INTRODUCTION TO CLEARING AND SETTLEMENT SYSTEM

Clearing Members

• Types of Clearing Members: There are three types of clearing members:
  • Self-clearing member: Clears and settles trades executed by them only, either on their own account or on account of their clients.
  • Trading member–cum–clearing member: Clears and settles their own trades as well as trades of other trading members and custodial participants.
  • Professional clearing member: Clears and settles trades executed by trading members.
• Key Functions of Clearing Members:
  • Clearing: Computing obligations of all his trading members, i.e., determining positions to settle.
  • Settlement: Performing actual settlement.
  • Risk Management: Setting position limits based on upfront deposits / margins for each TM and monitoring positions on a continuous basis.
• Clearing Banks: Funds settlement takes place through clearing banks, and all clearing members are required to open a separate bank account with the Clearing Corporation's designated clearing bank for the F&O segment.
• Clearing Member Eligibility Norms:
  • Net-worth: At least Rs.300 lakhs (Rs. 100 lakhs for a Clearing Member who clears and settles only deals executed by him).
  • Security Deposit: Rs. 50 lakhs to the clearing corporation.
  • Additional Deposits: Rs.10 lakhs for each additional TM, in case the Clearing Member undertakes to clear and settle deals for other TMs.

Clearing Mechanism

• Definition: The clearing mechanism is the process of calculating open positions and obligations of clearing members.
• Details: It involves aggregating open positions of all trading members (TMs) and custodial participants (CPs) clearing through a clearing member (CM) for each contract traded.

Key Concepts in Clearing Mechanism

• Open Position Calculation: A TM's open position is calculated by adding up their proprietary open position and clients' open positions for each contract traded.
• Proprietary Position: Calculated on a net basis (buy - sell) for each contract.
• Client Position: Calculated by summing together net positions of each individual client.
• Clearing Member's Open Position: Arrived at by adding long positions and short positions of all TMs and CPs clearing through them.

Example of Open Position Calculation

• Consider a clearing member 'A' with two TMs 'PQR' and 'XYZ' clearing through them.
• Calculation Steps:
  • Calculate proprietary and client positions for each TM.
  • Calculate net positions for each client.
  • Add up proprietary and client positions to get the TM's open position.
  • Add up open positions of all TMs to get the clearing member's open position.
• Example Output:
  • Clearing member A's open position for Nifty May contract: 6000 long positions and 2000 short positions.

Interoperability of Clearing Corporations

• Definition: Interoperability amongst clearing corporations refers to the ability of trades done on any exchange to be cleared and settled by the clearing corporation of any other exchange.
• Details: This framework was proposed by SEBI in 2018 and implemented in 2019, allowing brokers to choose a single clearing corporation for all their trades, regardless of the exchange on which they are executed.

Benefits of Interoperability

• Reduced Trading Costs: Market participants now only need to maintain margins and collaterals with a single clearing corporation, leading to better utilization of capital resources.
• Simplified Operations: Brokers only need to comply with the requirements of a single clearing corporation, simplifying their operations.
• Increased Competition: Brokers can choose the clearing corporation of their choice, promoting healthy competition among clearing corporations and potentially leading to improved pricing of their services.
• Risk Management: In case of a trading disruption at any exchange or a disruption of the link between an exchange and its clearing house, brokers can still route their trades to other clearing corporations, ensuring that clearing and settlement of trades are not affected.

Example of Interoperability

• Net Position Calculation: If a client has a long position in 10 lots of SBI May futures on NSE and a short position in 6 lots of the same contract on BSE, the net position will be determined as “long 4 contracts” and margin will be computed accordingly, demonstrating the efficiency of interoperability in managing positions across different exchanges.

Risk Management

• Definition: Risk management in the derivatives segment refers to the comprehensive risk containment mechanism used by exchanges with the help of Clearing Corporations.
• Details: The key features of risk containment measures in the F&O segment include:
  • Capital Adequacy: Stringent requirements of capital adequacy for membership help in risk management by ensuring the financial strength of a member.
  • Initial Margin: Clearing corporation charges an upfront initial margin for all open positions of a Clearing Member (CM), which is specified on a daily basis and follows Value-At-Risk (VaR) based margining.
  • Mark-to-Market (MTM) Settlement: Open positions of members are settled on an MTM basis for each contract at the end of the day.
  • Online Position Monitoring: Clearing corporation's online position monitoring system monitors a CM's open position on a real-time basis, setting limits and generating alert messages when pre-determined benchmarks are reached.
  • Margining System: The margining system is a critical component of risk containment, with actual position monitoring and margining carried out online using the SPAN® (Standard Portfolio Analysis of Risk) system.
  • Trading Terminal: A trading terminal helps CMs monitor open positions of all TMs clearing and settling through them, allowing CMs to set limits and stopping TMs from further trading when limits are exceeded.

Margining and Mark to Market under SPAN

• Definition: SPAN (Standard Portfolio Analysis of Risk) is a risk management and margining product designed by Chicago Mercantile Exchange (CME) to manage risk efficiently in the Indian securities market.
• Details: The objective of SPAN is to identify overall potential risk in a portfolio and determine the largest possible loss that a portfolio might reasonably be expected to suffer from one day to the next.

Key Concepts

• Initial Margin: Computed by the clearing corporation up to client level with the help of SPAN, and collected by the Clearing Member based on the margins computed.
• Premium Margin: Charged at the client level, includes premium amount due to be paid to the Clearing Corporation towards premium settlement.
• Assignment Margin: Required to be paid on assigned positions of Clearing Members towards final exercise settlement obligations for option contracts on individual securities.
• Intra-day Crystallised Losses (ICMTM): Computed for all trades which are executed and result into closing out of open positions, and is part of initial margin.
• Delivery Margins: Levied on lower of potential deliverable positions or in-the-money long option positions, four days prior to expiry of derivative contracts.
• Exposure Margins: The VaR and Extreme Loss percentage as computed in the Capital Market segment are applied on client level settlement obligations.
• Peak Margin Obligation: Introduced by SEBI to strengthen risk management by brokers, requires clearing corporations to send a minimum of 4 snapshots of client-wise margin requirement to TMs/CMs.
• Cross Margin: Available across Cash and Derivatives segment, allows clients to offset their positions in both segments.
• Early Pay-in of Securities and Funds: Exempts positions from delivery margins, and allows clearing members to make early pay-in of securities through depositories.
• Mechanism for Pledge/Repledge of Client Securities: Introduced by SEBI to curb misappropriation or diversion of client securities by brokers, requires clients to provide collateral for margin purposes only through a margin pledge.
• Segregation and Monitoring of Collateral at the Client Level: Requires TMs and CMs to report disaggregated information on collaterals received by them at the client level, to provide clear visibility of client-wise collateral at all levels.

Violations and Penalties

• Definition: Non-compliance of any provisions of the Rules, Bye-laws and Regulations by any clearing member or trading member is treated as a violation and attracts appropriate action which includes penalties.
• Details: The following are some of the compliance lapses which attract such penal charges:
  • Non-fulfilment of initial margin obligations
  • Non-fulfilment of settlement obligation
  • Non-fulfilment of securities deliverable obligation
  • Non-fulfilment of minimum deposit requirements
  • Exposure margin violation
  • Position limit violation
  • Mis-utilisation of trading member/constituent/client collaterals and deposits
  • Violation of exercised positions
  • Short or non-reporting of client margin
  • Market wide Position Limit (MWPL) violation

Consequences of Violations

• Action by Clearing Corporation: In the event of a violation, the Clearing Corporation may advise the Exchanges to withdraw any or all of the membership rights of the clearing member including the withdrawal of trading facilities of all trading members and/or clearing facility of custodial participants clearing through such clearing members, without any notice.
• Additional Measures: The Clearing Corporation can also take additional measures like:
  • Imposing penalties
  • Collecting appropriate deposits
  • Invoking bank guarantees or fixed deposit receipts
  • Realising money by disposing off the securities
  • Closing out the outstanding positions of such clearing member and/or trading members clearing and settling through such clearing member, which shall be final and binding on the clearing member and/or trading member.

Settlement of Running Account of Client's Funds

• Definition: Settlement of running account refers to the process of reconciling and settling the client's funds held by the Trading Member (TM) on a regular basis.
• Details: The settlement is done to prevent misuse of client funds by brokers, as mandated by SEBI.

Key Concepts

• Settlement Frequency: The settlement of running accounts can be done on a monthly or quarterly basis, as per the client's preference.
• Settlement Dates: The Stock Exchanges jointly issue an annual calendar for the settlement of running accounts at the beginning of the financial year, ensuring uniformity and clarity on dates.
• Credit Balance: For clients with a credit balance who have not done any transactions in the last 30 calendar days, the entire credit balance shall be returned to the client by the TM on the upcoming settlement dates of the monthly running account settlement cycle.
• Transaction After 30 Days: If a client trades after 30 calendar days and before the upcoming settlement dates, the settlement of the account shall continue to be done as per the client's preferred quarterly/monthly settlement cycle.

5. Cyber Security & Cyber Resilience framework (CSCRF) for Stock Brokers / Depository Participants

• Definition: The Cyber Security and Cyber Resilience Framework (CSCRF) is a set of measures, tools, and processes designed to prevent cyber-attacks and improve cyber resilience in the securities market.
• Details: The framework is based on 5 cyber resiliency goals:
  • Anticipate: Maintain a state of informed preparedness from adversary attacks.
  • Withstand: Continue essential business functions at times of adversary attacks.
  • Contain: Localize containment of crisis and isolate trusted functions from untrusted ones to continue business operations.
  • Recover: Restore business functions to the maximum extent, subsequent to adversary attacks.
  • Evolve: Change business functions and its supporting cyber capabilities to minimize adverse impacts of adversary attacks (actual or predicted).
• SEBI Regulated Entities (REs): The CSCRF applies to REs, including:
  • Stock Exchanges
  • Depositories
  • Clearing Corporations
  • KYC Registration Agencies (KRAs)
  • Qualified Registrars and Transfer Agents (QRTAs)
• Cyber Resilience: An organization's ability to prepare and respond to a cyber-attack and to continue operation during, and recover from, a cyber-attack.
• Key Objective: The key objective of CSCRF is to address evolving cyber threats, align with industry standards, encourage efficient audits, and ensure compliance by SEBI Regulated entities.