Trading and Settlement — how shares actually move

The one job everything else hangs off

Strip away everything else a depository does and one service remains: moving securities from one account to another when the account holder says so. Dematerialisation gets the shares in. Corporate actions add to them. But the daily work of a DP is transfer.

And here is the first rule, which surprises people. Both sides have to instruct. The seller tells his DP to deliver. The buyer tells his DP to receive. Nobody can push securities into your account without your say-so.

That would be exhausting if you had to do it every time, so the buyer is allowed a shortcut: a Standing Instruction (SI) given once, usually at account opening, which tells the DP "credit anything that arrives." If SI is not given, the transferee has to give a separate receipt instruction each time securities have to be received. In CDSL the same idea is called a Purchase waiver or Confirmation waiver.

Three reasons securities move

Securities are transferred between demat accounts for exactly three purposes:

1. An off-market transaction — a transaction between two accounts on mutually agreeable terms, done person-to-person, without going through the stock exchange mechanism
2. A transfer arising out of a trade executed on a stock exchange — a market transaction
3. A transfer arising out of transmission or account closure — covered in other chapters

This chapter is about the first two.

The Delivery Instruction Slip

A beneficiary account can be debited only if the beneficial owner has given a Delivery Instruction (DI) in the prescribed form — the Delivery Instruction Slip (DIS).

Requirements for a valid DIS:

• The form must clearly indicate whether it is an off-market trade or a market trade, by ticking the right box
• It must be complete in all respects
• All the holders, authorised signatories and POA holders of the account have to sign it
• If the debit is to happen on a future date, the account holder writes that date in the execution date field

Scanning of DIS

SEBI's Circular No. CIR/MRD/DP/01/2014 dated January 07, 2014 standardised the DIS and added a monitoring duty. DPs must scan the DIS and tag it to the correct DIS serial number while uploading the scanned image into the NSDL/CDSL system immediately, but not later than two days.

The depository sends the DP a report listing DIS that were used for transactions but whose scanned image was never uploaded. Failure to scan and upload within the prescribed time attracts a penalty as per a pre-defined penalty structure. These guidelines took effect from October 1, 2014.

Off-market settlement, step by step

Any trade that is cleared and settled without the participation of a clearing member or clearing corporation is an off-market trade. In practice this route carries large deals between institutions, trades among private parties, transfers between a client and a sub-broker, and large trades in debt instruments.

The flow:

1. The transferor submits a DIS with "off-market trade" ticked, specifying the execution date
2. The DP checks the form is complete and in order, then enters it in the DP system
3. The system generates an instruction ID, which the DP writes on the instruction slip for future reference
4. On the execution date the instruction runs. If the balance is adequate, that quantity is debited
5. If the balance is inadequate, the instruction waits for adequate balances till the end of the execution day
6. The transferee receives the credit automatically if SI was given; otherwise he must submit a Receipt Instruction (RI) form for every expected receipt

The money never touches the depository. Exchange of funds for off-market transactions is handled outside the depository system.

One difference between the two depositories

If the shortfall is made good during the day, the two depositories behave differently:

The outcome is identical when it fails. The difference is only in how quickly a late top-up gets picked up.

Consideration details — proving money changed hands

For all off-market transfers made for the reason "off market sale/purchase", capturing the consideration is not optional. DPs must mandatorily obtain the following payment details in the DIS from the client:

• Mode of payment — Cash, Cheque or Electronic payment
• Bank Account Number
• Date of payment
• Bank Name
• Branch Name
• Transferee Name
• Date of Issue / Transfer
• Cheque / Reference Number

Where the mode is cheque or electronic payment, the transferee's name, bank account number and bank name must be given, along with the transaction reference number for electronic payments or the cheque number for cheques.

The purpose is plain: an off-market transfer with no money trail is how benami transfers and unreported gifts used to happen.

OTP consent for off-market transfers

From an execution date of November 1, 2020, SEBI required the client's consent through a One Time Password (OTP) for all off-market transfers — both transfers within a depository and inter-depository transfers — out of the source client's demat account.

All off-market transfers are permitted only by execution of a physical DIS signed by the client himself, or by way of electronic DIS, with OTP consent on top.

In NSDL, on the execution date a link is generated and sent to the mobile number and e-mail id registered in the demat account. The client clicks it, authenticates, sees the pending instructions and confirms. Transactions awaiting this show the status "Pending for OTP Confirmation", and if the OTP confirmation is not completed by the end of day of the execution date, the transaction is rejected. Processing is also subject to payment of stamp duty as applicable.

One waiver exists. SEBI has waived the OTP requirement for the off-market transfer reason code "Implementation of Government / Regulatory Direction / Orders".

Adding the beneficiary first

SEBI added a second gate. Off-market transfers are allowed only if the buyer's demat account (the transferee) has been added as a "Beneficiary" under the seller's demat account (the transferor).

The seller submits a registration form to his DP in the format specified by the depositories, then authenticates the beneficiary details by providing an OTP. On successful verification the buyer's details are stored as a Beneficiary. This pre-requisite applies to all off-market reason codes available in the system.

Market settlement

A market trade is one that is settled through the participation of a Clearing Corporation or Clearing House (CC/CH). The securities still move by account transfer — the CC simply sits in the middle.

The classic four-step flow:

1. The seller gives a DI to his DP to move securities from his account to the broker's CM account
2. Securities move from the broker's account to the CC on a delivery-out instruction
3. On pay-out, securities move from the CC to the buying broker's account
4. The buying broker gives instructions and securities move to the buyer's account

Two shortcuts exist. If a broker gives the pay-out breakup of his clients to the CC/CH, pay-out securities are directly credited to the clients' accounts by the CC/CH, skipping step 4. And direct delivery of securities to clients can be effected by the CC, subject to completing the necessary procedures.

As always, the movement of funds takes place outside the depository system, and Unique Client Code (UCC) details are mandatory for settlement of market transactions.

The Block Mechanism

With effect from 1st August 2021 — under SEBI circular SEBI/HO/MIRSD/DOP/P/CIR/2021/595 dated July 16, 2021 — a seller BO can deliver securities directly to the CC of the exchange (BO Level pay-in) through the Block Mechanism, available in both CDSL and NSDL.

How it works: when the client intends to sell, the shares are blocked in the client's own demat account in favour of the Clearing Corporation. If the sale transaction is not executed, the shares continue to remain in the client's demat account and are unblocked at the end of the T day.

The point is to stop shares travelling out of the client's account for early pay-in and then travelling back if the trade never happened.

The clearing member account

Every broker of a stock exchange that offers settlement through a depository must open a clearing member account. These are popularly called the broker settlement account or broker pool account, and are identified by BOIDs / CM BP IDs.

Two things the exam likes:

• In addition to brokers, custodians registered with SEBI and approved by stock exchanges can open a clearing member account.
• If a broker deals in more than one stock exchange, he must have a separate set of CM accounts for each stock exchange.

The four descriptions that must go on a market DIS

Market type — stock exchanges offer different market segments, segmented by type of settlement or type of trade. Each segment is a market type in the depository system.

Settlement number — trading periods of each segment are identified by a settlement number. Every settlement number has a trade beginning day, trade-ending day, settlement pay-in day and settlement pay-out day. Exchanges divide a year into settlement periods and allot a number to each. All these days collectively are called the settlement calendar, and the depository system carries the full calendar for each exchange.

Clearing member — the BOID / CM BP ID of the CM account relevant to the exchange on which the trade was done.

Delivery deadline — see below.

The contract note or trade confirmation slip given by the broker carries the settlement details the client needs to fill in.

The deadline that clients actually miss

Exchanges set a deadline by which clearing members must deliver securities. A CM can only meet it if his clients delivered to him in time. So SEBI has advised DPs to instruct their clients to submit settlement instructions on T+1 — in physical form up to 4 p.m., and up to 6 p.m. in the case of electronic instructions — for pay-in of securities.

The workbook's own example: pay-in for trades executed on Monday will be on Wednesday. So clients must submit instructions to their Participants on Tuesday — by 4 p.m. physical, 6 p.m. electronic. And the client must submit the DIS to the DP before the DP's own acceptance deadline, which may be earlier still.

Pay-in and pay-out

Pay-in is the process of a broker or trading member submitting securities sold on behalf of his client to the CC of a stock exchange. All CMs must complete pay-in before the exchange's deadline.

• Selling clients move securities to the broker settlement account before the deadline
• Securities made available before the deadline are reported to the CC in a pay-in file
• If the seller client or CM cannot deliver within the pay-in deadline, the short deliveries are auctioned and purchased by the CC in an open auction. The difference in price is borne by the defaulter CM.

Pay-out is the CC transferring securities to the broker's CM account for the quantity purchased on behalf of clients. Pay-out time is also fixed by the settlement calendar.

• The CC credits the buying CM account immediately on pay-out
• The CM transfers securities from its CM settlement account to the buyers' accounts
• If the buying client is a sub-broker, that sub-broker transfers securities to the final client using the off-market route

Inter-settlement transfers

Inside a CM account, securities are always kept in a bucket of a specific market type and settlement number. A CM may need to shift securities from one market-type/settlement-number bucket to another from which pay-in is to be made. That movement is an inter-settlement transfer, and the Clearing Member gives the instruction — not the exchange, not the CC, not the depository.

Tracking what has arrived

A CM must track securities received for pay-in. Three sources:

1. Its clients — ask the selling clients whether they delivered
2. Its DP — ask what has landed in the CM settlement account
3. The internet — IDeAS of NSDL, and easi and easiest of CDSL

easi (Electronic Access to Securities Information) gives real-time holdings, instruction status, past transactions, printable statements, daily valuation of stocks and aggregate portfolio value. easiest (Electronic Access to Securities Information and Execution of Secured Transaction) goes further — it permits BOs and CMs to submit debit/credit transaction instructions for off-market, on-market, inter-depository and early pay-in transactions, plus freeze/unfreeze and pledge, unpledge and confiscation.

Automatic Delivery-out (NSDL)

In NSDL, delivery-out instructions moving securities from the CM Pool Account to the CM Delivery Account can be generated automatically by the Clearing Corporation, based on the net delivery obligations of its Clearing Members. The CC does this only for CMs who have authorised it, and generates the auto DOs around the time the delivery obligations are downloaded to the CMs.

Such CMs need not give delivery-out instruction forms to the Participants for those obligations. They learn of the auto DOs from CC downloads, the Auto DO Report from the DP, or the depository's internet facility.

Auto DOs are NOT generated in two cases:

• Irreversible Delivery-out (IDO) required for margin payment or exemption. If the IDO is given before the auto DO is generated, the CM must later instruct the Participant to cancel the corresponding auto DO and give a delivery-out form for the balance quantity. If the IDO is given after the auto DO, the auto DO must be cancelled first, and a form given for the balance quantity.
• Shifting of the CM Settlement Account from one Participant to another. Auto DOs are generated only for the CM Settlement Account designated to receive pay-out as of the date of generation — so during the shift, securities may be lying in both accounts. This point applies only to NSDL.

Three pay-in modes

Both depositories offer early pay-in, normal pay-in and auto pay-in.

Early pay-in is used to avail margin exemptions and other benefits, including Buy-back and Tender Offer transfers. The CC maintains separate early pay-in accounts for each CM. For margin exemption, the CM or BO can give early pay-in instructions from one day prior to the day of trading up to the pay-in day, or such time as the exchanges specify. Execution happens only if adequate balance is available. The BO may use the Block Mechanism instead. Note the hard rule: in Buyback and Tender Offer transactions, transfers from the BO account are permitted only to the respective CM's early pay-in account through the early pay-in mechanism.

Normal pay-in can be used by a CM — applicable only to BSE CMs; instructions from non-BSE CM accounts are not allowed — or by the seller BO, to deliver securities to the CC. Normal pay-in instructions can be given any time from the T day to the pay-in day till the pay-in time, even if no balance is available in the account.

• BSE pay-in: at pay-in time CDSL earmarks the balance to the extent of the quantity specified, and the accounts of the CM/BO are debited during pay-out time
• Non-BSE pay-in: at pay-in time the BO account is debited to the extent of the quantity entered and credited to the respective CM accounts; pay-in is then taken from the CM's settlement account

Auto pay-in is available to BSE CMs on written request to the CC (ICCL/NSCCL). The CM gives no pay-in instructions to his DP at all; securities are automatically considered for pay-in. Details can be viewed on the CDSL system from T+1 day afternoon, after the CC uploads them. Securities are earmarked in the designated CM account and debited at the time of pay-out.

A similar facility exists for NSE CMs on written request to NSCCL, with this reporting logic:

And note the default: for trades done on exchanges other than BSE, auto pay-in is the default option, where auto pay-in instructions are not generated by the CC. At the designated pay-in time the securities lying in the CM's account under the respective settlement pocket are automatically taken for pay-in.

CM-to-CM transfers

A CM may instruct its DP to debit its settlement/pool account and credit the settlement account of another CM in a prescribed format. The receiving CM gives a receipt instruction, or a standing instruction, to have its account credited. The DP must ensure the form is complete and the CM's signature is valid before executing.

Inter-depository transfer

Transfer of securities from an account in one depository to an account in another depository is an inter-depository transfer. The rules:

• Under the SEBI (Depositories and Participants) Regulations, 2018, both depositories must be inter-connected to enable it
• It can be done only for securities available for dematerialisation on both depositories
• The account at either end may be a clearing member account or a beneficiary account
• To debit, the CM or BO submits an "Inter-depository delivery instruction" form to its DP
• To credit, the standing instruction applies; if no SI was given, an "Inter-Depository Receipt Instruction" form is required
• Instructions for the day are exchanged online between the two depositories
• The deadline for DPs to verify and release inter-depository transfer delivery/receipt instructions is 9.30 p.m. on weekdays and 2.30 p.m. on Saturdays
• Effective December 21, 2020, in an inter-depository transfer from an NSDL account to a CDSL account where the receiving CDSL account is a CM account, only securities credited under the appropriate settlement id can be considered against the CM's settlement pay-in obligation

Interoperability

Under interoperability, a Clearing Member may choose to have a preferred Clearing Corporation. Trades executed on multiple exchanges can be consolidated into a single CC, and there is no strict one-to-one association of exchanges and CCs.

The plumbing runs through a Delivery Versus Payment (DvP) agent appointed by the interoperable CCs, responsible for settlement of obligations. The DvP agent maintains an exchange-wise separate pool account with each depository.

The sequence:

1. Once pay-in is complete at a CC, the CC submits a pay-out file to the respective pool accounts of the DvP agent, to the extent of interoperable securities receivable by CMs of other CCs
2. The DvP agent transfers those securities to the respective settlement accounts of the CCs
3. At the same time each CC receives pay-out into its settlement account from other pool accounts of the DvP agent
4. Once intra-settlement transfer between all CCs is complete, the CCs process a pay-out crediting securities to the client's account or the pool account of the TMs/CMs

Mutual fund units

Beneficial owners can use the same DIS book for securities as well as mutual fund units. There is no separate slip.

Buying through the exchange. Each AMC opens (a) a Principal Account and Pool Account for BSE, (b) a Clearing Member Account for NSE and other exchanges, and (c) an AMC Beneficiary Account — all with any CDSL DP, based on the CM ID allotted by the exchange. Eligible CMs enter purchase orders on the exchange platform. After the order entry deadline the order file goes to the AMC/RTA for validation. For valid orders, the AMC/RTA submits a Corporate Action file to CDSL for allotment of MF units in the AMC beneficiary account. The AMC then submits a DIS as "Normal Pay-in" quoting CM ID and Settlement ID. On pay-out, units are credited to the buyer's CM pool account, and the CM transfers them to the BO's demat account.

Redeeming through the exchange. The investor places the order through an eligible CM. The BO transfers units for pay-in with a DIS quoting Settlement ID and Settlement type. Units are debited from the BO account and credited to the CC/CH house account, then debited from there and credited to the AMC beneficiary account, from where they are redeemed. Two restrictions: the early pay-in facility is not applicable for settlement of mutual fund units, and part or insufficient balance of MF units is not considered for redemption or repurchase.

Redeeming through the DP directly. A BO can redeem units held in his demat account directly through the DP, without going through the stock exchange mechanism. SEBI requires that the AMFI/NISM certification and the SEBI code of conduct for mutual fund intermediaries apply to DPs who accept such requests, and the DP must send a copy of the AMFI/NISM certificate to CDSL for updation. The BO submits a Repurchase/Redemption Request Form to the DP.

• The DP must ensure the bank details are entered in the CDSL system — if they are not, the request may get rejected
• For the entire holding, the DP sets up the request with the quantity option "ALL", with no quantity typed in
• If a quantity is stated, the DP sets up that quantity; the Issuer/RTA may confirm up to that amount from the folio
• If an amount is stated, the RTA may confirm units up to or equivalent to that amount
• Payment is made to the BO by the AMC/RTA
• Modification is not allowed for a repurchase/redemption request

Clients' securities and the unpaid-securities pledge

The Securities Contracts (Regulation) Act, 1956 and the SEBI (Stock-Brokers) Regulations, 1992 require a stock broker to segregate the securities or moneys of the client and not use them for itself or for its other clients.

The mechanism that enforces this is worth learning as a timeline, because every step has a number:

Three more rules that go with it. The unpaid securities are sold in the market with the Unique Client Code (UCC) of the respective client, and any profit or loss on the sale is transferred to or adjusted from the respective client account. The TM/CM may invoke the pledge only against the delivery obligation of the client — on invocation the securities are blocked for early pay-in in the client's demat account, with a trail maintained in the TM/CM's client unpaid securities pledgee account, and the depositories verify the block details against the client-level obligation. And such unpaid securities pledged in the client's account are not considered for the margin obligations of the client.

Stamp duty

The Central Government amended the Indian Stamp Act, 1899 and notified the Indian Stamp (Collection of Stamp-Duty through Stock Exchanges, Clearing Corporations and Depositories) Rules, 2019, which came into force on July 1, 2020.

The aim was uniformity and affordability of stamp duty on securities across states — collection at one place by one agency (a stock exchange, a clearing corporation authorised by the exchange, or a depository), on one instrument, with subsequent disbursement of the duty collected to the respective states.

What a DP needs to know:

• Stamp duty is collected before execution of off-market transfers involving transfer of securities in the depository system
• It is collected from the transferor or pledgee itself, or through their DPs, before executing off-market or pledge-invocation transactions
• It is calculated and collected on the "Consideration Amount" captured in the depository system from the consideration details on the DIS
• The consideration amount can be captured for all types of off-market transfers, including inter-depository transfers. In NSDL, where no consideration is involved, there is an option to select the flag "Without Consideration"
• The rate is governed by Schedule I of the Principal Act. Three categories are defined: "Debenture", "Government Securities" and "Securities other than Debenture"
• Stamp duty is not applicable on Government Securities
• The depository does not collect stamp duty for the State of Sikkim