NISM Series VIII: Equity Derivatives | Chapter 7: Clearing and Settlement | Full Study Notes

CHAPTER 7: CLEARING AND SETTLEMENT SYSTEM

7.1 INTRODUCTION

The Clearing Corporation acts as a legal counterparty to all trades and guarantees their financial settlement. Clearing and settlement in the F&O segment are managed by the Clearing Corporation with support from Clearing Members and Clearing Banks.

Key Entities

  • Clearing Members (CM): Handle clearing and settlement for Trading Members. They determine positions to settle, perform actual settlement, and manage risk by setting position limits.

  • Clearing Banks: Fund settlement occurs through Clearing Banks. CMs must open a separate account with a Clearing Corporation-designated bank.

Clearing Member Eligibility Norms

  1. Net-worth: Rs. 300 lakhs for those handling deals for others; Rs. 100 lakhs if only handling their own deals.

  2. Security Deposit: Rs. 50 lakhs to the Clearing Corporation.

  3. Incremental Deposit: Rs. 10 lakhs for each additional Trading Member (TM) they clear for.

7.2 CLEARING MECHANISM

Calculates and aggregates open positions of all TMs and participants under a CM.

  • Proprietary trades: Netted (buy-minus-sell).

  • Client trades: Summed per client.

7.3 INTEROPERABILITY

Implemented in 2019, this framework allows trades on any exchange to be cleared and settled by any clearing corporation.

  • Advantages: Lower trading costs, efficient capital use (consolidated margins), and simplified compliance.

7.4 SETTLEMENT MECHANISM

(A) Mark-to-Market (MTM) Settlement

  • Calculation: Difference between trade price and the day's settlement price.

  • Futures Price: Based on the last 30 minutes volume-weighted average price.

  • Timing: Pay-in and pay-out occur in cash before market hours on T+1 day.

(B) Final Settlement

  • Cash-Settled Futures: All positions marked to the final settlement price on the last trading day.

  • Physically Settled Futures: Settlement occurs on T+1. Long futures result in receiving securities; short futures result in delivering securities.

Example: Stock Futures Final Settlement

Client Mr. XYZ (Long 1 lot, 1500 shares) at expiry:

  • Final Price: Rs. 475 | Prev Day Price: Rs. 482.

  • MTM Payout: (475 - 482) × 1500 = Rs. 10,500 (Payable by Mr. XYZ).

  • Physical Obligation: Must buy 1500 shares at Rs. 475 (Total: Rs. 7,12,500) on T+2.

Options Settlement

  1. Daily Premium Settlement: Buyer pays and seller receives premium on T+1.

  2. Final Exercise Settlement:

    • Index Options: European style; cash-settled based on intrinsic value on T+1.

    • Stock Options: European style; settled by physical delivery of shares on T+2.

      • Long Call: Buyer receives shares.

      • Long Put: Buyer delivers shares.

7.5 RISK MANAGEMENT & MARGINING

The SPAN® (Standard Portfolio Analysis of Risk) system is used for real-time margin computation.

Types of Margins

  • Initial Margin: Upfront payment based on a 99% Value-at-Risk (VaR).

  • Premium Margin: Covers unpaid premiums at the client level.

  • Assignment Margin: Covers final settlement obligations for assigned options.

  • Intra-day Crystallised Losses (ICMTM): Computed for trades closing out open futures positions during the day.

  • Delivery Margin: Additional funds required starting 4 days before expiry for positions to be delivered (staggered from 20% to 80%).

  • Exposure Margin: Additional funds based on VaR and Extreme Loss percentages.

Margin Collection

  • Peak Margins: Introduced Dec 1, 2020. Margins are collected at multiple points throughout the day to control leverage.

  • Net Option Value: Difference between long and short options; added to CM's Liquid Net Worth.

7.6 POSITION LIMITS

Limits prevent market manipulation:

  1. Client-Level: For individual stocks, the higher of 1% of free float market cap or 5% of open interest.

  2. Market-Wide Position Limit (MWPL): 20% of a company's free float.

    • Alerts at 60%; no new positions allowed if over 95%.

7.7 VIOLATIONS & PENALTIES

Common lapses leading to penalties (fines or withdrawal of trading rights):

  • Failing securities delivery or margin obligations.

  • Violating MWPL or exposure limits.

  • Misusing client collaterals.

7.8 SETTLEMENT GUARANTEE FUND (SGF)

  • Core SGF: Ensures trades are settled if a member defaults.

  • Investor Protection Fund: Compensates investors for defaulting member assets and promotes education.

Dhaval Visariya

AMFI Registered Distributor (ARN-327925) | Software Developer & Finance Enthusiast

Connect with me:
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Disclaimer: I am an AMFI Registered Mutual Fund Distributor. Views expressed here are for educational purposes. Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
📧 Contact: info.apollofinancialservices@gmail.com

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