Clearing and Settlement

System
Different types of clearing members
Clearing and settlement mechanism for equity derivatives
Risk management in equity derivatives segment
Margining system in equity derivatives segment
Clearing and settlement
• Clearing and settlement activities in the F&O segment are undertaken
by Clearing Corporation with the help of the following entities:
• Clearing Members
• Clearing Banks.
Clearing Members

• Broadly speaking there are three types of clearing members

• Self clearing member: They clear and settle trades executed by them only,
either on their own account or on account of their clients.
• Trading member–cum–clearing member: They clear and settle their own
trades as well as trades of other trading members and custodial participants.
• Professional clearing member: They clear and settle trades executed by
trading members.
Clearing Banks
• Funds settlement takes place through clearing banks.
• For the purpose of settlement all clearing members are required to
open a separate bank account with Clearing Corporation designated
clearing bank for F&O segment.
Clearing Member Eligibility Norms
• Net-worth of at least Rs.300 lakhs. The Net-worth requirement for a
Clearing Member who clears and settles only deals executed by him is
Rs. 100 lakhs.
• Deposit of Rs. 50 lakhs to clearing corporation which forms part of
the security deposit of the Clearing Member.
• Additional incremental deposits of Rs.10 lakhs to clearing corporation
for each additional TM, in case the Clearing Member undertakes to
clear and settle deals for other TMs.
Clearing Mechanism
• The first step in clearing process is calculating open positions and
obligations of clearing members.
• The open positions of a CM is arrived at by aggregating the open positions
of all the trading members (TMs) and all custodial participants (CPs)
clearing though him, in the contracts which they have traded.
• The open position of a TM is arrived at by adding up his proprietary open
position and clients’ open positions, in the contracts which they have
traded.
• While entering orders on the trading system, TMs identify orders as either
proprietary (Pro) or client (Cli).
• Proprietary positions are calculated on net basis (buy-sell) for each contract
and that of clients are arrived at by summing together net positions of each
individual client.
• A TM’s open position is the sum of proprietary open position, client open
long position and client open short position.
Settlement Mechanism In India
• SEBI has given the stock exchanges the flexibility to offer:
• a) Cash settlement (settlement by payment of differences) for both
stock options and stock futures
• b) Physical settlement (settlement by delivery of underlying stock) for
both stock options and stock futures
• c) Cash settlement for stock options and physical settlement for stock
futures
• d) Physical settlement for stock options and cash settlement for stock
futures.
Settlement Schedule
• The settlement of trades is on T+1 working day basis.
• Members with a funds pay-in obligation are required to have clear
funds in their primary clearing account on or before 10.30 a.m. on the
settlement day.
• The payout of funds is credited to the primary clearing account of the
members thereafter.
Settlement of Futures Contracts on Index or
Individual Securities In Futures contracts
• Both the parties to the contract have to deposit margin money which
is called as initial margin.
• Futures contract have two types of settlements, the MTM settlement
which happens on a continuous basis at the end of each day, and the
final settlement which happens on the last trading day of the futures
contract.
Mark to Market (MTM) Settlement
• Mark to Market is a process by which margins are adjusted on the
basis of daily price changes in the markets for underlying assets.
• The profits/ losses are computed as the difference between:
• The trade price and the day's settlement price for contracts executed during
the day but not squared up.
• The previous day's settlement price and the current day's settlement price for
brought forward contracts.
• The buy price and the sell price for contracts executed during the day and
squared up.
Mark to Market (MTM) Settlement
• The clearing member who suffers a loss is required to pay the MTM loss
amount in cash which is in turn passed on to the clearing member who has
made a MTM profit.
• The pay-in and pay-out of the mark-to-market settlement are affected on
the day following the trade day (T+1) where trading member is responsible
to collect/ pay funds from/ to clients by the next day.
• Clearing Members are responsible to collect and settle the daily MTM
profits/losses incurred by the TMs and their clients clearing and settling
through them.
• After completing day’s settlement process, all the open positions are reset
to the daily settlement price.
• These positions become the open positions for the next day.
Final Settlement
• On expiration day of the futures contracts, after the close of trading
hours, clearing corporation marks all positions of a clearing member
to the final settlement price and the resulting profit/ loss is settled in
cash.
• Final settlement loss/profit amount is debited/ credited to the
relevant clearing member’s clearing bank account on the day
following expiry day of the contract.
• All long positions are automatically assigned to short positions in
option contracts with the same series, on a random basis.
Daily Premium Settlement
• In options contract, buyer of an option pays premium while seller receives
premium.
• The amount payable and receivable as premium are netted to compute the
net premium payable or receivable amount for each client for each option
contract.
• The clearing members who have a premium payable position are required
to pay the premium amount to clearing corporation which in turn passed
on to the members who have a premium receivable position.
• This is known as daily premium settlement.
• The pay-in and pay-out of the premium settlement is on T+1 day (T=Trade
day).
• The premium payable amount and premium receivable amount are directly
credited/ debited to the clearing member’s clearing bank account.
Final Exercise Settlement
• All the in the money stock options contracts shall get automatically
exercised on the expiry day.
• All the unclosed long/ short positions are automatically assigned to short/
long positions in option contracts with the same series, on the random
basis.
• Profit/ loss amount for options contract on index and individual securities
on final settlement is credited/debited to the relevant clearing members
clearing bank account on T+1 day i.e. a day after expiry day. Open
positions, in option contracts, cease to exist after their expiration day.
• The pay-in/ pay-out of funds for a clearing member on a day is the net
amount across settlements and all trading members/ clients, in Future &
Option Segment.
Settlement of Custodial Participant (CP) Deals
• Clearing corporation provides a facility to entities like institutions to
execute trades through any trading member, which may be cleared
and settled by their own CM.
• Such entities are called Custodial Participants (CP). A CP is required to
register with clearing corporation through this clearing member,
which allots them a unique CP code.
• The CP and the CM are required to enter into an agreement.
• All trades executed by such CP through any TM are required to have
the CP code in the relevant field on the F&O trading system at the
time of order entry.
Margining and mark to market under SPAN
• In order to manage risk efficiently in the Indian securities market,
exchanges have adopted SPAN (Standard Portfolio Analysis of Risk), a
risk management and margining product designed by Chicago
Mercantile Exchange (CME), Chicago, USA.
• This software was developed for calculating initial margins on the
various positions of market participants.
• The objective of SPAN is to identify overall potential risk in a portfolio.
• The program treats futures and options uniformly, while recognizing
the unique exposures associated with options portfolios.
Margins
• Initial margin
• Margins are computed by clearing corporation upto client level with the help
of SPAN.
• Clearing corporation collects initial margin for all the open positions of a
Clearing Member based on the margins computed.
• Margins are required to be paid up-front on gross basis at individual client
level for client positions and on net basis for proprietary positions.
• A Clearing Member collects initial margin from TM whereas TM collects from
his clients.
• Initial margin requirements are based on 99% value at risk over a one day
time horizon.
 Margins
Premium Margin
• Along with Initial Margin, Premium Margin is also charged at client level.
• This margin is required to be paid by a buyer of an option till the premium settlement is
complete.
Exposure Margins
• Clearing members are subject to exposure margins in addition to initial margins. The exposure
margins for options and futures contracts are as follows:
• For Index options and Index futures contracts: 3% of the notional value of a futures contract.
• In case of options it is charged only on short positions and is 3% of the notional value of open
positions.
• For option contracts and Futures Contract on individual Securities: The higher of 5% or 1.5
standard deviation of the notional value of gross open position in futures on individual
securities and gross short open positions in options on individual securities in a particular
underlying.
Client Margins
• Clearing corporation intimates all members of the margin liability of each of their client.
• Additionally members are also required to report details of margins collected from clients to
clearing corporation, which holds in trust client margin monies to the extent reported by the
member as having been collected from their respective clients.
Position Limits & Position calculations
• All long and short positions of a client in a contract are netted to
arrive at his open position at a point of time.
• Nevertheless, the positions of one client are not set-off against the
positions of other client/clients, while arriving at the open position of
a member broker.
• Therefore, member broker’s open position is his client’s net open
positions on a gross basis.