Unit -II Unit II- Trading and Settlement System in Stock Exchanges.pdf

Stock Market Operation
Master of Commerce, RCUB.
Mr. Mustaq Mulla, SRFGCC, RCU, Belagavi
1
Unit II
Trading and Settlement System in Stock Exchanges
• Listing of Securities:
o Meaning, Merits and Demerits
o Listing Requirements
o Listing Procedure
o Listing Conditions of BSE and NSE
o De-listing
• Indian Stock Exchanges:
o BSE – Different Trading Systems
o Share Groups on BSE
o BOLT System
• Settlement System:
o Different Types of Settlements
o Pay-in and Pay-out
o Bad and Short Delivery
o Auction
• NSE:
o Market Segments
o NEAT System Options
o Market Types, Order Types and Order Books
• Settlement Mechanism:
o Demat Settlement
o Physical Settlement

2
o Institutional Segment
o Funds Settlement
o Valuation Debit
o Valuation Price
o Bad and Short Delivery
o Auction
Meaning of Listing of Securities
Listing of securities refers to the admission of a company's securities (such as shares, bonds,
or debentures) to trading on a recognized stock exchange. It's a formal process where a
company applies to a stock exchange, provides detailed information about its operations
and financial health, and agrees to comply with the exchange's rules and regulations. Once
approved, the company's securities can be bought and sold by investors on that exchange.
In essence, listing is like getting a "seal of approval" from the stock exchange, indicating
that the company meets certain standards of corporate governance, financial stability, and
transparency. This seal of approval can significantly enhance a company's reputation and
attract investors.
Merits of Listing of Securities
For the Company:
• Increased Access to Capital: Listing provides access to a larger pool of investors,
making it easier for the company to raise capital through the issuance of new shares
or other securities. This capital can be used for expansion, research and
development, acquisitions, or debt repayment.
• Enhanced Company Image and Reputation: Listing on a reputable stock exchange
enhances the company's visibility, credibility, and prestige. It signals to the market
that the company is well-managed, financially sound, and committed to
transparency.

3
• Improved Liquidity of Securities: Listed securities are generally more liquid than
unlisted securities, meaning they can be bought and sold more easily and quickly.
This increased liquidity makes the securities more attractive to investors.
• Facilitates Mergers and Acquisitions: A listed company's shares can be used as
currency in mergers and acquisitions, making it easier to acquire other companies
or be acquired itself.
• Employee Stock Options (ESOPs): Listing makes it easier to implement employee
stock option plans, which can be a powerful tool for attracting, retaining, and
motivating employees.
• Valuation Benchmark: The market price of listed securities provides a benchmark
for valuing the company, which can be useful for various purposes, such as raising
capital, attracting investors, and assessing performance.
For Investors:
• Increased Liquidity: Listed securities can be easily bought and sold on the stock
exchange, providing investors with liquidity and flexibility.
• Transparency and Information: Listed companies are required to disclose a
significant amount of information about their operations and financial performance,
providing investors with greater transparency and enabling them to make more
informed investment decisions.
• Price Discovery: The stock exchange provides a platform for price discovery, where
the forces of supply and demand determine the fair market value of the securities.
• Investor Protection: Stock exchanges have rules and regulations in place to protect
investors from fraud and manipulation.
• Opportunity for Capital Appreciation: Investing in listed securities offers the
potential for capital appreciation as the company grows and its share price increases.
• Diversification: Listing provides investors with a wider range of investment
options, allowing them to diversify their portfolios and reduce risk.

4
Demerits of Listing of Securities
For the Company:
• Compliance Costs: Listed companies face significant compliance costs associated
with meeting the exchange's reporting requirements, corporate governance
standards, and other regulations.
• Increased Scrutiny: Listed companies are subject to increased scrutiny from
investors, analysts, and the media, which can put pressure on management to deliver
short-term results.
• Loss of Control: Listing can dilute the control of existing shareholders, as new
shareholders are brought in.
• Exposure to Market Volatility: The price of listed securities can be volatile and
subject to market fluctuations, which can be unsettling for management and
shareholders.
• Risk of Hostile Takeover: A listed company is more vulnerable to a hostile takeover
attempt, as its shares are publicly traded.
• Disclosure of Sensitive Information: Listing requires companies to disclose
sensitive information about their operations and financial performance, which could
be used by competitors.
For Investors:
• Market Volatility: The price of listed securities can be volatile and subject to market
fluctuations, which can lead to losses for investors.
• Information Overload: The amount of information available about listed companies
can be overwhelming for investors, making it difficult to make informed decisions.
• Risk of Fraud and Manipulation: Although stock exchanges have rules and
regulations in place to protect investors, there is still a risk of fraud and
manipulation.

5
• Company Specific Risks: Even listed companies can face financial difficulties or
go bankrupt, leading to losses for investors.
Listing Requirements
Listing requirements are the eligibility criteria that a company must meet to have its
securities listed on a stock exchange. These requirements are designed to ensure that only
companies with a sound financial position, good corporate governance practices, and
growth potential are listed, thereby protecting investor interests. The specific requirements
may vary slightly between the BSE and NSE, but the core principles remain consistent.
Common Listing Requirements for BSE and NSE:
1. Paid-up Capital: The company must have a minimum prescribed paid-up capital.
This requirement ensures that the company has a sufficient equity base. The exact
amount varies and is subject to change based on regulatory updates. Refer to the
latest circulars from BSE and NSE for the specific figures.
2. Market Capitalization: A minimum market capitalization is required. This reflects
the overall value of the company in the market.
3. Profitability: The company should demonstrate a track record of profitability for a
specified period (e.g., the last three years). This indicates the company's ability to
generate sustainable earnings.
4. Net Worth: A minimum net worth is required. Net worth represents the company's
assets minus its liabilities and indicates its financial strength.
5. Number of Shareholders: The company must have a minimum number of public
shareholders. This ensures sufficient liquidity and public participation in the
company's shares.
6. Compliance with SEBI Regulations: The company must comply with all applicable
regulations issued by the Securities and Exchange Board of India (SEBI), including
those related to disclosure, corporate governance, and insider trading.

6
7. Corporate Governance: The company must adhere to sound corporate governance
practices, including having an independent board of directors, an audit committee,
and a grievance redressal mechanism for investors.
8. Dematerialization: The company's shares must be available in dematerialized form
(i.e., held electronically in demat accounts). This facilitates easy trading and
settlement.
9. Other Requirements: Other requirements may include restrictions on promoter
holdings, lock-in periods for pre-IPO shares, and compliance with industry-specific
regulations.
Specific Requirements for BSE:
• BSE has specific requirements related to the company's track record, financial
performance, and compliance with listing agreements.
Specific Requirements for NSE:
• NSE also has its own set of criteria, focusing on aspects like the company's business
model, growth prospects, and adherence to high standards of corporate governance.
Listing Procedure
The listing procedure involves a series of steps that a company must follow to get its
securities listed on a stock exchange. This process typically includes preparing the
necessary documents, submitting an application, undergoing due diligence, and complying
with the exchange's requirements.
General Listing Procedure:
1. Appointment of Lead Manager: The company appoints a lead manager (investment
bank) to guide it through the listing process. The lead manager assists in preparing
the offer document, conducting due diligence, and coordinating with regulatory
authorities.

7
2. Due Diligence: The lead manager conducts a thorough due diligence of the
company's business, financials, and legal compliance.
3. Preparation of Offer Document: The company, with the assistance of the lead
manager, prepares a draft offer document (prospectus) containing detailed
information about the company, its business, financial performance, risk factors,
and the terms of the IPO.
4. Filing with SEBI: The draft offer document is filed with SEBI for its review and
approval. SEBI scrutinizes the document to ensure that it contains all material
information and complies with regulatory requirements.
5. SEBI Approval: After reviewing the draft offer document, SEBI may issue
observations or require modifications. Once SEBI is satisfied, it grants its approval.
6. Application to Stock Exchange: The company submits an application to the stock
exchange (BSE or NSE) for listing its securities.
7. Exchange Review: The stock exchange reviews the company's application and
supporting documents to ensure that it meets the listing requirements.
8. Listing Agreement: The company enters into a listing agreement with the stock
exchange, which outlines the terms and conditions of listing, including ongoing
compliance obligations.
9. IPO Launch: The company launches its IPO, inviting investors to subscribe to its
shares.
10. Allotment of Shares: After the IPO closes, the company allots shares to successful
applicants based on the allotment criteria.
11. Listing and Trading: The company's shares are listed on the stock exchange, and
trading commences.

8
Specific Procedures for BSE and NSE:
Both BSE and NSE have detailed guidelines and checklists for the listing process, which
companies must adhere to. These guidelines cover aspects such as documentation, fees, and
timelines.
Listing Conditions of BSE and NSE
Listing conditions are the ongoing obligations that a company must comply with after its
securities are listed on a stock exchange. These conditions are designed to ensure
transparency, maintain investor confidence, and promote fair trading practices.
Common Listing Conditions:
1. Disclosure Requirements: The company must make timely and accurate disclosures
of all material information that could affect the price of its securities. This includes
financial results, corporate actions (e.g., dividends, bonus issues, mergers), and
significant events.
2. Corporate Governance Compliance: The company must continue to adhere to sound
corporate governance practices, including maintaining an independent board of
directors, an audit committee, and a grievance redressal mechanism.
3. Compliance with SEBI Regulations: The company must comply with all applicable
regulations issued by SEBI, including those related to insider trading, takeover
code, and delisting regulations.
4. Annual Reports: The company must publish annual reports containing audited
financial statements and other relevant information.
5. Shareholder Meetings: The company must hold annual general meetings (AGMs)
and other shareholder meetings to keep shareholders informed and provide them
with an opportunity to participate in corporate decision-making.

9
6. Payment of Listing Fees: The company must pay annual listing fees to the stock
exchange.
7. Compliance with Listing Agreement: The company must comply with all the terms
and conditions of the listing agreement.
8. Handling of Investor Grievances: The company must have a mechanism for
addressing investor grievances and resolving disputes.
9. Other Conditions: Other conditions may include restrictions on related party
transactions, compliance with environmental regulations, and adherence to
industry-specific guidelines.
Specific Conditions for BSE and NSE:
• BSE and NSE have their own specific listing conditions, which are outlined in their
listing agreements and circulars. These conditions may cover aspects such as
reporting requirements, compliance procedures, and penalties for non-compliance.
What is Delisting?
Delisting refers to the removal of a company's securities from a stock exchange, making
them no longer available for trading on that exchange. This means investors can no longer
buy or sell the company's shares on that particular platform. Delisting can occur for various
reasons, and it's important to understand the context to assess the potential impact.
Reasons for Delisting
Several factors can lead to a company's delisting from a stock exchange. These reasons
generally fall into two categories: voluntary and involuntary.
Voluntary Delisting
Voluntary delisting occurs when a company chooses to remove its securities from an
exchange. Common reasons for voluntary delisting include:

10
• Mergers and Acquisitions (M&A): When a company is acquired by another entity,
the acquiring company may choose to delist the target company's shares. This
simplifies the corporate structure and eliminates the need for separate reporting and
compliance requirements.
• Going Private: A company may decide to go private, meaning it is bought out by a
private equity firm or a group of investors. This often involves delisting the shares
from the exchange. The reasons for going private can include a desire to avoid the
scrutiny and regulatory burdens of being a public company, or to implement
strategic changes without the pressure of short-term market expectations.
• Cost Savings: Maintaining a listing on a stock exchange involves significant costs,
including listing fees, compliance expenses, and administrative overhead. If a
company believes the benefits of being listed no longer outweigh the costs, it may
choose to delist.
• Restructuring: A company undergoing significant restructuring may choose to
delist its shares to facilitate the process. This can provide greater flexibility in
making operational and financial changes without the constraints of being a
publicly traded company.
• Low Trading Volume: If a company's shares experience consistently low trading
volume, it may choose to delist. Low liquidity can make it difficult for investors to
buy or sell shares, and it can also reduce the company's visibility in the market.
• Strategic Realignment: A company may delist from one exchange to list on another,
potentially to target a different investor base or benefit from more favorable listing
requirements.
Involuntary Delisting
Involuntary delisting occurs when a stock exchange forces a company to remove its
securities due to non-compliance with listing requirements. Common reasons for
involuntary delisting include:
• Failure to Meet Financial Requirements: Stock exchanges typically have minimum
financial requirements that companies must meet to maintain their listing. These

11
requirements can include minimum levels of revenue, profitability, or market
capitalization. Failure to meet these requirements can result in delisting.
• Non-Compliance with Reporting Requirements: Publicly traded companies are
required to file regular financial reports with regulatory authorities, such as the
Securities and Exchange Commission (SEC) in the United States. Failure to file
these reports on time or accurately can lead to delisting.
• Violation of Corporate Governance Standards: Stock exchanges have corporate
governance standards that companies must adhere to. Violations of these standards,
such as inadequate board oversight or conflicts of interest, can result in delisting.
• Bankruptcy: If a company files for bankruptcy, its shares may be delisted from the
stock exchange.
• Low Stock Price: Many exchanges have minimum share price requirements. If a
company's stock price falls below a certain threshold for an extended period, it may
be delisted.
• Public Interest Concerns: In rare cases, a stock exchange may delist a company if it
believes that doing so is in the public interest. This could occur if the company is
involved in illegal activities or if its operations pose a significant risk to investors.
The Delisting Process
The delisting process typically involves the following steps:
1. Company Announcement (Voluntary Delisting): In the case of voluntary delisting,
the company will typically announce its intention to delist its shares. This
announcement will usually include the reasons for delisting and the expected
timeline.
2. Shareholder Approval (Voluntary Delisting): In many jurisdictions, voluntary
delisting requires shareholder approval. The company will hold a shareholder vote
to approve the delisting.
3. Notification to the Exchange: The company must notify the stock exchange of its
intention to delist.

12
4. Exchange Review (Involuntary Delisting): In the case of involuntary delisting, the
exchange will review the company's non-compliance with listing requirements. The
company may be given an opportunity to address the issues and avoid delisting.
5. Public Notice: The stock exchange will typically issue a public notice of the
delisting.
6. Suspension of Trading: Trading in the company's shares may be suspended prior to
the actual delisting date.
7. Delisting Effective Date: The delisting becomes effective on a specified date, after
which the company's shares are no longer traded on the exchange.
8. Alternative Trading Venues: After delisting, the company's shares may still be
traded on over-the-counter (OTC) markets or other alternative trading venues, but
liquidity may be significantly reduced.
Consequences of Delisting
Delisting can have significant consequences for both the company and its investors.
Consequences for the Company
• Reduced Access to Capital: Delisted companies typically have more difficulty
raising capital through public markets.
• Lower Visibility: Delisting can reduce a company's visibility and reputation in the
market.
• Increased Regulatory Burden (Going Private): While delisting can reduce some
regulatory burdens, going private can introduce new compliance requirements.
• Potential for Restructuring: Delisting can provide a company with greater flexibility
to restructure its operations and finances.
Consequences for Investors
• Reduced Liquidity: Delisted shares typically have lower liquidity, making it more
difficult for investors to buy or sell them.

13
• Lower Valuation: The value of delisted shares may decline due to reduced liquidity
and investor confidence.
• Limited Trading Options: Investors may have limited options for trading delisted
shares, potentially only through OTC markets.
• Potential for Loss: In some cases, delisting can result in significant losses for
investors, particularly if the company is facing financial difficulties.
• Uncertainty: Delisting can create uncertainty for investors, as the future of the
company and its shares may be unclear.
BSE – Different Trading Systems
The Bombay Stock Exchange (BSE) has evolved its trading systems over time to enhance
efficiency, transparency, and accessibility for investors. Here's a look at some of the key
trading systems employed by BSE:
1. Open Outcry System (Historically): Before the advent of electronic trading, BSE
utilized the open outcry system. This involved brokers physically gathering in the
trading ring and shouting out bids and offers to execute trades. This system was
characterized by its vibrant atmosphere but was also prone to inefficiencies and lack
of transparency.
2. BOLT (BSE Online Trading) System: The introduction of BOLT marked a
significant shift towards electronic trading. BOLT is a fully automated screen-based
trading system that allows brokers to execute trades from their offices using
computer terminals. This system significantly improved efficiency, transparency,
and reach, enabling investors from across the country to participate in the market.
BOLT is discussed in detail in a later section.
3. Internet-Based Trading: BSE also facilitates trading through internet-based
platforms. This allows investors to directly access the market and execute trades
from their computers or mobile devices. Internet-based trading has further
democratized access to the stock market, making it easier for retail investors to
participate.

14
4. Mobile Trading: Recognizing the increasing prevalence of mobile devices, BSE has
also enabled mobile trading platforms. These platforms allow investors to trade on
the go, providing convenience and flexibility.
5. Derivatives Trading System: BSE has a dedicated trading system for derivatives,
including futures and options. This system allows investors to trade contracts based
on underlying assets, providing opportunities for hedging and speculation.
6. Currency Derivatives Trading System: Similar to derivatives trading, BSE also has
a system for trading currency derivatives. This allows investors to trade contracts
based on exchange rates between different currencies.
7. Debt Market Trading System: BSE also provides a platform for trading debt
instruments, such as bonds and debentures. This system facilitates the trading of
fixed-income securities, providing investors with opportunities for diversification
and income generation.
Share Groups on BSE
BSE categorizes listed companies into different share groups based on various factors,
including market capitalization, liquidity, and compliance with listing requirements. These
share groups help investors assess the risk and potential of different stocks. Here's an
overview of some of the key share groups on BSE:
1. A Group: This is the most prestigious group on BSE and includes companies that
have a large market capitalization, high liquidity, and a strong track record of
compliance with listing requirements. Stocks in the A Group are generally
considered to be the safest and most liquid on the exchange.
2. B Group: This group includes companies that are smaller in size than those in the
A Group but still meet certain listing requirements. Stocks in the B Group may be
more volatile than those in the A Group but can also offer higher potential returns.
3. T Group: This group includes stocks that are traded under the Trade-to-Trade
segment. In this segment, intraday trading is not allowed, and investors must take

15
delivery of the shares they purchase. This is done to curb excessive speculation and
volatility in certain stocks.
4. Z Group: This group includes companies that have failed to comply with listing
requirements or have other issues that raise concerns about their financial health.
Investing in Z Group stocks is generally considered to be very risky.
5. M Group: This group represents SME (Small and Medium Enterprise) companies
listed on the BSE SME platform. This platform provides a dedicated avenue for
smaller companies to raise capital and gain visibility in the market.
6. MT Group: This group is for companies admitted to dealings on the Main Board
that were previously listed on the SME platform.
7. CC Group: This group is for companies listed on the BSE that are under the
observation of the exchange due to various reasons, including corporate governance
issues or financial irregularities.
8. Other Groups: BSE may also have other share groups based on specific criteria or
sectors.
BOLT System
The Broker's Order Led Trading (BOLT) system is a fully automated screen-based trading
system developed by the Bombay Stock Exchange (BSE). It revolutionized trading on the
BSE by replacing the traditional open outcry system with an electronic platform. Here's a
detailed look at the BOLT system:
Key Features of BOLT:
• Screen-Based Trading: Brokers can execute trades from their offices using
computer terminals connected to the BOLT system.
• Order Matching: The system automatically matches buy and sell orders based on
price and time priority.

16
• Transparency: All orders and trades are displayed on the screen, providing
transparency to the market.
• Efficiency: The system enables faster and more efficient order execution compared
to the open outcry system.
• Nationwide Reach: Brokers from across the country can participate in trading
through the BOLT system.
• Real-Time Information: The system provides real-time market information,
including prices, volumes, and order book depth.
• Order Types: BOLT supports various order types, including limit orders, market
orders, and stop-loss orders.
• Risk Management: The system incorporates risk management features to prevent
excessive speculation and volatility.
Benefits of BOLT:
• Increased Efficiency: BOLT significantly improved the speed and efficiency of
order execution.
• Enhanced Transparency: The system provides transparency to the market, reducing
the potential for manipulation.
• Wider Participation: BOLT enabled brokers from across the country to participate
in trading, increasing market liquidity.
• Reduced Costs: The system reduced transaction costs compared to the open outcry
system.
• Improved Risk Management: BOLT's risk management features helped to prevent
excessive speculation and volatility.
How BOLT Works:
1. Order Entry: Brokers enter buy or sell orders into the BOLT system through their
computer terminals.

17
2. Order Matching: The system automatically matches buy and sell orders based on
price and time priority. The order with the best price and earliest time stamp is
matched first.
3. Trade Confirmation: Once an order is matched, a trade confirmation is sent to both
the buyer and the seller.
4. Clearing and Settlement: The trades are then cleared and settled through the clearing
corporation.
Settlement System in Financial Markets
The provides an overview of settlement systems in financial markets. It covers different
types of settlements, the processes of pay-in and pay-out, handling bad and short deliveries,
and the role of auctions in the settlement process. Understanding these aspects is crucial
for participants in financial markets to ensure smooth and efficient transactions.
Different Types of Settlements
Settlement refers to the process of transferring assets (e.g., securities, funds) from a seller
to a buyer and the corresponding transfer of funds from the buyer to the seller. This process
ensures that both parties fulfill their obligations arising from a trade. There are several types
of settlement systems, each designed to cater to specific market needs and asset classes.
Delivery Versus Payment (DVP)
DVP is the most common type of settlement, especially for securities transactions. It
ensures that the transfer of securities occurs simultaneously with the transfer of funds. This
reduces the risk of one party defaulting on their obligation. DVP can be further categorized
into:
• Model 1 (Gross Settlement): Each transaction is settled individually and
immediately. This model minimizes counterparty risk but can be resource-intensive
and may require significant liquidity.

18
• Model 2 (Net Settlement): Transactions are netted against each other over a specific
period (e.g., end of day), and only the net amount is settled. This reduces the number
of transactions and liquidity requirements but introduces some counterparty risk.
• Model 3 (Hybrid): Combines elements of both gross and net settlement. Critical or
large-value transactions may be settled gross, while smaller transactions are netted.
Real-Time Gross Settlement (RTGS)
RTGS systems are used primarily for high-value payments, such as interbank transfers.
Transactions are settled individually and in real-time, providing immediate finality. RTGS
systems are crucial for maintaining stability in the financial system by minimizing systemic
risk.
Continuous Linked Settlement (CLS)
CLS is a specialized settlement system designed for foreign exchange (FX) transactions. It
operates on a payment-versus-payment (PVP) basis, ensuring that both legs of an FX
transaction are settled simultaneously. This eliminates settlement risk, which is particularly
important in the FX market due to the cross-border nature of transactions and time zone
differences.
T+N Settlement
T+N refers to the number of business days after the trade date (T) that settlement occurs.
For example, T+2 means settlement occurs two business days after the trade date. The
specific settlement cycle varies by market and asset class. Many markets have moved
towards shorter settlement cycles (e.g., T+1) to reduce counterparty risk and improve
efficiency.
Pay-in and Pay-out
The pay-in and pay-out processes are integral to the settlement system. Pay-in refers to the
process where sellers deliver the securities or funds they are obligated to transfer. Pay-out
refers to the process where buyers receive the securities or funds they are entitled to receive.

19
Pay-in Process
1. Notification: The clearinghouse or central counterparty (CCP) notifies participants
of their pay-in obligations based on their trading activity.
2. Delivery: Sellers deliver the securities or funds to the designated account at the
clearinghouse or central securities depository (CSD).
3. Verification: The clearinghouse verifies that the delivered securities or funds match
the pay-in obligations.
4. Confirmation: Once verified, the clearinghouse confirms the pay-in to the seller.
Pay-out Process
1. Notification: The clearinghouse notifies participants of their pay-out entitlements
based on their trading activity.
2. Allocation: The clearinghouse allocates the securities or funds to the buyers'
accounts.
3. Confirmation: The clearinghouse confirms the pay-out to the buyer.
4. Withdrawal: Buyers can then withdraw the securities or funds from their accounts.
Challenges in Pay-in and Pay-out
• Timing: Ensuring timely pay-in and pay-out is critical to avoid settlement delays.
• Accuracy: Accurate matching of pay-in and pay-out obligations is essential to
prevent errors.
• Liquidity: Participants must have sufficient liquidity to meet their pay-in
obligations.
Bad and Short Delivery
Bad and short deliveries are situations where the seller fails to meet their delivery
obligations fully or correctly.

20
Bad Delivery
Bad delivery occurs when the securities delivered do not conform to the requirements of
the trade. Examples of bad delivery include:
• Incorrect Securities: Delivering the wrong type or quantity of securities.
• Missing Documentation: Failing to provide necessary documentation, such as
transfer deeds or certificates.
• Restricted Securities: Delivering securities that are subject to transfer restrictions.
Short Delivery
Short delivery occurs when the seller fails to deliver the securities by the settlement date.
This can happen due to various reasons, such as:
• Inventory Shortage: The seller does not have enough securities in their inventory.
• Operational Issues: Problems with the seller's internal systems or processes.
• Borrowing Difficulties: Inability to borrow the securities needed to fulfill the
delivery obligation.
Handling Bad and Short Deliveries
1. Notification: The buyer notifies the seller or the clearinghouse of the bad or short
delivery.
2. Rectification: The seller is given an opportunity to rectify the issue, such as
providing the correct securities or borrowing the necessary securities.
3. Buy-in: If the seller fails to rectify the issue within a specified timeframe, the buyer
may initiate a buy-in. A buy-in involves purchasing the securities in the market and
charging the seller for any difference between the original trade price and the buy-
in price.
4. Penalties: The clearinghouse may impose penalties on the seller for failing to meet
their delivery obligations.

21
Auction
Auctions can play a role in the settlement process, particularly in situations involving short
deliveries or failed trades.
Buy-in Auctions
When a seller fails to deliver securities, the buyer may initiate a buy-in auction to acquire
the securities needed to complete the trade. The auction process typically involves:
1. Notification: The clearinghouse notifies market participants of the buy-in auction.
2. Bidding: Participants submit bids to sell the required securities.
3. Allocation: The securities are allocated to the bidder with the lowest price.
4. Settlement: The seller who failed to deliver is responsible for covering the
difference between the original trade price and the buy-in price.
Sell-out Auctions
In some cases, a sell-out auction may be used to dispose of securities that have been rejected
due to bad delivery. The auction process is similar to a buy-in auction, but in this case, the
seller is trying to sell the rejected securities to the highest bidder.
Benefits of Auctions
• Price Discovery: Auctions provide a transparent mechanism for determining the
market price of securities.
• Efficiency: Auctions can facilitate the efficient allocation of securities in situations
involving short deliveries or failed trades.
• Risk Management: Auctions help to mitigate the risk of losses due to failed trades
by providing a mechanism for buyers to acquire the securities they need.

22
NSE: Market Segments, NEAT System Options, Market Types, Order Types, and Order
Books
Market Segments
The NSE offers a diverse range of market segments catering to different investment needs
and risk profiles. These segments include:
• Equity Market: This is the primary segment for trading stocks of listed companies.
It is further divided into:
o Cash Market (CM): Also known as the spot market, it involves immediate
delivery of shares against payment. Trades are settled on a T+1 basis (Trade
date plus one day).
o Derivatives Market (F&O): This segment deals with trading futures and
options contracts on individual stocks and indices. It allows investors to
hedge their positions or speculate on future price movements.
• Debt Market: This segment facilitates trading in fixed-income securities such as:
o Government Securities (G-Secs): These are sovereign bonds issued by the
central government.
o Corporate Bonds: These are debt instruments issued by companies to raise
capital.
• Currency Derivatives Market: This segment allows trading in currency futures and
options contracts, enabling participants to hedge against currency risk or speculate
on exchange rate movements.
• Commodity Derivatives Market: This segment facilitates trading in commodity
futures and options contracts, allowing participants to hedge against commodity
price risk or speculate on commodity price movements.
• Mutual Funds Market: This segment provides a platform for trading units of various
mutual fund schemes.

23
• SME Platform: This platform is designed to facilitate the listing and trading of
shares of small and medium enterprises (SMEs).
NEAT System Options
The NSE uses the National Exchange for Automated Trading (NEAT) system, a fully
automated screen-based trading system. NEAT offers various options to traders, enhancing
efficiency and flexibility. Key options include:
• Order Placement: Traders can place orders through various
channels, including:
o Broker Terminals: Brokers provide trading terminals to their clients for
placing orders directly into the NEAT system.
o Internet Trading Platforms: Many brokers offer online trading platforms that
allow investors to trade from anywhere with an internet connection.
o Mobile Trading Apps: Mobile apps provide convenient access to the market
for placing orders on the go.
• Order Modification and Cancellation: Traders can modify or cancel their orders
before they are executed.
• Market Information: NEAT provides real-time market
information, including:
o Best Bid and Offer (BBO): The highest price a buyer is willing to pay (bid)
and the lowest price a seller is willing to accept (offer).
o Market Depth: The quantity of shares available at different price levels.
o Trade Information: Details of executed trades, including price and quantity.
• Risk Management: NEAT incorporates various risk management
features, such as:
o Price Bands: Limits on the daily price fluctuations of securities.
o Circuit Breakers: Trading halts triggered by significant market movements.

24
o Margin Requirements: The amount of money required to be deposited with
the broker to cover potential losses.
Market Types, Order Types, and Order Books
Market Types
The NSE primarily operates in two market types:
• Normal Market: This is the regular trading session where most transactions occur.
• Auction Market: This market is used to discover prices for illiquid securities or
when there is a significant imbalance between buyers and sellers.
Order Types
The NSE supports various order types to cater to different trading
strategies:
• Market Order: An order to buy or sell a security immediately at the best available
price. Market orders guarantee execution but not price.
• Limit Order: An order to buy or sell a security at a specified price or better. Limit
orders guarantee price but not execution.
• Stop Loss Order: An order to buy or sell a security when the price reaches a
specified level (the stop price). Stop loss orders are used to limit potential losses.
• Stop Loss Market Order: An order that becomes a market order when the price
reaches the stop price.
• Stop Loss Limit Order: An order that becomes a limit order when the price reaches
the stop price.
• Immediate or Cancel (IOC) Order: An order that must be executed immediately and
any portion of the order that cannot be filled is cancelled.

25
• Fill or Kill (FOK) Order: An order that must be executed in its entirety immediately
or it is cancelled.
Order Books
The order book is an electronic record of all outstanding buy and sell orders for a particular
security. It displays the best bid and offer prices, as well as the quantity of shares available
at each price level. The order book is the central mechanism for price discovery on the
NSE.
• Price Priority: Orders are executed based on price priority, meaning that the best-
priced orders are executed first.
• Time Priority: If multiple orders are placed at the same price, they are executed
based on time priority, meaning that the order placed earlier is executed first.
• Matching Engine: The NEAT system's matching engine automatically matches buy
and sell orders based on price and time priority. When a match occurs, a trade is
executed.
Settlement Mechanisms in Financial Markets
Demat Settlement
Demat settlement, short for dematerialized settlement, refers to the process of settling
trades electronically using dematerialized securities. In this system, physical share
certificates are converted into electronic form and held in a demat account.
Key Features:
• Electronic Transfer: Securities are transferred electronically from the seller's demat
account to the buyer's demat account.
• Faster Settlement: Demat settlement significantly reduces the time required for
settlement compared to physical settlement.

26
• Reduced Risk: Eliminates the risks associated with handling physical certificates,
such as loss, theft, or damage.
• Efficiency: Streamlines the settlement process, making it more efficient and cost-
effective.
• Accessibility: Allows for easier trading and transfer of securities, especially for
retail investors.
Process:
1. Trade Execution: A trade is executed on a stock exchange.
2. Clearing: The clearing corporation confirms the trade and determines the
obligations of the buyer and seller.
3. Settlement: On the settlement date, the securities are debited from the seller's demat
account and credited to the buyer's demat account. Funds are also transferred
simultaneously.
4. Confirmation: Both the buyer and seller receive confirmation of the settlement from
their respective Depository Participants (DPs).
Physical Settlement
Physical settlement involves the actual delivery of physical securities (e.g., share
certificates) from the seller to the buyer. This method was prevalent before the widespread
adoption of dematerialization.
Key Features:
• Physical Delivery: Requires the physical transfer of securities certificates.
• Time-Consuming: Settlement process is slower compared to demat settlement due
to the logistics involved.
• Higher Risk: Susceptible to risks such as loss, theft, forgery, and damage of physical
certificates.
• Cumbersome: Involves significant paperwork and administrative overhead.
• Less Efficient: Generally less efficient and more costly than demat settlement.

27
Process:
2. Clearing: The clearing corporation confirms the trade and determines the
obligations of the buyer and seller.
3. Delivery: The seller delivers the physical share certificates to the clearing
corporation or designated intermediary.
4. Verification: The clearing corporation verifies the authenticity and validity of the
certificates.
5. Settlement: The certificates are transferred to the buyer, and funds are transferred
to the seller.
Institutional Segment
The institutional segment refers to the part of the financial market where large institutional
investors, such as mutual funds, pension funds, insurance companies, and foreign
institutional investors (FIIs), participate. Settlement in this segment often involves specific
procedures and considerations due to the large volumes of transactions.
Key Features:
• Large Volumes: Transactions typically involve large quantities of securities.
• Dedicated Systems: Often utilizes dedicated settlement systems and processes
tailored to institutional investors.
• Custodial Services: Institutional investors often rely on custodial services for
safekeeping and settlement of securities.
• Regulatory Oversight: Subject to stringent regulatory oversight to ensure market
integrity and investor protection.
• Negotiated Deals: May involve negotiated deals and block trades that require
specific settlement arrangements.
Process:

28
1. Trade Execution: Institutional trades are executed through various channels,
including stock exchanges, negotiated deals, and block trades.
2. Clearing: The clearing corporation clears the trades and determines the obligations
of the buyer and seller.
3. Settlement: Securities and funds are transferred between the accounts of the
institutional investors or their custodians.
4. Reporting: Detailed reporting of transactions and holdings is required to comply
with regulatory requirements.
Funds Settlement
Funds settlement refers to the process of transferring funds between the buyer and seller to
complete a transaction. This is a critical component of the overall settlement process.
Key Features:
• Monetary Transfer: Involves the transfer of funds equivalent to the value of the
securities traded.
• Clearing Banks: Typically facilitated through clearing banks that act as
intermediaries.
• Real-Time Gross Settlement (RTGS): Often utilizes RTGS systems for immediate
and final settlement of large-value transactions.
• Netting: May involve netting arrangements to reduce the number of individual fund
transfers.
• Risk Management: Incorporates risk management measures to ensure timely and
secure transfer of funds.
Process:
2. Clearing: The clearing corporation determines the funds obligations of the buyer
and seller.
3. Funds Transfer: The buyer transfers funds to the clearing corporation or designated
clearing bank.

29
4. Disbursement: The clearing corporation disburses the funds to the seller.
5. Confirmation: Both the buyer and seller receive confirmation of the funds transfer.
Valuation Debit
Valuation debit refers to a charge or deduction applied to an account to reflect a decrease
in the value of an asset or portfolio. This is often used in the context of mark-to-market
accounting.
Key Features:
• Mark-to-Market: Reflects changes in the market value of assets.
• Accounting Adjustment: An accounting adjustment to reflect losses or declines in
value.
• Margin Requirements: May trigger margin calls if the valuation debit reduces the
account balance below the required margin level.
• Risk Management: Used as a risk management tool to assess and manage potential
losses.
Process:
1. Valuation: The value of an asset or portfolio is assessed based on current market
prices.
2. Debit Calculation: If the value has decreased, a valuation debit is calculated.
3. Account Adjustment: The debit is applied to the account, reducing the account
balance.
4. Reporting: The valuation debit is reported to the account holder.
Valuation Price
Valuation price refers to the price used to determine the current market value of an asset or
security. This price is crucial for various purposes, including mark-to-market accounting,
portfolio valuation, and margin calculations.
Key Features:

30
• Market Reflective: Should accurately reflect the current market value of the asset.
• Transparency: The methodology for determining the valuation price should be
transparent and well-defined.
• Reliability: The source of the valuation price should be reliable and credible.
• Consistency: Valuation prices should be applied consistently across different
periods and accounts.
Determination:
• Market Prices: Typically based on actual market prices from exchanges or other
trading venues.
• Fair Value: In the absence of market prices, fair value may be determined using
valuation models or other techniques.
• Independent Sources: Often sourced from independent pricing services or data
providers.
Bad and Short Delivery
Bad delivery refers to the delivery of securities that do not meet the required standards or
specifications. Short delivery occurs when the seller fails to deliver the securities on the
settlement date.
Key Features:
• Non-Compliance: Bad delivery involves securities that are not in good order (e.g.,
forged certificates, missing endorsements).
• Failure to Deliver: Short delivery involves the seller's failure to deliver the securities
as agreed.
• Penalties: Both bad and short deliveries can result in penalties and corrective
actions.
Handling:
• Rejection: The buyer has the right to reject a bad delivery.

31
• Rectification: The seller is responsible for rectifying the bad delivery by providing
valid securities.
• Auction: In the case of short delivery, the exchange may conduct an auction to
purchase the securities and deliver them to the buyer.
Auction
Auction is a mechanism used to resolve situations where a seller fails to deliver securities
on the settlement date (short delivery). The exchange conducts an auction to purchase the
securities from other market participants and deliver them to the buyer.
Key Features:
• Short Delivery Resolution: Used to address short delivery situations.
• Market Purchase: Involves purchasing the securities from the market.
• Cost Recovery: The defaulting seller is typically responsible for covering the costs
of the auction, including any price difference.
• Fair Price Discovery: Aims to ensure fair price discovery in the absence of the
original seller's delivery.
Process:
1. Short Delivery Identification: The clearing corporation identifies a short delivery.
2. Auction Announcement: An auction is announced to the market participants.
3. Bidding: Market participants submit bids to sell the required securities.
4. Awarding: The clearing corporation awards the securities to the lowest bidder.
5. Settlement: The securities are delivered to the original buyer, and the defaulting
seller is charged the auction costs.

Unit -II Unit II- Trading and Settlement System in Stock Exchanges.pdf

Unit -II Unit II- Trading and Settlement System in Stock Exchanges.pdf

More Related Content

What's hot

Similar to Unit -II Unit II- Trading and Settlement System in Stock Exchanges.pdf

More from Mr. Mustaq Mulla, SRFGCC, Kitturu Rani Channamma University Belagavi

Recently uploaded

Unit -II Unit II- Trading and Settlement System in Stock Exchanges.pdf