When you buy or sell stocks in the market, your job ends with the transaction. However, there is a massive back-end process that goes on behind the scenes to enable your trade to go through smoothly. For example, the trade is only one part of the entire secondary market transaction. The other two back end processes of clearing and settlement are equally important.
What exactly is a trade?
A trade is either carried out in an offline mode or in online mode. The trader can execute via phone, laptop or mobile app. A trade occurs when the order placed by one party finds counterparty. There are millions of trades on the NSE in the cash market and the F&O market segments. Being an anonymous trading system, the buyer and seller do not know one another. The stock exchange uses an electronic order matching system to match ‘buy’ and ‘sell’ orders from different traders. That is how each trade is executed.
Clearing of the trades
The exchange clears the trades for all the transactions executed on the exchange for a particular day. Once the trade is executed, the next step is to clear the trade. Clearing is a multi-level structure which includes the brokers, the clients, the clearing members, the exchange and the clearing corporation of the exchange. They jointly form the clearing matrix for the trades.
What exactly is clearing?
Clearing is the identification of obligations. For example, if Client A has done an intraday trade and made a loss of Rs.50,000, that has to be paid to the exchange. If Client B has bought shares, then the client needs to ensure that the free funds for the purchase plus transaction costs are made available in the trading account. If Client C has sold the shares, then the client needs to ensure that they have clear delivery in the demat account. By T+1 day, the trader must either give DIS or have a POA given to the broker to debit the demat account.
Clearing process begins only after orders are matched and the trade is executed. Clearing is important because it enables the identification of what security is owed to the buyer and how much money is owed to the seller. The entire process is managed by ‘clearing houses’. Although, these clearing houses are affiliated to the stock exchanges, their management is totally independent to keep Chinese walls.
Clearing is a gross level activity. At the end of the day, your net obligations in money and shares will be determined to enable you to know how much has to paid or received and how much shares have to be delivered or received. Traders tend to conduct multiple transactions in any trading day. As a result, the clearing house identifies all the transactions and the net amount or net securities owed to the trader are calculated.
Finally, the settlement process
This is the last and final step in the trade. Once the net obligations are calculated in the clearing process, the next step is to ensure that these financial obligations are honoured. The fulfilment of the financial obligations identified in the clearing step is called as settlement of the trade. Once the trade is settled, the loop is completed. The buyer receives the shares and the seller receives the bank credit by the end of T+2 day. Once the buyer receives the security and the seller receives the payment, the transaction is settled.
Some important settlement types on the stock exchange
These are some of the popular settlement types on the NSE.
Normal segment (N)
Trade for trade Surveillance (W)
Retail Debt Market (D)
Limited Physical market (O)
Non cleared TT deals (Z)
Auction normal (A)
Trades in the settlement type N, W, D and A are settled in dematerialized mode. Trades under settlement type O are settled in physical form. Trades under settlement type Z are settled directly between the members and may be settled either in physical or dematerialized mode.