Settlement and clearing are two important processes in the derivatives market in India. They are essential for ensuring the smooth functioning of the market and reducing counterparty risks. Here is a detailed explanation of the settlement and clearing processes in derivatives in India:
Settlement: Settlement is the process by which the obligations of a derivatives contract are discharged. It involves the exchange of cash or the underlying asset, depending on the type of contract. In India, there are two types of settlement processes used for derivatives contracts: cash settlement and physical settlement.
Cash settlement: In cash settlement, the difference between the contract price and the settlement price is settled in cash. For example, if a buyer purchases a futures contract for Rs. 1,000 and the settlement price is Rs. 1,100, then the seller would pay the buyer Rs. 100 on the settlement date.
Physical settlement: In physical settlement, the underlying asset is delivered to the buyer at the settlement date. For example, if a buyer purchases a futures contract for 1,000 shares of a company and the settlement date arrives, the seller would deliver the 1,000 shares to the buyer.
Clearing: Clearing is the process by which the counterparty risks associated with derivatives contracts are minimized. It involves the use of a central counterparty (CCP) that acts as an intermediary between the buyer and seller. The CCP ensures that both parties meet their obligations and that the transaction is completed smoothly.
In India, the clearing process for derivatives contracts is carried out by two organizations: National Securities Clearing Corporation Limited (NSCCL) and Indian Clearing Corporation Limited (ICCL).
NSCCL: NSCCL is the clearing corporation for equity derivatives traded on the National Stock Exchange of India (NSE). It provides a range of services, including risk management, settlement, and collateral management.
ICCL: ICCL is the clearing corporation for commodity derivatives traded on the Multi Commodity Exchange of India (MCX). It provides similar services as NSCCL.
Overall, settlement and clearing are critical processes in the derivatives market in India. They help to minimize counterparty risks and ensure that transactions are completed smoothly. Understanding these processes is essential for anyone interested in participating in the derivatives market.