Dealings in the Stock Exchange: 5 Steps | India | Financial Management

The following steps are involved in the buying and selling of securities in a stock exchange:- 1. Selection of a Broker 2. Placing an Order 3. Making the Contact 4. Preparing Contract Note 5. Settlement of Transaction.

Step # 1. Selection of a Broker and Opening a Trading Account:

The purchase or sale of shares has to be made only through a broker. Therefore, the first thing to be done by a client to operate in the market is to select a broker. The intending investor or seller may approach his bank or any other stock broker for this purpose.

The banks have their own brokers at exchanges. On a recommendation from the bank the client’s account is opened by the broker. The bank assures about the financial condition of the client. Credit worthy clients can contact the brokers directly also.

The client has to sign a “Member-Client agreement” / “Sub broker-Client agreement” for the purpose of engaging a broker. A Model Agreement between broker-client / Sub Broker client and Know your Client Form can be viewed from SEBI website at www(dot)sebi(dot)gov(dot)in. The agreement contains clauses defining the rights and responsibilities of client vis-a-vis broker / sub broker. The client has to furnish details and documents like ID proof. Address proof, PAN No., details of bank account, passport photo etc. After accepting the application the broker will issue a unique client code, user id and password to the client. The broker assists the clients in opening DEMAT account also.

Step # 2. Placing an Order:

After opening trading account and demat account, the client can place order through the broker either in online mode or in offline mode. In online mode, the client himself by using the client id, user name and password provided, access the trading platform using the broker’s website and do trade.

The broker also guides the client about the type of securities to be purchased and the proper time for it. If a client is to sell the securities then “the broker tells him about the favourable time for sale. In offline trading, the client instructs the broker, to perform trade on behalf of him.

In purchasing, the broker is told to purchase shares, their number and price to be paid. Sometimes a definite price is given on which the purchase is to be made. In certain cases minimum price to be paid is told. The broker will try to make purchases as far as possible to the nearest price offered by the client. The order will be placed in the computerized software system of the exchange for matching bids.

The orders can be of different types:

(a) At Best Order:

This is an order which doesn’t specify any price. The order must be executed immediately at the best possible price. Example- Buy 100 Tatas at best.

(b) Limit Order:

This is an order for purchase and sale at a fixed price specified by the client.

Example- Sell 1000 Reliance @ 450.

(c) Stop Loss Order:

This is an order to sell as soon as the price falls up to a certain level or buy when the prices are up to a specified level.

Example- Buy 100 SBI at 125 stop.

(d) Immediate or Cancel Order:

This order has to be executed immediately and if not the order is to be cancelled.

Example- Buy 100 Tatas immediately/cancel.

(e) Discretionary Order:

In this type of order the client gives complete discretion to the broker to do business on his behalf. It means that he has full faith in the broker.

Step # 3. Making the Contract or Execution of Order:

When matching bid is identified the clients order get executed automatically. If no immediate match is found, the order will be kept in the ‘books’ on a price cum time priority basis. Price priority means that if two orders are entered in to the system, the order having the best price gets the highest priority. Time priority means if two orders having same price are entered, the order entered first get the highest priority.

Step # 4. Preparing the Contract Note:

Contract note is a confirmation slip of trade done on a particular day on behalf of a client. Brokers issue the contract note to the client in the prescribed format showing details. The details of securities traded are given in this note mentioning their number, price etc. Being documentary evidence, the contract note should contain the name of the company, date of purchase, date of delivery, brokerage etc. A duplicate copy of the same will be kept by the broker.

Step # 5. Settlement of the Transaction:

The spot dealings are settled there in full. The settlement for ready delivery and forward contracts is done with a different procedure.

Settlement of Ready Delivery Contracts:

With effect from April 1, 2003 all stock exchanges are following T+2 rolling settlement cycle. If the settlement is done by giving actual delivery of securities on receiving the price it is called liquidation in full. In another method the dealings are squared by adjusting price differences only.

Settlement of Forward Delivery Contracts:

The forward delivery contracts are done for speculative purposes. Only the active and broad market securities are traded in forward contracts.

The settlement of forward contracts can be done in any of the two ways:

1) Liquidation on full

2) Liquidation by payment of difference

Clearing & Settlement Process in Stock Markets:

As we all know, Stock Exchange is an entity which facilitates dealing in securities. Dealing in stock exchanges is done through registered members (also called brokers), who transact business primarily on behalf of their clients (or investors). For those who are actively involved in stock market trading, it’s always advisable to know the processes involved in it.

Clearing and Settlement activity constitutes the core part of equity trade life cycles. After any equity deal is confirmed (when equities are obliged to change hands), the broker who is involved in the transaction issues a Contract Note to the Investor which has all the information about the transactions in detail, at the end of the trade day. In response to the Contract Note issued by broker, the investor has to settle his obligation by either paying money (if his transaction is a buy transaction) or deliver the shares (if it is a sell transaction).

Clearing House is an entity of the stock exchange through which settlement of equities happens. The details of all transactions performed by the brokers are made available to the Clearing House by the Stock Exchange. The Clearing House gives an obligation report to Brokers and Custodians who are required to settle their money/securities obligations with the specified deadlines, failing which they are required to pay penalties. This obligation report serves as statement of mutual contentment.

Settlement Cycle is the period for which equities are traded in Exchange. For Indian stock exchange NSE, the cycle starts on Wednesday and ends on the following Tuesday, and for BSE the cycle starts on Monday and ends on Friday. At the end of this settlement cycle period, the obligations of each broker are calculated and the brokers then settle their respective obligations according to the guidelines, laws and regulations institutionalized by the Clearing agency.

Pay-In is a process whereby a stock broker and Custodian (in case of Institutional deals) bring in money and/or securities to the Clearing House. This forms the first phase of the settlement activity.

Pay-Out is a process where Clearing House pays money or delivers securities to the brokers and Custodians. This is the second phase of the settlement activity.

The whole set of money transaction is performed by a bank in the Stock Exchange premises. Exchange appoints this bank to handle the money part of the transaction.

All the above information is mostly in relation to the Indian Stock market. Sometimes in different countries processes may have some deviation from it, but the basic fundamentals behind the whole process remains same. In India, the Pay-in of securities and funds happens on T+ 2 by 11 AM, and Pay-out of securities and funds happen on T+2 by 3 PM.

Settlement Cycle:

The important settlement types are as follows:

(i) Normal segment (N)

(ii) Trade for trade Surveillance (W)

(iii) Retail Debt Market (D)

(iv) Limited Physical market (O)

(v) Non-cleared TT deals (Z)

(vi) Auction normal (A)

Trades in the settlement type N, W, D and A are settled in dematerialized mode. Trades under settlement type O are settled in physical form. Trades under settlement type Z are settled directly between the members and may be settled either in physical or dematerialized mode. Details of the two modes of settlement are as under.

Dematerialised Settlement:

NSCCL follows a T+2 rolling settlement cycle. For all trades executed on the T day, NSCCL determines the cumulative obligations of each member on the T+1 day and electronically transfers the data to Clearing Members (CMs). All trades concluded during a particular trading date are settled on a designated settlement day i.e. T+2 day. In case of short deliveries on the T+2 day in the normal segment, NSCCL conducts a buy in auction on the T+2 day itself and the settlement for the same is completed on the T+3 day, whereas in case of W segment there is a direct close out.

For arriving at the settlement day all intervening holidays, which include bank holidays, NSE holidays, Saturdays and Sundays are excluded. The settlement schedule for all the settlement types in the manner explained above is communicated to the market participants vide circular issued during the previous month.

Physical Settlement:

Limited physical Market:

To provide an exit route for small investors holding physical shares in securities the Exchange has provided a facility for such trading in physical shares not exceeding 500 shares in the ‘Limited Physical Market’ (small window).

Following are the salient features of limited physical market:

Salient Features of Limited Physical Market:

(i) Delivery of shares in street name and market delivery (clients holding physical shares purchased from the secondary market) is treated as bad delivery. The shares standing in the name of individuals/HUF only would constitute good delivery. The selling/delivering member must necessarily be the introducing member.

(ii) Any delivery of shares which bears the last transfer date on or after the introduction of the security for trading in the LP market is construed as bad delivery.

(iii) Any delivery in excess of 500 shares is marked as short and such deliveries are compulsorily closed-out.

(iv) Shortages, if any, are compulsorily closed-out at 20% over the actual traded price. Non-rectification/replacement for bad delivery is closed out at 10% over the’ actual trade price. Non-rectification/replacement for- objection cases are closed out at 20% above the official closing price in regular Market on the auction day.

(v) The buyer must compulsorily send the securities for transfer and dematerialisation, latest within 3 months from the date of pay-out.

(vi) Company objections arising out of such trading and settlement in this market are reported in the same manner as is currently being done for normal market segment. However securities would be accepted as valid company objection, only if the securities are lodged for transfer within 3 months from the date of pay-out.

Bad Deliveries (In Case of Physical Settlement):

Bad deliveries (deliveries which are prima facie defective) are required to be reported to the clearing house within two days from the receipt of documents. The delivering member is required to rectify these within two days. Un-rectified bad deliveries are assigned to auction on the next day.

Company Objections (In Case of Physical Settlement):

The CM on whom company objection is lodged has an opportunity to withdraw the objection if the objection is not valid or the documents are incomplete (i.e. not as required under guideline No. 100 or 109 of SEBI Good/Bad delivery guidelines), within 7 days of lodgment against him.

If the CM is unable to rectify/replace defective documents on or before 21 days, NSCCL conducts a buying-in auction for the non-rectified part of defective document on the next auction day through the trading system of NSE. All objections, which are not bought-in, are deemed closed out on the auction day at the closing price on the auction day plus 20%. This amount is credited to the receiving member’s account on the auction pay-out day.

Clearing and Settlement:

Clearing and settlement is the next phase in a transaction after trading. Rolling and settlement is followed for clearing and settlement. All actively traded scrips are held, traded and settled in demat form. The obligations of members are communicated to custodians by the clearing agency.

They make available the required securities in their pool accounts with Depository Participants (DP) by the prescribed pay in time for securities. The depository transfers the securities from the pool of accounts of custodians to the settlement account of the clearing agency.

As per the schedule determined by the clearing agency, the securities are transferred on the pay-out day by the depository from the settlement account of the clearing agency to the pool accounts of members/custodians. The pay in and pay out of securities is affected on the same day for all settlements.

The trading members are required to maintain account with banks selected by clearing agency for electronic transform of funds. When members are informed electronically about their pay in obligations of funds, they make available required funds in their accounts with clearing banks by the prescribed pay-in-day.

The clearing agency forwards funds obligations file to clearing banks which in turn debit the accounts of members and credit the account of the clearing agency. On the pay-out day the funds are transferred by the clearing banks from the account of clearing agency to the accounts of members as per member’s obligation. In the T+2 rolling settlement, the pay in and pay out of funds as well as securities takes place 2 working days after the trade date.

The core processes involved in the settlement process are:

(i) Determination of obligation of trading members by National Securities Clearing Corporation Ltd. (NSCCL)

(ii) The members make available the required securities/ Funds in the designated accounts with the clearing banks/depositories by the prescribed pay in time.

Upon the instruction of NSCCL clearing banks debit member’s account to the extent of payment obligations.

(iii) Settlement is complete upon release of payout funds and securities to custodian/ members. For pay-out of funds/securities the depositories and clearing banks debit accounts of NSCCL and Credit settlement accounts.

The NSCCL, with the help of clearing members, custodians, clearing banks and depositories settles the trades executed on exchange.