Equity Trading and Settlement


Stock exchanges ensure a platform for trading, while clearing corporation ensures the funds and securities related issues of the trading members and make sure that the trade is settled through the exchange of obligations.

Equity Trading and Settlement

Introduction

The secondary market transactions follow the below sequence

Trading -> Clearing -> Settlement

Stock exchanges ensure a platform for trading, while clearing corporation ensures the funds and securities related issues of the trading members and make sure that the trade is settled through the exchange of obligations. The depositories and clearing banks provide necessary interface between the custodians or clearing members for settlement of securities and funds obligations.

Clearing Corporation

National Securities Clearing Corporation Limited (NSCCL) is the 1st clearing corporation in India; it is owned by National stock exchange (NSE) and was started in August 1995 for bringing confidence in clearing and settlement of securities. It is responsible for risk management and clearing and settlement of trades on the stock exchange. It also maintains and promotes the operating of a tight risk containment system, short and consistent settlement cycles and providing counter-party risk guarantee.

Clearing Members

Clearing corporation determines clearing members as responsible for settling their obligations. On the date of settlement, clearing members do this by making available funds in designated accounts with clearing bank or depositories.

Custodians

Custodians are clearing members, but they are not the trading members, they settle the trades on behalf of trading members. If a trade is assigned for settlement, then the custodian is required to authorize that whether he is going to settle or not. If he or she confirms then Clearing Corporation assigns that particular obligation. There are 13 custodians empaneled with NSCCL, and they are HDFC Bank, ICICI Bank Ltd, Axis Bank Ltd, Kotak Mahindra Bank, JP Morgan Chase Bank, State Bank of India, HSBC Bank, Stock Holding Corporation of India Ltd, Infrastructure Leasing and Financial Services Ltd, Deutsche Bank, Standard Chartered Bank, Orbis Financial Corporation Ltd, DBS Bank and Citibank.

Clearing Banks

Clearing bank plays a vital role in settlement of funds between clearing members and Clearing Corporation. Every clearing member must open a clearing account with one of the 13 designated clearing banks which are listed above. For clearing based on clearing member’s obligation, the clearing member receives funds in case of a pay-out and makes funds available in clearing account for the pay-in.

Depositories

There are two depositories in India they are National Securities Depository Ltd (NSDL) and Central Depository Services (India) Ltd (CDSL). Securities of investors in their dematerialized accounts are held by these Depositories in India. Every clearing member must maintain a clearing pool account with the depositories, and he must make available the required securities in the designated account on the settlement day. The depository runs an electronic file to transfer the securities from accounts of the custodians/clearing member to that of NSCCL and vice-versa as per the Schedule of allocation of securities.

Professional Clearing Member

Professional clearing members (PCMs) are special category of members admitted by National Securities Clearing Corporation Ltd (NSCCL). They can clear and settle trades executed for their clients just as similarly like custodians and also undertake settlement and clearing of trading members. In this case, PCM has no trading rights, but they have clearing rights and clears trades of their associate trading members and institutional clients.

Applications Supported by Blocked Amounts (ASBA)

SEBI has made this facility available for all bank account holders. In this money does not leave individuals account until shares are allotted. The amount concerning shares will be blocked in our bank account and only debited when allotment is done. It takes about between 10 to 15 days for share allotment and in the meantime amount is in our bank account, so we do not lose the interest income on the same.

Clearing and Settlement Process

The clearing and settlement process has three primary activities - Clearing, Settlement and Risk management

clearing and settlement process
  • Details of trade (real-time and end of day trade file) from Exchange to National Securities Clearing Corporation Limited (NSCCL).
  • National Securities Clearing Corporation Limited (NSCCL) notifies the details of trade to clear members or custodians who affirm back. Based on the affirmation, it applies netting and determines obligations.
  • Download of pay-in advice of funds or securities and obligation which are sent by NSCCL to clearing members or custodians.
  • Clearing members or Custodians gives instructions to make funds available by pay-in time for clearing banks.
  • Clearing members or Custodians gives instructions to make securities available by pay-in-time to depositories.
  • Pay-in of securities (NSCCL directs to debit pool account of custodians or Clearing members and credit its account to depository and depository do it)
  • Pay-in of funds (NSCCL directs to the debit account of custodians or Clearing members and credit its account to Clearing Banks and clearing bank do it)
  • Pay-out of securities (NSCCL directs to credit pool account of custodians or Clearing members and debit its account to depository and depository do it)
  • Pay-out of funds (NSCCL directs to credit account of custodians or Clearing members and debit its account to Clearing Banks and clearing bank do it)
  • Depository informs custodians or Clearing members through DPs.
  • Clearing Banks inform custodians or Clearing members.

The fundamental processes in clearing and settlement are

Trade Recording

The vital information regarding trades is recorded to provide the basis for settlement. This information is automatically recorded in the electronic trading system of the exchanges.

Trade Confirmation

The parties to a trade agree upon the terms of trade like quantity, security, price, and settlement date, but not the counterparty which is the National Securities Clearing Corporation Limited (NSCCL). The electronic system will automatically create confirmation by direct participants.

Determination of Obligation

The subsequent step is a determination of what counter-parties owe, and what counterparties are due to obtain on the settlement date. The National Securities Clearing Corporation Limited (NSCCL) intervenes itself as a central counterparty between the counterparties to trades and lattices the positions so that a member has security wise net obligation to receive or deliver that security and has to either receive or pay funds. The process of settlement begins as soon as member’s obligations are determined through clearing process. The process of Settlement is carried out by Clearing Corporation with help of clearing banks and depositories. Clearing Corporation provides significant link between the clearing banks and the depositories.

Pay-in of Funds and Securities

Pay-in of funds and securities requires members to carry in their funds or securities to the clearing corporation. The Clearing members sort the funds or securities available in designated accounts with the two depositories. The depositories transfer the funds or securities available in the pool accounts, to the pool account of the clearing corporation. Likewise, Clearing members with funds obligations make funds available in the designated accounts with clearing banks. Electronic instructions are sent to the clearing banks by clearing corporation to debit clearing members accounts to the extent of payment obligations. The banks process these guidelines, debit accounts of Clearing members and credit accounts of the clearing corporation. This establishes pay-in of funds and securities.

Pay-out of Funds and Securities

Clearing corporation sends electronic instructions to the depositories or clearing banks to release pay-out of securities after processing for shortages of securities and ordering for movement of securities from surplus banks to deficit banks through Reserve Bank of India (RBI) clearing. The depositories and clearing banks debit accounts of the Clearing Corporation and credit accounts of clearing members. This institutes pay-out of funds and securities. The settlement is deemed to be complete upon declaration and release of pay-out of funds and securities.

Settlement Cycle

National Securities Clearing Corporation Ltd (NSCCL) settles and clears trades as per well-defined settlement cycles shown in the table below. Settlement cycle for CM segment is shown in the table.

Table: Settlement Cycle in Capital Market Segment

settlement cycle in capital market segment

All the securities are being traded and settled within T+2 rolling settlement. NSCCL notifies the relevant trade details to custodians or clear members on the trading day (T), which are affirmed on T + 1, to NSCCL. Based on this, NSCCL nets the positions of counterparties to determine their obligations. A clearing member has to pay-in or pay-out securities and funds.

The obligations are netted for members across all securities to determine fund obligations, and has to either receive or pay funds. Members pay-in or pay-out obligations are determined latest by T+1 and these are forwarded to them on the same day so they can settle their obligations on T+2. The securities or funds are paid-in or paid-out on T+2 day to the members clients and the settlement is complete within 2 days from the end of the trading day.

Dematerialized Settlement

National Stock Exchange (NSE) along with the leading financial institutions established the National Securities Depository Ltd. (NSDL), the first depository in India , with an objective of reducing the menace of forged and pilferage securities and thereby improving the efficacy of settlement systems. This has helped in an era of dematerialized trading and settlement. SEBI has been progressively promoting dematerialization by mandating settlement only through the dematerialized form for more and more securities. The share of demat delivery in total delivery at NSE was 100% regarding value during 2008-09.

Settlement Statistics

There has been large reduction in short and bad deliveries. Short deliveries has averaged around one-fifth of total delivery in FY- 2008-09. During FY- 2008-09, wholly taking all the stock exchanges, nearly 23% of securities accounted for 22 % turnover and was settled by delivery, and the balance was squared up or netted out. In the preceding year, 29.5% of shares accounted for nearly 28 % of turnover and was settled by delivery. This indicates a preference for non-delivery-based trades.

Risk Management

Risk management system is very important for an effective settlement system. National Securities Clearing Corporation Ltd (NSCCL) makes sure that trading member obligations are proportional to their net worth. It has placed a comprehensive risk management system, which is regularly monitored and upgraded to neutralize market failure. It observes performance and record of members and their net worth and recovers online tracking of member positions and exposure of the market and collects margin from members and it automatically disables the members if the limits are breached. The methods of risk management adopted by National Stock Exchange (NSE) have brought the Indian stock market in line with the international markets.

Risk Reduction Measures

The risk reduction measures have repeatedly been reviewed and revised to remain up to date with the realms of the market.

Capital Adequacy

National stock exchange (NSE) formulates the capital adequacy requirements that are significantly more than minimum requirements as compared to that which are mentioned by other exchanges. Corporates seeking membership in the Commodity and Futures and Options segment must have a net worth of Rs.100 lakh and maintain a security deposit (interest free security deposit) of Rs.125 lakh and collateral security deposit of Rs.25 lakhs with the Stock Exchange. The deposits kept in the stock exchange form a part of the membership requirement which may be used towards the margin requirement of the member. Additional capital will be provided by the member for handling the additional exposure.

On-Line Monitoring

National Securities Clearing Corporation Ltd (NSCCL) has adopted an on-line monitoring and surveillance system, where there will be an exposure of the members that can be monitored on a real-time basis. A system of alerts has been made so that member and NSCCL are alerted as per the levels (reaching 70%, 85%, 90%, 95% and 100%) as and when the members reaches these limits. System entitles National Securities Clearing Corporation Ltd (NSCCL) to check the micro-details of member positions, if required and take urgent action if it is needed.

The on-line surveillance mechanism generates alerts or reports on any price or volume movement of securities not in line with past trends. Open positions are also analyzed in a detailed manner. For this purpose, the exchange maintains strong database which can generate instantaneous alerts. These alerts are scrutinized and if necessary are taken for follow up action. Besides this, fake news circulated in the print media is tracked, and where they are found to be price sensitive, companies are approached to verify the same. This is then informed to the members and the public.

Off-line Surveillance Activity

Off-line surveillance activity includes inspections and investigations. As per SEBI norms, trading members are to be inspected to verify the level of compliance with various rules, bye-laws, and regulations of the Exchange. The inspection verifies if investor interests are being compromised in the conduct of business by the members.

Margin Requirements

National Securities Clearing Corporation Ltd (NSCCL) imposes strict margin requirements as a part of its risk control measures. The classification of stocks for the imposition of margins has the structure as given below

Stocks which have traded at least for 80% of the days for the last 6 months constitute the Group I and Group II. Out of the scripts identified for Group I & II category, the scripts having mean impact cost <= 1% are categorized under Group I and the scripts where the impact cost > 1, are segregated to under Group II. The rest stocks are put into Group III. The impact cost is calculated on the 15th date of every month on a rolling basis considering the order book records of the previous six months. By this impact cost that is calculated, the scripts move from one group to other from the 1st of the next month.

Securities that have been listed for less than 6 months, the trading frequency and the effect of cost are computed using the trading history of the security.

Categorization of newly listed securities

Until the time of monthly review new listed security is released to the categorization in that Group where the market capitalization of the newly listed security exceeds or equals the market capitalization of 80% of the securities in that particular group.

Consequently, 1 month after, whenever the next monthly review is done, the actual trading frequency and impact cost of the security is calculated to determine the liquidity category of the security.

Daily margin comprises of
  • VaR margin
  • Extreme Loss margin and
  • Mark to Market margin.

Value at Risk Margin (VaR Margin)

The securities are categorized into three groups for VaR (Value at Risk) margin.

The securities listed in Group I, the daily volatility is calculated using the exponential weighted moving average method which is applied to daily returns identically as in the derivatives market.

For the securities listed in Group II, the VaR margin is higher for scrip VaR (3.5 sigma’s) or three times the index VaR, and it is scaled up by root 3.

For the securities listed in Group III, the VaR margin is equal to five times the index VaR and scaled up by Thrice.

The index Value at Risk, for the purpose, would be the higher for daily Index VaR based on NSE Nifty 50 or BSE Sensex. The index VaR is subjected to a minimum of 5%.

Security specific Margin: National Securities Clearing Corporation Ltd (NSCCL) may stipulate security specific margins for the securities on a daily basis. The VaR margin rate computed as mentioned above will be charged on net outstanding position (buy value-sell value) for the respective investor’s for their respective securities across all the open settlements. There would not be netting off of positions across different settlements.

The Value at Risk margin shall be collected on an upfront basis by adjusting against the total liquid assets of the member at the time of the trade. The VaR margin that is collected is released for pay-in of settlement. The VaR numbers are computed six times during the day taking into account price and volatilities at various time intervals and are published on the Exchange’s website.

Extreme Loss Margin

The Extreme Loss Margin for security is higher than 5%, or 1.5 times the standard deviation of daily returns (in logarithmic scale) of the security price for the last half a dozen months. The Extreme Loss Margin is be collected/ adjusted against the total liquid assets of the member on a real-time basis

Mark to Market Margin

Mark to market loss is estimated by marking each transaction in security to closing price of the security at the end of trading. In case if security has not been traded on a particular day, the most current closing price at the NSE terminal is taken into account for the closing price. The difference between the buy value and the sell value is taken for the loss to calculate the mark to market margin, if the net outstanding position for security is zero. Mark to market margin (MTM) is collected from the member before the start of the trading for the next day. The MTM margin is also collected from or against the cash or any cash equivalent component of the liquid net worth deposited with the Exchange. Mark to market margin (MTM) margin so collected is released on the culmination of pay-in of the settlement.

Close Out Facility

From June 2007 an online facility has been started to close-out open positions of the members in capital market segment whose trading facility can be withdrawn for any reason. On disablement, trading members are allowed to place close-out orders through this facility. Only orders which result in dwindling of current open positions at the client level would be accepted through the close-out facility in a healthy market. Members would not be allowed to create any fresh position in the close-out mode, to place close out orders with custodial participant code and to close out open positions of securities in trade for trade segment.

Index-based Market-wide Circuit Breakers

A three-stage system of index movement either way at 10%, 15%, and 20% is applied by an index based market-wide circuit breaker system. These circuit breakers bring a coordinated trading halt in trading in equity as well as equity derivatives markets across the country. The breakers are triggered by movements in either Nifty 50 or Sensex, based on which one culminates first.

  • In case of a 10% movement on both sides of these indices, there would be an hour market halt if the movement takes place before 1:00 p.m. In case the movement takes place at or after 1:00 p.m. but before 2:30 p.m. there would be trading halt for 30 minutes. If in case movement takes place at or after 2:30 p.m. there will not be trading halt at the 10% level, and the market would continue for trading.
  • In case of 15% movement of either index, there should be 2 hour halt if movement takes place before 1 p.m. If the 15% trigger is reached on or after 1:00 p.m. but before 2:00 p.m., there must be an hour halt. If the 15% trigger is reached on or after 2:00 p.m. the trading must be halted for the remainder of the day.
  • In case of a 20% movement in the index, trading should be halted for the rest of the day.

    NSE may drastically cancel the orders if there is an absence of any immediate notification from the members that these orders are genuine or for some valid reason as it may occur. The Stock Exchange views entries of orders which are not genuine are handled with utmost seriousness as this has large market consequences. As an extra measure of safety, individual scrip-wise price bands have been fixed as below:

  • Daily price bands of 2% either way on a particular set of securities
  • Daily price bands of 5% either way on a particular set of securities
  • Daily price bands of 10% (either way) on a particular set of securities
  • The price bands of 20% (either way) on all remaining securities (including warrants, debentures, and preference shares etc., which are traded on NSE CM segment).
  • Price bands are not applicable on scrip on which derivative products are available or scrips which are included in indices on which derivative products are available. However, to prevent members from entering orders at non-genuine prices in those securities, the Exchange has fixed operating range of 20% for these securities.

Price bands for securities in the Limited Physical Market are same as those applicable to the securities in the Normal Market. For Auction market the price bands of 20% are applicable.

Settlement Guarantee Fund

The Settlement Guarantee Fund allows support for any residual risk and operates like a self-insurance mechanism where the members themselves contribute to the fund. During the event, a trading member failing to meet his settlement obligation, then the fund is utilized to the extent required for the culmination of the settlement.

This results in an elimination of counter-party risk of trading on the Stock Exchange. The market has full confidence that settlement will take place in time and shall be completed irrespective of default by isolated trading members.


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