Clearing and Settlement Process in Stock Markets

The process of Buying or Selling Stocks online has been made smooth and seamless.  The amount is debited from your account and you receive the shares in your DEMAT Account. Same way, for sale transactions, shares are debited from your DEMAT Account while the selling price is credited to your banking account.

To ensure smooth operations and minimal risk, regulators have designed a Trading Cycle, as well as, a Clearing and Settlement Process. As an investor, you do not need to get into the technical details of these processes. However, it is important that you understand the work.

It is to be noted that according to a recent SEBI announcement, all F&O equities and remaining stocks in the T+2 Settlement Cycle will switch to the T+1 Settlement Cycle starting on January 27, 2023. All equities will now gradually transition to a T+1 Cycle.

In this blog, we will look at everything that you should know about the Clearing and Settlement Process in the Stock Market.

Clearing and Settlement Process When You Buy a Share

You require a DEMAT Account, where your shares are held and used for trading, as well as a bank account for financial transactions, in order to purchase or sell shares.

• T-Day

Trade Day, often known as T-Day, is the day that you buy a stock.

The contract note for the transaction and the costs are given to you by the broker on this day. The contract note resembles a stock purchase bill. Your bank account has been debited, but the shares have not yet been credited to your DEMAT Account.

• Trade Day + 1

The day after your buy is day two. It is often referred to as T + 1 Day or Trade Day + 1. On this day, your broker's fees, and the amount for the acquired shares are paid to the stock exchange. Additionally, the shares are credited to the broker's account and debited from the seller's DEMAT Account on this day.

Your DEMAT Account is subsequently credited by the broker with those shares. The seller's bank account is credited with the funds that were deducted from yours to acquire the shares.

Due to the T+1 settlement cycle, trade-related settlements must be made a day, or 24 hours, after a transaction is completed. According to T+1, for instance, if a consumer purchased shares on Wednesday, they would be deposited to their DEMAT Account on Thursday.

Simply, if an investor sells a share using the T+1 format, she will get the payment within a day and the buyer will receive the shares in her DEMAT Account the next day.

Clearing and Settlement Process When You Sell a Share

• On Day 01 or T-Day, you sell shares. The shares are instantly blocked in your Demat account. Consequently, you are unable to sell identical shares on the same day.
  
  
• The broker delivers the shares to the exchange on Day 02 or T+1 Day, and you also receive money in your banking account after all fees have been deducted on the same day.

The Clearing & Settlement Process

Currently, the clearing and settlement procedure consists of these two steps-

• Trade Execution

This is the process by which you carry out a purchase or sell order. T-Day is when this occurs.

• Clearing & Settlement

The process of determining the number of shares that the seller owes and the sum of money that the buyer owes for each deal is known as Clearing. It also establishes each party's commitment and evaluates risk.

Further, Settlement is the procedure through which the shares are transferred from the seller's account to the buyer's account, and the funds are transferred from the buyer to the seller. These two processes are carried out on T+1 Day.

This is the core clearing and settlement process in a stock exchange. T+1 denotes that trade-related settlements must be made one day after the conclusion of the transaction.

Entities Involved in the Clearing and Settlement Process

• Depository

While traditionally shares were held in a physical certificate format, today it is mandatory to hold them in the electronic or dematerialized form. Hence, a DEMAT Account is mandatory for share transactions. SEBI has created a structure to ensure optimum performance and maximum control over DEMAT Accounts by creating Depositories – entities that hold your DEMAT Accounts.

All participants including investors, brokers, and clearing members need to have a DEMAT Account to trade in the stock exchange.

• Clearing Corporation

This is an entity associated with a stock exchange that handles the confirmation, settlement, and delivery of shares. It acts as a buyer for the seller and a seller for the buyer. In simpler terms, it facilitates purchase on one end of the transaction and sale on the other.

It ensures that the settlement cycles are short and consistent while keeping the transaction risks in check and providing a counter-party risk guarantee.

• Clearing Members and Custodians

The clearing corporation fulfills its role by transferring every trade to a clearing member or custodian. Their core responsibility is ensuring that the funds and shares are available on T+1 Day.

They need to have a clearing pool DEMAT Account with a depository for receiving and sending shares pertaining to the trade.

• Clearing Banks

Since there is a movement of money, SEBI has created a list of 13 clearing banks that aid in the settlement of funds. Every clearing member must open a clearing account with one of these banks. If the clearing member is settling a purchase transaction, then it needs to ensure that the funds are made available in this account before the settlement.

On the other hand, if it is settling a sale transaction, then the funds are received by the clearing member in the clearing account. Almost all the banks do this clearly including HDFC Bank, ICICI Bank, SBI, and Axis Bank.

How Trades are Cleared and Settled in the Stock Market

Here is a quick overview of the actual process of clearing and settlement in the stock market-

1. The stock exchange transfers the details of every trade to the clearing corporation on T-Day.
   
   
2. The clearing corporation informs the clearing members and custodians about the details of the trade and asks them to confirm if they are willing to settle the trade or not. Upon receiving the confirmation, the clearing corporation determines the obligations of the clearing member or custodian.
   
   
3. The clearing corporation sends the details of the obligations and pay-in advice of securities or funds to each clearing member/custodian.
   
   
4. Once the details are received, the clearing members or custodians to:

• Clearing banks to make the funds available; and 
• Depositories to make securities available by the pay-in time.

5. The clearing corporation receives funds and securities from the clearing banks and depositories for purchase and sale transactions respectively. So, if a clearing member is settling a purchase transaction, then the corporation receives the money in its clearing account via the clearing bank. Also, for sale transactions, the corporation receives securities in its pool account via the depository. 

6. Once this is done, it instructs the depositories and clearing banks to transfer the securities and funds to clearing members/custodians for purchase and sale transactions.
   
   So, if a clearing member is settling a purchase transaction, then the corporation transfers securities to its pool account. Also, for sale transactions, the corporation transfers money to the clearing account via the clearing bank.

Conclusion

In conclusion, SEBI protects market integrity in a variety of ways by acting as the counterparty to each trade in the clearing and settlement process. Finally, faster transaction completion results from a shorter settlement period. The user is permitted to withdraw money one day sooner in a T+1 settlement cycle.