Part 6: NISM Series VII SORM - Settlement Process

NISM Series VII SORM – Chapter 6: The Settlement Process (T+2, Auctions, Corporate Actions)

This is Chapter 6 of the NISM Series VII Securities Operations and Risk Management (SORM) short notes. The settlement process is a critical examination topic in the NISM SORM certification exam. This chapter covers the equity settlement cycle, derivatives settlement, auction procedures, close out procedures, and corporate action adjustments.

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T+2 Settlement Cycle in Indian Equities

In the Indian equities market, all trades done on recognised stock exchanges follow a T+2 settlement cycle. This means:

• A trade entered on Day T (Trade Day) must be settled on the 2nd working day after the trade date
• On T+2, funds pay-in or securities pay-out takes place

Example: A trade done on Monday (T) is settled on Wednesday (T+2), assuming no holidays.

Determination of Settlement Obligations – Equity Segment Netted Obligations

All purchase and sell transactions are netted against each other to determine the final obligation. A member has an obligation to deliver securities only if total sell quantity exceeds total buy quantity for a given security.

Trade-to-Trade (Gross) Obligations

Some securities are placed in the Trade-to-Trade (T2T) segment where netting is not permitted:

• Security pay-in obligation = cumulative sell quantity
• Security pay-out = cumulative buy quantity
• Funds pay-in = cumulative value of all buy transactions
• Funds pay-out = cumulative value of all sell transactions

Settlement of Derivatives – F&O Segment Daily Mark to Market (MTM) Settlement of Futures

All open futures positions are marked to market (MTM) daily. The process:

• Daily settlement prices are computed for each futures contract using a specified methodology
• All open positions are valued at the daily settlement price
• MTM losses or gains are settled in cash

Final Settlement of Futures (Cash Settled)

For equity F&O index futures (cash-settled contracts):

• On the last trading day, all positions (open, created during the day, closed out during the day) are marked to market at the final settlement price
• All positions are then settled in cash

Premium Settlement for Options Contracts

Premium settlement for options contracts:

• Settled in cash by debit/credit of the clearing accounts of clearing members with their respective clearing bank
• The premium payable or receivable is computed after netting the premium payable and receivable positions of the clearing member

Exercise Settlement for Cash-Settled Options

When options are exercised:

• Long positions at in-the-money (ITM) contracts are assigned to short positions of the same series on a random basis
• Settlement is by debit/credit of relevant clearing accounts with the clearing bank for the exercise settlement value per unit of the option contract

Settlement of Funds Mode of Payment and Delivery

All payments between brokers and clients must be made via:

• Account payee crossed cheques / demand drafts
• Direct credit through EFT (Electronic Funds Transfer) or any other RBI-approved mode

Brokers must only accept cheques drawn by the clients and issue cheques only in favour of the clients — no third-party payments are permitted.

Margin Payment

The initial and exposure margin must be paid upfront by clearing members. Initial margins can be paid in the form of:

• Cash
• Bank Guarantee
• Fixed Deposit Receipts (FDRs)
• Approved Securities (with applicable haircuts)

Settlement Dues

Clearing members and custodians must pay the clearing agency the amounts due for their cleared positions. In turn, the clearing agency pays clearing members and custodians the moneys due to them for their cleared positions.

Settlement of Securities Process of Securities Delivery

1. A buyer can give a one-time standing instruction to their DP for receiving securities in their account
2. Purchased securities are first delivered to the broker's demat account by the Clearing Corporation/Clearing House
3. The broker subsequently transfers securities to the client's demat account
4. Alternatively, the broker can request the Clearing Corporation to deliver securities directly to the purchaser's demat account

Settlement Through the Depository Clearing System

• Securities pay-out takes place on the same date as securities pay-in (i.e., on T+2)
• Securities pay-out is done simultaneously through both depositories (NSDL and CDSL)
• The process is typically completed by 1:30 PM on the settlement day

Auction of Securities

An auction is conducted when there are shortages in delivery by a seller broker. The clearing corporation conducts a buy-in auction through the exchange system to purchase shares from the open market for delivery to the buyer.

When Do Securities Shortages Occur?

• A short seller fails to square up their position
• A seller fails to deliver shares on time
• A seller delivers bad or wrong shares

Auction Tender Notice

Exchanges/Clearing Corporations issue an Auction Tender Notice to trading members informing them about:

1. Names of scrips that are short or have not been delivered
2. Quantity available for auction
3. Date and time of the auction session on the Exchange

Close Out Procedure

If no sellers participate in the auction on the auction day, the Clearing Corporation/Clearing House initiates a Close Out procedure. In this process:

• The buyer is compensated in cash
• The compensation amount is the higher of:
  • The highest price of the security on the exchange from the trade date to the auction date, OR
  • 20% above the official closing price on the auction day

Corporate Actions and Adjustments

Corporate actions are events initiated by a company that affect its securities. They are broadly classified as:

• Stock Benefits: Bonus, Rights, Mergers/De-mergers, Amalgamation, Splits, Consolidations, Hive-offs, Warrants, Secured Premium Notes (SPNs)
• Cash Benefits: Dividends

Corporate action adjustments in derivatives are carried out on the last day on which a security is traded on a cum basis in the underlying equities market (after the close of trading hours).

Adjustment Methodology in Equity F&O For Bonus, Stock Splits, and Consolidations

For Rights Issues

Dividends

Dividends below 5% of the market value of the underlying stock are treated as ordinary dividends — no adjustment is made to the strike price of equity F&O contracts for ordinary dividends.

Mergers

After the announcement of the Record Date for a merger, no fresh futures or options contracts will be introduced on the underlying that will cease to exist after the merger.

Quick Revision – Key Points for NISM VII Chapter 6

• T+2 settlement: Trade Day + 2 working days
• In T2T segment: No netting; gross obligations apply
• Futures MTM settled daily in cash at daily settlement price
• ITM options exercised are assigned to short positions on a random basis
• All client payments must be through account payee instruments or EFT; no third-party payments
• Securities pay-out happens simultaneously through NSDL and CDSL; typically by 1:30 PM on T+2
• Auction is conducted when there is short delivery by a seller
• Close out = highest price from trade date to auction date, or 20% above closing price on auction day (whichever is higher)
• For bonus/splits in F&O: Strike price ÷ adjustment factor; lot × adjustment factor
• For rights in F&O: Strike price × adjustment factor; lot ÷ adjustment factor
• Dividends below 5% of market value are ordinary — no F&O adjustment

📌 Next Chapter: NISM Series VII SORM – Chapter 7: Investor Grievances, Arbitration and Other Broker Services

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Related reads: T+2 Settlement Explained | Corporate Actions in F&O | NISM Series VII Practice Questions