Capital, Commodity and Money Market Settlement System
Settlement System
The settlement means netting of transactions. It actually reflects exchange or delivery of against the agreed amount of money. It is a system that allows/permits the holding and transfer of securities against the agreed sum of money and this is called netting off the transaction.
There are 2 types of Settlement Systems:
- Accounting Period Settlement System; and
- Rolling Settlement also referred as T+2 rolling settlement
Accounting period settlement system is not used nowadays i.e. all the transactions are generally settled using Rolling Settlement System only.
- Accounting Period Settlement System :
It is a traditional method of settlement of transactions. As per this method the Sock market functions by clubbing the trades into preset periods. For example Monday to Friday on Bombay Stock exchange (BSE). This system encourages liquidity i.e. entering into transactions of buying and selling the securities without having to pay the actual money on an immediate basis. The transaction is settled on a net basis. But this system is not a favorable one because it takes a longer time period to settle the transaction which makes it a riskier system of settlement.
- Rolling Settlement :
Since the accounting period settlement system had risks hence, a new settlement system was introduced by SEBI called Rolling Settlement System. It had less risk i.e. if one share is bought today, then the settlement process starts at the end of the day. However, when the Rolling Settlement system was first introduced, there was a sudden fall in the liquidity of stocks.
Each trading day is a trading period. In the Rolling Settlement System, the trades done on a particular day are settled on a given number of business days instead of settling of all the transactions done during a week on a weekly or fortnightly basis. Transactions done on a day are to be settled on a net basis for the day i.e. for the one trading period.
Advantages of Rolling Settlement System :
- Since in the rolling settlement the transactions are settled earlier than the accounting period settlement, the settlement risk is lower. In this trades done on a particular day are to be settled separately from the trades done on the next day.
- It reduces speculation and arbitrage in scripts as settlement occurs on a daily basis. Thus, there would be an increase in delivery based transactions reducing the speculation.
- It reduces pricing glitches and manipulation and explores a better price discovery process.
- It reduces the end of settlement period pressure as shares are delivered and cash is paid every day.
- It narrows the bid-ask spread, reduces the settlement risk.
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