One important term in trading is the settlement cycle. It is the period between the trade and settlement dates. The trade date is when the order is executed, and the settlement date is when the ownership of the securities is transferred from the seller to the buyer, and the payment is made from the buyer to the seller. The settlement cycle is determined by regulators, such as the Securities and Exchange Board of India (SEBI) and the Reserve Bank of India (RBI), in consultation with market participants, such as stock exchanges and clearing corporations.
Rolling settlement in India
Rolling settlement is the process where the trades are settled on a continuous basis, according to a fixed time period. For example, if the settlement cycle is T+2 days, it means trades done on Monday settle on Wednesday, trades on Tuesday settle on Thursday, and so forth.
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But, before 2001, India had a different settlement process called account period settlement. Under this process, the trades were settled in batches, according to a fixed time interval.
For example, if the account period was 14 days, it means that all the trades executed in the first 14 days of the month will be settled together at the end of the month. This system had many drawbacks, such as high settlement risk, low liquidity, and price manipulation.
How is the settlement process carried out in India?
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Trade confirmation: The parties involved verify and confirm the trade details. For example, if you buy 100 shares of Reliance Industries at Rs. 2000 per share on Monday, you will receive a trade confirmation from your broker, who will also send the trade details to the stock exchange. Similarly, the seller of the shares will also receive a trade confirmation from their broker, who will also send the trade details to the stock exchange. The stock exchange will then match the buy and sell orders and generate a trade contract note, which will be sent to both brokers.
- Clearing: The net obligations of the parties are calculated and settled. For example, if you buy 100 shares of Reliance Industries at Rs. 2000 per share on Monday and sell 50 shares of Tata Motors at Rs. 1500 per share on Tuesday, your net obligation will be to receive 50 shares of Reliance Industries and pay Rs. 50,000 (100 x 2000 - 50 x 1500). Similarly, the seller of the shares will have their net obligation calculated. The clearing process is done by the clearing corporations, such as National Securities Clearing Corporation Limited (NSCCL) for National Stock Exchange of India (NSE) and Indian Clearing Corporation Limited (ICCL) for Bombay Stock Exchange (BSE), who act as intermediaries and guarantee the settlement of the trades.
- Settlement: This is where the actual transfer of securities and funds occurs. For example, if your net obligation is to receive 50 shares of Reliance Industries and pay Rs. 50,000, you will have to deliver the 50 shares of Tata Motors from your demat account to the clearing corporation on Wednesday, and the clearing corporation will credit 50 shares of Reliance Industries to your demat account on Wednesday.
Similarly, on Wednesday, you will have to pay Rs 50,000 from your bank account to the clearing corporation, and the clearing corporation will pay Rs 50,000 to the seller of the shares on Wednesday. The settlement process is done through depositories, such as National Securities Depository Limited (NSDL) and Central Depository Services (India) Limited (CDSL), which hold the securities electronically, and the banks facilitate the fund transfer.
- Post-settlement: This is the final step, where the parties receive the settlement statements and reports and resolve any disputes or errors. For example, if you receive 50 shares of Reliance Industries and pay Rs. 50,000, you will receive a settlement statement from your broker, who will also update your ledger account. Similarly, the seller of the shares will also receive a settlement statement from their broker, who will also update their ledger account.
Different types of settlement risks
Settlement risks can arise from various sources and factors, such as:
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Default risk: This is the risk that one party fails to fulfill its obligations, either through insolvency, bankruptcy, or fraud.
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Operational risk: This is the risk that the settlement process is affected by human errors, system failures, or external events.
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Systemic risk: This is the risk that the failure or delay of one settlement affects the other settlements, leading to a chain reaction or a domino effect.
Conclusion
The settlement process is an essential aspect of trading that affects the security and efficiency of transactions. This process has undergone several changes in India, from the account period settlement to the rolling settlement, to improve market liquidity and stability. However, some risks in the settlement process, such as default, operational, and systemic risks, still require careful management and mitigation.
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