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Understanding Settlement Periods in Financial Transactions

08 Aug 2023

Introduction

Traders and investors need to understand a plethora of concepts and technical jargon before they can analyze the financial market and make informed trading decisions. The settlement period is an important concept that investors should understand in order to know the duration between the execution of a trade and its completion. 

The settlement period refers to the timeframe between the execution of a trade or transaction and the actual transfer of the agreed-upon assets or securities, as well as the finalization of the associated financial obligations. It represents the time it takes for both parties involved in a transaction to fulfil their contractual obligations and complete the exchange.

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What are the Types of Settlement Periods?

Settlement periods are usually notated using the acronym T+n, where n can be any positive integer value. The settlement period has a long history. During the pre-digitization era, it used to take five business days to complete the transaction, whereas today it has been reduced to two days or T+2. This was led by the digital wind that spurred the advent of dematerialized accounts and online trading platforms.

Settlements can be classified into three types, each of which is discussed below.

Cash Settlement: A cash settlement is related to the delivery of assets to the buyer. Cash settlements can be further divided into three types:

  • Gross Settlement: Gross settlement is when the investor is trying to sell an asset that they don't own.
  • Net Settlement: A net settlement is when the investor is trying to sell an asset that they own. 
  • Delivery versus Payment (DVP): DVP is when an asset and cash are exchanged at the same time to facilitate an on-the-spot trade completion.

Rolling Settlement: Rolling settlement is usually made for futures contracts where, instead of squaring off the contract on the date of expiry, the investor enters into a new contract with an extended period of expiry.

What is the Settlement Process?

The settlement process involves the transfer of cash, in the case of a cash settlement, from the payer to the payee, and the transfer of securities between the parties involved. When a trade is executed in an exchange, the broker checks whether the trader has adequate resources to execute the trade. If not, then the broker stops the trader from executing that trade.

If the trade passes, the trade prompt is sent to the clearing house for verification, after which the trade is approved and completed. At the completion stage, one party delivers the asset to the other in exchange for cash consideration.

Conclusion

The settlement process includes assessing trader resources, trade verification by clearinghouses, and final completion. It entails the transfer of cash and securities, ensuring that both parties fulfil their obligations.

Related Articles : Settlement procedure for Index Futures Contracts | is T plus settlement possible | T-1 settlement avenue of new possibilities in the Indian market

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