Settlement
Also written Settlement process · Final settlement
The step where the obligations computed by clearing are actually discharged — commodities against funds on a delivery-versus-payment basis, or cash against the settlement price.
In plain language
Settlement is where the money and the goods change hands.
For a cash-settled contract that is one transfer: the difference between the settlement price and where you were marked yesterday. For a delivery contract it is two flows moving together — a warehouse receipt travelling one way and funds travelling the other, neither released until the other arrives. That simultaneity is delivery versus payment, and it is what removes the risk that one side pays and the other does not perform.
The netting rules are asymmetric and the exam knows it. Commodity obligations are netted at the client level and grossed up at the member level. Funds obligations are netted at the member level, which cuts the number of bank transfers sharply.
How it works
Three delivery logics are available on Indian commodity futures, set per contract in the specification:
| Logic | What happens at expiry |
|---|---|
| Compulsory delivery | Every open position must give or take delivery |
| Both options | Delivery happens only if buyer and seller both opt for it; otherwise cash settled at the Due Date Rate |
| Cash settlement | Every open position settles in cash against the Final Settlement Price |
Once delivery obligations are assigned, the seller raises the bill on the buyer at the Final Settlement Price, inclusive of GST — never at the price the trade was originally struck at. The difference between the two was already paid across in daily mark-to-market. The settlement of DVP is made for the full tax-paid invoice value, and exchanges accept the GST rate the seller provides and guarantee settlement at that rate without testing whether the rate is correct.
Obligations from expiring Options on Goods are merged into the futures delivery obligations of the same day, and devolved Options on Futures become futures positions that settle through the futures cycle. Index futures and index options, being cash settled, settle purely in funds.
A worked example
A cash settlement, end to end.
A trader is long one lot of MCX BULLDEX index futures. Lot size 500 units, which is what the workbook gives: the minimum lot must be worth Rs 5 lakh on the start date, and at a base index of 1,000 that makes 500 units. He bought at 15,000, giving a contract value of 1 x 500 x 15,000 = Rs 75,00,000.
He holds to expiry. On expiry day the index Final Settlement Price is determined after 5:00 pm, from the weighted average traded prices of the constituent futures between 4:00 pm and 5:00 pm. It comes in at 15,120. The previous day's daily settlement price was 15,060.
Final cash settlement = (15,120 - 15,060) x 500 = Rs 30,000
credited on the following morning. Every rupee of the move from 15,000 to 15,060 had already been settled on earlier days through MTM; only the last leg is left for final settlement.
No warehouse, no receipt, no GST invoice, no delivery period margin — index futures carry none of it. Had this been one lot of gold instead, the same expiry would have obliged the short to hand over a kilogram of quality-certified gold against Rs 50,00,000 plus GST.
Why NISM asks about it
Chapter 7 (Clearing, Settlement and Risk Management), sections 7.2, 7.3 and 7.13, with the index and options variants in section 7.12. Expect "transactions involving transfer of ownership of commodities are settled on ____ basis" (delivery versus payment) and questions on which obligations are netted at which level.
Common exam traps
- Commodities net at the client level and gross up at the member level; funds net at the member level. The two halves follow different rules and the exam asks for the difference.
- The bill is always raised at the Final Settlement Price, whatever price the trade was struck at. Candidates who invoice at the traded price double-count the MTM.
- Both options is not the same as compulsory delivery. Under both options, one side declining is enough to force cash settlement at the Due Date Rate.
- The exchange guarantees financial settlement, not gross delivery settlement. It compensates the aggrieved party; it does not conjure the goods.
- Exchanges do not verify the GST rate the seller supplies — they guarantee settlement at whatever rate is given.
- Index futures and index options have no delivery period margin, because there is nothing to deliver.
Check yourself
1.How does the funding of the Settlement Guarantee Fund differ from that of the Investor Protection Fund?
- a)Both are funded entirely by exchange contributions
- b)The SGF receives settlement-related penalties, while the IPF receives all other penalties plus 1% of turnover fee or Rs 10 lakh a year, whichever is higher
- c)The SGF is funded by SEBI and the IPF by the clearing corporation alone
- d)The IPF receives settlement penalties and the SGF receives investor education levies
Show the answer
Answer: (b) The SGF receives settlement-related penalties, while the IPF receives all other penalties plus 1% of turnover fee or Rs 10 lakh a year, whichever is higher
SGF: "a corpus made up of CONTRIBUTIONS BY THE EXCHANGE, CLEARING CORPORATION, AND THE CLEARING MEMBERS. Besides, A PORTION OF ALL THE PENALTIES RELATED TO SETTLEMENTS collected from participants WILL ALSO BE CREDITED to the Settlement Guarantee Fund."
IPF: "The source funds include ALL PENALTIES COLLECTED FROM THE VIOLATING PARTICIPANTS (OTHER THAN SETTLEMENT VIOLATIONS) AND 1% OF THE TURNOVER FEE that is collected by the exchange from its members, OR A MINIMUM OF Rs 10 LAKHS (WHICHEVER IS HIGHER) IN A FINANCIAL YEAR."
The division is clean and worth memorising as a pair: settlement penalties feed the SGF; every other penalty feeds the IPF. The money follows the harm — a settlement failure threatens the settlement system, so its penalty reinforces the settlement buffer.
What each does:
SGF IPF Purpose "A BUFFER FOR ANY RESIDUAL RISK, operating LIKE AN INSURANCE MECHANISM", drawn on through a DEFAULT WATERFALL when a member fails to settle "INITIATIVES OF INVESTOR EDUCATION AND AWARENESS", and to "PAY THE CLAIM OF CLIENTS OR INVESTORS IN THE CASE OF DEFAULT BY A MEMBER where dues exceed margins deposited" Administration Held with the clearing corporation ⚠️ Administered by a TRUST meeting SEBI norms Minimum ⚠️ Rs 10 CRORE minimum required corpus (MRC) for the commodity derivatives segment ⚠️ Rs 10 LAKH minimum annual funding Note the recent flexibility on the SGF: excess contributions "may be returned to the contributing stakeholders on a PRO-RATA BASIS, SUBJECT TO PRIOR APPROVAL OF SEBI", and SEBI "may grant EXEMPTIONS OR RELAXATIONS... ON A CASE TO CASE BASIS."
2.In the clearing and settlement of commodity derivatives, how are the transfer of commodity ownership and the fund obligations handled?
- a)Both are netted at the client level and then netted again across members at exchange level
- b)Commodity transfers are netted at member level, while fund obligations are settled gross at client level
- c)Commodity transfers are settled on DVP by netting at the client level and grossing up at the member level, while fund obligations are netted at the member level
- d)Both are settled gross, trade by trade, with no netting at any level
Show the answer
Answer: (c) Commodity transfers are settled on DVP by netting at the client level and grossing up at the member level, while fund obligations are netted at the member level
The workbook's words: "Transactions involving transfer of ownership of commodities are settled on DELIVERY-VERSUS-PAYMENT (DVP) basis by NETTING AT A CLIENT LEVEL AND GROSSING UP AT THE MEMBER LEVEL, whereas FUND OBLIGATIONS ARE NETTED AT THE MEMBER LEVEL to reduce the number of settlement transactions as part of the clearing process." So option (c) is right.
Why the two are treated differently: goods belong to a particular client. One client's delivery cannot cancel out another client's receipt, so goods are netted per client and then added up (grossed) for the member. Money is interchangeable, so the member's fund obligation can be netted across all its clients. That reduces the number of payments.
Why the others are wrong: (a) nets goods across members, which would mix up different owners' goods. (b) swaps the two treatments. (d) ignores netting completely, although the workbook says netting is there "to reduce the number of settlement transactions."
Clearing vs settlement: clearing is "the process of accounting to update and reconcile obligations/payments". Settlement "involves matching the outstanding buy and sell instructions, by transferring the commodities ownership against funds between buyer and seller AT THE EXPIRY of the contract."
3.How is the Final Settlement Price of a commodity index futures contract determined on its expiry day?
- a)It is the index value at 11:30 PM based on the last traded prices of the constituents
- b)It is the average of polled spot prices of the constituents over the last three days
- c)It is determined after 5:00 PM, from the index calculated on the volume weighted average traded price of the constituents' futures contracts during 4:00 PM to 5:00 PM on the expiry date
- d)It is the previous day's Daily Settlement Price of the index futures
Show the answer
Answer: (c) It is determined after 5:00 PM, from the index calculated on the volume weighted average traded price of the constituents' futures contracts during 4:00 PM to 5:00 PM on the expiry date
The workbook's words: "On Expiry day of Index Futures, FINAL SETTLEMENT PRICE (FSP) OF INDEX IS DETERMINED AFTER 5:00 PM. It is based on index calculation on VOLUME WEIGHTED AVERAGE TRADED PRICE OF CONSTITUENTS' FUTURE CONTRACTS DURING 4:00 PM TO 5:00 PM on the expiry date." So option (c) is right.
How it is then used: "The DIFFERENCE BETWEEN PREVIOUS DAY'S DSP OF INDEX FUTURES AND FSP is used to do CASH SETTLEMENT ON THE NEXT DAY MORNING."
Why the others are wrong:
- (a) invents a late-night fixing based on last traded prices.
- (b) is the FSP method for Options on Goods, which uses spot prices from the last three days (E, E-1, E-2). The index FSP uses the constituents' futures prices.
- (d) The previous day's DSP is the starting point for the final cash settlement, not the FSP.
Index futures in brief: they are "like any other normal Futures with THE ONLY SETTLEMENT OPTION OF CASH SETTLEMENT". Before expiry, initial margin (from both buyers and sellers) and daily MTM are collected. Being cash settled, they have no delivery period margin.
Where this is taught
Free preparation for NISM Series IVRelated terms
- Final Settlement PriceThe price at which a commodity derivative is finally settled at expiry — a simple average of the polled spot prices of the expiry day and the two days before it.
- ClearingThe daily accounting step that reconciles what every party owes and is owed on its open and closed positions, and turns a day of trades into one net obligation per member.
- Both optionsA commodity futures settlement type in which physical delivery happens only if both the buyer and seller agree to it — if either declines, the open position is cash-settled at the Due Date Rate instead.
- Compulsory deliveryA delivery logic under which every position still open at expiry must give or take physical delivery — neither side can elect to settle in cash.
- Net obligation reportThe end-of-day report giving a trading member's net obligation, margin deposit, margin utilised, available deposit, the pay-in or pay-out required and the transaction fee payable or receivable.
- Staggered delivery periodThe window before expiry in which buyers and sellers holding open positions may mark an intention to give or take delivery, spreading deliveries out instead of stacking them on expiry day.
- Settlement cycleThe time window, fixed by the exchange, within which securities and funds for a trade must be delivered — T+1 in Indian secondary markets since 27 January 2023, meaning one trading day after the trade.
- Principal riskThe risk of having paid or delivered without receiving the other side — the settlement half of counterparty risk, eliminated by a central counterparty acting through novation.