The ChoosaBroker Trading Academy
6.6. Clearing and Settlement Process
In a stock market transaction, there is always a buyer and a seller. When a person buys a certain quantity of shares, there can be a single or multiple traders who have sold those shares. This trade is settled only once the buyer receives the shares and the seller receives the money from the sale.
Let us try to understand in easy language how this complex operation unfolds.
CLEARING AND SETTLEMENT PROCESS IN STOCK MARKET
Any financial securities transaction on a regulated exchange involves three key phases. We will discuss each one of them in detail below.
- Send the order to the floor of the exchange
- Direct the order to a market maker
- Fill the order from the broker’s own inventory of stocks
- Route the order to an electronic communications network
- The name and quantity of the financial security being bought and sold
- The transaction price and date
- The identity of the buyer and the seller
Settlement is the actual exchange of money and securities between the parties engaged in a trade on the “settlement date.” The settlement date normally occurs two or three business days following the trade execution date to allow for certain processing steps to be completed, which, in turn, ensures higher efficiency of the system. As technology has advanced, the entire trade settlement process has become electronic, with the securities interests of participants being recorded by credit entries in accounts maintained against their names. Such a system removes the need for paperwork, permitting quicker settlement of trades. In the United States, securities settlements have been taking place two business days (T+2) following the trade day since September 2017. Thus, if a trade were to be executed on Monday, the official transfer of the securities to the buyer’s account and the cash to the seller’s account would happen on Wednesday. It is important for traders to note that the settlement cycle does not include weekends and public holidays.
The clearing and settlement of securities is quite a theoretical topic. But it is important that you understand the mechanics behind it. As an investor you need not actually worry about how the trades get cleared and settled as there are professional intermediaries to seamlessly carry out this function for you. However a lack of understanding of the process could leave a void in your knowledge base. For this precise reason, we have explored what goes on behind the scenes.