Custodial participant
Also written CP · Custodial participant (CP)
A client allowed to trade through several trading members while clearing and settling through a single clearing member, identified by a unique CP code; its CM must confirm the trades.
In plain language
Large institutional clients often want to spread their orders across many brokers — for execution quality, research or relationships — but settle everything in one place.
The custodial participant (CP) arrangement allows exactly that. The workbook's definition: custodial participants are those constituents who are eligible for trading through multiple trading members and who clear and settle deals through a single clearing member.
Three mechanics make it work:
- The CP registers with the clearing corporation through its clearing member and gets a unique custodial participant code, linked to that clearing member.
- Whichever trading member executes a CP order enters the CP code at order entry.
- The CP's clearing member confirms those trades. Confirmed trades become that clearing member's obligations — margins, penalties, levies and settlement.
If the clearing member does not confirm a trade, it stays with the executing trading member and its own clearing member.
How it works
Which clearing members can clear CP trades (Chapter 7, section 7.2.2):
| Clearing member type | Clears CP trades? |
|---|---|
| Trading cum Self Clearing Member | No — own and own clients' trades only |
| Trading member-cum-clearing member | Yes |
| Professional clearing member (SEBI-registered custodians, recognised banks) | Yes |
Margin blocking (Chapter 7, section 7.9). Before confirmation, margin on a CP trade is blocked in this order: (i) CP collateral through the executing TM, (ii) the executing TM's proprietary collateral, (iii) the proprietary collateral of that TM's CM. On confirmation, that is released and margin is re-blocked from (i) CP collateral through the confirming CM, then (ii) the confirming CM's proprietary collateral. The duty to ensure enough collateral is allocated falls on the confirming CM.
Clearing positions. A clearing member's open position aggregates all its TMs' positions and all CPs clearing through it; premium netting for options is done at the trading member / custodial participant level for each contract.
Risk reduction mode. When a broker hits 90% collateral utilisation and enters risk-reduction mode, it may not place orders with a CP code, and client and CP code modification is not permitted.
A worked example
Illustrative. The fund, brokers, bank and quantities are hypothetical; the rules are the workbook's.
Sahyadri Mutual Fund is a custodial participant, clearing through Coastal Bank, a professional clearing member. On Monday it hedges a USD exposure by selling 600 lots of USDINR futures at 83.25 through three brokers:
| Executing TM | Lots | Enters CP code? |
|---|---|---|
| Broker A | 200 | Yes |
| Broker B | 250 | Yes |
| Broker C | 150 | Yes |
Total notional = 600 × 1,000 × 83.25 = Rs 4,99,50,000
Before confirmation, margin on Broker A's 200 lots is blocked from Sahyadri's collateral through Broker A, then Broker A's own collateral, then Broker A's CM.
Coastal Bank confirms the trades from A and B. Their margin is released at the brokers and re-blocked from Sahyadri's collateral through Coastal Bank. Those 450 lots are now Coastal Bank's obligations.
Coastal Bank does not confirm Broker C's 150 lots (say, a mismatch in the order details). Those 150 lots remain the obligation of Broker C's clearing member, as if Broker C had traded them for itself.
Why NISM asks about it
Chapter 7 carries the definition (footnote to section 7.1 and section 7.5.2), the clearing member types that may clear CP trades (7.2.2), the margin-blocking sequence (7.9) and the risk-reduction mode restriction on CP codes (7.9.3). Expect the definition, "which member cannot clear for CPs", and what happens to unconfirmed trades.
Common exam traps
- Many trading members, one clearing member. Not the other way round.
- The CP code is linked to the clearing member, but entered by the executing trading member.
- Unconfirmed trades stay with the executing TM's clearing member.
- A trading-cum-self-clearing member cannot clear for custodial participants; TCMs and PCMs can.
- In risk-reduction mode, orders with a CP code are not allowed.
- After confirmation, the confirming CM is responsible for ensuring collateral covers the margin.
Check yourself
1.As a risk reduction measure, all unexecuted orders are cancelled once a stock broker breaches what level of collateral utilisation?
- a)90 percent
- b)75 percent
- c)80 percent
- d)50 percent
Show the answer
Answer: (a) 90 percent
All unexecuted orders are cancelled once a stock broker breaches 90 percent collateral utilization level.
The trigger: Stock Exchanges/Clearing Corporation need to ensure that the stock brokers are mandatorily put in risk-reduction mode when a specific percent (currently 90%) of the stock broker's/clearing member collateral available for adjustment against margins gets utilized on account of trades that fall under a margin system.
And it applies at both levels: the risk reduction mode is applicable at the level of the trading members as well as clearing members.
What else the mode does:
Only orders with Immediate or Cancel attribute are permitted in this mode — nothing may rest in the order book.
All new orders are checked for sufficiency of margins. Fresh orders placed by members to reduce the open position are accepted, but orders that will result in an increase in the position are checked for the sufficiency of margin. Orders that are not supported by adequate margins are rejected.
Plus: the member is not allowed to place orders with custodial participant code and modification of Client and Custodial Participant code is not permitted.
Exit is at a different number: the stock-broker is moved back to the normal risk management mode only when the percentage of utilized collateral is lower than the utilization level specified by the clearing corporation from time to time (currently 85%).
In at 90%, out below 85% — a five-point buffer so a member near the line does not oscillate all day.
Risk reduction mode sits within a wider system that includes alerts to members on various levels of collateral utilization and, beyond it, automatic disablement from trading when limits are breached.
Where this is taught
Free preparation for NISM Series IVRelated terms
- Professional Clearing MemberA clearing member — typically a bank or custodian — who clears and settles trades for other trading members and institutional clients but is not itself a trading member of the exchange.
- SPANThe scenario-based system clearing corporations use to compute initial margin — it revalues a client's whole derivatives portfolio under sixteen what-if scenarios and charges the worst loss.
- Clearing corporationThe entity that steps between every buyer and seller in the derivatives segment by novation, becoming the counterparty to both sides and guaranteeing that the trade settles.
- Trading memberA member of a stock exchange who trades on behalf of clients or on his own account, under a trading member ID shared by all his registered users — and who must clear through a clearing member.
- Initial marginThe deposit both the buyer and the seller of a futures contract must place before the position is accepted, sized to cover a 99% worst-case one-day loss on that position.
- Unique Client CodeThe single code a broker assigns to a client once KYC is complete, mapped to that client's PAN and demat account, under which every one of the client's orders must be entered on the exchange.
- Risk reduction modeThe restricted state a stock broker is put into when 90% of its collateral is used up by margins: pending orders are cancelled, only IOC and margin-checked orders pass, until utilisation falls below 85%.
- Foreign Portfolio InvestorAn entity established or incorporated outside India that proposes to invest in India, registered under the SEBI (Foreign Portfolio Investors) Regulations, 2019 as Category I or II.
- Straight Through ProcessingElectronic processing of a trade in one pass from deal to final settlement through a single system, without manual re-entry; mandatory for institutional trades since 2004.
- INST tradeA trade entered with the placeholder Custodial Participant code "INST" for an institutional client, later allocated by the back office to the client's actual sub-schemes within a fixed time window.
- Trading cum clearing memberA clearing member who is also a trading member of the exchange, and may clear and settle its own trades, its clients' trades, and the trades of other trading members and custodial participants.