UNIT 6 TRADING AND SETTLEMENT Trading and

Settlement

Objectives
After studying this Unit you should be able to:
• Understand the history of Trading in India
• Appreciate the process of Transformation of Trading System
• Explain the various steps in the Securities Trading process
• Analyse the role of different Institutions involved in the Securities
Trading process

Structure
6.1 Introduction
6.2 The History of Trading in India
6.3 Transformation of Trading System
6.4 NEAT & BOLT
6.5 Steps from Order Placement to Settlement
6.6 Order Placement
6.7 Order Execution
6.8 Clearing and Settlement
6.9 Settlement Procedure
6.10 Clearing Corporation
6.11 Depositories
6.12 Summary
6.13 Self Assessment Questions
6.14 Further Readings

6.1 INTRODUCTION
Secondary market is a market in which existing securities including financial
instruments such as stock, bonds, options, futures, etc., are traded. In India,
secondary markets consist of recognized stock exchanges operating under
bye-laws, rules and regulations that are duly approved by the Government of
India, and the regulators such as; SEBI or RBI. The stock exchanges
comprise of the organized markets segment. These securities that are traded
may be issued by the Central or State Government, public sector institutions,
companies, etc.

Alternatively, most bonds and structured products (customized contracts)

trade in the over-the-counter (OTC) markets. Hence, all stock exchanges, and
over-the-counter markets, serve as secondary markets which help in reducing
the risk of investment and in maintaining liquidity in the financial system.

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Secondary Secondary Market with reference to the segment of Capital Markets relates to
Markets
trading of already-issued (outstanding) shares. After the shares are issued in
the Primary Market, it is listed on a recognized stock exchange in case of
equity shares. Bonds are traded on the Negotiated Dealing System of RBI in
case of debt market securities. Secondary markets provide liquidity for
investors. Secondary Markets usually follow either an auction-based system
or dealer-based system. While the stock exchange is part of an Auction
Market, Over-the-Counter (OTC) market is a dealer-based system.

For the general investor, the Secondary Market provides an efficient platform
for trading of securities. The fair price of the security is "discovered" in the
secondary markets - thus leading to either price appreciation or depreciation.
Banks facilitate secondary market transactions by opening direct accounts to
individuals and companies. Banks also extend credit against securities. Banks
may also act as Clearing House Banks.

The Indian Secondary market can also be classified into two parts:

a) Secondary market for corporate and financial intermediaries on

recognized stock exchanges such as; BSE, NSE, OTCEI, ISE and other
regional exchanges. The participants in these markets are registered
brokers - both individuals and institutions. They operate through a
network of sub-brokers and sub-dealers and are connected through a
network of electronic trading system.

b) Secondary market for Government Securities, PSU Bonds, corporate

debt instruments. The Government Securities market is divided into short
term money market instruments such as treasury bills, and long term
Government bonds of maturity up to even 30 years. The main
participants in the secondary debt markets are primary dealers, banks,
mutual funds, and financial institutions. Since the September, 1994,
trading in Government Securities were conducted through the Subsidiary
General Ledger (SGL). Presently, Government Securities and PSU bonds
are traded on the Wholesale Debt Market (WDM) segment of NSE, BSE
and OTCEI.

As discussed in Block 1 of this course, Securities and Exchange Board of

India (SEBI) supervises the activities of stock markets, regulates the
functioning of stock exchanges and intermediaries and registers Foreign
Institutional Investors (FII) trading in Indian scrips. Globalization has
subjected India to the vagaries of international market prices. Growing inter-
linkages between different markets has led to greater interdependence. The
result has been emerging complexities in financial markets. This in turn had
necessitated the introduction of more innovative and complex financial
instruments to meet the changing needs of the market. It is in this context that
the role of the secondary market comes into prominence.

6.2 THE HISTORY OF TRADING IN INDIA

We know that Bombay is an old established port in India. Cotton was the
main produce which was being sent to various countries by ship. Since
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despatching a full ship was expensive and full of risk certain traders would Trading and
Settlement
join hands to do so and contribute capital/investment. Once money was
received from International buyers, the profits were shared by the investors.
This was the first initial phase of trading in India. Traders involved in such
trades soon became rich because of the risk they took in the partnerships of
profitable and promising businesses. Bombay traders were dealing in cotton.
Similarly, Ahmedabad traders were dealing in cotton textiles, Calcutta traders
were dealing in Jute and so on.

The Bombay Stock Exchange is the oldest exchange to be established in

Asia. It traces its history to 1855, when four Gujarati and one Parsi
stockbrokers would gather under banyan trees in front of Mumbai's Town
Hall. The location of these meetings changed many times as the number of
brokers constantly increased. The group eventually moved to Dalal Street in
1874 and in 1875 became an official organization known as "The Native
Share & Stock Brokers Association". On 31st August 1957, the BSE became
the first stock exchange to be recognized by the Indian Government under the
Securities Contracts (Regulation) Act. In 1980, the exchange moved to the
Phiroze Jeejeebhoy Towers at Dalal Street, Fort area.

The main objective behind establishing BSE was to firstly, make public
capital available to the entrepreneurial class; secondly, to ensure high returns
on investment; thirdly, to create, promote and develop a well-developed
market for the purchase and sale of securities; and lastly, to develop and
promote ethical trading practices in the securities market. The BSE set out
with the sole idea of encouraging and fueling investment culture across the
country.

6.3 TRANSFORMATION OF TRADING SYSTEM

Prior to 1994 when physical share securities existed, there were 21 Regional
Stock Exchanges in India. They were physically located in various parts of
the country. This was required as shares in India were physical and had to be
given to the Stock Exchange physically after their sale or trade on the Stock
Exchange. Since the Pay-in of Shares was time bound investors would sell it
on their Regional Stock Exchange.

All Regional Stock Exchanges were using the Open Outcry method for share
trading on the Trading Floor. The Trading floor saw an enormous number of
traders physically coming together to trade on behalf of brokers, investors
and speculators. It was a scene of utter chaos with people shouting,
screaming, jostling and pushing each other. It was like a utter fish market
with no transparency about transactions taking place. Once data was put into
the trading system at the Back Office towards the evening, net settlement
positions, trend, etc., could be calculated. Objections, Mismatch or Vanda
were rampant. Overall, using sign language and notepads, traders could
manage to trade with each other before the introduction of the online trading
systems.

Pay-in of Securities to the Clearing and Settlement House was a herculean

task especially for large Financial Institutional Investors or their Custodians.
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Secondary Huge net positions meant large volumes of shares had to be withdrawn from
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the custodies, Transfer deeds were attached. The transfer deeds were then
filled, signed by authorized signatories and share transfer stamps were pasted
on the transfer deed. The Certificate Numbers and Distinctive Number Range
of each certificate was then recorded as shares were distinct and not fungible.
Checking and counting was done multiple times before packing these bulky
but expensive papers. Bullet proof vehicles such as the ones used to fill cash
in ATM machines today, were used to transport the securities to the Clearing
and Settlement House. Security guards are accompanied by an officer and
security guards having machine guns.

The physical movement of these packed securities to the Clearing and

Settlement House was also challenging. The entire process is reverse at the
time of Pay-out.

After securities are received by the custody department, they can not induct
them into their custody without getting the securities transferred in the name
of the Financial Institution. Electronic trading is much faster and less
complicated than trading in the physical stock market. Online stock market
trading involves the real time placement of buying and selling orders for
stocks. The transaction is completed when the trading system is able to match
bids and a confirmation is received. The open outcry system, prevalent a few
years ago on regional stock exchanges, has been replaced by on-line screen-
based electronic trading system. NSE and OTCEI had adopted screen-based
trading right from inception. With almost all the exchanges going electronic,
trading has shifted from the floor to the brokers' office where trades are
executed through a computer terminal. The electronic trading system is
superior to the open outcry system of the past. It ensures transparency, as it
enables participants to see the full market during real time. It increases
information efficiency by allowing faster incorporation of price sensitive
information into prevailing prices and thereby helps in efficient price
discovery. This also results in operational efficiency as there is a reduction in
time, cost, risk of error, and fraud and elimination of a chain of brokers and
jobbers, which result in low transaction costs. This system has enabled a
large number of participants, in every part of the country to trade in full
anonymity with one another simultaneously, thereby improving the depth and
liquidity of the market. It has further led to the integration of different
'trading centres spread all over the country into a single trading platform.
SEBI has permitted the setting up of trading terminals abroad as well as
Internet trading. Now investors in any part of the world can route the order
through the Internet for trading in Indian scrips. Internet trading is more cost
effective than using trading terminals.

Three Stock exchanges were set up in the reforms era, viz., National Stock
Exchange (NSE), the Over the Counter Exchange of India Limited (OTCEI),
and Interconnected Stock Exchange of India Limited (ISE). All three are
mandated for nationwide trading networks. The ISE has been promoted by 15
regional stock exchanges in the country and is based at Mumbai. The ISE
provides a member-broker of any of these stock exchanges an access into the
national market segment, which would be in addition to the local trading
152 segment available at present.
The NSE, OTCEI, ISE, and majority of the regional stock exchanges have Trading and
Settlement
adopted the Screen Based Trading System (SBTS) to provide automated and
modern facilities for trading in a transparent, fair and open manner with
access to investors across the country.

The OTC Market

Over-the-counter (OTC) or Off-exchange Trading or Pink Sheet Trading is
done directly between two parties, without the supervision of an exchange. It
is contrasted with exchange trading, which occurs via exchanges. A stock
exchange has the benefit of facilitating liquidity, providing transparency, and
maintaining the current market price. In an OTC trade, the price is not
necessarily publicly disclosed.

In general, the reason for which a stock is traded on over-the-counter

is usually because the company is small, making it unable to meet exchange
listing requirements. Also known as "unlisted stock", these securities are
traded by broker-dealers who negotiate directly with one another over
computer networks and by phone.

The OTC market is generally considered risky, with lenient reporting

requirements and lower transparency associated with these securities. Many
stocks that trade OTC have a lower share price and may be highly volatile.

6.4 NEAT & BOLT

When a market participant wants to trade (buy/sell) shares, he/she may do so
as a client of a member/broker. After completion of the KYC norms, an
individual/corporate/any other registered entity can access the electronic
trading system provided by the Member - Broker of the exchange.
Trading in securities listed on the recognized stock exchanges was possible in
an open outcry mode until mid-1990s. Brokers used to assemble in a trading
ring for doing transactions in securities. After the stock market crash in 1992,
a few nationalized banks and financial institutions established the National
Stock Exchange of India Ltd (NSE) in 1994. This facilitated an electronic
trading system referred to as "National Exchange for Automated Trading" or
NEAT system. This is a fully automated screen based trading system. NSE
facilitated trading in equity shares on November 3, 1994. Bombay Stock
Exchange Ltd (BSE) switched over to a fully automated computerized mode
of trading known as BSE On-Line Trading System or BOLT; which
commenced its functioning on March 14, 1995.

Through the NEAT system of NSE and BOLT system of BSE, the member-
brokers can enter orders for purchase or sale of securities listed on the
exchange. These securities need to be in the approved segment of the
respective stock exchanges.
NSE follows an "order driven" form from the beginning whereas, BSE
system, which was initially both "order" and "quote driven", is currently only
"order driven". In an order driven system, the traders only put their orders for
buying and selling of securities, whereas in quote driven system, the jobbers
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Secondary put buy as well as quotes in the same scrip with a price difference. The
Markets
jobbers quotes used to get priority in execution over the orders put in by other
market participants at the same price. The quote driven system has been
removed by BSE from August 13, 2001. This was because of gradual decline
of interest by market participants to provide a 2-way quote. The
transformation into a pure order driven system also improved the order
matching efficiency of the system. The system at BSE is now only order
driven. The order driven system ensures faster processing, matching and
execution of orders in a transparent manner.

The entire order and trade management system which forms the backbone of
the exchange trading platform may be segregated into different systems and
sub-systems as follows:
• Order Placement (also called Order Capture or Order Validation system)
• Order Matching and Trade Validation (executed orders based on price-
time priority) or Order Execution.

In the next section of this unit, we shall trace the process flow involved in the
entire Trade Management System in secondary market.

6.5 STEPS FROM ORDER PLACEMENT TO

SETTLEMENT
In normal course, putting a trade through online trading platform in the
Indian Stock Market involves the following steps:
• Investor/trader decides to trade.
• Places order with a broker to buy/sell the required quantity of respective
securities.
• Best priced order matches based on price-time priority.
• Order execution is electronically communicated to the broker's terminal.
• Trade confirmation slip issued to the investor/trader by the broker.
• Within 24 hours of trade execution, contract note is issued to the
investor/trader by the broker.
• Pay-in of funds and securities before T+1 day.
• Pay-out of funds and securities on T+1 day

Some of these steps are discussed in detail in this Unit.

6.6 ORDER PLACEMENT

When a user logs into the Trader Work Station (TWS) of the exchange and
places an order through the buy/sell order entry screen, he inputs the
following parameters:
• Regular Lot Order or Stop Loss Order
• Scrip Code and Scrip Name - both are available from a drop list box
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• Quantity of shares to be bought/sold Trading and
Settlement
• Price
• Disclosed Quantity
• Client Code for Client Order/Member OWN code for Proprietary Order
• Remarks

The process flow involved in the order placement system of trading in

secondary markets is presented in the Figure 6.1.

Start

Order Placed by
Client/Member

Order Number &

Timestamp assigned

Cancel Order from

Is Order No System and send
Stop
Valid message of order
cancellation to user
Yes

Accept Order into

Order Matching
System Order Master
Database

Order Matching
System

Figure 6.1: Order Placement System

The above parameters vary, depending on the software used. But most of the
above parameters are mandatory to be entered into the TWS. Once the order
is entered into the system, an order number is automatically generated. The
order validation system verifies the parameters entered. If the data entered is
accepted after validation, then the order is despatched to the order matching
system.

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Secondary A master database stores the details of the order entered into the system. This
Markets
is the repository for all orders placed by the user. In case the order is rejected
after validation/verification procedure is conducted, then a message alert is
sent to the user's terminal stating that the order is rejected. The same is also
notified to the central order master database.

Markets take "orders',' (which is intent to trade) as input and produce "trades"
as output. The exchange is a market place, where trading in listed securities
happens. For general investor, the secondary market provides an efficient
platform for trading of his/her securities. For the management of the
company, secondary equity markets serve as a monitoring and control
conduit - by facilitating value-enhancing control activities, enabling
implementation of incentive-based management contracts, and aggregating
information (via price discovery) that guides management decisions. Trading
in the equity segment takes place on all days of the week (except Saturdays
and Sundays and holidays declared by the exchange in advance).
Depending on the type of trading activity that a trader undertakes in the
market, he/she may be an investor/speculator, hedger or arbitrageur. Investors
enter into a transaction for investment purposes. Speculators enter into a
transaction by taking a view about the market from the available or prevailing
information/news. Hedgers transact to protect against price fluctuations
thereby minimizing the risk arising from such fluctuations. Arbitrageurs enter
into a transaction in reaction to information flows that cause price differential
between different markets. Arbitrageurs typically transact in multiple
correlated assets which are traded in different markets.
The trading on exchange happens only by becoming a registered Trading
Member of the exchange. There are three kinds of members who are
generally registered by an exchange. Trading Members can place orders on
the exchange. Trading Members provide only trading services for their
customers. They cannot clear the trades of their clients or their own trades.
They need to associate with a Professional Clearing Member in order to have
their and their client trades cleared. Trading and Clearing Members (TCM)
facilitate both trading and clearing services for their customers (and their own
proprietary trades). Professional Clearing Members do not offer any trading
services, but only provide clearing services for their customers who are
typically other Trading Members. The exchange allows access to trading
members and their sub-brokers. TCM have clearing and settlement
obligations with the exchange. Sub-brokers appointed by the TCM need to
have their settlement obligations cleared through the TCM. A TCM can have
multiple sub-brokers. Every sub-broker can only trade through one TCM.

As shown in Figure 6.1, as and when the order is entered into the system, the
order is numbered and the specific time of order submission is stamped along
with the order. The order number and time stamp is unique for each order
submitted. Then the order is checked for validation and verification
parameters. If the order is valid, then the order is accepted. If the order is
rejected, then the same is communicated to the user terminal. The message
appears in the message box of the user terminal.
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Accepted orders are then placed in the order queue based on price time Trading and
Settlement
priority. If the order does not find an immediate match, then the order is
placed as a "passive" order and is stored in the order queue. The analysis of
the price-time priority of order matching is explained in detail in the
following sections of this unit.

6.7 ORDER EXECUTION

Having analyzed the process involved in order placement, let us discuss the
process involved in the Order Execution. When any order enters the trading
system, it is an active order. It tries to find a match on the other side of the
books. If it finds a match; a trade is generated. If it does not find a match, the
order becomes a passive order and goes and sits in the order book.

The Order Execution System involves the trading engine identifying the best
buy quote with the best sell quote based on price time priority. All orders
existing in the system can be modified till the time they do not get fully
traded and it can be done only during market hours. At a branch level, once
an order is modified, the branch order value limit gets adjusted automatically.
Order modification authority is given according to the corporate hierarchy, as
given below:
• A dealer can modify only the orders entered by him.
• A branch manager can modify his own orders or orders of any dealer
under his branch.
• A corporate manager can modify his own orders or orders of all dealers
and branch managers of the trading member firm.

The corporate manager/branch manger cannot modify order detail such that it
exceeds the branch order value limit set for the day. A Trading Member who
is suspended or deactivated by the exchange for any session cannot modify
the orders entered by him. Any order modification resulting in price or
quantity freeze shall not be allowed. For such modification request, the user
will receive a message from the Order and Trade Management System.
Orders which have not been fully or are partially traded (for the untraded part
of partially traded orders only) can only be cancelled and that is done only
during market hours.

Different types of Order Execution

Following are the different types of order execution in an exchange:

1) Market Order: Market order is one that will be executed immediately at

whatever the current price where the security is traded. This is the
simplest of all orders. If you want to buy, say, 100 shares of INFOSYS at
the best available price immediately, then you can place a "Market
Order" by simply specifying the quantity without indicating the price of
purchase. The system automatically recognises that you are placing a
market order, and matches the quantity of purchase (100 shares) with the
best available sell quotes in the order book. The entire lot of 100 shares
is matched at the best sell quotes and the order is executed. It should be
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Secondary noted that this is a risky strategy since the market may be sometimes so
Markets
volatile that the actual price at which the order is matched may be at
extreme points. Hence, you need to be careful when you are placing
market order.

2) Limit Order: This is a conditional order in which the lowest or highest

price, at which you want to sell or buy shares respectively, is specified.
A sell limit order will be executed at the specified price or higher; a buy
limit order will be executed at the specified price or lower. e.g., "Buy
100 shares of TISCO at Rs. 100". The order will be executed at Rs. 100
or lower. A Sell Limit Order may be "Sell 100 shares of TISCO at Rs.
110; the order will be executed at 110 or higher.
Sell Limit Orders will always be above the market & buy limit orders
will always be below the current market price. If a sell limit was below
the current market price (or if a buy order is above), they would be
immediately executed. In case of high volatility, the trader needs to take
care while feeding limit orders, with limits close to the market price.
3) Stop Loss Order: In these type orders a price is specified with a trigger
price. If the price is traded at trigger price, the order becomes a market
order. Suppose I buy (long) 100 shares of TISCO at 100 & I want to
limit my losses to Rs. 5 per share. I can enter an order to "sell 100 shares
of TISCO at 95 on a stop with trigger price at 96. Once TISCO trades at
96 or lower, the system will sell on my behalf 100 shares of TISCO at
the market. If TISCO does not trade at 96 or lower, the order will not be
executed and stay in abeyance mode. In case of non execution, order
stand in the "Stop Loss Order Book". A buy stop order can be used to
protect a short position.
When a trader has an existing open short position, the risk for the trader
is a sudden increase in the price of the security. Hence, in order to
minimize losses, he can place a stop-loss buy order. In this case, the limit
price is placed above the current market price and the trigger price is
specified just below the limit price. When the market price increases, the
trader's existing short position begins making losses. In such eventuality,
when the trigger price is breached, the stop loss buy order is activated
and a corresponding buy order is initiated.
When a trader has an existing open long position, the risk for the trader is
a sudden decrease in the share price. Hence, in order to minimize losses,
he can place a stop-loss sell order. In this case, the limit price is placed
below the current market price and the trigger price is specified just
above the limit price. When the market price decreases, the trader's
existing long position begins making losses. In such eventuality, when
the trigger price is breached, the stop loss sell order is activated and a
corresponding sell limit order is initiated.
The advantage of a stop order is that, any sudden adverse movement in
the market can limit losses to a great extent. The disadvantage is that the
stop-loss order could be activated by a short-term fluctuation in the price.
The solution is to choose a stop-loss percentage that factors day-to-day
158 fluctuation while preventing as much downside risk as possible. Also,
 when the trigger price is breached, the stop-loss order is released into the Trading and
Settlement
system. The actual traded price of the stop loss order may be different
from the limit price specified. This is especially possible in a dynamic
market where prices can change rapidly.
Placing stop-loss orders do not cost anything for the client. The
brokerage is charged only once the stop-loss trigger price has been
breached and order executed. Hence, it functions like an Insurance
policy. Second, but most important, a stop-loss allows decision making
to be free from any emotional influences. People tend to believe that the
market may bounce back from an adverse movement. This causes the
trader to procrastinate and delay the action to cut losses. Stop loss orders
ensure discipline in trading.
In extremely volatile situations, it may be observed sometimes that stop
loss orders are triggered but not executed. In order to avoid this
possibility, precaution needs to be taken to maintain adequate gap
between the trigger price and the limit price specified in the stop loss
order. This ensures that the high volatility in the market will not lead to
bypass of the stop loss buy/sell price after breach of the trigger price.
4) Market if Touched (MIT): MIT becomes a market order if a designated
price is reached. MIT to buy becomes market order if market falls to a
given price while stop order to buy becomes a market order if the market
rises to given price. (MIT to sell becomes a market order if market rises
to specified price).
5) Day Order: This order stays in the system for a day, if not executed it
expires at the end of the trading session of that day.
6) Good Till Cancelled (GTC): This type of order remains in the system till
it is executed or cancelled. It remains open until either the order is
cancelled from the system, it is executed or for a period of 6 months,
whichever is earlier.
7) Fill or Kill/Immediate or Cancel (IOC): This is an order to buy or sell a
security immediately. If the order is not executed at once, it is treated as
withdrawn or expired. This type of an order is often used by a party
wishing to take out a large bid/offer but, in case of a failure, it does not
wish to be viewed as a possible large counter party in the market.

6.8 CLEARING AND SETTLEMENT

Clearing is a mechanism which helps determine the obligations of the trading
members. Whereas Settlement involves taking and giving delivery of funds
and securities thereby discharging obligations of the trades placed on the
exchange terminal by the trading members.
Every exchange has a designated clearing house which operates to complete
the clearing and settlement processes of the exchange. The Clearing House
helps determine the obligations i.e. what the parties to the transaction would
receive and what they would pay to the other parties.
Every Clearing House has two clearing members - a Trading Member and a
Custodian. Once the obligations are passed on from the trading member to
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Secondary the custodian, the custodian confirms them. This confirmation request is sent
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to the custodian through the clearing house through real time and end of day
trade file. Once a confirmation is received the clearing process commences.
Clearing involves consolidation of transactions and calculates the settlement
requirements. This phenomenon is termed as ‘Multi-lateral Netting’. The
advantage of using this to determine the obligations is that it reduces
transaction costs and improves operating efficiency. The clearing member
determines the obligations of the pay-in and pay-out of funds and securities.
The details of which are forwarded to the trading members so that they can
settle their obligations by T+1. The time period for trading and settlement are
specified by the exchange. At the end of the trading period and settlement
period the net obligations are computed.
The clearing house determines the obligations after it receives the
confirmation of trades from the exchange. It then transfers the details of the
transaction in electronic form to the clearing members. The trades carried out
during a particular period specified for trade are settled together. Multilateral
netting serves to determine the net obligations of the clearing members. The
clearing house assigns delivery between the members of funds and securities
to ensure completion of transaction. A settlement process is said to be
complete upon declaration and release of pay-out of funds and securities.

Suppose a trader 'A' buys 100 shares of Company ABC and sells 50 shares of
the same company on the same day then his net obligations would involve 50
shares of company ABC.

Settlement involves the actual settlement of obligations towards the

transaction and eventually pay-in and pay-out of funds and securities. Paying
in of funds or securities means delivery of the securities or funds by the
members who wish to part with them. While paying out means giving
delivery of funds or securities to members who wish to receive them in
exchange for their payments

6.9 SETTLEMENT PROCEDURE

The Figure 6.2 depicts the step-wise flow of funds and securities which
allows for the settlement of funds.

Figure 6.2: Settlement procedure

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Steps in Settlement Process: Trading and
Settlement
1) The first step involves downloading of the trade information (real time
and end of day trade files) from the exchange to the clearing corporation.
2) The clearing house then intimates the clearing member about the trade
details who confirm the same. The clearing house performs multi lateral
netting to determine the obligations.
3) The clearing members download the trade details and pay-in advice.
4) The clearing member gives instructions to clearing banks to make funds
available by pay-in time.
5) They also give instructions to the depositories to make securities
available by pay-in time.
6) Pay-in of securities - The clearing house advises depository to debit pool
account of custodians/CMs and credit its account. This is carried out by
the Depository.
7) Pay-in of funds - The Clearing house advises Clearing Banks to debit
account of custodians/CMs and credit its account. This is carried out by
the clearing bank.
8) Pay-out of securities - The clearing house advises depository to credit
pool account of custodians/CMs and debit its account. This is carried out
by the depository.
9) Pay-out of funds - The clearing house advises Clearing Banks to credit
account of custodians/CMs and debit its account. This is carried out by
the clearing bank.
10) The Depository informs custodians/CMs through depository participants.
11) The Clearing Banks inform custodians/CMs.

A clearing member has to deliver securities on the pay-in day as per the
instructions of the clearing house. In case he/she is not able to deliver then
the clearing house identifies those deliveries and carries out a buy-in action
process for those securities through the trading system. The clearing member
gets a valuation for the security and is debited of the amount for which the
securities were not delivered. If he gets a higher valuation he can make good
of the difference. All shortages not bought in are deemed to be closed out at
the highest price between the first day of trade and before squaring off or
closing price on the auction day plus 20%, whichever is higher.

This amount is credited to the receiving member's account on the auction

pay-out day.

Auctions may be carried out by the Exchange on behalf of trading members

for settlement. The main reasons for Auction are; Shortages, Bad Deliveries
and Objections. There are three types of participants in the auction market:
• Initiator: Initiates the auction process.
• Competitor: Enters on the same side as of the initiator.
• Solicitor: Enters on the opposite side as of the initiator.
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Secondary The trading members participate in the Exchange initiated auctions by
Markets
entering orders serving as a solicitor. For example, the trading members enter
sell orders as solicitors in case of a buy-in auction. When the auction starts,
the competitor period for that auction also starts during which competitor
order entries are allowed.

A Competitor order is an order which competes against the initiator’s order.

Once this competitor period ends, the solicitor period commence during
which solicitor order entries are allowed. Solicitor orders are exactly opposite
to the initiator order i.e., if the initiator order is a buy order, then all the sell
orders for that auction are solicitor orders and vice versa. Order matching
takes place after the solicitor period. A trade price is computed for the
initiated auction by the systems in place. This completes the auction process.
The time period for competitors and solicitors is specified by the exchange.

6.10 CLEARING CORPORATION

The Clearing Corporation or the clearing house carries out the clearing and
settlement of the trades. It clears trades through a defined settlement cycle
and maintains the same procedure for clearing all trades. It sums up the trades
over the trading period, nets the positions to compute the liabilities of
members and ensures movement of funds and securities to meet respective
liabilities. Clearing houses conceptualize 'novation' (where the clearing
corporation acts as seller to the buyer and buyer to the seller) by eliminating
obligations of other counterparties with its own obligation thus minimizing
counterparty risk ensuring completion of transaction. Every Stock exchange
has a designated clearing house. It empanels clearing banks to provide
services to the trading members and with depositories for settlement of
trades.
Every member is required to maintain a clearing account with the designated
clearing bank for clearing operations which includes settlement of funds and
other obligations like payment of margin or any other penalties. Only
clearing members can access their clearing account to make or receive
payments as assigned by the clearing house depending on his obligations.
The bank then carries out debit or credit operations with respect to the
instructions received from the Clearing Corporation.
The Clearing Banks are required to provide the following services as a single
window to all Clearing Members of Clearing Corporation and also to the
Clearing Corporation:
• Branch network in cities that cover bulk of the trading cum clearing
members.
• High level automation including Electronic Funds Transfer (EFT)
facilities.
• Facilities like, (a) dedicated branch facilities, (b) software to interface
with the Clearing Corporation, (c) access to accounts information on a
real time basis.
• Value-added services to members such as free-of-cost Funds Transfer
162 across centers, etc.
• Providing working capital funds. Trading and
Settlement
• Stock lending facilities.
• Services as Professional Clearing Members.
• Services as Depository Participants.
• Other Capital Market related facilities.
• All other banking facilities like issuing bank guarantees/credit facilities
etc.

Role of the Clearing House

Pay-in of Funds and Securities: This requires members to bring in their
funds/securities to the clearing corporation. The Clearing Members (CMs)
make the securities available in designated accounts with the two depositories
(CM pool account in the case of NSDL and designated settlement accounts in
the case of CDSL). The depositories move the securities available in the pool
accounts to the pool account of the clearing corporation. Likewise CMs with
funds obligations make funds available in the designated accounts with
clearing banks. The clearing corporation sends electronic instructions to the
clearing banks to debit designated CMs’ accounts to the extent of payment
obligations. The banks process these instructions, debit accounts of CMs and
credit accounts of the clearing corporation. This constitutes pay-in of funds
and of securities.

Pay-out of Funds and Securities: After processing for shortages of

funds/securities and arranging for movement of funds from surplus banks to
deficit banks through RBI clearing, the clearing corporation sends electronic
instructions to the depositories/clearing banks to release pay-out of
securities/funds. The depositories and clearing banks debit accounts of the
Clearing Corporation and credit accounts of CMs. This constitutes pay-out of
funds and securities.

6.11 DEPOSITORIES
NSDL or National Securities Depository Limited was established in 1996 as
per the recommendations of the Pherwani Committee to maintain the shares
held by investors in dematerialised form. As of June 30th 2023, it manages
assets of over Rs. 348.59 lakhs crore. It is presently one of the largest
depository institutions in the world, managing more than 3.31 crore investor
accounts through the various Depository Participants (DPs) across India.

CDSL or Central Depository Services (India) Limited was established in

1999 and is the second depository institution in India. Similar to NSDL,
CDSL is a Market Infrastructure Institution (MII) and acts as the
intermediary between exchanges, clearinghouses, DPs, issuers, and investors.
It facilitates the safe storage of securities held by investors in dematerialised
form and enables the smooth processing of securities purchases and sales. As
of June 30th 2023, CDSL manages over 8.8 crore investor accounts and offers
its services through 588 DPs. The securities held in CDSL’s custody value
exceeds INR 4.52 crore.
163
Secondary There are many differences between CDSL and NSDL, including promoter
Markets
status, founding date, the scope of operation, and investor accounts.
However, what makes them similar is what they do. Both serve as depository
institutions maintaining investors’ stocks, bonds, ETFs, mutual fund units,
etc. Also, both institutions are registered and approved by the Indian
Government. Moreover, both institutions are regulated by the Securities and
Exchange Board of India. Additionally, all Indian brokers can transact with
any of these institutions.
In terms of services to investors, there is no key difference between having a
Demat account with a DP registered either with NSDL or CDSL. Both are
regulated by SEBI and provide similar trading and investing services.

In India, investors usually do not choose the depository institution. The

depository participants oversee the account opening process. Generally, the
DP looks at the charges and service quality of NSDL and CDSL before
opening investor accounts. Brokers can access NSDL and CDSL to transfer
shares, bonds, ETFs, etc., to the Demat account from the trading account.

Issuer

NSDL

DP DP

Investor Investor Investor Investor

Figure 6.3: Flow of Securities transfer in Demat System

Services provided by Depository

• Dematerialisation (usually known as demat) is converting physical
certificates of Securities to electronic form
• Rematerialisation, known as remat, is reverse of demat, i.e. getting
physical certificates from the electronic securities
• Transfer of securities, change of beneficial ownership
• Settlement of trades done on exchange connected to the Depository
• Pledging and Unpledging of Securities for loan against shares
• Corporate action benefits directly transfer to the Demat and Bank
account of customer

6.12 SUMMARY
Secondary market is a market in which existing securities and financial
instruments such as; stock, bonds, options, and futures are bought and sold.
164 Secondary market comprises of equity markets and the debt markets.
After the Financial Instruments are issued in the Primary Market, it is listed Trading and
Settlement
on a recognized stock exchange for providing liquidity and price discovery.

Products of secondary market include equity shares, preference shares,

Security receipts, government securities, debentures, bonds, commercial
papers, Units of Mutual Funds and treasury bills. This market attracts a
varied group of participants like investors, speculators, hedgers, arbitragers
and jobbers. Some of them come to market to mitigate risk while some come
to take chance on the market movement and make money. Further, the
secondary markets provide liquidity for investors. The fair price of the
security is discovered in the secondary markets - thus leading to either price
appreciation or depreciation.

This market provides an automated online trading platform, where different

types of orders can be placed and executed on order matching basis. For
example, the online trading platform on NSE is called NEAT and on BSE is
called BOLT. The Exchanges have placed efficient infrastructure to monitor
the settlement process. The regulators like SEBI intervene to amend
guidelines in the interest of the investors. Clearing and settlement is said to
be one of the most important segment of a transaction without which a trade
ceases to exist.

Clearing mechanism involves a unified contribution of clearing house,

clearing members, custodians and depositories. Settlement Mechanism
involves confirmation of trades by the custodian which is then followed by
the settlement of funds and securities. Auctions are conducted by the
exchange if the obligations are not delivered within the stipulated time.
Auction processes are carried out by initiators, solicitors and competitors as
participants.

6.13 SELF-ASSESSMENT QUESTIONS

1. When did initial trading start in India and why?
2. Is it safe to trade in the OTC market?
3. What is OTC trading?
4. What issues were being faced by the economy in India during the regime
of physical securities?
5. Why are the suggestions of the Pherwani committee very significant for
the changes brought about in the Indian financial market?
6. Why does India have two Depositories? What do these Depositories do?
7. Which stock exchange first introduced an online screen-based trading
system in India?
8. What is the trading and settlement process in online trading?

6.14 FURTHER READINGS

Khan, M Y., (2019) Financial Services, Tata McGraw Hills.
-Ramesh Babu, G., (2015) Indian Financial System, Himalaya Publishing.
165
Secondary Gupta, N K., and Chopra, Monica., (2021) Financial Markets Institutions
Markets
and Services, Ane Books India.
Kohn, Meir., (2013) Financial Institutions and Markets, Oxford University
Press.
Singh, Preeti., (2018) Dynamics of Indian Financial System, Ane Books
India.
Gordon, Natarajan, K., (2016) Financial Markets and Services, Himalaya
Publishing.
Murthy, D K., Venugopal, (2013) Indian Financial System, I K International.

Weblinks:
https://www.cdslindia.com
https://nsdl.co.in
https://finshots.in/
https://pwskills.com/blog/top-15-stock-markets-in-the-world-2023/
https://www.gcia.in/stock-markets-in-developed-vs-developing-economies/

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