Introduction
Since its introduction, online investing and trading have paved the way deep into people's hearts. In the modern world, DEMAT accounts have allowed investors and traders to buy and sell trades from the market quickly.
However, keeping track of online transactions, crediting and debiting shares, and accurately distributing the money took a lot of work. Therefore, regulatory authorities came up with the clearing and settlement processes in the stock market to ensure smooth operations and a hassle-free trading cycle for investors.
While you do not need to understand the background technicalities of the clearing and settling processes, here is what these terms mean in the stock market.
Key Aspects of a Trading Cycle
In the stock market, three key aspects are involved in a trading cycle. These are:
- Trade
- Clearing
- Settlement
The successful completion of these three processes marks the execution of one complete trade cycle. To briefly understand, trade refers to the act of buying or selling placed on the stock exchange. Followed by clearing and settlement, let us know what these processes are and how they contribute to the successful completion of a trading cycle.
What is Clearing & Settlement?
Clearing and settlement are mandatory when you place a buy or sell order in the stock market. Let's dive into it!
It is the trading day when you trade on the stock exchange. After making your desired trade on the trading day, it is determined how many shares the seller owes you and the amount you owe to the seller, or vice versa. This process of deciding which party owes what respectively and in how much quantity is known as clearing.
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Ahead of the clearing process is the settlement process. The settlement process occurs on the T + 1 day (one day after the trade). This process includes the transfer of shares from the seller’s account to the buyer’s account and the transfer of funds from the buyer’s account to the seller’s.
Therefore, clearing and settlement processes together create a trading cycle that takes place every time you make a trade in the market.
Difference Between Settlement and Clearing
While clearing and settlement are two entirely different aspects, many investors often need clarification. To differentiate, the clearing process determines which securities the buyer and seller own, respectively. In contrast, these securities are allocated to execute one complete trading cycle in the settlement process successfully.
India's clearing corporation carries out the clearing and settlement processes. The clearing corporation in India is an organisation that is associated with the stock exchange with the sole objective of confirming, settlement, and delivery of transactions. The clearing corporation, also known as the cleaning house or clearing firm, takes care of all trading cycles in the stock market.
How Trades are Cleared & Settled
When two parties exchange, a complete trading cycle occurs in the stock market. Firstly, the clearing cycle occurs wherein the clearing house looks after allocating respective securities to the buyer and the seller.
Further, the monetary commitments are to be settled. It is carried out in the “Settlement Process”. So further, the securities are finally delivered to their respective owners, and an entire trade cycle is successfully finished.
A similar process is repeated every time a trade occurs in the market.
Settlement Agencies Involved in an Exchange
Every time a trade/exchange takes place in the stock market, it triggers the role of various agencies that ensure that the transaction is carried out smoothly and with complete accuracy.
Here is a list of all the agencies involved in a transaction:
- National Securities Clearing Corporation Limited (NSCCL)
- Clearing Members
- Custodians
- Clearing Banks
- Depositories
- Professional Clearing Members
With the above agencies' contribution to every trade, a stock exchange successfully executes a trading cycle.
Conclusion
Clearing and settlement are two aspects of the stock market that ensure that trades are not wrongly carried out. It is also critical for traders and investors to understand the details of the trade deals, claims, and settlements in every trading cycle. As mentioned above, the agencies ensure the transactions are carried out smoothly. Both clearing and settlement are essential parts of the entire trading cycle, guaranteeing seamless functioning.
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