Investments, however simple they might seem, always require a certain amount of due diligence - be it in understanding where you put your money, how the investment goes through or what is the return on investment you can expect. It's imperative that you as an investor know these details, for your own illustration and knowledge - thereby negating dishonest third party agents and brokers who can take you for a ride. BondsKart advocates for clarity and transparency of investment decisions and on that note, today we shed light on the process of Clearing and Settlement of Corporate Bonds.

To put it quite simply - the process of clearing and settlement of corporate bonds functions exactly as their name suggests - establishing the chronology of the transaction and then settling the transaction between all the concerned parties. These systems are designed to maintain a record of every bond transaction and to reduce the risk of non-payment, defaulting and fraud.

The system of clearing and settlement differs from country to country - adapted to suit its local market and economy the best, but in its essence, its functionality remains the same, which is manually matching a buyer to their seller, while documenting the agreed-upon terms of the transaction. These documents are legally binding and the transaction falls through if any of the involved parties fail to comply, eliminating the possibility of fraud right at the beginning of finalizing the trade.

The process is broadly broken down into three segments: a) Pre-settlement b) Settlement Activity and c) Post - Settlement.

From this point on in the article, we endeavour to break down the clearing and settlement process, walking you through every step - leaving very little room for ambiguity and misinformation.

ALL THE PARTIES PRIVY TO THE CLEARING & SETTLEMENT PROCESS

Just as it is important to understand the chronology of events in the process of settling corporate bonds, an investor must know who all they must come in contact with - for their transaction to go through. This will also help an investor determine whether they’d like to make the trade with the help of a third-party custodian or by themselves alone. The following are the participants involved in making a settlement:

• Depositaries: the body which maintains bond records in a dematerialized format
• Custodians: Custodians are clearing members but not trading members. They settle trades on behalf of their clients that are executed through other trading members. This could often be a bank on an investor’s behest.
• Clearing House, which in this case is almost always the National Securities Clearing Corporation Limited (NSCCL)

As participants agree to use the services of the NSCCL, they also inherently agree to certain terms and conditions, some of the important ones being:

• NSCCL does not guarantee the performance of the transactions settled by it. Performance of the transactions shall be the sole responsibility of the respective parties and NSCCL is not a counterparty to any transaction settled by it.
• NSCCL shall hold the securities or funds deposited by the Participant as a trustee.

BREAKING DOWN THE PROCESS: A - Z OF THE SETTLING CORPORATE BONDS

For the purposes of posterity and to maintain records, both sellers and buyers must fill up an annexure that allows the NSCCL to step in and carry out the transaction on their behalf. The format looks a little like this:

Pre-Settlement Activities: In this phase, all participants will be involved in updating the accounts of the trading parties and arranging for the transfer of money and securities. There are 2 types of clearing: bilateral clearing and central clearing. In a bilateral clearing, the parties to the transaction undergo the steps legally necessary to settle the transaction. Central clearing uses a third party — usually a clearinghouse — to clear trades. The steps are as follows:

• Transactions reported on NSE-WDM, NSE website and FIMMDA are deemed ready for settlement.
• Participants should choose to settle through NSCCL through the front end.
• An alert confirming the same will be generated and sent to both participants.
• Participants may modify selected fields of the transactions. The confirmation for the same is sent to both participants about the modifications.
• The confirmation status will be reflected for each transaction like ‘Buyer confirmed’, ‘Seller confirmed’, ‘Unconfirmed’ and ‘Fully confirmed’. Only ‘Fully confirmed’ will be settled through NSCCL.

This is where the clearing process ends, and what begins from here is the settlement process.

Settlement Activities: At settlement, the buyer will complete his side of the transaction by making the necessary payments to the seller, and the seller will in turn transfer the securities purchased to the buyer. The settlement will be completed when the clearing corporation transfers ownership of the securities to the buyer and once the funds are transferred to the seller. The steps are as follows:

• NSCCL conducts active follow-up with obligated participants for funds and bonds in respect of transactions to be settled through NSCCL.
• On receipt of bonds an alert will be sent to sell and buy participants for confirmation of receipt of bonds in the NSCCL Beneficiary account.
• On receipt of funds an alert will be sent to buy and sell participants for confirmation of receipt of funds in NSCCL Bank account.
• On matching of the above the bonds and funds will be swapped to the respective participants and alerts for the same will be sent respectively.
• In case the transaction details do not match, an alert will be sent to the respective participants.
• If the confirmation from participants is not received by cut-off time then the respective deals shall be deemed to be cancelled.
• In case participants have opted for settlement through NSCCL, but both bonds and funds are not transferred to NSCCL Beneficiary A/c and NSCCL bank A/c respectively, the deal will be deemed to be cancelled.
• In case of a buyer transaction, if a participant has transferred his funds respective to its deal, but the counter participant has failed to deliver bonds, the transaction will be deemed to be cancelled.
• In case of seller transaction, if a participant has delivered bonds respective to its deal, but the counter participant has failed to pay the funds, the transaction will be deemed to be cancelled.
• In case of cancelled deals, the bonds or funds will be returned back to the respective participant.

This coherently surmises the settlement process for corporate bonds. NSCCL sends regular updates from its end that allows the participants to follow the settlement process and schedule. Following are the steps of the Post Settlement Activities:

• All the transaction during a day will be reported on the website
• All historical transactions will be provided to the participant by way of a report.

Settlement Schedule: NSE carries out the settlements of corporate bond trades between Monday to Friday for three settlement cycles viz., T+0, T+1 and T+2. The indicative cut-off timings for settlements are as under: