Unit – 5

Topic 1:
Introduction:
Clearing and settlement are essential processes in the securities market that
ensure the smooth and efficient transfer of securities and funds between buyers
and sellers.
Clearing: Clearing refers to the process of validating and matching the trade
details, such as quantity, price, and date, between the buyer and seller. It
involves a clearinghouse or a central counterparty (CCP) that acts as an
intermediary to ensure the completion of the trade. The clearinghouse verifies
the trade details, calculates the obligations of each party, and facilitates the
transfer of securities and funds.
Settlement: Settlement on the other hand, is the actual transfer of securities
and funds between the buyer and seller. It involves the delivery of securities
from the seller's account to the buyer's account and the transfer of funds from
the buyer's account to the seller's account. Settlement can be done either through
a centralized system, such as a central securities depository (CSD), or through a
direct participant-to-participant transfer.
The clearing and settlement process plays a crucial role in ensuring the integrity
and efficiency of securities transactions. It helps reduce counterparty risk,
promotes transparency, and provides a standardized framework for trade
settlement. The involvement of intermediaries and infrastructure providers helps
streamline the process and mitigate potential risks associated with securities
trading
Here are some key reasons why clearing of securities is important:
I. Risk reduction: Clearinghouses act as intermediaries between buyers and
sellers, guaranteeing the completion of trades and reducing counterparty
risk. By assuming the counterparty risk, clearinghouses protect
participants from potential defaults or failures to fulfill obligations.
II. Price transparency: Clearinghouses provide transparency by
establishing a centralized marketplace for securities trading.
III. Regulatory compliance: Clearinghouses enforce compliance with
regulatory requirements, such as margin requirements, position limits,
and reporting obligations. They help ensure that market participants
adhere to the rules and regulations set by the relevant regulatory
authorities.
IV. Liquidity facilitation: Clearinghouses play a vital role in facilitating
liquidity in the financial markets. By providing a central counterparty,
they enable market participants to transact with each other more easily,
enhancing market liquidity and depth.
Topic 2 :
Settlement Cycle: The settlement cycle represents the timeframe within which
the securities and funds are exchanged between the buyer and the seller. The
settlement cycle duration varies across different markets and jurisdictions.
Common settlement cycles include T+2 (trade date plus two business days),
T+3, and T+1, where "T" represents the trade execution date
the settlement cycle for various types of securities is as follows:
1. Equities: The settlement cycle for equities is currently T+1, which means
the settlement has to be completed within two working days from the
trade execution date. The buyer receives the securities in his Demat
account, and the seller receives the payment within this time frame.
2. Debt Instruments: The settlement cycle for debt instruments like bonds
and debentures is also T+2.
3. Government Securities: The settlement cycle for government securities is
T+1, which means the settlement has to be completed within one working
day from the trade execution date.
4. Mutual Funds: The settlement cycle for mutual fund units is T+1.
It is important to note that these settlement cycles may be subject to change
based on regulations and market conditions.
Topic 3:
Securities Settlement: Securities settlement involves the transfer of ownership
or title of securities from the seller to the buyer. It typically includes the
delivery of physical share certificates or the transfer of securities held in
electronic or dematerialized form through the relevant depository systems.
The main objectives of securities settlement are to ensure the timely and
accurate transfer of ownership, minimize counterparty risk, and provide a
transparent and efficient process for all market participants. It is regulated by
various regulatory bodies, such as central banks and securities commissions, to
maintain the integrity and stability of the financial markets.
Topic 4:
Funds Settlement: Funds settlement, also known as cash settlement, refers to
the transfer of money from the buyer to the seller in exchange for the securities.
It involves the movement of funds between bank accounts, usually facilitated
through electronic payment systems or central bank-operated settlement
systems.
In a fund settlement, the buyer and seller agree on the terms of the transaction,
including the price and quantity of the funds being traded. Once the trade is
executed, the settlement process begins, which involves the transfer of funds
from the buyer to the seller and the transfer of securities or assets to the buyer.
Topi 5:
Clearing Process: The clearing process involves the validation, verification,
and matching of trade details between the buyer and the seller. It ensures that
both parties have agreed on the terms of the transaction and that the necessary
funds and securities are available for settlement. Clearing is typically conducted
by a central clearinghouse or clearing corporation that acts as an intermediary
between market participants.
Here is a general overview of the clearing process:
1. Trade Execution: Once a trade is executed between a buyer and a seller,
the details of the trade are recorded, including the type of security,
quantity, price, and settlement date.

2. Trade Confirmation: The trade details are confirmed by the broker or

exchange to both the buyer and the seller, providing the trade
confirmation document.

3. Trade Matching: The broker or exchange compares the trade details

from both the buyer and the seller to ensure they match. Any
discrepancies are resolved before proceeding.

4. Trade Netting: If a broker is involved, they may net off trades from
multiple clients. This means that the broker will aggregate the trades of
all their clients and calculate the net amount owed by each client. This
reduces the number of transactions that need to be settled.

5. Clearing: Once the trade is confirmed, the process of clearing begins.

Clearing involves validating the trade details, ensuring the availability of
 funds and securities, and preparing for the settlement process.
Clearinghouses or clearing agencies often facilitate this process, acting as
intermediaries between the buyer and the seller.

6. Clearing House: The trade details are sent to a clearinghouse, which acts
as an intermediary between the buyer and seller. The clearinghouse
ensures the trade is valid, calculates the net positions of each participant,
and manages the settlement process.
Topic 6:
Settlement Process: Once the trade has been cleared, the settlement process
takes place. It involves the actual transfer of securities and funds between the
buyer's and seller's accounts. The settlement process can be facilitated through
various mechanisms, such as delivery versus payment (DVP), where the transfer
of securities and funds occurs simultaneously, or free of payment (FOP), where
securities are delivered without an immediate cash payment.
A general overview of the settlement process in securities:
1. Settlement Instruction: The buyer and the seller submit settlement
instructions to their respective custodians or brokers, specifying how they
would like the securities to be delivered or received. These instructions
include details such as the delivery method (electronic or physical), the
account to which the securities should be credited, and any other specific
requirements.
2. Securities Delivery: On the settlement date, the seller transfers the
securities to the buyer. This can involve electronic book-entry transfers or
physical delivery of securities certificates, depending on the market and
the type of securities.
3. Payment Settlement: Simultaneously with the delivery of securities, the
buyer pays the agreed-upon amount to the seller. The funds are
transferred from the buyer's account to the seller's account through
various payment systems, such as wire transfers or electronic funds
transfers.
4. Confirmation and Reconciliation: Once the securities and funds have
been exchanged, the buyer and the seller receive confirmation of the
settlement. Both parties reconcile their records to ensure that the
transaction has been successfully completed.
5. Post-Settlement Activities: After the settlement, additional processes
may occur, such as updating account holdings, reporting to regulatory
bodies, and recording the transaction in the books and records of the
parties involved.
Topic 7:
Shortages Handling: Shortages may occur when there is an insufficient
quantity of securities or funds available to complete the settlement. In such
cases, the clearinghouse or settlement agent may arrange for borrowing or
lending of securities or funds to fulfil the settlement obligations. Shortages
handling procedures ensure that the settlement process can proceed smoothly
despite any temporary imbalances.
Here are some common steps taken to handle shortages in securities:
1. Identify the Shortage: The first step is to identify and confirm the
existence of a shortage. This is usually done by comparing the quantity of
securities that should be held with the actual quantity available for
delivery.
2. Notification: Once a shortage is identified, the concerned parties, such as
the custodian, clearinghouse, or relevant regulatory authorities, need to be
notified promptly. This allows for appropriate actions to be taken to
rectify the situation.
3. Investigation: An investigation is conducted to determine the cause of
the shortage. This may involve reviewing transaction records,
communication with involved parties, and examination of settlement
processes to identify any errors or discrepancies.
4. Rectification: Depending on the cause of the shortage, different actions
may be taken to rectify the situation. Some common measures include:
(a) Buy-ins: If the shortage is a result of failed deliveries or non-delivery,
the affected party may initiate a buy-in process. This involves purchasing
the securities in the open market to fulfill the delivery obligations. The
defaulting party would be responsible for any additional costs incurred
during the buy-in process.
(b) Reversal of Trades: In some cases, if the shortage is due to an error in
trade processing or settlement, affected trades may be reversed or
canceled to correct the discrepancy.
(c) Borrowing or Loaning: Securities may be borrowed from other market
participants or obtained through securities lending programs to fulfill
delivery obligations and address shortages.
(d) Regulatory Intervention: Regulatory authorities may step in to enforce
compliance and facilitate the resolution of shortages. This can involve
imposing fines, penalties, or other measures to ensure market integrity
and participant accountability.
5. Prevention and Risk Mitigation: To avoid future shortages, market
participants typically implement risk management measures, including
enhanced monitoring, improved settlement processes, and robust internal
controls. This helps to identify and address potential issues before they
result in shortages.