method may seem very convenient for investors from the above, but if we delve a little further, there are many entities involved in this process pursuing a smooth protocol.
Stock markets ensure a trading platform, while the clearing corporation assures that the trading participants provide funds and securities related issues and ensures that the transaction is concluded by the exchange of obligations. Depositories and clearing banks have the required interface for the settlement of shares and fund liabilities between the custodians or clearing representatives.
Before we dig any further, let us understand which are the entities involved during a trade, their roles, and later on, understand the procedure of clearance of trade and the settlement of securities which is divided into three phases.
Entities involved during a trade
- Clearing Members/Broker: A broker must be mandatorily registered with SEBI and must be a member of the clearing corporation which shall trade in securities on behalf of their clients. Broker’s job is usually to take orders from the clients in respect to buying or selling of their securities and thereafter executing those trade by placing orders on Stock Exchanges. The other duty of these brokers is to open an account with clearing banks and depositories primarily for the purpose of clearing and settling the transactions.
- Clearing Corporation/Clearing House: Clearing Corporations are entities that are designed for the purpose of clearing the trades made by brokers on behalf of their clients. Every SEBI registered broker is a member of a clearing corporation known as a Clearing Member. Every Stock Exchange has its clearing corporation. For instance, National Stock Exchange Clearing Limited (NSE Clearing) formerly known as National Securities Clearing Corporation Limited (NSCCL) is a clearing corporation of the National Stock Exchange (NSE) which is also a wholly-owned subsidiary of NSE. India Clearing Corporation Limited (ICCL) is a clearing corporation of BSE and a wholly-owned subsidiary of it as well. It is mandatory for the brokers to be a clearing member of the Clearing Corporation i.e. NSE Clearing or ICCL.
- Depositories: There are two depositories in India which are National Securities Depositories Limited (NSDL) and Central Depositories Service Limited (CDSL). These depositories are incorporated by our Market Regulator, SEBI, whose objective is to hold investor’s shares, debentures, mutual funds, etc. in a dematerialized form. NSDL and CDSL are to shares what banks are to cash and fixed deposits. For the purpose of settlement of securities, it is mandatory for the brokers to open an account with the depositories which are known as Depositories Pool Account or Dedicated Pool Account, where all the shares after the trade are transferred.
- Clearing Banks: It is necessary for the clearing members/brokers to open a clearing pool account with these clearing banks which are registered with the clearing corporations. Funds can only be settled through these banks. There are 13 registered clearing banks, which are, Axis Bank Ltd., Bank of India, Canara Bank, Citibank N.A, HDFC Bank, Hongkong & Shanghai Banking Corporation Ltd., ICICI Bank, IDBI Bank, IndusInd Bank, Kotak Mahindra Bank, Standard Chartered Bank, State Bank of India and Union Bank of India.
The Indian Stock Exchange implements a rolling ‘T+2’ settlement period. The day the transaction is executed is known as the ‘Trade Day and signifies ‘T.’ Any working day after the trading date is referred to as T+1, T+2, and so on (excluding weekends and stock exchange holidays). Trades are settled in India on T+2 basis.
Example: Mr. Rishabh buys 20 shares of company XYZ at Rs 500 per share on Tuesday. Here Tuesday and the date associated is known as the Trade Date and is signified by ‘T’. The next day which is Wednesday shall be signified as ‘T+1’ where the clearing procedure takes place and the day after that i.e. Thursday, shall be signified as ‘T+2’ where the final settlement of trade shall be concluded.
SEBI has made this service open to all bank account holders. This money would not be deducted from a client’s account until the shares are allotted and shall be blocked therein for a short period and will only be debited once the allotment is made. It takes between 10 to 15 days for share allotment, and in the meantime, the balance remains in the bank account, so the client does not miss any interest income on the same basis.
The transfer of shares is implemented into three phases mentioned below:
- Execution/Trading: On ‘T’ day brokers of both seller and buyer shall place an order on behalf of their clients and later on such order shall be transferred to the Stock Exchange i.e. NSE. Orders are executed by the mechanism of Automatic Order Matching System, where price, quantity, and stock’s name of buyer’s order shall be matched with the requirements of the seller’s order. E.g. Mr. Rishabh placed a buy order of 20 shares of XYZ at a price of Rs. 500 for each share. Mr. Anurag who is a seller must also consider selling the same 20 shares of XYZ at a price of Rs 500 each share. Once their order is matched, such information is transferred to the depositories and the clearing corporations on the same day.
- Clearance: After receiving the above information, on ‘T+1’ day, the clearing corporation i.e. NSE Clearing, shall send a list of obligations to the clearing members/broker of both buyer and seller asking to fulfill the requirement of transferring the amount into the clearing pool account of their designated clearing banks and to the seller for transferring the shares into their depository pool account of the depositories.
From the perspective of the buyer, the clearing member/broker shall transfer the particular amount into the clearing pool account and shall provide a receipt to the clearing member of the seller of such transfer.
And, from the perspective of the seller, the broker shall deposit the respective shares of the seller into the depository pool account and shall acknowledge the buyer of such transfer.
- Settlement: Once the above procedure is concluded, on ‘T+2’ day, settlement of an amount and shares shall take place.
From the perspective of the buyer, the amount deposited into the clearing bank of the buyer’s clearing member/broker shall be transferred to the clearing bank of the seller’s broker and thereafter such amount shall be transferred to the client’s Demat account.
From the perspective of the seller, the shares deposited into the depository pool account by the seller’s broker shall be transferred to the depository pool account of the buyer and thereafter such shares shall be forwarded into the Demat account of the client.
- A list of obligations must be sent by the clearing corporation to the clearing members/broker.
- Clearing member/broker of buyer opens a clearing pool account and transfer the respective amount into the clearing bank.
- Clearing member/broker of seller opens a depository pool account and therein deposits the respective shares.
- Transfer of amount shall take place from buyer’s clearing bank to seller’s clearing bank.
- Transfer of shares shall take place from the seller’s depository pool account to the buyer’s depository pool account.
- Finally, the amount shall be credited to the seller’s Demat account.
- And, respective shares shall be allotted into the buyer’s Demat account.
Earlier, for U.S. securities, the Depository Trust Company (DTC) operates as the primary depository and the National Securities Clearing Corporation (NSCC), the clearinghouse. The Canadian Depository for Securities (CDS) performs these functions for Canadian securities. Previously, the settlement cycle for both U.S. and Canadian securities was is 3 business days following the trade date but w.e.f from September 2017, the settlement period or securities traded on U.S. and Canadian exchanges has been reduced from 3 business days (T+3) to 2 business days (T+2). This shortening of cycle shall yield many benefits along with the enhancement of global settlement harmonization with other international markets in Europe and Asia which currently operates at ‘T+2” settlement cycle.
In India, the above-mentioned stock exchange settlement process may sound complicated, but it operates in good accordance to ensure the smooth operation of the stock market. If we relate how far the economies have gone from the 1960s to the 1970s, the disparity would be huge. At that time, payments were made only on paper checks. The markets closed on Wednesday, which took five business days to clear the trades so that the paperwork could be done.
Compared to the non-functioning stock market throughout the week and five days for the trading cycle, we can now thank technological and procedural advances for the ease of functioning we enjoy.
Students of Lawsikho courses regularly produce writing assignments and work on practical exercises as a part of their coursework and develop themselves in real-life practical skill.
LawSikho has created a telegram group for exchanging legal knowledge, referrals and various opportunities. You can click on this link and join: