How Does Settlement Work in the Stock Market?
Every transaction you ever make requires a buyer and a seller with the underlying medium of the transaction being money.
But when it comes to buying and selling shares in the stock market, transactions are not instantaneous. You do not get the shares in your DEMAT account the very moment you place a buy order.
It isn’t instantaneous because of the involvement of the various intermediaries in the entire process. The authorities need to ensure that this movement is as smooth and standardized as possible so as to minimize the involved risk.
In the Indian stock market, a trade involves the completion of 3 phases, trading, clearing and settlement.
These 3 phases happen on 3 respective days, the Trade Day, or the T-Day, the T+1 day and the T+2 day.
So, when you buy some shares on T-day, you receive the shares in your DEMAT account generally after 2 days, that is, on the T+2 day, which is also the case if you were to sell some shares, for which you receive the money on the T+2 day.
The first phase is the trading phase which happens on the T-day. This is the day where you place any buy or sell orders for the securities you choose. If you’re placing a buy order, the money gets debited from your bank account and goes to your broker along with any brokerage charges. If you’re placing a sell order, the shares you’re selling get blocked immediately so as to prevent you from selling them multiple times.
The second phase happens on the next day, that is the T+1 day. If you had placed a buy order on the previous day, your broker transfers the money to the stock exchange and if you had placed a sell order, the broker transfers the shares to the stock exchange.
The third and the final phase of trade settlement happens on the T+2 day. If you had placed a buy order, then your broker credits the shares you purchased into your DEMAT account and if you had placed a sell order, your broker transfers the funds into your bank account after deducting brokerage charges.
A trade is termed as settled once the buyer of the stocks receives the stocks and the seller receives the payment for these stocks.
In order to keep this entire process hassle-free, SEBI, the Securities and Exchange Board of India has designated entities, which are depositories, clearing banks, clearing corporation and the clearing members/custodians.
These entities work in perfect unison to keep the system running.
Clearing corporations are the ones responsible for everything that happens on the T+1 day. They ensure that the trade is settled at the end and they are obligated to meet all settlements irrespective of member defaults.
The clearing corporation then transfers the trade details to the clearing members who have to determine and confirm the positioning of shares and the funds required to suit the trade and subsequently settle the entire trade.
This entire process of settlement happens through clearing banks wherein every clearing member has to have an account.
The clearing members receive funds from clearing corporations when the stock exchange has to deliver funds to the seller and they have to make funds available to clearing corporations when the buyer sends the funds to the stock exchange. These situations are respectively known as the pay-out and pay-in.
Depositories hold the DEMAT accounts of everyone involved, the traders and the clearing members. When shares are in transit, they go through all these accounts in order to make it to their destination.
There also exists a special type of entity, known as Professional Clearing Members. All they do is clear and settle trades and are not permitted to make trades of their own.
All in all, these entities are the lifeblood of the Indian share market and they are very good at ensuring that you receive your shares or your money whenever you place a buy or a sell order.
Before we end, here’s a short summary:
- In the Indian stock market, a trade involves the completion of 3 phases, trading, clearing and settlement.
- If you place an order on a day ‘T’, you will receive either the funds or the securities on the T+2 day.
- A trade is termed as settled once the buyer of the stocks receives the stocks and the seller receives the payment for these stocks.
- Depositories, clearing corporation, clearing members, clearing accounts and professional clearing members are the entities involved in moving around the funds and the securities in a hassle-free manner.
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