Introduction:

It is internationally acknowledged that payment and settlement systems should function on a

well-founded legal basis. This entails among other things, proper authorization requirement
for setting up and payment systems, legal recognition for netting, settlement finality,
providing for regulation and oversight of the payment and settlement systems. Many countries
have either provided for these requirements in their central bank statutes or have drafted
separate and comprehensive laws for this purpose.

In India where the economy is growing at a fast pace increasingly large volumes and values
are being handled by payment systems. Non-bank entities who are outside the explicit
regulatory purview of the central bank are running/ are likely to run important payment
systems. A number of innovative payment instruments/ systems have been introduced by
unregulated entities. While large payment systems which are unregulated present risks to the
stability of the financial systems, unauthorized retail payment systems without proper
management and operational structures can undermine public confidence in the efficacy of
the payment systems as a whole. The Reserve Bank and the Government felt that there should
be an explicit law to regulate the payment and settlement systems.

The Parliament has enacted the Payment and Settlement Systems Act in December 2007. This
Act empowers the Reserve Bank to regulate and supervise the payment and settlement
systems and provides a legal basis for multilateral netting and settlement finality. The Act
empowers the Reserve Bank to lay down the policies for regulation and supervision of the
payment and settlement systems, authorize their setting up/continuance, for issuing directions,
laying down standards, calling for information/data, initiating prosecution/levying penalties
for violation of the provisions of the Act, its regulations and directions etc. The Act will come
into operation very shortly.
Trading and Settlement Procedure:

1] Selecting a Broker or Sub-broker

When a person wishes to trade in the stock market, it cannot do so in his/her individual capacity.
The transactions can only occur through a broker or a sub-broker. So according to one’s
requirement, a broker must be appointed. Now such a broker can be an individual or
a partnership or a company or a financial institution (like banks). They must be registered under
SEBI. Once such a broker is appointed you can buy/sell shares on the stock exchange.

2] Opening a Demat Account

Since the reforms, all securities are now in electronic format. There are no issues of physical
shares/securities anymore. So, an investor must open a dematerialized account, i.e. a Demat
account to hold and trade in such electronic securities. So, you or your broker will open a Demat
account with the depository participant. Currently, in India, there are two depository participants,
namely Central Depository Services Ltd. (CDSL) and National Depository Services Ltd.
(NDSL).

3] Placing Orders

And then the investor will actually place an order to buy or sell shares. The order will be placed
with his broker, or the individual can transact online if the broker provides such services. One
thing of essential importance is that the order /instructions should be very clear. Example: Buy
100 shares of XYZ Co. for a price of Rs. 140/- or less. Then the broker will act according to your
transactions and place an order for the shares at the price mentioned or an even better price if
available. The broker will issue an order confirmation slip to the investor.

4] Execution of the Order

Once the broker receives the order from the investor, he executes it. Within 24 hours of this, the
broker must issue a Contract Note. This document contains all the information about the
transactions, like the number of shares transacted, the price, date and time of the transaction,
brokerage amount, etc. Contract Note is an important document. In the case of a legal dispute, it
is evidence of the transaction. It also contains the Unique Order Code assigned to it by the stock
exchange.

5] Settlement

Here the actual securities are transferred from the buyer to the seller. And the funds will also be
transferred. Here too the broker will deal with the transfer. There are two types of settlements,

• On the Spot settlement: Here we exchange the funds immediately and the settlement
follows the T+2 pattern. So, a transaction occurring on Monday will be settled by
Wednesday (by the second working day)

• Forward Settlement: Simply means both parties have decided the settlement will take
place on some future date. It can be T+% or T+9 etc.
SETTLEMENT OF TRADE IN DEMATERIALISED SECURITIES

The Depository System has facilitated paperless trading and settlement of dematerialised
securities. Now the time taken to complete transaction has shrunk drastically in favour of
investors. This chapter deals with the settlement related operating procedures that are to be
followed by the investors in depository environment. The chapter has been designed to
evaluate the effectiveness of the depository system with the help of survey results in terms of
eradicating the irritations of old system of transfer of securities in physical mode. Role of
depositories regarding preparedness of settlement of T+2 has been mentioned in this chapter.
Survey Results regarding operational problems in Market Transfers of settlement of trade has
been discussed. Why an investor is sometimes exposed to the risk of auction or square off?

Whether he himself is responsible for this because of any of his negligence or he suffers even
without his own negligence? These curiosities have been discussed with the help of survey
results based on Personal Interviews held with CMs. Precautions that should be taken care by
the investors while going for settlement of Market Trade and Off Market Trade has been
mentioned in the end of the chapter with the aim to enlighten investors and to safeguard him
against the losses because of his negligence. The chapter also recommends that some
privileged facilities should be provided to investors as are presently available for CMs as
clients of the DPs.

Depositories have nothing to do with trading of securities but execution of trading(settlement)

is not possible without depositories. Depositories provide basic service of transfer of
electronic securities from one account to another account on the instruction of the account
holder and thus they have helped in shrinking of settlement cycle. Every settlement of
transaction in securities market comprises two movements- portion relating to movement of
securities and the aspect relating to movement of funds. The depositories with their
constituents like DPs, Issuers/RTAs, facilitate shorter settlement cycles and faster electronic
movement of securities irrespective of geographical locations while movement of funds is
outside the scope of Depositories because Depositories are not registered with RBI (Reserve
Bank of India) as banking organizations.

For settlement of trades on the exchange, the depositories interact with the clearing
corporations 109 for delivery and receipt of net obligations. The CC/CH with its CMs, plays
a vital role in effecting the settlement of trades concluded on the respective stock exchange.
Depository does not move the securities from the delivering members (sellers) to the receiving
members (buyers) until the clearing corporation confirms that all funds have been received.
The clearing corporation is required to ensure that no participant, at any time, either receives
funds without delivering securities or receives securities without having paid funds. Thus
CC/CH ensures delivery vs. payment system with the help of depositories. Each CM is
required to open one CM A/c with a DP of his choice. This account enables the CM to receive
securities from its clients (selling investors) for delivery to the CC/CH as pay-in and to
distribute the pay -outs received from the CC/CH to clients (Buying investors).
Settlement of Trade in dematerialised securities

On the basis of process for buying and selling securities, settlement of trade can be bifurcated
into two parts:

(1) Market Transfers - Any settlement of trade that is cleared and settled by the CC/CH of
the exchange is considered as Market Transfer.

(2) Off Market Transfers- Any settlement of trade that is not cleared and settled by the CC/
CH of the exchange is considered as Off Market Transfer. (1) Market Transfers These
transfers are routed through the clearing members accounts opened with DPs.

A diagrammatic presentation of Market transfers can be made as under:

On the basis of above diagram, Market transfers can be divided under four legs of transactions
that are following:

A) Receiving securities for pay-in from clients (Selling investors to CMs)

B) Delivering securities to CC/CH for pay-in by CMs
C) Receiving pay-out from the CC/CH to the CMs
D) Distribution of pay- out to clients. (Clearing member to buying investors)

A) Receiving securities for pay-in from clients (Selling investors to CMs):

A selling client of a clearing member (broker) transfers securities from his beneficial owner
account to the clearing account of the clearing member for onward delivery to the CC/CH.
This transfer is affected by his DP on the basis of a delivery instruction or electronic
instruction provided by the selling client. Once the transfer is affected in the CM’s Pool
account by the DP of the seller, CM is required to track the securities which has been received
for pay-in. A CM can obtain such information 119 either from selling clients itself or its DPs
or by using Internet based facility of depositories to view the status of securities pay-in.
After tracking of securities received for pay-in, CM can issue Inter-Settlement Instructions to
his DP. In a CM Account, the securities are always kept in a bucket of specific settlement
number. The CM may have to move securities from one bucket with a different settlement
number to another bucket from where pay-in is to be affected. Securities can be transferred
only to a settlement whose deadline for pay-in is not complete. It means that securities can be
transferred only to a current or future settlement and not to an old settlement. SEBI has
advised the DPs to instruct their clients to submit the settlement instruction at least 24 hours
prior to the pay-in date.

B) Delivering securities to CC/CH for pay-in by CMs:

At the time of pay-in, the securities move from the clearing account of the CM to the CC/CH.
This movement is automatic if the CM has given such an undertaking to its CC/CH. Most of
the CMs give automatic instruction to deliver securities from pool accounts to the CC account
via delivery account. However, even if the CM has given such an undertaking it may have to
submit a separate delivery instruction form in the following cases:

• Non pari-passu securities

• If the CM desires to deliver securities other that the instructions automatically generated
based on instruction received from the CC/CH in case of short of delivery in any securities.

From the CM Pool account, securities move to CC/CH via CM delivery Account. In the
delivery account, securities are readily available for delivery to CC. If the securities available
in the relevant bucket in the CM delivery account is less than the securities to be delivered,
then at the time of settlement, the securities to the extent available in the bucket would be
transferred. The instruction for the full quantity would not be rejected. It means there is facility
of part pay-in of securities in CM’s account. The short securities are settled through auctions
latter on.

C) Receiving pay-out from the CC/CH to the CMs:

The pay- out is declared and distributed by the CC/CH. The CM will automatically receive
120 pay-outs in its pool account via its receipt account. CM is not required to submit any
instruction to its DP for this purpose.
The statement of account provided by the DP of CM contains the details of the pay-out to the
investors. This can also be viewed on the Internet using facility of depositories in case CM
has registered himself for this facility.

D) Distribution of pay- out to clients (Clearing member to buying investors):

After pay-out of securities by the CC/CH the CM delivers securities from its clearing account
to the beneficial owner account of the buying client. This transfer is effected by its DP on the
basis of a delivery instruction provided by the CM. For this purpose, CM can take a print-out
of the details of its receiving clients from its back office software
The following penal charges are levied for failure to pay funds/ settlement obligations:

Penal Charges

A penal charge will be levied on the amount in default as per the byelaws relating to failure
to meet obligations by any Clearing Member.

Penalty Charge per

Type of Default day Chargeable to
Overnight settlement shortage of value more Clearing
than Rs.5 lakhs 0.07% Member
Clearing
Security deposit shortage 0.07% Member
Clearing
Shortage of Capital cushion 0.07% Members

Violations if any by the custodial participants shall be treated in line

with those by the trading member and accordingly action shall be initiated against the
concerned clearing member.

Short Reporting of Margins in Client Margin Reporting Files

The following penalty shall be levied in case of short reporting by trading/clearing member
per instance.

Short collection for each client Penalty percentage

(< Rs 1 lakh) And (< 10% of applicable margin) 0.5%
(= Rs 1 lakh) Or (= 10% of applicable margin) 1.0%

If short/non-collection of margins for a client continues for more than 3 consecutive days,
then penalty of 5% of the shortfall amount shall be levied for each day of continued shortfall
beyond the 3rd day of shortfall.

If short/non-collection of margins for a client takes place for more than 5 days in a month,
then penalty of 5% of the shortfall amount shall be levied for each day, during the month,
beyond the 5th day of shortfall.

Notwithstanding the above, if short collection of margin from clients is caused due to
movement of 3% or more in the Nifty 50 (close to close) on a given day, (day T), then the
penalty for short collection shall be imposed only if the shortfall continues to T+2 day.
All instances of non-reporting are treated as 100% short reporting for the purpose of levy of
penalty.
Penalty and penal charges for margin/limit violation:

Penalty for margin / limit violation is levied on a monthly basis based on slabs as mentioned
below or such other amount as specified by the Clearing Corporation from time to time.

Instances of
Disablement Penalty to be levied
1st instance 0.07% per day
2nd to 5th instance of
disablement 0.07% per day + Rs.5,000/- per instance from 2nd to 5th instance
6th to 10th instance of 0.07% per day + Rs.20,000/- (for 2nd to 5th instance) +
disablement Rs.10000/- per instance from 6th to 10th instance
0.07% per day + Rs.70,000/- (for 2nd to 10th instance) +
Rs.10,000/- per instance from 11th instance onwards.
Additionally, the member will be referred to the Disciplinary
11th instance onwards Action Committee for suitable action.

Instances as mentioned above refer to all disablements during market hours in a calendar
month. The penal charge of 0.07% per day is applicable on all disablements due to margin
violation anytime during the day.

FII/Mutual Fund position limit violation:

In case of violation of FII/Mutual Fund limits a penalty of Rs. 5,000/- would be levied for
each instance of violation.

Client wise/NRI/sub account of FII/scheme of MF position limit violation:

In case of open position of any Client/NRI/sub-account of FII/scheme of MF exceeding the

specified limit following penalty would be charged on the clearing member for each day of
violation. 1% of the value of the quantity in violation (i.e. excess quantity over the allowed
quantity, valued at the closing price of the security in the normal market of the Capital
Market segment of the Exchange) per client or Rs.1,00,000 per client, whichever is lower,
subject to a minimum penalty of Rs.5,000/- per violation / per client.

When the client level/NRI/sub-account of FII/scheme of mutual fund violation is on account

of open position exceeding 5% of the open interest, a penalty of Rs.5000 per instance would
be levied to the clearing member.

Market wide Position Limit violation:

At the end of each day during which the ban on fresh positions is in force for any security,
when any member or client has increased his existing positions or has created a new
position in that security the client/trading members will be subject to a penalty 1% of the
value of increased position subject to a minimum of Rs.5000 and maximum of Rs.100000.
The positions for this purpose will be valued at the underlying close price.
Risks In equity investment:
Although an equity investment is the most rewarding in terms of returns generated, certain
risks are essential to understand before venturing into the world of equity.

❖ Market/ Economy Risk.

❖ Industry Risk.
❖ Management Risk.
❖ Business Risk.
❖ Financial Risk
❖ Exchange Rate Risk.
❖ Inflation Risk.
❖ Interest Rate Risk.

How to overcome risks:

Most risks associated with investments in shares can be reduced by using the tool of
diversification. Purchasing shares of different companies and creating a diversified portfolio
has proven to be one of the most reliable tools of risk reduction.

The process of Diversification:

When you hold shares in a single company, you run the risk of a large magnitude. As your
portfolio expands to include shares of more companies; the company specific risk reduces.
The benefits of creating a well diversified portfolio can be gauged from the fact that as you
add more shares to your portfolio, the weightage of each company’s share gets reduced. Hence
any adverse event related to any one company would not expose you to immense risk. The
same logic can be extended to a sector or an industry. In fact, diversifying across sectors and
industries reaps the real benefits of diversification. Sector specific risks get minimised when
shares of other sectors are added to the portfolio. This is because a recession or a downtrend
is not seen in all sectors together at the same time.

However, all risks cannot be reduced:

Though it is possible to reduce risk, the process of equity investing itself comes with certain
inherent risks, which cannot be reduced by strategies such as diversification. These risks are
called systematic risk as they arise from the system, such as interest rate risk and inflation
risk. As these risks cannot be diversified, theoretically, investors are rewarded for taking
systematic risks for equity investment.

Selection of Shares:
Proper selections of shares are of two types:

1.Fundamental analysis:

It involves in depth study and analysis of the prospective company whose shares we want to
buy, the industry it operates in and the overall market scenario. It can be done by reading and
assessing the company’s annual reports, research reports published by equity research houses,
research analysis published by the media and discussions with the company’s management or
the other experienced investors.
2.Technical analysis:

It involves studying the prices movement of the stock over an extended period of time in the
past to judge the trend of the future price movement. It can be done by software programs,
which generate stock prices charts indicating upward. Downward and sideways movements
of the stock price over the stipulated time period.

When to buy & sell shares:

With high volatility prevailing in the market, major price fluctuations in equities are not
uncommon. Therefore, apart from ascertaining ‘which’ stock to buy or sell, it becomes
equally important to consider ‘when’ to buy or sell. Any investor should be aware of the fact
where all the investor is following i.e. Buy Low, Sell High. That means we should buy stocks
at a low price and sell them at a high price.
Currency Derivatives as a tool for Currency Risk Management:

A currency derivative is derivatives contract where the underlying asset is a currency. Among
currency derivatives, currency future is the most efficient and effective tools for currency risk
management. Various risks related to the exchange rate volatility (currency risk) can be
managed with the help of currency derivatives. Let us now consider each type of currency
derivatives separately as below:

A. Currency Swaps:

As the name signifies, currency risk is a risk that involves exchange rates. It occurs when
transactions are done in foreign currency and the main reason for it is the volatility in the
exchange rates. Currency swaps were first introduced in 1970s in the United Kingdom. It was
the time when the UK companies had to pay a premium to borrow in US Dollars. Later, they
found a solution for this. UK companies set up back-to-back loan agreements with US
companies wishing to borrow Sterling. A currency swap is a foreign exchange agreement
between two parties to exchange the principal or the interest of a loan in one currency for
equivalent the principal or the interest of an equal in net present value loan in another
currency.

Suppose a person holds a debt in one currency, he can exchange it with another person who
holds a debt in a different currency. The parties exchange no cash initially but they are entitled
to exchange future cash flows. Globalization has led to the necessity of currency swaps in
order to mitigate the currency risk involved in international transactions. A company which
intends to invest in foreign markets will also need to finance its operations with foreign
currency. Thus, in order to mitigate the currency risk, currency swaps will necessarily be
useful. A firm involved in such activities globally, can use currency swaps by borrowing in a
domestic currency and then swapping it to a foreign currency.

Currency swaps with a longer maturity, helps the firms easily achieve the risk management
objectives. I order to understand more clearly let us go through an example. A company based
in India has its branch situated in USA. For the operations in USA, the company will
necessarily need US Dollars. In order to meet out its needs, the company will have to borrow
US currency and accordingly pay interest on such loan. In this case there will be an exposure
to currency risk. Suppose, another company based in USA has its branch in India. This
company will need INR in order to operate its branch in India. This company, too, will face
the exposure to currency risk. If both the companies enter into an agreement of currency
swapping, they will be able to manage their currency risk. This can be done in two ways:
Firstly, if the companies have already borrowed in the currencies each needs the principal in;
they can agree to swap the cash flows only, so that each company's finance cost is in that
company's domestic currency. Secondly, the companies could borrow in their own domestic
currencies and then get the principal in the currency they desire by agreeing to swap only the
principal amount of the loan. However, the second option is possible only if they have some
comparative advantage. However, through this instrument, one finances its activities with its
domestic currency and a currency swap and thus, is able to reduce the cost that would have
been incurred in case it had used only the foreign currency.
 B. Forward Contracts:

A forward contract is a non-standardized contract between two parties to buy or sell an

underlying asset at a specified future time at a price agreed upon today. Investopedia defines
a forward contract as a cash market transaction in which delivery of the commodity is deferred
until after the contract has been made. Although the delivery is made in the future, the price
is determined on the initial trade date. Forward contracts are traded on the over-the-counter
exchange. A currency forward contract is a contract between two parties where the exchange
of currencies would take place at a future date at a rate of exchange decided upon at the time
of agreement. The sole idea of entering a forward contract is to avoid exchange rate risk. A
company that has invested or borrowed in foreign currency will definitely face the exchange
rate risk.

Suppose a firm intends to purchase machinery for US $5000 from another firm after three
months. If the exchange rate currently is Rs. 45/$, his purchase amount is Rs. 2,25,000/- and
if after three months the exchange rate be Rs. 50/$ then the firm though pays $5000 but this
costs to Rs. 2,50,000/- thus, Rs. 25,000/- is the loss to him due to exchange rate volatility. In
order to mitigate this loss, the firm can opt to buy a 3 months forward contract with a bank.
With this forward contract, on the date of maturity the firm will pay Rs. 2,25,000/- to the bank
and the bank will pay to the firm $5000 which it will then pay to the seller. In this way, the
firm would be able to mitigate its loss of Rs.25,000/- that would have been occurred if no
forward contract was used for hedging the risk.

C. Futures Contracts:

A futures contract is a standardized form of forwards contracts. Currency futures are

exchange traded financial derivatives contracts. A Futures contract is a standardized contract
between two parties to buy or sell a specified asset of standardized quantity and quality for a
price agreed upon today with delivery and payment occurring at a specified future date, the
delivery date. Where the specified asset is an exchange rate, it is referred to as a currency
future. A currency future is a futures contract to exchange one currency for another at a
specified date in the future at a price (exchange rate) that is fixed on the purchase date.
Currency futures have significantly gained importance all over the world since the first
currency futures contract was traded in the year 1972.

Since the, currency futures is most significantly used as a risk management tool by the
hedgers. It is also used for speculation. Currency futures are safer than forward contracts
because forward contracts holds counter-party risk because of unavailability of clearing
houses; in case of currency futures, initial margins are held from both parties and so the risk
of counter-party denying the contract on maturity is eliminated.
 D. Options Contracts:

Option is a derivative contract between two people where one person grants the other person
the right to buy or sell a specific asset at a specific price within a specific time period, without
an obligation. The person, who has received the right must pay for this right as premium is
known as option buyer. The person who has sold the right and received the premium is known
as option writer.

There are two types of options:

Call option & Put option.
A call option is an option that gives the buyer the right to buy a specific asset at specified
price within a specified price without an obligation.
A put option is an option that gives the buyer the right to sell a specific asset at specified price
within a specified price without an obligation. A currency option is such an option where the
specified asset is a currency. A firm or financial institution that is to receive some payments
in foreign currency may purchase a currency put option. In case the foreign currency
depreciates, the put option will be exercised so that the firm gets its expected amount
unchanged and the loss is, thus, averted. In case the foreign currency appreciates, the firm will
not exercise the put option and will, thus, reap the benefits of the increased yields and that
too, at a cost of the contract premium. In this way, the firm will be able to mitigate its currency
risk by hedging in currency options.

Currency Risk Management Process using Currency Futures

We have already discussed the four derivatives that could help mitigate the currency risk.
Currency futures are the most efficient and effective tool for hedging currency risk. Currency
risks can be managed with the help of an appropriate hedging strategy. Let us now discuss the
most essential two steps in considering a hedging strategy:

• Assess the amount of currency risk exposure:

The first and foremost thing that must be carefully assessed while hedging currency
risk is the amount of risk exposure.

• Determination of hedge ratio:

The hedge ratio is very simple to be determined. It is just the linear function of the
value of the risk exposure relative to the futures contract size. It can be arrived at by
the following equation:

Hedge Ratio = Value of risk exposure / Futures contract size

Conclusion:

In India where the economy is developing at a quick pace progressively enormous volumes
and qualities are being taken care of by installment frameworks. Non-bank substances who
are outside the unequivocal administrative domain of the national bank are running/are
probably going to run significant installment frameworks. Various imaginative installment
instruments/frameworks have been presented by unregulated elements. While huge
installment frameworks which are unregulated present dangers to the solidness of the
budgetary frameworks, unapproved retail installment frameworks without appropriate
administration and operational structures can undermine open trust in the adequacy of the
installment frameworks all in all. The Reserve Bank and the Government felt that there ought
to be an express law to control the installment and settlement frameworks.

It is globally recognized that instalment and settlement frameworks should work on a well-
established lawful premise. This involves in addition to other things, legitimate approval
prerequisite for setting up and installment frameworks, lawful acknowledgment for mesh,
settlement absolution, accommodating guideline and oversight of the installment and
settlement frameworks. Numerous nations have either accommodated these prerequisites in
their national bank resolutions or have drafted independent and thorough laws for this reason.

The Parliament has authorized the Payment and Settlement Systems Act in December 2007.
This Act enables the Reserve Bank to manage and administer the installment and settlement
frameworks and gives a lawful premise to multilateral netting and settlement irrevocability.
The Act engages the Reserve Bank to set out the approaches for guideline and supervision of
the installment and settlement frameworks, approve their setting up/duration, for giving
bearings, setting down models, calling for data/information, starting indictment/imposing
punishments for infringement of the arrangements of the Act, its guidelines and headings and
so forth. The Act will come into activity quickly.
References

✔ www.nseindia.com
✔ www.bseindia.com
✔ www.religaresecurities.com
✔ www.moneycontrol.com
✔ www.indiamart.com